Unlocking the Mystery of Capital Gains Taxes (Including the Wash Sale Rule)

June 06, 2025

Understanding capital gains and losses is important for managing investments and taxes. The IRS says almost everything you own and use for personal or investment reasons is a capital asset, like your home, stocks, and bonds. When you sell any of these, you either make a profit (a gain) or lose money (a loss). Profits and losses may increase or decrease the amount of tax you owe, depending on how long you’ve owned the asset.

Capital gains and losses can affect how much tax you pay in the year you sell your assets, but remember, if you sell personal things like your home or car, you can’t use those losses to lower your tax bill. For now, let’s focus on investments.

Short-term or long-term

There are two types of gains and losses: short-term and long-term. If you’ve owned something for one year or less, it’s considered short term. If you hold on to it for more than one year, it’s considered long term. This matters for tax purposes because short-term and long-term gains have different tax rates. Keep this in mind when selling investments in a taxable, non-qualified brokerage account.

How the sale of an investment is taxed

Here’s how to figure out how your investments will be taxed:

First, calculate gains and losses on assets you’ve held for one year or less (i.e., short-term assets). To determine a gain or loss, take the proceeds from the sale of each asset and subtract the amount you paid for it (i.e., its cost basis). The result is either a gain or a loss. Subtract short-term losses from short-term gains to find your net short-term gain or loss.

Next, calculate gains and losses on assets you’ve held for more than one year (i.e., long-term assets) using the same process. Subtract long-term losses from long-term gains to find your net long-term gain or loss.

If you have a net long-term gain and a net short-term loss: Subtract your short-term loss from your long-term gain to get your “net capital gain or loss.” Long-term gains are taxed at lower rates than your income. The rate can be 0%,15%, or 20% depending on your income. There may also be an extra 3.8% Medicare surtax. State tax rates can be different, so check with your local tax office.

If you have a net short-term gain and a net long-term loss: Subtract the long-term loss from the short-term gain. Any remaining gain will be taxed at your tax bracket based on your income level.

If you have both a net short-term gain and a net long-term gain: The short-term gain will be taxed at your regular income rate, while the long-term gain will have its own lower rates.

If you have a net loss, you can subtract up to $3,000 of losses from your other income on your tax return. If you have more losses, you can use them in future years.

The Wash Sale Rule

Lastly, there’s a rule called the wash sale rule. If you buy back the same investment (or one very similar) within 30 days before or after selling it, you cannot claim a loss on your tax return for that sale. You can, however, add the loss to the cost of the repurchased investment and benefit from the loss down the road when you sell that investment. Capital gains taxes can be tricky, but a tax professional can help you understand them better. To learn more, check out IRS Tax Topic 409, Capital gains and losses.

How are Restricted Stock Units (RSUs) Taxed?

June 06, 2025

Restricted Stock Units (RSUs) are a form of equity compensation. They are awarded as company stock and can be viewed as part of an employee’s overall compensation package. How this form of compensation is taxed can be tricky, so it is important to know the ins and outs so that there are no surprises come tax time.

RSU Basics

RSUs are typically awarded when an employee starts their job and/or on a regular basis at the discretion of the employer. When RSUs are awarded, the employee does not own them yet. Ownership comes according to a predetermined timetable known as a vesting schedule. For example, an award of 1,600 shares may vest 100 shares per quarter for the next 16 quarters (four years). As shares vest, employees can sell the shares as needed to generate cash. The selling of shares may be subject to restricted trading windows, so employees should check with their employer on that. Here is a breakdown of when and how employees are taxed on RSUs:

Taxation At the Time of Award

Unless your RSUs are immediately vested, they are generally not taxed at this time.

Taxation At the Time of Vesting

The vesting of your shares is a taxable event. The value of the shares that vest is taxed as ordinary income in the year that the vesting occurs, even if you don’t sell the shares. For example, if 100 shares vest on May 15th and the value per share is $50, $5,000 (100 shares x $50 per share) will be added as taxable income for the year.

The amount of federal taxes owed depends on your tax bracket which is determined by your overall tax situation for the year. Depending on your state of residence, state and local taxes may be owed as well. Note that the employer may automatically sell a certain amount of shares to be used for tax withholding at the federal and state levels, if applicable. Check with your employer to see if the number of shares sold for withholding can be changed to reflect your anticipated overall tax situation.

Taxation At the Time of Sale

The sale of vested RSUs is a taxable event as well. You will have to pay capital gains tax on any appreciation of the value of the stock from the time of vesting to the time of sale. Building on the example above, if the 100 shares are later sold for $60 per share (a total value of $6,000), you will owe capital gains tax on the $1,000 of appreciation (i.e., $6,000 sale value – $5,000 cost basis).

There are two types of capital gains:

Short-term capital gain. If the time between vesting and selling is one year or less, it will be a short-term capital gain and taxed as ordinary income for the year. 

Long-term capital gain. If the time between vesting and selling is more than one year, it will be considered a long-term capital gain and will be subject to long-term capital gains tax rates. 

Generally, less taxes are owed with a long-term capital gain, but you should always compare short- and long-term gains to identify which sales would reduce tax liability most effectively. If the value of the shares when sold is less than the value when they vested, this will incur a capital loss that may be used to offset capital gains in the same year (but be aware of the wash sale rule).

Pro Tip: If you don’t intend to hold on to them very long, consider selling shares that vest immediately to minimize taxes.

If you are fortunate enough to receive RSUs as a form of stock compensation, it’s important to understand how they are taxed as part of an overall tax planning strategy. As with many tax matters, it’s a good idea to consult with a tax professional to get advice on your specific tax situation.

NUA – One Overlooked Benefit Of Employer Stock In Your 401(k)

April 11, 2025

Should you own stock in your current or former employer? There are mixed opinions out there regarding the risk of holding too much stock in the same company that provides your paycheck, but before you liquidate a large holding in your 401(k), keep reading.

One little known benefit of holding company stock in a 401(k) plan is the ability to have the “net unrealized appreciation” of the stock or “NUA” taxed at a lower tax rate. Normally, when you take money out of a traditional 401(k), it’s taxed at your ordinary income tax rate. However, the gain in employer stock can be taxed at the lower long term capital gains rate if you meet several conditions:

Here’s how NUA works

1) You have to reach a triggering event. This can be death, disability, separation from service, or reaching age 59 ½. You can’t take advantage of this at any time. Most people take advantage of it upon retirement or after.

2) You have to take a lump sum distribution of the entire account. You can’t just withdraw the shares of stock. However, you can choose to roll the rest of the money into an IRA or another retirement account, while moving the company stock shares to a regular brokerage account.

3) The employer stock has to be distributed “in kind.” Basically, this means you can’t sell the shares and then withdraw the cash as you would typically withdraw money from a 401(k). Instead, you have to transfer the shares of stock into a brokerage firm.

If you meet the criteria above, then when you do a withdrawal of the company stock, you will pay ordinary income taxes on the cost basis of the stock (essentially the value of the stock when you purchased or received it) at that time. You may choose to hold the stock or liquidate some or all of it at that point. When you do so, you’ll pay taxes at the lower long term capital gains rate on any growth in the value of the shares beyond what you paid for them (regardless of how long you actually held them).

