October 5, 2016
Finding money is fun, and even as adults, people still get a kick out finding dollar bills in the street or quarters under a seat cushion. Since these aren't exactly life-changing finds, there are several things people can do to effectively find much more meaningful sums of money.
Here are some everyday ways you could find yourself a little extra money:
1. Switch from savings to CDs
Money sitting for a long time in a savings account is probably missing an opportunity to earn more interest. Certificates of deposit (CDs) typically pay higher rates than savings accounts. While the generally low level of bank rates these days makes it difficult for people to get very excited about those rates, in some ways the low rate environment magnifies the differences between rates on various bank products.
For example, according to recent FDIC figures, 5-year CD rates average 0.78 percent, while savings account rates average 0.06 percent. That seemingly small difference means you would earn more than 13 times as much interest in a 5-year CD than in a savings account.
While it is useful to keep some money readily available, people tend to let more money than they are likely to need in a hurry build up in their savings accounts. If the chance that you will need the money soon is slim, you would be better off risking paying an early-withdrawal penalty in a CD than routinely accepting less interest in a savings account.
2. Pool your money to qualify for jumbo rates
People have a habit of acquiring bank accounts somewhat haphazardly over time - a checking account here, some savings there, perhaps an old CD at another bank. Separating your money can be a mistake if it prevents you from qualifying for jumbo rates. These are special rates given for large accounts, typically $100,000 or more.
However, some banks also give bonuses for new deposits above a certain amounts, and those thresholds are often well below $100,000. These extras may only amount to a few extra basis points, but if you concentrate your deposits you can start earning that extra money month-in and month-out.
3. Shop around for the best bank accounts
Whether it is CDs, savings accounts or other bank products, never forget that banking is a very competitive business, with a wide range of choices. In particular, online banking is making more competitive products available in all areas of the country. Customers tend to be lethargic about switching banks, but actively shopping for rates or accounts with no maintenance charges year after year is another way to find yourself with a little extra money accumulating in your account.
4. Ratchet up your automated savings
Whether it is a direct deposit into a savings account or a deferral into a company 401(k) retirement savings plan, push the amount up by a few more dollars. Chances are, you won't miss that little bit from paycheck to paycheck. But over the course of the year, it can really add to your savings.
5. Work on your credit rating
Bad credit is very costly. It will cause you to pay higher credit card rates and loan rates when you borrow money. Some insurance companies even charge higher auto insurance rates to people with low credit scores, so improving your credit rating can save you money in a variety of different ways.
6. Ask your insurance agent about better rates
Like banking, insurance is a very competitive business, but one where passive clients tend to get taken for granted. Your insurance agent isn't likely to spontaneously offer you a better rate out of the blue, but he might be able to come up with one if faced with losing your business. In particular, if you have been with a company for several years without making a claim, you may well qualify for a better rate.
7. Consider a high-deductible insurance approach
Whether it is auto insurance or health insurance, if you are the type of person who rarely makes an insurance claim, you may be paying too much for your policy if it has a fairly low deductible. High-deductible premiums are much cheaper. Instead of routinely paying extra money to an insurance company, you can start putting those dollars into an emergency savings account just in case you have to pay that higher deductible at some point.
None of these is particularly dramatic, but that is exactly why these fairly ordinary ideas tend to get overlooked. If you take the trouble to attend to these fairly mundane details, it could be like finding money every day.
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October 3, 2016
There is a new species of investment roaming around these days, known as a unicorn. Investors have put more than $500 billion into these unicorns so far. But before you join in, you need to ask whether this investment proposition is an opportunity to capture a rare and valuable creature, or get skewered by a sharp and dangerous horn.
After all, these unicorns are not something out of fantasy literature. A unicorn is the name that is given to tech companies that have stayed privately-held and yet have amassed valuations of more than $1 billion. Large private equity investors and retail mutual fund investors can find ways to invest in these privately-held companies. But as their valuations rise, the question of whether or not these investments are wise becomes more compelling.
The case for companies staying private longer
In the dot-com generation, the goal of many an entrepreneur was to cash in by taking the company public. So why are many of their counterparts today choosing to remain private? Here are four good reasons:
1. Management can avoid a quarterly earnings focus
The short-term pressures of public investors can be distracting, especially when a company is still in the early stages of development.
