Avoid These Common Mistakes When Investing In ETFs

May 28, 2019

ETFs, which are baskets of stocks, bonds, or commodities that are traded on a stock exchange, are becoming an increasingly popular way to invest especially with young investors. Due to their accessibility, instant diversification, transparency, low expenses, tax efficiency, and ability to be traded like individual stocks, some experts even think they’ll eventually make traditional mutual funds obsolete.

However, there are downsides to be aware of too. If you have ever heard the adage “your greatest strength can be your weakness as well,” then you will see why the following mistakes can creep up on an ETF investor if they are not aware of them.

Mistake: not changing how you invest your money

Many people invest by depositing a set amount into their investment account every month (dollar cost averaging strategy), which they use to buy mutual funds. This can be a mistake with ETFs because you pay a commission for every buy and sell order you place which means that your monthly investment will be reduced by commission costs. (Note: this could be negated if you are with an online brokerage firm that provides free trades.)

Mistake: losing focus of your long term strategy

ETFs are generally viewed as a long term investment holding but because of the benefit of being able to trade it (as often as intra-day), a mistake could be made if the investor gets tempted to buy and sell with more of a short term outlook (read: market timing) which can result in selling at the wrong time and having higher trading costs and taxes.

Mistake: not researching how an ETF diversifies your portfolio  

This can work against you in two ways:

  1. Redundancy. For example, by investing in an ETF that tracks the S&P 500 and also holding a large-cap mutual fund, you are investing in essentially the same type of stock and oftentimes both investments will hold the same companies. 
  2. Liquidity risk of specialized ETFs. The other miscue is if your ETF is invested in a specific sector, for example in an Antarctic oil sands benchmark (I’m inventing a sector), you may have difficulty selling your shares when you want.

Mistake: trading “over your head”

“Just because a strategy exists doesn’t necessarily mean you need to use it.”

One of the advantages of investing in ETFs is the flexibility of how they are traded and the different strategies that can be employed. For example, one strategy is to “short-sell” an ETF. This strategy is used by investors who believe the price of their ETF will go down. The investor in effect borrows shares from the brokerage firm and then will pay back the borrowed shares with the cheaper shares – assuming the price does in fact go down. 

Sounds easy right? Nope! This is a practice that only experienced investors might employ and while the reward (a higher return) could be nice, the risk is very high. 

Good rule to live by: just because a strategy exists doesn’t necessarily mean you need to use it.

Finally, if you eventually decide to invest in ETFs, in general it’s best when you have a lump sum to invest as that will help minimize trading costs (see mistake 1). Many ETFs will have low minimum investment requirements (could be as low as $250) but be careful, a very low minimum investment may require monthly deposits which, because of commission costs could eat away at your overall return.

Should You Invest In ETFs?

May 17, 2019

A common investing question I get in my workshops is, “What are ETFs?” and “Should I consider them for added diversification?” 

These are good questions and tell me more people are educating themselves about different financial instruments and that they want to know whether something makes sense for “them” and not blindly investing because everyone else at the office is what I affectionately call “lemming investing.” So let’s see if I can shed a bit of light on the two aforementioned queries.

What are ETFs (Exchange Traded Fund)?

The most simple definition of an exchange traded fund is that it is a basket of different stocks that is designed to track a specific market index, such as the S&P 500, but unlike a mutual fund ETFs can be traded at any point – like an individual stock. Much like an index mutual fund, it is passively managed which means there is no active buying and selling of individual stocks which results in a lower cost of ownership for the investor. 

Now, does it make sense to own ETFs? Let’s take a look at some of the benefits.

Should you be investing in ETFs?

As mentioned earlier, ETFs can offer more diversification. Since they track individual benchmarks you can be invested in broader benchmarks such as the S&P 500 to a more specific industry or country benchmark such as biotechnology or India for example. Some other considerations may be:

  • Low transaction costs. ETFs are not actively managed, so costs are generally below 1% of your investment. One thing to be aware of though is your commission costs. If you actively trade ETFs, commission costs can add up dramatically.
  • Liquidity needs. ETFs can be traded as often as intra-day so there is more immediate access to your money if the need arises. (a lot of people don’t realize that mutual funds are actually only traded at day-end prices, so you can enter an order to buy or sell at any time, but it’s not executed til the market is closed)
  • Ability to employ strategic trading involving option and short selling opportunities (for more experienced investors) These two strategies allow the investor to leverage their investing dollar to possibly gain a larger return. (Note: these strategies also leverage the risk factor as well!)

