Small-Cap
Small-capitalization stocks, often referred to as small-caps, offer exciting opportunities for investors, historically outperforming large-cap stocks.
So what exactly are small-cap stocks and how can you invest in them?
What Is Small-Cap Investing?
A small-capitalization stock is defined as one whose valuation lies in the range of $250 million to $2 billion. The small-cap universe runs the gamut from the next hot company everyone is talking about to companies perhaps on the brink of bankruptcy.
The most popular gauge in the small-cap segment is the Russell 2000 index. This benchmark is composed of the 2000 smallest companies in the Russell 3000. The typical index stock has a median market cap of roughly $1.15 billion.
Historically, small-caps have outperformed large-caps. As of late 2021, in the past 20 years, the S&P 600, an index of small-cap-stocks, had outperformed its related indexes for large- and mid-caps on an average annualized basis, according to figures from S&P Dow Jones Indices.
During that period, the S&P’s benchmark small-cap index returned an average of 8.3% annually, compared to 8% and 6.3% from its mid-cap and large-cap counterparts, respectively.
The same goes for the Russell 2000. From 2001-2019, investors in the iShares Russell 2000 ETF saw their money grow, including dividends, by 344%, while investors in the SPDR S&P 500 ETF saw their money grow by just 253%.
And there is always a special attraction there for growth-oriented investors. Many of these smaller companies have tremendous upside potential, so investors continue to look for the “next Amazon” that will deliver returns of 100 times or more.
These companies though may experience more volatility and pose higher risks to investors.
Since many small-cap stocks have little to no earnings, or limited cash on their balance sheets, more of them file for bankruptcy than their larger peers. This is especially a risk during tough times (like the pandemic) because their balance sheets aren’t as strong as larger companies’, and they don’t have the same access to lending.
Two other factors to keep in mind: many of these smaller companies are domestically-focused – missing growth opportunities overseas – and do not pay a dividend.
And in the shorter term, some small-cap stocks may experience wild swings in price and can be illiquid, meaning they don’t trade frequently and can be difficult to sell for cash.
Why Invest in Small-Caps?
According to the American Association of Individual Investors, a conservative investment strategy might have a 10% allocation to small-cap stocks, compared with 20% for an aggressive strategy.
Your own individual risk tolerance will determine how much money you put into small-cap stocks.
As of December 2021, the S&P SmallCap 600 gauge – with a median market cap of about $1.4 billion – was priced at 14.5 times 2022 expected earnings, according to FactSet data. This valuation is well below the 21.3 times for the benchmark S&P 500 index.
This data from FactSet offers one good reason to invest in small-caps. The S&P 600 price-to-earnings ratio, at about 68% of the S&P 500, is among the lowest levels since the dot-com bubble at the turn of the century. And small-capitalization value stocks are trading at even steeper discounts.
Also, by definition, small-cap stocks have greater opportunity for growth than large-caps. The law of large numbers means it gets more difficult for companies to grow as they get bigger. It’s much easier for a $1 billion company to become a $2 billion company, for example, than it is for a $1 trillion business to double to a $2 trillion value.
How to Participate in Small-Cap Investing
The primary advantage of investing in individual small-cap stocks is the potentially large upside growth that is unmatched by larger companies. Small-cap index funds also offer a way for passive investors to boost returns.
However, these opportunities for big profits also come with some risks. In effect, small-cap investors sacrifice stability for potential.
If investors have some safer large caps, bonds, and funds, they may consider putting a percentage of their money at higher risk to try to get higher returns.
You need to look at the risk of your entire portfolio rather than any single investment. For example, if you have half of your portfolio in Treasury bonds, putting a small percentage in risky small-cap stocks would make sense and give your portfolio some growth potential.
While younger investors who plan to hold stocks for decades are generally better suited for small-cap investing than retirees living off dividend income.
Still, owning a few small-cap stocks is a good idea for most investors. If just one of these stocks takes off, it can transform your wealth or make up for dozens of bad picks.
For help in finding the right small-cap stock or ETF for you, check out www.magnifi.com and its ‘natural search’-generated results.
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The information and data are as March 30, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Large-Cap
There is no doubt that investing in large-cap (which is a shortened version of the term “large market capitalization”) U.S. stocks has been a winning long-term investing strategy.
