Objective information about financial planning, investments, and retirement plans

Avoid these 9 Investing Mistakes

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Investing is at best a risky proposition and sometimes even the best investment ideas don’t work out. However avoiding these 9 mistakes can help improve your investing outcomes.

Avoid these 9 Investing Mistakes

Inability to take a loss and move on 

It’s difficult for many investors to sell an investment at a loss. Often they prefer to wait until the investment at least gets back to a break-even level. I think its part of our competitive nature. Investing is not a competitive sport, leave that for our Olympians.  When reviewing your investments ask yourself “Would I buy this holding today?” If the answer is no, it’s time to sell and invest the proceeds elsewhere.

Not selling winners

I’ve seen many investors over the years refuse to sell highly appreciated holdings, all or in part. There is always the risk that you’ll sell and the price will keep going up. But sometimes it’s best to protect your gains and sell while you’re ahead or at least consider selling a portion of the holding and reinvesting the proceeds elsewhere. The latter can be part of your portfolio rebalancing process.

Investing without a plan

When you take a road trip in your car you generally have a map to help you to get to your destination. Investing is a means to an end, a road map to achieve your goals such as providing a college education for your children or funding your retirement.

Without a financial plan how will you know how much you need to accumulate to achieve your goals?  How much risk should you take?  What types of returns do you need to shoot for? Are on track toward your goals?  Essentially investing without a plan is much like hopping in the car without any idea where you are headed. 

Trying to time the market

It’s difficult to predict when the market will rise and fall. Even if the stock market is following a general trend, there will be up and down trading days. Trying to buy and sell based on those daily fluctuations is difficult. While there are professional traders who do this for a living, for most of us this is a losing proposition.

Worrying too much about taxes

Taxes can consume a significant portion of your investment gains for holdings in a taxable account. While nobody wants to pay more tax than needed, in my opinion paying taxes on a gain is almost always better than dealing with an investment loss.

Not paying attention to your investments

Your portfolio needs to be evaluated and monitored on a periodic basis.  You should reevaluate a stock when the company changes management, when the company is acquired by or merges with another company, when a strong competitor enters the market, or when several top executives sell large blocks of stock.

This applies to mutual funds as well. Manager changes, a dramatic increase or decrease in assets under management or a deviation from its stated style should all be red flags that cause you to evaluate whether it may be time to sell the fund.

Failure to rebalance your holdings  

This goes hand in hand with having a financial plan. Ideally you have an investment policy for your portfolio that defines the percentage allocations of your investments by type and style (stocks, bonds, cash, large stocks, international stocks, etc.).  A typical investment policy will set a target percentage with upper and lower percentage ranges for each style. It is important that you look at your overall portfolio in terms of these percentages at least annually.

Different investment styles will perform differently at various times.  This can cause your portfolio to be out of balance. The idea behind rebalancing is to control risk. If stocks rally and your equity allocation has grown to 75% vs. your target of 60% your portfolio is now taking more risk than you had planned. Should stocks reverse course, you could be exposed to over-sized losses.

Assuming recent events will continue into the future  

The first 15 plus years of this century have been tough on investors. The market tumbled during the 2000-2002 time frame and then again in 2008-2009. More recently the stock market dropped steeply and suddenly in the wake of the Bexit vote in the U.K. These events have instilled fear into many investors. It’s hard to blame them.

However this fear and the assumption that recent events will continue into the future might also be keeping you from investing in the fashion needed to achieve your financial goals. Taking the events of recent years into account is healthy, however letting these events paralyze you can be destructive to your financial future. This holds true for stock market drops as well as protracted bull markets.

Building a collection of investments instead of a well-crafted portfolio

Are you investing with a plan or do you simply own a collection of investments?  Great football teams like my beloved Green Bay Packers have a better chance of winning when everyone embraces and executes their role in the game plan for that week.  In my experience you will increase your chances for investment success when all of the holdings in your portfolio fulfill their role as well.

