« »
Showing posts sorted by relevance for query financial instruments. Sort by date Show all posts
Showing posts sorted by relevance for query financial instruments. Sort by date Show all posts

Thursday, February 3, 2011

Tips for choosing a financial planner

Financial planners are professionals who's primary function is to help a client expand, and make the most of their financial assets. The best financial planners will support a client's possible objectives of fiscal empowerment, financial freedom, and optimized money management. A client should leave a financial planner feeling satisfied the service they have received will put them in a better financial situation.

Financial planners who don't put their client's needs and financial goals ahead of their own corporate objectives are more like a competing business that offers financial planning services to its competitors. Since financial planners charge a fee and/or commission for their services there should be no complication regarding this matter because these fees and commissions, if reasonable, should be all a financial planner needs in exchange for services rendered. A few important functions financial planners should be capable of, are the following:

• Growing money
• Facilitating financial needs
• Managing monetary goals
• Advising on financial issues
• Knowledge of, and Promotion of investment products and services

In addition to the above services, things to look for in a financial planner also include the following important traits, characteristics and qualifications.


While a license is not required to be a financial planner, Certified Financial Planners (CFP's) are specifically trained for the purpose of financial planning. Certified Financial Planner's certification includes at least 3 years of experience in financial planning, ethics review, and rigorous examination.
Not all certified financial planners are guaranteed to be able as some non-certified financial planners. Nevertheless, in case of doubt, certification does increase a client's chances of receiving the best possible service. Depending on one's specific needs, other certified and/or licensed financial professionals may be more suitable.


Organizations such as the Financial Planning Association and the International Association of Registered Financial Consultants may offer assistance in finding reputable financial planners. What's more, since money is sometimes a sensitive issue for individuals, a professional financial planner is desirable for several reasons.

First, people's money is not something to be taken lightly and a financial planner should be able to treat client's money with integrity, respect and with all the intentions of the client in mind. Second, if a financial planner does not take his or her function seriously, they may not take the money they help manage seriously either. While this is somewhat a matter of trust, professionalism inspires trust..

Financial institution

The company or organization a financial planner works for may having bearing on the quality of service offered in addition to complimentary services and products. Both large and small financial planners may offer unique advantages. For example, a large well financed company that provides financial planning services may also have its own investment products available, proven track record and established performance. However, smaller financial planners may be able to offer more personalized service that may include a more tailored financial plan.

Financial packages

A financial planner may or may not be able to provide special incentives for using affiliated financial products and services. If a financial planner or service does not offer sponsored products, they should still be equipped and knowledgeable about where to find the best, and most suitable investment and financial instruments to help meet a clients needs and expectations.

Among the services and products a financial planner should be able to advise upon are investing, budgeting, retirement planning, net worth optimization, and end of life asset management. In addition to these services, a financial planner may also be knowledgeable about certain business financing concerns and bureaucratic financial procedures.

Experience and knowledge

Financial planning services can be of assistance to both fiscally experienced and savvy clients and inexperienced clients alike. The reason for this is managing money and assets is the profession of a financial planner.

Consequently, they may know of technicalities and monetary plans even well aware clients may not have knowledge about. In other words, even if the need is small, financial planners may offer important guidance in fine tuning and/or adjusting individual, and in some cases, business financial goals.

Terms of service

The terms of service and fine print are important and become more important with higher amounts of money being planned. The fine print in a financial planning agreement can include information on fees, commissions, liability disclaimers, asset protection clauses or lack thereof, privacy disclosures and any other legal or technical issue that may arise in the future. Taking the time to read the fine print and understand what it means could mean the difference between losing one's assets and keeping them however unlikely that scenario is.

Financial planners should ideally meet some, if not all of the aforementioned requirements. When considering the above mentioned items, choosing or deciding to utilize the services of a financial planner and/or financial planning corporation can be made easier. While not all financial planners offer standardized services and products, a financial planner that meets the criteria contained herein may be better positioned to provide a more complete and beneficial financial planning service.

Friday, February 4, 2011

Estate planning 101

Estate planning manages the financial assets, both real property and personal property, that comprise the net worth of an individual that will be passed onto beneficiaries following death. Estates can exist during the lifetime of the estate owner in the form of Trusts and other estate tools where the estate owner is the primary trustee until some future point in time.

Estate planning can be divided into three sub-categories: estate tools, estate planning goals and estate taxes. Estates are an aspect of financial planning that are most relevant in the post retirement years and often accompany end stage or end of life financial planning. This is reiterated in the 17 second long video below:

Estate planning mechanisms

Estate tools are the means by which estate planning can be implemented. These tools include legal and financial instruments that allow the estate owner to allocate assets, determine who will be able to make decisions on behalf of the estate, and how assets are owned. Estate planning tools require advance preparation, often require notorization, may also need the signature of witnesses and should comply with state and federal estate law.

When planning an estate’s legal management with an attorney, information that informs the attorney of the estate owners goals, heirs, and assets are likely to be obtained; an example of this is this linked to ‘Estate Planning Checklist’ from abanet.org

• Power of attorney
• Last Will and Testament and Living Will
• Financial Trusts
• Additional financial instruments ex-IRA’s, life insurance

Estate planning

Estate planning incorporates the goals of an estate and the wishes of the estate owner into a financially viable, documented and effective way. Estate planning can achieve a number of useful purposes to all relevant parties affected by the estate. Estate planning is a fundamental aspect of financial planning in later years and becomes more relevant when the estate becomes subject to heavy taxation. In other words estate planning is essential for protecting, growing, preserving and allocating financial assets.

• Reduces or avoids potential estate taxes
• Protects estate assets
• May help ensure privacy of estate beneficiaries
• Helps preserve family legacy
• Facilitates transition of estate ownership
• May directs asset allocation during probate

The estate tax

Estate tax law can be complex and varied across the states and is also subject to revision by changes to federal legislation. State estate laws should follow federal statutes but have latitude in the amount of estate tax and the estate value amounts at which the estate tax if any occur. Estate taxes can lower the value of an estate considerably and do not include inheritance taxes that can further reduce the value of an estate.

