Month: March 2018

Taxes Part III AKA The Lazy Man’s Post

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

This is one of the ways to think about how the federal tax system works.

There’s plenty of ways to think about it, but I thought this was rather clever illustration of how federal taxes are paid and the rhetoric often employed after federal income tax cuts are proposed.

Believe it or not, unlike most of my long-winded posts, that’s it for today!

Go out there and enjoy your life!

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues.

Talk to you soon.

Until next time…

As Constant As Death: Taxes Part II (Taxes on Investments)

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

Last time, we reviewed the basics of the federal income tax system and its latest changes. This post will detail the basics of how investments are taxed.

As noted previously, the recent tax reform bill that was passed in late 2017 changed federal income taxes significantly. One thing that didn’t change however is the following: Dividends are considered “qualified” once you own the stock or fund producing the dividend for over sixty days (ninety days for preferred stock). Selling before that would make your dividends taxed as ordinary income which would mean that they are taxed far higher than what the taxes would be for qualified dividends given the income levels for the average physician.   

Dividends are now taxed at the following rates:

  1. 0% below $77,200 of taxable income for married joint filers or below $38,600 if single (or, the rarer category, married filing separately)
  2. 15% between $77,200-$479,000 for married joint filers or $425,800 if single (or, in the rarer category of being married, but filing separately, $38,600-$239,500)
  3. 20% if above any of the upper thresholds listed above in the 15% bracket
  4. The 3.8% NIIT (Net Investment Income Tax also called the Obamacare surtax among many other things) is still applied to all dividends based on your modified adjusted gross income of $250,000 for married joint filers or $200,000 for single (or all other) filers.

As of 2013, the dividend tax had been 15% (or 20% for you all rich fat cats that light your fancy cigars with $100 bills and were in the top income tax bracket of 39.6%) with a 3.8% surcharge for married couples with incomes over $250,000 or single taxpayers with an income of $200,000 which was enacted in 2010 to help pay for the Affordable Care Act. [Thanks a lot, Obama!])

If you were in the top income tax bracket of 39.6% from 2010-2017, your entire dividend tax was 23.8% (20% dividend tax + 3.8% NIIT) except for the sad residents of the great states of Tennessee and New Hampshire whose states tax dividends (but not income).

Thankfully, for the sake of convenience (if nothing else), capital gains (selling a security like a stock or mutual fund for more than you bought it for) is taxed at the exact same levels as dividends are (see above) except for one major subtraction.

There is no NIIT levied against your capital gains.

So, if you’re selling stocks and/or funds for a gain, your profits alone (not the original amount invested) will be taxed at a capital gains tax rate. Short term capital gains are defined as anything held less than a year. Anything held over a year and then sold for a profit is considered a long-term capital gain. Short term capital gains are taxed at whatever level your income level determines as short-term capital gains are taxed as what is known as “ordinary income”.

Long term capital gains, however, are taxed far below what the taxes would be for short-term capital gains given the income levels for the average physician. Therefore, hold on to those stocks/funds as best as you can for at least 366 days. It’ll be worth your while. (This definitely should change your thinking on day trading as all those profits are being taxed at a much higher rate [most probably] than if it had been held. As will be discussed in a later post, you should only consider your gains after all the taxes and fees have been paid out. Therefore, you should ALWAYS  [rare in medicine, even rarer in life that we can use this word, so ALWAYS [see what I did there?] pay attention when you it is used] pick the most tax efficient investing route possible.)    

Just to be clear…

Please understand that only the profits are taxed at the above rates, not the entire amount of proceeds. (For example, if you put $30,000 into a fund [ Whoa there big spender!] and then sell it at $50,000 five years later, then you will be taxed on the $20,000 profit, not all $50,000.)  

Realize that there are no local or state taxes on dividends. There are no local taxes on capital gains, but there are state taxes on any capital gain.

There’s entire professions, seminars, books, and the like designed for all of this, so we will revisit this from time to time, but never be even close to being comprehensive. The more complex your taxes are/become, the more you’ll need an outstanding tax professional.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues.

Talk to you soon.

Until next time…

 

Taxes: The Greedy Hand

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

INCOME TAXES

Benjamin Franklin, the indispensable American, was absolutely 1000% (my math may be off here by a little bit or a factor of ten [whichever is closer]) correct as per usual. Let’s avoid the topic we all like to avoid talking about both in our professional and personal lives and delve into the other topic we cannot dodge indefinitely.

First of all, and most importantly, the federal income tax rates changed with the recent massive tax reform law passed in December 2017(officially titled as The Tax Cuts and Jobs Act of 2017 [TCJA]).

Below are the 2018 and then 2017 tax brackets in reverse chronological order.

