02/26/2009
Stock Growth vs. Stock Value: What's the Difference
With the wide variety of stocks in the market, figuring out which ones you want to invest in can be a daunting task. Even if you don't want to select stocks yourself, it can be helpful to understand the concepts that professionals use in evaluating and buying stocks.
There are generally two schools of thought about how to choose stocks. Value investors focus on buying stocks that appear to be bargains relative to the company's intrinsic worth. Growth investors prefer companies that are growing quickly, and with finding companies and industries that have the greatest potential for appreciation in share price. Either approach can help you better understand just what you're buying when you choose a stock for your portfolio.
Value investors look for stocks with share prices that don't fully reflect the value of the companies, and that are effectively trading at a discount to their true worth. A value investor believes that eventually the share price will rise to reflect what he or she perceives as the stock's fair value. A stock's price-earnings (P/E) ratio--its share price divided by its earnings per share--is of particular interest to a value investor, as are the price-to-sales ratio, the dividend yield, the price-to-book ratio, and the rate of sales growth.
Contrarian investors are perhaps the ultimate example of a value investor. Contrarians believe that the best way to invest is to buy when no one else wants to, or to focus on stocks or industries that are temporarily out of favor with the market.
The challenge for any value investor is figuring out how to tell the difference between a company that is undervalued and one whose stock price is low for good reason. Value investors who do their own stock research comb the company's financial reports, looking for clues about the company’s management, operations, products, and services.
Growth investors look for companies that are expanding rapidly. Stocks of newer companies in emerging industries are often especially attractive to growth investors because of their greater potential for expansion and price appreciation despite the higher risks involved. A growth investor would give more weight to increases in a stock's sales per share or earnings per share (EPS) than to its P/E ratio. A growth investor's challenge is to avoid overpaying for a stock in anticipation of earnings that eventually prove disappointing.
Momentum investors look not just for growth, but for accelerating growth that is attracting a lot of investors and causing the share price to rise. Momentum investors believe you should buy a stock only when earnings growth is accelerating and the price is moving up. If a stock falls, momentum theory suggests that you sell it quickly to prevent further losses, then buy more of what's working.
Day traders are the most extreme momentum investors who may hold a stock for only a few minutes or hours then sell before the market closes that day. Momentum investing obviously requires frequent monitoring of the fluctuations in each of your stock holdings, and is best suited to investors who are prepared to invest the time necessary to be aware of those price changes.
Growth stocks and value stocks often alternate in popularity. A company can be a growth stock at one point and later become a value stock. Some investors buy both types, so their portfolio has the potential to benefit regardless of which is doing better at any given time. Investing based on data can assist you as you evaluate a possible purchase and also help you know when to sell because your reasons for buying are no longer valid.
Consult your friendly home town banker for questions you have in structuring your investment portfolio.
02/12/2009
Grantor Retained Annuity Trusts
A grantor retained annuity trust (GRAT) is an irrevocable trust into which you make a one-time transfer of property, and from which you receive a fixed amount annually for a specified number of years (the annuity period). At the end of the annuity period, the payments to you stop, and any property remaining in the trust passes to the persons you've named in the trust document as the remainder beneficiaries, or the property can remain in trust for their benefit.
GRATs are generally used to transfer rapidly appreciating property or high income-producing property to heirs. The main goal is to transfer, free of federal gift tax, a portion of any appreciation in, or income earned by, the trust property during the annuity period.
Because a GRAT is an irrevocable trust, when you transfer property to the GRAT, you're making a taxable gift to the remainder beneficiaries. The value of the gift is discounted because of your retained interest. The amount of the discount is calculated using IRS valuation tables that assume the property in the trust will realize a certain rate of return during the annuity period. This assumed rate of return is known as the Section 7520 rate, discount rate, or hurdle rate. If the property in the trust grows more than the IRS assumes it will, the excess growth will pass to the remainder beneficiaries gift tax free.
