Beachside Resident #8 Mutual Funds Supplemental

In the January issue, we built a portfolio using index funds but did not stop to explain. For our purposes, a fund is a collection of investments. They come in a variety of styles but we will focus on the two most common: open end mutual funds and exchange traded funds (ETFs). An index fund is one that invests in the same components of an index, like the S&P 500 for example.

Let’s set ETFs aside for now and look at mutual funds. A mutual fund is a pool of money that is managed by a fund manager. Shares of the fund are bought directly from the fund. When sold, they’re sold directly back to the fund. The shares are valued every day at the close based on the investments held to determine the price per share. The share price is called NAV or Net Asset Value. This is the price the shares can be sold for. It the fund is a no load fund, they can be bought for that same price. If a fund has a load (commission), it will show a POP price. Discount brokers will say there’s no statistical evidence that paying the load leads to better results so why pay the fee? Advisors who sell loaded funds will have a different story.

All funds will have an annual charge that’s used to pay management fees called an expense ratio. A fund’s focus is supposed to be evident in its name. If a fund is managed to play the market it will have higher fees. Sometimes these funds beat the indices and sometimes they don’t. Comparing their return of the last 5 and 10 years is a good indication but doesn’t guarantee anything. One of the advantages of using index funds is the lower fees. Index funds won’t outperform or underperform the market. They are the market.

For the portfolio we built, the index funds are easy and straight forward. The name of the fund should clearly describe its focus. For the more adventurous, managed funds come in a variety of flavors that can focus on a specific industry and/or theme. Some funds will use derivatives to magnify the markets. Stick with the index funds. They’ll get you there with much less drama.

Market risk is everywhere. It can be diluted with diversification.

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Beachside Resident #7 Taxes

I hate tax season but, it’s here so let’s cover some tax issues. First and foremost, consult with a tax specialist to save headaches in the future. The laws constantly change and you never know what you don’t know.

At age 59 1/2, we can begin taking distributions from our IRAs without penalty. The general idea is to not draw money out but rather leave it invested to grow. When you do take money out, you will be taxed at your current tax rate. If you take it out before 59 1/2, there’s a 10% penalty so unless it’s an emergency, don’t do it.

At age 70 1/2, we’re required to begin taking distributions. The annual amount is based on age and size of the account. Most brokerage firms calculate this automatically and it should be posted on their website. It’s commonly referred to as RMD (required minimum distribution).

Inheriting an IRA requires extra care. If the IRA came from your spouse, you can simply take the account assets right into your own and the distribution ages listed above will apply. If the IRA is from anyone other than a spouse, it should be transferred into an Inherited IRA and kept separate from other accounts. Regardless of age, the IRS wants distributions to begin soon. Get help with this as there are different ways to play.

Beyond IRAs we have taxable brokerage accounts. The big taxable issues are interest, dividends and capital gains. For the capital gains, simply find the difference of the price paid and the price sold. Again, most brokerage firms will have this information and provide it to you on a form called a 1099. If an investment is inherited the original cost is hardly ever found so look into something called Step-Up cost basis. It will save you money.

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Beachside Resident #6 Real Estate

This is the real estate issue so let’s consider it as a piece of the investment mix. It requires more active management than most of your other investments. Don’t overextend on a mortgage. A conservative approach is best. The economy and markets will cycle around and wash out those not prepared.

Most people think they’re buying a house when in fact, they’re buying the land and any “improvements” on it. Improvements might be a house (coincidence), a garage, a dock, etc. It might seem like I’m splitting hairs but improvements are temporary while the land is permanent and defined by the boundaries of the property.

There are many rights that come with land ownership. The right to occupy, the right to rent, the right to dig and all the water/mineral rights. The list goes on (subject to local laws). Property lines extend down to the center of the earth and up into the sky. Aircraft have the right to fly over so forget about charging a toll for passing through your airspace.

The first real estate investment for most of us is our home. Mortgages come with a variety of choices. The monthly payments for a 15 year loan are not twice that of a 30 year loan. If the higher payment is workable, it will save a ton of interest over time. Read the fine print. Avoid variable rates and balloon payments.