2018 Income Tax Brackets In The Way We All Think Of Them

Rate Individuals Filing Jointly
10% Up to $9,525 Up to $19,050
12% $9,526-$38,700 $19,051- $77,400
22% 38,701-$82,500 $77,401-$165,000
24% $82,501-$157,500 $165,001-$315,000
32% $157,501- $200,000 $315,001-$400,000
35% $200,001-$500,000 $400,001-$600,000

37% Over $500,000

Over $600,000

 

2018 Tax Brackets In Greater Detail (ie, the way your income is actually taxed)

Rate Taxable Income Bracket Tax Owed
10% $0 to $9,325 10% of Taxable Income
15% $9,325 to $37,950 $932.50 plus 15% of the excess over $9,325
25% $37,950 to $91,900 $5,226.25 plus 25% of the excess over $37,950
28% $91,900 to $191,650 $18,713.75 plus 28% of the excess over $91,900
33% $191,650 to $416,700 $46,643.75 plus 33% of the excess over $191,650
35% $416,700 to $418,400 $120,910.25 plus 35% of the excess over $416,700
39.60% $418,400+ $121,505.25 plus 39.6% of the excess over $418,400

 

2017 Taxes in Greater Detail

Rate Taxable Income Bracket Tax Owed
10% $0 to $18,650 10% of taxable income
15% $18,650 to $75,900 $1,865 plus 15% of the excess over $18,650
25% $75,900 to $153,100 $10,452.50 plus 25% of the excess over $75,900
28% $153,100 to $233,350 $29,752.50 plus 28% of the excess over $153,100
33% $233,350 to $416,700 $52,222.50 plus 33% of the excess over $233,350
35% $416,700 to $470,700 $112,728 plus 35% of the excess over $416,700
39.60% $470,700+ $131,628 plus 39.6% of the excess over $470,700

 

All the above charts are from The Tax Foundation.

 

Deductions

The standard deduction (ie, what you get for just being alive as a federal taxpayer and using this amount rather than itemizing deductions) in 2018 will jump to $24,000. For single filers, it jumped from $6,500 in 2017 to $12,000 now.

The child tax credit currently was at $1,000 and started to phase out at $110,000 in income for couples and $75,000 in income for single people or married, but separate filers (more on them later). Moving forward, this credit doubled to $2,000, $1,400 of which is a refundable tax credit. Furthermore, it only starts phasing out at $400,000 in income for couples and $200,000 for singles.

State and local taxes can still be deducted from your federal taxes, but they are now capped at $10,000 when it used to be unlimited, but just dependent on how much you paid in state and local taxes.This was the so-called SALT (State And Local Taxes) deduction that was being so hotly debated as the tax reform bill wound its way through Congress.

Interest on mortgages for primary and secondary homes (ie, the proverbial vacation home) is still deductible. The limit, however, has come down from loans up  to $1 million to loans up to $750,000. (Remember that this deduction is just the interest on the home loan, not the entire mortgage.)

Medical expenses in 2017 and 2018 are deductible if they exceed 7.5% of your income (down from 10%).

The Alternative Minimum Tax (AMT)

The AMT, created in the 1960s, was designed to prevent high-income taxpayers from avoiding the individual income tax. Unfortunately for these individuals or families, the AMT requires high-income taxpayers to calculate their tax bill twice: once under the ordinary income tax system (the one we all fear and loathe) and again under the AMT. (Talk about your invisible taxes.) Then, you are required  to pay the higher of the two.

Ouch.

The AMT uses a different definition of what is taxable income called Alternative Minimum Taxable Income (AMTI).

SR: It’s the government. Of course, it does…

A source of major consternation and even bitterness has been that occasionally in the past, it has nabbed middle-income (and even more rarely low-income) taxpayers forcing them to pay more than they should have by all rights.

To prevent this problem, taxpayers are allowed to exempt a significant amount of their income from AMTI. However, this exemption phases out for high-income taxpayers (depending on what your definition of high income is).

Dr. Know It All: $40 million a year!!

PWT: Uh, yeah…sure…OK….Anyway…

The AMT is at two similar rates: 26 percent and 28 percent.

The 26% AMT rate for 2018 has the exemption expire at $70,300 for singles and $109,400 for married couples that are filing jointly.

In 2018, the 28 percent AMT rate applies to excess AMTI of $95,750 for singles and $191,500 for all married joint filers.

Last thing of note:

If you’re wondering why a married couple would file separately (which is rather rare), it’s usually a couple making about the same amount of each money yearly. In this scenario, depending on what state you live in, filing separately may save you and your spouse on your state taxes though it will likely cost you both more as a federal tax payer (no spousal tax breaks any longer). Therefore, the savings on state taxes for each of you have to exceed the federal tax hit you’re both taking. It’s a rare instance that this happens, but it does happen therefore make sure if you and your spouse are making roughly the same in any given year (or every year), your tax preparer should be checking which route makes sense for you as a couple. If not, FIRE THEM!!

Just kidding.

Check with them if they have done so…and, if not, have them do it for your 2017 taxes and make sure joint filing is the way to go for you. After all, you’re paying them. They really should have done that for you anyway without you prompting them to do so. My people do every year (and I’ve joint filed every year as a result armed with the knowledge and security of paying less) without me ever asking once.

Finally, one last thing…

The state you live in likely taxes you (there are seven total that have no state income taxes) in many ways (income, sales, property, alcohol, sin…yep, sadly, even something as American as sin is taxed…stupid moralists!) that are complex making state to state comparisons difficult for an individual and nearly impossible for a large mass of people with different homes, wants, and needs.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues.

Talk to you soon.

Until next time…

Risk: A Game of Not Global Domination, But Financial Planning

Never forget these two axioms:

Money frees us, but its pursuit may enslave us.

It’s not how much you have at the end; it’s how much you could have made.

Risk: A Game of Not Global Domination, But Financial Planning

Before determining what you’re buying at what price in what quantity and keeping said security for whatever length of time, you need to decide for yourself (and your family if applicable) what you want as an end result of your investing and what risk you’re willing to take to hold them as an investment.

Realize that all investments contain risk.

ALL.

OF.

