Closed-End Funds
What Are Closed-End Funds?
A closed-end fund (CEF) is a type of mutual fund that issues a fixed number of shares through a single initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange like a stock. However, no new shares will be created and no new money will flow into the fund.
In contrast, an open-end fund, such as most mutual funds and exchange-traded funds (ETFs), accepts a constant flow of new investment capital. These funds issue new shares on a continuing basis.
Like many mutual funds, a closed-end fund has a professional manager overseeing the portfolio and actively buying, selling, and holding assets. Closed-end funds are registered with the Securities and Exchange Commission (SEC) and subject to SEC regulation. In addition, the funds’ investment advisers are also registered with the SEC.
And like any stock or ETF, closed-end fund shares fluctuate in price throughout the trading day. But a closed-end fund generally is not required to buy its shares back from investors upon request (not directly redeemable).
Closed-end funds are allowed to hold a greater percentage of illiquid securities in their investment portfolios than mutual funds are. An “illiquid” security generally is considered to be a security that cannot be sold within seven days at the approximate price used by the fund in determining NAV.
However, closed-end funds and open-end mutual funds do have some similarities, including making distributions of income and capital gains to their shareholders as well as charging an annual expense ratio for their services.
Why Invest in Closed-End Funds?
Investors have two potential ways to make money with closed-end funds: income, paid via dividend distributions, or growth, that is produced by the fund’s investments. And, you may be able to buy shares of the fund at a discount to its net asset value (NAV).
Perhaps the most unique characteristic of a closed-end fund is its pricing.
The net asset value of the fund is calculated regularly, based on the value of the assets in the fund. However, the price that it trades for on the exchange is market-driven. This means that a closed-end fund can trade at a premium or a discount to its NAV. (A premium price means the price of a share is above the NAV, while a discount is below NAV value.)
There are several possible reasons for this. A fund’s market price may trade at a premium because it is focused on a sector that is currently popular with investors, or because its manager is well regarded among investors. On the other hand, a history of underperformance or volatility may make investors wary of the fund, pushing down its share value to a discount to its NAV.
Most often, your best odds of success come when you buy a closed-end fund at a discount to its net asset value. That’s why many investors aim to buy closed-end funds at a substantial discount. How substantial? It’s not uncommon to find closed-end funds trading at 10% or even 15% below their net asset value.
This might not sound like a lot, but that kind of discount could give you a built-in edge on the market. Not only could you gain if the fund’s holdings rise in value, you may also benefit if the discount to net asset value has decreased and you decide to sell your shares.
Fixed-income investors are often attracted to closed-end funds because many provide a steady stream of income, usually on a monthly or quarterly basis. This is more favorable than the typical biannual payments provided by individual bonds.
Investors generally have the option of receiving distributions in cash or having their distributions reinvested. By automatically reinvesting dividends, investors purchase additional closed-end fund shares on an ongoing basis, which has the potential to lead to higher future returns.
Keep in mind though that many closed-end funds make use of leverage (borrowed money) to boost their returns and dividends to investors. That means higher potential rewards in good times and higher potential risks in bad times.
How to Invest in Closed-End Funds
Closed-end funds can be bought through any brokerage firm just like stocks.
Your search for the right closed-end 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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The information and data are as May 24, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Carbon
Carbon is a term used to describe carbon dioxide (CO2) and other greenhouse gas emissions, which build up in our atmosphere and lead to climate change.
A new record reading for the highest daily level of carbon dioxide in the atmosphere was set in early May 2022, ringing alarm bells about the pace of global warming.
The daily record of 421.37 parts per million CO2 was recorded at Mauna Loa by the Scripps Institute of Oceanography, with similar numbers reported by the National Oceanographic and Atmospheric Administration.
What Is Carbon Investing?
Investors are increasingly looking to invest in ways that align with their values, which often include climate concerns. One way to do this is by investing in carbon credits. A carbon credit is a certificate or permit that represents a reduction in carbon emissions, with one credit representing one metric ton of carbon dioxide.
Companies that emit less than their permitted amounts of carbon can sell their excess permits on the market. While those firms that exceed their limit must purchase these carbon credits.
There are two types of carbon credit systems: voluntary and regulatory.
In a voluntary system, companies use carbon credits to track their greenhouse gas emissions. The most common form of this system is called an “offset,” in which carbon credits are created through greenhouse gas reducing practices, such as planting a forest or running carbon-capture systems. However, there is no enforcement mechanism in a voluntary system.