Nothing guarantees investment success.  Avoiding these 9 investing mistakes as well as others can help you increase your odds of being a successful investor.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner . Please check out our Resources page for links to some additional tools and services that might be beneficial to you. 

 

Review Your 401(k) Account

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For many of us, our 401(k) plan is our main retirement savings vehicle. The days of a defined benefit pension plan are a thing of the past for most workers and we are responsible for the amount we save for retirement and how we invest that money.

Asset Allocation on Wikibook

Managed properly, your 401(k) plan can play a significant role in providing a solid retirement nest egg. Like any investment account, you need to ensure that your investments are properly allocated in line with your goals, time horizon and tolerance for risk.

You should thoroughly review your 401(k) plan at least annually. Some items to consider while doing this review include:

Have your goals or objectives changed?

Take time to review your retirement goals and objectives. Calculate how much you’ll need at retirement as well as how much you need to save annually to meet that goal. Review the investments offered by the plan and be sure that your asset allocation and the investments selected dovetail with your retirement goals and fit with your overall investment strategy including assets held outside of the plan.

Are you contributing as much as you can to the plan?

Look for ways to increase your contribution rate. One strategy is to allocate any salary increases to your 401(k) plan immediately, before you get used to the money and find ways to spend it. At a minimum, make sure you are contributing enough to take full advantage of any matching contributions made by your employer. For 2016 the maximum contribution to a 401(k) plan is $18,000 plus an additional $6,000 catch-up contribution for individuals who are age 50 and older at any point during the year.

Are the assets in your 401(k) plan properly allocated?

Some of the more common mistakes made when investing 401(k) assets include allocating too much to conservative investments, not diversifying among several investment vehicles, and investing too much in an employer’s stock. Saving for retirement typically encompasses a long time frame, so make investment choices that reflect your time horizon and risk tolerance. Many plans offer Target Date Funds or other pre-allocated choices. One of these may be a good choice for you, however, you need to ensure that you understand how these funds work, the level of risk inherent in the investment approach and the expenses.

Review your asset allocation as part of your overall asset allocation

Often 401(k) plan participants do not take other investments outside of their 401(k) plan, such as IRAs, a spouse’s 401(k) plan, or holdings in taxable accounts into consideration when allocating their 401(k) account.

Your 401(k) investments should be allocated as part of your overall financial plan. Failing to take these other investment assets into account may result in an overall asset allocation that is not in line with your financial goals.

Review the performance of individual investments, comparing the performance to appropriate benchmarks. You shouldn’t just select your investments once and then ignore them. Review your allocation at least annually to make sure it is correct. If not, adjust your holdings to get your allocation back in line. Selling investments within your 401(k) plan does not generate tax liabilities, so you can make these changes without any tax ramifications.

Do your investments need to be rebalanced?

Use this review to determine if your account needs to be rebalanced back to your desired allocation. Many plans offer a feature that allows for periodic automatic rebalancing back to your target allocation. You might consider setting the auto rebalance feature to trigger every six or twelve months.

Are you satisfied with the features of your 401(k) plan?

If there are aspects of your plan you’re not happy with, such as too few or poor investment choices take this opportunity to let your employer know. Obviously do this in a constructive and tactful fashion. Given the recent volume of successful 401(k) lawsuits employers are more conscious of their fiduciary duties and yours may be receptive to your suggestions.

The Bottom Line

Your 401(k) plan is a significant employee benefit and is likely your major retirement savings vehicle. It is important that you monitor your account and be proactive in managing it as part of your overall financial and retirement planning efforts.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email.

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The Bull Market Turns Seven Now What?

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On March 9, 2009 the market downturn fueled by the financial crisis bottomed out as measured by the S&P 500 Index. On that day the index closed at 677. Yesterday, on the bull market’s seventh birthday, the index closed at 1,989 or an increase of about 194 percent. According to CNBC the Dow Jones Industrial Average has increased 160 percent and the NASDAQ 267 percent over this seven-year time frame.

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With the bull market turning seven, now what? Here are some thoughts and ideas for investors.

