Personal Finance Articles

Article / Updated 11-21-2022

Factor investing is an investment portfolio general strategy that favors a systematic approach using factors or “shared characteristics” of individual stocks (and other assets, such as bonds) that have a historical record of superior risk and return performance. These factors can range from individual characteristics, such as the company’s sales (revenue indicated on the company’s income statement) or debt (total liabilities indicated on their balance sheet), to their performance in macro environments, such as inflation or economic growth. A factor is a trait or characteristic that can explain the performance of a given group of stocks during various market conditions. There are two main categories of factors: style factors and macroeconomic factors. Style factors Style factors take into account characteristics of the individual asset, such as its market size, value and industry/sector, volatility, and growth versus value stocks. Style factors help to explain or identify characteristics that drive that asset’s price performance in the marketplace. These factors are also referred to as microeconomic because they are an individual security or asset that drives its performance as a singular member or participant of the overall market and economy. Style factors include value, size, quality, dividend, growth, volatility, and momentum. We'll go over a few of these here: Value factors Looking at value means typically looking at the company’s fundamentals. The fundamentals are the most important financial data of the company, like the company’s sales and net profits, balance sheet (assets and liabilities), and important ratios, like the price-earnings (P/E) ratio. Looking at public companies (as through their common stock) through the lens of value factors is one of the most important factors because value investing has survived and thrived ever since they were initially codified by the work of Benjamin Graham during the Great Depression years. One of the most important reasons to embrace value as a primary factor (especially for beginning investors) is the emphasis on stocks that are undervalued, which makes them safer than other stocks. Undervalued means that all the key fundamental financial aspects of the company (like book value or the price-earnings ratio) generally indicate that the price of the stock is not overpriced, meaning that you will not pay an excessive stock price versus the value of the underlying company and its intrinsic worth. The reason becomes obvious in market data; overpriced stocks are more apt to decline more sharply in a correction or bear market versus reasonably priced stocks. The bottom line is the fundamentals of a stock mean a safer bet and a better chance at long-term price appreciation. Size factor The size of the asset, in this case, public company, is a reference to its market size based on market cap or capitalization (total number of shares outstanding times the price per share). The most common cap sizes used are small cap and large cap. If you’re seeking growth, lean toward the small-cap factor. Large-cap assets may be safer but typically don’t exhibit the same growth or price appreciation relative to the small-cap stocks. The historical data generally bears this out. Growth factor The growth factor highlights the measure of change in sales and earnings by the company in relation to its group (like in individual industries or sectors). Is the stock growing better than its peers? If so, this factor should be considered. As the historical market data suggests, companies with growing sales and revenue show stronger relative stock price appreciation, since investors notice the growth and buy up the stock. Volatility factor Market research over an extended period of time suggests that low-volatility stocks tend to earn a better return over the long term compared to high-volatility stocks. Given that, this factor will be beneficial. A useful indicator to look at is beta, which is listed at many popular financial websites for a given stock. The beta indicates how much more (or less) a given stock is volatile versus the general market (based on recent market trading data). For beta, the stock market itself is assigned a value of 1. A stock with a beta that is less than 1 is less volatile than the general stock market, while a stock with a beta greater than 1 is more volatile than the general stock market. A stock with a beta of 1.2, for example, is considered 20 percent more volatile than the general stock market. A stock with a beta of, say, .9 is 10 percent less volatile than the general stock market. A good example of a stock that has low volatility would be a large-cap public utilities company. A good example of a high-volatility stock would be a small-cap technology firm. If you’re a retiree, you would most likely benefit from this factor to ensure getting low-volatility stocks. Macroeconomic factors You could compare stocks and the stock market/economy to fish in a pond. You can analyze the fish and choose great fish (using, for example, style/microeconomic factors). But you should also analyze the pond (macroeconomic factors). You could choose the greatest fish in the pond, but what if the pond is polluted? Then even the great fish will underperform (putting it mildly). Shrewd investors will find a different pond. For investors, the U.S. economy and stock market represent the “biggest pond” on the global financial scene. So if you’re going to participate, you should understand the good, the bad, and ugly of this marketplace. Economic growth factor Gross domestic product (GDP) is one of the most watched economic indicators by investors and non-investors alike. It’s a broad measure of the economic output (value of products and services) in a given timeframe (typically a calendar quarter or year) by a nation’s economy. When GDP is growing, companies (and their stocks) are doing well. In fact, when the economy is growing and doing well, the stock market tends to outperform other markets (such as the bond market). Factors tied to economy growth such as GDP offer profitable guidance for investors. Given that, the major investing sites regularly report this and related economic data so that this factor helps investors optimize the returns in their portfolio. Inflation factor Inflation is a key factor. Most folks look at price inflation (the rising price of consumer goods and services). However, price inflation is not a problem. It’s a symptom. Many people don’t understand the cause of inflation (including many government officials and economic policy makers unfortunately). The cause is monetary inflation (the overproduction of a nation’s currency supply) that precedes the price inflation. When too much money is created and when that supply of money is chasing a finite basket of goods and services, then the price of these goods and services will rise. The goods and services didn’t become more valuable the currency lost value (due to overproduction). A complicating factor is the supply shortage issues during late 2021 to 2022 that augurs in cost-push inflation. When shortages occur (supply issues) and consumers contain to purchase the products in question (demand), the price inflation is further exacerbated. In early 2021, when the federal government and the Federal Reserve were increasing the money supply (by spending trillions of dollars), this was the cue for alert investors to consider the inflation factor. This factor would have guided portfolio managers toward securities that would have outperformed in an unfolding inflationary environment. Interest rates factor In early 2022, the Federal Reserve (America’s central bank) is (and likely will be) raising interest rates. Interest rates are essentially the price of borrowed money, and a factor on interest rates is key to making more optimal choices in your portfolio. In general (and all things being equal), low interest rates are good for the economy while high (or rising) interest rates tend to be negative. Because so much economic activity (both business and consumer activity) is tied to credit (business loans, credit cards, home mortgages, and so on), rising interest rates tend to dampen or diminish economic activity while low or decreasing rates tend to do the opposite. Given that, factors tied to interest rates can help you avoid stocks (and bonds) that would be harmed by rising interest rates so that your portfolio can continue to perform satisfactorily.