According to Goldman Sachs, 10-year stock market returns have averaged 9.2% over the past 140 years. More recently – between 2010 and 2020 – Goldman notes that the S&P 500, which is regarded as one of the best gauges of large-cap U.S. equities, has done even better than the historic 10-year average, with an annual average return of 13.6% in that decade.
This record is likely why even legendary investor Warren Buffett advises small investors to buy S&P 500 index funds.
What Is Large Cap Investing?
A large-cap company is defined as one with a total market capitalization of over $10 billion. The valuation is calculated by multiplying the number of a company’s shares outstanding by its stock price per share.
These stocks are larger, more established companies and are therefore usually safer investments than small-cap or mid-cap stocks. However, with the exception of some of the technology giants, many of these companies are slower growing than their smaller counterparts.
Large-cap stocks represent about 93% of the total U.S. stock market, as measured by the Wilshire 5000 Total Market Index.
Since large-cap stocks represent the majority of the U.S. stock market, they are often looked to as core portfolio investments.
Why Invest in Large-Caps?
Certain characteristics of large cap stocks attract investors. These include the following:
- Transparency: Large cap companies are typically transparent, making it easy for investors to find and analyze public information about them.
- Liquidity: Another plus is that large cap equities offer an ample amount of liquidity. It’s therefore easy to buy and sell these stocks at current prices, no matter the market conditions. The same cannot be said, at times, about smaller stocks during periods of high market volatility.
- Stability: Most large-cap companies are financially sound and have a track record of consistent growth and profitability. That’s why they are sometimes referred to as “blue-chip” companies.
- Dividend Payers : Established large cap companies are most often the companies investors choose for dividend income distributions. Their maturity allows them to commit to stable or rising dividend payouts. Once again though, many of the large tech stocks are an exception and do not pay higher dividends.
The very best of these steady payers are called the Dividend Aristocrats. To qualify for this elite status, a company must be in the S&P 500 and have 25+ years of dividend increases. In 2021, there were 65 such companies.
The features that define large-cap companies are why investors find them to be key pieces of any portfolio. During periods of volatility in both the economy and the stock market, a large-cap company will usually have an edge over its smaller rivals when it comes to riding out pricing fluctuations or larger shifts in the economy. Larger companies not only have more buying power – allowing them to perhaps cut deals with suppliers – but also have greater access to capital from banks and the financial markets.
Quite often, these companies can also outperform when the economy is on the upswing. That’s due to the fact both investors and other businesses are more willing to deal with larger, more well-known companies.
How to Participate in Large Cap Investing
There are a few things to keep in mind with regard to investing in large-cap stocks.
These types of stocks generally aren’t great for investors who are looking for a buy-and-sell at a quick and large profit trade. Although, once again, on occasion, the large-cap tech stocks are exceptions.
Usually though, these blue-chip stocks are much better suited for a buy and hold strategy, such as espoused by Warren Buffett and his mentor, Benjamin Graham.
Investors are attracted to large-cap stocks because they can help you diversify your portfolio to help manage risk. And if you choose to invest in dividend paying large-cap stocks, they can help you generate income too.
Bottom line: large cap stocks can play an important part in your overall investment strategy. However, it’s important that you diversify your portfolio so your returns aren’t overly reliant on one specific segment of the market.
The easiest way to buy large-cap stocks is through a mutual fund or ETF. Or, of course, you can always purchase individual stocks, if you do your due diligence. A simple search on Magnifi indicates numerous ways for investors to access large-cap funds with low fees.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as March 23, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Liability-Driven Investing
Liability-driven investing (LDI) is a process, more than a pure investment strategy. It means, for an institution or a household, focusing on the liabilities as a starting point for developing its investment strategy. At times, it is referred to as a dedicated-portfolio strategy.
The basic idea is to gain enough assets to cover all current and future liabilities. For example, the primary obligation of a pension fund manager is not to beat a benchmark index, but to ensure that current and future payouts promised to beneficiaries are made.
What Is Liability-Driven Investing?
At an extreme, liability-driven investing may involve establishing a portfolio that closely matches the expected cash flows arising from the liabilities.
In most cases, however, LDI involves establishing a specific liability benchmark and then assessing the risk/reward implications of departures from the liability benchmark to determine the asset mix.
LDI is designed for situations where future liabilities can be predicted with some degree of accuracy.
For individuals, a good example would be the stream of withdrawals (liabilities) from a retirement portfolio that a retiree will make to pay living expenses from the date of retirement to the date of death.
