04/23/2009
Why Do Bonds Have So Many Different Types of Yields?
When it comes to investing in bonds, what exactly is "yield?" The answer depends on how the term is being used. Generally, an investment's yield is the return you get on the money you've invested. However, there are many different ways to calculate yield. Comparing yields can be a good way to evaluate bond investments, but you need to know what yields you're comparing and why. The four common yields associated with bond investing are: current yield, yield to maturity, yield to call, and after-tax yield.
A bond’s current yield is sometimes confused with its coupon rate. The coupon rate represents the amount of interest you earn annually, expressed as a percentage of the bond’s face (par) value. If a $10,000 bond pays $500 a year in interest, its coupon rate would be 5%. Current yield is different because it represents those annual interest payments as a percentage of the bond's market value. Market value can differ from par value daily. When bond prices go up and down in response to market conditions, the current yield will vary also. If you bought that same $10,000 bond on the open market for $9,000, its current yield would be 5.55% ($500 divided by $9,000).
A bond’s coupon rate and yield are the same if you buy it and hold it to maturity. However, the coupon rate and yield are different if you bought the bond at a premium or discount to its par value.
Current yield calculations generally provide you enough information if you’re primarily purchasing bonds for portfolio income. But if you’re looking at bond performance over a number of years, the yield to maturity will be more useful.
Yield to maturity is a more accurate reflection of the return on a bond if you hold it until its maturity date. It includes the bond's interest rate, principal, time to maturity, purchase price, and the value of the interest payments as you receive them over the life of the bond. The yield to maturity will be higher for a bond you buy at a discount because you not only receive interest on the bond, but you redeem more than you paid for it at maturity. The opposite is true if you pay a premium to buy a bond.
Yield to maturity lets you accurately compare bonds with different maturities and coupon rates. It's useful when you're comparing older bonds being sold at a discount or premium rather than a new issue at face value.
A callable bond is one where the issuer may repay the principal before the maturity date of the bond. For a callable bond, you need to calculate what the yield would be if the bond were called at the earliest call date. This calculation is the yield to call and will demonstrate the reduced yield to you if the bond is called early. Why? You get all of your principal back, but the interest paid through the call date will be less than the interest paid to maturity.
A bond's after-tax yield--the rate of return after taking into account taxes (if any) on the income received--is also important to know. Some municipal bonds and U.S. Treasury bonds may be tax exempt at the federal or the state level. In general though, most bonds are taxable.
Bond yields and maturities are related. Typically, bonds with longer maturities pay higher yields because the risk is greater for the longer term. Bonds with shorter maturities pay lower yields because investors get their principal back sooner. The yield curve is used to graphically depict the relationship between bond yields and maturities. If the graph shows an upward sloping line, maturities are lengthening and yields are increasing. The steeper this line gets, the greater the difference between short and long maturities. The flatter the yield curve is, the less difference there is between short and long maturities. If short term maturities have higher rates than long maturities, the yield curve is inverted and usually signals an upcoming recession.
Still have questions about bond investing? Contact your friendly home town banker to help structure a bond portfolio that’s right for you.
04/15/2009
Will Social Security Be There For You?
Watching the news, you've probably come across many stories on the health of Social Security. Social Security has been described as needing only minor adjustments to being in crisis requiring immediate, drastic reform. The underlying assumptions used can skew one's perception of the solvency of Social Security, and even experts disagree on the best remedy. So let's take a look at what we know.
According to the Social Security Administration (SSA), approximately 54 million Americans currently collect some sort of Social Security retirement, disability or death benefit. Social Security is a pay-as-you-go system, with today's current workers paying the benefits for today's retirees. Today's workers have the first $102,000 of their annual wages subject to 12.4% Social Security payroll tax, with half being paid by the employee and half by the employer. Self-employed individuals pay all 12.4%. This money is put into the Social Security trust fund and is used to pay out current benefits.