Cheat Sheet / Updated 11-10-2022

Factor investing helps maximize your odds of being a successful investor in many ways, including helping you control and avoid self-defeating investor behaviors. Understanding the behavioral finance aspect of factor investing, as well as how great investors have dealt with it in the past, can make you an even better investor.

Cheat Sheet / Updated 11-08-2022

Listen to the article:Download audio Knowing how to build your 401(k) retirement plan, devising investment strategies, and making the most of your plan can all help to financially secure your path to retirement. During economic difficulties, you may be tempted to tap into your 401(k) funds, but most often, you're much better off financially if you can leave the funds alone. And your 401(k) management duties don't end when you retire; you still need to invest and spend wisely.

Cheat Sheet / Updated 11-08-2022

Listen to the article:Download audio You're investing in stocks — good for you! To make the most of your money and your choices, educate yourself on how to make stock investments confidently and intelligently, familiarize yourself with the online resources available to help you evaluate stocks, and find ways to protect the money you earn. Also, be sure to do your homework before you invest in any company's stock.

Cheat Sheet / Updated 10-21-2022

Are you surprised that it's so hard to consistently earn money on the stock exchange? The explanation is as simple as it is sobering: It's because we are all human beings, with all the associated genetic dispositions that come with that fact. The neural structure of the human brain is the result of our evolutionary development. Your thought and behavior patterns, such as the deep-seated fight-or-flight response, continue to influence your decisions today on the financial markets. Your nature is not particularly well-suited to trading, but you can learn to do it. The human brain is capable of change and development. You can learn the mental prerequisites for brain-compatible trading. With the right mindset, you can recognize and avoid errors before they occur. The innovative discoveries of modern neurofinance research will lead the way to success factors for brain-compatible and, therefore, successful trading.

Cheat Sheet / Updated 10-14-2022

Veterans are entitled to a wide range of benefits, but unfortunately most veterans benefits aren’t well publicized. Sometimes they’re hidden in long, confusing pieces of legislation, and other times, they’re buried among broken links on half-dead government websites. Fortunately, this Cheat Sheet is here to help.

