Investing School

What is a 457 Plan and Who Qualifies for One?

Investing School — Wed, 16 May 2012 16:53:18 +0000

A 457 plan is a “non-qualified, deferred compensation plan” that allows employees to defer up to 100% of their income up to the permitted dollar amount per year. This means that any compensation placed into such a retirement account grows on a tax-deferred basis and is not taxed until the funds are distributed. As the investor is likely to be at retirement age at that time, taxes are likely to be much lower than they are when the account is funded, which can add up to significant tax savings.

This type of plan is made available to government employees and some types of non-governmental workers as well. Typically run in much the same fashion as a 403(b) or 401k, the main difference is the lack of penalty for early withdrawal. While individuals don’t face the 10% penalty associated with taking money from their account before the age of 59 ½, the funds are subject to normal income taxation. Another difference is that independent contractors can also participate in such plans; they can’t in 401(k)s or 403(b)s.

In recent years the limits on 457 plans have been brought into line with other retirement accounts. Contribution limits are now identical to those set on 401(k) accounts. However, qualified individuals can contribute to both types of plans at maximum levels.

The least common type of employee plan used, it has often been the “red headed stepchild” of retirement planning, but the simplification of the rules has made it more appealing to many employers. They remain the only non-qualified group plan which offers tax-deductible contributions.

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Understanding a 403 (b) Plan

Investing School — Mon, 14 May 2012 16:58:45 +0000

There are many different types of retirement plans but the 403 (b) is specifically designed for certain public school employees, people who work at tax-exempt organizations and self-employed religious leaders. These accounts are set up and maintained by individuals who qualify.

Employers may choose to contribute to such plans but that can complicate the legal requirements involved. Without such contributions the plan does not have the same technical challenges inherent in a 401 (k) and saves effort from an administrative perspective.

There are three types of 403 (b) plans a person may choose from:

A 403 (b) can be set up as an annuity contract provided by an insurance company. This sort of plan is also referred to as a TSA (tax-sheltered annuity) or a TDA (tax-deferred annuity).
The 403 (b) can be set up as a custodial account which is provided through a retirement account custodian. Investments in such accounts are restricted to such funds as mutual funds which are regulated.
The final option is a retirement income account which allows investment in both annuities and mutual funds.

Employers may restrict which financial institutions are used to maintain the account and that can help determine how the 403 (b) will be established. For the employees there are certain advantages of initiating such an account: decreased taxable income, tax free income and the odds that they will pay less tax on the assets when disbursed during retirement.

Like other retirement accounts, the 403 (b) can be used to fund short term loans if necessary.

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What is Return on Equity (ROE)?

Investing School — Fri, 11 May 2012 16:39:38 +0000

Unlike the more commonly known term Return on Investment, Return on Equity (ROE) defines the amount of net income that is returned as a percentage of a shareholder’s equity. You might also see the term Return on Net Worth (RONW) used interchangeably. This tool is used to measure the profitability of a company by displaying just how much profit the company generates from the funds that shareholders have invested.

ROE is defined as a percentage which is calculated by the formula:

Return on Equity = Net Income/Shareholder’s Equity

The full year’s net income is used, before common stock holders are paid their dividends, but after the dividends of preferred stock are paid out.

Using ROE is useful if you want to compare the profitability of more than one company in the same line of work. Additionally, by looking at changes in ROE over time an investor my get a better idea of how the company’s profitability changes in certain market conditions. Furthermore, just because a company has a high ROE yield doesn’t mean it is of benefit to the investor. In fact, chances are they will end up paying more for the stock without a commensurate gain down the line.

Where a good return on equity does help is that the earnings are reinvested in companies which have high ROE rates. That results in better growth for the company which may provide better dividends for the investor. If the earnings are not being reinvested, knowing the ROE may be irrelevant. Finally, consider that return on equity (ROE) numbers are just as easily manipulated by the company as any other such figures and other tools should be used in conjunction with ROE to determine a wise investment.

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The Purpose of a Lifecycle Fund

Investing School — Wed, 09 May 2012 15:54:21 +0000

There are all sorts of ways to invest over the years. For some the prospect of constantly moving things around and deciding where to put one’s money is overwhelming. In such cases a lifecycle fund is a good option.

A lifecycle fund is a portfolio of mutual funds which is managed in such a fashion as to accommodate a specific date of retirement. The fund is set up so that as the investor ages, an increasing number of conservative purchases is made, reducing the risk to the holder. Risk is reduced by shifting funds into stable bonds. For those who know when they plan to retire this can be a real advantage.