Beyond personal residence is income property and here the sky is the limit. For example, if the kids are off to college and you help with the rent, why not buy a large home near the school and have them rent out rooms? A valuable lesson in property management is one of many benefits. Homes in these areas are constantly bought and sold as students pass through and there are always renters looking for a room. When graduation finally comes after 10 years the home can be sold (maybe) for a profit. The one downside to investing in college properties is that college renters tend to be a little rough on the property so remember the three little pigs and buy something sturdy.

Another way to invest in real estate is the stock market. Specialized mutual funds, ETFs, REITs and others offer a way to benefit from a rising real estate market without having to manage it. Naturally, results will vary and the management still needs to be done but that’s all factored in and paid for before they produce results.

Real estate is a nice addition to any investment portfolio. Because of the complexities of ownership, do not cut corners. Insist on a lease, credit check, and a deposit. Always use professionals. Realtors, tax specialists and attorneys can help prevent headaches down the road.

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Beachside Resident #5 Portfolio Theory

In the spirit of the new year, let’s build an investment portfolio. Normally, this would be the in the final chapter but, we muscled through financial basics. Time to have some fun. Later, we’ll dive into more advanced trading techniques and then circle back to answer questions and clarify.

You already have investments. Real estate, art, jewelry, and anything else of value. We’re going to focus on the stock market. Most advisors will follow the asset allocation models that have been around for years.

The theme is stable diversification. Imagine your portfolio as a pie. The primary ingredients are Large Cap, Medium Cap, Small Cap, International, and Fixed Income. In other words, big companies, medium companies, small ones and foreign stock as well as bonds and cash. Unlike a pie, which has specific amounts of each ingredient, your proportions will depend on your specific situation and risk tolerance.

A well balanced portfolio will be surprisingly stable. As some investments go up, others go down. The overall direction should be upward but they won’t all run together. Sticking with the theme of diversification, each segment listed above should have more than one or two stocks. How to pick you ask? It’s very easy. In prior months we discussed indexes such as the S&P 500 and the Dow Jones Industrials. The S&P 500 is a perfect example of a large cap index. There are dozens of indexes and they come in all shapes and flavors.

Mutual Funds and ETFs are the easiest way to invest in these indexes. If you have an online broker, you can search for them using their screening tools. Simply screen for a Large Cap Index fund. If you decide your portfolio will be equally weighted, then put 20% in that fund and do the same thing with each of the others.

If you don’t want equal weights, you can make the portfolio more conservative by overloading on the Fixed Income section. If you want the portfolio to be more aggressive, overweight the stock side. The exact mix is up to you. No one can predict the future or the market. Anyone who tells you they can is trying to sell you something.

Be careful if you overweight fixed income. When interest rates rise, bond prices will fall. I’ll explain why when we talk bonds.

So there you go. The bottom line is diversification. It provides opportunity and stability to any portfolio. The market is emotional with wild fluctuations. Ignore the waves and the tides. Ride the current. Focusing on the long term is better than trying to time the market.

Happy New Year

Beachside Resident #4 Dividends

Fun fact: 73.6% of all statistics are made up. My point is, don’t let the numbers and the math throw you. I’m providing some terminology and background for a better understanding of how the market works. Whether you manage your own account or use an advisor, knowing the game will make you a better player. Ask questions. Be curious.

We’ve covered the origins of the stock market and how stock is created. Market Cap, Earnings, P/E ratios explained some of the basic terms to measure a company. These are commonly found on your brokers website. The good ones will even provide official definitions.

Dividends are another biggie. In Finance 101 we learned that the primary goal of every company is to maximize shareholder wealth. If a company is losing money, their goal is to stop the bleeding and turn around. If the company is profitable, decisions are made as to how to spend that money. If they can invest in research or expansion to help the firm grow, they’ll crunch numbers to justify the decision and move forward. If they’ve grown all they can and the money is flowing in, they’ll give it to the owners in the form of a dividend.

Companies with a strong history of dividends are prized by investors. This is especially true when interest rates are low. Traditionally, retired investors relied on interest on their savings to provide a little extra income and kept their money safe in cd’s and government bonds. As low as today’s rates are, many retirees are choosing to buy dividend yielding stocks. If this is you, please remember there’s market risk that should not be ignored. It can be minimized by diversification but it’s still there.

Dividend history is a quick look at the health of a company. If they pay the same dividend consistently, that’s a sign of strength. If they regularly increase the dividend, they’re growing and doing something right. Conversely, a decreased dividend can be a red flag for obvious reasons.