Article / Updated 10-06-2022

As of January 1, 2013, an additional 3.8 percent tax was added to investment income in estates and trusts, thanks to provisions in the Health Care and Education Reconciliation Act of 2010. It's not an additional tax on every dollar, but only on the lesser of undistributed net investment income or any amount of adjusted gross income in excess of the highest tax bracket in any year. What sorts of investment income are included? Here’s a list: Annuities Capital gains (including the taxable portion of the gain on the sale of a personal residence) Dividends Interest Passive activity income from partnerships and Subchapter S corporations Rents and royalties You may have noticed that excluded from the list are tax-exempt interest, wages, and distributions from qualified pension, profit-sharing, and stock bonus plans — although you may still be tagged with this tax (or a portion of it) if the trust or estate’s overall income is too high. In addition, it’s important to note that the tax is on net investment income, not gross investment income. As a result, you can allocate portions of all your deductible expenses against the total income, and only pay the tax on the portion that remains that’s over the limit. All irrevocable trusts that are required to file Form 1041 are subject to this tax. However, the following trusts are apparently excluded: Grantor trusts (all income is reported by the grantor on his/her individual income tax return) Charitable foundations Charitable remainder trusts The rules surrounding how investment versus non-investment income are treated in Electing Small Business Trusts (ESBTs) are quite complex. If you’re the trustee of an ESBT, you should check with a competent tax advisor for assistance in this calculation. How to calculate the tax The UIMC tax was only intended to apply to high-income individuals, but the basic inequity in the size of the tax brackets for trusts and estates versus individuals created an unfriendly environment for estates and trusts, one where only quite small entities are exempt from paying it. The tax is imposed as an additional tax, after all other income taxes are levied. How to lessen the tax’s impact The UIMC tax is only imposed on taxable income in the trust or the estate over certain limits; if the income doesn’t reach those limits, there’s no additional tax. So, your job as executor, administrator, or trustee is to try to reduce the taxable income in the trust, while still behaving in a responsible way. You could, for example: Keep track of capital gains and plan to offset gains with some losses, if necessary. As executor, you should be aware of the size of the estate’s capital gains before the end of the year. If your gains are large but you own something that’s a less-than-sterling performer, sell it before the end of the tax year. The loss from that sale will reduce the total gains year-to-date. Invest in tax-exempt bonds and funds. Remember, tax-exempt income isn’t included in the threshold calculation, so it isn’t subject to the tax. Increase distributions to beneficiaries, but only if the trust instrument allows, and the distribution otherwise makes sense. You still have to follow the terms of the trust instrument and pay attention to the intentions of the settlor. But if you manage to pass out income to beneficiaries, that income will be included in their threshold calculation for this additional tax, not the trust or estate’s. Plan deductions to fall into years when income is higher and pay fewer deductible expenses in years the trust doesn’t perform as well or when more is distributed to the beneficiary. That’s assuming you can predict these things, which you may not be able to precisely. But if you normally pay a trustee fee in January, and your income for the prior year is high enough to trigger this tax, you may want to take the January fee in December of the prior year. There is no perfect solution here because the techniques that might enable the trust or estate to pay taxes at a lower rate may not be consistent with either the intent of the donor or what’s in the best interest of the beneficiary. It’s up to you to weigh all these possibilities and arrive at the most equitable solution. Whatever you do, be sure to jot down your reasoning and put it in the file. That way, should anyone ever question your decision, you’ll be able to remind yourself why; and next year, when faced with the same questions and the same dilemmas, you’ll be able to see what you did in the past and judge for yourself how well it worked.

Article / Updated 10-06-2022

Established in 1848, the Chicago Board of Trade (CBOT) used to be the oldest commodity exchange in the world. The CBOT was the go-to exchange for grains and other agricultural products, such as oats, ethanol, and rice. The exchange also offered several metals contracts targeted at individual investors, including the mini gold and mini silver contracts. In 2007, the Chicago Mercantile Exchange (CME) merged with the CBOT as part of a great consolidation wave. CME rolled up the CBOT's popular grain contracts and now offers them on its electronic platform. Many traders still refer to some of these contracts as CBOT grains. CME is the largest and most liquid futures exchange in the world. The CME has the heaviest trading activity — and open interest — of any exchange, partly because of the depth of its products offerings. Besides agricultural commodities, it trades economic derivatives (contracts that track economic data such as U.S. quarterly GDP and nonfarm payrolls), foreign currencies (it offers a broad currency selection, ranging from the Hungarian forint to the South Korean won), interest rates (including the London Inter Bank Offered Rate, the LIBOR), and even weather derivatives (contracts that track weather patterns in various regions of the world). Because of its broad products listing, the CME is perhaps the most versatile of the commodity exchanges. In addition, the CME was one of the first exchanges to launch an electronic trading platform, the CME Globex, which became an instant hit with traders. It now accounts for more than 60 percent of the exchange's total volume. In 2006, the New York Mercantile Exchange (NYMEX) entered into an agreement with the CME to trade its marquee energy and metals contracts on Globex, an electronic trading system. In 2008, the CME went on a series of acquisitions and purchased the NYMEX and COMEX. The CME is also the first exchange to go public. Investors greeted the initial public offering with enthusiasm, raising the stock from $40 in 2003 to more than $500 in 2006. For more on the CME, check out its website, which also includes helpful tutorials on all its products.