Be aware that GRATs have risks associated with them, such as:
- You may fail to outlive the annuity term. If you die during the GRAT term, all of the property in the trust will be included in your gross estate for federal estate tax purposes. The advantages of the GRAT will be lost, and you will have incurred the costs of creating and maintaining the GRAT for nothing.
- The GRAT may fail to outperform the Section 7520 rate. If the GRAT property does not produce a return that exceeds the Section 7520 rate, there will be no excess to transfer and no tax savings will be achieved, which defeats the purpose of the GRAT.
- GRATs are generally not appropriate for generation-skipping transfers. The federal generation-skipping transfer tax (GSTT) will apply to transfers of property made to a GRAT if some or all of the remainder beneficiaries are two or more generations below the grantor (these are known as skip persons). Since the transfer does not actually occur until the grantor's retained interest terminates, a GRAT may not be an appropriate device for making transfers to skip persons.
- Remainder beneficiaries do not receive a step-up in basis. Unlike property received because of the death of the transferor, property transferred to the remainder beneficiaries does not receive a step-up in basis.
- GRATs are considered a grantor trust for income tax purposes. Being classified as a grantor trust means that all items of income and deductions flow through to the grantor. This is the case even if all of the income earned by the trust property is not distributed to the grantor.
Is a GRAT right for you? First, consider the property type you will be granting to the trust. If it is rapidly appreciating now, will it keep doing so for all or most of the annuity period? If it is producing high income now, will it do so for all or most of the annuity period? Drill down on these two questions and determine a percentage of likelihood that your property will continue to perform in order to achieve your desired results. How’s your health? Do you have a known illness that might prevent you from living until the end of the annuity period? None of us are promised life for tomorrow, but knowing this risk, does the GRAT benefit you now and your beneficiaries later?
Consult your friendly home town banker for all of your tax, gift and trust planning needs.
02/12/2009
The Scoop on Roth IRA Conversions
There are currently two ways to fund a Roth IRA--you can contribute directly, or convert all or part of a traditional IRA to a Roth IRA. Generally, you can contribute up to $5,000 to an IRA in 2008, whether it is traditional, Roth, or a combination of both. This amount increases to $6,000 if you're age 50 or older. But your ability to contribute directly to a Roth IRA depends on your "modified adjusted gross income," or MAGI. If you file single/head of household, you can’t contribute to a Roth in 2008 if your MAGI equals $116,000 or more. If you file married filing jointly, you can’t contribute to a Roth if your MAGI equals $169,000 or more. If you file married filing separately, you can’t contribute to a Roth if your MAGI equals $10,000 or more.
Regardless of your MAGI, you can convert an existing traditional IRA to a Roth IRA, but, you'll have to pay income tax on the taxable portion of your traditional IRA at conversion. If you're married filing separately, or your MAGI exceeds $100,000, you currently aren't allowed to convert a traditional IRA to a Roth IRA.
The Tax Increase Prevention and Reconciliation Act (TIPRA) of 2006 allows taxpayers, regardless of your filing status or income, to convert a traditional IRA to a Roth IRA. However, this provision doesn't take effect until 2010. But, there are steps you can take now if you want to maximize the amount you can convert in 2010. Simply start making the maximum annual contribution to a traditional IRA, and then convert that traditional IRA to a Roth in 2010.
Remember that deductible contributions to a traditional IRA may be limited if you or your spouse is covered by an employer retirement plan and your income exceeds certain limits. But any taxpayer, regardless of income level or retirement plan participation, can make nondeductible contributions to a traditional IRA until age 70½. And because nondeductible contributions aren't subject to income tax when you convert your traditional IRA to a Roth IRA, they make sense for taxpayers considering a 2010 conversion, even if they're eligible to make deductible contributions.
