Many prudent investors may have at least some of their holdings in stocks, corporate bonds, or both. In fact, when most people think of “investing,” they think of Wall Street and the stock markets.
Many fail to realize that there are a number of ways to invest in stocks besides owning individual shares.
Mutual Funds
A mutual fund is a collection of stocks, bonds, or other securities. Investors purchase shares of the mutual fund that is managed by a professional investment company.
A typical mutual fund may hold dozens of different securities. That offers some measure of diversification — a sharp decline in an individual security wouldn’t be nearly as damaging to your portfolio as it would be if you only owned a few securities. Diversification is a method used to help manage investment risk; it does not guarantee against loss.
Mutual funds are professionally managed. Fund managers devote their attention to buying and selling securities according to the goals of their funds.
And mutual funds often have a minimum investment of only $1,000 — some will accept even less.
The return and principal value of mutual funds fluctuate with changes in market conditions. Shares, when sold or redeemed, may be worth more or less than their original cost.
Bond funds are subject to the interest-rate, inflation, and credit risks associated with the underlying bonds in the fund. As interest rates rise, bond prices typically fall, which can adversely affect a bond fund’s performance.
Variable Universal Life Insurance
The insurance companies have developed some innovative products that enable you to invest in a wide range of securities — including stocks — through your life insurance policy.
A variable universal life (VUL) insurance policy operates much the same as a “traditional” universal life policy. In exchange for premiums, the insurance company provides a death benefit. And, just like more traditional life insurance policies, the cash value within the policy accumulates tax deferred. When considering this product, you should have a need for life insurance.
But here is the unique difference: you decide how the premium is divided among the subaccounts. With most policies you can select from several different investment subaccounts (or investment options). These investment options allow you to participate in the market and experience the gains and losses realized by the underlying securities.
The cash value of a VUL policy is not guaranteed. The investment return and principal value of the variable subaccounts will fluctuate. Your cash value, and perhaps the death benefit, will be determined by the performance of the chosen subaccounts. Withdrawals may be subject to surrender charges and are taxable if you withdraw more than your basis in the policy. Policy loans or withdrawals will reduce the policy’s cash value and death benefit, and may require additional premium payments to keep the policy in force. There may also be additional fees and charges associated with a VUL policy.
Variable Annuities
The insurance companies have developed another interesting product: the variable annuity. With a variable annuity, you invest a sum with an insurance company, just as you would with a fixed annuity.
But instead of investing your money in its general account, as with a fixed annuity, the insurance company invests it in a separate account. Like a variable universal life insurance policy, this separate account is made up of a number of different investment subaccounts. You specify how much of your annuity will be invested in the various subaccounts. Your return will be based on the performance of the investments you select.
There are contract limitations, fees, and charges associated with variable annuities, which can include mortality and expense risk charges, sales and surrender charges, investment management fees, administrative fees, and charges for optional benefits. Withdrawals reduce annuity contract benefits and values. Variable annuities are not guaranteed by the FDIC or any other government agency; they are not deposits of, nor are they guaranteed or endorsed by, any bank or savings association. Withdrawals of annuity earnings are taxed as ordinary income and may be subject to surrender charges plus a 10 percent federal income tax penalty if made prior to age 59½. Any guarantees are contingent on the claims-paying ability of the issuing company. Variable annuity subaccounts fluctuate with changes in market conditions, and when surrendered, your principal may be worth more or less than the original amount invested.
Mutual funds, variable annuities, and variable universal life insurance are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the mutual fund, variable annuity contract, or variable universal life policy and their underlying investment options, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
As tax laws change, college investment planning becomes increasingly complex. The most beneficial strategies for creating a college fund are quite similar to other investment tactics. Investment products that are tax deferred, tax exempt, or transferable without tax consequences can be especially advantageous.
This could be even more effective if you do your planning early.
One important aspect of an investment is its balance of yield and risk. Determine the amount of risk you can tolerate, given the amount of time you have to recover from any potential losses.
