Wooden Investments
Blog: Our Thoughts
High Frequency Trading- Does it Affect Your Retirement Accounts?
June 22, 2012
Over the last six months, there has been a building crescendo about the negative effect of high frequency traders on long-term investment returns. We know there is a problem when our clients and professional acquaintances refer to high frequency traders as changing the investment landscape. We view high frequency traders as a normal and accepted part of the stock market.
Unfortunately, the May 6th2009 intraday market correction of hundreds of points in a matter of minutes, more commonly known as the flash crash, has brought high frequency traders into the lime light. High Frequency Trading uses quantitative investment computer algorithms to hold short-term positions and quickly sell them with the intent of capturing just a fraction of a penny per share or currency unit on every trade.
In an effort to give our opinion, let me first state that high frequency trading has been going on for as long as there has been a stock market. Since the 1800s, if you wanted to trade a stock quickly you had to have enough money to buy a seat on the NYSE. The beginning of the High Frequency Trading started in the early 1980s, where computer trading became available with the ability to place millions of orders a day. The current version of High Frequency Trading is no different than what started in the early 1980s, just a little bit faster on the information and order processing.
So you might be thinking, what in the world does this have to do with me and my retirement investment account: NOTHING. That's right; after all the hubbub surrounding High Frequency Trading, there is no evidence that long-term investment returns have been affected at all. According to Google Finance¹, for the 30 years beginning, 6-25-1982 to 6-21-2012, the S&P 500 Index has increased by 1,135.56% or an annualized rate of return of 8.74%. This example helps to illustrate that if you intend to be a long-term investor, then high frequency trading will have minimal affect on your returns.
The long-term Investor should be more concerned about buying the right stock at the right price; hence, investing. These High Frequency Traders are playing a different game, by trying to make a quick penny on millions of shares; otherwise known as speculating. So continue to be the long-term investor and grow your nest egg by sticking to a sound investment plan and contributing regularly.
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Left your job? Don't leave your assets!
June 6, 2012
Here are the biggest reasons why we advocate for rolling over your old retirement plan (401k, 403b, SIMPLE IRA, etc.).
Beneficiary Designation- We all know beneficiaries change from time to time (Divorce, children, etc.) but if your account is at your old employer, are you going to remember to make the necessary changes?
Investment Selection- Even if your previous retirement plan has a good investment selection, you still may not have access to all of the different asset classes (i.e. Individual stocks, ETF's, etc.). We have the ability to use an open architecture IRA brokerage account which allows you to purchase and hold many of the securities available today.
Control (Plan Accessibility) - As long as your account is in a company retirement plan, it is technically the asset of the company. At this point, you have left the company and it would only make sense to take your assets with you to invest as you wish.
Stretch IRA's- We have found that if you have control of your assets with the proper beneficiaries assigned, it is easier for your heirs to transfer their portion into designated beneficiary accounts for their lifetime. There may even be greater stretch benefits if you have a wide disparity between the ages of the heirs. As always, we recommend that you receive tax advice from a qualified tax accountant/attorney.
Consolidation- It is very easy to lose track of an old investment that you may not be able to view regularly. By consolidating your accounts, you not only are able to track where your accounts are but you can also make sure the total portfolio is allocated properly.
Expenses- Even though company retirement plans are disclosing fees more and more, you may still find it difficult to track exactly what you are paying for the investments.
There is one situation where we would recommend leaving your plan at your old employer and that is:
Early Retirement- If you plan on retiring before age 59.5 (but at least age 55), the 401k has more advantageous distribution rules. These advantage distribution rules disappear once the account holder turns 59.5.
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Social Security Benefits
May 22, 2012
Based on our informal Facebook poll last week, the majority of the respondents (22 of 25) believed that Social Security would not be around when they retired. While they might be right (none of us has a crystal ball), I tend to believe that it will be around in some fashion. I have formed this view not only from personal experience but also from a few scary statistics. According to the Employee Benefit Research Institute in 2011, Fifty-six percent of American workers have saved less than $25,000 for retirement, and 46% have saved less than $10,000. At this point in the lifecycle of a government entitlement, which was signed into law by FDR on 8/14/1935 (see http://www.ssa.gov/history/hfaq.html), the benefits have become not only a safety net but also an expected part of retirement income. Let's also not forget that as the number of pension plans continues to be reduced, the onerous is on the worker to save for retirement.