Be aware that withdrawing a large amount of stock could push you into a higher tax bracket for that year, so you’ll want to be strategic about when you make this move. However, removing the stock from your retirement account would also reduce the amount of required minimum distributions you’d have to take starting at age 73. (Incidentally, the capital gain would not be subject to the 3.8% Medicare surtax on investment income, but the stock would not benefit from a step-up in basis when you pass away.)

It’s about more than just the taxes

As the saying goes, don’t let the tax tail wag the dog. This is not a reason to load up on company stock. After all, individual stocks are always a lot riskier than diversified mutual funds since an individual stock can go to zero and never recover. This is even more true when it’s the company that your job is tied to. A good rule of thumb is to never have more than 10-15% of your portfolio in any one stock, especially your employer’s.

That being said, it could be a good reason to keep some money in company stock, especially if you already have shares that have appreciated quite a bit. In fact, this is one of the main reasons you may not want to roll a former employer’s retirement plan into an IRA or a new retirement plan while still working.

How to decide whether NUA is right for you

You can calculate the value of doing an NUA distribution versus an IRA rollover here. If you’re still not sure whether this makes sense for you, see if your employer offers access to an unbiased financial planner who can help you with what can be a complex decision, or consult your own financial advisor if not.

The 401(k) Self-Directed Brokerage Window

February 09, 2025

Are you a hands-on investor seeking investments beyond your 401(k) plan’s core list of investment choices? If so, you may have a self-directed brokerage account (SDBA) option in your retirement plan.

Who typically uses a self-directed brokerage account in a 401(k) plan?

SDBAs are intended for experienced investors who are comfortable making their own investment decisions. This option is generally popular among savers with larger retirement plan balances or who work with an outside financial advisor. For example, Schwab recently reported that the average account balance of those using this option is just over $273,000. Compare this to Fidelity’s reported average balance of all 401(k) participants, which is just under $104,000.

What does a self-directed brokerage account offer?

The main benefit is that SDBAs give you more flexibility regarding the investment options available. Wider access can be a refreshing alternative if you are generally unhappy with the currently available investment options.

For example, let’s say your 401(k) plan doesn’t include target-date or asset allocation funds. With the SDBA, you can add those funds to your retirement portfolio. This can be appealing if you’re trying to access asset classes not represented in your core portfolio. Examples include emerging market stocks, international small cap, and value or growth-oriented funds. SDBAs can even help you diversify with alternative asset classes such as real estate and commodities.

Beware of the paralysis of too many choices

But as behavioral finance studies on the paradox of choice have shown us, too many options can hinder participation. This is true for 401(k) plans as well. Choosing the right investments for your goals, risk tolerance, and time horizon also requires discipline. Most investors lack a written game plan or investment policy statement. As a result, many individual investors are prone to the “behavior gap” and underperform the actual funds they own due to mistakes related to emotional decision-making and market timing. 

Self-directed brokerage accounts are designed for advanced investors who know how to research and manage their investments. Bankrate warns investors that the additional choices commonly associated with self-directed accounts do not lead to better outcomes for most investors. In order to follow a disciplined investment plan, focus on things within your control, such as asset allocation, contribution rates, minimizing costs, and asset location (i.e., pre-tax vs. Roth 401(k)).

Pay attention to the fees

It’s important to note that while SDBAs offer greater investment flexibility, they may also come with higher fees. These fees can include transaction fees, account maintenance fees, and trading commissions. So, carefully consider the costs and benefits of an SDBA and your investment objectives and risk tolerance before opening one.

Minimizing your overall investment costs is one thing you have some control over as an investor. So, it’s equally important to understand all fees and expenses as it is to know your core 401(k) plan expenses.

Some 401(k) plans charge an annual maintenance fee for using the mutual fund or brokerage window. It is also necessary to identify if there are any commissions and transaction costs associated with trades made through SDBA accounts. You can check your plan’s fee disclosure to better understand the actual costs related to your 401(k) plan.

Check mutual fund expenses

In some cases, you may also see increased mutual fund expenses when you go outside your core investment options. This is because most funds available in the SDBA are retail share classes. Retail share classes tend to be much more expensive than the institutional funds many large retirement plans provide access to. On the other hand, if your 401(k) plan has expensive mutual funds, the self-directed brokerage account is a potential remedy.

How does its performance compare?

Finally, it is important to note that there is a reason self-directed brokerage accounts are underutilized. The average investor is often better served by simplifying their investments as much as possible. That is why it is important to establish benchmarks to track your performance.

Self-directed brokerage accounts give you an opportunity to try to outperform or diversify your plan’s core options. But if you choose to take the self-direct route and find that your investment performance consistently lags behind the core investment portfolio, you may need to take a simpler approach to your retirement savings plan.

The Risks Of Employer Stock

February 09, 2025

One of the biggest risks lurking in people’s investments is having too much in a current or former employer’s company stock. What’s too much?

Rule of thumb

You should generally have no more than 10-15% of your investment portfolio in any single stock. It’s worth noting that an investment adviser can lose their license for recommending more than that.

More than just a stock when it’s your job

So why is this such a bad idea? What if your company stock is doing really well? Well, remember Enron, anyone? While it’s practically impossible for a well-diversified mutual fund to go to zero, that could easily happen with an individual stock. In that case, you could simultaneously be out of a job and a good bulk of your nest egg.

Now, I’m not saying your company is the next Enron. It could be perfectly managed and still run into trouble. That’s because you never know what effect a new technology, law, or competitor can have, regardless of how good a company it is.

Nor does the company have to go bankrupt to hurt your finances. Too much in an underperforming stock can drag down your overall returns, and even a well-performing stock can plummet in value just before you retire. As volatile as the stock market is as a whole, it’s nothing compared to that of an individual stock.

Why do we over-invest in our own companies?

So why do people have so much in company stock? There are two main reasons. Sometimes, it’s inadvertent and happens because you receive company stock or options as compensation. For example, your employer may use them to match your contributions to a sponsored retirement plan. Other times, it’s because people may feel more comfortable investing in the company they work for and know rather than a more diversified mutual fund they may know little about.

A general guideline is to minimize your ownership of employer stock. After all, the expected return is about the same as stocks as a whole (everyone has an argument about why their particular company will do better, just like every parent thinks their child is above average). Still, as mentioned before, the risks are more significant. That being said, there are some situations where it can make sense to have stock in your company:

When it might make sense to keep more than usual in company stock

1) You have no choice. For example, you may have restricted shares that you’re not allowed to sell. In that case, you may want to see if you can use options to hedge the risk. This can be complicated, so consider consulting with a professional investment adviser.

2) You can purchase employer stock at a discount. If you can get a 10% discount on buying your employer’s stock, that’s like getting an instant 10% return on your money. If so, you might want to take advantage of it but sell the shares as soon as possible and ensure they don’t exceed 10-15% of your portfolio.

3) Selling the stock will cause a considerable tax burden. Don’t hold on to a stock just because you don’t want to pay taxes on the sale, but if you have a particularly large position, you may want to gift it away or sell it over time. If you do the latter, you can use the same hedging strategies as above.

