9 Secrets of Achieving Financial Freedom, Pt VIII

“9 Secrets of Achieving Financial Freedom Pt VIII”

As I conclude this series on the ‘9 Secrets to Achieving Financial Freedom’, let’s begin with a review of what we’ve covered so far. The Secret of Decision states that before you can accomplish any goal, you must ‘decide’ what you truly want. With the Secret of Total Commitment and the Secret of Clarity you commit to do, “Whatever it takes” to succeed and get very clear exactly what success will look like for you. Once you’re clear about what you intend to achieve, use the Secret of Decisive Action to both develop and execute a written game plan. Any goal worth achieving will likely involve many challenges and obstacles so you’ll need to fortify yourself by implementing the Secret of Perfect Attitude. With this secret you discover that while you may have little choice regarding your challenges and obstacles, you get to choose how you react to them. That choice allows you to respond in a positive, constructive and productive way…and will hasten your journey to success. Adopting the attitude of success allows you to incorporate the Secret of Financial Focus. Each day ask yourself, “What can I do today that will move me closer to my goal?” and then take a positive step. Most major goals are accomplished with hundreds of ‘baby steps’. The Secret of Passive Income states that to be truly financially free, you must create a source of cash flow outside of your own paycheck that is at least equal to lifestyle expenses. Think of it as a way of ‘automating’ your success. With the Secret of Leverage, you’re looking for ways to accelerate your success…to reduce the time it would normally take otherwise. In the world of personal finance leverage is available in many forms. Donald Trump and millions of other people use financial leverage to create personal fortunes with modest amounts of money. Business owners use ‘people’ leverage to magnify results. Just look at what Bill Gates has accomplished by assembling a group of highly talented employees. Our government provides tax laws that allow you to leverage returns through tax deductible retirement plans. And the list goes on and on.

This brings us to the final secret, the Secret of Team. Rarely have I met a Self-Made Multimillionaire who got there without a lot of help. In fact, built into most Self-Made Multimillionaires DNA is the intuitive knowledge that they’ll need to develop a Team; seek out mentors; and model others who have gone where they intend to go. You should do likewise. Whatever your goal, think about who you could get to help you achieve it. It might be a professional, a friend, a family member or someone you don’t know personally but will need to meet. You’ll find most people are willing to help you if you’ll just ask.

In my own Ultimate Fitness Quest, I used all of the above ‘secrets’ as I set out to lose 20 pounds of body fat in 40 days and cut my waistline from 37 inches to 34 inches. Each secret proved critical to success as each is interconnected. By day 40, I lost 20 ¼ pounds and cut my waistline to 33 inches. So where do I go from here? I’ll set a new health and fitness goal that builds on my current success. You can as well. Whether your goals are in the area of personal finance or fitness, take the first step today and visit www.StewartWelch.com.

Financial Freedom & the Ultimate Fitness Quest - Part 8

Financial Focus!

9 Secrets of Achieving Financial Freedom - Part V

In this continuing series of the ‘9 Secrets to Achieving Financial Freedom’, today I’ll discuss the Secret of Financial Focus. One of the reasons that so many people struggle financially is they fail to give proper attention to their finances. Sure, they’re paying the bills and maybe putting a little money into their company’s retirement plan but that’s not enough to create financial success. The success of the Secret of Financial Focus lies in consistent attention to your finances. If you want to become financially free, how much time should you spend? In my experience, 30 minutes a day is adequate to significantly accelerate your progress towards that objective. Think about it. Your money is the ‘glue’ that holds your financial situation together. Most people will spend more time planning a vacation than planning their personal finances. No wonder so many folks are drowning in financial deep water. Realize that becoming financially astute is a process. As my wife is fond of saying, “Bloom where you are planted”, meaning start wherever you are and bloom from there. A logical place to start is to determine your ‘baseline’…by listing everything you own and owe. To access a form go to the Resource Center at www.WelchGroup.com; click on ‘Links’; then Asset/Liability Review. Next, educate yourself about the in’s and out’s of personal finance. Commit to spending 30 minutes each day learning about personal finance and investments. A good place to start is my ‘9 Secrets to Achieving Financial Freedom’, a free 30-day Internet course that will give you a good foundation from which to build. You can access it at www.StewartWelch.com. There’s also lots of information on the Internet and many great books on the topic.

