Five Warning Signs of Financial Fraud

Posted on July 29, 2015 | AAII Journal

The SEC recently listed five red flags investors should watch out for, including claims of high return with little or no risk.

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The Sequence in Which Returns Occur Affects Your Wealth

Posted on May 9, 2015 | AAII Journal

One of the big uncertainties facing investors is the sequence of returns they will experience in the future.

Sequence of returns refers to the order in which positive and negative returns occur over a given time period. The sequence of returns is particularly important during the period surrounding the transition into retirement when an investor moves from accumulating assets to drawing down his or her savings.

The sequence of returns poses two challenges. First, it is impossible to predict how the markets will perform over an extended period. While valuation measures, for instance, can offer insight into the prevailing long-term attractiveness or elevated risk level of the market, they cannot accurately predict how stocks will actually perform in the future. Secondly, a period of negative absolute returns or low real (inflation-adjusted) returns can adversely affect an investor’s ability to withdraw a desired amount of cash flows.

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Greater 401(k) Focus on Retirement, But Not Annuities

Posted on March 27, 2015 | AAII Journal

About 93% of employers are very likely or likely to “create or broaden focus on financial well-being of employees beyond retirement” this year, according to an Aon Hewitt survey. Yet the focus for many employers will not extend to including annuities or other similar lifetime income products as investment options in defined-contribution [e.g., 401(k)] plans.

Aon Hewitt says seven Americans are reaching age 65 every minute. Given this, it is not surprising that nearly three-quarters of plan sponsors will experience an increase in retirement-eligible employees over the next three years. In response, 52% of employers say they are very likely and 38% say they are likely to offer retirement planning to near-retirees. Slightly more than half (51%) are very likely and 38% are likely to increase communication about the retirement process. Online modeling tools and mobile apps designed to help employees determine how much they will be able to spend in retirement may be made available by 53% of employers (“moderately likely action”), with 17% seeming more certain about providing them (“very likely action”).

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Achieving Greater Long-Term Wealth Through Index Funds

Posted on March 26, 2015 | AAII Journal

John Bogle (JB): Let’s start off with the obvious. Imagine a circle representing 100% of the U.S. stock market, with each stock in there by its market weight. Then take out 30% of that circle. Those stocks are owned by people who index directly through index funds. The remaining 70% are owned by people who index collectively. By definition, they own the exact same portfolio as the indexers do in aggregate, so they will capture the same gross return as the direct indexers. But by trading back and forth, trying to beat one another, they will inevitably lose by the amount of their transaction costs, the amount of the advisory fees they pay, and the amount of all those mutual fund management costs they incur: marketing costs, processing, technology investments, everything. When we look at the big picture of the costs of investing, including sales loads as well as expense ratios and cash drag, it is a foregone conclusion that active investors, in aggregate, will under perform index investors. It’s the mathematics.

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High Buyback Yields

Posted on March 25, 2015 | AAII Journal

Companies with excess cash can pay out dividends as well as repurchase outstanding shares that have been issued to the public. When a company reduces the number of outstanding shares, remaining shares gain a slightly larger proportional claim to the company and its profits. This allows earnings per share to expand more quickly than net income. A share buyback can also signal to the market that management thinks that the shares are attractively priced at current levels.

The easiest way to calculate the buyback yield is to look at the change in the average shares outstanding from one fiscal period to another. For example, DST Systems (DST) had 42.1 million shares outstanding during its 2013 fourth quarter, but it reduced the number of outstanding shares to 37.9 million by its 2014 fourth quarter. The 10.0% reduction in the number of shares is the buyback yield. A company that issues more shares will have a negative buyback yield.

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The “Dirty Dozen” Tax Scams for 2015

Posted on March 24, 2015 | AAII Journal

The Internal Revenue Service (IRS) says aggressive, threatening actions from scam artists have been occurring nationwide during the early weeks of the 2015 tax season. These calls top the agency’s “Dirty Dozen” list of scams.

The top tax scams includes:

Phone Scams: Criminals are calling certain groups, including retirees, with threats of police arrest, license revocation and other things. (The IRS never calls about taxes owed or to demand immediate payment without first having mailed a bill.)

Phishing: Fake emails are being sent and phony websites are being established with the intent of stealing personal information. The IRS says it will not send an email about a tax bill or a refund “out of the blue.”

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A Key to a Lasting Retirement Portfolio

Posted on February 27, 2015 | AAII Journal

If you’re retired—or nearing it—ensuring that your retirement investment portfolio lasts your lifetime is critical. And that’s not easy because by nature the stock market is volatile. What if a market downturn takes a bite out of your investment portfolio?

While you cannot completely control the market’s impact on your portfolio, there are things you can control that can also make a significant difference in how long your portfolio may last. One: your withdrawal rate from your portfolio. The amount you take can directly impact how long your assets could last in retirement.

But what about in difficult markets? At Fidelity, we still believe in inflation-adjusted withdrawal rates of no more than 4% to 5% a year for individuals who retire at age 65. That’s because we did the analysis using our Retirement Income Planner and an inflation-adjusted withdrawal rate of more than 5% steeply increased the risk of depleting retirement savings during an investor’s lifetime. We also ran some further analysis to determine the influence of different market environments.

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The Individual Investor’s Guide to the Top Mutual Funds 2015

Posted on February 3, 2015 | AAII Journal

The returns realized by mutual fund shareholders in 2014 depended significantly on the categories they chose and, at least on the domestic equity front, whether they went with an active or a passive fund.

We bring this up because a significant part of a fund’s returns are influenced by the performance of the category it operates in. For example, the average energy fund plunged 18.0% last year. The culprit: oil. Oil prices fell from $105.37 per barrel on June 30, 2014, to $53.27 per barrel on December 31, 2014. Fund managers required by their funds’ objectives to invest in energy stocks in their portfolios could do nothing but sit and grimace.

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Few Investors Plan to Keep Allocations Unchanged in 2015

Posted on February 3, 2015 | AAII Journal

Last month’s Asset Allocation Survey special question asked AAII members what, if any, allocation changes they expect to make this year. Slightly fewer than three out of 10 (30%) said they don’t anticipate making any changes. About 16% intend to increase their allocations to equities, while 7% plan on reducing their exposure to stocks. Close to 15% intend to boost their bond allocations and just under 10% say they will boost their cash allocations.

A Comprehensive Approach to Covered Call Writing

Posted on January 14, 2015 | AAII Journal

Setting up a covered call portfolio using securities that generated significant dividend distributions was covered by Ben Branch, professor of finance at the University of Massachusetts, Amherst, in two wonderful articles published in the AAII Journal last year.

The articles ran under the titles “Assembling a Covered Call Portfolio on Dividend-Paying Stocks” (June 2014), and “Managing a Portfolio of Covered Calls” (July 2014) and can be found in the archives. This article adds information to the key facts highlighted in Branch’s articles and presents another perspective as to how and why such a covered call portfolio can be constructed and managed.

Covered call writing is a strategy where individual investors can sell options against securities—stocks or exchange-traded funds (ETFs)—they already own to generate monthly cash flow. In its traditional sense, profits can be gleaned both from the sale of the option and from share appreciation if the option selected has a higher value than the current market value of the stock. (For example, an investor buys a stock for $48 and sell the $50 call option; this known as an “out-of-the-money” strike.) If the option selected had a strike price (agreed exercise price) the same as (“at the money”) or less than the current market value (“in the money”), the maximum return would be the time value component of the option premium only.

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