THEM.

By risk, we mean that you will lose money on said investment, possibly even all that hard earned money you put in originally.

We all do this every day as doctors. As we take care of patients, we weight the risks and benefits of each treatment or testing option and move forward with the most beneficial course with risks ranging from none to tolerable to even high.

That’s essentially all investing is when talking about what is known as risk tolerance.

Virtually all securities that return a greater amount of money carry a higher risk than those that return a lesser amount.

Unfortunately, risk and return are directly related.

In my mind (and perhaps mine alone), it’s like why all the best tasting stuff is bad for you and the healthiest stuff tastes…meh.

ANYWAY…

In reverse order of risk:

Bonds carry low risk.

Federal or AKA Treasury bonds (bills and notes too, but I’ll just say bonds moving forward for the sake of convenience) are considered risk free because of the almost metaphysical certitude by which they are paid. The US government would have to completely fold and not pay anything ever before bond payments stop . If you recall, you as the bondholder are the creditor that is owed money before the debtor (in this case, the US government)  goes bankrupt. Given the fact that the US government can literally print as much as money as needed for any reason under the sun (reading this again as I proofread this post…this explains a lot of what is perhaps wrong with our current polticoeconomic situation), it’s virtually impossible to have US Treasury bonds default. Thus, risk free…

Municipal (AKA US city or county) bonds are slightly higher risk than federal bonds, but lower risk than any other widely available security. CIties (or counties or states) would have to go bankrupt before bonds issued by them became worthless. It can happen (hello again, Detroit! Also, hello Stockton, California!), but it’s extremely rare, may not affect these bonds while the city or county or state government “reorganizes” its finances, and is easily avoidable in the first place by knowing which areas are fiscally distressed. The latter is easily found out by a five minute Internet search into the area that is issuing the bonds or just simply (here’s a novel idea!) reading/listening to the news and being aware of the world around you. Remember that there may be extra tax benefits to certain municipal bonds which may make the juice worth the squeeze.

Corporate bonds are still safer than either stocks or funds by quite a bit (provided that they are not the often talked about and greatly derided/feared junk bonds), but less safe than other aforementioned (What a great word! You literally cannot sound stupid saying it) types of bonds. As expected, the riskier these bonds the higher the yield, And the lower the yield, the lower your risk you have to endure to get your money.

Mutual funds and ETF’s carry a risk in between bonds (lowest) and stocks (highest risk). The collection of stocks and/or bonds will offer downside protection because even as some stocks fall, other will rise or at least stay even.

Stocks offer the highest return of the Big Three widely commercially available securities with the highest possibility of downside. Just ask anyone who suffered through the 2008-2009 Great Recession.

In 2008, the S&P 500 finished the year 37% lower than it opened.

This is what the risk averse and haters of the stock market in general or stocks specifically bring up as soon as the topic of investing comes up. Even if you had suffered through the brutality of the 2008 market (which didn’t hit its bottom until March 2009 actually), the market went on a tear that hasn’t slowed down since. In fact, it’s been on a rocket since 2017 began.

The annualized return from January 1, 2009 to December 31, 2017 (thus even including the terrible months of Jan-March 2009) is 15.29%.

SR: Uh, yeah, stats guy. That’s great and all…IF YOU’RE A NERD!!! What does that mean in real dollars?

 

PWT: Sure Great question. After all, that’s why we’re all here.

 

SR: Nah. I’m mostly here to crack wise. I’m like a digital Statler…or Waldorf…or both.

 

PWT: Not one millenial here has any idea what you’re talking about right now.

 

SR: Ah, shut up, money man.

 

PWT: Anyway…

For every $100 you had in the stock market (not bonds, cash, etc.) at the start of 2008, you would have $63 at the end of that same year.

SR: Ouch

Dr. Scared: This is it!! This is how they screw you!

For every $63 (the amount left from the original $100 once reduced by the annus horribilis of 2008)  in stocks starting at the beginning of 2009, you’d have $226.80 on January 1, 2018.

So, 226% increase since 2009.

Not bad.

Even if you include 2008, the worst performing year of the last three decades in the stock market, you had a 8.49% per year annualized return in a S&P 500 only portfolio from Jan 1, 2008 to Dec. 31, 2017.

SR: Hey there, guy, I just need…

PWT: We know, We know.

For every $1 you put into the market at the start of 2008,  you would have wound up with $2.26 by the end of 2017…and that’s with surviving the worst year in recent memory.

For those who would argue that they would have retired in 2009 if the stock market hadn’t crashed, then you likely weren’t positioned for retirement in the first place. (Much more about this in a later post.)

Also, this assumes you were only in stocks, not any outperforming fund, bonds, any alternative investments, or just cash (always in style, always fits, and never gets old). Even if you had 100% of your portfolio in only stocks, and then decided to not see the 2008-2009 crash as a buying opportunity (but hopefully not as a selling point either), then you would have been forced to work until 2012 ended. (If you worked through the end of 2011, your stocks only portfolio would be 94% of its January 1, 2008 value.)

The above is predicated on two basic assumptions:

  1. ) Your stocks only portfolio is completely identical to the gyrations of the         S&P 500.
  2. ) All dividends were included and calculated in these returns.

This shouldn’t scare you off from the stock market, but rather convince you that you need to always be cognizant of your age, your net worth, your closeness to retirement, and what your Magic Number is.   