2. Private equity is plentiful
Between low bond yields and a weak stock market, investors are desperate for alternatives to traditional investments. This makes it easier for private equity to attract money.
3. The private market discount has been reduced
Entrepreneurs typically receive lower valuations from private investors than from public ones. But as money has flowed into privately-held tech companies, they have had to give up less of a discount.
4. Reporting requirements are not as stringent
It takes a team of legal and investor-relations specialists to keep up with the reporting requirements of a public company. So the attraction of avoiding these headaches for as long as possible is understandable.
Some of the things that make staying private beneficial to entrepreneurs come at the expense of private equity investors. Traditionally, private equity investors have been willing to put up with limited liquidity and less transparency in exchange for the potential for higher returns.
The idea is that investing before a company goes public means getting in on the ground floor. However, when private company valuations become inflated, it may take a pretty steep climb to get to that ground floor. Effectively, high valuations diminish future return potential. Thus, they negate some of the reward investors are supposed to receive in exchange for the higher risk of private investments.
5 tips for investors: Taming your unicorns
If you understand the drawbacks but still find privately-held tech companies to be compelling investments, here are some things you can do to try to tame the unicorns in your portfolio.
1. Limit your exposure
Understand the role these should play. As high-risk/high-return propositions, you don't need a huge position to make a difference if things go well. Limited position sizes will help control the damage if things go poorly.
2. Understand these are long-haul investments
Unicorn companies typically are still in the developmental stage, meaning they are still formulating their business models, refining their product lines, and building scale. As a result, most have not yet reached profitability, and that could still be a long ways off.
3. Look at them as individual businesses, not an asset class
The problem with unicorns being a trendy investment is that people tend to look at them collectively as a type of investment rather than as what they are, as a series of very different companies with distinct business and valuation characteristics. These companies have little in common with each other, so don't look at them as an asset class that is likely to rise or fall in unison.
4. Be careful of cash flow sink holes
These are R&D-heavy companies which don't always know just what they are looking for, so they can burn through investor money with alarming speed.
5. Look at public/private valuation comparisons
Compare valuations with similar companies that are publicly held. One premise behind making private equity investments is that you can benefit from the valuation expansion that typically occurs when a company goes public. If there is little difference between a private company's valuation and comparable public valuations, this potential benefit is diminished.
There is something of a mystique around these unicorn tech companies these days, and mystique is one of those things that tends to lead investors to overpaying for a company. That's always a danger with any trendy sector, but the danger is heightened by the limited liquidity and lower transparency of a private company. In other words, exercise extreme caution if you decide to go unicorn hunting.
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September 30, 2016
With college costs rising every year, parents often worry whether they will have enough stored in savings accounts to pay for their children's education. Before taking out loans, determine your options for college savings plans, including a 529 plan in your state. Through the right college savings accounts, families could walk away with less student loan debt and a better financial footing after graduation.
The high cost of higher education
According to Fidelity Investments, parents plan to cover 70 percent of the cost of their children's higher education. However, based on their current savings, they are on track to only put away 29 percent of the expected price of a degree.
"We've got some definitely positive behaviors and optimism from families," says Keith Bernhardt, vice president of college planning for Fidelity Investments.
That's the good news from the firm's 10th Annual College Savings Indicator Study. However, there is still progress to be made. The number of parents saving for college is at an all-time high, but they may not be saving at a rate great enough to cover their future expenses.
Types of college savings accounts
Fortunately, for those who want to put more aside, there are several tax-favored accounts to use when you save for college. When it comes to how to save for college, parents will find the following are the most common options used today:
529 Plans: Two ways to pay for college
A 529 plan is often considered the best way to save for college. There are two types of plans available: those that allow people to essentially pre-pay tuition at today's rates and those that let people save money to be withdrawn tax-free for future qualifying education expenses. To sweeten the pot, some states allow residents to deduct their contributions to 529 plans.
"They've become very popular, especially because they are very flexible on who can put money in," says Bill Van Sant, senior vice president and managing director at Girard Partners headquartered in King of Prussia, Pennsylvania.