The amount of your retirement benefit is based on your average earnings over your working career. Your age at the time you start receiving benefits also affects your benefit amount. The full retirement age is in the process of rising from 65 to 67 in two-month increments. For instance: If you were born in 1940, your retirement age is 65 & 6 months; if you were born from 1943-1954, your retirement age is 66; if you were born in 1960 or later, your retirement age is 67. You can begin receiving Social Security benefits as early as age 62, but if you retire early, your Social Security benefit will be less than if you had waited until your full retirement age. If your full retirement age is 67, you'll receive about 30 percent less if you retire at age 62. This reduction is permanent with no future increases available.
Demographic factors are complicating Social Security's problems. Life expectancy is increasing and the birth rate is decreasing. This means that over time, fewer workers will have to support more retirees. According to the SSA, in 1950 there were 16 workers per beneficiary. Today there are 3 workers per beneficiary, and within 40 years there will be only 2 workers per beneficiary. The SSA predicts that in 2017, Social Security will begin paying out more money than it takes in. However, the SSA estimates that Social Security should be able to pay promised benefits until 2041.
The SSA continues to urge Congress to address its solvency issues sooner rather than later, to allow for a gradual phasing in of any necessary changes. While no one can say for sure what will happen, here are some solutions that might fix the problems:
- Allow individuals to invest some of their current Social Security taxes in personal retirement accounts
- Raise the current 12.4% payroll tax
- Raise the current ceiling on wages subject to the payroll tax
- Raise the retirement age beyond age 67
- Reduce future benefits
For now, the best thing you can do is stay informed. You should periodically check your Social Security earnings record and review your Social Security Statement, which the SSA mails annually about three months before your birthday to every worker over age 25. This statement will estimate the amount of Social Security benefits you will be eligible to receive in the future, based on your actual earnings and projections of future earnings. If you have questions, call the SSA at (800) 772-1213 or go to www.ssa.gov for more information.
Contact your friendly home town banker to help you estimate and plan for the income you will receive during retirement.
04/09/2009
Investing with a Separately Managed Account
Many investors seeking professional money management have historically turned to mutual funds. But when you buy shares of a mutual fund, your assets are pooled with those of other fund shareholders. You gain professional money management, but you don’t get individual investor attention to address your needs. For investors who want or need a more customized approach, separately managed accounts (SMAs) have become popular. SMAs are available to investors as an alternative to mutual funds, but many require a higher minimum investment of $50,000.
An SMA is a personal investment account that is customized and managed for you by one or more professional money managers. In an SMA, your assets are not combined with those of other investors. With a mutual fund, you buy and sell shares of a fund which represents your proportionate ownership of individual securities within the fund but, your share of each of those securities is tiny. In an SMA, you are the sole owner of each security within your separately managed account. You also can place securities you already own in an SMA. You and your financial professional have more control over management of specific investments in an SMA. Why is control important? It increases your ability to coordinate the sale of specific securities to complete your overall financial plan.
Unlike traditional, commission-based brokerage accounts, SMA fee structures are asset-based. They typically cover the investment management fee, trading costs, custody, reporting, and financial planning services. One thing to consider when comparing mutual fund expenses against SMA fees is the "invisible" trading costs incurred by mutual funds. Mutual fund expense ratios cover fund management fees, administrative costs, and other operating expenses, but they don't cover trading costs, which include brokerage commissions whenever the fund buys or sells securities. Estimates of these costs can range anywhere from .5% to 1%.
Wrap accounts also charge fees based on the size of assets in the account. With a wrap account, your financial professional may select individual securities or mutual funds for your portfolio. With an SMA, your financial professional may use one money manager who specializes in bonds and another manager who specializes in stocks. An SMA must be managed by a registered investment advisor, who may be independent or part of the same firm as your financial professional.
Mutual funds generally lack tax efficiency. When you buy shares of a mutual fund, you automatically get a share of its embedded tax liabilities. Mutual funds are required to pay out capital gains to all fund holders, regardless of how long you have held its shares. Sometimes fund investors can find themselves owing income tax on their fund investment, even though the fund’s value decreased during the year.
By contrast, each security held in an SMA has an individual cost basis. This allows you to make specific tax-motivated moves. For example, you can request that your manager sell a position with an unrealized loss in order to offset capital gains. This can reduce your income tax liability.