Therefore, the closer you are to your Magic Number, the more you need to be oriented towards maintaining your net worth (what is known as capital preservation) rather than growing it further.

ANYWAY…

Think of risk tolerance as an individual exercise. Don’t worry that yours may be dramatically different than your best friend’s, colleagues at work, etc.It should be different. In fact, I’d be worried if your risk tolerance is the same as everyone else you know.

Think of it like this.

How do you drive? How aggressive are you? How fast above the speed limit are you willing to push it on a highway? How willing are you to hit bumpers when you have to parallel park?

There’s plenty of online quizzes that test your risk tolerance as an investor that you can search for, but none of them are much better than thinking about what kind of driver you are.

It all boils down to the following:

Aggressive investors are willing to lose money in the short term in order to make outsized gains in the future/long term.They’re exchanging security for better returns.

Conservative investors are willing to have lower returns as long as their original investment is preserved and gradually increases in value over time. They’re exchanging returns for security. Or, as some might say, they’re exchanging returns for peace of mind.

And there are moderately aggressive investors that have a blended approach between the two which is likely where the vast majority of us are.

Just reading this probably tells you where you lie based on how you felt as you read that last passage.

It’s easy to be critical of others that aren’t like you, but being more aggressive than you’re comfortable and working on an ulcer rather than sleeping each night is nothing to brag about. But, people do it all the time. I know some that do. I’m sure you do as well.

Grousing about how well the market is doing and bitching about it all the time when you’re investing too conservatively for you and your family is nothing to celebrate and is certainly is not any way to live.

Personally, I’ve always been an aggressive investor and it has been great for me. But, realize what that means. You don’t have to be invested in companies you don’t understand like high technology (ie, AI, cloud computing, cybersecurity, etc) companies, but rather blue chip Dividend Aristocrats along with index funds which will get you great returns, but still categorize you as an aggressive investor. I always wanted to ensure my investments after any fees and taxes were subtracted out was significantly above inflation (3.3% on average, remember?). At the end of the day, though, you need to invest to your style and comfort and no one else’s.  

What is your risk tolerance?

Think about it.

If you’re married or in a seriously committed relationship, talk to your spouse or partner about it. Hopefully, if you’re not on the same page, you can find a very terrifically happy medium.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues.

Talk to you soon.

Until next time…

Preferred Stock (Or, in this case, Forgotten, not Preferred)

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

Preferred Stock

OK, people.

Confession time.

I made a massive mistake and am now correcting the error of my ways. While going over the basics of stocks, I somehow ignored/forgot the ins and outs of preferred stock.

PWT: Physician, Wealth Thyself to the rescue!!!

SR: What a dork…

Preferred stock lies somewhere between common stock (I know. Common…it makes you sound like a peasant…and this whole time you thought you were a budding tycoon…Damn!) and bonds in terms of what you are owed by the company and what you owe the company or are restricted doing. As the owner of preferred stock, once the company is in bankruptcy and has to liquidate its assets, it cashes out to everyone it owes money to including bond holders and then owners of preferred stock and then finally common stock owners…if anything at all is left over…which there never is.

Generally speaking, preferred stock have dividends and those dividends are paid out as a higher priority than those of common stocks. Even when the company in question is cutting or suspending dividends for common stock, it will pay out the dividends for preferred stock. However, if the company falls into such a bad cash flow situation that all dividends are suspended, eventually even the dividends of some types of preferred stocks can and will be stopped (whereas others cannot such as cumulative preferred stock—more on this later).

Preferred stocks are actually rated by credit agencies similar to bonds, but they are almost always rated lower than the best bonds because bond holders are creditors (ie, the bank for the company, remember?) and the company owes them above all others.

There are many types of preferred stocks which you can learn about on your own if you’d like, but I would not be a regular investor in them unless you have been a stock investor for years and really understand the ups and downs of stock investing OR have a financial advisor that is doing so for you. Even then, your financial advisor should be able to explain to you why they are putting your hard earned money into this preferred stock rather the common stock of the same company or any other investment. If this isn’t the case, you should either ask or not be invested in the preferred stock in the first place.

As a preferred stock holder, you have no voting rights in the operations of the company which is OK for virtually all retail investors (regular Joe and Jill investors like you and me), but it does need to be noted.

There are multiple reasons a company may issue preferred stock, but on the retail investor side, it’s essentially one line of thinking that leads you to buy preferred stock. You want a large, well established company that issues preferred stock with a high dividend which is well protected. Think of something on the order of a bond, but that pays a higher dividend that a bond does in its yield (generally speaking) and doesn’t lock you in for multiple years necessarily.

Here is a quick rundown of the pros and cons of owning a preferred stock.

Pros of Preferred Stock:

  1. Higher fixed-income payments than bonds (usually) or common stock
  2. Lower investment per share compared to bonds
  3. Priority over common stocks for dividend payments and liquidation proceeds
  4. Greater price stability than common stocks typically
  5. Greater liquidity than corporate bonds of similar quality

Cons of Preferred Stock:

  1. Callability (Depending on the kind of preferred stock and/or the terms attached to it, the issuing corporation can expire the preferred stock like a bond (remember?) depending on the needs of the corporation at any given time.
  2. Lack of specific maturity date makes recovery of invested principal uncertain
  3. Limited appreciation potential (You’re making money on the dividends typically and not the share price of the preferred stock itself.)
  4. Interest rate sensitivity (Yes, interest rates will fluctuate and they can in turn affect the dividend rates on your preferred stock. As it becomes more expensive for the corporation to borrow money, then it will pinch down on money it has already borrowed from others (ie, you) when and where it can (such as it can with preferred stock and some types of bonds).
  5. Lack of voting rights (if this matters to you)

