Growing Your Wealth

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Learning to live with risk

People who are averse to risk often consider cash investments such as money market funds and CDs to be worry-free, “safe” investments. Today, especially, volatile markets and the fear of a lengthy recession are likely to make these choices, for some, the correct path to take. But ever-present inflation—even low inflation—eats into the buying power of your money. Only if your investment surpasses inflation are you gaining ground.
The truth is, all investing involves risk. But risk shouldn’t keep anyone from investing. Successful investors learn how to manage their risk by finding a comfortable balance between the risks that they are willing to take and the rewards commensurate with those risks.

Stock risks
Historically, stocks have offered investors the highest long-term total returns. Of course, as we have seen recently, the results can be very different when measured in the short term.
What kinds of risk do investors in equities face?
• Company and industry risk. If the company issuing the stock fares badly, or is held in low regard for some reason, the price is likely to fall. And a falloff in business in an industry can affect the price of a company’s shares, even if the company itself is not faring that badly.
• Market risk. Certain factors may cause the market as a whole to move. They may be economic—for example, expected or reported rises or falls in economic growth—or national or international events. Of course, factors that can depress a stock’s price may have a flip side—good news can send the market, as well as the investor’s equity holdings, upward.
• Liquidity risk. There is always the danger with any investment of not being able to get out of the investment conveniently, at a reasonable price. When forced to sell a holding suddenly, an investor could suffer a significant loss. (This risk is not limited to stocks alone.)

Bond risks
Bonds generally are perceived as a lower-risk investment than stocks. When bonds are held to maturity, bondholders should receive back their principal, in addition to the income earned on the bond.
Default and credit risk. Here’s why we said “generally”: It’s possible that a company or other bond issuer will fail to make scheduled payments on its debt or not pay the bondholder back all or part of his or her principal. The risk of default is, perhaps, more on some people’s minds now as municipalities struggle with large budget deficits.
Interest-rate risk. Bond prices are sensitive to changing market conditions. When interest rates rise, bond values fall. Therefore, when new bonds pay more income than bonds that an investor owns, the risk arises that if the investor has to sell the bonds, he or she may have to do so for less than what was paid.

Managing risk
The first step in risk management is to determine how much risk you can live with—and stick with. Many factors will contribute to your decisions about how much risk to take: Your age, your knowledge about investments, your attitude toward risk are just a few of them.
If you know your comfort level, you can take the necessary actions to manage the risks that you are willing to accept. For instance, developing an asset allocation strategy and diversifying your investment capital among a mix of stocks, bonds and cash reserves are important steps in the process.
To find the right level of risk is every investor’s challenge, but one that needn’t be faced alone. Calling upon the knowledge and experience of our professionals to assist you will help you meet that challenge.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

 

 

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Investment aspects of life insurance

Almost everyone believes that he or she needs life insurance to provide cash for his or her family, business partners and charitable endeavors that he or she values. But what people don’t always consider is the utility of life insurance as an investment vehicle during one’s lifetime.

Overview: cash value policies
In general, there are two types of insurance. Term life insurance is pure insurance and provides only protection—in the form of a cash payment to a beneficiary upon your death. Cash value life insurance (sometimes referred to as permanent life insurance) has the added bonus of the tax-free buildup of accessible wealth. With these policies the premiums that you pay cover the insurance company’s overhead and the cost of insuring the lives of the company’s customers, with the balance going into the policy’s cash value.
Because of initial selling costs, cash values build up very slowly at first but accelerate in later years to provide competitive long-term yields. There are various types of policies, differing in how the death benefit is fixed, how the cash value is invested and how the policy owner can utilize the cash value.

General account policies
In whole life insurance the premium is fixed and calculated to be paid until a given age. (When cash value is equal to the death benefit, the policy is paid up, and no further premiums are required.) Your cash value is placed in the insurance company’s general account, which, by regulation, is invested quite conservatively.
The insurance company guarantees a minimum rate of return and pays dividends in addition. You can take dividends in cash, add them to your tax-deferred investment and use them to reduce your premium or to buy small “paid-up” additions to your policy, boosting the total death benefit. The cash value is available through tax-free loans, which, as long as not repaid, reduce the death benefit. Dividends generally may be withdrawn tax free.
Universal life insurance involves a general account investment in which interest is credited at prevailing rates with a guaranteed minimum. You choose, within limits, how much in premiums to pay, and the death benefit varies with your results.
Paying the target premium proposed by an insurance agent guarantees that coverage at the desired level will last for life. Paying more than the amount proposed builds up additional tax-sheltered value. Paying much less, however, may require you to increase premiums in later years to keep the cash value from being exhausted by policy expenses and, as a result, the policy lapsing.
With a universal policy you choose how your cash benefit is applied. In Option A (also referred to as Option 1), cash value is applied to the death benefit, reducing the insurance component over time. With Option B (or Option 2), the insurance amount remains fixed, and the cash value increases the death benefit, providing a substantial inflation hedge. You can withdraw money from the cash value tax free up to the cost basis, but you should be careful to leave enough to prevent the policy’s collapse.
The risk with both types of this insurance is that interest rates may decline, and the insurance company may not produce sufficient returns in its general account. Companies’ failure to meet legal capitalization standards will bring in regulators to slash the cash values of policy holders.

