Personal Finance Articles

The “invest in what you know” school of investing was popularized by legendary mutual fund manager Peter Lynch in his best-selling book One Up on Wall Street.

In that book, Lynch wrote about buying the stock of Dunkin’ Donuts because he liked the coffee and Hanes because his wife wore the company’s L’eggs pantyhose.

Today, many investors still follow this strategy, buying the stocks of companies they like because they assume others will like them as well.

As interesting as that concept is, however, it may not be a good strategy – at least not for the bulk of your investments.

One reason is the tendency individual investors have to simplify the strategy.

Lynch didn’t just buy Dunkin’ Donuts and Hanes. He thoroughly researched them first. In fact, in One Up on Wall Street he writes that “finding the promising company is only the first step. The next step is doing the research.”

Indeed, the ability to research stocks – not great taste in coffee, pantyhose and other products – is what made Lynch such a great investor.

That’s because even if a company makes a great product, it may not have the quality of management, solid balance sheet or other qualities to grow and increase stock value.

Understanding these ideas takes some financial knowledge and skill.

That’s not to say individual investors can’t research stocks. Many can and many do with success.

But do you really want to spend your time poring over balance sheets and financial projections?

If not, that’s where a financial advisor is helpful.

A financial advisor can help you analyze stocks and mutual funds and decide which ones work for you.

You get the benefit of solid financial knowledge without expending the effort and time to do all the research.

The massive tax bill passed by Congress in December brought good news for many Individual Retirement Account (IRA) investors. It resurrected an expired provision that allows special charitable donations of IRA assets.

The provision allows taxpayers who are 70½ years or older to contribute a total of $100,000 in IRA assets to one or more qualified charities.

Qualified charities include schools, churches and public charities, but not private donor-advised funds or foundations. The contribution must pass directly from the IRA sponsor to the charity.

The good news is that the charitable contribution can satisfy your required minimal distribution so you don’t have to report the payout as income. In fact, it bypasses tax calculations altogether.

The bad news is that donating in this way means you get no tax deduction for your donation, which means it isn’t necessarily the most tax-efficient way to donate while you are alive.

One strategy is to donate appreciated assets such as a long-held stock during your lifetime and donate other assets such as IRAs after your death. Donating appreciated assets when you are alive allows you to qualify for a full-market-value deduction, allowing you to avoid capital gains tax on growth.

Your financial advisor, who is familiar with your individual financial circumstances and goals, can help you decide which strategy might be right for you.

Steep losses from the market meltdown of 2008 and 2009 have many financial advisors recommending that investors consider alternative investments. But what are these so-called alternatives and how do they fit into a portfolio?

Alternatives, in general investing terms, comprise portfolios that hedge their positions, invest in commodities through futures contracts or even trade currencies.

These portfolios may take long positions, which involve buying a security in the hope it will increase in value, or short positions, which involve selling a borrowed security in the hope it will decrease in value and can be purchased and returned to the lender at a lower price.

These strategies have long been used by institutional investors but are now available to retail investors through mutual funds and exchange-traded funds (ETFs) – and they’re increasing in popularity. A survey by investment firm Rydex/SGI found that 71% of financial advisors advocate alternative investments, and 19% already have at least half of their clients using them.

The potential benefit? Alternatives may have a low correlation to traditional investments like stocks and bonds, and that can increase diversification potential. Although diversification cannot ensure a profit or protect against a loss, more than 75% of financial advisors surveyed by Rydex/SGI said the primary reason they use alternative investments is to further diversify their clients’ portfolios.

But alternative investments aren’t for everyone. The performance of alternative mutual funds and ETFs can vary as widely as their strategies.

You may want to consider if alternatives are right for you. However, it’s wise to consult your financial advisor before jumping in. You may already have some exposure to alternatives, because traditional mutual fund managers might invest more in companies that benefit from rising commodity prices when commodity prices rise.

In today’s volatile market environment, a lot of investors are turning to dividend stocks. They have increased in popularity as the stock market has tumbled, in part because they offer some indication of corporate management’s confidence in the future of the business.

However, the stocks that pay the biggest dividends may be outside the United States.

To start, the international equity markets provide a broader universe of high-dividend-yielding stocks. While there are 116 U.S. stocks with market capitalizations greater than $1 billion that have dividend yields greater than 5%, 530 international stocks met those criteria as of Aug. 31, 2010, according to Morningstar.