How does this bull market stack up?

According to data from the most recent quarterly Guide to the Markets report from JP Morgan Asset Management, the average bull market following a bear market lasts for 53 months and results in a gain of 153%. By both measures this bull market is a long one.

Does this mean that investors should brace for an imminent market correction? Not necessarily but bull markets don’t last forever either.

There have been some speed bumps along the way, including 2011, a sharp decline in the third quarter of 2015 and of course the sharp declines we saw to start off 2016. Again this is not an indicator of anything about the future.

Winners and losers

A commentator on CNBC cited a couple of big winners in this bull market:

  • Netflix (NFLX) +1,667%
  • General Growth Properties (GGP) +9,964%

Additionally, Apple (APPL) closed at a split-adjusted $11.87 per share on March 9, 2009. It closed at $101.12 on March 9, 2016.

The CNBC commentator cited giant retailer Walmart (WMT) as a stock that has missed much of the bounce in this market, as their stock is up only 42% over this time period.

What should investors do now? 

None of us knows what the future will hold. The bull market may be getting long of tooth. There are factors such as potential actions by the Fed, China’s impact on our markets, the threat of terrorism and countless others that could impact the direction of the stock market. It seems there is always something to worry about in that regard.

That all said, my suggestions for investors are pretty much the same “boring” ones that I’ve been giving since I started this blog in 2009.

  • Control the factors that you can control. Your investment costs and your asset allocation are two of the biggest factors within your control.
  • Review and rebalance your portfolio This is a great way to ensure that your allocation and your level of risk stay on track.
  • When in doubt fall back on your financial plan. Review your progress against your plan periodically and, if warranted, adjust your portfolio accordingly.
  • Contribute to your 401(k) plan and make sure that your investment choices are appropriate for your time horizon and risk tolerance. Avoid 401(k) loans if possible and don’t ignore old 401(k) accounts when leaving a company.
  • Don’t overdo it when investing in company stock.
  • If you need professional financial help, get it. Be sure to hire a fee-only financial advisor who will put your interests first.

The Bottom Line 

The now seven-year bull market since the bottom in 2009 has been a very robust period for investors. Many have more than recovered from their losses during the market decline of 2008-09.

Nobody knows what will happen next. In my opinion, investors are wise to control the factors that they can, have a plan in place and follow that plan.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.

4 Things To Do When The Stock Market Drops

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The stock market has started out the new year with some hefty declines. We are seeing firsthand the impact that China has on our markets. CNBC is calling this the worst start to a new year in almost a century. What should you do now? Here are 4 things to do when the stock market drops.

4 Things to do When the Stock Market Drops

Breathe 

Cable news networks like CNBC have a field day during steep, sudden stock market corrections like we are seeing this week. It’s easy to get caught up in all of this hype. Don’t let yourself be sucked in.

Step back, take a deep breath and relax.

Take stock of where you are 

Review your accounts and see the extent of the damage that has been done. Depending upon how you are invested it may be minor or a bit more significant. Investors who are well-diversified have probably been hurt but not to the extent of those with a heavy allocation to equities and other areas that have been hit.

Review your asset allocation 

Has your portfolio weathered this storm and the declines of this past summer as you would have expected? If so your allocation is likely appropriate. If not, then perhaps it is time to review your asset allocation and make some adjustments. Proper diversification is great way to reduce investment risk.

Go shopping 

Market declines can create buying opportunities. If you have some individual stocks, ETFs or mutual funds on your “wish list” this is the time to start looking at them with an eye towards buying at some point. It is unrealistic to assume you will be able to buy at the very bottom so don’t worry about that.

Before making any investment be sure that it fits your strategy and your financial plan. Also make sure the investment is still a solid long-term holding and that it is not cheap for reasons other than general market conditions.

The Bottom Line 

The stock market declines we’ve seen since the start of 2016 have been steep and unnerving. Don’t panic and don’t let yourself get caught up in all of the media hype. Stick to your plan, review your holdings and make some adjustments if needed. Nobody knows where the markets are headed but those who make investment decisions driven by fear usually regret it.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email.