Of course, that is the catch. It is difficult to know when you will retire any more. The days of remaining in one company for your whole working life have gone. A person may change jobs repeatedly. It isn’t uncommon to hold a position in 5 or more firms before retirement. The current economic downturn has caused people to put off retirement indefinitely, altering investment plans dramatically. The lifecycle fund depends upon the ability to predict the future to some extent.

Simple Retirement Planning

Since the fund adjusts automatically, the investor can put money in without worrying about a high level of risk as they approach retirement. Older individuals who were still heavily invested in stocks when the market plummeted in 2008 learned a painful lesson which put off retirement for many. Another advantage is the need to only track one fund, and that fund is managed for them.

Lifecycle funds also may be called age based funds, target funds or target-retirement funds. Regardless of the name, the portfolio is maintained with a specific end point in mind. Usually dictated in 5 year increments, the balance of the fund is adjusted, based upon commonly accepted percentages, so as to decrease the risks as retirement age approaches.

One Size Doesn’t Fit All

Opponents say that this kind of investment may not actually suit everyone, since people’s goals and needs vary tremendously. Additionally, circumstances may demand changes to investment goals. The investor has little to no say over how their assets are invested once they place them in the lifecycle fund.

Because of the conservative nature of the lifecycle fund, the investor doesn’t necessarily have the opportunity to take advantage of a sudden upswing in the market. This kind of fund is the plodder’s choice, and it is reliable as it is dull.

The Big Picture is Yours to Draw

In truth, the decision to invest in a lifecycle fund is one that can only be made by the individual. For an investor who wants to let their assets run on ‘autopilot’ these sorts of investments are ideal. They simply deposit their contributions on a schedule and that is the extent of their involvement.

For investors who want to be actively involved in decisions and changes, a lifecycle fund is pointless. Additionally, if circumstances change mid-stream, and you have to make changes in your investment strategy, a lifecycle fund can actually be detrimental as it will start shifting your balance whether you are ready to retire or not.

As always, investments must be carefully considered and monitored. Only you can determine whether placing a portion of your retirement income into a lifecycle fund is appropriate.

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Finding a Safe Harbor in a Financial Storm

Investing School — Mon, 07 May 2012 21:14:30 +0000

The concept of a ‘safe harbor’ is common in many environments. Whether in sailing or in investing, the basic idea is very much alike: a situation where one enjoys the benefit of additional protections.

When applied to financial matters a safe harbor may be interpreted as one of three states:

When a company is targeted for potential takeover, it makes itself deliberately less attractive, thereby providing its own ‘safe harbor’ against attack.
A way of accounting that generates a simpler method of determining the taxes assessed.
A legal provision that will decrease or completely eliminate liability for as long as good faith is maintained.

Each of these harbors suit a specific goal.

The first makes the company so unattractive that it reduces any interest from potential acquirers. By presenting the firm as financially unstable a business may be able to avoid being taken over. Of course it is important not to actually fall into the trap of financial ruin.

The second allows some financial manipulation between firms owned by the same parent company. This may allow them to claim specific tax credits in a way that wasn’t possible before. As assets are moved around they may need to be leased back by the original ‘owner’ for a variety of other purposes.

The third is a protective measure for the management. The SEC allows companies to make financial projections, as long as they are made in good faith, that aren’t fulfilled. Since it is impossible to truly know the future, this limits liability when a projection is inaccurate and investors don’t earn what they expected.

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A Ramp Up is a Good Sign

Investing School — Fri, 04 May 2012 16:56:31 +0000

Every successful company hopes to be able to offer its investors a period during which it is expanding. Such a time is typically called a ‘ramp up’ of production or services. Normally you see ramp ups more frequently when small companies are just starting out and are expanding their product lines or number of locations; however, any company, no matter how large, can do the same.

Since a company which is involved in a ramp up must invest significantly, it is expected that there will be capital spent and that research has proven that the market exists for the greater services. If the desire for the new products falters, the company may end up loaded down with additional debt and inventory which it cannot sell. This leads to a decline in stock value rather than the hoped for increase.

A ramp up may be the result of obtaining a new distributer or the opening of new territory. For example, with the damage caused by last year’s typhoon in Japan, Toyota production is suffering. China has poised itself to enter the vehicle market in Japan and it is ramping up production, and hopefully sales, as a result.

