Per Stirpes or Bust

Credit: Grant Cochrane

Do you have a will that leaves things to friends and family you care about? Do you think there is a pretty good chance you might inherit some money from someone who is still alive? If you answered yes to either or both questions, listen up!

Say you have a will and you wish to leave your fortune to your three sons: Alvin, Simon, and Theodore. Say Alvin, Simon, and Theodore have all grown up, and each has a son of his own. Well, if you wrote your will to state that the remainder of your estate was to be divided up equally between Alvin, Simon, and Theodore, what would happen if Alvin died before you had a chance to update your will? If you had the Latin legal phrase known as “per stirpes” included in your wishes (which means “by root or representation”), then Alvin’s son would inherit Alvin’s portion, and Simon and Theodore would inherit their portions. If you do not have per stirpes written, and instead have the phrase “per capita” included in your wishes, then Alvin’s son would get nothing, and Simon and Theodore would split your estate 50/50. Talk about a family feud! If you don’t have “per stirpes” or “per capita” included in your wishes, and Alvin died before you, I honestly couldn’t tell you how your will would pay out without carefully reading the entire document.

I’m not writing this today to scare you to death so we can see how your estate plan shakes out. I’m writing this to encourage you to dust off your latest will and make sure it actually reflects your last wishes, whether per stirpes or per capita. If you think you might inherit some money from someone who is still alive, I encourage you to figure out a way to share this post or drop some sort of hint to make sure your heirs are looked after should something happen to you before your likely grantor.

Finally, please make sure your retirement accounts (401(k)s, IRAs, deferred compensation plans, etc.) and life insurance policies’ beneficiary designations also reflect the last wishes of your will. This is imperative because retirement accounts and life insurance policies' beneficiary designations trump a will. For example, if your 401(k) beneficiary designation says Alvin, Theodore, and Simon per capita, and your will says everything to Alvin, Theodore, and Simon per stirpes, your 401(k) will actually be split per capita! Remember, that would mean your grandson (Alvin’s son) would not see a dime from your 401(k) should Alvin predecease you!

Most of the clients I work with seem to want “per stirpes” to be in place, but that is neither right nor wrong. If you want to ensure that only the people you have specifically named will be able to initially receive your assets, it’s perfectly fine to have “per capita” in place. I just want to encourage you to take a look at your will and beneficiary designations if you are not sure what you have in place because relying on the defaults could lead to your final wishes being skewed and some pretty unhappy chipmunks.

-Tom

Trading vs. Investing

Credit: rattigon

Last week I ended up waiting in line for a fairly long time while my car’s emissions were tested at a very busy car maintenance facility. I had come straight from work, so I was still dressed up in a suit and tie, and in hindsight, I guess I might have looked a little out of place at a Jiffy Lube. Another customer who had finished reading the same sports section of the newspaper I had, and seemed to be even less interested in the Judge Judy rerun playing in the background than I was, decided to strike up a conversation with me. I’m fairly social and am always up for meeting new people, so it wasn’t too difficult to chitchat until he asked me what I did. When I responded that I was a financial planner and investment advisor, he countered with, “So, you’re a stock trader?” I politely replied, “Of sorts,” but that’s not what I do; that’s not even what I recommend. A harmless conversation with a nice stranger at a Jiffy Lube was not the place to dive into the important differences between trading and investing, but it got me thinking that today’s post just might be!

Trading and investing might be synonymous to some people, but not to me. In my mind, “trading” usually means the frequent buying and selling, or sudden buying and selling, of financially significant quantities of a handful of securities. When I think of the term “investing,” I think of a long-term time horizon, occasional and strategic buying and selling, and a well-diversified portfolio. Before you stop reading and accuse me of splitting hairs, please let me give you three reasons why trading is not investing, and why I believe investing is better. 

