Investment

Rating Bonds

August 15, 2024 by byfadmin

Before you add bonds to your portfolio, you should understand how they work and what variations exist among them. Just as importantly, you need to identify the risks that come with owning bonds and how you can protect yourself from them.

Bond Basics

Bonds are essentially IOUs, issued by federal, state, and municipal governments as well as by corporations and governmental agencies. They are intended to raise revenue for a wide variety of activities. For example, governments issue bonds to finance the construction of infrastructure projects, such as roads, bridges, airports, public housing, and schools. Corporations may use the proceeds of bonds to pay for the construction of new manufacturing facilities, research and development, or to expand into new markets.

Bond investors essentially loan money to the bond’s issuer. In return, they receive interest payments at specified intervals plus a promise that the issuer will return the bond principal to investors when the bond’s term ends on its maturity date.1

Interest Rate Risk

Bonds are not a risk-free investment. Rising interest rates may reduce the desirability of the bonds you own because there is an inverse relationship between bond prices and yield. If you opt to sell a bond before it matures because interest rates on newly issued bonds have gone up, you will most likely have to accept a lower price than you paid for it.

The Importance of Credit Quality

Credit risk — or the risk that a bond issuer will fail to make promised interest and principal payments — is another important consideration. Bonds issued by companies or entities that are financially healthy are not as risky as bonds from issuers that are less financially sound. Bonds with low credit ratings offer higher yields to compensate for added risk to your portfolio.

Rating Agencies

Rating services assess municipal bonds, all types of corporate bonds, and international bonds. U.S. Treasury bonds are not rated. Before rating a bond, analysts assess various factors that could affect the issuer’s willingness and ability to meet its obligations to bondholders. For example, they examine other debt the company carries and how fast the company’s revenues and profits are growing. They take a holistic approach in that they also review the state of the economy and the financial health of other companies in the same business. In the case of municipal bond issuers, they examine and compare municipalities of a similar size and similar budget.

Credit ratings influence the interest rate an issuer must pay in order to sell its bonds. However, credit ratings are opinions about credit risk. Even though credit ratings are forward looking in that they assess the impact of foreseeable future events and can be useful to investors, they are not a guarantee that an investment will pay out or that an issuer will not default. While investors may use credit ratings in making investment decisions, they are not indicators of investment worth nor are they buy, sell, or hold recommendations. You can learn more about the rating systems of the two major services, Standard & Poor’s and Moody’s, on their websites.

This information is not meant as tailored investment or tax advice. Before building a portfolio that includes bonds, you may find it helpful to discuss your strategy with a financial professional.

1Bonds can gain or lose value based on economic conditions and market events. Principal is not guaranteed.

The Many Types of Investment Risk

May 7, 2024 by byfadmin

It is important for investors to understand that every investment has its own set of risks. One key to successful investing is to recognize the different types of risks that could be a threat to one’s financial well-being and to take steps to minimize their impact. What follows is an overview of the primary forms of investment risk as well as some tips on how to minimize that risk.

Market Risk

This is the risk that the prices of securities may fall due to external factors such as world events, economic changes, or investors’ expectations and outlook. Stock investors are more likely to be impacted by this form of risk than fixed-income investors.

Inflation Risk

Also known as purchasing power risk, this is the risk that is connected to the uncertainty over the future purchasing power of the income and principal of an investment. When prices rise (inflation), purchasing power typically falls. Historically, stocks have been less impacted by this type of risk since they have been able to appreciate in price at a faster rate than the rate of inflation. Typically, lower yielding cash equivalents are more likely to be affected by a rise in inflation.

Interest Rate Risk

When interest rates move up and down, bond prices change. When interest rates move up, newly issued bonds will generally pay a higher interest rate than similar, older bonds. What happens next is that the market of existing bonds falls because there is less demand for them. In other words, they lose market value. The opposite happens when interest rates fall: Older, previously issued bonds will pay higher rates of interest than newly issued bonds, making the older bonds more appealing to investors. The bottom line is that falling interest rates are generally beneficial to bond owners.