Ok, I know this might not be your number one fun thing to do in life but each of us has a responsibility to be a good steward of our money. I love this quote from Sir Josiah Stamp, “It is easy to dodge our responsibilities, but we cannot dodge the consequences of dodging our responsibilities”. There’s a universal law called the Law of Attention which states, “What you put your attention (focus) on, expands”. Pay attention to your money and watch it grow. Consider thinking of your personal finances in a new way. Think of it as a business you own with the intention of growing it into a big business. If you really did have a business, it would get daily attention. So should your personal finances.

How would I cross-relate the Secret of Financial Focus to my own ultimate fitness quest…my personal goal of losing 20 lbs of body fat in 40 days? Simply drop the ‘Financial’ and insert ‘Health & Fitness’. I’m focusing daily attention on what I eat as well as exercise. For me it’s been focusing on one day at a time. “What do I need to focus on TODAY to move me towards my health and fitness goal?” Check out my results…then realize you too can use the Secret of Financial Focus to transform your financial circumstances. Or you can use the same concept to transform your own heath and fitness in just 40 days! For your fitness transformation, visit www.UltimateFitnessQuest.com.

Stewart's 20 Day Update on his Ultimate Fitness Quest

Achieving Financial Freedom - Part 3

9 Secrets of Achieving Financial Freedom - Part 2

What does it take to achieve financial freedom? What does it take to achieve anything that you truly desire? Most people haven’t a clue. I spent thirty years studying people who have achieved extraordinary success and found that they each consciously or unconsciously do and think differently from everyone else. I call these the 9 Secrets of Achieving Financial Freedom. Last week, I discussed the first two secrets: the Secret of Decision and the Secret of Total Commitment. To achieve any worthy objective it first requires that you decide what you want and then make a total commitment to making it happen. Not every successful person does this but you will increase your chances of success many-fold if you write it down. This leads me to the third secret; the Secret of Clarity. You must have a crystal clear vision of what you want to do, become or have. The clearer the picture, the easier it will be to attain. The Secret of Clarity includes seeing yourself ‘as-if’ you already are that which you wish to be. It’s ‘imagining’ yourself into the future to that time when you are what you set out to become. Your mind will then begin to make decisions towards that reality.

Perhaps my favorite story of clarity relates to a struggling Asian actor. In 1970, in a letter to himself, he wrote, “By 1980, I will be the best known oriental movie star in the United States and will have secured $10 million dollars. In return, I will give the very best acting I could possibly give every time I’m in front of the camera…” In 1973 Bruce Lee completed the film Enter the Dragon and became in instant mega-star and martial arts legend. Through hard work, Bruce Lee became who he had to become to be that mega star. And I love that he included what he’d give back in return.

It is said that the human mind makes a wonderful slave but a terrible master. What you tell your mind often enough, it believes. Successful people learn to control their thoughts so that roadblocks to success become ‘challenges’. And everyone loves a challenge.

In applying the Secret of Clarity in your personal finances, get perfectly clear on exactly what success looks like for you. Is it being debt free? Is it being financially free? And what exactly does each of these mean for you? Certainly ten people would arrive at ten very different answers.

I’m currently using the 9 secrets to transform my own heath and fitness over a 40-day period. I made the decision, am totally committed and have perfect clarity around what I intend to achieve. Using proper nutrition and exercise I’ll slash 20lbs of unwanted body fat and reduce my waistline three inches. I’m calling it the Ultimate Fitness Quest and invite you to join me in a quest of your own. A team of health and fitness experts is showing me (and you) how to turn my body into a fat burning furnace. They promise me I’ll never go hungry and won’t have to spend hours in the gym. Apparently, little changes can make a world of difference. If you’d like to join in the fun or just follow along visit www.StewartWelch.com.