• Taxes – Let’s say a single lady makes around $75,000 this year. When you look at the 2013 federal tax brackets, she falls in the 25% bracket. This lady is doing pretty well for herself, but she’s doing even better considering that she bought 5,000 shares of Bank of America stock in August of 2012 for $8 a share. She likes “dabbling” in the market from time to time, and she felt she had made a great pick with Bank of America, but now she wants to buy another stock, so she sold the 5,000 Bank of America shares in June of 2013 for $13 a share. Because she held those Bank of America shares for less than a year, her gain must be taxed at her ordinary income tax rate, so her investment will land her roughly $18,750 after federal taxes (((5,000 shares x $13 sales price) – (5,000 shares x $8 purchase price)) x (1 - 25% tax rate)). If she had treated those Bank of America shares as a longer-term investment and sold them in August of 2013 (after she had held the position for a year) for the same $13 a share, the federal long-term capital gain tax rate of 15% would have applied! Her investment could have landed her roughly $21,250 ($2,500 more than $18,750) after federal taxes (((5,000 shares x $13 sales price) – (5,000 shares x $8 purchase price)) x (1 - 15% tax rate)) even though the theoretical sales price was the same! There are certain situations where selling a security with a short-term gain makes plenty of sense, but it’s always worth considering the potential tax benefits of longer-term investing versus the potential tax consequences of shorter-term trading. 
• Costs/Fees – Whether someone is into stock trading or investing, there are times when new securities need to be bought and old securities need to be sold. In my book, transactions should always have a strategic aim, be executed for tactical, security-specific reasons, or be completed to free up cash, but everyone should remember that transactions are not free. There are costs and fees to facilitate transactions, and depending on your investment custodian and/or investment advisor, these costs and fees could range all over the place. For argument’s sake, let’s consider E*Trade’s fee of $9.99 per trade. If someone were to make 10 trades a year through E*Trade, they would incur around $100 in fees. That might be peanuts to some people, but $100 worth of fees on a $10,000 brokerage account is a loss of 1% of the total account! That means, at best, those fees would dampen the positive performance of someone’s $10,000 brokerage account, and at worst, those fees are just additional salt in the wound of the negative performance of someone’s $10,000 brokerage account. Costs and fees are too insignificant to drive a stock trader or a stock investor’s transaction decisions, but they are significant enough to consider, particularly if the number of transactions is excessive and/or the account’s value is relatively small.
• Diversification – When I was a senior in high school, there was a statewide contest to see which group of economics students could grow the largest fantasy investment portfolio over a three month period. The rules were that participants could only place trades at the end of the day and could only buy stocks that were trading at more than a dollar, so I quickly convinced my group that the only way we were going to get enough stock price movement to have a chance to win was to go all-in on a single stock that was trading near a dollar that was scheduled to have an earnings announcement in the next couple of days. (PLEASE NOTE I ADVISE AGAINST THIS STRATEGY AND IN NO WAY RECOMMEND IT UNDER ANY CIRCUMSTANCES WHATSOEVER.) As luck would have it, the company whose stock we picked announced that they had beaten earnings expectations and were in talks to be bought out, so the stock soared. The problem was that two other groups of students in the state had done the same thing, and we were all tied in first. My group elected to sell the next day with the hopes that the stock would return to orbit, but the other two groups held on as the stock eked up a few more pennies, thus landing us in third. First place in the state won fame and fortune, and third place won a T-shirt, so we decided to roll the dice again with our all-in, single-stock strategy by buying shares in a company that had an upcoming earnings announcement. This time, the company we picked failed miserably compared to expectations, and some of their executives had decided to leave, so the stock fell like a lead balloon filled with lead balloons. Our strategy had hit us a home run once on the very first try, but as we tried it again and again for the rest of the contest, we lost and lost. We actually finished second to last in the state. I told you that long story because I wanted to share my powerful, first lesson in why diversified investing is better than non-diversified trading - singles and doubles over the long term are a lot better than one home run and a lot of strikeouts in the short term!

If you enjoy trading, that’s wonderful, but call it what it is: a risky hobby. If you’re trying to reach financial independence or if you are trying to maintain financial stability, I urge you to invest, not trade. Trading is sexier, and it may make you feel like you are actually doing something about your holdings more often, but the tax effectiveness, cost effectiveness, and diversification benefits of letting the market do its thing over time are hard to argue with.

 

Are you a stock picker says he? No. I’m an investment advisor says I!

 

-Tom

The Lightning Round: Take 2

Credit: FreeDigitalPhotos.net

Thanks to all of you for the many questions I received. I’m back from vacation and ready to roll, so now, as promised, here are my responses to five of your questions...