8 Portfolio Rebalancing Tips

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My last post discussed 4 Benefits of Portfolio Rebalancing. This post continues on the rebalancing theme and looks at some ways to implement a rebalancing strategy. Here are 8 portfolio rebalancing tips that you can use.

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Set a target asset allocation 

Your asset allocation should be an outgrowth of a target asset allocation from your financial plan and/or a written investment policy. This is the target asset allocation that should be used when rebalancing your portfolio. 

Establish a time frame to rebalance 

Ideally you are reviewing your portfolio and your investments on a regular basis. As part of this process you should incorporate a review of your asset allocation at a set interval. This might be semi-annually for example. I generally suggest no more frequently than quarterly. An exception would be after a precipitous move up or down in the markets.

Take a total portfolio view 

When rebalancing your portfolio take a total portfolio view. This includes taxable accounts as well as retirement accounts like an IRA or your 401(k). This approach allows you to be strategic and tax-efficient when rebalancing and ensures that you are not taking too little or too much risk on an overall basis.

Incorporate new money 

If you have new money to invest take a look at your asset allocation first and use these funds to shore up portions of your asset allocation that may be below their target allocation. A twist on this is to direct new 401(k) contributions to one or two funds in order to get your overall asset allocation back in balance. In this case your will need to take any use of your plan’s auto rebalance feature into account as well. 

Use auto pilot 

For those with an employer sponsored retirement plan such as a 401(k), 403(b) or similar defined contribution plan many plans offer an auto-rebalancing feature. This allows you to select a time interval at which your account will be rebalanced back to the allocation that you select.

This serves two purposes. First it saves you from having to remember to do it. Second it takes the emotion and potential hesitation out of the decision to pare back on your winners and redistribute these funds to other holdings in your account.

I generally suggest using a six-month time frame and no more frequently than quarterly and no less than annually. Remember you can opt out or change the interval at any time you wish and you can rebalance your account between the set intervals if needed.

Make charitable contributions with appreciated assets 

If you are charitably inclined consider gifting shares of appreciated holdings in taxable accounts such as individual stocks, mutual funds and ETFs to charity as part of the rebalancing process. This allows you to forgo paying taxes on the capital gains and provides a charitable tax deduction on the market value of the securities donated.

Most major custodians can help facilitate this and many charities are set-up to accept donations on this type. Make sure that you have held the security for at least a year and a day in order to get the maximum benefit. This is often associated with year-end planning but this is something that you can do at any point during the year.

Incorporate tax-loss harvesting

This is another tactic that is often associated with year-end planning but one that can be implemented throughout the year. Tax-loss harvesting involves selling holdings with an unrealized loss in order to realize that loss for tax purposes.

You might periodically look at holdings with an unrealized loss and sell some of them off as part of the rebalancing process. Note I only suggest taking a tax loss if makes sense from an investment standpoint, it is not a good idea to “let the tax tail wag the investment dog.”

Be sure that you are aware of and abide by the wash sale rules that pertain to realizing and deducting tax losses.

Don’t think you are smarter than the market 

It’s tough to sell winners and then invest that money back into portions of your portfolio that haven’t done as well. However, portfolio rebalancing is part of a disciplined investment process.  It can be tempting to let your winners run, but too much of this can skew your allocation too far in the direction of stocks and increase your downside risk.

If you think you can outsmart the market, trust me you can’t. How devastating can the impact of being wrong be? Just ask those who bought into the mantra “…it’s different this time…” before the Dot Com bubble burst or just before the stock market debacle of the last recession.

The Bottom Line 

Portfolio rebalancing is a key strategy to control the risk of your investment portfolio. It is important that you review your portfolio for potential rebalancing at set intervals and that you have the discipline to follow through and execute if needed.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email.