In order to lower an estates value so it does not qualify for estate tax a combinations of methods may be used. For example, charitable deductions, acquisition of non-qualifying assets, and jointly held assets. Some of the following IRS Estate Tax Forms and publications may be necessary or helpful in understanding how the government is informed of and records estate information.

• There are both federal and state estate taxes
• Non-existent federal estate tax for 2010 tax year
• Taxation of an estate can reduce its value by over 50%
• Estate tax does not include inheritance tax

Estate planning tips

When estate planning there may be a number of legal, financial and personal considerations to take into account. This may become complex and involve large amounts of capital, assets and financial obligations. In such cases, it may be prudent and advisable to seek the consultation of a financial professional familiar with estate planning practices. Effectively planning an estate can mean the difference of having a lot of one’s personal net worth pass onto the government or beneficiaries of choice. Several tips may be helpful when estate planning.

• Identify estate planning goals in advance
• Study and acclimate with both Federal and State estate laws
• Seek the advice of a financial planner, estate attorney or accountant
• Effective tax strategy can save a significant portion of the estate

Estate planning is an important aspect of financial planning that can assist retired persons or persons of high net worth in effectively managing their finances during later years in life. The implementation of an estate plan can vary based on the state(s) in which one’s estate is held, the time at which estate laws apply, the estate owner’s financial goals and objectives and the value of the estate itself.

Estate planning involves tax planning, asset management, end of life preparations. And use of both legal and financial instruments. Without estate planning, estate owners would not be able to as effectively maintain the worth of their estate and pass on the value of the estate to heirs and beneficiaries while simultaneously carrying out the goals of the estate owner or primary trustee of the estate.


1. Internal Revenue Service http://www.irs.gov/ (U.S. Internal Revenue Service)
2. http://retirementliving.com/RLtaxes.html (RetirementLiving.com)

Wednesday, October 5, 2011

Key tools used In estate planning

Estate planning does not have to be a daunting and expensive ordeal involving endless attorney, accounting and financial planning fees. A key in keeping estate planning cost effective and simple is to separate what is needed from what is not in an estate plan. Many times complicated trusts and financial instruments are not necessary, but even when they are it does not have to be a maze of confusion.Before further elaborating on estate planning tools, the following video is useful in introducing the concept of estate planning.

A good place to begin estate planning is assessing the size or total value of the estate; this includes tax deferred retirement accounts and will determine whether or not specific financial instruments are needed to bypass Federal Estate Tax.  For example, real property such as homes and land are potentially subject to both estate and inheritance tax depending on the value and the state in which the property is located. However, by using a qualified personal residence trust, the total estate value can be reduced according to the CPA Journal Online


Defined benefit plans such as employer pensions and defined contribution plans such as 401(k)s can be used to defer taxes on retirement income until it is withdrawn. These tax benefits allow estate owners to manage retirement income to optimize taxes paid to the Internal Revenue Service. These retirement planning benefits extend to beneficiaries if they roll over the inherited retirement account to the appropriate account. According to Schwab, a number of retirement accounts can be rolled over into Inherited Individual Retirement Accounts without tax penalty. 


Trusts are financial instruments that protect assets from taxes and designate distribution of estate assets in particular ways determined by the trust and its terms. Numerous types of trusts exist for various purposes such as guaranteeing money for grandchildren, and establishing a foundation upon death. In any case, when a trust is necessary discussing the options with an accredited estate planner such as an insurance agent accredited through the National Association of Estate Planners & Councils might be cheaper than an attorney or accountant with the same estate planning qualification. 


A Will is a key document probate courts use to allocate assets per the State Bar of California. These documents define trustees and verify beneficiaries for assets within the state's jurisdiction i.e. non-protected assets.  Different types of Wills exist so be sure to review them to identify which is best for you.  Be sure that the terms of other financial instruments such as trusts are conducive to the terms of the Will or this can hold up probate proceedings. The University of Maryland University College and The Porter County Communication Foundation have useful checklist s of information to include in a Will. 


Payable on death accounts are an easy way for account beneficiaries to avoid probate. It is a simple matter of going to a financial institution and filling out the appropriate forms. These types of arrangements only apply to FDIC insured accounts, but similar arrangements can be made with non-insured accounts in some states according to Kiplinger. For example, a brokerage account can also carry  similar terms in those states. 

Monday, March 21, 2011

Benefits of investing in exchange traded funds

Exchange traded funds, also called ETF's, have an array of financial advantages not necessarily available through competing financial products and instruments. This article will discuss ETF's, their benefits and ability to advantage investors' financial objectives.

ETF's combine multiple asset investments such as company stocks and place them into one financial instrument called an ETF which is managed by a fund specialist and overseen by an affiliated bank.  ETF's are similar to Mutual Funds in the sense they combine assets into a fund, but are also traded in secondary markets such as the stock exchange. This allows brokers and investors to purchase and sell shares of the fund freely.

Historical performance of exchange traded funds (ETFs)

Since the inception of Exchange Traded Funds in 1993 (online.wsj.com), ETF's have gained ground in the investment world in terms of volume and awareness. The amount of funds invested in Exchange Traded Funds has increased dramatically along with investor interest in these financial instruments.

The capital appreciation and value of ETF's underlying assets varies on market conditions, investor confidence, quality of the ETF's investments etc. making the historical performance of ETF's in general less accurate an indicator than each individual ETF. Some examples of Exchange Traded Funds are listed below.

• PXR: Invests in U.S. and International utility companies via Depository Receipts
• SPY: Large S&P 500 Index tracker with low expense ratio
• QQQQ: PowerShares Exchange Traded Fund: Well known Nasdaq 100 tracker fund
• EWJ: Ishares International Japan: Invests in Japanese company stocks

Benefits of exchange traded funds (ETFs)

The benefits of Exchange Traded Funds (ETF's) address the concerns of investors which typically center around wealth management and financial planning. Consequently, the ability of ETF's to meet investor and financial institution's financial planning goals is an essential ingredient in their composition and structure. There are several advantages to using Exchange Traded Funds, several of which are listed below.