SEP and SIMPLE IRAs can also be converted to Roth IRAs. Consider maximizing your contributions to these plans now, and then converting them to Roth IRAs in 2010. If you've made only nondeductible contributions to your traditional IRA, then only the earnings will be subject to tax at conversion. The IRS has proration rules that apply to Roth conversions consisting of both deductible and non-deductible contributions. One way to avoid the prorating requirements is to first roll over all of your taxable IRA money. This will leave only the nontaxable money in your traditional IRA, which you can then convert to a Roth IRA tax free. Even if you have to pay tax at conversion, TIPRA allows you to make a conversion in 2010, and report half the income from the conversion in 2011 and the other half in 2012.
In 2008, you can roll over your employer 401(k) plan distribution directly to a Roth IRA. You'll still be subject to income limits for 2008 /2009 and you'll still need to pay income tax on any taxable dollars rolled over.
So, is a Roth IRA right for you? The answer depends on many factors, including your income tax rate, the length of time you can leave the funds in the Roth IRA without taking withdrawals, state tax laws, and how you'll pay the income taxes due at the time of conversion.
Consult your friendly home town banker to help you determine if opening or converting to a Roth IRA will benefit you now and in 2010.
02/05/2009
Forecasting: Will Your Money Last Through Retirement?
Financial planners use many tools to help you make informed decisions about investments, insurance, and retirement. Financial forecasting involves predicting what will happen with your funds in the future, given that certain circumstances occur. Let’s look at some forecasting methods so you can determine which ones might be most beneficial to your situation.
Straight-line forecasting methods assume a constant value for the projection period. It takes a value from today and projects it to its new value after applying years of compounding interest at a specified rate. This method gives you the best case scenario for the growth of your money, but rarely do returns end up this consistent year after year.
Scenarios forecasting provides a range of possible outcomes. It will use the straight-line method with optimal rate and term to reveal your best case scenario. It will assume some rate fluctuation within the defined term to reveal your most likely scenario. Finally, it will add life expectancy tables to the rate fluctuations to reveal your worst case scenario. Although scenarios forecasting gives you a better idea of the range of possible outcomes, it’s not very precise in estimating the likelihood of any specific result.
The Monte Carlo forecasting method produces analysis based on computer-generated simulations. It works like computer-generated weather forecasts that look at weather behavior near you and moving toward you and predicts what your weather will be in the future, based on those variables. The Monte Carlo method relies on computer models to replicate the behavior of economic variables, financial markets and different investment asset classes.
In contrast to other forecasting methods, a Monte Carlo simulation explicitly accounts for volatility, especially the volatility of investment returns. It enables you to see the spectrum of thousands of possible outcomes, taking into account not only the many variables involved, but also the range of potential values for each of those variables.
By attempting to replicate the uncertainty of the real world, a Monte Carlo simulation can actually provide a detailed illustration of how likely it is that a given investment strategy will meet your needs. When it comes to retirement planning, a Monte Carlo simulation can help you answer specific questions, such as:
- What is the probability that you will run out of funds before age 85?
- If that probability is unacceptably high, how much additional money would you need to invest each year to decrease the probability to 10%?
A Monte Carlo simulation is an important tool because it illustrates how changes to your financial plan can affect the likelihood of achieving your goals. Combined with periodic progress reviews and financial plan updates, Monte Carlo forecasts can help you make better-informed investment decisions to keep your financial goals on track. A Monte Carlo simulation illustrates how your future finances might look based on the assumptions you provide. But remember, there is no guarantee of this outcome.
If you’re planning for retirement, it’s important to have frequent financial check-ups, just like you go to the doctor for check-ups. Things change in your financial life that can drastically impact how your investments respond to these changes. Or, your financial life can be solid as a rock, but the financial world around you changes. This can also have a huge impact on how your investments respond to these changes.
Contact your friendly home town banker to schedule your financial check-up. We have the tools and financial advisors to help you plan your financial future. And, we are with you all the way to make adjustments when needed to give you financial peace in knowing you’re doing everything you can to make your financial dreams come true.