Take the time to familiarize yourself with the financial aid formulas. This could help you determine whether assets and income should be in your name or your child’s name. Structuring your investments ahead of time can have a significant effect on the net amount of funds available for your child’s education.
There are a number of funding options available for your college investment plan. This list contains a few of the more common.
Certificates of Deposit
CDs offer a reasonable return with a relatively high degree of safety. They are FDIC insured to $250,000 (per depositor, per federally insured institution in interest and principal) and offer a fixed rate of return, whereas the principal and yield of investment securities will fluctuate with changes in market conditions.
The interest earned on a CD is taxed as ordinary income. And CDs are not very liquid. You could pay a significant interest penalty for withdrawing money before it reaches maturity.
Bonds
Many people consider U.S. government bonds to be among the least risky investments available. They are guaranteed by the U.S. government as to the timely payment of principal and interest.
The interest on Series EE bonds is tax-free to low- and middle-income families if the proceeds are used to fund a college education. This benefit phases out for individuals and couples in the upper middle class and above.
Zero-coupon bonds are purchased at a substantial discount and pay their face value upon maturity. Because they do not pay interest until maturity, their prices tend to be more volatile than bonds paying interest regularly. Thus zero-coupon bonds make it possible to buy high-quality bonds for far less money up front. Interest income is subject to taxes annually as ordinary income, even though no income is being paid to the investor.
The return and principal value of bonds fluctuate with market conditions and when sold, bonds may be worth more or less than their original cost.
Stocks and Mutual Funds
Many people who use stocks to fund a college investment program invest in mutual funds.
Mutual funds are professionally managed. They buy and sell securities to meet the specific goals of their fund, weighing risk against security, yield against quality. They can be an effective addition to a college investment plan. The investment return and principal value of stocks and mutual funds fluctuate with market conditions, and, when sold or redeemed, shares may be worth more or less than their original cost. Bond funds are subject to the same inflation, interest-rate, and credit risks associated with their underlying bonds. As interest rates rise, bond prices typically fall, which can adversely affect a bond funds performance.
Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Making Choices
There are college investment options to fit almost any investor. No matter how modest or how ample your income, careful planning could be the most effective way to “find” the money for college. The key is to start early and remain consistent.
Once you’ve determined how much it could cost to send your children to college, your next prudent step is to develop a systematic investment plan that may help you to accumulate the necessary funds.
What are your funding options? Which would be appropriate for your situation? We’ve listed several below, along with a brief description of each.
Universal Life Insurance
Universal life insurance policies build cash value through regular premiums and grow at competitive rates. These policies carry a death benefit. In addition to providing cash to your heirs in the event of your death, this death benefit gives universal life insurance policies their tax-free status. Money can usually be withdrawn from these contracts through policy loans, often at no interest. These withdrawals may reduce the policy’s death benefit.
Zero-Coupon Bonds
Zero-coupon bonds represent the ownership of principal payments on U.S. government note or bonds. Unlike traditional bonds, zero-coupon bonds make no periodic interest payments. Instead, they are purchased at a substantial discount and pay face value at maturity. The value of these bonds is subject to market fluctuation. Their prices tend to be more volatile than bonds that pay interest regularly. And even though no income is paid, the inherent interest is still taxable annually as ordinary income.
Mutual Funds
Mutual funds are established by an investment company by pooling the monies of many different investors and then investing that money in a diversified portfolio of securities. These securities are selected to meet the specific goals of the fund. The value of mutual fund shares fluctuates with market conditions so that, when sold, shares may be worth more or less than their original cost.
Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Independent College 500-Indexed Certificates of Deposit
The I.C. 500 is the College Board’s index of college inflation based on a survey of the costs at 500 independent colleges and universities. I.C. 500-indexed Certificates of Deposit are a relatively new funding vehicle offered by a few savings institutions. Their rate of return is linked to the I.C. 500 index.