• Lower risk: Pooled investments tend to average out risk
• Diversified investments: ETF's spread investments across multiple financial products.
• Professional management: Fund management by experienced industry professionals
• Nontaxable earnings in some cases: i.e. ETF's that invest in non-taxable bonds
• Access to individually unattainable investments: Treasury notes and bills.
• Exchange in secondary markets: ETF's are a liquid asset class and easily transferred
• Lower Expense ratios: In some cases ETF management is cheaper than Mutual Fund's
• Index tracking: Some ETF's mimic the performance of financial indexes
• Federal regulation and oversight: Both the Securities and Exchange Commission and the Depository Trust Clearing Corporation review and monitor ETF activity. (seekingalpha.com)

How Exchange Traded Funds meet investment objectives

In understanding the benefits of Exchange Traded Funds, one may wish to realize how ETF's address key investor goals. These goals are what bring investors and funds together, and if funds were unable to help accomplish the financial objectives of their clients, obtaining funding for the ETF could be challenged.

In other words, the performance of the fund is in many cases, correlated to the Price to earnings ratio (PE ratio) of the fund. The higher the perceived future earnings of the fund, the higher the PE ratio will be indicating investor belief in the funds financial viability and performance. Some of the investor and institutional goals sought in ETF's are the following:

• Capital appreciation
• Diversification
• Risk management
• Income generation
• Tax and Estate planning products
• Retirement funding products

To summarize, Exchange Traded Funds are a financial instruments that reinvest large amounts of money across multiple companies and/or additional financial vehicles. ETF's may be used to mimic a batch of companies within an 'index' such as the S&P 500 or help its investors achieve specific financial objectives.

There are several advantages to ETF's that make them a useful tool within a financial portfolio and/or investment strategy. This article has discussed some of those benefits, the reasons for them and how they are accomplished through the Exchange Traded Fund.


1. http://www.investopedia.com/terms/e/etf.asp
2. http://finance.yahoo.com/etf
3. http://online.wsj.com/ad/focusonetfs/history.html
4. http://seekingalpha.com/article/48402-are-etfs-safe-or-insured
5. http://www.etftrends.com

Friday, February 11, 2011

Diversification of investment risk

Investment diversification is a type of risk management that used by investors and refers to the spreading of investment capital through multiple financial instruments and/or economic sectors. An example of diversification is stock ownership across a number of industries such as oil, utilities, biotechnology, retail etc. Diversification is similar to hedging in the sense that it is employed to lighten negative impacts from downturns on a specific financial instrument, economic condition/sector, and localized investments.

Many people diversify their money in different ways. For example, someone may put money into a house, have a savings account, own jewelry, use a money market account, hold certificates of deposit (CD's), and save through Individual Retirement Accounts (IRA's) or a pension fund. This is diversification in the sense if one or other of these investments falls through, there is another to relieve the overall risk to one's net worth. The hallmarks of diversification are listed below:

• Distributes money across an array of investments
• Shields investors from volatile fluctuations in prices
• Broader investment net may capture otherwise unrealized capital gains
• Allows riskier investments while simultaneously limiting exposure to associated risk

The following video outlines the risk reducing effect of investment  diversification: 

Diversifying through mutual funds

Diversifying risk is easy to do if one has tons of money to spread around. However, for those who don't have millions of dollars, mutual funds do. What's more, mutual funds often consider diversification an essential part of their investment strategy even if it is just within one economic sector.

For around the first 30 investments an investor or mutual fund makes, the level of risk declines significantly, especially if those investments are across different industries. However after a certain point, the lowering affect diversification has declines making the risk to number of investment ratio change less and less. A few ways diversification in the stock market takes place including through mutual funds are listed below:

1. Diversified Mutual Funds
2. Investment in international as well as domestic stocks
3. Time spread investments i.e. dollar cost averaging
4. Selection of stocks that span a number of economic sectors
5. Investment in large cap, mid cap as well as small cap stocks and pink sheets
6. Ownership of stocks, stock mutual funds and exchange traded funds
7. Diversification through investment in multiple stock exchanges.

Other types of investment diversification

Diversification can be achieved in a number of ways and at varying levels of risk. One can diversify through the methods listed above or one can diversify using multiple financial instruments. Some examples of this type of diversification includes the following methods:

• Low-risk diversification

1. Low risk mutual funds such as precious metals, utilities and bond funds
2. Treasury Bonds, Savings accounts, Australian Government Bonds
3. Investment through IRA's, Life Insurance Policies and Certificates of Deposit

• Medium-risk diversification

1. Investment in index funds
2. Diversification through middle capitalization and large capitalization companies
3. Capital investment in Bonds, stocks and higher risk mutual funds

• High-risk diversification

1. Investment across a range of small capitalization companies
2. Diversification through a number of risky exchanges such as foreign exchange, futures and growth sectors of the economy.

Risks typically associated with non-diversification

When one does not diversify, one's net worth can decline dramatically. An example of this is the Tech bubble of the late 1990's and the Housing Bubble of the middle 2000's. If an investor had all their money in either of these industries after the bubble burst they could have lost a great deal of money.

An economic 'bubble' does not have to burst for an asset class or industrial sector to have a correction of 10-20% because there are many integrated market forces that drive prices of financial instruments outside of abnormal pricing. While diversification does not eliminate all one's investment risk, it can present some very safe options depending on how risky the investments are.

How one diversifies is also important because as with any investment strategy there are many different ways to diversify. Some methods are better than others. For example, if one diversifies in secure and Government backed financial instruments one's risk will be lower than if diversification takes place through high risk stocks across a number of industries. Also the choice of investments one chooses to diversify with can create a combination of risk and return that is ideal for an individual investor.

In summary, investment diversification limits but does not eliminate risk. The safer the investments that are diversified, the lower the overall risk will be. Diversification can be achieved through mutual fund investing as well as through investment in multiple asset classes and financial vehicles. The benefits of diversification are well known and considered a beneficial investment strategy.