Back to President's Articles
02/26/2009
Stock Growth vs. Stock Value: What's the Difference
With the wide variety of stocks in the market, figuring out which ones you want to invest in can be a daunting task. Even if you don't want to select stocks yourself, it can be helpful to understand the concepts that professionals use in evaluating and buying stocks.
There are generally two schools of thought about how to choose stocks. Value investors focus on buying stocks that appear to be bargains relative to the company's intrinsic worth. Growth investors prefer companies that are growing quickly, and with finding companies and industries that have the greatest potential for appreciation in share price. Either approach can help you better understand just what you're buying when you choose a stock for your portfolio.
Value investors look for stocks with share prices that don't fully reflect the value of the companies, and that are effectively trading at a discount to their true worth. A value investor believes that eventually the share price will rise to reflect what he or she perceives as the stock's fair value. A stock's price-earnings (P/E) ratio--its share price divided by its earnings per share--is of particular interest to a value investor, as are the price-to-sales ratio, the dividend yield, the price-to-book ratio, and the rate of sales growth.
Contrarian investors are perhaps the ultimate example of a value investor. Contrarians believe that the best way to invest is to buy when no one else wants to, or to focus on stocks or industries that are temporarily out of favor with the market.
The challenge for any value investor is figuring out how to tell the difference between a company that is undervalued and one whose stock price is low for good reason. Value investors who do their own stock research comb the company's financial reports, looking for clues about the company’s management, operations, products, and services.
Growth investors look for companies that are expanding rapidly. Stocks of newer companies in emerging industries are often especially attractive to growth investors because of their greater potential for expansion and price appreciation despite the higher risks involved. A growth investor would give more weight to increases in a stock's sales per share or earnings per share (EPS) than to its P/E ratio. A growth investor's challenge is to avoid overpaying for a stock in anticipation of earnings that eventually prove disappointing.
Momentum investors look not just for growth, but for accelerating growth that is attracting a lot of investors and causing the share price to rise. Momentum investors believe you should buy a stock only when earnings growth is accelerating and the price is moving up. If a stock falls, momentum theory suggests that you sell it quickly to prevent further losses, then buy more of what's working.
Day traders are the most extreme momentum investors who may hold a stock for only a few minutes or hours then sell before the market closes that day. Momentum investing obviously requires frequent monitoring of the fluctuations in each of your stock holdings, and is best suited to investors who are prepared to invest the time necessary to be aware of those price changes.
Growth stocks and value stocks often alternate in popularity. A company can be a growth stock at one point and later become a value stock. Some investors buy both types, so their portfolio has the potential to benefit regardless of which is doing better at any given time. Investing based on data can assist you as you evaluate a possible purchase and also help you know when to sell because your reasons for buying are no longer valid.
Consult your friendly home town banker for questions you have in structuring your investment portfolio.
02/12/2009
Grantor Retained Annuity Trusts
A grantor retained annuity trust (GRAT) is an irrevocable trust into which you make a one-time transfer of property, and from which you receive a fixed amount annually for a specified number of years (the annuity period). At the end of the annuity period, the payments to you stop, and any property remaining in the trust passes to the persons you've named in the trust document as the remainder beneficiaries, or the property can remain in trust for their benefit.
GRATs are generally used to transfer rapidly appreciating property or high income-producing property to heirs. The main goal is to transfer, free of federal gift tax, a portion of any appreciation in, or income earned by, the trust property during the annuity period.
Because a GRAT is an irrevocable trust, when you transfer property to the GRAT, you're making a taxable gift to the remainder beneficiaries. The value of the gift is discounted because of your retained interest. The amount of the discount is calculated using IRS valuation tables that assume the property in the trust will realize a certain rate of return during the annuity period. This assumed rate of return is known as the Section 7520 rate, discount rate, or hurdle rate. If the property in the trust grows more than the IRS assumes it will, the excess growth will pass to the remainder beneficiaries gift tax free.