Mutual funds often carry a cash cushion that can cause a drag on performance. Though an SMA involves its own risks and doesn't automatically guarantee better returns, you don't have to worry about the impact of other investors' actions, because an SMA has no other investors.
Generally speaking, the larger your account, the more likely you are to benefit from an SMA. Before investing, ask your financial professional to do a comparison between SMAs and mutual funds, including total fees and trading costs, to determine which is the better deal in terms of overall costs.
Another important feature of SMAs is their ability to allow you to exclude certain securities. You can set sector guidelines to avoid investing in a sector you might not like. This flexibility allows you to better tailor your asset allocation for your own unique circumstances. But don't expect to micromanage every single trade, as you might with a traditional brokerage account. Within the guidelines you set, the money manager will have discretion to implement strategies that he or she feels will provide the best returns for you. And you'll always be able to track what has been bought and sold on your behalf.
For investors who place a priority on control and tax efficiency, and meet the minimum investment requirements, an SMA program may make a lot of sense.
Contact your friendly home town banker to help you crunch the numbers, look at your overall financial picture, and determine if an SMA might be right for you.
04/02/2009
Long Term Stocks: Time vs Timing
Investing with an eye to the long term is particularly important with stocks. Historically, stocks have typically outperformed bonds, cash, and inflation, though past performance is no guarantee of future results. It can be challenging for years like 2008, which was the worst year for the Standard & Poor's 500 since the Depression era. Times like those can frazzle the nerves of any investor. With stocks, having an investing strategy is only half the battle; the other half is being able to stick to it.
Your own definition of "long term" is most important, and will depend on your individual financial goals and when you want to achieve them. Your strategy should take into account that the market will not go in one direction forever and it's helpful to look at various holding periods for stocks over the years. Historically, the shorter your holding period, the greater the chance of experiencing a loss. Even though the S&P 500 showed a return of -1.38% for the 10 years that ended December 31, 2008, the last negative-return 10-year period before then ended in 1939.
Trying to second-guess the market can be challenging. Research has shown that stock investors who try to time the market typically experience lower returns than investors using a buy-and-hold approach. Historically, a handful of months or days account for the bulk of both market gains and losses. Forecasting exactly which days those will be could make you a millionaire. Miss it by just a little bit and you could lose your shirt.
You need to have strategies in place that build your financial and psychological readiness to take a long-term approach to investing in stocks. Even if you're not a buy-and-hold investor, a trading discipline can help you stick to a long-term plan. Having predetermined guidelines that anticipate turbulent times can remove emotion from your decisions. Your strategy may be to sell and take profits when the market rises by a certain percentage, and to buy when the market falls by a certain percentage. Or your strategy might be to put a large percentage of your portfolio under the buy-and-hold plan, while putting the smaller percentage of your portfolio in short-term, higher risk stocks.
Market downturns are a test of how well you've diversified your assets. Diversifying your portfolio can help you manage risk by spreading it among various types of investments, some of which may be performing better than others. And don't forget to look at how far you've come since you started investing. Keeping track of where you stand relative to not only last year but to 3, 5, and 10 years ago may help you remember that the current situation won’t to last forever. If you're retired and worried about a market downturn's impact on your income, think before you react. If you sell stock during a period of falling prices, you might not get the best price and that sale might also reduce your ability to generate income in later years.
Having some cash holdings can be as financially comforting as napping in your favorite recliner. It can enhance your ability to make thoughtful decisions instead of impulsive ones. An appropriate asset allocation strategy can help you prevent having to sell stocks at an inopportune time just to meet ordinary expenses. A cash cushion coupled with a disciplined investing strategy can change your perspective on market downturns and may increase your ability to be patient.
Any investor can look good in good market conditions, but knowing how to survive in bad market conditions defines your ultimate investing success. So, build your investment strategy for the best scenario and have a back-up strategy if things fall apart. Diversify your assets to keep some performing well when others don’t. Know why you bought each investment and have a strategy that defines buy/sell/hold during various shifts in the market. And don’t forget the comfort factor of having a stash of cash.
Consult your friendly home town banker to help with all of your investment strategies.