4) You have employer stock in a retirement account. This is a similar tax situation because if you sell the shares, you’ll pay ordinary income tax when you eventually withdraw it. However, if you keep the shares and later transfer them out in kind to a brokerage firm, you can pay a lower capital gains tax on the “net unrealized appreciation.” (You can estimate the tax benefit of doing so here.) In that case, you may want to keep some of the shares, but I’d still limit it to no more than 10-15% of your total portfolio.

5) You have a really good reason to think it’s a particularly good investment. For example, you work at a start-up that could be the proverbial next Google. It may be too small of a company for analysts to cover, so it may genuinely be a yet-to-be-discovered opportunity. In that case, go ahead and get some shares. You may strike it rich. But remember that high potential returns come with high risk so ensure you’ll still be financially okay if things don’t pan out as hoped.

The ups and downs of the stock market typically get all the media and attention. But your greatest investment risk may come from just one stock. So don’t put all your eggs in it.

Should You Contribute To Pre-Tax Or Roth 401k?

February 07, 2025

For all the efforts that companies undertake to make participating in their retirement plan benefits easy, there’s no simple way to help employees decide whether the money they contribute from their own paychecks should be traditional (also called pre-tax) or Roth (also sometimes called after-tax Roth). The answer can be very nuanced depending on your situation, and for the most part, we won’t know whether we chose correctly until it’s too late. We’ll only really know if we got the answer right when it comes time to withdraw and we actually know our taxable income, current tax brackets, and lifestyle needs.

Since my crystal ball seems to be broken, I’ve attempted to distill the various factors in a way that makes more sense. Keep in mind that many of the factors listed in the chart below are just different ways of saying the same thing, but the intention is to present it in the way that makes the most sense to you.

The biggest factor affecting this decision: taxes

If we all could just know what tax rates will be when we retire and start withdrawing from our retirement savings, along with what our own income will be at that point, this would be a simple choice – if you knew your tax rate would be lower when withdrawing from your retirement account, you’d choose pre-tax and avoid paying taxes on the money today so that you could pay at a lower rate in the future.

On the flip side, if you knew that tax rates would be higher when you’re withdrawing and you’d be paying more in taxes, choose Roth to pay today’s lower rates, then enjoy your savings without tax consequences in the future.

Predicting the future of tax rates

I’m personally making Roth contributions right now in my 401(k) because I believe that we are currently experiencing the lowest tax rates I’ll see in my lifetime. And while I very well may have a lower income in retirement, the tax brackets themselves may be different, so even if I have a lower income, I think I might have a higher tax rate in the future. (keep in mind that I could be wrong about this – reason tells me that tax rates will have to go up in the future, but Congress has surprised us before!)

I like that I can change this strategy at any time. For example, when my husband sold some stock he’d been given as a child for a big capital gain, I switched to pre-tax for the rest of that year in an effort to lower our overall taxable income.

Income limits and the ability to withdraw without taxes

I also like the idea of having investments available to me in retirement that I can liquidate and withdraw without concern for the tax consequences, and my husband and I have too high of a combined income to contribute to Roth IRAs, so I like that the Roth 401(k) doesn’t have an income limit.

Now, there is a way around those income limits using a “back-door” Roth IRA, but that doesn’t work for me because I also have a rather large rollover traditional IRA.

Another consideration: access to the contributions for early retirement

You can’t withdraw Roth 401(k) contributions before 59 1/2 without penalty. However, you can withdraw contributions to a Roth IRA early. If you’re lucky enough to retire before then, you can always roll your Roth 401(k) into a Roth IRA. Then, tap those contributions if necessary, without concern for taxes or early withdrawal penalties. That’s another reason you want to at least have some retirement savings as Roth, regardless of tax rates.

Factors to consider:

Factor:Traditional (pre-tax)Roth (after-tax)
You think your taxes are higher today than they’ll be when you withdrawMakes more senseMakes less sense
You think your taxes are lower today than they’ll be when you withdrawMakes less senseMakes more sense
You want to avoid required distributions after age 73Makes less senseMakes more sense, as long as you roll to a Roth IRA
You think your income tax bracket will be lower when you withdrawMakes more senseMakes less sense
You think your income tax bracket will be higher when you withdrawMakes less senseMakes more sense
You need more tax deductions todayMakes more senseMakes less sense
You have a long time until withdrawal and plan to invest aggressivelyMakes less senseMakes more sense
You’d like access to your contributions before the traditional retirement ageDoesn’t make senseMakes sense

Splitting the difference

If you’re unsure or thinking about it makes your head hurt, you could always split your contributions between the two. In other words, if you’re putting 10% away, you could do 5% pre-tax and 5% Roth. The contribution limit applies as a total for both. However, there’s no rule that you have to put your money into just one bucket or the other at a time.

One more thing to know

No matter your contribution type, any matching dollars or employer contributions will always be pre-tax, per IRS rules. So even if you put all your own contributions into Roth, you’ll still have pre-tax money if you receive any from your job. Now, you may be able to convert those contributions to Roth, depending on plan rules. But if you do that, you’ll have to pay taxes on the amount converted, so plan carefully.

4 Steps To Perform Your Own Investment Analysis

February 07, 2025

Two of the most common questions that I get as a financial coach are, “Do my investments make sense for me?” and, “Am I paying too much?” Generally, those are questions that I can’t answer in one minute, but with the right tools and a few minutes anyone can figure out the answer.

When I was a financial advisor trying to convince a potential client that I could do better than their existing advisor, here are the steps I would take – anyone can do them with the right knowledge.

How to do a self-analysis of your investments

Step 1 – Take a Risk Tolerance Assessment

You must know what amount of risk makes sense for you. I don’t care about your friends, relatives or co-workers. Does your mix of investments make sense for you?

To find out, this Risk Tolerance Assessment takes about 2 minutes or less, and will then offer you general guidelines as to how much money you should have in stocks, bonds and cash (aka money markets or stable value funds). If you have two entirely separate goals, such as a college fund that you need in 10 years and retirement in 25 years, then take the assessment more than once, each time with that specific goal in mind.

Step 2 – Figure out exactly what investments are held in your funds

Just because your fund says one thing in their objective doesn’t mean that it’s clear what your fund actually owns. If you really want to know, you can actually find out using a tool on Morningstar. Here’s how:

  1. Get a copy of your statement, then look for your account holdings. You are looking for fund names such as ABC Growth Fund Class R5. Even better, see if you can find the “ticker symbol” for each fund, which is a multi-letter code such as “ABCDE.”
  2. Go to Morningstar.com and enter the name or ticker symbol.
  3. Once you’ve found the Morningstar page for your fund, click on the tab labeled “Portfolio.”
  4. This tab will break down the mix in the fund by stocks, bonds and cash – keep in mind that Stocks include both US and non-US stocks, while bonds will simply be labeled as Bonds, and cash or money market will be listed as Cash.
  5. You can really geek out if you want by digging into how much is in large company stocks compared to mid and small sized companies or look at what sector of the economy your fund focuses on (such as technology or manufacturing, etc.) You may even find some fun in looking at the Top 10 holdings in each fund to see if you have an overload in a certain company.

