Category: Stock

Three benefits of a Separately Managed Account

A Separately Managed Account (SMA) is an investment account managed by a professional investment manager that can be used as an alternative to a mutual fund.  They provide diversification and professional management.  But they differ from mutual funds in that an SMA investor owns individual stocks instead shares in a fund.

Here are some of the benefits of SMAs.

  • Customization: Investors in SMAs can usually exclude certain stocks from their portfolio.  They may have an aversion to certain stocks, such as tobacco or alcohol.  Or they may have legal restrictions on owning certain stocks.  SMAs allow some customization that’s not available in mutual funds.
  • Taxes: Investors in SMAs can take advantage of tax loss harvesting at the end of the year by instructing a manager to sell certain stocks to reduce capital gains taxes. In addition, an SMA has another advantage over mutual funds in that each stock in an SMA is purchased separately.  Mutual fund investors are liable for “embedded capital gains” even if the shares were purchased before the investor bought the fund shares.
  • Transparency: You know exactly what you own and can see whenever a change is made in your account.  Mutual fund investors don’t see the individual securities they own or what changes are being made by the portfolio manager.

These are features that are attractive to certain investors.  However, they are not for everyone.  Most SMAs require minimum investments of $100,000.  That means that they are only appropriate for high net worth investors who will typically use several SMA managers for purposes of diversification.  In addition, the fees associated with SMAs are often higher than fees for mutual funds.

For more information, please contact us.

"Will a Stock Market Drop Affect My Dividend Payments?"

We got this question from a client of ours earlier this week in response to the stock market’s wild market ride.  It is a great question!
The quick and easy answer is “No, it shouldn’t.”  And we could pretty much stop right there.  But if you know us, you know we love to get into the explanation!  So here it goes…
Let’s go back to the very start, with “What is a dividend?”  A dividend is a payment of a portion of a company’s earnings distributed to the company’s shareholders.  Dividends typically are paid in cash, and the company’s board of directors decides the amount distributed.
Now the next question would be, “What causes a company to raise or lower their dividend?”  The answer is cash flow.  It all comes down to earnings and profitability and how much money the company has remaining after paying for all the things that keep it running, such as salaries, research and development, marketing, etc.  After those expenses and the dividend payment, the remaining profits go back into the company.
When a company pays a dividend, their board is essentially deciding that reinvesting all of the company’s profits to achieve further growth will not offer the shareholders as high a return as a dividend distribution.  That said, companies offer a dividend as extra enticement for investors to buy their stock.  Moreover, a steadily increasing dividend payout is an indication of a successful company.
Therefore, it stands to reason that a company’s steady or increasing profitability will typically lead to steady or increasing dividend rates, and a decline in profitability will lead to that company reducing or eliminating their dividends.  Most U.S. companies are loathe to reduce their dividend rates because it signals to investors that their profits are lagging, which results in their stock price getting pummeled.  And that is not a good thing for their company’s board or management.
The final long-winded answer: You will often see companies cut their dividends when there is a severe economic crash, but not in reaction to a market correction.  Since dividends are not a function of stock price, market fluctuations and stock price fluctuations on their own do not affect a company’s dividend payments.
If you have a question, feel free to send it our way!
(Here is an interesting tidbit: the term “dividend” comes from the Latin word dividendum, which means “thing to be divided.”  With a dividend, companies are dividing their profits up among shareholders.)

Are You an "Affluent Worker?"

Forbes magazine recently had an article about some of our favorite clients. They call them the “High Net Worker.” These are people who are successful mid-level executives in major businesses. They range in age from 40 to the early 60s. They earn from $200,000 per year and often more than $500,000. They work long hours and are good at their jobs.

According to the Forbes article, many have no plans to retire. Our experience is different; retirement is definitely an objective. But many have valuable skills and plan to begin a second career or consult after retiring from their current company.

At this time in their lives they have accumulated a fair amount of wealth, own a nice home in a good neighborhood, and may be getting stock options or deferred bonuses. That means that at this critical time in their lives, when they are focused on career and have little time for anything else, they have not done much in the way of financial planning.