Protecting Your Assets from Lawsuit - Part 1 - Stewart Welch III

There is a litigation crisis in America where the mantra is, “Sue everybody and we’ll sort it out later’. It is estimated that there are over 1 million lawyers in America…one for every 300 citizens. So what are the chances of you getting sued sometime during your lifetime? Turns out they’re pretty good. In fact, some research suggests that you’ll be involved in an average of five lawsuits during your lifetime. So if we can agree that there is at least a risk of you getting sued, wouldn’t it make sense to develop an asset protection strategy?

Over the next few weeks, I’ll cover a wide range of strategies that discusses lifestyle; insurance; titling of property; trusts; and estate documents.

Monitor your lifestyle. At the most basic level, your lifestyle can either minimize or elevate your risks of a lawsuit. Some of the obvious things would include not drinking and driving; observing the speed limits; securing a fence around your pool; etc. For example, research proves that talking on the phone while driving is the equivalent of driving while slightly intoxicated. Driving while texting on your phone is the equivalent of driving while drunk. I was recently sitting at a red light when a young lady whose attention was momentarily diverted scraped my bumper. No one was hurt but the damage to my scraped bumper was still $1200 and the costs of repairing her car, I suspect, was much more.
To Do: Take a moment to think about how you could reduce lawsuit risks related to your lifestyle.

Insurance as your first line of defense. A number of years ago, a client and his family were driving to the airport in Denver, Colorado after a week of snow skiing. It was a beautiful sunny day with clear roads. Suddenly, he hit a patch of ice and his car slid into the oncoming lane. Fortunately, he and his family had buckled up and were not injured. Unfortunately, the two young ladies in the other car had not buckled up and both came through the windshield causing severe facial lacerations. They sued and won a judgment in excess of $700,000. If my client’s auto liability coverage had been, say $50,000, where would the young ladies’ attorney gone to satisfy the balance of the judgment? Answer: His personal assets. Fortunately, we had wrapped his auto and homeowners insurance with a $1 million Umbrella Liability policy.

In my experience, most people do not carry umbrella liability coverage, yet it’s perhaps the least expensive and most effective way to shield your assets from lawsuit. An umbrella liability policy typically has a very large deductible, say $300,000 or $500,000, but then covers any liability that arises from an auto or homeowners claim up to $1 million above your deductible. In order to avoid having a ‘gap’ in coverage, you’ll need to make certain that your auto and homeowner’s coverage limits are equal to your umbrella deductible.
To Do: Meet with your property and casualty agent and have him or her add an umbrella liability policy for a minimum of $1 million. This policy often costs less than $300 per year but you may have to increase coverage for your auto and homeowners insurance.

Creating Alternative Sources of Income

Over the past several weeks, I’ve discussed retirement strategies based on whether you’re in your twenties to thirties; forties to fifties; or are in your sixties with retirement just around the corner. To review those column’s go to the Resource Center at www.welchgroup.com; click on ‘Links’; then ‘Stewart’s Column’.

One retirement solution everyone should consider is creating one or more alternative sources of income. While this may seem to be a daunting task, you may just discover that it’s easier than you think. Consider these success stories:

Years ago, a stockbroker discovered the love of running. While being a stockbroker provided the income to drive his lifestyle, for fun he began to organize runs with small groups of people on a weekly basis. One thing he noticed was that there were a number of novice runners who were interested in becoming more proficient and had goals of running in, and completing a marathon. He developed a novice running club and charged a small fee as he organized and taught a disciplined running regime that would prepare these novices for a marathon. He found that the club members loved the program and began to spread the word. He also discovered how much he loved combining his love of running with his new passion for teaching and seeing how it changed lives. Turns out that he wasn’t just teaching running, he was also teaching life skills.

A friend of mine was looking for an alternative income source; specifically he wanted something he could turn into passive income where his involvement would be minimal. He looked at many options and finally decided on an Internet-based discount retail purchasing web portal that allowed him to purchase everyday products at a discount plus add additional friends, family and other families where he would receive cash incentives for their purchases as well. If these new ‘customers’ also recruited customers, everyone would benefit. He worked diligently for three years building his new ‘business’ and today, spending only three hours per week has a monthly income exceeding $20,000!

