With the U.S. Presidential election only 10 days away, much uncertainty lingers amongst investors, especially in light of yesterday's FBI announcement regarding the investigation into Hillary Clinton's emails. Such October surprises are common in Presidential politics, but that doesn't mean they rattle investors any less. As soon as the FBI announcement was made public, the Dow dropped substantially and the Mexican peso declined sharply versus the U.S. dollar. Thus, political and economic news can substantially move markets, and also, investor's expectations. Wall Street has differing views on what a Hillary Clinton or Donald Trump Presidency means for stocks and the economy, but the nervousness that Wall Street watchers may exhibit over the Presidential outcome shouldn't cloud individual investor's judgement.
A key argument in favor of staying calm despite highly uncertain times comes from the recent decision by British citizens to vote in favor of the United Kingdom exiting the European Union (EU). While public opinion polls up until the day of the vote seemed to indicate that British citizens would vote to remain in the EU, the news of Brexit was met with dire predictions of economic calamity and misfortune (i.e. reduced free trade, labor and people movements, etc.) that would befall the U.K. should it choose to leave the economic and trade connections with the EU. While we are dealing with a relatively small sample size, the U.K. economy actually grew more than expected (+0.5%) post-Brexit. While much could change in the future, this is one recent example of the doom and gloom that pundits and media often predict failing to come to fruition.
The Brexit discussion, in turn, brings me back to the jitters investors are exhibiting regarding our Presidential election. While emerging economies like China and India will no doubt play a larger and more important role in the world in the coming decades, the United States still remains the world's pre-eminent economic superpower. Many analysts argue that we could lose that role to China or some other emerging players in the future, but we must focus on the here and now and improving American economic competitiveness on the world stage. The media likes to use loaded, attention grabbing headlines to influence public opinion and drive viewership. A key consequence of this is that the editorializing that we see from both political viewpoints leads to uncertainty. This uncertainty often manifests itself in spikes in the VIX, a key indicator of volatility in the marketplace. If there is one thing investors hate, it is uncertainty. Markets tend to perform better when the future is easily mapped out and understood. If I could make one recommendation for the next few weeks, it would be to avoid focusing too much on the electoral headlines and the doom and gloom that the media may push regarding either outcome. Despite what many pundits would have you believe, we will likely be just fine either way. Remember, the United States has endured two World Wars, depressions, recessions, terror attacks, and countless other calamities that we recovered from economically. Stay invested in the market, dollar cost average into your positions, and keep your eyes on the prize: building wealth over the long-term, slowly but surely.
Saturday, October 29, 2016
Saturday, October 22, 2016
The Hidden 401(k) Fee Trap: Administration Fees
My employer offers a 401(k) plan through Fidelity which offers different tiers of investment options. I can choose from a variety of actively and passively managed mutual funds, "target retirement" funds, as well as individual stocks if I choose. Most millennial investors hear the same story from the financial press about 401(k)'s: contribute up until your employer match. It is indeed good advice because it's never a good idea to leave free money on the table. After all, if you earn $50,000 in a year and contribute 5% to your 401(k) with a dollar for dollar employer match, you will have $5,000 in your 401(k) at year end instead of $2,500; nothing beats doubling your money without any additional work! However, I wanted to take some time to focus on something that many millennial investors may overlook but can be equally dangerous as passing up free money: hidden fees in the 401(k) plan.
The U.S. Department of Labor has published a good guide that examines the variety of fees and expenses within 401(k) plans. Remember, all fees and expenses reduce investment returns, and therefore the long-term returns your 401(k) may earn. The Dept. of Labor guide discusses a scenario where a 1% increase in fees reduces a retirement account balance by 28% at retirement...that's a huge hit!
The hidden 401(k) fee trap that I mention in the post title refers to the fact that while many people are familiar with the fees and expenses charged by mutual funds (i.e. sales charges and management fees), your 401(k) plan administrator may actually charge a plan administration fee, among other fees. Generally these fees are charged at the plan level and some percentage may also get passed on to individual employees. This blog post will be the first in a series of posts discussing these different fees.
A plan administration fee may be taken directly from your investment returns (a silent killer!), or you may pay it yearly, sometimes as a flat fee deducted from your account at the end of the year. There are multiple arrangements, but this fee is levied to pay for administrative services such as accounting, records keeping, and possibly even for additional service and support that your employer may have contracted for. Some employers automatically enroll employees in financial advice/planning programs, or offer other services that you ultimately pay for. Since many large corporations have so many employees enrolled in 401(k)'s, the overall administration fee burden on employees may be smaller, and in turn, larger for employees who work for smaller businesses.