The most important thing is that when you add up all the money in stocks based on this analysis it is close to what your risk tolerance suggests. The other key thing to check is that everything doesn’t look exactly the same. So if all of your funds are mostly large companies or all of them are US Stocks, then you may be out of balance.

Step 3 – Analyze fees

Once you have determined that your investments are or are not matching up with your risk, the next step is determining how much you are actually paying the mutual fund companies through fees, which are also called “expense ratios.”

While Morningstar has good info on that, the FINRA Fund Analyzer is a more helpful tool for this purpose. Here’s how:

  1. Again, enter the fund name or the ticker symbol into the analyzer, and when you’ve found your fund, click on “View Fund Details.”
  2. Scroll down to “Annual Operating Expenses” to see how the expenses for your fund stack up against its peers.
  3. Also look to see if you must pay a fee to get into or out of that fund.

Obviously, the ideal is to invest in funds where the fees built into the fund are at or below the average fee for that peer group.

Step 4 – Compare your advisor fees to benchmarks (if you have an advisor)

If you are a do-it-yourself investor, you can skip this last step, but if you have an investment advisor who is helping you with your investments then the last step is figuring out if you are paying them more than average.

Commission-based advisor

If you are investing in funds that showed a lot of up-front commissions or “Contingent Deferred Sales Charges” or “CDSCs” in Step 3, then that means your advisor is paid by commission. If so, then the key here is to make sure that the commissions are comparable to industry averages and that you are holding onto the funds – or at least staying in the same mutual fund company options – for about 7 years or longer in order to realize the value of the up front fees. This allows you to minimize the overall fees paid and avoids paying commissions too frequently.

“Fee-only” advisor

If your advisor is “fee-only,” then they don’t charge commissions, and instead they charge a management fee based on the total value of your investments. Generally, this is a fee that is collected quarterly, so in that case each quarter the fee is applied to your balance and then divided by 4. So, if you have a 1% fee on your $100,000 account, your fee would be $1,000 per year or $250 per quarter. Keep in mind that this is in addition to the fees you explored in Step 3, and will show up as a separate fee on your statement.

How much is too much?

As for what your fee should look like, a good rule of thumb is that if you are paying close to or above the average, then you should be receiving value for that in the form of other services such as financial planning, tax planning, etc. to justify the higher fee.

That said, it can vary quite a bit depending on the size of your account. In other words, the more money you have, the lower the percentage, but probably higher the dollar amount of your advisory fee.

Ultimately, it’s up to you to determine if you’re receiving proper value for any advisor-based fees. If you don’t think you are, then consider shopping around.

What about robo-advisors?

Today, there are lots of robo-advisors out there that will do most of the same things when it comes to managing your investments that a typical advisor would do, but the fees tend to be lower, ranging from 0.25 – 0.35%. Does that mean everyone should be using robo? Like anything else, some people are very comfortable with using technology as a tool and getting planning or guidance somewhere else. If that is you, then a lower-cost robo advisor may make sense.

If, however, you are like many folks and prefer someone you can call when you have questions who is intimately familiar with you and your situation, then paying up to that industry average may be worthwhile. Lastly, if you like your advisor but their fees are above average then you can always try to negotiate with them for lower fees and/or additional services like financial planning, retirement or college planning, etc.

Should You Let A Robo-Advisor Pick Your Investments?

February 07, 2025

Technology has revolutionized everything from choosing a restaurant to getting directions or even a ride to that restaurant, but is it time for technology to get you to your investment destination as well? While this may sound like science fiction, the rise of “robo-advisors” has made this into a plausible option.

These online automated investment services can provide investment advice or management for typically a lot less than a human advisor. But should you really entrust your nest egg to a computer and if so, which of the many options would make the most sense for you?

Pros of robo-advisors

  • It’s convenient. You don’t have to have a large amount to invest or go to a fancy office and talk to a pushy salesperson. Most robo-advisors have very low minimums and allow you to set up and fund the account from the comfort of your smartphone or at least, your computer.
  • You get a customized asset allocation. “Asset allocation” is a fancy term for dividing your money into various types of investments (called “asset classes”) like stocks, bonds, and cash. Rather than having to make this decision on your own, robo-advisors generally do this for you based on your responses to questions that are designed to determine your time frame and comfort with risk. All you need to do is then fund the account.
  • The costs are relatively low. You could get asset allocation advice from a human advisor, but that typically costs about 1% of your assets. They may also put you into funds with high fees. Robo-advisors generally charge a lot less and use low cost index funds.

Cons of robo-advisors

  • The “advice” is very limited. Robo-advisors generally only help you with your investments. You typically won’t get help with other financial planning issues like how much you should be saving, what type of accounts to invest in, and whether you have adequate insurance coverage and estate planning. The investment advice you do get may also not incorporate taxes or how your money is invested elsewhere.
  • There’s no “hand holding.” One of the most valuable services of an advisor is to talk you out of doing something stupid – whether that’s putting too much in an aggressive tech stock or bailing out when the market takes a downturn. To the extent that robo-advisors do this, they still lack the emotional connection and persuasive/motivational ability of a trusted human advisor.
  • There are generally still advisory fees. Even a small advisory fee can add up over time. You could do a lot of what robo-advisors do without paying their fees by simply investing in an asset allocation fund that matches your risk level or taking a risk tolerance questionnaire and following the asset allocation guidelines.

How to get started if a robo-advisor is what you need

  • Know what you’re looking for. If you’re investing in a taxable account, you might want to look for a robo-advisor that offers tax-efficient investing and/or tax loss harvesting. A few offer access to a human advisor by phone. Make sure you’re also comfortable with the program’s investment strategy.
  • Know your options. Your employer’s retirement plan may offer a robo-advisor program. Some are also offered by particular brokerage firms for their clients.
  • Know what you’re paying. Look at both the fees that the robo-advisor charges and the expenses of the funds it recommends. “Free” robo-advisors may put you in their own bank accounts and mutual funds, which may be more expensive than another program’s fees.

For investors who are looking for investment management or advice but are unwilling or unable to hire a financial advisor, robo-advisors can offer a simple and relatively low cost solution. (Just be aware of their limitations.) At the very least, they will make human advisors work that much harder to earn the fees they charge.

Should You Be In An Asset Allocation Fund?

February 07, 2025

One of the most common questions we get on the Financial Helpline is how to choose investments in your employer’s retirement plan. Investing can be complex and intimidating so it doesn’t surprise me that people are looking for help with their decision. What does surprise me is how few of them understand and use an option that was created to help simplify their decision.

Target date or target risk funds

Depending on your plan, you may have a target date or a target risk fund available to you. Both are “asset allocation funds” that are designed to be fully-diversified “one stop shops.” All you need to do is pick one fund that most closely matches your target retirement date or your risk level. (Target date funds can also be “set it and forget it” because the funds automatically become more conservative as you get closer to the target retirement date.)