Some 529 college savings plans, such as those offered by Fidelity, allow parents to create personal webpages for their children that make it easy for grandparents and others to contribute to the fund.
Contribution limits for a 529 plan
Each person donating to a 529 plan can deposit up to $14,000 per year without incurring gift taxes or, in certain situations, make a lump sum deposit of up to $70,000.
Coverdell Education Savings Accounts
At one time, a Coverdell Education Savings Account was one of the most common ways to save for college. However, they seem to have fallen out of favor with the introduction of 529 plans that offer more flexibility and higher contribution limits.
"For my practice, we don't see much money [put into] these," Van Sant says.
Coverdell savings accounts vs. 529 plans
Contributions to Coverdell accounts, previously known as an education IRA, are capped at $2,000 per child per year.
What's more, money must be deposited before a child turns 18 and must be used by age 30, restrictions not found in 529 savings plans. However, these accounts do have a perk not found in 529s. Money from them can be used to pay for private school at the elementary and secondary levels in addition to college expenses.
Although a Roth individual retirement account (IRA) is intended for retirement funding, some parents are using it to pay for their children's college education. Money put into a Roth account is already taxed so the principal amount can be withdrawn prior to retirement without tax or penalty. Then, the gains can remain in the account to grow tax-free.
Why keep college and retirement savings separate
While it can be tempting to use a Roth IRA for the dual purposes of college and retirement savings, Van Sant cautions against comingling these funds.
"I would never lead with the IRA," he says. Instead of planning to use a Roth IRA, pulling money from it should be a last resort. "There's a big consequence. It's really dipping into one's retirement."
Checking or savings account
Checking and savings accounts don't come with any tax benefits and typically offer little, if any, interest nowadays. Still, they are a popular way to save for college.
"Actually, checking and savings is the No. 1 one way for saving [for college]," Bernhardt says.
While they may not be the best way to save for college when you consider the tax benefits of other options, Bernhardt adds there is nothing wrong with starting a college fund in a savings account.
"The simplest way is to have a dedicated account, he says.
To get the most out of their account, parents can research the best savings accounts or checking accounts with high interest rates. While the Federal Deposit Insurance Corporation reports the national rates for savings and interest checking accounts that contain less than $100,000 are close to zero, there are accounts available with bank rates at 1 percent or higher. These high yield savings accounts could mean a difference of thousands of dollars in interest earned once your child reaches college age.
Why find the best savings and checking rates for college savings
If you have an initial deposit of $10,000 in your savings account with an annual percentage yield (APY) of 1 percent when your child is born, you could earn about $1,971 in interest once your offspring turns 18. Compare this to the FDIC's average national rate for savings accounts (with less than $100,000) of just 0.06 percent APY with $108 in interest earned in 18 years.
This is a difference of about $1,863 over the course of your child's development and just a small amount compared to the staggering cost of college that will likely only grow.
If you have a specific savings goal in mind before your child heads off to college, use a compound interest calculator to see whether keeping your deposits in a regular or jumbo savings account is best for you.
How to select the right college savings plan
From a tax benefit standpoint, there is a lot to like about 529 plans. Money in the accounts grow tax-free and can be withdrawn tax-free for qualified education expenses.
"The only drawback would be if the child didn't ultimately go to school," Van Sant says.
In that case, money pulled from the account would be taxed and incur a 10 percent penalty. However, both can be avoided by changing the beneficiary to another child, grandchild or other relative.
The ability to change beneficiaries is an added benefit for high-worth families who want to minimize the size of an estate.
"[529 plans] are the only option I know of where the money leaves the estate, but you still control it and can take it back if you want," Bernhardt says.
However, if there's a good chance a child may forego college, it could be better to select a different college savings account. Bernhardt says the best advice is to not worry about picking the right savings account or finding the best 529 plans immediately.
"People sometimes feel a bit overwhelmed," he says. "Please don't let that stop you. You don't have to have a perfect plan - just get started."
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September 28, 2016
It's not easy saving for retirement when you work a full-time job that provides a steady income every month. But if you work as a freelancer, small business owner or independent contractor? Saving enough for retirement can be even more challenging because your income can vary so much each month.