Be aware that GRATs have risks associated with them, such as:
- You may fail to outlive the annuity term. If you die during the GRAT term, all of the property in the trust will be included in your gross estate for federal estate tax purposes. The advantages of the GRAT will be lost, and you will have incurred the costs of creating and maintaining the GRAT for nothing.
- The GRAT may fail to outperform the Section 7520 rate. If the GRAT property does not produce a return that exceeds the Section 7520 rate, there will be no excess to transfer and no tax savings will be achieved, which defeats the purpose of the GRAT.
- GRATs are generally not appropriate for generation-skipping transfers. The federal generation-skipping transfer tax (GSTT) will apply to transfers of property made to a GRAT if some or all of the remainder beneficiaries are two or more generations below the grantor (these are known as skip persons). Since the transfer does not actually occur until the grantor's retained interest terminates, a GRAT may not be an appropriate device for making transfers to skip persons.
- Remainder beneficiaries do not receive a step-up in basis. Unlike property received because of the death of the transferor, property transferred to the remainder beneficiaries does not receive a step-up in basis.
- GRATs are considered a grantor trust for income tax purposes. Being classified as a grantor trust means that all items of income and deductions flow through to the grantor. This is the case even if all of the income earned by the trust property is not distributed to the grantor.
Is a GRAT right for you? First, consider the property type you will be granting to the trust. If it is rapidly appreciating now, will it keep doing so for all or most of the annuity period? If it is producing high income now, will it do so for all or most of the annuity period? Drill down on these two questions and determine a percentage of likelihood that your property will continue to perform in order to achieve your desired results. How’s your health? Do you have a known illness that might prevent you from living until the end of the annuity period? None of us are promised life for tomorrow, but knowing this risk, does the GRAT benefit you now and your beneficiaries later?
Consult your friendly home town banker for all of your tax, gift and trust planning needs.
02/12/2009
The Scoop on Roth IRA Conversions
There are currently two ways to fund a Roth IRA--you can contribute directly, or convert all or part of a traditional IRA to a Roth IRA. Generally, you can contribute up to $5,000 to an IRA in 2008, whether it is traditional, Roth, or a combination of both. This amount increases to $6,000 if you're age 50 or older. But your ability to contribute directly to a Roth IRA depends on your "modified adjusted gross income," or MAGI. If you file single/head of household, you can’t contribute to a Roth in 2008 if your MAGI equals $116,000 or more. If you file married filing jointly, you can’t contribute to a Roth if your MAGI equals $169,000 or more. If you file married filing separately, you can’t contribute to a Roth if your MAGI equals $10,000 or more.
Regardless of your MAGI, you can convert an existing traditional IRA to a Roth IRA, but, you'll have to pay income tax on the taxable portion of your traditional IRA at conversion. If you're married filing separately, or your MAGI exceeds $100,000, you currently aren't allowed to convert a traditional IRA to a Roth IRA.
The Tax Increase Prevention and Reconciliation Act (TIPRA) of 2006 allows taxpayers, regardless of your filing status or income, to convert a traditional IRA to a Roth IRA. However, this provision doesn't take effect until 2010. But, there are steps you can take now if you want to maximize the amount you can convert in 2010. Simply start making the maximum annual contribution to a traditional IRA, and then convert that traditional IRA to a Roth in 2010.
Remember that deductible contributions to a traditional IRA may be limited if you or your spouse is covered by an employer retirement plan and your income exceeds certain limits. But any taxpayer, regardless of income level or retirement plan participation, can make nondeductible contributions to a traditional IRA until age 70½. And because nondeductible contributions aren't subject to income tax when you convert your traditional IRA to a Roth IRA, they make sense for taxpayers considering a 2010 conversion, even if they're eligible to make deductible contributions.