When it comes to investing, most view themselves as conservative. But because of their compensation their investments are actually much riskier than they think. It is not unusual for executives of large corporations to have well over 50% of their net worth tied to their company’s stock. Few people realize the risks they are taking until something bad happens. For example, the industrial giant General Electric’s stock lost over 90% of its value over a nine year period ending in 2009. The stock of financial giant UBS dropped nearly 90% between May 2007 and February 2009. These companies survived. There are many household names, like General Motors and K-Mart whose shareholders lost everything.

The affluent worker’s family usually includes one or more children who are expected to go to college. Many of these families have a 529 college savings plan for their children. Most have IRAs and contribute to their company’s 401k plan, but because many don’t have a financial planner they do not have a well thought out strategy for this part of their portfolio.

At a time when many less affluent families are downsizing, many families in this category are either looking to upgrade their homes, buy a bigger home, or buy a second – vacation – home. They may even help their adult children with down-payments.

If you are an Affluent Worker, give us a call and see what we can do for you. If you already have a financial advisor, it may be time to get a second opinion.

How do you get income with interest rates as low as they are?

I was reminded recently how low interest rates were when I downloaded my investment account activity into Quicken. Each account with a money market balance received a few pennies worth of interest, not enough to buy a cup of coffee. Certainly not enough to buy a Happy Meal. The average money market fund yields 0.02%. Every $1,000 investment will give you 20 cents in a year. And that’s before taxes. You could make more money collecting bottles at the side of the road.

There are some alternatives. One way is to invest for growth and forget about income. You can always spend some of the growth when you need the money.

But for those who want to see income flowing into their accounts, there’s always the “Dogs of the Dow.” The “Dogs” are members of the 30 Dow Jones industrial average with the highest dividend yields. This may be the result of a drop in prices, hence the name. For example, two of the highest yielding stocks in the DJIA are oil stocks which have declined in price even as they increased their dividends.

The current yield on the “Dogs” portfolio is over 3.5% and last year the total return (dividends plus capital appreciation) was over 10%. For more information on this strategy, contact us.

Financial tips for corporate executives

The December 2014 issue of Financial Planning magazine had an article about “Strategies for Wealthy Execs.” It begins:

Just because your clients are successful executives doesn’t mean they understand their own finances.

And that’s true. Successful executives are good at running businesses or giant corporations. But that does not make them experts in personal finance.

One of the ways executives are compensated is with stock options. But options must be exercised or they will expire. Yet 11% of in-the-money stock options are allowed to expire each year. That’s usually because they don’t pay attention to their stock option statements.

Executives usually end up with concentrated positions in their company’s stock. Prudence requires that everyone, especially including corporate executives, have to be properly diversified. Their shares may be restricted and can only be sold under the SEC’s Rule 144. To prevent charges of insider trading, many executives sell their company stock under Rule 10b5-1.

An additional consideration for executives is charitable giving. Higher income and capital gains tax rates make it beneficial for richer executives to set up donor-advised funds, charitable lead trusts, charitable remainder trusts, or family foundations.

For more information on these strategies, consult a knowledgeable financial planner.

What is the purpose of a stock market?

Before there was a stock market, there were stock companies.

A stock company allows individuals to pool their money to create an organization to operate and grow.  Stock is used to determine how much a person owns of a company.  Owning a stock does not necessarily create wealth.  Wealth creation can only occur if the stock can be sold to someone else who is willing to pay you more for it than what you originally paid.  This led to the creation of a market for people who owned shares in stock companies.

A stock market has two functions.  First, it allows the owners of stock to sell their ownership interest easily and quickly.  Second, it also allows people who would like to be owners to buy an ownership interest quickly and easily.  Now even people who do not have substantial financial resources can participate in the growth in value of large enterprises.

For example, the founders of Apple were able to raise money for their company by selling their shares of Apple stock to people who were willing to bet that the company would be successful.  That was 1976.  In 1980 the shares of Apple were first allowed to be publicly traded.  As a result, the founding shareholders were able to profit from their original investment and the company itself raised millions of dollars that it could invest in growth.  It also allowed people who did not personally know the founders to become partial owners and benefit from the company’s growth.  The stock market allowed people who believed in Apple computers to bet on the company’s future, and also provided them with a ready market for their shares if they needed to sell or decided they no longer believed in the company’s future.