4 Benefits of Portfolio Rebalancing

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As we move into the last month of the year and look forward to the new year many of us look to get our financial situation in order. One of the most important things you can do is to ensure that your investments are properly allocated. Portfolio rebalancing is something that all investors should do periodically. Here are 4 benefits of portfolio rebalancing.

4 Benefits of Portfolio Rebalancing

Balancing risk and reward

Asset allocation is about balancing risk and reward. Invariably some asset classes will perform better than others. This can cause your portfolio to be skewed towards an allocation that takes too much risk or too little risk based on your financial objectives.

During robust periods in the stock market equities will outperform asset classes such as fixed income. Perhaps your target allocation was 65% stocks and 35% bonds and cash. A stock market rally might leave your portfolio at 75% stocks and 25% fixed income and cash. This is great if the market continues to rise but you would likely see a more pronounced decline in your portfolio should the market experience a sharp correction.

Portfolio rebalancing enforces a level of discipline

Rebalancing imposes a level of discipline in terms of selling a portion of your winners and putting that money back into asset classes that have underperformed.

This may seem counter intuitive but market leadership rotates over time. During the first decade of this century emerging markets equities were often among the top performing asset classes. Fast forward to today and they are on track for their third year of losses.

Rebalancing can help save investors from their own worst instincts. It is often tempting to let top performing holdings and asset classes run when the markets seem to keep going up. Investors heavy in large caps, especially those with heavy tech holdings, found out the risk of this approach when the Dot Com bubble burst in early 2000.

Ideally investors should have a written investment policy that outlines their target asset allocation with upper and lower percentage ranges. Violating these ranges should trigger a review for potential portfolio rebalancing.

A good reason to review your portfolio

When considering portfolio rebalancing investors should also incorporate a full review of their portfolio that includes a review of their individual holdings and the continued validity of their investment strategy. Some questions you should ask yourself:

  • Have individual stock holdings hit my growth target for that stock?
  • How do my mutual funds and ETFs stack up compared to their peers?
    • Relative performance?
    • Expense ratios?
    • Style consistency?
  • Have my mutual funds or ETFs experienced significant inflows or outflows of dollars?
  • Have there been any recent changes in the key personnel managing the fund?

These are some of the factors that financial advisors (hopefully) review as they review client portfolios.

This type of review should be done at least annually and I generally suggest that investors review their allocation no more often than quarterly so perhaps the full-blown portfolio review would not be done each time you do a rebalancing review.

Helps you stay on track with your financial plan 

Investing success is not a goal unto itself but rather a tool to help ensure that you meet your financial goals and objectives. Regular readers of The Chicago Financial Planner know that I am a big proponent of having a financial plan in place.

A properly constructed financial plan will contain a target asset allocation and an investment strategy tied to your goals, your timeframe for the money and your risk tolerance. Periodic portfolio rebalancing is vital to maintaining an appropriate asset allocation that is in line with your financial plan.

The Bottom Line 

Regular portfolio rebalancing helps reduce downside investment risk and ensures that your investments are allocated in line with your financial plan. It also can help investors impose an important level of discipline on themselves.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email.

Financial Planning Steps for the rest of 2015

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Labor Day is here and the college football season started with our local Big 10 team Northwestern scoring an upset win over a ranked Stanford team. Next weekend is the first full weekend of NFL football with my Green Bay Packers visiting Soldier Field where they should continue their winning streak over the hapless Bears.

With a bit less than a third of 2015 left there are a number of financial planning steps you should be taking between now and the end of the year. Frankly I wrote a similar piece at this time last year Eight Financial To Do Items for the Rest of 2014 and I would encourage you to check this piece out as these eight items are just as applicable in 2015. The eight items (for those who prefer the Cliff Notes version) are:

While all eight of these items are critical financial planning steps to be tended to or at least reviewed this year or in any year, the environment in the financial markets has changed from this time a year ago.

August and so far early September has proven to be a rough patch for the stock market with much volatility and pronounced drops from highs reached earlier in 2015. The financial press is filled with stories about what to do and this has become a major event for the cable financial news stations.