In July 2012, the Dept. of Labor enacted a rule to ensure that plan administrators mail you a fee disclosure so you can see exactly what fees and expenses you may be subjected to while enrolled in your 401(k). Most investors likely just discard this notice, but you should pay special attention to it. You can also log into your 401(k) account, or request this information from your HR or Benefits Dept. where you work.
What can you do? Some employers may allow you to opt out of additional services that are paid for by the administration fee, so you may be able to lessen your fee burden that way. As the Dept. of Labor says, "generally the more services provided, the higher the fees." You should question whether you really use or even need the extra services that are being offered. This is particularly relevant when you are charged a yearly fee that is deducted directly from your account balance and not paid out of plan assets, because you will see the fee deduction at the end of every year.
Why is this all important? Consider the following. If you have a $10,000 401(k) account balance and are charged a 1% yearly administration fee, that's $100 that is taken away and won't contribute to long-term compounded investment returns. Assuming your 401(k) balance never changes (it will as the market moves up and down and as you invest more during your career), that yearly $100 charge turns into $3,000 over a 30 year career! With a 7% annual return, that $3,000 alone would become $22,836 over a 30 year career. The silent killer indeed!
The U.S. Department of Labor has published a good guide that examines the variety of fees and expenses within 401(k) plans. Remember, all fees and expenses reduce investment returns, and therefore the long-term returns your 401(k) may earn. The Dept. of Labor guide discusses a scenario where a 1% increase in fees reduces a retirement account balance by 28% at retirement...that's a huge hit!
The hidden 401(k) fee trap that I mention in the post title refers to the fact that while many people are familiar with the fees and expenses charged by mutual funds (i.e. sales charges and management fees), your 401(k) plan administrator may actually charge a plan administration fee, among other fees. Generally these fees are charged at the plan level and some percentage may also get passed on to individual employees. This blog post will be the first in a series of posts discussing these different fees.
A plan administration fee may be taken directly from your investment returns (a silent killer!), or you may pay it yearly, sometimes as a flat fee deducted from your account at the end of the year. There are multiple arrangements, but this fee is levied to pay for administrative services such as accounting, records keeping, and possibly even for additional service and support that your employer may have contracted for. Some employers automatically enroll employees in financial advice/planning programs, or offer other services that you ultimately pay for. Since many large corporations have so many employees enrolled in 401(k)'s, the overall administration fee burden on employees may be smaller, and in turn, larger for employees who work for smaller businesses.
In July 2012, the Dept. of Labor enacted a rule to ensure that plan administrators mail you a fee disclosure so you can see exactly what fees and expenses you may be subjected to while enrolled in your 401(k). Most investors likely just discard this notice, but you should pay special attention to it. You can also log into your 401(k) account, or request this information from your HR or Benefits Dept. where you work.
What can you do? Some employers may allow you to opt out of additional services that are paid for by the administration fee, so you may be able to lessen your fee burden that way. As the Dept. of Labor says, "generally the more services provided, the higher the fees." You should question whether you really use or even need the extra services that are being offered. This is particularly relevant when you are charged a yearly fee that is deducted directly from your account balance and not paid out of plan assets, because you will see the fee deduction at the end of every year.
Why is this all important? Consider the following. If you have a $10,000 401(k) account balance and are charged a 1% yearly administration fee, that's $100 that is taken away and won't contribute to long-term compounded investment returns. Assuming your 401(k) balance never changes (it will as the market moves up and down and as you invest more during your career), that yearly $100 charge turns into $3,000 over a 30 year career! With a 7% annual return, that $3,000 alone would become $22,836 over a 30 year career. The silent killer indeed!
Saturday, October 15, 2016
Dividend Reinvestment for Millennials
It only took 5 years between my last post and the post before it, so a 6 month gap shouldn't be considered too bad! I hope to be able to post more in the coming weeks as time permits, but today I would like to focus on a very important topic that many millennial investors tend to ignore in favor of flashier strategies: income investing through dividend reinvestment.
While readers know I am a big advocate of index funds, I also think high dividend yield stocks can play an important role in millennials' investment portfolios, especially when the dividends are reinvested. I have covered the topic of dividend reinvestment before, but basically it means that whenever a company pays its quarterly dividend, those dividends will go towards purchasing more shares of stock in the company instead of being routed to your account's cash balance. The tax implications are exactly the same whether the dividend is paid out in cash, or if it's reinvested; most millennial investors will pay a 15% tax on qualified dividends.