So at the end of the day, if you are looking for a lower cost investment where you are not throwing a dart at an individual stock, but instead buying into a benchmark which will enhance your portfolio diversification (and you seek the advantage of more liquidity), then looking into an exchange traded fund may well be worth your time.

Strategies To Make The Most Of Your Required Minimum Distributions

May 03, 2019

I was doing some workshops for a group of pre-retirees (talk about envy!) and we were going over a lot of the basic questions that group often has:

  • How do I know if I have enough money?
  • How do I plan for medical costs?
  • What should I do about my investment allocations?

But the question that seemed to generate a lot of interest was if there were any strategies surrounding taking the Required Minimum Distribution (RMD), which is when you have to begin withdrawing funds from 401(k) accounts, pre-tax IRAs and some annuities at age 70 1/2. The strategies listed below can help you be more efficient in deciding which dollars you should consider using to pay your RMD.

Consider the number of retirement accounts you have

A lot of people have a misconception that if you have several retirement accounts you need to withdraw the required amount from each account. While you can do that, it’s important to understand what you’re allowed to do, since it varies by account type. 

If you have more than one IRA, you have a choice to withdraw each account’s required amount or you can take the combined distribution from one account. An important consideration here is that you cannot group your employer sponsored plan(s) like a 401(k) into this strategy. If you have more than one 401(k) (including Roth!) you would actually need to figure out the RMD from each 401(k) separately and withdraw from each one.

What investments do you currently have?

What if you have an investment that is doing very well and it’s time for you to take your RMD, do you absolutely have to sell that investment? Well if it is your only investment holding yes, but many people have more than one holding. 

Consider selling an investment that is not returning as much as others, i.e. dollars that you have in a money market account or perhaps a mutual fund you’ve been thinking of selling anyway. This can also provide an opportunity for re-balancing. 

For example, say you have too much in bonds, by selling off a portion of bonds you can make your RMD and get back to a percentage in bonds that you are comfortable with.

Re-investing your RMD if you don’t need the money

What happens if you don’t need the money that the RMD forces you to take? (I know, nice dilemma!) Well you still have to take it, unless of course you like the penalty for not taking it (50% of the amount you should have taken). So what are your choices? 

Of course you can spend it, I mean after all you worked hard for it, but you could also re-invest. Some things to consider might be tax efficient investments, such as municipal bonds or if you are working, consider funding a Roth IRA where future growth can be pulled out tax free (after you have held the account for 5 years). 

Consider a charitable donation strategy

If you must take an RMD and you normally donate to charity, consider making your donation directly from your IRA account. This is called a Qualified Charitable Distribution and can help lower your taxes, especially if you no longer itemize your deductions because the standard deduction is so much higher than it use to be. You can give up to $100,000 from your IRA each year in this way. 

For example, say your RMD for the year was supposed to be $10,000 and you normally give $2,000 to charity each year. You could have the $2,000 sent directly from your IRA to the charity and withdraw the remaining $8,000 RMD from your IRA account. That way, you would not have to pay tax on the $2,000 donated to charity. 

If you are in the 22% tax bracket, then you would save $440 in taxes by doing it that way. Otherwise, with a $2,000 charitable donation, you may not be able to itemize your deductions to receive a tax benefit. See IRS Pub 590-B “Qualified charitable distributions.” section for more information.

Bottom line, just because you have to take your RMD, doesn’t mean you can’t be tax efficient by re-investing the money!

Keep in mind that your strategy may be quite simple or may employ some of the above tips, but the one constant is that you want to continue to be on time with your RMD and whenever possible, make it as advantageous for you as you can.

Spring Cleaning For Your Finances

March 15, 2019

With the official start of spring looming, perhaps it’s time for some spring cleaning of all those things we’ve been ignoring up until now. I’m not just talking about your home or your work space. Here are some financial areas of our lives that could probably use some spring cleaning too:

Your tax records

With tax season upon us as well, it’s a reminder of our own version of that overstuffed file cabinet in the corner that we’d rather not think about. (If you don’t know what I’m referring to, your spring cleaning may consist of starting such a file.) We know we probably don’t need all that paper but we’re afraid of getting rid of anything for fear that it will someday get us in trouble with the dreaded IRS.

What the IRS recommends

There are a few other exceptions to the 3 year rule. If you filed a claim for a credit or refund after filing your return, keep records for the later of 2 years after you paid the tax or the regular 3 years after you filed. Keep those records 7 years if you filed a claim for a loss from worthless securities or bad debt reduction.

Keep all employment tax records for 4 years after when the tax is due or is paid, whichever was later. Finally, keep records related to property until after the period of limitations runs out for the year in which you sell the property.