The bottom line is that the stock market creates liquidity.  Without liquidity it becomes much harder for a company to raise the capital it needs to grow in a modern economy.

Two Views of GE

General Electric is one of the most widely owned stocks in the world.  And as a GE alumnus we are often asked about it.  At present there are two main schools of thought about GE and it’s outlook over the next year.

The bullish case argues that General Electric still has many growth opportunities, especially considering its $223B order backlog. Six out of seven of General Electric’s business segments posted earnings growth in Q2 compared to last year, with three seeing double-digit growth.  In addition, GE is one of the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), with a dividend yield of over 3{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.

The neutral case is made Goldman Sachs:

“Our view is based on limited upside to 2013/2014 EPS coupled with a balanced risk/reward at this time. Specifically, we believe the 2013 margin targets are aggressive and a lower asset base at Capital will weigh on 2014 growth. Over the long term, we like GE’s position in attractive markets, simplification efforts and actions since the global financial crisis to make Capital stronger/safer. However, while GE appears well on its way to achieving its ENI reduction targets, we believe more can be done to improve its returns/ growth profile, making it a more attractive investment longer-term,”

With a P/E ratio of over 17, our view is that GE has limited upside potential.  We see the likelihood of an announcement of a dividend increase in the 4th quarter.  GE still has a lot of restructuring in its future as it sheds more of its GE Capital businesses.  This stock is not for the impatient.

Passive investing vs. Active Investing

Comment from Oppenheimer Funds.

 Indexing clusters investment assets in securities which represent past success, are widely owned, and often fully valued.  Investing is about the future.  Good active investors are adept at uncovering future success.   Compounded over a long time horizons, the difference in so called “terminal wealth” can be very large between passive approaches, average active approaches, and above average active approaches.    

Translation: Most indexes, like the S&P 500, represent the best performing stocks of the past, not necessarily the best ones to own in the future.

What is an asset class?

Financial professionals constantly talk about asset classes, but what does that mean?  In the broadest sense, asset classes refer to a group of securities that have similar risk/return characteristics.  So, for example, in the broadest terms, stocks, bonds and cash represent the three most common asset classes.  Each has different risk and return characteristics and behave differently in response to a variety of economic and political events.  Stocks react most to corporate profitability, bonds to interest rates and cash to inflation.     That does not mean that these are the only issues that these assets react to but they are the predominant ones.

Most managers divide these broad assets classes into subgroups that act differently at different times.  Stocks, for example, can be divided into large cap, small cap, foreign or domestic.  Bonds can be subdivided into government, agency, municipal, corporate, foreign or domestic.  These classes can be divided again into their own subgroups.   The challenge for the investor is to find ways of participating in these investments.  This is where the expertise of the professional investment advisor comes into play.

Why is this important?  Because investment management is often about risk control and this is often achieved by balancing various assets classes to achieve the degree of risk to which a portfolio is subjected.  Modern portfolio theory demonstrates that investment with low correlation to the rest of the portfolio can lower over-all volatility even if the underlying investment itself is volatile.

 

What is an IPO?

An “IPO” or “initial public offering” is the first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded.

An example if the recent offering to the public of the common stock of Facebook.  This company was private until it decided to offer it shares to the general public and allow itself to be traded on a major exchange.  From Investopedia.

In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), the best offering price and the time to bring it to market.

The benefit to the founders of the company is that it gives them the ability to sell part of their stake in the company to the public, often making them millionaires or even billionaires overnight.   It also provides the company with much more capital than it previously had for purposes of expansion and growth.

The benefit to the public is their ability to participate in the company’s growth alongside the founding shareholders.

IPOs should be viewed with a great deal of caution.

IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, which are subject to additional uncertainty regarding their future values.

Investors in the IPO of Facebook found this out when the excitement and hype surrounding its initial offering resulted in such a demand for the stock that people were willing to pay much more for the stock than was warranted.

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