Friday, October 12, 2012

Questions to ask before opening a new brokerage account

Brokerage accounts offer trading platforms and financial analysis tools
Overseas brokerage accounts are subject to different regulations

Opening a brokerage account is an important banking decision that affects individual finances and any financial commitment made to the account. Understanding how the account works and where one's individual responsibilities lie in regard to managing the account is necessary. Being properly informed of what brokerage accounts entail is instrumental in the choice to open one. Below are some questions worth considering before opening a new brokerage account.

What types of services are offered?

The types of services offered by brokerage accounts often surpass those of traditional banking. For example, some financial institutions offer spread betting, and full-service brokerage firms typically offer financial planning services as well. In other cases, premium services are only reserved for account holders with higher net worths. An alternative to this is to obtain the advice of a licensed securities professional on a per transaction basis via commission on services rendered.

Are the financial instruments worthwhile?

The range of financial instruments offered by various brokerage houses is staggering. Choosing the right financial institution is therefore, of paramount importance to the future of one's finances. This is because the financial products invested in influence potential yields, capital gains taxes, and opportunity cost. Carefully researching what an individual brokerage firm has to offer in addition to the advantages and disadvantages of a brokerage firm is key to making the right banking decision.

How well are the account assets protected?

Asset protection is something all investors should take seriously because of the potential consequences of not being fully aware of specific investment risks. For instance, assets held within a brokerage account are not necessarily insured, and not all account types are protected from creditors. Different assets and accounts have varying levels of security that investors would do well to understand prior to opening an account, and before engaging in transactions through that account.

Do available accounts suit specific financial goals?

Differing accounts are offered by various brokerage businesses. To illustrate, some brokerage firms offer individual retirement accounts and individual business accounts, but do not necessarily offer exotic financial instruments, whereas other firms make more unique financial products available including simulations such as a currency spread betting trial account, but do not necessarily provide those products through a wide range of accounts.

Which jurisdiction is the best choice?

Jurisdiction is a major factor when opening a new brokerage account. Since each jurisdiction is subject to the laws and regulations governing it, the impact on individual banking is noteworthy. For example, Panamanian corporate brokerage accounts are not taxed in the same way as an individual brokerage account located in the United States. Before opening a brokerage account with a large balance, investigating brokerage account jurisdiction options and advantages is potentially a time worthy pursuit.

Image license: US-PDGov

Thursday, February 3, 2011

Investing: Determining your risk tolerance

Investment risk tolerance is a measure used by investors and financial planners in investment planning. The risk tolerance scale is also a useful risk management tool and ranges from low to high with the lower end of risk tolerant investors choosing financial instruments such as insured bank accounts or financial instruments and/or guaranteed investments such as certificates of deposits, bonds and money market accounts.

These basic types of risk are also comprised of more in depth risks that once elaborated upon sometimes change the actual risk level of some financial instruments that may usually be classified as low or high risk. This article will discuss the types of risk tolerance, risk types and provide tips on determining individual risk tolerance. The video below offers a helpful introduction to investment risk and how investment goals and decision affect that risk.

How to determine risk tolerance

To find an ideal risk level involves assessing and combining 1) financial goals, 2) personal perspective, and 3) life decision history with the realities of the financial markets such as percentage price losses, market volatility, personal comfort and amount invested. A simple way of looking at risk tolerance involves identifying how much general risk one likes to take financially in terms of a low to high scale.

The following link provides an example of a basic risk tolerance scale. This scale does not illustrate the types of investment associated with each type of risk, however additional graphics do, this risk/investment pyramid being one example. The difference between the scale and the pyramid is that the pyramid includes investments associated with each level of risk. However, what the pyramid does not illustrate is the finer details within each risk group and investment choice.

Investments are not always as black or white; or right or wrong as some risk illustrations seem to imply. This is because there are different types of risk within each risk category. For example, of the lowest risk level, which bonds are the safest? or which companies providing certificates of deposit are most financially solvent?

What may seem to be low risk, might actually be quite a high risk if the financial institution(s) issuing the investment instrument are doing so with a low credit rating or precarious business financials. This is why it is important to look beyond the simple risk diagrams often used in determining risk tolerance.

Types of risk and individual investment choices

As we have seen, there are essentially between three and five types of risk that may include very high, high, medium and low. To identify which one is most comfortable think back to times when such risk was occurring in life. For example, one might think about questions such as how it felt, what was the response to it, was it easy to stay emotionally balanced during the risk and what happened next.

Once one has an idea of what kind of risk one feels comfortable with, the next step can involve applying those thoughts and feelings to one's finances. Would it feel the same to have such risk levels in one's financial investments and what level of risk would be right both in terms of financial needs and goals. To further illustrate the types of risk one may be exposed to it can be helpful to understand which investment circumstances are affiliated with each type of risk.

• Financial market risk

Each financial market has a different level of risk per se. For example, the bond market tends to be more predictable and provide more stable outcomes than stock trading, but has less potential for gain. Furthermore, the Foreign Exchange market can be thought of to have high risk as the chance of losing money in this market can be high just as the chance for making money can be great. Choosing which financial markets to invest is a way to invest with risk in mind.

• Price volatility

When investing in the stock market, prices can be volatile within double digits percentages either up or down within as little time as a few hours. This can mean an investment could lose as much as 20% or more if an adverse event, sudden unfavorable economic news or weak market conditions strike one's investment. Being prepared both financially and mentally for such risk is a key part of risk comfort. If one would rather not expose oneself to such risk there are other ways to invest and avoid such risk.

• Investment choice

The choice of one's investments is also a way to identify and invest with risk in mind. Bank insured and guaranteed investments are among the safer of investments, followed by treasury bonds, conservative mutual funds, blue chip stocks, growth stocks, and futures trading in that order. One may wish to try a little in each to determine what one feels most comfortable with before deciding which risk level is right.

Tips for determining risk level

• Market simulations may help one get the feel for which type of investing one is comfortable with. Such programs do not involve real cash are thus risk free, but help one identify potential risks and pitfalls within that financial market.

• Invest Conservatively at first to see how it really feels, to make and lose real money. The first hand experience shows what is really involved both financially and mentally.