Dividend yield is the return on your investment. The yield depends on the price paid for the stock and the dividend paid. Today’s websites calculate it for you so don’t worry about the math.

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Merry Christmas!

Beachside Resident #3 Stock Basics


Early on, we covered the need for insurance and emergency funds before investing. A brief history of the stock market and the role your broker plays when you buy or sell set the stage for our various investment choices. Nearly everything roots back to stocks so it’s here we begin.

Stocks by themselves are far too risky. It’s so easy to diversify your portfolio with mutual funds and ETFs that we should only buy individual stock under special circumstances and in limited quantities.

Buying stock means you’re buying a piece of a company. The stock price is determined by supply and demand. If there is demand for shares, the price will go up. If sellers start dumping shares and there aren’t enough buyers, the stock price will fall.

The number of shares issued during the IPO is basically what trades every day. If you take that number and multiply it by the price per share, you get that companies’ total market capitalization. In the future, we’ll talk about large cap, medium and small cap stocks. It’s simply a fancy way to describe big, medium or small companies.

The price of a stock is based on future earnings expectations. If a company is coming out with new products that are big sellers, their stock price should be on the rise. If a company makes replacement parts for 8 track players well…you know.

Comparing a companies stock price to its earnings gives us a P/E ratio. Don’t be overly concerned with the math but the lower the P/E ratio, the better. It’s a good way to compare companies in similar industries. It wouldn’t make sense to compare a computer maker to a restaurant chain. The P/E ratio is only for companies with earnings. If a company loses money every year, they won’t have one.

Beachside Resident #2 Eliminating debt and stock defined

Last month, we established a starting point which included insurance and emergency funds before investing. Excessive debt should also be eliminated.

Monthly payments feel like you’re running in sand. Nearly impossible to get ahead of them, no? Assuming you can stay current on all payments, consider this easy way out. Arrange your debts by size. Focus on the debt with the smallest balance, pay more than the minimum due and pay it off first. Next, use the money used to pay on that loan and apply it to the next smallest balance and work your way up. If possible, stop buying on credit. Consider how much more you could buy if you didn’t have to pay the interest charges. That’s enough math for one day.

When you pay anything above your normal payments on a loan, clarify if you’re making extra payments or paying down the balance. The lender will lean towards counting it as extra payments. Your loan should pay off faster if you apply it to the balance.

So, what are stocks and where do they come from? Imagine the following scenario:     Joe and Mary make the best widgets in the world. Demand is strong but they can only make them so fast. They need to expand production but have already exhausted their life savings to get this far. They are willing to sell a portion of their company to raise funds so they can grow. Fast forward past all the regulatory crap (you’re welcome) and investment banks will bring their company public with an IPO or Initial Public Offering
Normally, investment bankers reserve the shares for their biggest customers. When those customers sell them, they are sold on a secondary market like the NYSE or Nasdaq. That’s where we can buy them.

The New York Stock Exchange was founded in 1792. Regional exchanges opened later and in 1971 Nasdaq opened. What does this mean? When we buy or sell securities, we place an order through our broker and they present that order to the market. It’s an efficient ongoing auction driven by supply and demand.

Next up, stock.

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Beachside Resident #1 Intro

This is the first in a series to discuss money: How to make, save, invest, whatever. Many times we’ll merely scratch the surface of a topic and that’s OK. Feel free to dig deeper on your own. No topic is off the table and I’ll try to answer questions as they come. I’ve seen people make the same avoidable mistakes over and over. My aim is to break that cycle.

I have no intention of offering advice. Rather, I hope to introduce some ideas and mindsets to help build and maximize your nest egg for retirement. My first finance professor at UCF used to say “Money isn’t everything but it’s way ahead of anything else in second place”. While this might be disturbing on several levels, it makes a point. Money makes life easier (and sometimes more complicated). Either way, let’s get started.

Before investing, most planners will tell you that we should all have life insurance and three months’ salary saved for emergency purposes. Anything less assumes some risk and that becomes a personal decision based on your own risk tolerance and personal situation. The younger you are, the more important this next part is…invest in your future by contributing to a 401k plan at work or IRA. Check with your tax preparer for eligibility. It takes a lot of discipline but pay yourself first. Thank me later.

Final thought, when going to the beach, protect your valuables. Manage your keys, money and jewelry. The people with metal detectors scanning beach are not looking for stuff they lost. They’re looking for stuff we lost.

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