Variable policies
Variable universal life insurance offers all the premium and death benefit flexibility of universal life while cash value builds up in investment accounts managed by the policy holder.
You are typically given a choice from a universe of accounts, similar to mutual funds, that invest in stocks, bonds, and money market and other funds. You may vary your premium within limits, but it’s important not to exceed a government-mandated “seven-pay” test during the policy’s first seven years so that the policy will not be classified as a “Modified Endowment Contract.” Such a designation would prevent tax-free loans and withdrawals.
Because the cash value of a variable policy is subject to market conditions, it is possible for it to fail. To “bullet proof” a policy, consider keeping three years’ worth of policy expenses in the company’s guaranteed interest account.
The risks in variable policies are market risks. History tells us that the markets, over time, tend to outperform the guaranteed returns achieved by insurance company general accounts. This is especially true with the added power of tax-deferred compounding. Equally important, variable policy cash values are not subject to the fortunes of the insurance company.
As you can see from this very brief overview, determining the type of insurance policy that best fits your needs requires serious consideration. In addition, there are issues of how to structure the ownership of your policy. We recommend, therefore, that before making decisions, you consult your advisors.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

 

 

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Investing with style

How do you define your approach to investing? There may be many answers to that question. One answer goes to the style of investing that you choose: value or growth.
Are you looking for value?
The goal of a value investor is to seek out “bargains,” finding those companies whose stock may be out of favor for one reason or another and whose stock is inexpensive relative to the company’s earnings or assets. Value investors are looking for companies that have shown low or no sales growth, have little corporate debt and experience below-average earnings increases.
Identifying a company that meets the above criteria is only the first step.
The next step is to determine whether or not the company’s low share price is unjustified. For instance, can the undervaluation be traced to the fact that the company’s industry or products are currently out of favor? Has the company experienced short-term earnings disappointments? Or is it because of some problem within the company for which there is no immediate or near-term solution? The answers to those questions will determine whether true value exists.
The value approach goes back to the work of Benjamin Graham, widely regarded as the “father of value investing” and whose wisdom may still be worth following today. His 1934 book, Security Analysis, coauthored with David Dodd, advocated a fundamental analysis of a company’s balance sheet before deciding to invest. Graham also emphasized the importance of building a “margin of safety” into one’s analysis. The investor’s aim, he said, should be to “purchase a dollar for 50 cents.”
It’s often said that patience is a key attribute of the value investor. By its very nature, value investing means being able to sit back and wait. The belief is that other investors soon will draw the same conclusions about a company’s potential and bid up the stock price. While the value investor waits, he or she still may receive some reward: Value stocks typically have an above-average dividend yield.
Are you seeking growth?
For growth investors, it’s a matter of expectations. Growth investors are on the lookout for companies whose sales and earnings are expected to grow steadily. Because a profitable company rarely goes unnoticed, growth stocks generally are not inexpensive. However, given the appreciation potential that they see, growth investors are willing to pay the premium involved.
The companies whose shares fall within the growth style are those: whose sales growth is greater than that of their competitors; that usually have incurred major debt for expansion; and that usually will deliver little in the way of dividends. They have high earnings per share and high price/earnings and price/book ratios.
Because their appreciation usually is based upon earnings announcements, share prices of growth stocks tend to fluctuate rapidly. But, despite volatility, a good growth stock will report steadily growing earnings. The growth investor’s challenge, of course, is to buy early enough, not sell off the winners too early, and not hang on to the losers too long.
Style drift
A stock identified as either “growth” or “value” need not retain that characteristic forever. Over time stocks may drift from one category to the other as their fortunes change. As that happens, a portfolio inadvertently may drift from one style to the other. The significant variability of the investment returns between these two styles suggests that “style diversification” may be appropriate or, at least, that style should be one of the metrics by which an investment portfolio is measured periodically.
A combination of styles?
History shows that the market does not tend to favor one style of investing over another for very long. Both growth and value have had their day in the sun.
It isn’t necessary to choose one style over the other. There are ways to build your portfolio in a manner that combines value and growth stocks in a proportion with which you can be comfortable. In other words, you can think of not one style versus the other but, rather, of the styles falling across a spectrum. In that manner you stand the best chance of taking maximum advantage of the market’s changing preferences.
We can help you find where you want to be along that spectrum. Just give us a call to set up an appointment.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

 

 

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Information overload

Over the years, employers have taken many steps to improve 401(k) plans, to make them more attractive to participants and to encourage higher participation rates. One of those steps was to increase the number of investment choices available, so that each participant would be more likely to find an investment alternative exactly to his or her taste.
Here’s the anomaly: The more investment choices that a plan offers, the lower the participation rate tends to be. Exactly the reverse of what was hoped for.
An experiment done in 1995 may shed some light on this result. The study was conducted by Professor Sheena Iyengar, who is the author of “The Art of Choosing,” published in March, 2010.
In the study a sample booth was set up in a gourmet food store, offering patrons samples of jam. Sometimes there were six flavors of jam to choose from, sometimes there were 24 choices on display. At all times, anyone who tried a sample received a coupon for $1 off for a purchase of a jar of jam. The coupons were tracked, some results were unexpected.
• The larger flavor assortment drew many more shoppers to try a sample, a 50% increase in samplers.
• On average the shopper tried two flavors of jam, whether presented with a large or small number of choices.
• Shoppers presented with fewer choices were far more likely to use the coupon to buy jam. Of those who selected their samples from the array of 24 flavors, just 3% purchased jam. For those presented with only six alternatives, a whopping 30% decided to buy!
Although the result may seem surprising at first, a logical explanation is possible. Busy shoppers typically don’t have time to try more than two samples, no matter how many they have to choose from. When one samples two of six choices, one has tried one-third of the possibilities, and so may have a higher confidence level about making the “best” choice. On the other hand, with the larger array one leaves 22 jams untasted, and so could easily decide that more investigation is warranted before making an unplanned purchase.
How much more difficult—and important—is the choice faced by 401(k) investors? Investors generally, who are managing their taxable portfolios, have still more choice and still more information to filter and analyze.
Perhaps that’s why some 401(k) plan sponsors are considering offering investment advice to participants, and it’s why more and more affluent individuals are turning to professionals for investment help.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.