Back to President's Articles
04/23/2009
Why Do Bonds Have So Many Different Types of Yields?
When it comes to investing in bonds, what exactly is "yield?" The answer depends on how the term is being used. Generally, an investment's yield is the return you get on the money you've invested. However, there are many different ways to calculate yield. Comparing yields can be a good way to evaluate bond investments, but you need to know what yields you're comparing and why. The four common yields associated with bond investing are: current yield, yield to maturity, yield to call, and after-tax yield.
A bond’s current yield is sometimes confused with its coupon rate. The coupon rate represents the amount of interest you earn annually, expressed as a percentage of the bond’s face (par) value. If a $10,000 bond pays $500 a year in interest, its coupon rate would be 5%. Current yield is different because it represents those annual interest payments as a percentage of the bond's market value. Market value can differ from par value daily. When bond prices go up and down in response to market conditions, the current yield will vary also. If you bought that same $10,000 bond on the open market for $9,000, its current yield would be 5.55% ($500 divided by $9,000).
A bond’s coupon rate and yield are the same if you buy it and hold it to maturity. However, the coupon rate and yield are different if you bought the bond at a premium or discount to its par value.
Current yield calculations generally provide you enough information if you’re primarily purchasing bonds for portfolio income. But if you’re looking at bond performance over a number of years, the yield to maturity will be more useful.
Yield to maturity is a more accurate reflection of the return on a bond if you hold it until its maturity date. It includes the bond's interest rate, principal, time to maturity, purchase price, and the value of the interest payments as you receive them over the life of the bond. The yield to maturity will be higher for a bond you buy at a discount because you not only receive interest on the bond, but you redeem more than you paid for it at maturity. The opposite is true if you pay a premium to buy a bond.
Yield to maturity lets you accurately compare bonds with different maturities and coupon rates. It's useful when you're comparing older bonds being sold at a discount or premium rather than a new issue at face value.
A callable bond is one where the issuer may repay the principal before the maturity date of the bond. For a callable bond, you need to calculate what the yield would be if the bond were called at the earliest call date. This calculation is the yield to call and will demonstrate the reduced yield to you if the bond is called early. Why? You get all of your principal back, but the interest paid through the call date will be less than the interest paid to maturity.
A bond's after-tax yield--the rate of return after taking into account taxes (if any) on the income received--is also important to know. Some municipal bonds and U.S. Treasury bonds may be tax exempt at the federal or the state level. In general though, most bonds are taxable.
Bond yields and maturities are related. Typically, bonds with longer maturities pay higher yields because the risk is greater for the longer term. Bonds with shorter maturities pay lower yields because investors get their principal back sooner. The yield curve is used to graphically depict the relationship between bond yields and maturities. If the graph shows an upward sloping line, maturities are lengthening and yields are increasing. The steeper this line gets, the greater the difference between short and long maturities. The flatter the yield curve is, the less difference there is between short and long maturities. If short term maturities have higher rates than long maturities, the yield curve is inverted and usually signals an upcoming recession.
Still have questions about bond investing? Contact your friendly home town banker to help structure a bond portfolio that’s right for you.
04/15/2009
Will Social Security Be There For You?
Watching the news, you've probably come across many stories on the health of Social Security. Social Security has been described as needing only minor adjustments to being in crisis requiring immediate, drastic reform. The underlying assumptions used can skew one's perception of the solvency of Social Security, and even experts disagree on the best remedy. So let's take a look at what we know.
According to the Social Security Administration (SSA), approximately 54 million Americans currently collect some sort of Social Security retirement, disability or death benefit. Social Security is a pay-as-you-go system, with today's current workers paying the benefits for today's retirees. Today's workers have the first $102,000 of their annual wages subject to 12.4% Social Security payroll tax, with half being paid by the employee and half by the employer. Self-employed individuals pay all 12.4%. This money is put into the Social Security trust fund and is used to pay out current benefits.