Due to its fixed higher dividend rate(s), preferred stock has become more popular over the years and especially so over the past decade. Ten years ago, in the first quarter of 2008, the entire preferred stock market was valued at approximately $100 billion which seems staggering except when compared to other securities. At that time, the common stock and funds total market value was $9.5 trillion (9500% more than that of preferred stock) and the total value of the bond market then was over $4 trillion (4000% more than that of preferred stock). The increase in the preferred stock market has been steady as it was $241 billion by mid 2015 and $34.1 billion of new preferred stock was issued in 2016 alone. However, again, it was dwarfed by the $22.71 trillion total value of all available stocks/funds/bonds at that time. In fact, just three years ago, the total preferred stock market was only 3% of the total value of just the CORPORATE bond market alone (exclusive of the municipal and federal bond markets).   

One last thing of note for preferred stocks is how they are listed. Common stocks are just listed with the name of the company and what is known as the stock symbol or ticker symbol (such as Apple with AAPL or McDonald’s with MCD).

Preferred stocks however are listed in their own language such as the following:

Ashford Hospitality Trust Inc 8.45% Cum Pfd Ser D

SR: What in the name of all that holy is that abomination of a name mean?

Ashford Hospitality Trust Inc (Incorporated) is the name of the corporation issuing the preferred stock.

The 8.45% is the dividend yield that can reliably be expected as long the preferred stock is owned.

The Cum refers to…

SR: Yeah, hold it right there, Professor, We all know what that means…

PWT: Uh, yeah. ANYWAY…

That uh…abbreviated designation refers to the fact that this preferred stock is cumulative (see the links above for the most common types of preferred stock) meaning that if for any reason that the dividend is not paid at the expected time, then it is promised to be paid later (ie, the dividends/payments will accumulate).

The “Pfd” simply refers to the fact that it is preferred stock.

The “Ser D” means Series D refers to the fact that it is the fourth time preferred stock has been issued by this company. (Since D is the fourth letter of the alphabet, it indicates that it is the fourth offering of the preferred stock issued by this particular corporation.)

Dr. Know It All: Exactly how stupid do you think we are?

SR: Wait! Don’t answer that.

The way preferred stock is listed is as variable as the numbers and types of preferred stock.

Personally, I like it that way. It’s not meant to be confusing, but certainly can be. Consider it like a check against yourself or a speed bump to slow down you deploying your hard earned capital into the scary world. If you can’t understand every single bit of the listing of the preferred stock on your own (no cheating on the Internet!), then you shouldn’t invest in it. That’s a pretty good rule of thumb I would say.

I think this is a pretty good stopping point.

My apologies to all of you for skipping over this earlier, but maybe it was a good thing since this made for a more bite sized post to digest. (Self rationalization is also a good thing.)

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your family, friends, and colleagues.

Talk to you soon.

Until next time…

 

Stock Exchanges

Never forget these two axioms:

 

Money frees us, but its pursuit may enslave us.

It’s not about how much you have at the end; it’s how much you could have made.

 

Stock Exchanges

 

Not to get too big of a head, but let me quote myself from an earlier post…

 

“There’s a marketplace where people go to buy stocks just like you (or people you know because I’ve actually never done this even once in my life) buy produce at a farmer’s market.  This marketplace is called an ‘exchange’.”

 

Realize that not only stocks, but bonds and other securities (i.e., any tradeable financial instrument) can be bought and sold (i.e., traded) in what are commonly called “stock exchanges” or just “exchanges”, but clearly involve far more than stocks alone.

 

There are 18 stock exchanges in the world that have a market capitalization (i.e., all the combined value of all the stocks of all the companies in said exchange) of over $ 1 trillion (US) each. They are sometimes referred to as the “$1 Trillion Club”. These 18 exchanges accounted for ~90% of global market capitalization in 2015.

The below are the top twenty exchanges in the world ranked by market capitalization.

(The below are the name of the exchange, country, city, and market capitalization in millions of US dollars as of October 2017.)

 

1.)    New York Stock Exchange    United States    New York    21,377

2.)    NASDAQ    United States    New York    9,585

3.)    Japan Exchange Group    Japan    Tokyo    5,974

4.)    Shanghai Stock Exchange    China    Shanghai    5,043

5.)    Euronext European Union         Amsterdam/Brussels/Lisbon/London/Paris 4,388

6.)  London Stock Exchange    United Kingdom London    4,297

7.)    Hong Kong Stock Exchange    Hong Kong 4,135

8.)    Shenzhen Stock Exchange    China    Shenzhen    3,688

9.)    TMX Group    Canada    Toronto    2,360

10.)    National Stock Exchange of India India    Mumbai    2,194

11.)    Deutsche Börse    Germany    Frankfurt    2,181

12.)    Bombay Stock Exchange    India Mumbai 2,175

13.)    Korea Exchange    South Korea    Seoul    1,683

14.)    SIX Swiss Exchange      Switzerland    Zurich    1,649

15.)    Nasdaq Nordic    Northern Europe, Armenia    Stockholm    1,561

16.)    Australian Securities Exchange    Australia    Sydney    1,428

17.)    JSE Limited      South Africa    Johannesburg    1,129

18.)    Taiwan Stock Exchange    Taiwan    Taipei    1,068

19.)    BM&F Bovespa  Brazil    São Paulo    935

20.)    BME Spanish Exchanges  Spain Madrid    896

 

The New York Stock Exchange (NYSE)

 

New York, New York…The Big Daddy of Them All…Make It There and You’ll Make It Anywhere

 

The New York Stock Exchange (NYSE) is by far the largest of all the exchanges at over $21 trillion (roughly the value of the next four biggest exchanges in the world combined) with daily trading over $30 billion (often over $35-40 billion) and even a few days in 2017 near or above $100 billion just for that day.