Moreover, many foreign companies pay bigger dividends than U.S. companies do. That’s because a number of foreign countries, both developed and emerging, have a more dividend-friendly culture that encourages paying cash to shareholders rather than keeping it as retained earnings and reinvesting it in the business.

One way to take advantage of the potential for higher dividends abroad is to invest in an international equity mutual fund that emphasizes income.

Keep in mind, however, that there are downsides to investing internationally, including less transparent markets and currency fluctuations. Moreover, many foreign companies link their dividends to a percentage of their earnings, so dividends can fall when earnings do.

Do you have a brokerage account? If so, you’ve probably received a mailing or call about a new tax law that takes effect this year. Let’s hope you didn’t ignore it.

Starting in 2011, after you sell a stock, your broker has to provide the Internal Revenue Service (IRS) with the investment’s cost basis. This is the price you paid to acquire an investment. It’s the starting point for determining, after you sell a stock, whether you had a profit or a loss.

In the past, the IRS had no way of knowing whether taxpayers were accurately calculating and reporting capital gains and losses correctly. Some studies showed the errors were resulting in a large amount of underpaid taxes.

Brokers must begin tracking acquisitions and subsequent sales of stocks, real estate investment trusts and foreign stocks starting in January 2011, but mutual fund companies and dividend-reinvestment plans don’t have to do so until January 2012. For individual bonds and options, the law doesn’t go into effect until January 2013. Other assets, such as exchange-traded funds, fall under more than one rule, depending on the type of asset.

The new rules apply only to the sales of investments purchased after these dates. So, for example, if next year you sell a stock you bought back in 2008, your broker doesn’t have to provide the IRS with the cost basis.

What does this mean for you?

Right now you should indicate how you want shares to be sold when you sell them.

FIFO (first-in, first-out), LIFO (last-in, first-out) or HIFO (highest-basis-in, first-out) are common options.

You may also let your broker choose for you, or decide on a case-by-case basis. But if you don’t tell your broker what to do, the law will choose for you – and it will usually choose FIFO.

The tax information in this article is merely a summary of our understanding and interpretation of some of the current laws and regulations and is not exhaustive. Investors should consult their tax counsel for advice and information concerning their circumstances.

Many economists and investment theorists have attempted to translate their academic ideas into reality by opening investment funds. But is it a good idea to invest in them?

Some, such as Dimensional Fund Advisors, have been successful. Others, such as Long-Term Capital Management, which imploded in 1998, have been massive failures.

Today, the $800 billion Exchange-Traded Fund (ETF) market is full of funds operated by renowned academics.

An ETF is an investment fund that tracks a market index. Unlike an index mutual fund, however, it’s traded on an exchange like a stock. Many ETFs are basic, tracking a standard market index such as the S&P 500 Index or MSCI EAFE Index.

But other ETFs are complex investment vehicles that track subsets of market indices, such as dividend-paying stocks. Others track housing investments or oil prices. Some get very complex, combining bullish and bearish stock bets or pools of U.S. Treasury securities.

While market research by renowned academics has certainly helped shape how investments are managed, and the actual investments these academics create have sometimes performed well, they haven’t always. They’re also extremely complex.

Before investing in an ETF, we suggest you consult a financial adviser who can help determine if it’s the right investment for you given your financial circumstances and goals.

When you hear economists talk about risks in today’s environment, inflation is usually bandied about more than deflation – but the latter should not be discounted.

Deflation is a decrease in the general price of goods and services. It results in an increase in the real value of money, which allows one to buy more goods and services with the same amount of money.

Why is that bad? Because it could lead to what economists call a deflationary spiral, which is a situation in which falling prices lead to falling production, which, in turn, leads to lower wages, which, in turn, lead to a further decrease in prices.

Because of this vicious cycle, deflation is believed by many to be a cause of the Great Depression.

But is deflation a real risk in today’s economy? While many economists say no, others disagree. In fact, depending on how you measure deflation, it may already have arrived. For example, consumer prices have been fairly flat recently, according to the Department of Labor.

Whether deflation is a possibility or a reality, an important consideration is what implication it could have on your investment strategy.

Should deflation arrive, investors may want to seek dependable sources of income.