The amount of your retirement benefit is based on your average earnings over your working career. Your age at the time you start receiving benefits also affects your benefit amount. The full retirement age is in the process of rising from 65 to 67 in two-month increments. For instance: If you were born in 1940, your retirement age is 65 & 6 months; if you were born from 1943-1954, your retirement age is 66; if you were born in 1960 or later, your retirement age is 67. You can begin receiving Social Security benefits as early as age 62, but if you retire early, your Social Security benefit will be less than if you had waited until your full retirement age. If your full retirement age is 67, you'll receive about 30 percent less if you retire at age 62. This reduction is permanent with no future increases available.
Demographic factors are complicating Social Security's problems. Life expectancy is increasing and the birth rate is decreasing. This means that over time, fewer workers will have to support more retirees. According to the SSA, in 1950 there were 16 workers per beneficiary. Today there are 3 workers per beneficiary, and within 40 years there will be only 2 workers per beneficiary. The SSA predicts that in 2017, Social Security will begin paying out more money than it takes in. However, the SSA estimates that Social Security should be able to pay promised benefits until 2041.
The SSA continues to urge Congress to address its solvency issues sooner rather than later, to allow for a gradual phasing in of any necessary changes. While no one can say for sure what will happen, here are some solutions that might fix the problems:
- Allow individuals to invest some of their current Social Security taxes in personal retirement accounts
- Raise the current 12.4% payroll tax
- Raise the current ceiling on wages subject to the payroll tax
- Raise the retirement age beyond age 67
- Reduce future benefits
For now, the best thing you can do is stay informed. You should periodically check your Social Security earnings record and review your Social Security Statement, which the SSA mails annually about three months before your birthday to every worker over age 25. This statement will estimate the amount of Social Security benefits you will be eligible to receive in the future, based on your actual earnings and projections of future earnings. If you have questions, call the SSA at (800) 772-1213 or go to www.ssa.gov for more information.
Contact your friendly home town banker to help you estimate and plan for the income you will receive during retirement.
04/09/2009
Investing with a Separately Managed Account
Many investors seeking professional money management have historically turned to mutual funds. But when you buy shares of a mutual fund, your assets are pooled with those of other fund shareholders. You gain professional money management, but you don’t get individual investor attention to address your needs. For investors who want or need a more customized approach, separately managed accounts (SMAs) have become popular. SMAs are available to investors as an alternative to mutual funds, but many require a higher minimum investment of $50,000.
An SMA is a personal investment account that is customized and managed for you by one or more professional money managers. In an SMA, your assets are not combined with those of other investors. With a mutual fund, you buy and sell shares of a fund which represents your proportionate ownership of individual securities within the fund but, your share of each of those securities is tiny. In an SMA, you are the sole owner of each security within your separately managed account. You also can place securities you already own in an SMA. You and your financial professional have more control over management of specific investments in an SMA. Why is control important? It increases your ability to coordinate the sale of specific securities to complete your overall financial plan.
Unlike traditional, commission-based brokerage accounts, SMA fee structures are asset-based. They typically cover the investment management fee, trading costs, custody, reporting, and financial planning services. One thing to consider when comparing mutual fund expenses against SMA fees is the "invisible" trading costs incurred by mutual funds. Mutual fund expense ratios cover fund management fees, administrative costs, and other operating expenses, but they don't cover trading costs, which include brokerage commissions whenever the fund buys or sells securities. Estimates of these costs can range anywhere from .5% to 1%.
Wrap accounts also charge fees based on the size of assets in the account. With a wrap account, your financial professional may select individual securities or mutual funds for your portfolio. With an SMA, your financial professional may use one money manager who specializes in bonds and another manager who specializes in stocks. An SMA must be managed by a registered investment advisor, who may be independent or part of the same firm as your financial professional.
Mutual funds generally lack tax efficiency. When you buy shares of a mutual fund, you automatically get a share of its embedded tax liabilities. Mutual funds are required to pay out capital gains to all fund holders, regardless of how long you have held its shares. Sometimes fund investors can find themselves owing income tax on their fund investment, even though the fund’s value decreased during the year.
By contrast, each security held in an SMA has an individual cost basis. This allows you to make specific tax-motivated moves. For example, you can request that your manager sell a position with an unrealized loss in order to offset capital gains. This can reduce your income tax liability.