A regulatory system is one in which a government issues carbon credits. A regulatory body will set a cap on how much carbon dioxide an industry or economy can emit in a given year then release credits meeting that amount. Companies can sell and trade these credits among themselves. This creates a private market for carbon emissions known as cap and trade; the government has capped emissions, but allows companies to trade those credits privately to determine their most efficient use. Once issued, credits do not expire.
However, this market is still in its early stages globally. These programs aren’t yet common in the U.S. as they are elsewhere (for example, Europe), but several states have joined regional initiatives to enact such policies.
Why Invest in Carbon Credits
There is no doubt the market for carbon credits is growing by leaps and bounds.
The Taskforce on Scaling Voluntary Carbon Markets forecasts that, in order to meet the climate change targets as set forth in the Paris Agreement, the voluntary carbon markets will need to grow 15-fold by 2030 – and 100-fold by 2050 – from 2020 levels.
That makes it a fast-growing asset class. According to Refinitiv, in 2021 the size of the global carbon market reached $851 billion, compared to only $270 billion in 2020. Wood Mackenzie, a commodities consulting firm, expects that the market could reach a breathtaking $22 trillion by 2050.
Carbon credits were one of the best-performing asset classes in 2021.
The IHS Markit Global Carbon Index returned 108% in 2021. The index tracks the futures of the major global carbon markets including Europe, California (also tied to certain Canadian provinces), and RGGI (Regional Greenhouse Gas Initiative, which covers the U.S. states from Virginia up to Maine. The European Union carbon allowance (EUA) futures returned 138% over the year, California returned 73%, and the RGGI returned 68%.
There is also a related asset – carbon offsets, of which there are two types.
An Avoidance Offset is a contractual agreement registered with an exchange that avoids pollution in the first place. Examples include paying landowners to not cut down trees or incentivizing farmers to not turn grasslands into crops.
A Removal Offset is taking carbon out of the atmosphere through, for example, reforestation.
However, there are not, as yet, many ways to invest in carbon credits and offsets (although there likely will be more in the future). With that said, here are a few ways investors can get started.
How to Invest in Carbon
One way is to purchase carbon-credit futures that trade on the Chicago Mercantile Exchange.
However, the easiest way is through a carbon-credit exchange-traded fund (ETF) that tracks the performance of the carbon market via carbon-credit futures contracts. There are now several of these on the market.
There is also a new ETF that tracks carbon offset futures contracts, which also trade on the Chicago Mercantile Exchange.
To help in your search for investments focused on climate change, check out www.magnifi.com. You just type in a term like “green funds” and instantly get relevant results (ETFs, funds, etc.) presented to you.
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The information and data are as May 18, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
International Equities
The United States is home to some of the largest companies in the world. But it is important to remember that there are many great companies outside of the U.S too. Overall, 80% of the world’s investable securities are outside of the U.S., as does 40% of the world’s market capitalization.
International markets are usually divided into two broad categories:
- Developed markets are similar to the United States. That is, they are countries that have established industries, widespread infrastructure and a relatively high standard of living. Examples of developed markets include the United Kingdom, Japan, Australia, Canada, and Germany.
- Emerging markets are countries that have developing capital markets and less-stable economies. However, they’re considered to be in the process of transitioning into developed markets, and often have much more rapid growth than already-developed economies.
Currently, emerging markets make up about 15% to 20% of international markets in total. Examples of emerging markets include India, China, Poland, Indonesia, South Africa, Mexico, and Brazil.
International markets can also be divided regionally. These include:
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- Asia-Pacific (Australia, Japan, China, India, Singapore).
- Europe (United Kingdom, France, Spain, Germany, Italy, Norway).
- Latin America (Brazil, Mexico, Argentina, Chile)
- Africa and the Middle East (South Africa, Egypt, Saudi Arabia)
Why Invest Internationally?
Markets outside the United States often don’t always rise and fall at the same time as the domestic market. In other words, failing to look across the U.S. border at shares of overseas companies means you’re overlooking complementary assets—securities that may zig when the U.S. zags.
One major reason for the difference in performance is the fact that different sectors make up large percentages of the indexes.
For example, in the United States, technology stocks make up about 28% of the S&P 500 index. In Europe, in the Stoxx 600 index, the two largest sector weightings are healthcare and industrial goods and services.