If you think of investing as getting you from point A to point B, asset allocation funds are like the commercial jets of investing. They’re much cheaper than a private jet (a financial advisor) and much simpler than piloting your own plane (picking your own investments). That’s why when I first heard about these funds early in my financial career, I assumed they would take over much of the mutual fund industry and even replace the need for a lot of financial advisors. While they have seen a meteoric rise, especially as the default option in retirement plans, they still aren’t utilized as much as I thought they would be. I think there are 3 main myths responsible for this:

1. Putting everything in one asset allocation fund is having all my eggs in one basket. What you don’t see is that an asset allocation fund is actually a basket of baskets. Each fund is composed of several other funds. In fact, one asset allocation fund is usually more diversified then the typical mix of funds that I see people in.

So why not have other funds in addition to it? Isn’t that making your portfolio even more diversified? The problem here is that these funds were professionally designed to hold a certain proportion of investments so adding others will throw the balance off. It’s like adding extra ingredients to a chef-prepared meal. Only do it if you really know what you’re doing (in which case, you probably don’t need an asset allocation fund anyway).

2. I can probably do better on my own. Remember that these funds were put together by professional money managers who’ve been trained in investment management and do this for a living. What’s the chance that you’ll create a better portfolio? One study of 401(k) participants showed that investors who chose their own funds did worse on average than those who just went with a target date fund.

Part of that is due to lack of knowledge. However, a lot is also likely due to the temptation to buy investments that are performing well and then sell them when they eventually underperform, which is a recipe for buying high and selling low. If nothing else, asset allocation funds provide discipline… assuming you don’t trade these funds too of course.

3. Asset allocation funds are always more expensive. You would think that this professional management would come at a steep price. After all, paying for investment management typically costs .5-1% of your portfolio. However, asset allocation funds are generally only slightly more expensive than other funds and if they’re composed of index funds, they can actually cost much less than most actively managed funds. Check the fund’s expense ratio before making assumptions as to their cost.

That all being said, there are reasons not to use an asset allocation fund. You may not have one available in your plan or the one you have may be too expensive. Sophisticated investors or those with an advisor may want to create a more personalized portfolio that better matches their risk level or complements outside investments to maximize tax-efficiency. But if those situations don’t apply to you, consider an asset allocation fund. Flying commercial may not be a perfect experience, but it’s better than the alternatives for most people.

What is a 403(b) Plan?

February 06, 2025

What is a 403(b) Plan?

If you have ever worked for a nonprofit organization, you likely have heard the term 403(b) retirement plan. While not as common as the 401(k), a 403(b) shares many of the same benefits that make it a very powerful retirement tool for those working for public schools and other tax-exempt organizations.

The Details

As noted above, 403(b) plans have much in common with the 401(k) plan, which is very common in the private sector. Participants that may have access to 403(b) include:

  • Employees of public schools, state colleges, and universities
  • Church employees
  • Employees of tax-exempt 501(c)(3) organizations

The 403(b) plan has the same caps on annual contribution as 401(k) plans.

Employers can match contributions based on the specific plan details, which vary from employer to employer. 

Employees may also be able to contribute to a pre-tax 403(b) and/or Roth 403(b), as both options may be available based on the plan details. A traditional 403(b) plan allows employees to have pre-tax money automatically deducted from each paycheck and deposited into their retirement account. The employee receives a tax break as these contributions lower their gross income (and income taxes owed for the year). The taxes will be due on that money only when the employee withdraws it in retirement.

A Roth 403(b) is funded with after-tax money, with no immediate tax advantage. But the employee will not owe any more taxes on that money or the profit it accrues when it is withdrawn (if they are 59 ½ and have a Roth for five years).

Pros and Cons

Being able to save for retirement automatically is a tremendous benefit of the 403(b) construct. The tax-deferred (pre-tax) or tax-free growth(Roth) nature of these savings is also a huge incentive for employees to save as much as possible – not to mention the free money an employer match may provide. Many 403(b) plans will have a shorter vesting period relative to their 401(k) cousin, which allows. This means employees will have access to the matching funds quicker should they change employers.

On the downside, withdrawing funds before age 59 ½ will likely result in a 10% early withdrawal penalty. And many 403(b) plans offer a more limited range of investment options than other retirement plans.

Summary

Like the 401(k), the 403(b) retirement plan is critical to retirement planning and saving for individuals with access to them. The automatic saving nature of the plan makes it very convenient to save for the future. Saving early, often, and as much as you can afford will set you up for your coveted retirement. Happy Saving!

How To Invest For Education Expenses

February 06, 2025

Today, I conclude my investing series with how to invest in an education savings account. The first question is whether you even should at all. Before investing for education, make sure you have adequate emergency savings, no high interest debt, and are on track for retirement. This may sound selfish but there’s no financial aid for your retirement. If you’re ready to save and invest for education, here are some things to consider:

How good is your state’s 529 plan?

529 plans are state-based education savings plans in which the earnings can be used tax-free for post-secondary education expenses (but otherwise subject to taxes and possibly a 10% penalty) and you’re not limited to the state in which you live or the state in which your child goes to school.  There are a couple of things to consider in deciding whether to use your state’s plan. The first is whether your state offers a state income tax deduction or lower expenses for residents contributing to the plan. The second is the fees charged by the mutual funds in the plan. This resource can be used to compare 529 plans.

Want more flexibility?

If your state isn’t on the “Honor Roll,” you may also want to consider contributing the first $2k per year (the contribution limit) to a Coverdell Education Savings Account (ESA), which also allows tax-free earnings for education (and otherwise subject to taxes and a 10% penalty as well). You can also use an ESA for tuition, books, and computers at K-12 schools if needed while 529 plans are eligible to use only up to $10,000/year for tuition at K-12 schools. Here is a list of low-cost Coverdell ESA providers. (Coverdell ESAs have income limits on the contributors but you can easily avoid this by gifting the money to your child and having them contribute it to the account.)

Another option is to open a custodial account in your child’s name. This allows you to invest it in anything and use the money in any way penalty-free for the child’s benefit (not just qualified education expenses). You will still get some tax breaks with custodial accounts, but not quite as good as those on 529 plans. Money in your child’s name can also reduce their financial aid eligibility more than other savings and they can legally use it for any purpose once they reach your state’s age of majority.

How soon is your child going to school?

If your state offers a state income tax deduction and your child is going to school soon, you may want to contribute to a 529 even if your state isn’t on the “Honor Roll.” That’s because the value of the tax deduction can outweigh the higher fund fees in the short term. In fact, in some states you can even contribute to the plan to get the state tax deduction and then immediately use the money for education expenses. In that case, you won’t even be investing the money at all.

If you’re still not sure which option is best for you, you might want to consult with an unbiased financial planner. If your employer offers you access to one-on-one consultations through your financial wellness program, take advantage.

How Your Company Stock Plan Benefits You

February 06, 2025

It wasn’t long ago (the late `90s, actually) that workers by the hundreds were becoming enviably wealthy through dot-com stock options. While those days of fast fortunes might largely be behind us, employee stock ownership plans, which make owners of all or most of a company’s workforce, can still provide a nice boost to compensation.

Stock ownership (otherwise known as equity compensation) plans come in a variety of forms, with some companies offering more than one type of opportunity to their employees.