With LDI, a retiree’s portfolio must be invested in a manner that provides the individual with the necessary cash flows to meet the yearly withdrawals, accounting for intermittent spending, inflation, and other incidental expenses that arise throughout the year.
For companies, a classic example would be a defined benefit pension fund that must make future payouts to pensioners over their expected lifetimes. The guarantees made to pensioners become the liabilities the LDI strategy must target.
Pension fund managers have two objectives. The first one is to manage/minimize risk from liabilities. These risks could range from a change in interest rates to inflation because they have a direct effect on the funding status of the pension plan.
To do this, the firm might project current liabilities into the future in order to determine a suitable figure for risk. And then hedge the fund against the risk using various methods – options, swaps and other derivatives.
The second objective for the pension fund manager is to generate returns (cash flow) from the funds’ assets – stocks or bonds – that generate returns commensurate with its estimated liabilities.
What Are the Benefits of Liability-Driven Investing?
The primary advantage of liability-driven investing is that its goal is simply to meet future obligations (liabilities).
It is therefore a more conservative, lower risk (though lower return) portfolio. The primary disadvantage is opportunity cost – a more aggressive portfolio could have possibly made more money.
And whether you’re a pension plan or an individual, implementing LDI is a great way to lower the market volatility component of your retirement/pension plan. This will allow you to more easily plan for your financial future many years or decades down the road.
Liability-driven investing returns significantly exceeded expectations in both 2019 and 2020, returning 14%-17% in 2019, and 12%-15% in 2020, depending on the duration of liabilities.
How to Participate in Liability-Driven Investing
LDI is most often used by ‘frozen’ single-employer pension plans. But it can be used by anyone, by following these basic two steps:
First, consider how different asset allocations interact with the liabilities. The most thorough way to do this is with an asset liability modeling study where an actuary uses sophisticated software to project your liabilities under a variety of scenarios.
You can first model your current asset allocation, while projecting how different scenarios could impact liabilities and funding needs over time. Then you can compare the current allocation to projections of alternate allocations that may better match your liabilities.
Next, choose your investment option lineup. This will be based on the outcome of the asset liability modeling study and the asset allocation that best aligns with your situation.
For help on choosing the right investments for a LDI strategy, check out www.magnifi.com. You can discover investing ideas there by using natural search. You just type in a term like “low risk funds for retirement income” or “how to invest in climate change” and instantly get relevant, tailored results without having to run screener and charts.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as March 22, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Tax Efficient Investing
Every investment has costs, such as opportunity costs or various types of fees. Among these, taxes can be the one cost that stings the most and takes the biggest bite out of your investment returns.
The good news is that there is a strategy called tax-efficient investing, which can minimize your tax burden and maximize your bottom line.
By understanding the tax implications of different types of accounts, as well as the investments you choose (stocks, bonds, funds, etc.), you can determine the most tax-efficient strategy for your portfolio.
What Is Tax Efficient Investing?
Tax efficient investing allows you to reduce, delay and manage taxes generated by investment activities. Investors can use a variety of methods to manage taxes efficiently, including selecting tax-advantaged investments and using IRAs, 401(k)s and other tax-deferred accounts.
Tax efficient investing combines selection of accounts and investments with tax-efficient strategies.
There are several investment account types that can help significantly to reduce your tax bite. These include: Individual Retirement Accounts (IRAs and Roth IRAs); other retirement accounts – 401(k) and 403(b); 529 college funding plan; and Health Savings Accounts (HSAs).
Tax-aware investors can choose from specific investments that provide tax benefits. These include:
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- Treasury securities – investors do not pay state or local taxes on interest earned from Treasuries.
- Municipal bonds – income from municipal bonds is usually free from federal income tax, and often state and local taxes as well.
- Tax-managed funds – Some mutual funds are managed with the specific objective of reducing tax impacts by, among other methods, purchasing municipal bonds and reducing turnover.
- Passively managed funds – Exchange-traded funds (ETFs) and index mutual funds that passively track an index are naturally tax-efficient because managers do not buy and sell securities as often as actively managed funds. This reduces the tax obligations created by short-term capital gains on investments held less than a year.