Mutual funds often carry a cash cushion that can cause a drag on performance. Though an SMA involves its own risks and doesn't automatically guarantee better returns, you don't have to worry about the impact of other investors' actions, because an SMA has no other investors.
Generally speaking, the larger your account, the more likely you are to benefit from an SMA. Before investing, ask your financial professional to do a comparison between SMAs and mutual funds, including total fees and trading costs, to determine which is the better deal in terms of overall costs.
Another important feature of SMAs is their ability to allow you to exclude certain securities. You can set sector guidelines to avoid investing in a sector you might not like. This flexibility allows you to better tailor your asset allocation for your own unique circumstances. But don't expect to micromanage every single trade, as you might with a traditional brokerage account. Within the guidelines you set, the money manager will have discretion to implement strategies that he or she feels will provide the best returns for you. And you'll always be able to track what has been bought and sold on your behalf.
For investors who place a priority on control and tax efficiency, and meet the minimum investment requirements, an SMA program may make a lot of sense.
Contact your friendly home town banker to help you crunch the numbers, look at your overall financial picture, and determine if an SMA might be right for you.
04/02/2009
Long Term Stocks: Time vs Timing
Investing with an eye to the long term is particularly important with stocks. Historically, stocks have typically outperformed bonds, cash, and inflation, though past performance is no guarantee of future results. It can be challenging for years like 2008, which was the worst year for the Standard & Poor's 500 since the Depression era. Times like those can frazzle the nerves of any investor. With stocks, having an investing strategy is only half the battle; the other half is being able to stick to it.
Your own definition of "long term" is most important, and will depend on your individual financial goals and when you want to achieve them. Your strategy should take into account that the market will not go in one direction forever and it's helpful to look at various holding periods for stocks over the years. Historically, the shorter your holding period, the greater the chance of experiencing a loss. Even though the S&P 500 showed a return of -1.38% for the 10 years that ended December 31, 2008, the last negative-return 10-year period before then ended in 1939.
Trying to second-guess the market can be challenging. Research has shown that stock investors who try to time the market typically experience lower returns than investors using a buy-and-hold approach. Historically, a handful of months or days account for the bulk of both market gains and losses. Forecasting exactly which days those will be could make you a millionaire. Miss it by just a little bit and you could lose your shirt.
You need to have strategies in place that build your financial and psychological readiness to take a long-term approach to investing in stocks. Even if you're not a buy-and-hold investor, a trading discipline can help you stick to a long-term plan. Having predetermined guidelines that anticipate turbulent times can remove emotion from your decisions. Your strategy may be to sell and take profits when the market rises by a certain percentage, and to buy when the market falls by a certain percentage. Or your strategy might be to put a large percentage of your portfolio under the buy-and-hold plan, while putting the smaller percentage of your portfolio in short-term, higher risk stocks.
Market downturns are a test of how well you've diversified your assets. Diversifying your portfolio can help you manage risk by spreading it among various types of investments, some of which may be performing better than others. And don't forget to look at how far you've come since you started investing. Keeping track of where you stand relative to not only last year but to 3, 5, and 10 years ago may help you remember that the current situation won’t to last forever. If you're retired and worried about a market downturn's impact on your income, think before you react. If you sell stock during a period of falling prices, you might not get the best price and that sale might also reduce your ability to generate income in later years.
Having some cash holdings can be as financially comforting as napping in your favorite recliner. It can enhance your ability to make thoughtful decisions instead of impulsive ones. An appropriate asset allocation strategy can help you prevent having to sell stocks at an inopportune time just to meet ordinary expenses. A cash cushion coupled with a disciplined investing strategy can change your perspective on market downturns and may increase your ability to be patient.
Any investor can look good in good market conditions, but knowing how to survive in bad market conditions defines your ultimate investing success. So, build your investment strategy for the best scenario and have a back-up strategy if things fall apart. Diversify your assets to keep some performing well when others don’t. Know why you bought each investment and have a strategy that defines buy/sell/hold during various shifts in the market. And don’t forget the comfort factor of having a stash of cash.
Consult your friendly home town banker to help with all of your investment strategies.
Back to President's Articles