Section 529 Plans
Section 529 Plans are also known as Qualified Tuition Plans. These state-sponsored and college-sponsored plans offer higher contributions than Coverdell IRAs along with tax-deferred accumulation. Once withdrawals begin, they are tax exempt as long as the funds are used to pay for qualified higher education expenses.
As with other investments, there are generally fees and expenses associated with participation in a Section 529 savings plan. In addition, there are no guarantees regarding the performance of the underlying investments in Section 529 plans. The tax implications of a Section 529 savings plan should be discussed with your legal and/or tax advisors because they can vary significantly from state to state. Also note that most states offer their own Section 529 plans, which may provide advantages and benefits exclusively for their residents and taxpayers.
Before investing in a 529 savings plan, please consider the investment objectives, risks, charges, and expenses carefully. The official disclosure statements and applicable prospectuses, which contain this and other information about the investment options and underlying investments, can be obtained by contacting your financial professional. You should read this material carefully before investing.
Lewis Carroll, the author of Alice’s Adventures in Wonderland, once said, “If you don’t know where you’re going, any road will get you there.” This is certainly true when it comes to investing: If you don’t know where you’re headed financially, then it is not as vital which investments make up your portfolio. If you do have a monetary destination in mind, then asset allocation becomes very important.
The term “asset allocation” is often tossed around in discussions of investing. But what exactly is it? Simply put, asset allocation is about not putting all your eggs in one basket. More formally, it is a systematic approach to diversification that may help you determine the most efficient mix of assets based on your risk tolerance and time horizon.
Asset allocation seeks to manage investment risk by diversifying a portfolio among the major asset classes, such as stocks, bonds, and cash alternatives. Each asset class has a different level of risk and potential return. At any given time, while one asset category may be increasing in value, another may be decreasing in value. Diversification is a method to help manage investment risk. Asset allocation and diversification do not guarantee a profit or protect against loss. So if the value of one asset class or security drops, the other asset classes or securities may help cushion the blow.
Dividing your investments in this way may help you ride out market fluctuations and protect your portfolio from a major loss in any one asset class. Of course, it is also important to understand the risk versus return tradeoff. Generally, the greater the potential return of an investment, the greater the risk.
As a result, the makeup of a portfolio should be based on your risk tolerance. Generally, you should not place all your assets in those categories that have the highest potential for gain if you are concerned about the prospect of a loss. It is essential to find a balance of asset classes with the highest potential return for your risk profile.
Other factors that are important to developing an asset allocation strategy are your investment goals and time horizon. When you are considering how to diversify your portfolio, ask yourself what you want to accomplish with your investments. Are you planning to buy a new car or house soon? Do you aspire to pay for your children’s college education? When retirement rolls around, would you like to travel and buy a vacation home? These factors should all be considered when outlining an asset allocation strategy.
If you require a specific amount of money at a point in the near future, you might want to consider a strategy that involves less risk. On the other hand, if you are saving for retirement and have several years until you will need the funds, you might be able to invest for greater growth potential, although this will also involve greater risks.
Whichever asset allocation scenario you decide on, it’s important to remember that there is no one strategy that fits every type of investor. Your specific situation calls for a specific approach with which you are comfortable and one that could help you pursue your investment goals.
When it comes to investing their money, many people are content to take a random approach.
They may have received a hot tip for a particular investment and decided to plow a large amount of money into it with no regard to the overall balance of their portfolios.
However, research has shown that it is through the careful selection of the various asset classes, rather than the individual investments themselves, that people prosper financially.
One study showed that on average, as much as 91.5 percent of an investment portfolio’s overall return can be attributed to asset class selection.
Therefore, the careful selection and distribution of your investments among the various asset classes is likely to prove crucial to the future success of your investment portfolio.
There are five broad asset classes that you should take into consideration when constructing your investment portfolio.
Cash refers to the most liquid holdings in your portfolio. It includes the balance in your checking account, money market account, and certificates of deposit.
Conventional wisdom holds that you should keep three to six months’ salary in cash to cover yourself in the event of an emergency.