Finally, there are tax efficient actions. Here are some of the most common and effective ones:
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- Capital gains strategies – One of the most widely used tax strategies is delaying the sale of investments in order to take advantage of long-term capital gains treatment. Gains on investments held less than a year are taxed as ordinary income, while gains on assets held more than a year are taxed as long-term capital gain rates of 15% for most investors.
- Loss harvesting – By selling money-losing investments you can shelter gains on profitable investments from taxes. When losses on investments in a given year total more than investment gains for that year, the losses can shelter up to $3,000 of earned income. Plus, losses can be carried forward to later years.
Why Is Tax Efficient Investing Important?
The Schwab Center for Financial Research evaluated the long-term impact of taxes and other expenses on investment returns. And while investment selection and asset allocation are the most important factors that affect returns, the study found that minimizing the amount of taxes you pay also has a significant effect.
There are two simple reasons for this. First, the money you pay in taxes is lost forever. You lose the growth that money could have generated if it were still invested.
Bottom line – your after-tax returns matter more than your pre-tax returns. When it comes to investing, it’s not just how much you make that matters—it’s how much you keep after taxes.
After all, it’s those after-tax dollars that you’ll be spending now and in retirement.
How to Participate in Tax Efficient Investing
There are numerous ways to do tax efficient investing, such as allocating higher-yield assets like high-dividend-paying stocks, to tax-deferred and tax-exempt accounts, such as IRAs, to minimize your exposure to current taxes.
Or, if your tax burden is rising, you can max out contributions to your account under your employer’s 401(k) plan, since contributions can be made on a pretax basis. Contributing to a traditional IRA can also lower your taxable income for the current year, since contributions may be tax-deductible.
And since qualified distributions from a Roth IRA are tax free, assets you believe will have the greatest potential for higher return are best placed inside a Roth IRA, when possible.
If you want to keep more of your income, managing your investments with tax efficiency in mind is a must. What’s more, tax efficient investing techniques are accessible to almost everyone—it just takes some planning to reap the benefits.
To help find the right tax efficient investment for you, make sure you check out the www.magnifi.com website.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as March 8, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Consumer Price Index (CPI)
At the start of 2022, the financial markets were surprised when the U.S. government’s Consumer Price Index (CPI) – the most widely used measure of inflation – rose at the fastest pace since 1982.
Inflation is the decline of a currency’s (the U.S. dollar in this case) purchasing power over time. An estimate of the rate at which the decline in purchasing power occurs can be shown in the increase of an average price level of a basket of selected goods and services in an economy over some period of time.
That’s where the Consumer Price Index comes in. So, what is it exactly and why is it so important?
What Is the Consumer Price Index?
The Consumer Price Index (CPI) is a monthly measurement of U.S. prices for household goods and services. The Bureau of Labor Statistics (BLS) computes the CPI by taking the average weighted cost of a basket of goods in a given month and dividing it by the weighted cost of the same basket the previous month. It then multiplies this percentage by 100 to get the number for the index.
The index shows how much prices have changed since the base year of 1982. The CPI was 281.1 in January 2022. That’s how much prices have increased since the base was established at roughly 100.
The basket represents the prices of a cross-section of goods and services commonly bought by urban households. This cross-section represents around 93% of the U.S. population, and it factors in a sample of 14,500 families and 80,000 consumer prices.
These are the major categories in the basket and how much each contributed to the CPI in January 2022: Housing (shelter) – 32%, Commodities (such as autos and medicine) – 21%, Food – 14%, Energy – 7%, Healthcare – 7%, Transportation – 5%, Others – 14%.
Why Is the Consumer Price Index Important?
The CPI plays a role in the lives of many Americans.
First, the CPI is tied to the adjustments made in the cost of living index. That’s important because the cost of living index determines things like annual changes in Social Security benefit amounts and how much money you can contribute to tax-advantaged retirement accounts on a yearly basis. Employers can also use cost of living adjustment data to increase wages paid to employees.
The Consumer Price Index is also important to economists as a tool for measuring how the economy as a whole is faring when it comes to inflation or, on occasion, deflation.
That is important when you’re planning how to spend or invest your money. It’s always a good idea to have a sense of which way prices are trending. That can help you better plan your budget.
The CPI is also very important because it is a key consideration for the Federal Reserve in setting its interest rate policy, which greatly influences financial markets globally.
The Fed will raise interest rates if it thinks the inflation rate is too high, to slow economic growth. By making loans more expensive, this tightens the money supply—the total amount of credit allowed into the financial system. Slowing growth and demand should put downward pressure on prices.