Whether such a ramp up will succeed depends upon many factors, only some of which are under the control of the Chinese auto market. The potential increase in market share makes the risk acceptable. Success could bring in a great deal of capital for Chinese auto makers, failure could result in a serious setback for the companies involved in the current changes.

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Evaluating Merrill Edge as a Brokerage Firm

Investing School — Mon, 30 Apr 2012 15:16:10 +0000

As often happens when a company changes hands, things change within the structure of the firm as well. In 2008 Merrill Lynch was acquired by Bank of America, along with numerous other financial institutions. BoA put its investment accounts under the new name Merrill Edge in 2010. Since then it has been running independently.

Application Process

The application process for a Merrill Edge account is online. The same basic information is requested as is with any other brokerage account and funds can be transferred into the new account from another existing account, check, cashier’s check or electronic transfer. Doubtless, each takes a certain amount of time, but estimates weren’t available at the website.

Pricing Structure

Pricing with Merrill Edge is a bit tricky, as it is on a tiered system when you are trading stocks and ETFs. Additionally, there are ways to gain free trades and occasional promotions. Here is a simplistic breakdown, but make sure to check before you commit.

Stocks or ETFs – balance under $250,000 or 0-119/0-29 trades per year/quarter: $8.95
Stocks or ETFs – balance $250K-$1M or 120+/30+ trades per year/quarter: $6.95
Stocks or ETFs – balance $1M + or 240+/60+ trades per year/quarter: $4.95
Stocks or ETFs – balance in $25,000 or more in your BoA, N.A. deposit accounts: 30 free equities trades per month
Options: $8.95, $6.95 or $4.95 + $0.75 per contract with the same stipulations as above
Self Directed Mutual Funds: 0.75% of gross proceeds
Representative Assisted Trades: +$44.95

As you can see, it gets complicated.

Tools

When trading without assistance it’s all about tools, and reportedly the tools with Merrill Edge are basic and unreliable. The platform used by Merrill Edge can’t keep up with those offered by other online brokerages and doesn’t always provide accurate information on the state of your accounts. This can be problematic if you trade based on what you think you have available rather than on what you actually have. Penalties can, and will, ensue.

The one bright spot in all the comments about the tools offered arrives when discussing the app available to iPad and iPhone users. Apparently the app is exceptional.

The Word Online

When you go in search of customer commentary the word isn’t good. There are a few compliments but the majority of online reviews by actual clients are negative. Consistent problems with order execution, trading fees and poor customer service turn up time and again.

The Pros and Cons

Even with the apparent challenges, Merrill Edge does offer some pros to investors. DRIPs are free, you can connect a free checking account and there are ways to cut your trading fees. For the large scale investor this brokerage may work.

On the down side are high fees, poor execution, the need to hold a $1M balance to make trading more affordable, technical issues and a poor trading platform.

To Sum It Up

For new or average investors Merrill Edge doesn’t offer as much as other online brokerage firms. Tiered fee structures are rarely an advantage to those who have limited funds to invest. Add reportedly customer service and a platform that is frequently inaccurate and difficult to manage and it seems that Merrill Edge has a long way to go.

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Trade Up to TradeStation (a Review)

Investing School — Fri, 27 Apr 2012 17:30:14 +0000

When searching for an online brokerage there are plenty of options; not all are suitable for every investor. TradeStation is one of those companies. In 2011 TradeStation was listed at the #1 online broker with Barron’s – quite a coup. Nevertheless, this firm is best suited to the truly serious investor, otherwise it may not be a good match.

Application Process

To open an account with TradeStation you must provide certain information: income, net worth and liquid net worth. In addition you will need to transfer funds into your new account. This can be handled by check, wire or cashier’s check, with the addition of a number of forms. While details were not clear, the process seems similar to that at other brokerage firms.