There’s a reason for all this money floating around.

To be listed on the NYSE, a company must have issued at least one million shares of stock worth $100 million and must have earned more than $10 million over the last three years. The entry fee to the NYSE is up to $500,000-$75,000 with a yearly listing fee of up to $500,000 as well.

Yeah, your corner Gas-n-Sip isn’t going to cut it…unless it’s one of 400 locations.

The NYSE is open for trading Monday through Friday from 9:30 am – 4:00 pm EST, with the exception of holidays. So, putting in buy or sell orders after work means it will only be done the next trading day.

Believe it or not, the NYSE is a giant series of simultaneous auctions on all the stocks in the exchange where traders can trade stocks on behalf of investors. The traders who work for the NYSE literally huddle around the appropriate post where a specialist broker, who is employed by a NYSE member firm (ie, not an employee of the NYSE), acts as an auctioneer in an open air auction where buyers and sellers are brought together to execute transactions. If you see any movies like “Trading Places” where they show the trading floor of an exchange, it looks chaotic. And in the days of pen and paper, quite frankly, it was.

Of historical record, on September 25, 1995, NYSE member Michael Einersen, who designed and developed this system, executed 1000 shares of IBM through wireless hand-held computers (HHC) (it was his honor to do so since he designed and developed the system which allowed traders to both receive and execute trades electronically) ending a 203-year process of paper only transactions forever. Within two years, virtually all companies’ stocks could be traded electronically. Well over 90% of the trades at the NYSE are done electronically allowing for last minute, end of the day trades with nearly instantaneous execution.

Following the Black Monday market crash in 1987 (October 19, 1987, the largest one day DJIA percentage drop [22.6%, or 508 points at that time] in history occurred), the NYSE imposed brakes on trading to decrease volatility and hopefully end massive panic selling.

The NYSE has set the following three thresholds based on the average closing price of the S&P 500 (note that it’s the S&P 500 used for the benchmark and not the DJIA) for the preceding trading day.

They are the following:

Level 1: -7%

Level 2: -13%

Level 3: -20%

Therefore, if there is a level 1 or level 2 decline, there will be a 15 minute stoppage in trading (unless it occurs after 3:25 pm in which case no stoppage in trading occurs).

A Level 3 decline, on the other hand, triggers a suspension of trading being for the remainder of the day no matter when it occurs.

The NASDAQ (National Association of Securities Dealers Automated Quotations)

The NASDAQ is the world’s second largest stock exchange as noted above (pretty impressive since it only started in 1971) and, as mentioned before, it tends to be heavy in technology companies. Microsoft, Apple, Cisco, Oracle, Dell, Google, Amazon, Facebook, and Netflix (but no chill) all debuted on the NASDAQ. It is still the go to exchange for the emerging technology company to debut on.

(In contrast to the NYSE, to be listed on the NASDAQ a company must have issued at least 1.25 million shares of stock worth at least $70 million and must have earned more than $11 million over the last three years. Speaking of contrast…the entry fee to the NASDAQ is $50,000-$75,000 with a yearly listing fee of ~$27,500. It’s good business to have low entry fees for tech startups gone big who are low on cash—which is the whole reason the company is offering shares in the first place.)

Not surprisingly, the NASDAQ was the first exchange in the US to start trading online, highlighting Nasdaq-traded companies and closing each trade with the boastful claim (and not so subtle jab at the old, stodgy NYSE) that the NASDAQ was “the stock market for the next hundred years”.

As of June 2015, the NASDAQ has an average annualized growth rate of 9.24% since its opening in February 1971.

Since the end of the so called “Great Recession” in June 2009, it has increased by 18.29% on average per year.

The NASDAQ Composite Index has actually more than quadrupled since January 2009.

Again, this is not at all surprising given how many of the largest technology companies (most of which are listed on the NASDAQ) are doing in the last forty years and especially the last decade.

Just so you know, there is a third stock exchange (also in New York just so they’re not feeling left out) called the American Stock Exchange or AMEX where approximately 10% of all the securities in the US traded. So, though you may have never heard of it, this is no small, cheap, chump change operation.

Once a major competitor of the NYSE before the NASDAQ came along in 1971, the American Stock Exchange is now mostly known for trading in small cap stocks, options, and exchange traded funds. Actually, AMEX is where ETFs were first employed.

AMEX has the least strict listing requirements among the three top American exchanges, which consequently results in many small companies joining it rather than the other two.

If you haven’t heard of Peabody Energy, you probably haven’t heard of any of the other companies listed on the American Stock Exchange.

Back to the Big Two…

So both the NYSE and NASDAQ are US stock exchanges (the two largest in the world) that the vast majority of publicly traded US companies are listed on with different entry fees.