• Personal history of decision making is a clue to one's risk preference. In life many decisions and choices are made, if such choices were often risky or less risky, this may be a good indicator of what type of investment risk one will prefer.

• Study and research investment choices and financial markets to garner a more exacting level of risk. Each market and investment has a life of its own and may not always be a good predictor of other similar investments.

Investment risk is something one may intuitively know beforehand or have to think about before investing. If one has to think about it a lot, this may imply one is naturally cautious regarding investments. However, caution alone may not determine risk preference. The above illustrations and tips can assist with such identification of risk levels, how to deal with those risk levels and which investments are more likely to yield each risk level.

Tuesday, March 15, 2011

How futures contracts are traded

To better understand how futures are traded, it is helpful to know what a future is, the history behind them, and the benefits of trading them in addition to the trading process. A 'future' is an evolved financial contract to buy or sell an underlying commodity or product at a future time. Futures are exchanged through authorized clearinghouses such as the Chicago Board of Trade and must be exercised on a predetermined date called the 'final settlement date'.

The exchange of futures contracts is regulated by the Commodity Futures Trading Commission and requires the use of credit to the contract purchaser and has less risk than a similar contract called a forward. Since futures contracts and prices are derived from a product or commodity they all called derivative securities. Speculators often buy and sell these contracts with the intent of making a profit off price fluctuations before the delivery date, however they are also used to by farmers and agriculturalists to hedge farm operating costs, and product sale prices such as those associated with animal feed and grain prices. The following video illustrates the futures trading process:

The history of futures

Modern day futures trading evolved out of a forward trading system which was used in the mid 1800's as a way for farmers, bankers and merchants to collaborate their interests financially. A forward contract is an agreement between two or more parties to deliver a specific product on a specific date in the future. These contracts are different from futures in that they don't have to be traded using an exchange and the settlement of price is determined by delivery of the product rather than the final settlement date.

One of the largest exchanges through which this process took place was the Chicago Board of Trade, which was called The Board of Trade of the City of Chicago in the 1840's. Over the following 30 years after 1840, futures trading which occurred through the exchanges became more regulated and standardized allowing the futures exchange to become more reliable and standardized. Eventually, in the 1970's a fixed market related to, but separate from the actual underlying commodities emerged in which financial instruments such as bonds and foreign currency could also be traded using futures contracts.

The trading process

Futures are traded using 'margin' which is a financial term for a credit account with a minimum down-payment or collateral. This margin amount is usually between 5-15% but may go much higher. A speculator or trader buys a futures contract through an exchange and/or a broker who works through the exchange and does so at a fixed cost of the underlying security. If the price of the underlying commodity or financial instrument rises during the term of the futures contract, the contract holder can make a profit.

Despite this, if the price falls, a loss will be incurred. During each day the buyer of the futures contract continues to hold it, the profit or loss is recalculated. Speculators in futures trading sometimes use a trading strategy using technical indicators and other financial tools to aid them in their decision making. A step by step process of trading futures is as follows:

1. Use a reliable brokerage account that works through an exchange that trades futures.
2. Choose a commodity or financial instrument to trade in such as coffee or currency.
3. Study the different contracts, the costs and goods.
4. Develop a trading strategy
5. Purchase the Futures contract and hope steps 1-4 work.

Why futures contracts are useful

Futures contracts are useful because their derivative nature affords them the ability to represent advanced securities transactions, products and financial instruments through a systematized trading environment. In other words, they greatly facilitate commercial trade. Some of the ways they do this are as follows:

• Control price risk fluctuations by locking into a fixed price
• Assist companies in generating capital in advance of sale.
• Demonstrate buyer and seller predictions of future prices.
• Assists with assessing economic & market conditions through price efficiency theory.
• Can be used across many markets such as currency, bond & commodities markets.

Who invests in futures contracts and why

Futures are traded by farmers, agriculturalists, financial institutions and speculators. While all have a financial interest in the contract, they may have different reasons for entering into the contract. In the case of 'hedging' for risk , farm managers and crop farmers attempt to bring a more stable cost and selling environment to their operations through locking into a futures contract price they think is fair. For speculators and financial institutions however, the purpose of the contract is different. For these latter two participants, the intent is profit. These latter two generally do not intend to exchange the underlying commodities but rather the money for them and hopefully at a profit. Since the clearinghouse assumes the cost of the commodities they take responsibility for the cost of the commodities and can re-sell the contract.

Futures contracts are financial agreements to buy or sell an underlying commodity at a fixed price on a settlement date. While the actual commodity need not be exchanged, this does happen as the futures market has evolved out of an actual commodities exchange system. The currently futures market is currently very sophisticated, and takes place through traditional trading and electronic exchanges that are regulated by Commodity Futures Trading Commission (CFTC). 

Futures contracts have the potential to be costly especially if the price of the commodity drops rapidly within a short time period. However, the contract may also be profitable if exercised at a profit. Futures contracts have a history in the commodities trade of farm products but have expanded to include metals, energy resources and financial instruments such as currency and bonds.


1. Zvi Bodie, Alex Kane and Alan J. Marcus. 'Investments' New York. 2002 McGraw-Hill Irwin. p.739-760.
2. http://www.answers.com/topic/futures-contract?cat=biz-fin
3. http://eh.net/encyclopedia/article/Santos.futures
4. http://www.riskglossary.com/link/future.htm
5. http://en.wikipedia.org/wiki/Futures_contract
6. http://www.cftc.gov/

Wednesday, February 23, 2011

Wash sales and worthless stock

Wash sales are a term given to the repurchase of securities such as stocks within 30 days prior to and following the selling of securities at a capital loss i.e. at a price lower than the price purchased. Such sales may be implemented to avoid 'worthless' securities transactions despite the wash sale rule. The wash sale rule is implemented by the U.S. Internal Revenue Service that disallows tax benefits usually afforded to financial losses incurred through capital loss on investments.