The recent outperformance of U.S. equity markets isn’t the natural state of affairs. History shows that stock market leadership has alternated between the U.S. and international stocks numerous times over the past four-plus decades.
There have been distinct periods of international dominance, including a time in the 1980s when Japan’s bull market crushed that of all other countries, and another in the early 2000s after a string of accounting scandals rocked the U.S. Excluding international equities precludes your portfolio from taking advantage of these periods of international outperformance.
Bottom line – domestic investing and the pull to buy only U.S. stocks is real, and it only grew stronger during the historic U.S. bull market run over the past decade. But this bias leaves investors vulnerable to a possible extended period of U.S. equity underperformance, which could have a lasting negative impact on your portfolio.
How to Invest in International Equities
Many financial advisers recommend putting 15% to 25% of your money in overseas stocks. This allocation is meaningful enough to make a difference to your portfolio, but not too much to hurt you if those markets temporarily fall out of favor.
There are a few ways you can invest in international markets via funds or ETFs:
International funds invest only in foreign markets, excluding the United States.
Global or world funds provide exposure to both foreign and U.S. markets.
Regional funds invest primarily in a specific part of the world, such as Europe or Asia.
Developed markets funds focus on foreign countries with developed economies, like Japan, Germany, or the United Kingdom.
Emerging markets funds invest in countries that are considered to have still-developing economies, such as India, Brazil, or China.
You can also access international stocks via American Depository Receipts (ADRs). ADRs are certificates issued by U.S.-based financial institutions that represent a share of a foreign company’s stock. They’re traded just like domestic stocks on U.S.-based exchanges, meaning you don’t need a special brokerage account to access them.
To help in your search for international funds, ETFs or stocks, check out www.magnifi.com.
You just type in a term like “international stock funds” and instantly get relevant, tailored results presented to you.
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The information and data are as May 10,, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Short-Term Bonds
Short-term bonds are those with a maturity date of less than five years. Any entity can issue short-term debt, including all levels of government (federal, state, local), as well as corporations.
A short-term bond fund is a fund that invests in short-term bonds. A short-term bond fund’s portfolio may include things like variable-rate corporate and real estate debt, taxable municipal bonds, packages of car loans and credit card bills, revolving equity credit lines, and even soon-to-mature junk bonds.
Keep in mind that risk and yield typically go hand-in-hand in the bond market. So lower-risk bond funds will often have lower yields than bond funds with higher-risk bonds with longer maturities.
Why Invest in Short-Term Bond Funds?
Short-term bonds are attractive to investors for 3 reasons:
- They’re low-risk. A key characteristic of short-term bonds is that they tend to have lower interest rate risk than intermediate- or long-term bonds. That’s because the shorter maturities normally translate to a lower risk of losing some of your principal.
- Predictable income. The yield of the fund’s portfolio is known on a daily basis and bonds are attractive because of the promise of repayment of your original investment at maturity.
- They offer a potentially higher yield than money market funds. A portfolio mix with a wide variety of bonds is why short-term bond funds offer higher yields than money market funds. Short-term bond funds can offer a decent yield advantage relative to money market funds—anywhere from 0.5%–2%, depending on their underlying investments—and this can add up over time.
However, one key feature of short-term bonds is that they are highly sensitive to expectations for interest rates.
So if market participants expect the Fed to raise interest rates in order to combat inflation, then the yields on shorter maturity bonds (such as a 2-year Treasury note) will quickly rise to meet those expectations.
The end result is a drop in the share price of the bond fund, although its drop will be less than that for bonds funds holding longer maturity bonds. That provides a better ratio of return for the risk taken.
In simple terms, all bonds carry default risks, interest rate risks, as well as the risk of rising inflation.
Short-term bond funds minimize these risks. Holding bonds that mature in just a few years means less opportunity for interest rates and inflation to fluctuate unpredictably higher. This makes these bond funds valuable to investors who want to know what will happen with their money.
These characteristics mean short-term bond funds are highly liquid. Their lower volatility and near-term bond maturities mean that investors get their money back quickly, which also makes them very easy to sell.
Short-term bond funds are usually best used as a way to keep money liquid and secure, but to get a better rate of return than a bank or money market can offer.
How to Invest in Short-Term Bond Funds
If you count yourself among those investors who need to prioritize capital preservation, short-term bond funds may be the right answer for you.