Maturity Risk

Since it is impossible to predict how the financial markets will perform in the future, long-term bonds are generally considered to be riskier investments than short-term bonds. This type of risk is known as maturity risk. Issuers of long-term bonds attempt to compensate for the additional risk by offering higher yields.

Credit Risk

Credit risk is the risk that a bond issuer will be unable to pay interest on the bonds it issued or repay principal when the bonds mature. Rating services, such as Moody’s Investor Services and Standard & Poor’s, carefully investigate the financial health of a bond issuer in order to alert investors to the risks of a particular issue. The rating services rate municipal bonds, corporate bonds, and international bonds. They do not rate Treasury bonds since the assumption is that they are solid, backed by the full faith and credit of the federal government. The rating services rate bond quality according to a system that employs letters and numbers, with AAA or aaa indicating the highest quality issues and CCC or ccc and below indicating poor quality issues that could default.

Currency Risk

Changes in currency exchange rates will have an impact on returns from overseas investments. For example, when the dollar rises in value in relation to the Euro, the return on a fund that holds a large number of stocks in European businesses is reduced when the Euros are converted to U.S. dollars. The opposite occurs when the dollar falls in value in relation to the Euro.

All investments have risks. Before buying a security, understand that the key to investing success is balancing risk. You can do this by having a well-diversified portfolio and an asset allocation strategy based on your risk tolerance and the number of years until you retire.

Diversification helps you manage risk by spreading your assets among a broad mix of different investments. When you do this, you are taking advantage of the fact that securities usually don’t move in the same direction at the same time. When some investments drop in value, others may rise or remain unchanged, offsetting to some degree those investments that lose value. Of course, diversification does not ensure a profit or protect against loss in a declining market.

Be sure to talk to your financial professional for insights on how you can balance risk in your investment portfolio.

Does Your Risk Tolerance Need a Realignment?

December 22, 2023 by byfadmin

Market volatility. A change in your time horizon. Different goals. All these things can affect the amount of risk you feel comfortable taking with your investments. Your ability to tolerate risk influences the investment choices you make and may have a significant impact on your success in achieving your financial objectives. Periodically revisiting your risk tolerance is an important step in the portfolio review process.

A Moving Target

Your feelings about risk may change depending on what the markets are doing. During a prolonged period of market volatility, you may find your comfort level dropping, even if you previously thought you had a high tolerance for risk. If you’re a conservative investor, an extended market upswing may have the opposite effect, encouraging you to take on additional investment risk. In either case, basing investment decisions on market behavior instead of a well-thought-out investing strategy isn’t the best plan. Instead, take time to reassess your feelings about risk. If they’ve truly changed, adjust your strategy going forward to reflect the changes.

More Than a Feeling

How much money could you afford to lose if investment values dropped significantly? Your ability to accept risk also depends on your financial circumstances and your time horizon for tapping your assets. If investment losses would leave your finances in jeopardy and you have a relatively short time frame before you’ll need your money, your capacity for taking risk may be limited. Make sure you consider your risk capacity in your review.

A Realistic View

A long period of either strong or weak market performance may convince you that the current trend will continue indefinitely. Perceived risk is how much risk you think an investment holds. However, your perception of an investment’s risk might not match its actual risk. In that case, you could be taking more or less risk than you should to remain within your comfort zone and still reach your goals.

Your financial professional can help you reassess your risk tolerance along with the level of risk in your portfolio.

Top Tax Benefits of Real Estate Investing

June 1, 2023 by byfadmin

Real estate investing comes with significant tax benefits. Find out how to identify the top tax strategies for maximum benefit and how to use them to your advantage come tax time.

As with all deductions, consult your tax accountant for the most up-to-date on what is/is not allowed regarding tax deductions related to real estate investing.

Self-Employment / FICA Tax

First and most straightforward, you can avoid payroll tax if you own rental property. That’s because the income from your rental property is not considered earned income. In addition to avoiding tax outright, there are numerous deductions available to real estate investors.

Expense Deductions

Real estate expenses directly related to your investment, such as property tax, insurance, mortgage interest, and maintenance or management fees, are deductible. These actual expenses are typical deductions the IRS considers “ordinary and necessary” to sustaining your real estate investment. However, a few deductions to which you may be entitled are often overlooked.