Do you have to have a bunch of money to start up your own business? Consider a recent case. This gentleman in his late sixties was not content to drift into the sunset of retirement and, after much research, decided on a franchise business to buy. He had a great idea, a good business plan but lacked the capital to launch his business. He took the business plan to a group of investors who funded the project on a partnership basis.

What you should do. Make a list of all of the things that you love to do. Start with things that you are really passionate about. Note that for each item, there is someone who is making a pile of money with a business based on what you love to do. You could model them or create an innovative alternative. Brainstorm the possibilities and see what you come up with. In this economy, now is a great time to start a business. If you can make it work now, it’ll take off once the next economic boom gets under way. For more information about starting your own business, visit www.entrepreneur.com.

Family Gifts Can Be Taxing - Stewart Welch

A friend once called me with concern over a gift his parents made to his sister. His parents had given her $150,000 worth of stock to purchase a home. She then sold the stock and bought the home. The parents didn’t see anything wrong with this. After all, it is their money and they should be able to do with it what they please, Right? What they did not understand was that they created two potential tax issues. First, when the daughter sold the stock, she created a ‘realized’ gain and owes substantial capital gains taxes. Second, the gift created potential gift taxes that would be owed by the parents. To avoid this the parents must file a gift tax return and use a portion of their Lifetime Exemption Amount. The point is that care needs to be taken when making gifts to family members. It is possible to make ‘gifts’ even when you did not intend to do so. Let’s look at some typical examples:

· You add your child’s name to your savings or checking account. This is considered a gift the moment your child makes a withdrawal. If the withdrawal exceeds the allowed Annual Gift Tax Exclusion ($13,000 for 2010) it will be considered a taxable gift.
· You want to be certain that a particular person receives a specific piece of real estate at your death. Your solution is to add their name to the deed. When the deed is executed, you have just made a gift for gift tax purposes.
· You decide to buy a security such as a stock, bond or limited partnership interest and do so in both your name and someone else’s name. As soon as you designate the joint owner, a gift is deemed to have occurred.

Under each of the preceding examples where you created a joint ownership arrangement, at your death the entire value of the property is included in your estate. This is because you provided all of the financial consideration.

· If you guarantee a loan for someone else, you could end up being deemed to have made a gift for gift tax purposes. Assume that your child wants to start a business with start up costs of $95,000. Your child has no money or collateral with which to obtain a loan from the bank. You agree to guarantee the loan at the bank. By doing so, you have created a potential gift. The Internal Revenue Service has indicated that no gift is imputed unless there is an actual default on the loan that requires you to satisfy the debt for the benefit of your child. If this occurs, you are deemed to have made a gift for the full-unpaid balance of the loan less any repayments to you by your child.

Providing loan guarantees can also create negative estate tax results. If you’re involved in this type of situation, proceed with caution and get competent legal advice.

Portions of this article were excerpted (or modified) from Mr. Welch’s book, J.K. Lasser's New Rules for Estate and Tax Planning.

Searching for Income - Convertible Bonds

In response to the economic crisis that began in 2007, the Federal Reserve has purposefully driven interest rates down in order to stimulate our economy. This artificially low interest rate environment has wreaked havoc on retirees who are dependant on interest from their investments to pay their bills and run their retirement lifestyle. As a result, retirees are constantly scanning the investment horizon in search for higher returns. One investment vehicle that has garnered attention is the convertible bond. A convertible bond is a bond issued by a publicly traded corporation that gives the bondholder the option to convert the bond to a certain number of shares of the corporation’s common stock at a specific price. Convertible bondholders are essentially creditors of the issuing company who have the right to become owners.

Convertible bonds are not a new investment product and, in fact, became popular in the latter part of the 19th century when the railroad and telephone companies used them as a means of financing their expansion. One of their primary advantages includes the ability to capture additional profits should the stock price rise above the conversion price. If the stock does poorly, you have the safety of owning a bond and collecting interest. As with all financial products, advantages come at a price. You will receive a lower yield than you would for a comparable non-convertible bond, so if you never convert to shares of stock, you have earned a sub-par return. Also, many convertible bonds are callable at the option of the issuing company at a price that effectively limits your profit potential should the stock price rise significantly.