Types of Plans

Restricted Stock Units (RSUs):

Restricted Stock Units (RSUs) represent an employer’s promise to grant employees one share of stock per unit based on vesting requirements or performance benchmarks. An employee receives the shares when they vest. Because this is taxable income, often the employer will sell the number of shares needed to cover the income and payroll taxes, thus giving the employee a tax basis on the remaining shares equal to the value of the shares at the time of vesting (vesting date price). The employee is not deemed to own the actual shares until vesting and does not have voting rights.

Because taxes have been paid on the shares when they’re received, short or long-term capital gains tax will be owed on the difference between the selling price and the vesting date price when the shares are sold.

Employee stock purchase plans (ESPPs):

An ESPP gives employees of public companies the chance to buy their company stock (usually through payroll deductions) over a specified offering period at a discount of up to 15 percent off the market price.

As with a stock option, after acquiring the stock, the employee can sell it for a profit or hold onto it for a while. Unlike with stock options, the discounted price built into most ESPPs means that employees can profit even if the market value of the stock has gone down a little since it was purchased.

Employee stock ownership plans (ESOPs):

An ESOP is similar in some ways to a profit-sharing plan. Shares of company stock are allocated to individual employee accounts based on pay or some other measure. The shares vest over time, and employees receive their vested shares upon leaving the company.

Employee stock options (ESOs) and related plans:

A stock option gives an employee the right to purchase a specified number of shares at a fixed price for some period in the future. For example, if an employee has a vested option to buy 100 shares at $10 each and the current stock price is $20, they could exercise the option and buy those 100 shares at $10 each, sell them on the market for $20, and make $1,000 profit. If the stock price never rises above the option price, the employee would simply not exercise the option.

Early on, companies gave stock options only to “key” employees (often to just the executive team). These days, many companies that give options extend them to all or most employees.

Keep in Mind

Equity compensation may not always be a sure road to the country club life, but company equity still offers great potential for financial reward. Just be sure that any company stock you own fits into your overall financial strategy. A good rule of thumb is to avoid having more than 10% in any one individual stock, so your investments are diversified. Consider contacting your personal financial coach to further discuss how these plans can play a part in achieving your financial goals.

Be A Tax Savvy Investor

February 05, 2025

Take advantage of long-term capital gains rates

Hold stocks and mutual funds for more than twelve months to have your gains taxed at lower capital gains rates.

Consider tax-advantaged investments

Municipal bonds are issued by state and local government agencies. The interest is tax free at the federal level, but may be subject to the alternative minimum tax. Those issued by the state or municipality where you live are tax free at the state or local level as well.

Sell investments at a loss

If you have stocks or mutual funds in a taxable account that are worth less than you paid for them, and your losses exceed your gains, you can take losses of up to $3,000 against your taxable income. Be sure to evaluate selling costs and the investment’s future potential first.

Watch out for the wash sale

You can sell mutual fund or stock losers and buy them back again if you feel they are good long-term investments (but make sure you wait at least 31 days before you buy them back or the IRS will disallow your loss).

Don’t buy mutual funds at the end of the year

Mutual funds may pay out capital gains accrued throughout the year as a taxable distribution toward the end of the year (even if you just bought the fund, you’ll owe taxes on this payout!). Wait until after the distribution is made if you wish to minimize your tax bill.

Know the limit if you’re selling your home

Qualifying homeowners are exempt from the first $250,000 of capital gains ($500,000 if married filing jointly) when they sell their home.

Understand the different tax rates for dividends versus interest

Qualified dividends paid from stock investments are taxed at the same rate as long-term capital gains. Interest earned on investments such as CDs, savings accounts, and money market funds, however, are taxed at higher ordinary income tax rates.

How to Invest in a Taxable Account

February 05, 2025

Investing in your retirement account can be quite different from investing in a taxable account. Here are some options to consider when investing in a taxable account:

Use it for short term goals. One of the advantages of a taxable account is that you don’t need to worry about any tax penalties on withdrawals. For that reason, it probably makes the most sense to use a taxable account for goals other than retirement and education like an emergency fund, a vacation, or a down payment on a car or home. In that case, you don’t want to take risk so cash is king. To maximize the interest you earn, you can search for high-yielding rewards checking accounts, online savings accounts, and CDs on sites like Deposit Accounts and Bankrate.

Keep it simple for retirement. Just like in a 401(k) or IRA, you can simplify your retirement investing as much as possible with a target date fund that’s fully diversified and automatically becomes more conservative as you get closer to the target retirement date. There are a couple of differences in a taxable account though. The bad news is that you’ll be paying taxes on it each year so you want a fund that doesn’t trade as often. The good news is that you’re not limited to the options in an employer’s plan so you can choose target date funds with low turnover (how often the fund trades and hence generates taxes) like ones composed of passive index funds.

Invest more conservatively for early retirement. If you plan to retire early, a taxable account can be used for income until you’re no longer subject to penalties in your other retirement accounts or to generate less taxable income so you can qualify for bigger subsidies if you plan to purchase health insurance through the Affordable Care Act before qualifying for Medicare at age 65. In either case, you’ll want to invest more conservatively than with your other investments since this money will be used first and possibly depleted over a relatively short period of time. Consider a conservative balanced fund or make your own conservative mix using US savings bonds (which are tax-deferred and don’t fluctuate in value like other bonds do) or tax-free municipal bonds instead of taxable bonds if you’re in a high tax bracket.

Make your overall retirement portfolio more tax-efficient. You can also use a taxable account to complement your other retirement accounts by holding those investments that are most tax-efficient, meaning they lose the least percentage of earnings to taxes. Your best bets here are stocks and stock funds since the gains are taxed at a capital gains rate that’s lower than your ordinary income tax rate as long as you hold them for more than a year. In addition, the volatility of stocks can also be your friend since you can use losses to offset other taxes (as long as you don’t repurchase the same or an identical investment 30 days before or after you sell it). When you pass away, there’s also no tax on the stocks’ gain over your lifetime when your heirs sell them.

In particular, consider individual stocks (which give you the most control over taxes) and stock funds with low turnover like index funds and tax-managed funds. Foreign stocks and funds in taxable accounts are also eligible for a foreign tax credit for any taxes paid to foreign governments. That’s not available when they’re in tax-sheltered accounts so you may want to prioritize them in taxable accounts over US stocks.

For retirement, you’ll probably want to max out any tax-advantaged accounts you’re eligible for first. But if you’re fortunate enough to still have extra savings, there are ways to make the best use of a taxable account. Like all financial decisions, it all depends on your individual situation and goals.

Real Estate Investing in a Crisis

April 29, 2020

There has been a surge of renter households in the US. As a result, the economic shockwaves set off by the coronavirus pandemic will reverberate not only for tenants but the owners of those properties. Whether you are an accidental landlord that has enjoyed income from your old primary residence or if you are depending on your multi-family real estate portfolio to provide the majority of your income in retirement, here is a summary of the obstacles and opportunities you need to consider.  

Financing 

Obstacles – The current economic downturn has drawn several comparisons to the most recent recession. While the causes are significantly different lenders have tightened their criteria again for home purchases for both home buyers and real estate investors. Recently, the FHA has significantly tightened their credit scoring criteria for qualifying for a loan.. In addition Non-Qualified (NQ) lending has reportedly taken a hit as well. This is a significant concern for some real estate investors that need short-term lending to purchase and renovate if they do not meet income standards. 