Pricing Structure

The pricing structure at TradeStation is fairly straightforward, but there are some minimums required if you are to gain access to certain tools. For basic investors this will be difficult. Here are the prices:

Equities Per-Share Pricing Program: $0.01 per share up to 500 shares, $0.006 per share thereafter, $1 minimum
Equities Per-Trade Pricing Program: $9.99 per trade (1-9 trades/month); $7.99 per trade (10-29 trades/month); $6.99 per trade (30+ trades/month). Additionally, direct routing is free for up to 5,000 shares, and costs $0.005 per share thereafter.
Options: $1 per contract
Bonds: $14.95 + $5 per bond
Broker Assisted Trades: $50
Mutual Funds $14.95
Futures: $0.25-$1.20 per side, per contract
Platform Fees: $99.95/month – can be waived based upon activity
Radar Screen tool fee: $59.95/month

In order to have your platform access and Radar Screen tool fees waived you must meet certain standards. Your options are:

Trade 50 or more equity and index option contracts
Trade at least 5,000 shares of stock
Trade 10 round-turn futures or future options contracts
Trade 50 round-turn single stock futures
End the previous calendar month with a balance of $1M USD in your account

Tools

The direct access trading platform provided by TradeStation is considered among the best in the business. It is approachable, provides traders with plenty of extras and allows clients to trade futures, options, equities and even forex from one location. There are some automated trading tools as well, and the tools can be customized for each user.

Educational tools include free Webinars and online tutorials. In person instruction is available. Additionally, you will find that TradeStation has a wiki that you can access if you have any questions which helps make up for the lack of a 24/7 support line.

The Word Online

Like most brokerages, TradeStation has supporters and detractors. Complaints seem to be centered around frequent small fees and poor customer service. Another issued raised was the compatibility of the TradeStation Platform with certain firewalls. Overall, customers seem happy with the brokerage.

The Pros and Cons

TradeStation offers several advantages to its clientele. With low commissions, an exceptional trading platform, many products to trade and superior analysis tools, this is a good company for those who are deeply involved in trading and have the knowledge base required.

For less involved traders, however, the monthly fees, high margin rates, a very expensive platform and a steep learning curve, TradeStation is difficult for the beginner to master. Furthermore, minimum balances are high.

To Sum It Up

TradeStation is a good choice if you are an advanced investor with a lot of capital and knowledge. The advantages found with this company are really directed at those who know what they are doing and how to do it when they open an account; otherwise, the fees will eat up any profits you might possibly make.

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Climb on Board to Understand Round-Trip Trading

Investing School — Wed, 25 Apr 2012 16:36:50 +0000

When someone plans on some round-trip trading there is only one destination in mind: the inflation of transaction volumes. By constantly buying and selling a particular asset, stock, commodity or security, round-trip trading creates the illusion of many shares changing hands in a short amount of time. When an asset is traded frequently it makes it appear as if it is highly desirable or creating a lot of interest. Sometimes several companies agree to purchase each other’s shares and then purchase back their own assets at the same price. A form of market manipulation, round trip trading has occurred in both the telecommunications and energy industry.

The reason round-trip trading helps the owners of the traded shares is that the practice causes a misrepresentation of the total number of sales and purchases which occurred during a specific day. While the trading causes volume and revenue numbers to be inflated, there is little actual difference in profits. The classic case cited would be the Enron scandal. Revenues increased, but, there was no actual increase in the income.

Even people engage in round-trip trading. An individual who purchases the same stock more than 3 times in one day, and then sells it on the same day, is said to be involved in round-trip trading. Many investment firms have built in protocols to prevent such buying/selling patterns; some will restrict sales for up to 90 days. The risk to both company and individual is high and is not recommended. Frequently a certain level of equity must be maintained in the investor’s accounts to ward off any problems.

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Does a Risk-Free Return Actually Exist?

Investing School — Mon, 23 Apr 2012 17:17:06 +0000

In an ideal world, and only in an ideal world, investing would involve no risks. You would select your funds, place your assets and watch them grow over time. You would have no concerns over losses. In reality, though, a risk-free return represents interest you would expect to earn upon your investment if said investment was completely risk free over a particular period of time.

Still not clear on the concept? The problem lies somewhere between theory and reality. If you could invest in something that was truly risk free, the return would be what you could expect for that outlay. Once the theory meets the real world a risk free investment doesn’t exist. No matter how safe an investment you pick there is always some level of risk. Treasury bonds are about as close as you can get to a truly risk-free investment as short term securities which have been issued by the government are so rarely defaulted upon.

While not truly risk free, the chances of a government defaulting over the short term is nearly unheard of. As a result, investments of this type are regarded as particularly safe. However, hyperinflation, which can be the result of specific economic forces, can lead to these things happening. Even if an investment appears extremely stable, there are no guarantees that it will remain so. This was the case in post-WWII Germany, where government issued bonds became valueless after the war ended. The current financial crisis in Europe certainly presents an argument on the side of uncertainty rather than on the side of an investment with a risk-free return.

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