Confused? If you’ve sold some property, consider speaking with a tax professional about what to keep and for how long.

Don’t forget that taxes aren’t the only reason to keep some of these records. Make sure that they’re not needed by your insurance company or creditors before you throw them away. You might also want to keep receipts for warranty purposes.

Your credit report

We’ve all heard about the importance of checking our credit report for errors but how many of us actually take the few minutes to do it? Having errors on your report doesn’t just mean you could be paying higher interest rates and being disqualified for loans and apartments. You could also be paying higher insurance premiums and risk being disqualified for jobs.

How to check for errors

The first step is to request a copy of your credit report from each of the 3 bureaus (Equifax, TransUnion, and Experian) on annualcreditreport.com if you haven’t already done so in the last 12 months. That is the only official site, so don’t fall for a copycat. If you’ve been denied credit, you can also get a free copy of your report from the bureau used by the lender that denied you.

Correcting credit report errors

If you see any errors on any of the reports, you can dispute it by filling out the form that comes with your report, using an online dispute form, calling the bureau, or contacting the creditor to request that they update the bureau with the right information.

If you make a phone call, you might want to follow up with a letter. In any case, be sure to be specific as to what information is wrong and why. The bureau must then complete their investigation within 30 days and send you a new copy of your credit report.

Cleaning up items that aren’t errors

Sometimes it’s not just the inaccuracies that need to be cleaned up. Try to bring any recently delinquent accounts up to date. If you have old debts, you might want to get them paid off or settled as well, especially if you’re planning to buy a home or refinance your mortgage. Just be aware that even just contacting an old creditor can actually hurt your credit score by turning an old debt into a new debt since more recent debts count more towards your score.

Paying it off should improve your score after 2-6 months though, especially if you can get the creditor to report them as “paid-in-full” or “paid-as-agreed” rather than “settled” or “charged-off.” That being said, you may want to ignore those old debts if you can’t pay them off (making a partial payment without settling it may only hurt your credit score) and they’re past the statute of limitations to sue you in your state or you’re planning to file for bankruptcy.

Your accounts

If you’re like most people, you may have multiple bank and investment accounts all over the place. It can be hard for you to manage and keep track of and even harder for your loved ones in case something were to happen to you. There may be good reasons for this but if not, it could be time to do some consolidation.

Why consolidate?

In addition to making your life easier, consolidating bank and brokerage accounts can qualify you for lower fees, higher interest rates on your savings, and other perks. Don’t forget to shop around on sites like money-rates.com and depositaccounts.com to see if someone new can give you an even better deal than your existing institutions.

You may also have retirement plans floating around out there from previous jobs. Unless they offer you a unique investment option, you might want to roll them into an IRA or your current employer’s plan. An IRA can give you more flexibility in how you invest the money and how you withdraw it (unlike other plans, you can use it penalty-free for education expenses and a first-time home purchase).

On the other hand, rolling it into your employer’s plan would allow you to have all of your retirement money in one place and possibly the option to borrow from it tax and penalty free at any time and for any reason. Your plan may also offer you unique investment options and free advice on investing within the plan. Finally, if you retire after age 55, you can withdraw penalty-free from a 401(k) while you’d have to wait until age 59 1/2 with an IRA.

Taxes, credit reports, and financial accounts — none of these sound particularly exciting to most people, which is how we come to neglect them. But if you take some time now and do some spring cleaning in these areas, you may be surprised to see how liberating it feels to have a smaller and cleaner tax filing cabinet, a credit report that’s not keeping you down, and money that’s working as hard for you as it can. You can then sit back and relax, knowing that summer is right around the corner.

4 Important Things To Consider When Buying A Condo

March 28, 2018

When it comes to buying a home, one of the first decisions you’ll need to make is the type of home you want to buy — a single family, town home, condo, etc. When my wife and I moved from California to the Midwest several years ago, we found ourselves shopping for a condo for the first time ever. The education we received through the process of buying, owning and now as landlords due to our move back to Cali was priceless. Here are the 4 things we learned to look out for when shopping for a condo:

1. Assessments (or HOA fees)

Be careful of these! This can take a supposedly affordable monthly housing payment and send it through the roof. For example, assume you have a mortgage payment of $1,500/mo and an additional $500/mo for taxes and insurance; that gives you $2,000/mo, BUT your building has assessments/HOA fees of $525/mo, so your real monthly cost is $2,525! You need to be aware of how that impacts affordability.

Know what it covers

You also need to know what you get for all that money, as each HOA is different. Often it will be landscaping, trash removal, water, common insurance and security. But take a close look because some assessments may also include pricey utilities such as gas and air conditioning (I actually saw one that included cable!).