The tax benefits lost due to a wash sale may be regained at a later time through a basis adjustment in which the loss on the sale of a financial instrument is added to the purchase price of the wash purchase. (www.fairmark.com) This is an important adjustment to note as overlooking it within a given tax year could lead to an over reporting of capital gains. The Kiplinger video below explains how the wash sale rule works and is used for tax purposes:

Calculating disadvantages of the wash sale rule

If the tax savings loss is greater than the potential capital gain incurred through an upward price movement following a wash sale, then the wash sale may not be profitable. In other words, for a wash sale to be financially prudent the repurchasing of securities should ideally lead to a profit greater than the tax savings incurred through a tax deduction on the loss of sale. To calculate the potential worth of a wash sale following specific steps may be helpful.

• Identify tax bracket
• Estimate adjusted gross income after the sale of securities
• Calculate tax savings using adjusted gross income estimate and tax bracket 
• Forecast potential capital gain on wash sale 
• Subtract estimated tax savings from forecasted capital gain

Securities affected and not affected by the wash sale rule

Wash sales do not apply to every exchange of securities within a 60 day period. In the case of certain financial instruments, the repurchase of securities either 30 days before or after a sale are not considered wash sales. Furthermore, according to the IRS, wash sales do not apply to the following items (www.irs.gov)

Financial Instruments not affected by the wash sale rule:

•Foreign exchange purchases and repurchases
•Futures contracts
•Non-equity options
•Dealer equity, or securities futures contracts

Financial Instruments affected by the wash sale rule:

• Purchase and sale of stocks through an individual retirement account (IRA)
• Sale of stocks through an options contract
• Purchase of similar types of securities ex-stocks of two similar oil companies
•Options contracts involving repurchase of the same stock

Wash sale tips

When entering into a wash sale a few considerations may be useful in one's financial management strategy. A few of those tips are provided below with the purpose of clarifying the potential benefits and disadvantages of wash sales.

• Time of year: If the wash sale takes place early in the fiscal year, the cost basis adjustment may offset the tax loss if a cost adjusted capital gain of equal proportion to the capital loss is incurred. Additionally, since wash sales only apply within a 60 time period, adjusting securities purchases outside of this time frame may be beneficial.

• Type of security: In the case FOREX and futures securities transactions the wash sale rule may not have an impact in which case such purchases and sales may have less tax implications

• Size of transaction: Depending on the size of the transaction the wash sale rule may incur relatively little or larger financial impact. For example, 1) a forgone capital loss that may have lowered tax filing bracket, 2) a large enough transaction in which the tax benefit loss is significant

• Investment & Tax strategy: Incorporating the potential for wash sales into one's investment and tax strategies can be useful in maximizing gains and minimizing losses. Considering the potential implications of purchases may lead to a more developed approach.

The wash sale rule is a part of the U.S. federal tax code and disallows tax benefits for the loss of various securities such as stocks and option contracts in the event an additional purchase of that or a similar security takes place within a 60 day time frame. Certain limitations exist for this rule including the basis adjustment calculation and purchase of securities not included in the wash sale rule. 

Calculating the potential loss from a wash sale involves the estimation of adjusted gross income, tax bracket, potential tax savings and capital gains and losses. Incorporating and understanding the rules of the wash sale into one's overall investment and tax strategy can be a useful in one's individual financial planning.


1. http://www.irs.gov/publications/p3991/ch01.html
2. http://www.fairmark.com/capgain/wash/ws101.htm
3. http://www.irs.gov/pub/irs-pdf/p550.pdf

Thursday, March 8, 2012

Investment risk-management techniques

Investment risk levels are affected by economic cycles
Risk management is commonly carried out via asset diversification

Investment risk is minimized a substantial amount by properly following three key principles. These include the use of risk avoidance techniques, understanding the situations in which investments are exposed to risk and knowing which financial tools have the best probability of capitalizing on reduced risk.

Understanding investment risk

Economic analysis

A method of understanding investment risk is economic analysis. By understanding what impact specific economic conditions have, an investor can more effectively manage his or her risk. Economic analysis involves more than just major economic trends, but also being able to forecast those trends, and what asset classes and investment instruments would be most likely affected by that economic event. To illustrate economic analysis, the Conference Board, a business research association, measures global business cycles to assist in evaluating the economic impact of those business cycles.

Market performance

Markets are sub-components of an economy. Broad based economic indicators may span across individual markets and therefore do not help in understanding all aspects of investment risk. Knowing each market, what affects it financially and what its performance depends on are ways to understand investment risk in those markets.

Risk management is an important aspect of individual portfolio planning and business strategy. The instructional video below further explains the process of risk management with an emphasis on business applications.

Risk avoidance techniques

Asset class

Asset class investing is a technique to manage financial risk and follows the principle of the risk pyramid. In the risk pyramid, investments are divided by asset classes or categories by risk level; the apex includes asset classes with the highest risk, and the base consists of more stable investments. Asset class risk levels can help an investor better assess what level of risk a particular type of asset is. Even less risky investments within asset classes cannot protect against all types of risk however. For example, U.S. Treasury bonds, in the bond asset class,  have relatively low socio-political risk, but are not all immune from interest rate risk.

Investment methods

A number of investment methods exist that protect against investment risk. Diversification and dollar cost averaging are widely known and practiced techniques of protecting against risk,  but these investment techniques are not the only ways available. For example, income investing, through investment in dividend paying stock protects against capital depreciation. Additionally, dividend reinvestment plans (DRIPS)  reinvest stock dividends that add to the affect of income investing. In the case of an initial public offering (IPO), price risk can be protected against by purchasing shares before they become publicly traded.

Investment risk management tools

Financial instruments

A financial instrument is a particular account, contract or financial arrangement that allows for and facilitate particular financial advantages, objectives and disadvantages irrespective of the asset class invested in. For example, a Roth IRA is a tax savings financial instrument designed to lower savings costs and prepare for retirement. Additionally, an Exchange Traded Fund or ETF, some might offer tax protection in the form of investment in tax free municipal bonds whereas others may invest in commodities. In both cases, the Roth IRA and the ETF are financial instruments that have the capacity to invest in multiple asset classes and thereby manage risk.