Analyzing which convertible bonds to purchase is a daunting task for most investors since it requires an in-depth understanding of bonds, stocks and corporate analysis. Your best bet is a convertible bond fund run by an experienced money manager. Consider no-load Vanguard Convertible Securities (VCVSX) run by manager Larry Keele, whose fund currently yields 3.8%. Convertible bond pioneer, John Calamos, along with his nephew, Nick Calamos, manage the Calamos Convertible fund (CCVIX), which currently yields approximately 3.1%. This load fund can be purchased on a no-load basis through Charles Schwab & Company.

Are convertible bonds or bond funds an appropriate investment for the individual investor? Sometimes referred to as ‘chicken stocks’, convertible bonds can provide risk adverse investors a way to participate in the often volatile stock market while reducing risk. However, the risk profile for convertible securities more closely resembles stocks. Take a look at the recent stock market extreme volatility for calendar years 2008 and 2009. For 2008, the stock market was down 37%. Vanguard’s and Calamos’ convertible bond funds were down 29.79% and 25.88% respectively. In 2009, the stock market rose 27% and these funds also rose 40% and 34% respectively. Convertible bonds are not for everybody but they are a valuable investment tool to add to your toolbox. Based on the recent stock market run-up since the March 9, 2009 lows, a lot of the short-term profit potential may have been wrung out of this strategy, so consider waiting on a market pull-back or plan on a long-term investment.

Stewart Welch

Free Financial Advice from The Money Bus

Hop on the Bus for Free Financial Advice - Stewart Welch

Last week I discussed the importance of being prepared for the unexpected, specifically for incapacity. Another threat looming large is the dismal economy we currently face where layoffs continue to plague workers across the country. If you have money in the bank and a secure job, consider yourself lucky. Most Americans have little or no savings and are therefore unprepared for just about any hiccup in their financial lives. Well, help is on the way, again. Last year, three organizations joined forces to provide consumers with basic advice on personal finances. The Consumer Education Foundation of The National Association of Personal Financial Advisors (NAPFA), TD Ameritrade Institutional and Kiplinger’s Personal Finance magazine have developed a bus tour across America and are offering you free access to professional financial advisors to answer your most urgent financial questions.

The program is called Your Money Bus Tour and will be coming to the Metro Birmingham area this coming Wednesday. The bus will park at the Hoover Library where Hoover Mayor Tony Petelos will kick off the event at 11:30 a.m. and Director of the Alabama Securities Commission, Joe Borg will offer tips for consumers. The kickoff will be held in the café area of the library.

You’ll are going to have an opportunity to meet one-on-one with a financial advisor from NAPFA. These advisors are volunteering their time and typically charge a minimum of $150 per hour for their consulting services. This is a true community services outreach program, not a sales promotion. Each attendee will receive a free Financial Tool Kit. The services are free and it is an excellent opportunity for you to get a head start on your finances for 2010. While you are welcome to ‘show up’ for the event, it would be best to make an appointment which you can do on line at www.yourmoneybus.com. Appointments begin at 9 a.m. with the last appointment at 6:45 p.m.

Anytime you meet with a professional advisor, whether it is a financial advisor, attorney, accountant or banker, it pays to be prepared. By doing so, you make the most of your time and their time as well. This is especially important at this event since the advisors are expected to handle a large number of appointments throughout the day. Here are a few tips to help you prepare for meeting with one of the volunteer advisors:

Make a list of what you own and what you owe. Known as a financial statement, this provides a quick reference to your advisor (and you), where you stand financially.
Develop a simple budget. Your budget will outline your monthly income and expenses. Your advisor can use this to quickly identify where problems are occurring and offer some easy-to-follow steps you can take to get you back on track.
Documents you’ll need to bring with you. Credit card statements and any loan agreements such as an auto loan will help your advisor understand not only how much you owe but what interest rate you are paying and terms of loan agreements.