Please note though that not all short-term bond funds are created equal.
Some funds invest in securities with higher credit risk, such as high-yield bonds, as they seek to offset the low-yield environment.
Before buying a fund, be sure to check its recent daily fluctuations relative to its peers. If it exhibits above-average volatility, that’s an indication that it may not offer the safety typically associated with short-term bond funds.
To help in your search for the right short-term bond fund for you, check out www.magnifi.com. You can discover investing ideas at Magnifi by using natural search. You just type in a term like “short-term bond funds for retirement income” and instantly get relevant, tailored results without having to run screener and charts.
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The information and data are as April 8, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
Short-Term Government Bonds
Short-term bonds are those with a maturity date of less than four years. Any entity can issue short-term debt, including all levels of government (federal, state, local), as well as corporations.
U.S. government bonds are called Treasuries. They are issued by the federal government and are considered to be among the safest investments you can make, because all Treasury securities are backed by the “full faith and credit” of the U.S. government.
Treasury securities are exempt from state and local taxes.
What Are Treasuries and Short-Term Government Bond Funds?
U.S. Treasuries come in all sorts of maturities from as short as one month to 30 years. The shorter term Treasuries are called Treasury bills (from one month to one year); intermediate term Treasuries are called Treasury notes (two year, three year, five year, seven year and ten year); longer term Treasuries are called Treasury bonds (30 years).
Treasury bills are non-interest-bearing. Instead, they are bought at a discount to face value (par) and investors are paid the face value when the bills mature.
Treasury notes and bonds pay interest on a semi-annual basis. The principal is paid back when the note or bond matures.
A short-term government bond fund will invest in Treasury bills and/or Treasury notes with a 2-3 year maturity, as well as short-term obligations of federal government agencies.
One major characteristic of short-term government bonds is that they usually have lower interest rate risk than intermediate- or long-term bonds. That’s because the shorter maturities translate to a lower risk of your bonds going down in price if interest rates rise.
Keep in mind that risk and yield typically go hand-in-hand in the bond market. So, in general, lower-risk bond funds of all types will often have lower yields than bond funds with higher-risk bonds with longer maturities.
Why Invest in Short-Term Government Bond Funds?
The interest generated by short-term government securities is typically higher than the rates on a bank savings account or a money market account. That makes them a good first step for highly risk-averse investors.
However, although the securities held by a short-term government bond fund might be safe, the fund itself is not insured by the Federal Deposit Insurance Corp., like banks are, or any other federal agency.
The share price of the fund is not guaranteed by the U.S. government and can fluctuate. Rising interest rates and inflation can adversely affect the value of short-term government bond funds. Although price fluctuations for short-term government bond funds are typically slight, it is possible to lose money.
In simple terms, a short-term government bond fund seeks to provide investors with current income while experiencing only modest price fluctuations in the price of the fund.
However, one key feature of short-term bonds, including short-term government securities, is that they are highly sensitive to expectations for interest rates.
So if market participants expect the Fed to raise interest rates in order to combat inflation, then the yields on shorter maturity bonds (such as a 2-year Treasury note) will quickly rise to meet those expectations.
For example, in early 2022, the yield on a 2-year Treasury note went from below 1% to about 2.5% in a few months.
The end result is a drop in the share price of the bond fund, although its drop will be less than that for government bond funds holding longer maturity bonds. That makes for a better ratio of return for the risk taken.
In summary, all bonds carry interest rate risks as well as the risk of rising inflation. However, short-term government bond funds minimize these risks because they hold securities that mature in 2-3 years or less.
How to Invest in Short-Term Government Bond Funds
All Treasuries can be purchased directly online at the U.S. government’s own website: www.treasurydirect.gov. They can be bought in very affordable denominations of $100.
However, to instantly gain access to a broad portfolio of Treasury securities, a short-term government bond fund is the preferred route.
Like stocks, short term government bonds are highly liquid. But they serve a different role in your portfolio. They are best used as a way to keep money liquid and secure, while getting a better rate of return than a bank or money market can offer.
So if you count yourself among those investors who need to prioritize capital preservation, short-term government bond funds may be the right answer for you.
To help in your search for short-term government bond funds, check out www.magnifi.com. You just type in a term like “short-term government bond funds for retirement income” and instantly get relevant, tailored results without having to run screeners or charts.
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The information and data are as April 8, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.
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.