The NASDAQ is owned and run by a for profit company. The NYSE was a non-profit entity…until March 8, 2006 when the NYSE became a for profit company publicly traded…on the NYSE. (To blow your mind further, the NASDAQ trades…on…wait for it…yep, you guessed it…the NASDAQ.)

So what’s the difference between the two?

Two principal differences:

1.) The NYSE has its trading occur on an actual physical “trading floor” at 11 Wall Street NYC. The NASDAQ doesn’t have a physical location for trading, but rather is a telecommunications network upon which all their online trading occurs.

2.) As noted before, the NYSE is like the world’s largest auction house where thousands of auctions between buyers and sellers happen every trading day (i.e., an auction market—I know, I know, I used the word ‘auction’ three times in one sentence, but there is no good synonym for that word I will not mention again in this post.) In the NYSE, you’re buying essentially what someone else has just sold.

The NASDAQ, though, is what is known as a dealer’s market where both buyers and sellers conduct their desired business through a third party.

That’s really it as far as us retail investors are concerned.

One last thing…

ADRs

Dr. Unwise: Uh…what now?

Dr. Scared: This is it! This is how they screw you!! Money under the mattress is the only way to go!

PWT: Uh, yeah, anyway…

 

ADRs or American Depository Receipts is how a non-US company can be listed on a US stock exchange. Think about it for a second. How does a, say, company in the UK like BP (it is British Petroleum after all) which is already listed on the London exchange get listed in the US? Honestly, what company wouldn’t want to have access to all the money American investors, retail and institutional, (aka the US capital market) provide?

So, this is how BP pulls off the neat trick of being listed at home in London and again in New York.

Before 1927 when ADRs were first introduced, the only way an American could buy into a foreign company was to buy shares on a foreign exchange.

The problem with that is twofold:

1.) You’re at the mercy of regulations in whatever country your company of choice is from.

2.) Currency fluctuations and foreign taxes may wipe out your gains.

An ADR is a US bank issued certificate that represents a share or a number of shares (or even a fraction of a share) in a foreign company that is traded in a US exchange. (To be more precise, every ADR is issued by a US bank [known as the custodian bank] once the underlying shares of the foreign company are deposited in a bank of the same  country of the foreign company.)

They act, feel, and trade like any other shares of any other company. ADRs are bought, valued, and even pay dividends in US dollars.

Generally speaking, the ADR moves in parallel with the foreign stock in its home country (but adjusted for the ratio of ADRs to shares of the foreign company in question since they don’t have to be 1:1).

Of note, UK companies that set up ADRs generate a 1.5% “creation fee” that you get to pay for the privilege of buying the ADRs of said UK company.

Other than a few exceptions like the above, ADRs should be evaluated, treated, and traded like any other stock.

Whew!

Enough.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

 

Talk to you soon.

 

Asset Class IIIB: Return of the Bonds: Revenge of the Market

Never forget these two axioms:

Money frees us, but its pursuit may enslave us.

It’s not about how much you have at the end; it’s how much you could have made.

Asset Class IIIB

 

Return of the Bonds: Revenge of the Market

 

Let’s get to it.

 

Three Types of Bonds:

 

1.) US Government Bonds

 

U.S. federal bonds are categorized according to its maturity.

 

Bills=bonds maturing in less than one year

Notes=bonds maturing between one and ten years

Bonds= er, bonds maturing in over a ten year period

(Sorry, Mrs. Cunningham. My high school English teacher insisted on never using the word in question to define that same word. But, I guess that’s the beauty [or curse] of having your own blog.)

 

The above bonds are known collectively as “Treasuries” —i.e., Treasury bills (often called T-bills since apparently saying “Treasury” is too tiresome), Treasury notes, and Treasury bonds. All the bonds  (AKA debt) issued by the U.S. government is regarded as extremely safe, often referred to and/or considered as “risk-free” as are the bonds of many highly developed countries.

2.) Municipal Bonds

Municipal bonds AKA “munis” are bonds issued by state or local (city or county) governments or even government agencies. These bonds are often riskier than national government bonds. Cities don’t go bankrupt almost ever, but it can happen (Hi, Detroit!! I’m talking about you!).

The major advantage municipal bonds convey to investors is that any returns are exempt from federal taxes.

And, even better, state and local governments will often (but not universally) make the returns on their bonds non-taxable for residents of said state or locality thus making some (definitely not all) municipal bonds completely tax-free which is known as “triple-tax free” (ie, no federal, state, or local taxes).

Because of these tax exemptions, the yields on municipal bonds are usually lower than those of equivalent taxable bonds. When considering municipal bonds as an investment, it literally pays to check on their tax exemption status vs. their yield.

3.) Corporate Bonds

Short-term corporate bond < 5 years maturity

Intermediate corporate bond=5-12 years maturity

Long-term corporate bond> 12 years maturity

A few type of corporate bonds include the following:

Convertible bonds:  corporate bonds that give the bondholder (you) the option to convert the bonds into shares of common stock at a later date.

The number of shares an investor gets for each convertible bond is determined by a conversion rate which may be variable or fixed depending on the terms at the time the bonds are offered.

For example, a conversion rate of 20 means that for every $1,000 of face/par value (remember that?) you hold and then convert, you receive 20 shares of stock.

It’s incumbent on you as the investor then to decide whether or not it makes sense to convert bonds into stock (i.e., equity).

The way to do that is by dividing the selling price of the bond by the conversion rate, known as the breakeven price, and seeing whether that price is lower or higher than the company’s stock price at that time.

