Archive for November, 2013

One of the questions that we frequently get is whether or not there is an advantage for long-term investors to use exchange traded funds instead of index mutual funds. It’s an excellent question, to be sure.

Many investors who have been using traditional open-end mutual funds are probably less familiar with ETF’s and tend to shy away from using them. However there are a number of compelling reasons to choose an index based ETF over mutual fund and this blog is going to look at several of them. Enjoy.

One important advantage is that, even though traditional mutual funds and ETF’s hold identical baskets of securities and track the same indexes, ETF’s usually cost less. The reason is that they aren’t forced to pay an army of customer service personnel and lots of other administrative expenses. Like traditional mutual funds do.

Another advantage that ETF’s have over traditional mutual funds (although a bit less obvious) is that when an investor decides to sell their ETF shares, their  shares are simply purchased by another investor with no need to sell any holdings and thus no capital gains are generated by the transaction. This simple fact reduces future tax costs for the shareholders. (However, in some cases, a traditional index mutual fund can be just as tax efficient if it’s run properly.)

The fact that ETF’s can be bought and sold while the market is still open (just like stocks) is another definite advantage for investing in them. Traditional mutual fund shares can only be bought and sold after the market closes and it’s for this reason that ETF’s are sometimes associated with market timing and day trading. For long-term investors who want to be able to move their money in or out of the market (in the case of a sharp downturn) and ETF can provide is extra advantage.

One caveat is that a person who invests heavily in ETF’s should be aware that impulsive decision-making is a problem, especially during times of market turmoil. The fact is, not being able to trade while the market is open (and emotions are still running high) can actually sometimes be an advantage. If you tend to make rash decisions based on what the markets doing on a daily basis, it’s possible that you might want to avoid ETF’s.

One final thing that you may want to consider when you’re weighing the difference between ETF’s and index-based mutual funds is that not all of them have a counterpart. While it’s true that many of the most commonly used indexes are available in both mutual funds and ETF’s, some of the more esoteric options may be only available in either one form or the other. That being said, there’s no reason that you can’t choose some ETF’s for your index-based investments and choose traditional mutual funds for others. That’s an excellent way to customize and diversify your portfolio to best suit your investing needs.

If you have questions about personal finance and investing, please let us know and we’ll get back to you with advice and answers right away.

Insurance company stock is a great way to get solid returns, especially if you buy in at a good time. Aflac (NYSE – AFL) is, right now, an excellent buy due to its recent post earnings pullback and, in our opinion, could easily be chosen over other insurance rivals like The Hartford and Berkshire Hathaway (which is quite diversified but also heavily insurance oriented).

How exactly do insurance companies make money?

Business models vary of course but insurance companies, generally speaking, all use the same set of basic principles to make their money. Their founding principle of course is to collect premiums from their customers in exchange for the promise to pay restitution if something negative happens to their property or assets. Due to this fact, most keep their collected premiums in a reserve fund so that, when the time comes for them to pony up huge amounts of cash, they’re able to do that without a problem.

The fact that most consumers don’t know is that the actual insurance premiums by themselves are not actually designed to be profitable. Just like a movie theater makes more money on their junk food than they do on the actual sale of movie tickets, an insurance company makes more money on their reserve account, and the way they invest it, not on the actual insurance premiums. If you’re wondering how the famous Warren Buffett has been so hugely successful with Berkshire Hathaway, it’s because of this very fact. Indeed, Mr. Buffett has remarked on several occasions that “our primary business is insurance”.

The true nature of Aflac.

Aflac offers a wide variety of supplemental life and health insurance policies including cancer, care, traditional life insurance, annuities and living benefit life plans. Something that most investors don’t realize is that the bulk of their earnings (nearly 80%) come from Japan rather than the United States. Indeed, they have an extensive range of channels in Japan where they sell their insurance products including over 90% of Japan’s banks and in over 1000 of their post offices, which coincidentally happen to be one of the most popular places for Japanese people to buy their insurance.