Fixed-principal investments are those that do not put your principal at risk to market forces. Fixed annuities and trust deeds fall into this category.
Debt makes up the third asset class. It includes municipal, corporate, government, and government agency bonds. It also covers other debt-secured investments such as collateralized mortgage obligations.
Equity represents an ownership interest in a business entity; this class covers any investment you might make in stocks. It also covers any interest you may have in a closely held corporation or partnership.
Tangibles include your holdings in real estate, art, gold, precious stones, stamps, baseball cards, or other valuable collector’s items.
How you choose to distribute your investments among the various asset classes depends on your goals, your risk tolerance, and your expected rate of return.
Keep in mind that asset allocation does not guarantee a profit or protect against loss; it is a method used to help manage investment risk.
All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost.
Source: 1) Brinson, Singer, and Beebower, “Determinants of Portfolio Performance II: An Update,” Financial Analysts Journal, May-June 1991 (most current data available)
Taken by itself, the word “risk” sounds negative. But broken down into what it really stands for in terms of investing, it begins to be a little more manageable. By understanding the different types of risk and keeping an eye on your investments, you may be able to manage your money more effectively. Remember, strategic investing doesn’t mean “taking chances” so much as “making decisions.” Long-term investing and diversification may be some of the most effective strategies you can use to help manage investment risk; however, neither guarantees against investment loss.
Inflation Risk
The main risk from inflation is the danger that it will reduce your purchasing power and the returns from your investments. If your savings and investments are failing to outpace inflation, you might consider investing in growth-oriented alternatives such as stocks, stock mutual funds, variable annuities, or other vehicles.
Interest Rate Risk
Bonds and other fixed-income investments tend to be sensitive to changes in interest rates. When interest rates rise, the value of these investments falls. After all, why would someone pay full price for your bond at 2% when new bonds are being issued at 4%? Of course, the opposite is also true. When interest rates fall, existing bonds increase in value.
Economic Risk
When the economy experiences a downturn, the earnings capabilities of most firms are threatened. While some industries and companies adjust to downturns in the economy very well, others — particularly large industrial firms — take longer to react.
Market Risk
When a market experiences a downturn, it tends to pull down most of its securities with it. Afterward, the affected securities will recover at rates more closely related to their fundamental strength. Market risk affects almost all types of investments, including stocks, bonds, real estate, and others. Historically, long-term investing has been a way to minimize the effects of market risk.
Specific Risk
Events may occur that only affect a specific company or industry. For example, the death of a young company’s president may cause the value of the company’s stock to drop. It’s almost impossible to pinpoint all these influences, but diversifying your investments could help manage the effects of specific risks.
What Is the Difference Between a Fixed Annuity and a Variable Annuity?
An annuity is a contract with an insurance company in which you make one or more payments in exchange for a future income stream in retirement. The funds in an annuity accumulate tax deferred, regardless of which type you select. Because you do not have to pay taxes on any growth in your annuity until it is withdrawn, this financial vehicle has become an attractive way to accumulate funds for retirement.
Annuities can be immediate or deferred, and they can provide fixed returns or variable returns.
Fixed Annuity
A fixed annuity is an insurance-based contract that can be funded either with a lump sum or through regular payments over time. In exchange, the insurance company will pay an income that can last for a specific period of time or for life.
Fixed annuity contracts are issued with guaranteed minimum interest rates. Although the rate may be adjusted, it should never fall below a guaranteed minimum rate specified in the contract. This guaranteed rate acts as a “floor” to potentially protect a contract owner from periods of low interest rates.
Fixed annuities provide an option for an income stream that could last a lifetime. The guarantees of fixed annuity contracts are contingent on the financial strength and claims-paying ability of the issuing insurance company.
Immediate Fixed Annuity
Typically, an immediate annuity is funded with a lump-sum premium to the insurance company, and payments begin within 30 days or can be deferred up to 12 months. Payments can be paid monthly, quarterly, annually, or semi-annually for a guaranteed period of time or for life, whichever is specified in the contract. Only the interest portion of each payment is considered taxable income. The rest is considered a return of principal and is free of income taxes.