You’ll also want to get an idea of what the HOA keeps in “reserves,” aka how much extra they have in their account to cover irregular expenses that come up. Which brings me to my next point.

2. Special assessments

This can be a tricky one as this type of assessment should only be implemented if absolutely necessary, but if you’re looking at a place that keeps low reserves, it could come up more often. Some examples might be for fixing a leaking roof or doing some retro-fitting in an earthquake zone. The bottom line here is that you will want to ask what special assessments have been levied in the past and what the likelihood of another is so that you can factor that into the total cost of what you’re buying.

3. Association budget

The answer to the aforementioned question often is answered by what the cash reserves looks like for the complex. Generally more established buildings have very healthy cash reserves so that most wear and tear type improvements — like a new roof due to age – will not require a special assessment. Always ask not only about the cash reserves but also how long the existing Board members have been in place.

4. Property taxes

This is on everyone’s favorite list and is pretty self explanatory, but be careful. Depending on where you live, and often in the same building (the higher you go, the better the view) you can find a wide range of tax amounts. Don’t just look at the average, get the numbers for the specific unit you’re looking at. Also note if it’s been many years since the property has sold — taxes are calculated based on property value, so if the unit is selling for much higher than it’s valued on by the county assessor, you could see an increase once your purchase price is recorded.

The bottom line

If you find yourself trying to decide between more than one unit, make sure you’re including all of the factors that come along with condo living. On one hand, it was nice to know that any issues with the roof or exterior would be shared with neighbors, but on the other, it can get very expensive very quickly if you don’t know what you’re signing up for when you buy.

How To Know If You Are Ready To Buy Investment Property

October 09, 2017

“How do I decide if I’m ready to get into real estate investing?”

I get this question all the time over the Financial Helpline and in one-on-ones with the employees we work with. I also hear it regularly from friends who want to know my perspective on this as a financial planner.

What is interesting about this question is that the answer, surprisingly, has very little to do with the real estate market. And that’s why so many people make bad decisions in this area. They base their decisions on what they think the real estate market is going to do, when instead, they should be looking at their own financial situation to make a decision on this.

The answer has very little to do with the real estate market.

You are a good candidate for investment property if you meet all or most of the following:

1. You have a very stable job and significant cash cushion. Ideally that would be 1 year plus of your living expenses in a liquid account that you can tap into immediately with no or very minimal penalty (aka it’s not in a retirement account).

2. You have excellent credit (generally 750 or above). This important for two reasons:

  • To get a better loan rate and
  • If you end up having more vacancies or home improvement expenses than you expect, you will have better access to credit to cover these expenses if need be.

3. You are ready, willing and able to be a landlord. Ideally you would enjoy that responsibility and/or you can cover the costs of paying someone to maintain the property like a building super who can address issues that tenants face and ensure the property is properly maintained. This becomes very important when you are ready to sell, not to mention it is your legal obligation as a landlord to maintain the property for tenants.

4. You are looking for a good tax shelter to offset income taxes and capital gains.While all of us want to reduce taxes, investment property can be particularly attractive for those who are in a high-income tax bracket. Some ways you can take advantage of this are through write-offs on such things as mortgage interest, property tax, gardening, property management, etc. You may also be able to write off as much as $25,000 in real estate losses against your total income depending on your adjusted gross income (AGI).

5. You can separate your emotions from the process and buy for purely financial reasons rather than personal preferences. Remember, you won’t be living in this property so whether or not it’s your favorite style of architecture is irrelevant. But whether or not you have a positive cash flow (meaning your rental income exceeds mortgage and other property expenses) is very important. So, you need to be ready to cast aside a love of real estate as an art form and cultivate a love of it as an investment vehicle in order to be financially successful.

Bonus criteria, but not essential

You have a spouse with a stable job. This further reduces risk of a major cash flow problem if you lose your job

You know a lot about real estate and/or have people around you who are experts in real estate and can advise you. Key knowledge areas include:

  • home improvements/renovations that are most likely to enhance retail value;
  • understanding of rental and vacancy rates in the area you are looking to buy;
  • trends in real estate prices and key facts about the neighborhood and how the local economy may impact future housing prices.

Real estate agents can help here, but it’s nice to have people with expertise that you know and trust on your side as well. This is why large real estate investors have teams of people who work for them.

You should not buy investment property if you meet ANY of the following criteria:

1. You are stretching to buy the property, or you have any reason to believe that your job is not secure. If your debt to income ratio begins to exceed 35% after the purchase, then you are stretching. If you do not have a liquid cash cushion (1 year plus of your living expenses is recommended) and would have to tap into your investments to cover a financial emergency (e.g. longer than expected vacancies, roof begins leaking), you are stretching and until you develop this cash cushion, you should not purchase the property.