One month, you might rake in the big dollars. The next? Your income might slow to a trickle. Because your expenses don't follow the same pattern, saving money for retirement can be a challenge.
When you're self-employed, you also don't have the benefit of a 401(k) retirement savings plan into which to automatically deposit retirement savings every time you get paid.
Fortunately, you can still save enough for your retirement years even when your income is unstable. It's all a matter of planning for your golden years and calculating how much you need to save for retirement each month to get there.
Here are five steps to take to save for retirement when you're self-employed:
1. Be realistic about your retirement date
Freelancers and independent contractors often say that they can keep working for as long as they need to. But that attitude isn't necessarily realistic.
"Freelancers are really no different from anyone else," says Teresa Ghilarducci, economist and director of the Schwartz Center for Economic Policy Analysis at The New School for Social Research in New York City. "They have to get real about how long they will be able to work and how much they'll need to save to enjoy a comfortable retirement."
Why the self-employed can't put off retirement forever
Ghilarducci, author of the book "How to Retire with Enough Money," says that even the self-employed should bank on retiring sometime around the age of 65. Even if they want to work longer, there is no guarantee that anyone will want to pay them past this age, Ghilarducci says.
"Even though you want to keep working part-time, the labor market changes a lot over time," Ghilarducci says. "Age discrimination is real. You might not be able to remain in the work force for as long as you expected."
This means that you can't put off saving for retirement -- or saving enough each year for your retirement years -- just because you think you can work forever.
2. Catch up on retirement savings
If you want to have enough money for retirement, you generally need to save at least 10 percent of your salary every year if you are in your 30s, 12 percent in your 40s and about 40 percent in your 50s.
What if you haven't done this because of the fluctuations in your income? Then it's time to start putting money in a retirement savings account now.
In case you are older and you haven't saved enough money, don't fret about your past missteps, says Kathy Colby, president of Financial Independents Inc. in Lansing, Michigan. It's too late to do anything about the past. But you can start putting away more money now. You can also look at your expenses to make sure that you aren't leaking money unnecessarily each month.
"It doesn't help to worry about what you haven't already done," Colby says. "People say that you should start saving early and often. But that doesn't do you any good if you haven't done it."
3. Build a larger emergency savings fund
ReKeithen Miller, a certified financial planner and portfolio manager with Palisades Hudson Financial Group's Atlanta office, says that it's important for those with unpredictable incomes to establish a deeper pool of assets. This will help cover emergencies and serve as a safety net during lean times.
How much freelancers or business owners should save in emergency funds
Once people have this larger emergency fund, they won't be as tempted to skimp on stowing away money for their retirement because they'll have the money they need to get them through those months when not as many checks are coming in.
"Instead of the usual three to six months of expenses recommended for an emergency fund, I'd recommend establishing an emergency fund that will cover at least nine to 12 months of expenses," Miller says. "These funds can be used to tide you over if there isn't enough income coming in."
4. Take advantage of retirement savings vehicles besides 401(k)s
While self-employed people don't have access to 401(k) plans, they can save in a Simplified Employee Pension (SEP) IRA. These savings vehicles, designed for those who do not work for others, have the same basic characteristics as traditional individual retirement accounts (IRAs). But they also allow self-employed people to save on a larger scale.
Contribution limits for a SEP IRA in 2016
For 2016, people can save the lesser of 25 percent of their compensation or $53,000 every year in a SEP IRA. Employees who contribute to 401(k) plans can only contribute up to $18,000 -- or $24,000 if you are 50 or older -- every year.
Contributions to a SEP IRA are voluntary. Someone having a low-income year can contribute less that year or can deposit nothing at all.
5. Split savings in accounts for various financial goals
Those with unpredictable incomes need to take even more control over their finances than typical salaried employees if they want to make sure they have enough money for retirement. That's why Kirk Jewell, president of Flint, Michigan-based Global Financial Services, makes sure that all of his self-employed clients create four accounts:
1. A personal checking account
Clients will use this checking account to pay their bills and fund their lifestyles.
2. A savings account
If you're self-employed, you can build an emergency fund in this account to cover unexpected expenses.
3. A business bank account
Open an account devoted to the business so you can deposit money into this account and use it to reinvest in your businesses, for everything from marketing to buying supplies to hiring employees.