Deferred Fixed Annuity
With a deferred annuity, you make regular premium payments to an insurance company over a period of time and allow the funds to build and earn interest during the accumulation phase. By postponing taxes while your funds accumulate, you keep more of your money working and growing for you instead of paying current taxes. This means an annuity may help you accumulate more over the long term than a taxable investment. Any earnings are not taxed until they are withdrawn, at which time they are considered ordinary income.
Variable Annuity
A variable annuity is a contract that provides fluctuating (variable) rather than fixed returns. The key feature of a variable annuity is that you can control how your premiums are invested by the insurance company. Thus, you decide how much risk you want to take and you also bear the investment risk.
Most variable annuity contracts offer a variety of professionally managed portfolios called “subaccounts” (or investment options) that invest in stocks, bonds, and money market instruments, as well as balanced investments. Some of your contributions can be placed in an account that offers a fixed rate of return. Your premiums will be allocated among the subaccounts that you select.
Unlike a fixed annuity, which pays a fixed rate of return, the value of a variable annuity contract is based on the performance of the investment subaccounts that you select. These subaccounts fluctuate in value with market conditions and the principal may be worth more or less than the original cost when surrendered.
Variable annuities provide the dual advantages of investment flexibility and the potential for tax deferral. The taxes on all interest, dividends, and capital gains are deferred until withdrawals are made.
When you decide to receive income from your annuity, you can choose a lump sum, a fixed payout, or a variable payout. The earnings portion of the annuity will be subject to ordinary income taxes when you begin receiving income.
Annuity withdrawals are taxed as ordinary income and may be subject to surrender charges plus a 10% federal income tax penalty if made prior to age 59½. Surrender charges may also apply during the contract’s early years.
Annuities have contract limitations, fees, and charges, which can include mortality and expense risk charges, sales and surrender charges, investment management fees, administrative fees, and charges for optional benefits. Annuities are not guaranteed by the FDIC or any other government agency; they are not deposits of, nor are they guaranteed or endorsed by, any bank or savings association. Any guarantees are contingent on the financial strength and claims-paying ability of the issuing insurance company.
Variable annuities are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the variable annuity contract and the underlying investment options, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
An annuity is a contract with an insurance company that is funded by the purchaser and designed to generate an income stream in retirement. It is a flexible financial vehicle that can help protect against the risk of living a long time because it provides an option for a lifetime income.
Two advantages of annuities are that the funds accumulate tax deferred and they can be distributed in a variety of ways to the contract owner.
There are many different types of annuities. Immediate annuities are designed to provide income right away, whereas deferred annuities are designed for long-term accumulation. Some annuities offer a guaranteed rate of interest, whereas others do not.
Generally, annuities have contract limitations, fees, and charges, which can include mortality and expense charges, account fees, underlying investment management fees, administrative fees, and charges for optional benefits. Most annuities have surrender charges that are assessed during the early years of the contract if the contract owner surrenders the annuity. Withdrawals of annuity earnings are taxed as ordinary income and may be subject to surrender charges, plus a 10 percent federal income tax penalty if made prior to age 59½. Withdrawals reduce annuity contract benefits and values. Any guarantees are contingent on the financial strength and claims-paying ability of the issuing company. Annuities are not guaranteed by the FDIC or any other government agency; they are not deposits of, nor are they guaranteed or endorsed by, any bank or savings association. For variable annuities, the investment return and principal value of an investment option are not guaranteed. Variable annuity subaccounts fluctuate with changes in market conditions; thus, the principal may be worth more or less than the original amount invested when the annuity is surrendered.
Variable annuities are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the variable annuity contract and the underlying investment options, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Mutual fund transactions can be complicated, especially with the fees and expenses that accompany the process. It’s important to understand mutual fund load, or sales, charges, and exactly what they entail so you can make informed investing decisions.