In this context here are a few thoughts regarding some financial planning steps for the rest of 2015.

Get a financial plan in place or update your current one 

To me a comprehensive financial plan is the basis of an investment strategy and frankly all else in your financial life. If you have a plan in place, revisit it. If you don’t this is a great time to find a qualified fee-only financial planner and have one done.

Where are you in terms of financial goals like retirement and saving for your children’s college education? Do you have an estate plan in place?

With the markets taking a breather this is a good time to see where you are and what it will take to get you where you want to be financially. An investment strategy is an outgrowth of your financial plan and this plan is something to fall back on in times of market turmoil like the present.

Review your investments and your strategy 

How has the recent market decline impacted your asset allocation? Does your portfolio need to be rebalanced? Is your asset allocation consistent with your goals, risk tolerance and time horizon as outlined in your financial plan?

While I don’t advocate making wholesale changes to your portfolio based on some temporary stock market volatility it is always appropriate to do a periodic review of your overall portfolio, your asset allocation and the individual holdings in your accounts. These include mutual funds, ETFs, individual stocks and bonds and so forth.

The recent weakness in the markets may have created some opportunities for year-end tax loss harvesting in your taxable accounts. This refers to selling shares that show a loss to realize taxable losses. If you want to do this but also want to continue to own these or similar investments be sure to consult with a financial or tax advisor who understands the wash-sale rules.

More likely you have many investments that have appreciated nicely and these represent and excellent vehicle to make charitable contributions. Not only do you receive a tax deduction for the value of the gift, but you eliminate the tax liability for any capital gains on the holdings. 

Review your 401(k) 

The current situation in the stock market is a good time to check your account and rebalance your holdings if needed. Better yet if your plan offers it sign up for automatic rebalancing so you don’t have to worry about this.

Fall open enrollment is often the time when companies roll out any changes to the plan in terms of the investments offered, the company match or other aspects of the plan. Additionally most plans were required to issue annual disclosures by the end of August so be sure to review yours to see where the investments offered are compared to their benchmark indexes and how much they are costing you.

Lastly check to see how much you are contributing to your plan. If you are not tracking toward the maximum salary deferrals of $18,000 or $24,000 (for those who will be 50 or over at any point in 2015), try to increase your contributions for the rest of 2015.

Summary 

Labor Day is here and summer is unofficially over. Use the remainder of 2015 to tackle these issues and to get your financial situation where it needs to be.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner.

Check out Carl Richards’ (The Behavior Gap) excellent book The One Page Financial Plan. Carl is a financial advisor and NY Times contributor. This is an easy read and offers some good ideas in approaching the financial planning process. 

The Risks of Too Much Company Stock in Your 401(k) Plan

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Retirement plan sponsors are starting to get it, requiring 401(k) participants to hold company stock in their accounts exposes them to major fiduciary liability if the stock price tanks. That said it is still an option in many 401(k) plans.

According to Fidelity about 15 million people own about $400 billion in company stock across 401(k) plans that they administer.

Too dependent on your employer    

Just ask former employees of Enron, Lehman Brothers or Radio Shack about this.

All employees depend on their employer for a paycheck. If you add a high level of company stock as a component of your 401(k) account you have a recipe for disaster. If the company tanks you might find yourself out of job with no income. If this difficulty causes the stock price to decline you are not only unemployed but your retirement nest egg has taken a hit as well.

How much is too much? 

There is no one right answer; this will vary on a case by case basis. Many financial advisors say the total in employer stock should be kept to a maximum of 5% to 10% of total investment assets. This not only includes stock held in your retirement plan but also shares held outside the plan as well shares represented by any stock options or restricted shares that may be held.

Employers and fiduciary risk 

In the past it was more common for companies to use their stock as the matching vehicle in the 401(k) plan and to require that it be held for a period of time. Both are less common today due to a number of lawsuits by employees against companies after significant declines in the price of their employer’s stock. Plan sponsors want to avoid this type of fiduciary liability.