Let's take a look at what got us into this mess. For all workers, who earn a paycheck, 6.20% of wages up to $110,100 in 2012 is taken from their pay and paid to the Social Security Administration. These Social Security dollars are used to pay current retirement benefits; however, as the baby boomers start drawing benefits, the number of workers left in the work force will diminish. So in essence there will not be enough money being paid in to cover the benefits being paid out.
Here is my guess (and it is nothing more) of what will happen. With the falling number of workers vs. number of retirees, one of two things will have to happen, if not both: 1. Social Security Taxes will go up and/or 2. Social Security Benefits will be reduced. Some of this we have seen already with the increasing of the Social Security Normal Retirement Age from 65 to a higher age based on your birthday.
Unfortunately, I am fairly certain this problem is one of the most critical of our era. To my knowledge, there has not been any consensus on how to stabilize this system so it doesn't become insolvent. It amazes me that we are not seeing any urgency out of Washington on this issue. At some point a decision will be made, I would just like to see it be done sooner rather than later, so we can all know whether or not we will enjoy our Social Security Benefits.
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Solo 401(k) for the Solopreneur
May 15, 2012
As we promised in our last post, this article will cover the Solo 401(k) retirement plan option. Solo 401(k)'s share many of the similarities to that of a traditional 401(k) with the benefit of being cheaper to set-up and administer. The Solo 401(k) was designed for an individual running a sole proprietorship or a small company with a spouse/immediate family member. Therefore, Solo 401(k)'s are frequently used for individuals who are taxed as a 1099 employee, but can also be used for anyone who is the only owner in their company.
Below is a list of the attractive features to the Solo 401(k):
Maximum Contributions: $17,000 in 2012
If you are 50 or older, you may contribute an additional $5,500 per year
Voluntary employer match
Loan and hardship withdrawals available
Relatively inexpensive to set-up and administer
Solo 401(k)'s are another great way to invest a significant amount of pre-tax dollars for retirement. This type of plan will provide the business owner with the benefits of a traditional 401(k), for a reduced cost. This post will be the final of our three-article segment on retirement plans for small business owners and we will go into detail in our next post about the cost of waiting to set up a retirement plan.
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SEP IRA- What and When?
May 10, 2012
Since our last post discussed SIMPLE IRA's, it only seems right to go over what a SEP IRA is as well. A SEP IRA is another retirement plan that gets pushed to the back burner as the majority of investors are more familiar with 401(k) plans. A SEP (Simplified Employee Pension) IRA is typically used with employers who have one or more employees and are looking for an easier and cheaper alternative to a 401(k) plan. A SEP IRA will allow the employer to make higher contributions which are tax deductible to the employer.
Additional features of a SEP IRA are as follows:
Employer makes annual contributions to employees' IRAs
No employee contributions are allowed
Contributions are discretionary and tax deductible to the employer
100% immediate vesting
Maximum contribution in 2012 is the lesser of 25% of total compensation or $50,000 per participant.
Due to the fact that most investors/employers are familiar with 401(k) plans/403 (b) plans, we feel like we should discuss some of the lesser known options. To that end, our next post will review one of our favorite options for self-employed individuals; The Solo 401(k).
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When To Use A SIMPLE IRA?
May 7, 2012
When an employer considers the idea of initiating a company retirement plan, the first thought that comes to mind is a 401(k) or 403(b). There is nothing wrong with either of those plans in the right situations; however, employers are quick to adopt a 401(k) plan without evaluating the other retirement plan options that are available. For instance, what about the forgotten SIMPLE IRA?
SIMPLE IRA's are a type of IRA retirement plan, similar to your Traditional and Roth IRA's, with a few caveats. The "SIMPLE" acronym stands for Savings Incentive Match Plan for Employees and was created for employers with 100 or fewer eligible employees who do not currently have another retirement plan. This type of IRA is suitable for firms that wish to offer employee salary-deferral compensation but are looking for an easier, and typically less expensive, plan to administer than a 401(k) plan.