Insurance is a risk management tool because it specifically serves as a hedge against risk realization that investments themselves can't protect against. To illustrate, insurance protects investments against liability claims from debtors or the need to use investments in adverse circumstances such as bankruptcy. In other words, investments made within an insurance product or financial instrument are afforded a certain amount of legal protection that can help reduce exposure to debtors. In the case of unemployment or disability insurance, a state provided protection indirectly helps reduce investment risk arising out of personal circumstances.

Image attribution: Janoon028, standard royalty free license

Sunday, February 13, 2011

Taxes: Tips for investing your refund wisely

Tax refund
Investing tax refunds profitably offsets previous years' taxes
Wisely investing a tax refund means allocating the money from the refund in such a way as to  grow net worth,  improve fiscal credibility,  build financial security,  enhance quality of life, and  lower costly debt all at a low risk and maximum benefit.

This article will discuss ways to go about investing tax refunds wisely by breaking down the tax refund allocation decision(s) into three steps. These three steps are described in sections one through three and involve taking a personal financial snapshot, identifying options for investing, and optimizing refund allocation(s).

Taking the financial snapshot

The financial snapshot helps one gauge where one stands in terms of assets, debt, investments, credit record, budget situation, expenses and so forth. Without an accurate financial snapshot, properly allocating a tax refund investment may be haphazard. To take a financial snapshot, the answers to a few pointed questions can present one's financial situation quite well. A few such questions are listed below for the purpose of mapping a financial direction with which to proceed when investing a tax refund.

• How much is the tax refund?
• What amount of debt is included in your budget?
• At what stage of life are you?
• What are your financial goals?
• Is your budget well organized?
• Do you have an emergency account?
• What kind of Return on Investment vs risk do you prefer?

After answering these questions, one is ready to move to the next stage of investing a tax refund. The reason this is so is because one's financial picture is clearer and financial problems, goals and needs are more likely to have been identified by taking a financial snapshot. The next step is to identify investment options.

Identifying investment options

Identifying investment options helps one define what financial choices are available so one can later assess the quality, potential ROI, benefits and risk of those particular choices. This is an important step as demonstrates which financial vehicles are available for navigating through the financial map of one's personal finances. Often times there are many tax refund investment choices that can be made, however sometimes, simpler choices can be better. The following list presents some example tax refund investment choices that may be available.

• Pay off debt (Investment in to higher savings)
• Apply tax refund to following years tax (Increase future tax returns)
• Invest in high medium to high yield savings instruments
• Build credit by collateralizing loans
• Open or build an interest bearing emergency account

Pay off additional interest accumulating expenses

After one has identified available tax refund investment options one knows their financial situation through the financial snapshot, and what options are available to help improve or make that financial situation better. However, knowing which options to take, and why can help optimize one's tax refund investment decision for a potentially greater benefit had only steps 1 and 2 been taken.

Optimizing tax refund investment decisions

The purpose of optimizing a tax refund investment decision is to garner greater financial benefit as mentioned previously, but it also has the added effect of improving one's personal financial management skills and quality of life. To determine which tax refund investment has the most benefit its value must be measurable in some way. For example, investment benefits can be measured using the following metrics.

• Quantitative benefit ex-Increase to net worth, highest possible ROI
• Financial security ex-retirement savings, larger nest egg
• Improved credit score and/or rating
• Lower personal debt to asset ratio
• Improved leveraging and/or loan capitalization options

After acclimating with fiscal measurements one can then apply those measurement techniques to the tax refund investment options to assess which financial objective or group of objectives is most optimal in terms of allocating tax refund investment funds. For example, if money is used to pay off high interest debt, it has the potential affect of increasing savings through lower interest payment(s) on the debt. Over time, the lowered or eliminated debt is similar in returns to an investment in the sense that a return is achieved through the percentage increase in savings rather than return on investment. Either way more money is being retained and/or acquired.

Each tax refund investment option has different benefits and advantages whether it be tax deductible retirement savings, creation of a rainy day fund higher asset value etc. A method of optimizing makes use of one or all the various allocation/investment techniques for the greatest net benefit whether that benefit be financial, social, spiritual, physical, or psychological.

For example, utilizing all the previously listed metrics, and calibrating them all together for the combination of highest return, a tax refund may have been wisely invested. Moreover if one is able to pay off debt and/or refinance debt at a lower interest with a collateralized loan that is based on a tax refund invested in a high yield Australian Certificate of Deposit one is also improving credit worthiness by building credit history.

Thus, by optimizing, multiple financial goals can be achieved at once. To illustrate further, if debt at 14% APR is refinanced at 4% APR using a collateralized loan based on a certificate of deposit earning 5% annual yield, one earns10% interest savings on debt plus 5% on interest for a total of 15% return provided the total amount invested in the CD would have been used to pay off the debt at a rate of 14%.

Figuring out how to wisely invest a tax refund is not much different from any other investment decision. That is to say, if wise investments include monetary allocations that can yield return through savings and other positive metrics such as greater retirement security, lowered financial related stress etc., then tax refunds can be invested well and improve one's financial situation.

A good way to invest a tax refund would to do so in such a way as to optimize or maximize the total potential benefits of the monetary allocation i.e. why invest at 10% with high risk when you get 15% with low risk? This article has provided some possibilities on how to do wisely invest a tax refund by breaking down the investment decision process into 3 steps, the financial snapshot, tax refund investment options and tax refund investment decision optimization.

Image license: 401(K) 2012; CC BY-SA 2.0

Wednesday, July 17, 2013

Should we trust S&P and Moody's in the future?

Historical failures have some questioning credit rating agencies
Three ratings agencies control 95% of ratings
By Jim Friedman

Standard & Poor's (S&P) and Moody's are credit rating agencies. These companies assign credit ratings to debt instruments, after considering and taking into account factors like the debtor's ability to repay the principle as well as probability of default. 

These ratings are given to many institutions that take on large amounts of debt, including companies and governments, and their rating affects the costs that are associated with their borrowing. By assigning a lower credit rating to a company or country, the credit agency increases their cost of borrowing, since lenders will want a higher interest to compensate them for their higher risk.

S&P and Moody's in particular are often singled out as representative of credit rating agencies in general because so they possess so much of the market share for credit ratings. Moody's and S&P take up almost 80% of the market share globally, and when combined with Fitch Ratings, these three credit ratings firms form the Big Three and control about 95% of ratings.