Diversify 

It is important to set a maximum allocation to your employer’s stock in your 401(k) plan and in total.  Use increases in the stock price as opportunities to take profits and diversify. Within your 401(k) plan there will be no taxes to pay on the gains, though there will be taxes due down the road when taking distributions from a traditional 401(k).

Make sure you fully understand any restrictions on selling company shares held in your plan.

Discounted purchases 

Often employees have the opportunity to purchase shares of company stock at a discount from the current market price. This is a great feature but the decision to purchase and how much to hold should not be overly influenced by this feature.

Net Unrealized Appreciation 

If you leave your employer and hold company shares in your 401(k) plan consider using the net unrealized appreciation (NUA) rules for the stock.

NUA allows employees to take their company stock as a distribution to a taxable account while still rolling the other money in the plan to an IRA if they wish. The distribution of the company stock is taxable immediately, at ordinary income tax rates, based upon the employee’s original cost versus the current market value.

The advantage for holders of highly appreciated shares can be sizable. Any gains on the stock will qualify for long-term capital gains treatment where the rates are generally lower. For a large chunk of company stock the savings can be very significant. Note there are very specific rules regarding the use of NUA so it is best to consult with a knowledgeable financial or tax advisor if you are considering going this route.

The Bottom Line 

Holding excessive amounts of your company’s stock in your 401(k) plan can expose you to undo risk should your employer run into financial difficulty. You could find yourself unemployed and with a much lower retirement plan balance if the stock price drops significantly. Set a target percentage for your overall holdings of employer stock and periodically sell shares if needed to rebalance just as you would any other holding in the plan.

How Much Apple Stock Do You Really Own?

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Apple (AAPL) stock has been a great investment over the years. Based upon its stock price and the number of shares outstanding it is the largest U.S stock based upon market capitalization.  This means it is the largest holding in popular index mutual funds and ETFs like Vanguard 500 (VFINX) and the SPDR S&P 500 ETF (SPY).

Chuck Jaffe recently wrote an excellent piece for Market Watch discussing the impact that a recent drop in Apple stock had on a number of mutual funds that hold large amounts of Apple.  He cited a list of funds that had at least 10% of their assets in Apple.  On a recent day when Apple stock fell over 4% these funds had single day losses ranging from 0.22% to 2.66%.

The point is not to criticize mutual fund managers for holding large amounts of Apple, but rather as a reminder to investors to understand what they actually own when reviewing their mutual funds and ETFs.

Stock overlap 

In the late 1990s a client had me do a review of their portfolio as part of some work I was doing for the executives of the company. He held 19 different mutual funds and was certain that he was well-diversified.

The reality was that all 19 funds had similar investment styles and all 19 held some of the popular tech stocks of the day including Cisco (CSCO), Intel (INTC) and Microsoft (MSFT). As this was right before the DOT COM bubble burst in early 2000 his portfolio would have taken quite a hit during the market decline of 2000-2002.

Understand what you own 

If you invest in individual stocks you do this by choice. You know what you own. If you have a concentrated position in one or more stocks this is transparent to you.

Those who invest in mutual funds and other professionally managed investment vehicles need to look at the underlying holdings of their funds.  Excessive stock overlap among holdings can occur if your portfolio is concentrated in one or two asset classes. This is another reason why your portfolio should be diversified among several asset classes based upon your time horizon and risk tolerance.

As an extreme example someone who works for a major corporation might own shares of their own company stock in some of the mutual funds and ETFs they own both inside their 401(k) plan and outside. In addition they might directly own shares of company stock within their 401(k) and they might have stock options and own additional shares elsewhere. This can place the investor in a risky position should their company hit a downturn that causes the stock price to drop.  Even worse if they are let go by the company not only has their portfolio suffered but they are without a paycheck from their employer as well.