4. An account to pay for taxes
Jewell recommends that his clients open an account to cover taxes, an important, and too-often neglected, expense for the self-employed.
Once self-employed clients fill these accounts each month, they know exactly how much money they can then deposit into a SEP IRA, traditional IRA, Roth IRA or other savings vehicle for retirement.
"It is so much easier when you are an employee and you can deposit into a 401(k) account without thinking about it," Jewell said. "When you are running your own business or are working as a freelancer, you have so much more to think about. Your business is an entity that can take up so much of your time. By having the discipline to set up these four accounts, though, you can help make sure that you will have enough money set aside for retirement."
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September 19, 2016
Quantitative investment formulas, often referred to as black-box investing, have been around for a long time. However, advances in data gathering and artificial intelligence are pushing some of these techniques to new heights of complexity. The question is, does that added complexity bring greater effectiveness?
There are arguments to be made for and against black-box investing. It can play a useful role in your portfolio, but you should understand its limitations. After all, no degree of mathematical precision can guarantee that a strategy will add value.
Why investors choose black-box investing
Here are some of the points that black-box investing has in its favor:
1. Investment discipline
An automated investment approach is one way to take human error and emotion out of investing. Human money managers are prone to straying away from their disciplines. Fear and greed influence decisions. In particular, professional money managers start to rationalize making exceptions when they are under the gun for poor performance. Following an automated formula should remove the problems that result from human nature.
2. A degree of predictability
A quantitative approach will tend to be very pure in terms of investment style. It might have a particular bias, such as towards growth or value investing. But, an analysis of the formula or the principles behind it should make it fairly clear what that bias is. Style purity brings some predictability to the results, and this in turn helps an investor construct an investment program in which different managers play clear, complementary roles.
3. Low management costs
Having a computer picking stocks is much cheaper than a team of analysts researching companies one by one. Additionally, the money management firm should be able to pass this cost savings on to its clients.
4. A high-speed way of identifying inefficiencies
Some strategies work by exploiting arbitrage opportunities created by small market inefficiencies - pricing anomalies in which market valuations become temporarily out of step with those of the same or similar securities.
These anomalies are small and generally short-lived, so the only way to reliably make money by exploiting this kind of thing is to spot them quickly and trade in high volume. Computers are much better suited than human investors to identifying these opportunities and executing decisions quickly enough.
5 ways black-box investing is flawed
Of course, if successful investing could be reduced to a formula, everybody would be following it by now. In actual fact, trying to invest this way does have its complications:
1. Back-fitting data can be deceiving
Promoters of black-box investing often test their formulas with historical data to see how they would have performed. This type of backward-looking test is called a back fit, and the results can be somewhat deceiving. With hindsight, it is not too difficult to devise a formula which would have been successful in the past, but that track record is no guarantee of how the strategy will perform once it is up and running in real time.
2. Conditions change
One of the reasons why back fits do not always carry over to the future is that conditions change. Artificial intelligence techniques are being used to create approaches that can adapt to changing conditions, but those adaptations are still akin to human experience. No matter how much experience is accumulated, the combination of conditions shaping markets is always going to be a little different from what was observed in the past.
3. Investors flock to successful approaches
Another reason formulaic investing has a hard time duplicating past success is that investors tend to jump on the bandwagon of any successful approach. This popularity starts to remove the opportunity from markets by making valuations less attractive.
4. Lack of transparency
Black-box investment managers have a dilemma: They need to describe their approaches without providing so much detail that their clients could simply replicate the approach for themselves. This means that those clients may not know everything about how their money is invested, and the unknown sometimes contains unpleasant surprises.
5. Blind obedience may be dangerous
Long-Term Capital Management was a high-flying hedge fund that went bust quickly and spectacularly in the late 1990s. Its proprietors had so much faith in its investment approach that they applied a high degree of leverage to it. That level of blind faith leaves little room for error.
There is certainly a place for quantitative methods in investing. How heavily to rely on those methods, though, is a tricky question. Taking the possibility of human error out of investing is a tempting proposition. But don't forget that ultimately even black box investors rely on human judgement to devise the right investment formula.
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