1. What is the difference between banks and credit unions? And which is better?
                                                                                                                              - Sandy              

Banks and credit unions are very similar. A credit union is essentially a group of owners or members who have pooled their cash to form their own bank; think teachers’ credit unions, airline credit unions, corporate credit unions, etc. It is usually a special bank for employees of a certain company or people of the same organization or trade. Since credit unions are smaller, they are known for having better customer service and for being more flexible. That being said, they probably have fewer account options, a less sophisticated website, and fewer locations than bigger commercial banks, like Bank of America or Wells Fargo, which are some of the possible advantages of banks.

Another major difference is that credit unions are usually not-for-profit, so they probably charge lower fees and offer slightly more favorable interest rates on savings accounts and loans to their members. However, because they are smaller, credit unions can also be more susceptible to failure than the larger national banks.

Are you trying to decide between a bank and a credit union? If so, and without knowing your details, I might leave my savings or rainy day fund with a credit union to get higher interest returns and maybe take out a mortgage or loan with them to get a better rate and more personal service, but I'd keep my day-to-day accounts with a larger bank, so I would have more branches to visit, more ATM access, and a larger network of customer service resources at my disposal if I was out of town. Hope that helps!

2. I’m heading to graduate school in the fall. Although my husband and I have saved up towards it, we will need to take out loans. In the years after I finish my degree, is it better to aggressively pay off the loans before saving towards a house down-payment, or to pay down loans at a moderate rate while saving for a house? Keep up the good work!
                                                                                                                               - Anonymous

Great question! Please don’t be too mad at me, but the answer is: it depends.

If you are close (or think you will be close) to hitting that “magic” 20% down payment threshold when you and your husband decide to buy a house, I would probably pay down the loans at a fairly minimal rate and direct most of your saving firepower towards hitting the 20%. Remember, 20% down usually means more favorable interest rates, lower monthly payments, and probably avoiding the additional expense and complications of Private Mortgage Insurance (PMI).

If 20% down is not a reasonable goal for you, I would probably direct more savings firepower toward extinguishing the loans. Student loans may offer a potential tax deduction, but they are usually just a fixed expense that can be a painful burden on recent college graduates and relatively new workers. The sooner you can eliminate that debt, the sooner your cash flow will improve, your financial position will strengthen, and you will probably even feel better.

Also worth mentioning is that the interest rates on your loans do matter. If the interest rates are much more than 5% or 6%, I would definitely work toward extinguishing the loans. If the interest rates are lower, historical returns would tell you that you might be better off in the long-run saving or even investing some of your funds. I’m pretty conservative and have a disdain for debt, but as you might recall, even I list paying off loans as tied for 7th place on my list of financial “Bear Necessities.” Good luck heading back to school!

3. Paying off student loans vs. saving for your child's college (and where/how to set that up) vs. saving for retirement.
                                                                                                                               - Rebecca

This is also a good question, and since it’s a little related to the second question, I thought we’d go ahead and cover it now. (For those of you looking for the Cliff Notes, saving for retirement gets the gold, paying off student loans gets the silver, and saving for your child’s college takes the bronze.)

In my book, gaining financial independence should be everyone’s long-term financial priority. By financial independence, I mean achieving the ability to sustain a standard of living or quality of life that you like or are willing to tolerate for the rest of your life without having to continue to work. This is primarily achieved by living within your means, saving for retirement, and paying off debt. As far as student loans vs. saving for retirement, I’d probably recommend maximizing any contributions to a 401(k) plan or retirement plan to the point that you receive any maximum employer matches you may have available to you and then making maximum IRA annual contributions (to a Roth, if possible) before I did much more than the minimum payments toward student loans. Then, as I mentioned in question #2, I’d suggest you look at the interest rates, consider your personal risk tolerance, and then either assault the debt principle or look at saving or investing a little more.