SEP and SIMPLE IRAs can also be converted to Roth IRAs. Consider maximizing your contributions to these plans now, and then converting them to Roth IRAs in 2010. If you've made only nondeductible contributions to your traditional IRA, then only the earnings will be subject to tax at conversion. The IRS has proration rules that apply to Roth conversions consisting of both deductible and non-deductible contributions. One way to avoid the prorating requirements is to first roll over all of your taxable IRA money. This will leave only the nontaxable money in your traditional IRA, which you can then convert to a Roth IRA tax free. Even if you have to pay tax at conversion, TIPRA allows you to make a conversion in 2010, and report half the income from the conversion in 2011 and the other half in 2012.
In 2008, you can roll over your employer 401(k) plan distribution directly to a Roth IRA. You'll still be subject to income limits for 2008 /2009 and you'll still need to pay income tax on any taxable dollars rolled over.
So, is a Roth IRA right for you? The answer depends on many factors, including your income tax rate, the length of time you can leave the funds in the Roth IRA without taking withdrawals, state tax laws, and how you'll pay the income taxes due at the time of conversion.
Consult your friendly home town banker to help you determine if opening or converting to a Roth IRA will benefit you now and in 2010.
02/05/2009
Forecasting: Will Your Money Last Through Retirement?
Financial planners use many tools to help you make informed decisions about investments, insurance, and retirement. Financial forecasting involves predicting what will happen with your funds in the future, given that certain circumstances occur. Let’s look at some forecasting methods so you can determine which ones might be most beneficial to your situation.
Straight-line forecasting methods assume a constant value for the projection period. It takes a value from today and projects it to its new value after applying years of compounding interest at a specified rate. This method gives you the best case scenario for the growth of your money, but rarely do returns end up this consistent year after year.
Scenarios forecasting provides a range of possible outcomes. It will use the straight-line method with optimal rate and term to reveal your best case scenario. It will assume some rate fluctuation within the defined term to reveal your most likely scenario. Finally, it will add life expectancy tables to the rate fluctuations to reveal your worst case scenario. Although scenarios forecasting gives you a better idea of the range of possible outcomes, it’s not very precise in estimating the likelihood of any specific result.
The Monte Carlo forecasting method produces analysis based on computer-generated simulations. It works like computer-generated weather forecasts that look at weather behavior near you and moving toward you and predicts what your weather will be in the future, based on those variables. The Monte Carlo method relies on computer models to replicate the behavior of economic variables, financial markets and different investment asset classes.
In contrast to other forecasting methods, a Monte Carlo simulation explicitly accounts for volatility, especially the volatility of investment returns. It enables you to see the spectrum of thousands of possible outcomes, taking into account not only the many variables involved, but also the range of potential values for each of those variables.
By attempting to replicate the uncertainty of the real world, a Monte Carlo simulation can actually provide a detailed illustration of how likely it is that a given investment strategy will meet your needs. When it comes to retirement planning, a Monte Carlo simulation can help you answer specific questions, such as:
- What is the probability that you will run out of funds before age 85?
- If that probability is unacceptably high, how much additional money would you need to invest each year to decrease the probability to 10%?
A Monte Carlo simulation is an important tool because it illustrates how changes to your financial plan can affect the likelihood of achieving your goals. Combined with periodic progress reviews and financial plan updates, Monte Carlo forecasts can help you make better-informed investment decisions to keep your financial goals on track. A Monte Carlo simulation illustrates how your future finances might look based on the assumptions you provide. But remember, there is no guarantee of this outcome.
If you’re planning for retirement, it’s important to have frequent financial check-ups, just like you go to the doctor for check-ups. Things change in your financial life that can drastically impact how your investments respond to these changes. Or, your financial life can be solid as a rock, but the financial world around you changes. This can also have a huge impact on how your investments respond to these changes.
Contact your friendly home town banker to schedule your financial check-up. We have the tools and financial advisors to help you plan your financial future. And, we are with you all the way to make adjustments when needed to give you financial peace in knowing you’re doing everything you can to make your financial dreams come true.
Back to President's Articles