As opposed to a Traditional or Roth IRA, an employee in a Simple IRA is capable of contributing the lesser of 100% of compensation or $11,500 for 2012. If you are 50 or older, you are allowed to contribute an additional $2,500 per year as a "catch-up" mechanism. The one main difference between a 401(k) plan and a SIMPLE IRA is that the employer, in a SIMPLE IRA, is obligated to match the employees' contribution and with a 401(k) the employer has the option to match. So Employers, when it comes time to set up a retirement plan for your company and you have 100 or fewer employees, do not forget about the forgotten Simple IRA.
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Following the Herd!
February 7, 2012
Of all the investing themes we run into by far the most prevalent is the Follow-the-Herd mentality. By Follow-the-Herd we mean good intentioned investors who invest their hard earned money just like everyone else is at the time. This inevitably leads to buying an asset higher than normal, or selling an asset lower than normal, which normally does not produce good investment results. If you read our last post, you know how we feel about results. If you did not read it yet, please do now. Anyway, there are only two ways to get results in investing. One is to get a dividend/interest payment, the other is capital appreciation.
It is capital appreciation that we want to talk about today. In order for an investment to have a realized capital gain, one has to sell an asset for more than they paid for it. This is why we favor an investing style that focuses on purchasing assets at a discount. With that said, why do so many investors want to see growth before they are willing to invest? The baffling part to us is that there is now, and has always been a certain love affair in our society with buying items at a discount. Think about how popular extreme couponing has become or how many viewers watch shows like Storage Wars. Most of us at our core really like to buy something at a discount relative to the value it brings. Isn't this really why we stop at yard sales?
We believe many investors find comfort in investing like their friends or family, or by what they hear on TV. They would rather be wrong with everyone else than to be right while being different. This we believe is exacerbated because the stock market is intimidating and valuing a company can be very difficult to do. Either way, people feel good about buying what others are buying and selling what others are selling. It is almost as if people are afraid of making a mistake, so they choose the same beaten path as everyone else does. It is classic herd mentality, and in some areas of life it is not a bad thing. As we all know, wanting to be part of group is a good thing at times. However, this is the nail in the proverbial value investing coffin.
Remember there is nothing wrong with being contrarian. If you think a stock is trading at a discount than you owe it to yourself to take a second look no matter what the herd is doing. If you are wondering how to value a stock, we will spend some time in a future post going over a few of the ratios used by professionals. Hopefully, the next time you hear someone talking about a stock, you first think about whether or not it is trading at a good price.
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When Investing Results Matter!
January 25, 2012
Results matter, plain and simple. We are not just talking about percentage results but the actual dollar return on your portfolio value as well. We understand this just as well as you the investor. This may sound like common sense, but generations of folks have been taught to put together and hold a diversified portfolio and not to focus on returns. The problem is most people have extrapolated proper advice of not watching your returns on a daily basis, to not watching them at all. We are not real sure where or how this mantra got started (probably by an investment manager with poor returns!), but it is still being espoused by financial planners and journalists on a near daily basis. Now don't mistake us, we do advocate for a diversified portfolio of mutual funds, stocks and bonds, (and of course, there is no guarantee that any investment strategy including diversification, will ensure favorable results), but it is not enough to stop there. If you take time to think about it, all that really matters is how much your portfolio is worth when you are ready to spend it.
Why worry so much about returns? In nearly all other aspects of life we worry about performance. When you take your car to the mechanic, you expect them to fix it properly. When you take your tax documents to your accountant you expect the tax forms to be filed correctly. So why not expect the same from your investment manager? To some degree, we believe the answer lies in the complexity of return percentages. This is why we believe that you should judge your investment manager on the actual portfolio value at the end of the investment period. If you just worry about the amount of cash that you have at the end of the reporting period compared to the amount you put in this will give you your net of fee's actual return.
Now we're not talking about cars or tax returns, we are talking about the difference in portfolio value over time. For example, the ending balance of a $100,000 initial investment returning either 5% or 6%/year over 30 years is $432,194.24 and $574,349.12 respectively. (This is a hypothetical example and not an actual result. There is no guarantee this result will occur) So yes, even 1% does make a difference over time and that is why results matter.
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