If you would like a free form you can use to list your assets and liabilities or complete a budget, go to the Resource Center at www.welchgroup.com, click on ‘Links’, then either Asset/Liability Review or Detailed Budget.

Preparing for the Unexpected - Stewart Welch

Stewart Welch Explains the Million Dollar Roth Child

The Million Dollar Roth Child

With a Roth IRA, you do not receive an income tax deduction for contributions, but your money grows tax deferred and qualified withdrawals are income tax free…forever! This creates an incredible opportunity to amass a small fortune for children. For example if a 10-year old made annual contributions of $1,000 to a Roth IRA until his age 22, by age 60 his $12,000 investment would be worth $268,000 based on 7% earnings. Compare this to a child who makes contributions beginning at age 22 and continuing those contributions until age 60. In this case, total contributions are $38,000 and his accumulated balance is $198,000. Through the power of time and compounding, our younger investor creates more wealth with less than a third of the money. If our young investor continued to invest $1,000 per year all the way to age 60, he’d have $466,000. And if we could figure out how to increase the investment to $5,000 per year, he’d accumulate an eye-popping $2.3 million by age 60!

Whether it’s a relatively small Roth IRA contribution or a maximum contribution, these are impressive numbers. In order to be eligible to make contributions to a Roth IRA, your child must have earned income. The rules allow a contribution of 100% of earned income up to $5,000. So how do we go about getting our ten-year-old earned income? Here are several possibilities:

1. Self employment income. Your child could have a job such as baby sitting or mowing the neighbor’s lawn. When I was twelve, I remember my father dropping me off in the neighborhood with a box of aerosol can fire extinguishers that I sold door-to-door. I bought the cans for $1 (with dad’s money!) and sold them for $3. That’s earned income that would qualify for a Roth IRA contribution.

2. Employment income. Typically, this would include after school or summer jobs such as working at a grocery store, golf club or restaurant. Here the child is drawing a paycheck from an employer. If the parents are self employed or sole proprietors, then they might hire their children to work in the business. The compensation must be ‘reasonable’ for the work performed and keeping excellent records is a must.

3. Household work. Children can qualify as household employees if they follow certain IRS guidelines (see IRS Publication 926 at www.irs.gov). Here, excellent record-keeping is vital.

Knowing that when children earn money they’re not likely to be very enthusiastic about investing in a Roth IRA, consider this strategy. You (or a grandparent) agree to gift them one dollar for every dollar they contribute to their Roth IRA. As a result, your children will learn the value of work, saving and investing for the long term and just maybe…become a millionaire in the process!


Correction: In last week’s column on estate planning, I indicated that under current law, the first $1.3 million of estate assets received a ‘stepped-up cost basis’ plus an additional $3 million for certain spousal transfers. The law actually allows an exemption for the first $1.3 of appreciation of estate assets plus a similar exemption of an additional $3 million for certain spousal transfers. My thanks to attorney Leonard Wertheimer for pointing this out.

Stewart Welch - Estate Tax Mess & Confusion

Stewart Welch - Estate Tax Ouija Board Game

In a late 2009 article in The Birmingham News, I predicted that Congress would extend the 2009 estate tax rules rather than allow the scheduled repeal of all estate taxes to take effect. I was wrong…maybe. It’s true that Congress failed to take any action which means that currently there are no estate taxes no matter what size your estate. This means that if Donald Trump and his wife died this year instead of receiving potentially hundreds of millions of dollars in estate taxes, the federal government would receive nothing and his heirs would receive the entire estate tax free! Maybe…maybe not. There is discussion on Capital Hill suggesting Congress will change the law later this year and make it retroactive to January 1, 2010. If this were to occur, you can bet someone will challenge it on constitutional grounds. Resolution would likely take years and eventually be settled by the Supreme Court.