Article / Updated 09-29-2022

People who invest online are usually do-it-yourself investors. This means they're probably working without a tax consultant. But this can make it hard to understand how the money they earn while investing is taxed. That's where understanding capital gains taxes enters the picture. When you sell a stock held in a taxable account that has appreciated in value, you usually have taxes to pay. Generally, such capital gains taxes are calculated based on the holding period. There are two holding periods: Short-term: That's the type of capital gain you have if you sell a stock after owning it for one year or less. You want to avoid these gains if you can because you're taxed at the ordinary income tax rate, which, as I explain shortly, is one of the highest tax percentages. Long-term: That's the type of capital gain result you get if you sell a stock after holding it for more than one year. These gains qualify for a special discount on taxes. You must own a stock for over one year for it to be considered a long-term capital gain. If you buy a stock on March 3, 2019, and sell it on March 3, 2020 for a profit, that is considered a short-term capital gain. Also, an important thing to remember is that the holding-period clock starts the day after you buy the stock and stops the day you sell it. Selling even one day too soon can be a costly mistake. If you're interested in cutting your tax bill in a taxable account, you want to reduce, as much as possible, the number of stocks you sell that you've owned for only a year or less because they're taxed at your ordinary income tax levels. You can look up your ordinary income tax bracket at this Internal Revenue Service website. Need an example? Say a stock rose from $10 to $100 a share (for a $90 per share gain). Say that you had $50,000 in taxable income that year and sold the stock after owning it for just three months. Your gain would fall from $90 to $67.50 after paying $22.50 in taxes. By owning stocks for more than a year, gains are taxed at the maximum capital gain rate. The rate you pay on long-term capital gains varies based on your normal tax bracket, but such rates are almost always much lower than your ordinary income tax rate, if not zero. Yes, zero — some investors' long-term capital gains are tax free! Long-term capital gains rates, though, can change dramatically due to political pressure. The following table shows the maximum capital gain rates for 2009 and 2010 for typical investments such as stocks and bonds. Maximum Capital Gain Rate If Your Regular Tax Rate Is Your Maximum Capital Gain Rate Is Greater than 35% 20% 25% or higher 15% Lower than 25% 0% Source: Internal Revenue Service

Article / Updated 09-29-2022

A stop-loss order (also called a stop order) is a condition-related order that instructs the broker to sell a particular stock in your investment portfolio only when the stock reaches a particular price. It acts like a trigger, and the stop order converts to a market order to sell the stock immediately. The stop-loss order isn’t designed to take advantage of small, short-term moves in the stock’s price. It’s meant to help you protect the bulk of your money when the market turns against your stock investment in a sudden manner. Say that your Kowalski, Inc., stock rises from $10 to $20 per share and you seek to protect your investment against a possible future market decline. A stop-loss order at $18 triggers your broker to sell the stock immediately if it falls to the $18 mark. If the stock suddenly drops to $17, it still triggers the stop-loss order, but the finalized sale price is $17. In a volatile market, you may not be able to sell at your precise stop-loss price. However, because the order automatically gets converted into a market order, the sale will be done, and you’ll be spared further declines in the stock. The main benefit of a stop-loss order is that it prevents a major loss in a stock that you own. It’s a form of discipline that’s important in investing in order to minimize potential losses. Investors can find it agonizing to sell a stock that has fallen. If they don’t sell, however, the stock often continues to plummet as investors hope for a rebound in the price. Most investors set a stop-loss amount at about 10 percent below the market value of the stock. This percentage gives the stock some room to fluctuate, which most stocks tend to do from day to day. If you’re extra nervous, consider a tighter stop-loss, such as 5 percent or less. Please keep in mind that this order is a trigger and a particular price is not guaranteed to be captured because the actual buy or sell occurs immediately after the trigger is activated. If the market at the time of the actual transaction is particularly volatile, then the price realized may be significantly different.