2. You enjoy a life free of hassle and try to limit your responsibilities. In other words, you don’t want to be tied down. In this case, it doesn’t matter how attractive the deal is, you are not ready to be a landlord and buy an investment property.

3. You have fair or poor credit (below 700). In this case, you may not even qualify for a loan. Or if you do, the interest rate could significantly drive up the cost of the mortgage and make the property a money pit where you are consistently paying more in mortgage than you are getting in rent.

4. You are already heavily invested in real estate relative to other assets. “Heavily invested” meaning 20% or more of your wealth, not including your primary residence, is tied up in real estate. This is particularly important if most or all of your real estate holdings are in one area — if housing prices plummet in that area, you could run into serious financial problems.

One more watch-out

Think twice if you are going to purchase the property with friends or relatives. This is not to say it can’t be done successfully — ironically, I’ve done it myself and it has worked out fine — but the odds are against you here. We were able to make our situation work because we selected partners who were financially responsible and also set up a legal structure to account for contingencies. If you’re skeptical about your potential partners’ financial position, you may want to shy away from the deal or go it alone.

Just the first step

Okay, so after all this, you should have a better handle on whether or not you are a candidate for investment property. But that’s only the first step. It doesn’t mean that the properties you are considering are a good investment. It only means that you are in a good financial position to be able to invest successfully in real estate.

The next step (for those who are good candidates for buying an investment property) is to find the right property. If I had a dollar for every time someone asked me if they should purchase a specific investment property…. well, I’d be able to buy another one myself!

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Investing: Two Paths, One Goal

December 16, 2010

My wife and I recently took our last vacation for the year (boy did we need it). Because of the environment that we were in, it was easy to do some writing. This place – Cabo Pulmo — is off the beaten path, meaning no phones, no internet and no TV, so my wife and I got to spend some quality time bantering with my Dad and step-mom. When we were done with that we also took in some great hiking.

As we were hiking on one of the trails, I came across the inevitable “fork in the road.”  Now in hiking, invariably one trail is easier to take, less elevation gain, fewer obstacles, easier on the body, etc.  But it takes a longer time to reach the end of the hike. The other trail, more often than not, results in reaching the end quicker but you will climb higher faster and probably run into several obstacles that could also be more dangerous.

As I was hiking, I thought how this trail closely resembles the path(s) of the conservative and aggressive risk tolerance profiles.

The Conservative Investor: They will often have the bulk of their investable assets in cash or cash equivalents.  In order to reach a retirement goal, they may have to save a lot more which could take a bit longer, but they won’t have to deal with market fluctuations.

The Aggressive Investor: They may be able to reach their retirement goal sooner due to the potential higher return their investments could earn, BUT they will also have to deal with obstacles such as 2008.

The point here is that much like hiking, there isn’t one right way to reach your goal, just know which path is the right one for you.

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Can Injuries Help Us Assess Risk?

July 29, 2010

I’m usually a good sleeper, but the other day I lost a battle with the sleep thief Insomnia. The reason for my blissful lack of sleep was that I found out that I need to have surgery to reattach my bicep tendon. (I’ll save that story for another blog and another time.) Anyway, one of my random thoughts was about the similarity between playing various sports and investing.

For starters they both require a fundamental knowledge to understand what are the right and wrong ways to succeed. Continue reading “Can Injuries Help Us Assess Risk?”

Why We Practice What We Preach (Part II)

July 22, 2010

Welcome back. I hope your time away from my blathering was enjoyable. So where was I? Oh that’s right, my wife wanting to retire in 5 years. Now keep in mind that as I was telling her we certainly could review where we are at and if it was possible, my internal dialogue was saying “Why bother? We don’t have enough money set aside yet.” But I shook off my negativity and started running our numbers. Continue reading “Why We Practice What We Preach (Part II)”

Why We Practice What We Preach

July 15, 2010

Picture a gorgeous sunny day sitting in the backyard relaxing on one of those (seemingly) rare days off. Feet up on the table, cold glass of (pick beverage of your choice) and an interesting magazine at the ready, when out of nowhere my wonderful wife states that it might be a good time to review our retirement. I pause a moment and think to myself, “Sure why not, it’s been about a year, we’re due,” and so I smile and say “Great idea! Let’s do it.” She smiles and breathes a contented sigh as she quietly states, “Good, because I REALLY want to retire in 5 years.” Continue reading “Why We Practice What We Preach”