Concentrated stock positions 

Funds holding concentrated stock positions are not necessarily a bad thing. A case in point is Sequoia (SEQUX) which has beaten its benchmark the S&P 500 by an average of 373 basis points (3.73 percentage points) annually since its inception in 1970.  Sequoia currently has about 26% of its portfolio in its largest holding and another 8% in the two classes of Berkshire Hathaway stock.  Historically the fund has held 25-30 names and at one time held about 30% of the portfolio in Berkshire Hathaway (BRK.A).  Year-to-date through August 14, 2015 the fund is up 16.5% compared to the benchmark’s gain of 2.88%.

The Bottom Line 

Mutual fund and ETF investors may hold more of large market capitalization stocks like Apple and Microsoft than they realize due to their prominence not only in large cap index funds but also in many actively managed funds. It is a good idea for investors to periodically review what their funds and ETFs actually own and in what proportions to ensure that they are not too concentrated in a few stocks, increasing their risk beyond what they might have expected.

Please feel free to contact me with any questions, comments or suggestions about this article or anything else on The Chicago Financial Planner. Thank you for visiting the site.

Reader Question: Do I Really Need a Financial Advisor?

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This question came from a reader who is around 60, works for a major corporation and has retirement assets in neighborhood of $1 million.  He indicated he is looking to either retire or be able to retire in the near future.  His question was in response to my recent request for story ideas and I appreciate this suggestion.  I will address this question largely from the perspective of this person’s situation as this is the type of client I am quite familiar with.

Do I really need a financial advisor? 

Do I really need a financial advisor? The only answer of course is that it depends.  There are many factors to consider.  Let’s take a look at a few of them.

How comfortable are you managing your own investments and financial planning issues? 

This is one of the main factors to consider.  The reader raised the point that the typical fees for ongoing advice on a portfolio of his size would likely be $8,000-$10,000 per year and wondered if the fee is worth it.

Certainly there is the issue of managing his portfolio.  It sounds like he has a significant 401(k) plan balance.  This will involve a decision whether to leave that money at his soon to be former employer or roll it to an IRA.  Beyond this decision is the issue of managing his investments on an ongoing basis.  And taking it a step further the fee level mentioned previously should include ongoing comprehensive financial planning advice not just investment advice.

Since it is likely that his 401(k) contains company stock (based upon who he works for) he has the option of electing the Net Unrealized Appreciation (NUA) treatment of this stock as opposed to rolling the dollars over to an IRA. This is a tactic that can save a lot in taxes but is a bit complex.

Can you be objective in making financial decisions? 

The value of having someone look at your finances with a detached third-party perspective is valuable.  During the 2008-09 stock market down turn did you panic and sell some or all of your stock holdings at or near the bottom of the market?  Perhaps a financial advisor could have talked you off of the ledge.

I’ve seen many investors who could not take a loss on an investment and move on.  They want to at least break-even.  Sometimes taking a loss and redeploying that money elsewhere is the better decision for your portfolio.

Can you sell your winners when needed and rebalance your portfolio back to your target allocation when needed?

Do you enjoy managing your own investments and finances?

This is important.  If don’t enjoy doing this yourself will you spend the time needed not only to monitor your investments but also to stay current with the knowledge needed to do this effectively?

In the case of this reader I suggested he consider whether this is something that he wanted to be doing in retirement.

What happens if you die or become incapacitated?

This is an issue for anyone.  Often in this age bracket a client who is married may have a spouse who is not comfortable managing the family finances.  If the client who is interested and capable in this area dies or becomes incapacitated who will help the spouse who is now thrust into this unwanted role?

Not an all or nothing decision

Certainly if you are comfortable (and capable) of being your own financial advisor at retirement or any stage of life you should do it.  This is not an irreversible decision nor is there anything that says you can’t get help as needed.

For example you might hire a financial planner to help you do a financial plan and an overall review of your situation.  You might then do most of the day to day work and engage their services for a periodic review.  There are also financial planners who work on an hourly as needed basis for specific issues.

Whatever decision that you do make, try to be as objective as possible.  Have you done a good job with this in the past?  Will the benefits of the advice outweigh the fees involved?  Are you capable of doing this? 

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