If you spend time traveling to and from your investment property, those miles may be deductible.

You also may be able to deduct non-mortgage interest fees related to your investment property. For example, loan or credit card interest incurred in connection with your investment property are deductible business expenses. Legal and other professional fees directly associated with the investment property are also deductible.

Depreciation

Suppose you have real estate investment property that produces income. In that case, you can deduct depreciation of that property as an expense. The depreciation deduction lowers your taxable income.

The IRS sets the life expectancy of real estate – 27.5 years for residential property and 39 years for commercial property – which determines the deduction to which you are entitled.

Incentive Programs

Some incentive programs make it possible to defer real estate taxes. For example, a 1031 exchange allows real estate investors to avoid paying capital gains taxes when selling an investment property and reinvesting in a replacement property. Investors can reinvest proceeds from the sale of one property into another property. This transaction must occur within a specified time to avoid capital gains taxes (the taxes on the growth of an investment when it is sold).

Suppose your real estate property qualifies as an “opportunity zone,” a low-income or disadvantaged parcel. You may be able to further defer capital gains tax, grow your capital gains, or entirely avoid capital gains.

These perks are time-dependent, which is something your qualified accountant can help you navigate.

Capital Gains

So, what if you sell your real estate investment property? Suppose you can wait until you’ve held the property for at least one year. In that case, you may be able to pay a much lower capital gains tax than if you sold sooner, or you could avoid capital gains altogether. That’s because holding onto a property for more than one year makes it a long-term investment. With that, you will pay a lower capital gains tax rate. If your income is under a certain amount (check with your accountant because these rates tend to change year to year), you may be able to avoid the tax entirely.

Qualified Business Income (QBI) Deduction

More commonly known as the pass-through deduction, this tax break encourages entrepreneurship. This deduction allows certain entities to deduct up to 20 percent of their business income. So, businesses like LLCs, S-corps, and sole proprietorships benefit. You may be wondering how this type of deduction helps real estate investors. If you own rental properties, you technically operate a small business by IRS standards. Therefore, you are entitled to the pass-through deduction. The deduction also benefits real estate investment trust investors (REITs) because REITs are technically considered pass-through entities. The deduction is not scheduled to end until 2025, so there’s still time to take advantage of this deduction.

Deductions like QBI and others on this list, such as depreciation and expense deductions, mean that real estate investment can significantly reduce tax liability. Speak to your qualified accountant or CPA to help you navigate the often tricky waters of tax deductions. The professionals make it their business to be in the know about the latest tax law changes, updates, and deductions. With the right professional on your side, you’ll be able to take full advantage of all the tax breaks you’re legally entitled to.

Long-Term Investing 101

January 12, 2023 by byfadmin

Investing for retirement can be intimidating for many people. Keeping these basic principles in mind can help you pursue your long-term goals.

Have Realistic Expectations

Be realistic about how well your investments will perform. If you are too optimistic, you could underestimate how much you should be contributing to your retirement account to reach your savings target. Instead of counting on big stock gains, it’s generally smarter in the long run to diversify* your investments. And always contribute an adequate amount, regardless of how the investment markets are performing.

Avoid Hot Trends

Hot investing trends can catch the attention of inexperienced investors. However, trends tend to fizzle out as quickly as they started, leaving inexperienced investors with losses. Rather than chasing trends, choose investments that are an appropriate match for your risk tolerance, the amount of time you have to invest, and your investing objectives.

Learn to Live With Volatility

The stock market rises on some days and falls on others — sometimes by a lot. When the market tumbles, you might be tempted to sell your stock funds or portfolios and buy less risky investments. However, periods of poor market performance are to be expected when you’re investing to reach long-term goals. While downturns are discouraging, the stock market historically has recovered from every downturn.** Over time, periodic setbacks may be followed by periods of strong growth. Unless you’ll need your money soon, it may be better to look beyond short-term volatility and stick with your investment strategy.

*Diversification does not ensure a profit or protect against loss in a declining market.

**Past performance does not guarantee future results.