Saving for your child’s college is admirable and a goal of many parents, but it really should come after your own financial situation. I know this may sound harsh, but what if your child one day gets a scholarship or decides not to go to college and those funds you painfully tucked away could have been used toward paying off your own student loans or saving for your retirement? Besides, if worse comes to worst and you haven’t saved enough money to pay for all of your child’s college, they can always take out student loans themselves. After all, you mentioned that you have student loans, and I know you turned out alright! All this being said, if you feel that it is your responsibility as a parent to pay for your child’s college education and you have the additional financial capacity to set aside some funds for your child’s college, the sooner you start saving, the better. I would recommend opening a 529 plan, a state-run education savings plan, because they are easy to set up and relatively flexible, and distributions used toward your child's qualified college costs come out tax-free. You could ask if grandparents, aunts, or uncles would also be willing to contribute, and many of the plans offer convenient, automatic age-based investment allocations that will periodically adjust to prudent risk allocations as your child gets closer to college (more risky when your child is younger, less risky as your child gets closer to college).

4. Do you watch shows like Squawk Box or Mad Money? Would you recommend those shows?
                                                                                                                              - Anonymous

(Squawk Box is as CNBC puts it, “the ‘must see’ pre-market morning news and talk program, bringing Wall Street to Main Street” and Mad Money is a show hosted by television personality and former hedge fund manager, Jim Cramer.)

I chose your question because I thought it was an interesting one, but, I do not watch these shows. I have previously watched Squawk Box, and I’ve seen Mad Money on the television in waiting rooms and in airports, but I don’t watch these particular shows or shows like them very regularly. They are intriguing, but personally, they stress me out and make my blood pressure go up.

The main reason I don’t watch these shows is because they target people with different investment philosophies than mine. There is nothing necessarily wrong with these shows, they are very popular, and many people might well claim that the advice they get from watching investment talk shows has helped them financially. Maybe so, but I don’t believe in acting impulsively. I believe if someone is talking about a stock tip, it’s often already too late. I believe in investing in a diversified portfolio made up of different holdings that will perform well under different market conditions. I believe in the cost savings and tax effectiveness of long-term investing versus short-term trading.

I’m all for people watching Squawk Box and Mad Money if they enjoy them and find their reporting insightful, but I would not recommend these shows to someone per se because I feel like they try to convince the viewer that they are suddenly empowered to trade and invest after watching. Call me crazy, but I believe that it’s a lot easier to lose money quickly than to make money quickly, and I will be the first to admit that watching Iron Chef does not make someone an exceptional cook!

5. Recently, my credit card was fraudulently used. I was alerted of the fraudulent charges by the financial institution the card is through, was able to remove the charges and got a new account number. I've heard about more elaborate identity protection services, but I am not sure if they're worth the investment. Do you ever recommend these types of services to clients? Also, are there any steps you'd recommend to clients after they experience credit card fraud, such as getting credit reports, etc.?
                                                                                                                             - Kristen

I’m so sorry to hear about your troubles. Several months ago, someone bought several hundred dollars worth of shoes with one of my credit cards, and I had to go through a similar routine. It’s not pleasant, and if you are like me, you feel a little violated, but you can recover and move on.

As you mentioned, there are many identity protection services available. As identity theft and cyber crimes continue to rise, there will likely be even more services available in the future. However, generally speaking, I do not recommend these types of services to clients. They could work and they could be worth the investment, but if you are vigilant, you are likely one of your own best (and least expensive) forms of protection.

I advise people to review their credit card statements and bank statements closely every single month, whether in electronic form or hard copy (which you must already be doing if you caught the fraudulent charge, so good job!). I advise people to be careful about using auto-pay and just assuming all is well. I advise people to save their receipts, use their checkbook ledgers, or use a program like Excel or Quicken to track their cash inflows and outflows to make sure they are the only ones spending their hard-earned money.

If you’ve already had one card fraudulently used, I would follow the steps I have mentioned above even more carefully just in case. If you have the option to have your credit card companies call you for purchases over a certain amount or purchases outside of the country, I would recommend utilizing these features. I would recommend not using the same password, secret question answer, or PIN for all of your financial accounts as an additional safeguard. Also, as you mentioned, checking your credit reports once every year or two (you are allowed to check for free once every 12 months, but you don't want to check too often because it can impact your credit score) can also be a good idea to make sure your identity is secure and all of your financial affairs are in order.


Thanks again for all the questions. Please always feel free to ask me anything that you think I may be able to help you with though, Lightning Round or not.

-Tom