Opportunity – While credit has tightened on several fronts, financing may offer significant upside for property owners that qualify. Today’s rates are near all time lows. If you meet mortgage lending guidelines you may be able to refinance a property at lower rates. Additionally, if you were planning to expand or improve your real estate portfolio you can borrow against the equity in your existing properties at historically low rates. 

Single Family housing 

Obstacles – There is no doubt unemployment has increased as a result of this pandemic. While the actual percentage is still unclear it is clear for anyone owning rental property that they are concerned about tenants not being able to pay.  Because of the passage of the CARES Act evictions are frozen for 120 days starting March 27, 2020 for renters who live in properties that receive federal subsidies such as Section 8 vouchers or for renters whose landlords have government-guaranteed loans, including loans backed by Fannie Mae, Freddie Mac, the FHA, or the USDA. If the rental unit is not covered by the CARES Act, many individual states have issued similar suspensions on evictions.  

Opportunity – While the CARES Act gives some tenants a means to avoid eviction homeowners with government-guaranteed loans may be able to request forbearance for up to a year if their income is reduced as a result of COVID. In order to determine if your mortgage is backed by a government agency, start with the two largest entities FannieMae and FreddieMac.  If your loans are not backed by a government agency speak with your loan servicer and ask about what options would be available in your situation. If your tenant is struggling to pay but they are an otherwise good tenant, consider using the mortgage reprieve to temporarily reduce or suspend rent for a predetermined period. You should also help make your tenant aware of the stimulus support and temporary unemployment benefit increase. These resources will not only help them pay you but help get them get back on their feet faster once the economic downturn subsides.  

Multi-family housing  

Obstacles – Just like smaller properties, multi-unit apartment complexes also are going to face problems with tenants who have lost their job or taken a steep pay cut.  Anything larger than 4 housing units cannot be financed with a mortgage, so the loan forbearance options through Freddie Mac or Fannie Mae don’t apply.   

Opportunity – That doesn’t mean that you are without options.  If you have a larger rental property, follow much of the same guidance as earlier – work with your tenants if they are good tenants to help them access relief so that they can pay you at least in part and stay in your unit long-term.  You also want to reach out to your bank right away to see how they can work with you.  Just like you don’t want to lose a good tenant, they don’t want your loan to go into foreclosure.  Ask them if they can work with you by skipping some payments and adding them to the end of your loan or temporarily making interest-only payments on your loan.  That way, if your tenants can pay enough rent to cover this lower payment, taxes, insurance, and other fixed costs you should be in a much better spot to navigate the COVID outbreak. 

Commercial property 

Obstacles – Similarly, many small businesses have been forced to close by state and local stay at home orders which limit their ability to bring in the revenue to pay their rent.  Commercial property cannot be financed with a mortgage, so the loan forbearance options through Freddie Mac or Fannie Mae do not apply. 

Opportunity – If your property is leased out to a small business(es) then you may want to work with your tenant to make sure that they have applied for the Payroll Protection Program if they are eligible.  If your tenants qualify for the PPP, then they can use a portion of those funds to pay their rent which is a huge relief to you.  Similarly, if you currently pay yourself a smaller salary but get more of your income from the rent your business pays to you, the PPP can help your business not only protect your paycheck, but also the rent you pay to yourself as long as it is reasonable for the local market. 

Staying prepared for future uncertainty 

By now you have noticed that if you have cash and a good credit score, it gives you more flexibility in terms of dealing with this crisis. In fact, there is a decent chance that if you make good moves in this market you can possibly walk out of this with a better real estate portfolio. Here are a few best practices to live by to keep your real estate portfolio in good standing in this and the next crisis: 

  • Maintain little or no credit card and other high-interest debt 
  • Maintain a credit score is 740 or higher 
  • Maintain enough cash to cover vacancies and maintenance on the target property for a year 
  • Maintain enough income to pay the rental property mortgage if there’s a sustained period of vacancy 

Three Ways to Skin the Asset Allocation Cat

December 02, 2019

Over the past several weeks, you’ve heard me talk a lot about investing and for good reason. Investing is one of the most important parts of any financial goal or wealth accumulation strategy. The problem, like with most things, is that there is no one perfect way to do it. You probably know the basics—diversify, re-balance, dollar-cost average—but did you realize that there are at least three forms of asset allocation? Knowing what they are, how they are different, and which one may be right for you could make you a better investor over time.

Strategic asset allocation

Strategic asset allocation is the one you are probably most familiar with and the one most often used by financial advisors and professionals. The objective of strategic asset allocation is to find an optimal portfolio that offers the highest potential return for any given level of risk. It usually starts with a risk tolerance assessment, followed by a recommendation of how you should split up your assets between stocks, bonds and cash.

Rather than being a typical buy-and-hold strategy, strategic asset allocation requires ongoing attention as certain asset classes perform differently at different times. As such, rebalancing is a key component of strategic asset allocation. Since rebalancing causes investors to sell out of asset classes that are outperforming in order to buy into asset classes that are underperforming, it forces the investor to buy low and sell high. For this reason, some might consider it a contrarian approach to investing.

Buying low and selling high is one potential advantage of strategic asset allocation. Another is reduced volatility. By keeping the ratio of stocks to bonds within a targeted range, potential returns are also expected to stay within a certain range. Investors can implement a strategic asset allocation strategy in a number of ways, including following the guidance of a financial advisor, using an online financial advisory service, or by investing in a target-date fund.

Tactical asset allocation

Ironically, what a lot of investors may think they are getting when they hire a financial professional is tactical asset allocation. The objective of tactical asset allocation is to improve portfolio returns by periodically changing the investment mix to reflect changes in the market. It may seem logical to move assets into fixed income when interest rates are high and away from fixed income when interest rates are low, but tactical asset allocation involves security selection and market timing—two things that are often considered taboo in the investment universe.

Tactical asset allocation can be as simple as sector rotation, such as moving assets away from the best performing sector to the worst performing sector, or as sophisticated as using charts and graphs to try and predict market movements. Style preference (growth v. value) can also be important when using a tactical asset allocation strategy. Investors should exercise caution when using a tactical asset allocation approach as market trends can sometimes last longer or shorter than expected.

Since the goal of tactical asset allocation is to try and increase performance by timing the market and moving money around, it would be appropriate for an investor with a high tolerance for risk, a low sensitivity to taxes, and an ability to devote time to developing and monitoring buy and sell indicators. Investors that wish to utilize a tactical asset allocation strategy should decide whether they will use actively-managed mutual funds, passively-managed index funds or ETFs, or individual securities. Investors may be able to implement this strategy with a financial advisor or on their own through a self-directed brokerage account.

Core/satellite asset allocation

If you are not sure which approach to take, why not take both? The objective of core/satellite asset allocation is to enhance performance by investing in two portfolios. The larger of the two (i.e., the core) typically represents 60-80% of the total portfolio and uses strategic asset allocation for determining its holdings. The remaining share (i.e., the satellite) uses tactical asset allocation to take advantage of market opportunities as they arise. For the core component, you may want to use low-cost index or exchange traded funds (ETFs) and rebalance periodically. For the satellite portion, you can use any combination of funds, individual securities, real estate (e.g. REIT), commodities, options, etc., based on where you see market opportunity.