To put the current law in perspective, the estate tax laws for 2009 exempted up to $3.5 million from estate taxes for individuals and with proper planning, a married couple could exclude up to $7 million. In addition, estate beneficiaries received a ‘stepped-up’ tax basis on inherited assets, meaning the market value of all estate assets was re-set based on the date of death, eliminating capital gains taxes on immediate sales and eliminating the need for record-keeping on tax basis. Under the 2010 law, up to $1.3 million of assets receive a stepped-up basis’ while the excess amount is subject to capital gains taxes at the time of sale. Certain spousal transfers receive an additional $3 million of stepped-up basis.

Should Congress fail to take action this year, the current estate tax law is automatically repealed and on January 1, 2011 the estate tax exemption would revert to $1 million causing millions of middle-class Americans to be subject to taxes they never anticipated.

If you feel like you’re locked in a dark room seeking answers from a Ouija board, you’re in good company. Congressional inaction has made it almost impossible to make effective plans and doing nothing could create disastrous results for your family. For example, many wills use a ‘formula’ stating the maximum exemption amount goes to a by-pass trust (that often has children as the beneficiaries) with the balance going outright to the spouse. For this year that means that all of the money would go to the family trust, potentially leaving the spouse out entirely!

With all of this uncertainty, what exactly should you do? Your best choice is to contact your attorney or financial advisor and review your current estate plan to determine if you could potentially be adversely affected. Second, consider writing your congressional representative and demand that he or she bring permanent resolution to this matter. This is what we pay them to do and it’s time they did their job. For a sample letter, visit the Resource Center at www.welchgroup.com; click on ‘Links’; then click on Estate Tax Letter to Congress. There’s also a link to the email address of your congressional representative.

What is an ETF & What are the Advantages?

ETFs - A Top Investment Tool

After more than a decade of extensive use by professional money managers, Exchange Traded Funds, or ETFs, are still not being heavily used by the general public. This is an education problem since ETFs offer a number of advantages over both managed mutual funds (called ‘active’ funds) and index mutual funds (called ‘passive’ funds). With actively managed mutual funds, the fund company hires a manager who actively buys and sells stocks and bonds in an attempt to outperform a certain benchmark such as the S&P 500 Index. With passively managed mutual funds, the fund company hires a computer programmer who ‘matches’ the exact same securities held in a particular index such as the S&P 500 Index. Let’s look at some of the comparative benefits of owning ETFs:

Like index mutual funds, an ETF represents a specific index such as the S&P 500 (U.S. large companies) or the Wilshire 5000 (the entire U.S. stock market) or the Russell 2000 (U.S. small companies). For example, by buying the ETF version (symbol SPY) of the S&P 500 Index, with one security purchase you own shares in 500 companies.
Like index mutual funds, ETF expenses are very low. Where Vanguard Total Stock Market Index (VTSMX) mutual fund charges 0.18% annually, their own ETF version (VTI) charges a meager 0.09% annually. Compare this to the management fee of the typical actively managed mutual fund, which averages 1.4% annually.
ETFs are highly tax efficient. By law, mutual funds are required to distribute at least 95% of all net realized capital gains each year to their investors as of a certain date, called the 'record date'. While this has been less of a problem with index mutual funds, it has been a significant problem with many managed mutual funds. ETFs minimize this problem as you only recognize gains when you sell an ETF in which you have made money. With a mutual fund, it is possible to actually have losses for the year, yet get hit with taxable gains on fund distributions.
ETFs trade like stocks…on an intra-day basis whereas mutual funds settle at the close of the day's prices. Under the new paradigm we find ourselves today where dramatic market changes can happen in the course of a single day, this can be an important benefit.
Many mutual funds, even no-load funds, charge a redemption fee when you sell your fund within a certain period of time from purchase (typically 90-days). ETFs do not have such restrictions, allowing investors to remain mobile and responsive to rapidly changing events. While I believe in having a long-term investment strategy, it’s important to maintain the flexibility to make changes should extraordinary circumstances arise.
You now have access to over 700 different types of ETFs, allowing you to be very strategic in your investing while still maintaining significant security diversification. We use ETFs extensively in managing our client's portfolios and have found them to be an excellent cost efficient management tool.