Failure of credit agencies

The legitimacy, reputation and reliability of these credit rating agencies have been seriously negatively affected by the credit crisis of 2007. The credit rating agencies gave billions of securities the highest possible debt rating during the financial crisis without fully understanding the underlying assets and risk. These debt instruments and derivatives were subsequently downgraded from their perfect score all the way down to junk, as investors who previously thought that they were investing in a safe instrument were left with a small fraction of their original investment.

The Financial Crisis Inquiry Commission, formed by the United States government to investigate the underlying causes of the financial crisis, found that the ratings agencies were "essential cogs in the wheel of financial destruction." This is because the assumption that their ratings meant low risk of their investment were essential to the sub-prime mortgages being marketed as debt which is virtually risk-free because of their triple-A rating from the credit rating agencies.

History of failure

Critics of credit rating agencies suggest that such agencies have had a long history of failure when it comes to downgrading securities only after the crisis has developed. This includes past events such as the 1997 Asian financial crisis, 1998 Russian financial crisis, Enron and Freddie Mac, among other notable financial disasters.

Cause of inaccuracy

There are numerous underlying causes for the inability of securities issuers to accurately judge the quality of debt instruments. The first is the symbiotic relationship that has developed between financial institutions and credit rating agencies. Unlike personal credit rating agencies like Equifax or Transunion, investment credit rating agencies are primarily dependent on business from the entities which are being rated, and the security issuers were found to even openly threaten to take their businesses to other firms in the Big Three. This indicates a fundamental conflict of interest in credit rating agencies.

Credit ratings firms have also been accused of threatening to downgrade to compel businesses to pay them their fees, as well as being criticized for the power and inaccuracy of their ratings when grading sovereign debt. Their downgrade of sovereign debt can cause economic collapse in the countries and spur a vicious cycle, as seen in various European countries that underwent sovereign debt crises.

Overall, it seems that S&P and Moody's have become untrustworthy as institutions that determine the underlying risk of debt instruments. Their past history of failure, as well as their relationship with financial institutions and conflict of interest, shows an organization whose core interests have shifted towards generating internal revenue rather than providing the most accurate credit rating possible.

About the author: Visit Jim Friedman's site http://getreasonablywelloffslowly.com for more articles on personal finance and general thoughts on the economy.

* Image license: Royalty free Smart Photo Stock

Friday, February 4, 2011

How to avoid common investment mistakes

Echoes of investing disenchantment sound over and over again in the investment world. Often this because financial instruments and regulations are elaborate and complex, but other times it is simply about not completely understanding how the markets work. Many variables influence the price of securities and all it takes is one missed or overlooked factor to throw an investment off. With a little thought, due diligence and sound investment i..e not speculative, strategy help make financial goals a reality.

The first step in avoiding common investment mistakes is to leap into a new way of thinking about your investments and then look at your past investing from that perspective. The reason being, if you look at investments with the same reasoning every time, you're likely to get similar if not the same solutions every time as well. What good is that if the standard investment advice yields lethargic results? Learning about investing is an ongoing experience, the video below discusses a few of the many possible mistakes investors make:

According to the CFA Institute, an organization that certifies financial professionals, there are several common investment errors some of which include poor strategy, too many investment expenses, high investment turnover, and inadequate buying and selling habits. (cfainstitute.org). These investment mistakes are important and should be avoided but what they are not is individual specific. Standard investment advice often leads to standard investment results. So, in light of this, the first investment mistake discussed here will be tuning into financial gurus too much.

Financial guru syndrome

Financial guru syndrome is the ongoing belief in the steady stream of re-wrapped investment terminology, information and reasoning. Financial gurus be they hedge fund managers, Chief Executive Officers of Banks, or mainstream economists may be wise, learned, and have a lot of experience and know how within the financial sphere but what they are most definitely not, is you, the individual investor. In the media, financial gurus speak to the masses not to the individual and who is more important than you when it comes to investing. Get it? The same advice for Mr. A may also apply to Mr. B, but that doesn't mean it applies to Mr. B's investments in the way Mr. B wants it to.

Mono-economic financial planning

Another technique to consider when avoiding investment mistakes is dual economic financial planning. If this sounds confusing don't be fooled because it's not. Dual economic financial planning involves investing for both good and bad economic times. Many investors choose conservative investments so they can withstand poor market performance, but that only goes half way in investing for dual economies. Taking investing to the next level, and rethinking investments for all scenarios is a useful step in avoiding the common investment mistake of ignoring down markets. By investing for both up and down markets one is not merely hedging bets, but banking on the good and the bad.

Rewriting investment history

Ever get the feeling your "new investment strategy" isn't quite as new as it should be? If yes, you could be rewriting investment history. Consider an investor who is within 5 years of retirement and has just lost 25% of retirement net worth. Using a retain worth conservative pre-retirement strategy is useful and not to be underestimated, however, this doesn't solve the problem of weak past investment performance or loss.

One way to approach this particular investment situation would be for the investor to realize not all that money will be needed in the first few years of retirement. That opens the door to a longer term investment horizon within which the investor can regain and potentially increase his or retirement funding. Overused financial strategies can lead to a rewriting of investment history. If you want to avoid that mistake, improve your approach to investing.

Tubular dollar vision

Tubular dollar vision is essentially the same as financial tunnel vision, and financial tunnel vision can be harmful to your financial health. By not rethinking investment strategy and technique in a new way, with new goals reduces the possibility of enhanced investment performance. For example, Mrs. Y has done reasonably well and achieved an individual average ROI of 12% after investment taxes and expenses.

Tubular dollar vision might say, that's good, keep on keeping on with that and the power of compounding and consistent ROI will leave you in good shape in such and such an amount of time. In Mrs. Y's case, tubular dollar vision might not be so debilitating, but this does not necessarily mean Mrs. Y is making the most of her money. To avoid tubular dollar vision, try a tri-kaleidoscopic frame of financial reference to avoid common investment mistakes and reach new financial attainments.