The benefit of this approach is that it gives you a disciplined investment strategy via the core while still allowing you to “play” the market with the satellite portion. If you make some good investment decisions with the satellite, you enhance your return. If your investment instincts are not so great, you still have the core working for you.

The core/satellite approach may be appropriate for investors that want to test their knowledge of investing against the market by comparing the performance of the satellite to that of the core. It would also be appropriate for investors that want to get more involved in investing but not all at once. Because there is a tactical component, investors will need to consider how much time they can devote to managing the portfolio before taking this approach.

As you can see, there are several ways to build an investment portfolio. Choose the one that is right for you based on your objective and level of involvement. And don’t forget to get help when needed.

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.

The Real Secrets To Investing Success

May 24, 2019

I always love it when someone asks me for the latest hot investing tip, as if there’s some investing secret that’s being hidden from the rest of the world. First of all, if I really knew what the absolute best things to invest in at any time was, do you really think I’d be writing this blog? 

I can’t blame people for thinking that we can read the tea leaves and know where to invest, and where not to invest though. I think the industry has done this to them on purpose. For years financial institutions have spent countless dollars trying to convince you that they have an edge, a better way to research, a better strategy for picking winners, etc.

Here’s a dirty little secret: when it comes to investing, there are no secrets.

You are just as knowledgeable as most professionals when it comes to choosing investments; we just make it easier for you. That’s not to say that you shouldn’t work with a financial professional, especially if they give you good advice, offer great service, and help you to stay the course when things get rough. That said, anyone can invest like a pro if they stick to these basic principles:

Principle #1 – Define your goals

Whenever someone asks me, “What is the best thing to invest in?” I’ll immediately ask them, “What are you investing for?” The best investment is the one that helps you achieve your goals. That means you have to have a goal before you invest. Goals can range from buying a car or home, to paying for college, retiring, or just becoming a millionaire as quickly as possible.*Here is a guide on setting goals to help you get started.

Principle #2 – Choose appropriate investments

History can tell us that investing in small company stocks over the last 80 years would have generated better returns than most other types of investments, but that doesn’t make them the “best” investment.  Different investments serve different purposes. 

Cash is good for liquidity. Bonds are good for current income. Stocks are good for growth. Build a well diversified portfolio around the investments most appropriate for your goals.*Use this guide on asset allocation to help you develop an investment strategy.

Principle #3 – Dollar Cost Average

Think of investments like a swimming pool. There are two ways to get in: gradually, or all at once. Dollar cost averaging is the gradual approach, and generally works well when you don’t know the best time to invest.

*Set up automatic transfers from a checking account to a savings or investment account to take advantage of dollar cost averaging.

Principle #4 – Rebalance periodically

Everyone knows you should buy low and sell high, so do it! Rebalancing your portfolio forces you to sell the investments that are performing well and to buy investments that are underperforming. Most investors instinctively do the opposite—investing in assets that are performing well and selling assets that are underperforming—thus “chasing” the market. It doesn’t matter how often you rebalance, but doing so at least once a year is a good idea.

*Click here for instructions on how to rebalance your portfolio.

Principle #5 – Invest for long periods of time

Setting aside money you plan to spend in the next five years is “saving;” setting aside money you won’t need for more than five years is “investing.” Successful investors know the key to growing wealth is not picking the right investment at the right time, but rather remaining invested in a well diversified portfolio for the right amount of time.

There you have it: all the investment wisdom of the ages, and you don’t have to buy a book, subscribe to a newsletter, or even be the 15th caller to get it. 🙂

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.

How Dollar-Cost Averaging Takes The Guesswork Out Of Investing

April 24, 2019

As you might guess, one of the most common investment questions we receive on the Financial Coaching Line is about when to buy and when to sell investments in order to maximize returns. My most common answer to that question is that if I knew precisely how to buy securities at the perfect price, I would be answering that question from my private island.

In all seriousness, the up and down nature of investing often causes investors to hit pause on executing their long-term investment plans, which can cause serious harm to their long-term results. If you are looking to buy and hold for the long run, there is a method of purchasing shares that can help you ride out the ups and downs of the market and potentially improve your returns over time. It’s called dollar-cost averaging.

Dollar-cost averaging is easy to implement

The beauty of dollar-cost averaging is its simplicity. All you do is invest the same amount of money in your desired investment on a consistent basis over time (say, every two weeks or each month, aka when you get paid). When the share price is high, the number of shares you will get for your investment dollars will be lower; when the share price goes down, you’ll get more shares for your money.

If you can resist the urge to adjust your investment amount and keep it constant each period, you’ll reap the rewards of your patience. Eventually, the greater number of shares you pick up when the share price is down will reduce the overall average share price on your investments and increase your average per-share return.

You might already be using dollar-cost averaging – if you participate in your employer’s 401(k)  or other retirement plan, the same amount of money is deducted from each paycheck and then invested per your selections. You are using dollar-cost averaging.

Dollar-cost averaging works

Because the stock market goes through many ups and downs over time, the odds of you being able to predict or pinpoint the lows with any consistency are extremely slim, making it unlikely that waiting and then investing all your money at once would pay off over the long term. But those fluctuations create the perfect conditions for dollar-cost averaging to work its magic.

Let’s say you’ve set up a program of investing $100 a month in a mutual fund. The fund share price generally hovers around $10, so you typically get about 10 shares for your monthly investment. But one month the market experiences a downturn and the share price drops to $5. Your $100 investment buys you 20 shares. You now own more shares that will be worth more when the market returns to its usual level.

In this example, dollar-cost averaging results in a 33% return for our investor. Not bad for someone who simply set up an investment plan and stuck to it.

An example of dollar-cost averaging leading to higher returns


Investment Amount
Shares Purchased
Share Price

Month 1 		$10010$10

Month 2		$10020$5

Month 3		$10010$10
Total$30040

Average Share cost:  $300 / 40 = $7.50

Current market price:  $10

Total Return:  33%

Note: This is a hypothetical example and is not representative of any specific situation. Your results will vary.

Dollar-cost averaging is not for everybody

Of course, dollar-cost averaging can have its downside. Such a strategy does not assure a profit and does not protect against loss in declining markets. If you are an active trader with a significant conviction about the price of a stock or ETF, you probably have zero interest in allowing your purchase price to be picked at random.

If you want to try something a little more active than traditional dollar-cost averaging, consider accelerating your purchases if you see a dip in the price of your desired investment. For instance, if you are dollar cost averaging $10,000 into an investment over 10 months you can decide that if there is a significant shift down in the price of the security, say 10%, you can double your investment that month.

Investing does not have to be complicated

If you’re like most people though, you’ll probably prefer to make dollar-cost averaging something you don’t have to think about. Most investment companies give you the option to set up automatic transfers from your checking account directly into your investment account, making investing on your own just about as easy as accumulating a nest egg in a 401(k) plan.

If you’re not already taking advantage of dollar-cost averaging, start now. As the old saying goes, time is money!