A “load” is a fee charged to an investor who buys or redeems shares in a mutual fund. It is similar to the commission that investors pay when they purchase a stock. There are two general types of sales loads. If a sales load is required at purchase, it is called a “front-end” sales load; if it is charged when shares are redeemed, it is a deferred or “back-end” sales charge.” The most common type of back-end sales load is a “contingent deferred sales charge” or CDSC. The amount will depend on how long an investor held the shares, and it could be nothing if they were held long enough.
Loads generally compensate brokers and/or salespeople for selling you a fund. For example, it might help compensate a financial professional who spends time with you at the beginning of your relationship, learning about your objectives and helping with your investment program. Brokers might also continually keep in touch with you and answer any questions you have. This communication can be particularly handy for busy people whose idea of investment tracking amounts to little more than an occasional call to their financial professionals.
Funds without load fees are called “no-load funds.” These funds are distributed directly by the investment company and therefore do not need to charge for brokerage services.
Despite this, all funds, even those with load charges, also have management and expense fees. Management fees pay for the administration of the fund and are usually based on a percentage of the fund’s assets. There are also 12b-1 fees, or distribution fees, that compensate brokers and other sellers of mutual funds for advertising and marketing costs. These fees are typically a very small percentage of the fund’s assets, often less than a half percent.
Funds that charge loads may have lower 12b-1 fees and administration fees, so when you are deciding which type of mutual fund to purchase, it is important to review all the costs and fees involved to see which funds may work best for your investment purposes. Fees and expenses vary from one fund to the next. When assessing different mutual funds, a fund with higher fees and expenses would need to generate higher returns than another fund with lower fees as higher fees can lower your returns.
Mutual fund share prices fluctuate with market conditions. Shares, when sold, may be worth more or less than their original cost. Investments seeking to achieve higher rates of return also involve greater risk.
Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Closed-end funds have been around since 1893, more than 30 years before the first mutual fund (also known as an open-end fund) was created in the United States. However, closed-end funds are much less common than open-end funds. There are fewer than 600 closed-end funds on the market, whereas there are more than 8,000 mutual funds available.
Closed-end funds are similar to open-ended mutual funds in that investors pool their money together to purchase a professionally managed portfolio of stocks and/or bonds. They also have dividends and capital gains that are distributed annually. In other ways, they are very different. Closed-end funds actually have more in common with stocks or exchange-traded funds (ETFs), but they are actively managed.
Closed-end funds have an initial public offering (IPO) with a fixed number of shares to sell to investors. After that point, the investment company usually does not deal with the public directly, and any investors who want to purchase shares must do so on a secondary market, such as the New York Stock Exchange. A closed-end fund’s investment portfolio is generally managed by a separate entity, known as an “investment adviser,” that is registered with the Securities and Exchange Commission.
Shares are bought and sold on the open market, creating a situation in which investor activity does not significantly impact decisions on handling the funds. The market price of closed-end fund shares trading on a secondary market is determined by supply and demand, not by the shares’ net asset value (NAV). Although closed-end funds start with a NAV, the trading price may be higher or lower than that value. If the price is higher, shares are selling at a “premium.” If the price is lower, they are selling at a “discount.”
If you are considering investing in a closed-end fund, there are some things to be aware of. Closed-end funds have broker trading fees and are considered riskier than open-ended mutual funds. They can invest in a greater amount of illiquid securities and can use leveraging methods usually avoided by mutual funds. Because they are harder to sell, they are less liquid than mutual funds. Closed-end funds are generally not redeemable. The investment company does not have to buy back shares to fulfill investor demand. And closed-end funds often charge between 1% and 2% annually for management fees.
Some people consider investing in closed-end funds because they are designed to provide a stream of income, often on a monthly or quarterly basis. Closed-end funds also could provide an important diversification element to their portfolios. Diversification is a method to help manage investment risk, but it does not guarantee a profit or protect against investment loss.
The value of closed-end fund and mutual fund shares fluctuate with market conditions. Shares, when sold or redeemed, may be worth more or less than their original cost.
Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