Most people who purchase Aflac’s supplemental insurance already have major medical in the United States. The reason that the average consumer gets there supplemental insurance from Aflac is that, when they have a claim, the company pays them in cash directly. In the last decade their success has been phenomenal due to their popular marketing approach, and company revenues have soared.

Aflac’s Performance and Price.

Currently Aflac’s stock is priced at 9.8 times earnings, a price well below their historic valuation multiple. When you compare them to their peers they appear to be an even better buy as, for example, The Hartford trades at a valuation comparable to Aflac but has a history of extremely shaky earnings. Berkshire Hathaway has an obvious track record of great success but that success is very costly as their shares currently trade for over 19 times what this year’s  earnings are expected to be.

What’s the reason that Aflac is priced so cheaply?

Insurance companies make money, as we said earlier, by investing their reserve funds. Thus when you have a low interest rate environment you find that returns are usually below average. Since Aflac invests in low risk investments, their yields aren’t especially high and a change of even 1 percentage point can have a huge impact on their bottom line, something that’s especially true when you have investment assets to the tune of about $116 billion.

The reason that they have had lower profit margins over the past several years is because their return on investments has gone down significantly. However, once interest rates begin to increase a similar 1 percent increase in returns will amount to approximately 1.16 billion in additional earnings for the company, an increase of about 40% over their profits this year. For that reason now may be the best time to purchase their stock before the rest of the market realizes Aflac’s huge earnings potential.


Increase your Retirement Savings without a 401(k)

One of the unfortunate facts of working today is that over 70% of smaller businesses don’t provide their employees with any type of retirement savings plans at all. That means no 401(k),  no pension, no nothing. Even if you’re not close to retiring that fact is a bit sobering. It’s also the reason that we’ve put together this short blog today about some of the ways that you can increase your retirement savings even if you don’t have the benefit of the 401(k) where you work. Enjoy.

One of the best things that you can do if you don’t have a 401(k) is to invest in a Roth IRA so that you get the benefit of a bit of tax diversity. Traditional IRAs allow people to contribute pre tax dollars up to $5500 a year (2013). For people over 50 years old, that limit increases to $6500. If you want to reduce your taxes in the future it’s a great way to do it.

The reason is that, since a Roth IRA is funded with after-tax dollars, at age 59 ½ you can start to withdraw money from your account without the risk of taxes and penalties. Another great reason to open a Roth IRA is if you anticipate that you’ll be in a higher tax bracket when you retire. If you’re keen on opening one, be aware that the IRS has a number of income requirements that you’ll need to meet in order to qualify.

Investing in a taxable brokerage account is also a great idea if you don’t have a 401(k). While it doesn’t carry the tax benefits of an IRA it can
be filled with a diversified mix of bonds, mutual funds and stocks. Also, it will let you access any earnings whenever you like without any penalties. Another benefit to a taxable brokerage account is that there are no income limitations and no rules on how much money you can contribute to the account every year. One of the best ways to minimize your tax exposure is to use a “buy and hold strategy”. If that’s not something you can do, you should at least avoid cashing in on any of the investments that you’ve made within the first year so that your long-term capital gains taxes will be lower.

Another way to invest for retirement, although a bit more risky, is alternative investments like real estate, startup funding for small businesses and artworks, among others. Indeed, these have the potential to advance your retirement plan greatly but keep in mind that they should not make up more than 10% of your portfolio because they carry quite a bit more risk than other types of investments.

One more tip is to simply delay receiving your Social Security checks as much as possible. While some people might argue that this is advice that the federal government would love you to follow, the fact is that the longer you wait to collect your Social Security checks the more money you’ll actually receive. If you’re in good health and can put off receiving your checks until your full retirement age, you’ll actually receive 8 percent more per year up until the age of 70, something that could increase the amount of money per check significantly.

Not having the availability of a 401(k) to invest in for retirement kind of stinks but, as you can see from the four examples above, there are a number of things that you can do to make up for it. If you have any questions about planning for retirement, personal finance or financial questions in general, please let us know and we’ll get back to you with answers, advice and solutions as soon as possible.


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