The longer-term risk for the Fed is falling behind in tightening (raising interest rates). Then it could be forced to play catch-up with a much bigger response – raising rates even higher than would have been needed if action was taken earlier.
How to Hedge Against Inflation
So how can you hedge against inflation?
For example, if the CPI is signaling that a period of inflation may be on the horizon, that should encourage you to make strategic moves to protect your investments. If prices are picking up, you may consider making defensive moves in your portfolio to hedge against inflation. Certain stocks, bonds and commodities or even real estate could benefit from a period of inflation.
Your search for various methods of protection against inflation can be made much easier by using Magnifi, a search-based investing platform that can help match investments to your goals. Magnifi’s AI driven system finds investment suggestions for you based on just a few inputs of your data, such as risk tolerance and investment time horizon.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as March 1, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Active Bond Funds
Most investors have a portion of their portfolio devoted to fixed income investments. For decades, the traditional ’60/40 portfolio’ has long been used as a guidepost for a moderate risk investor—a 60% allocation to stocks for capital appreciation and a 40% allocation to fixed income for income and risk mitigation.
One key component of your fixed income allocation should be an active bond fund.
What Are Active Bond Funds?
A bond portfolio can be managed in several ways. The primary methods are active, passive, or a hybrid of the two. Active bond portfolio management simply means that a professional manager takes an active role in the running of the bond portfolio.
Active management of bond funds involves portfolio managers who seek out bonds that are high performing and that they believe are more likely to surpass a benchmark index performance over time.
The ultimate goal is to create and manage a fund that performs at or above the index, including identifying and investing in bonds that are undervalued. Active bond portfolio management may also involve buying bonds that hedge against movements in interest rates.
Active managers can adjust their funds’ average maturity, duration, average credit quality, and position among the various segments of the fixed income market.
Why Invest in Active Bond Funds?
A major advantage is that an active manager controls the holding period of the bonds. All bonds come with a maturity date. Passively managed funds typically hold a bond until it matures. In an actively managed fund, however, the manager can benefit the fund’s investors by selling off bonds with a lower yield and shorter duration.
When interest rates rise, selling off such bonds boosts the yield of the portfolio overall, reducing the interest rate risk to investors. Generally speaking, bonds can be invested in more profitably by selling them at advantageous times in the interest rate cycle that occur prior to maturity.
In addition to the aforementioned interest rate risk, active bond managers can also help investors alleviate the greatest risk for bond investors – credit risk. That’s the risk that occurs if an issuer fails to pay interest or principal on its debt. The warning signs will be clear as an issuer’s financial condition deteriorates, causing rating agencies to downgrade the rating on an issuer’s bonds. The active manager can sell these bonds. With a passive bond fund, you’re stuck with these bonds.
In simple terms, an active bond fund manager can intentionally adjust the levels of credit and interest-rate risk to improve the performance of their bond portfolios. These capabilities allow active managers to add value in a wide range of market conditions. This flexibility is especially valuable when market conditions have introduced increasingly high levels of credit and interest-rate risks.
This flexibility is not possible for passive funds.
Examples of the “flexibility” active bond managers have include: adding value by including smaller issuers in their portfolios; buying variable rate securities, such as floating-rate notes or hybrid securities (fixed-to-floating rate notes) to benefit from changes in interest rates; adding allocations to inflation-linked bonds, such as U.S. Treasury Inflation Protected Securities (TIPS); take advantage of opportunities in shorter-maturity bonds, which carry much less interest-rate risk than longer-maturity bonds; and, when conditions warrant, add bonds rated below investment grade to enhance portfolio performance.
Of course, if you invest in an active bond fund, you do take the risk that the manager may underperform the bond benchmark indexes.
How to Invest in Active Bond Funds
Active bond funds – mutual funds and ETFs – can be bought just as easily as stock funds through any brokerage firm.
Such funds are gaining popularity. Through September 2021, Morningstar data showed that investors poured $330 billion into active-bond-funds in 2021. That was over $100 billion more than the $215 billion they put into passive fixed income funds.
Your search for the right active bond fund can be made much easier by using Magnifi, a search-based investing platform that can help match investments to your goals. Magnifi’s AI driven system finds investment suggestions for you based on just a few inputs of your data, such as risk tolerance and investment time horizon.
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Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.
The information and data are as March 1, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.