The reason income investing is enticing is that it can basically set an investor up for a large pot of passive income later in life. For example, if you buy 100 shares of Verizon Communications (VZ), you will receive $56.50 in dividend income every quarter ($0.565 quarterly dividend x 100 shares). As of 10/14/16, Verizon stock was trading at $50.28, so by reinvesting dividends, you are basically acquiring an additional share of stock every quarter - which in turn will earn more dividends - and this acts as an attractive source of compounding. The website buyupside features an easy to use dividend reinvestment calculator which helps to explain how dividend reinvestment increases long-term investment returns. As an example, assuming a 30 year investment horizon and 5% annual dividend and stock price growth rates, a $50 stock paying $2.00/year in dividends will result in 324.34 shares at the end of 30 years, and a total value of $70,088 versus $35,561 without reinvestment. This equates to a 30 year annualized return of 9.2% versus 6.76% without reinvestment. This is particularly beneficial later in life, because once an investor hits retirement, he or she can stop reinvestment and allow the dividends to be paid in cash to be used for whatever the heart desires.
For investors who tend to shy away from individual stocks, the same benefits can be had by reinvesting the dividends paid by your mutual funds. Most bond funds distribute interest payments monthly, and most actively and passively managed funds pay distributions quarterly.
A word of caution, however. Not all high dividend yield stocks are created equal. Many are master limited partnerships (MLP) which have run into trouble lately, others are companies with high yields due to poor financial position (yield goes up as a stock price goes down provided the dividend isn't cut), and some simply don't generate enough free cash flow to fund the dividend. Companies with strong free cash flow and payout ratios (dividend per share/earnings per share) in the 0.50 range may be attractive income investment candidates. Never purchase a stock on yield alone without doing more research into the sustainability of the dividend. It's important to consider the long-term dividend payout track record, as well as the cyclicality of the industry the company is in, among other factors.
While readers know I am a big advocate of index funds, I also think high dividend yield stocks can play an important role in millennials' investment portfolios, especially when the dividends are reinvested. I have covered the topic of dividend reinvestment before, but basically it means that whenever a company pays its quarterly dividend, those dividends will go towards purchasing more shares of stock in the company instead of being routed to your account's cash balance. The tax implications are exactly the same whether the dividend is paid out in cash, or if it's reinvested; most millennial investors will pay a 15% tax on qualified dividends.
The reason income investing is enticing is that it can basically set an investor up for a large pot of passive income later in life. For example, if you buy 100 shares of Verizon Communications (VZ), you will receive $56.50 in dividend income every quarter ($0.565 quarterly dividend x 100 shares). As of 10/14/16, Verizon stock was trading at $50.28, so by reinvesting dividends, you are basically acquiring an additional share of stock every quarter - which in turn will earn more dividends - and this acts as an attractive source of compounding. The website buyupside features an easy to use dividend reinvestment calculator which helps to explain how dividend reinvestment increases long-term investment returns. As an example, assuming a 30 year investment horizon and 5% annual dividend and stock price growth rates, a $50 stock paying $2.00/year in dividends will result in 324.34 shares at the end of 30 years, and a total value of $70,088 versus $35,561 without reinvestment. This equates to a 30 year annualized return of 9.2% versus 6.76% without reinvestment. This is particularly beneficial later in life, because once an investor hits retirement, he or she can stop reinvestment and allow the dividends to be paid in cash to be used for whatever the heart desires.
For investors who tend to shy away from individual stocks, the same benefits can be had by reinvesting the dividends paid by your mutual funds. Most bond funds distribute interest payments monthly, and most actively and passively managed funds pay distributions quarterly.
A word of caution, however. Not all high dividend yield stocks are created equal. Many are master limited partnerships (MLP) which have run into trouble lately, others are companies with high yields due to poor financial position (yield goes up as a stock price goes down provided the dividend isn't cut), and some simply don't generate enough free cash flow to fund the dividend. Companies with strong free cash flow and payout ratios (dividend per share/earnings per share) in the 0.50 range may be attractive income investment candidates. Never purchase a stock on yield alone without doing more research into the sustainability of the dividend. It's important to consider the long-term dividend payout track record, as well as the cyclicality of the industry the company is in, among other factors.
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