That could be good for solid fixed-income products like U.S. Treasurys, corporate bonds and high-quality municipal bonds.

Cash could also be a compelling place to put your money. If a savings account earns 0% interest but prices fall 1%, you’ve still made 1% in real terms, tax free.

Finally, gold might benefit from deflation, because the U.S. Federal Reserve Board would likely print money to prevent deflation, and that could help hard assets such as precious metals.

Your financial advisor can help you determine if deflation is a real risk – and if it is, how you might prepare.

For years, the price-to-earnings (P/E) ratio has been the go-to gauge of a stock’s value, but it may be losing its mojo. The P/E ratio compares a company’s current share price to its earnings per share. It is calculated by dividing market value per share by estimated earnings per share. The lower the P/E ratio, the cheaper a stock, in theory.

The problem with the P/E ratio in today’s economic environment is that the earnings can’t always be trusted. Corporate earnings estimates, say many analysts, are unrealistically high.

As a result, investors may want to seek other ways to value stocks that are quite removed from corporate earnings.

For example, investors may want to look at two other valuation measures, like enterprise value and free cash flow.

Enterprise value is a figure that values a company based on its entire capital base, which includes short- and long-term debt, preferred stock and minority interests, minus total cash.

Free cash flow is a figure that takes a company’s earnings and subtracts capital expenditures.

Because it reveals the amount of cash a company is able to generate after spending the money necessary to maintain or expand its asset base, it gives investors an idea of a company’s ability to boost dividends or buy back shares.

If you invest in stocks, your financial advisor can help you determine which ones are appropriate for you, based on a number of financial measures.

Taxes could soon take a bigger chunk out of your money – meaning now may be a good time to make the most of tax-advantaged investments in your retirement planning process.

The Bush administration tax cuts are scheduled to expire at the end of 2010 – and when they do, the maximum rate on ordinary income will rise from 35% to 39.6%, on long-term capital gains from 15% to 20%, and on dividends from 15% to 39.6%.

Additionally, in 2013, high-income households will have to pay more Medicare tax on wages and may also face a 3.8% Medicare levy on net investment income, thanks to healthcare reform.

While it’s possible that Congress will postpone the expiration of the Bush administration tax cuts, it’s still a good idea to plan for it and other rate hikes.

So, assuming you’re already maxing out your 401(k) plan contributions, what other steps can you take to make the most of tax-advantaged investments in your retirement planning process?

You may be able to contribute as much as $5,000 a year (plus an extra $1,000 if you’re 50 or older) to a traditional Individual Retirement Account (IRA) or Roth IRA.

If you don’t qualify for such an IRA, you can still put money in a Roth IRA indirectly by opening a non-deductible IRA (which anyone under age 70½ with earned income can do) and then convert it into a Roth IRA. If you have self-employment income, you may be able to put money in a SEP IRA or solo 401(k), which allows contributions of up to $49,000 this year (with an extra $5,000 for the solo 401(k) if you’re 50 or older).

The legal and tax information contained in this article is merely a summary of our understanding and interpretation of some current provisions of tax law and is not exhaustive. Consult your legal or tax counsel for advice and information concerning your particular circumstances. Neither we nor our representatives, may give legal or tax advice.

You’ve likely heard the old adage about sticking to high-quality stocks.

But what exactly are high-quality stocks?

When investment professionals refer to high-quality stocks, they’re referring to those of companies that have proven their ability to deliver strong and steady results over the long term. Following are three ways to spot such companies:

High ROE: Earnings don’t tell you how a company’s doing, but return on investment (ROE) does. ROE measures how much profit a company has earned relative to what shareholders have invested. For example, if a company generated a net income of $13 billion over a one-year period and shareholders invested $63 billion in the company, its ROE would be 20%. Companies with ROEs of 15% or higher are considered very efficient.

Steady Dividends: Companies that routinely pay generous dividends are clearly generating a healthy cash flow. But companies don’t necessarily have to pay high dividends to be strong. They just have to have enough general cash flow to be able to pay dividends if they want to. This is sometimes the case with technology companies.

Good Growth Prospects: High-quality stocks tend to have competitive advantages that can keep rivals at bay – and those advantages aren’t always clear. A fast-food chain may not seem to have an advantage, given that there’s a fast-food chain on just about every corner, but if the company has significant real estate holdings, the picture may change.