Example:

Let’s use the above bond for our purposes.

A.)

$1,000 bond with a conversion rate of 20.

Breakeven price=50

Company’s current stock price=$53.25

Get your shares, people!!

B.)

$1,000 bond with a conversion rate of 20.

Breakeven price=50

Company’s current stock price=$33.85

Hold steady with your bond(s)!

C.)

$1,000 bond with a conversion rate of 20.

Breakeven price=50

Company’s current stock price=$50

Aah. Dilemma time.

Break out your calculators and, to a lesser extent, your crystal balls.

You (should) know how many years you have left until maturity, what the bond’s coupon (remember that?) is, and what your payout is finally.

Then, compare that final total amount to what you think the company itself will do over that same time period including any possible/potential dividends.

Realize that dividends are taxed differently (currently 23.8% for annual incomes over $250,000 for a couple) than any bond payments will (which will be taxed as ordinary income, not exempt from taxes—remember, these are corporate bonds, not municipal bonds).

Much more on taxes and their impact on your investing in a later post.

Callable bonds: ones that can be redeemed by the issuer at some point prior to its maturity.

For example, if interest rates drop since the company first put out the bond, then the company will want to refinance this debt (remember that’s all bonds are from the perspective of the company—debt) at a lower interest rate.

In this case, the company “calls its current bonds” AKA reissues bonds at a lower rate of interest. Not surprisingly, callable bonds usually have a higher interest rate to compensate for the potential risk of them being reissued at a lower interest rate.

It’s no different than when you refinance your home mortgage. The only difference is that the advantage is for you in that case and to the issuing company in this case, BUT you do get an even higher interest rate than other bonds as compensation for an event that may actually never happen.

And just so you know and don’t accuse Physician, Wealth Thyself of shortchanging you (and I’m not sure how you can given how this is entirely free for you):

Asset-backed securities (ABS): a bond issued by banks or other large financial institutions

These bonds come from bundling the cash flows generated by other assets and offering them to investors thus why they are called “asset backed”.

If a bond like this is backed by a number of mortgages rather than other assets, they are known as mortgage-backed securities or MBS. These were a lot of the so-called “toxic assets” that propelled the entire planet into financial crisis once the US real estate market imploded.

Why?

Because these types of bonds, ABS or especially MBS, are usually only reserved for  institutional investors (i.e., banks, hedge funds, etc.) or extremely sophisticated, high net worth individuals, not just the average Joe and Jill investor like you and me.

Lastly, a few other bond types that you may hear about or be offered (just so you’ve heard of them—don’t ever blame Physician, Wealth Thyself for being neglectful):

A put bond (I know, I know. It’s spelled differently.) or putable bond is a bond that allows the holder (you) to force the issuer to repurchase the security at specified date(s) before maturity. The repurchase price is set at the time of the bond being issued and is typically par value AKA face value AKA what you paid for this bond originally. So, usually, this works to your advantage as an investor.

A discount bond is a bond that is issued for less than its face (or par) value, or a bond currently trading for less than its face value in that pesky secondary market. Discount bonds sound just like zero coupon bonds (remember them?) because they are except for one simple thing: zero coupon bonds do not pay interest.

A retractable bond is one where the holder (again, you) to force the issuer to redeem the bond before maturity at par/face value. You may choose to shorten the maturity on a bond because of market conditions or because you need the principal sooner than expected (hopefully for a hot new investment and not because you’re massively in debt). By doing so, you’re giving up on the interest payments of all those years you could have held the bond, but decided not to…but, at least, you have cash on hand.

An extendable bond is somewhat the reverse of the above retractable bond where an option to lengthen its maturity period exists. Depending on the specific terms of the extendable bond, the bond holder and/or bond issuer may have one (or even more) chances to delay the repayment of the bond’s principal during which time further interest payments continue to be paid out to you. Nice!

Also, the bond holder or issuer may—emphasis on “may”— have the option to exchange the bond for one with a longer maturity at an equal or even higher interest rate (Yay!). Because these type of bonds contain an option to push back the date of maturity, which makes them more valuable than other bonds, extendable bonds sell at a higher price than non-extendable bonds.

A few more concepts surrounding bonds:

To boil down complex stuff into a simple, neat axiom: the price of bonds are inversely related with interest rates. The hows, whys, etc. will be discussed in a later post. (Boy, I hope we have time for all these later posts.)

Yield-to-maturity (YTM) of a bond is an extremely helpful metric to evaluate a bond’s true price. YTM is the total return anticipated on a bond if the bond is held until the end of its lifetime. Makes sense given its name.

Though it’s considered a long-term bond yield, YTM is expressed as an annual rate. That number represents your return in any specific bond as long as you hold the bond until maturity and IF all payments are made as scheduled.

YTM is helpful as a measuring tool  weighing the attractiveness of one bond to another. It cuts across the differences between bonds with different coupons and different maturity dates, so you can compare them in a true apples to apples fashion.

For those of you desperate to know how YTM is calculated…

Dr. Unwise: Who are these freaks!?!?!

PWT: … you should know it’s fairly complex:

There is a formula and a calculator for YTM in the midst of a great website. 

There’s quite a bit left to know before actually investing in bonds.

Duration, modified duration, and convexity are all characteristics of bonds which we will leave for a later post before we get too far into the weeds.

Doesn’t it feel like a long lecture day in med school just let out and even the professors took pity on you…and themselves?

Whew.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Talk to you soon.