Are You An Accredited Investor?


I considered calling this post "What The Heck Is An Accredited Investor?" But unless you are hanging out with stock brokers,  you probably don't even recognize the term. That's a problem, because the SEC's accredited investor rule often dictates what you are allowed to invest in and what sort of businesses can afford to ask you for an investment in the first place. The rule has kept our money flowing in certain directions since the aftermath of the Great Depression. And for the first time since then, we are seeing serious efforts made to change it. So what is it and why should it matter to you?

So, are you an accredited investor?

Accredited Investors are the holy grail of ambitious start-ups and private fund managers. If you fall in the Accredited Investor category, the SEC assumes that you can look after yourself (financially, anyway), so many of the careful protections they put in place to keep us all from being squirreled out of our money don't apply to the deals you can make. You would think, then, that you'd have to be very rich or very sophisticated to be an Accredited Investor. The fact is, though, that a lot of well-off but not necessarily "wealthy" people are starting to fall into this category. And it's hard to see where we get the idea that they are all that financially sophisticated.

There are two ways that someone usually qualifies as "accredited":  1. you have at least $1,000,000 in assets (not including your home), OR 2. you made at least $200,000 a year for the past two years and believe you will earn that much next year (the number is $300,000 if it's you and your spouse jointly).  (SEC Reg D, Rule 501).

That first category pulls in quite a few retirees whose pension funds grew over the decades or who inherited retirement funds or property from their own parents. Some of these folks are very sophisticated about money. Most of them probably are not. And while earning $200,000 a year is a great thing, that's not exactly rare or a sign of financial sophistication, either. Sophisticated or not, though, if you are an accredited investor, private businesses, start-ups, hedge funds and other sometimes murky investments are out there looking for you.

Does That Mean I Can Invest In the Next Tech Start-up?

Why, yes it does—maybe. Your Accredited Investor status matters because it means companies can ask you to invest even if they haven't gone through the paperwork and review process that the SEC usually requires in order to sell an investment to the general public.  This can be a very good thing. With SEC public investment filings costing hundreds of thousands of dollars, smaller but equally worthy companies often just can't afford to the process. Limiting themselves to accredited investors means that they still have to follow some basic laws related to what they tell you (and don't tell you), but they don't have to come up with the independent audits and elaborately detailed paperwork. Note, though, that this also means they don't have to make all of that information public for inspection. In other words, it's up to you to make sure you ask the right questions.

What Should I Ask?

You should always ask questions about any investment before handing over your money. But if you are thinking of investing in an unregistered investment as an accredited investor, it's up to you to avoid the Ponzi schemes and the half-baked business plans. You need to ask some extra questions:

1. Who is selling you this thing? Make sure you research the person or company selling you the investment. That might be the company you are investing in, but it might also be an advisor, a hedge fund manager or a broker. Every day the SEC brings charges against people selling fake investments or giving misleading information to investors. Not everyone is caught, but a lot of these names end up on publicly available databases. Start with FINRA's Broker Check site and the Investment Advisor Public Disclosure website to find out more about a broker or advisor;

2. How much will I be charged? A start-up probably won't charge you for giving them money, but a hedge fund definitely will. Be sure you understand any fees you are paying to buy the investment (keep in mind that there might be two layers of fees if there is a broker and a fund involved);

3. How long do I have to leave my money with you? Ask whether your money will be locked in for a period and under what conditions you could sell the investment to get out. Hedge funds almost always require you to leave your money in for a period of time to ensure the manager can follow her long-term strategy. If you invest in a start-up or private business, the only way out will be if someone wants to buy your stake—never a certain event!;

4. How will it make money? Be sure you understand the plan for making money. An investment fund should have a clear, understandable strategy for bringing in returns. A business should be able to show you reasonable (and readable!) estimates for when and how it will make a profit. Make sure you figure in the fees and liabilities to this calculation in case your broker/founder/fund manager doesn't;

5. What can go wrong? If someone tells you there is no risk to an investment, walk away immediately—no such investments exist. Make sure you understand all of the ways your investment could lose value so you can decide how comfortable you are with that risk;

If, after you've asked those questions, you still don't understand something, get an expert. Don't let company representatives, brokers or even your own advisor gloss over the important facts about what you are buying. If the expert in front of you can not make these things clear, or if you are worried that he or she has a conflict of interest, bring in another expert review the materials. Ask an accountant, attorney or financial advisor who is not involved in the deal review the particulars.

For more questions that every investor should ask, check out the SEC's online investor guide.

Who Needs an Annuity and Why?


My clients might well be surprised to see this post—I spend a lot of time railing about the over-selling of annuities and the hefty commissions that go to the advisors who sell them. But the annuity has a long, respectable history and can actually be a good financial tool for the right situation. So what is that situation?

First, it helps to know how annuities work. They aren't quite as dreary as they sound. Way back in the 17th and 18th centuries, annuities were a great way for a very wealthy person to fund the retirement of a widow, an artist or a beloved servant. For that matter, they were one of the original prizes in government lotteries. Essentially, an annuity is a contract that gives the beneficiary the right to receive a certain sum of money every month or every year for the remainder of his or her life. Sounds great, right?

There is a little more to it, though. These days, annuities are insurance products. Like any insurance policy, the insurance company has used statistics about people's life spans to predict how much they need to charge you (and how much they could pay to the beneficiary) in order for the insurer to make a profit on the deal. So, for instance, Wholesome Life Insurers, Inc. are happy to sell you an annuity that costs $100,000 up front and pays $20,000 per year to your Aunt Betty for $100,000 if they think she'll drop dead after the second year of payouts.

And there are necessary costs. In addition to paying the people who sell you the annuities, the insurance company needs to pay people to file the required reports, process the applications, run the office, etc... That isn't all, though. In point of fact, your insurance company is hoping to make most of their profit by investing your initial $100,000 until it needs to be paid out. For that, of course, they need to pay investment managers. All of these costs are built into how much the annuity costs you.

So why not just invest the $100,000 yourself and skip the other costs? This is the question at the heart of the matter when it comes to annuities. In most cases, it is cheaper to fund your own (or your Aunt Betty's) annuity. But relying on your $100,000 investment to grown enough that it can pay you back the money you need in retirement is a gamble—a gamble on the investments and a gamble on your lifespan not going longer than planned.

In the Bloomberg article with which I started this series, David Little, Director of the Retirement Income Planning Program at the American College of Financial Services, chose to take care of most of his own investing, trusting that he would do better than the relatively high fees and low returns that an insurer would get. But he also purchased an annuity as a supplement to the investments. The annuity offers him a baseline amount that he will get every month during retirement to prop up his social security benefits in case the investments disappoint or in case he lives to, well, 103.

As Little's plan suggests, annuities make sense in those instances when security matters to you much more than cost. Whether it's being able to insure a comfortable living for your Aunt Betty, or locking in a baseline for yourself, annuities are about covering a basic need—often psychologically as much as financially.

Just one last note on annuities—there is no such thing as a "guaranteed" investment. Make sure you feel as confident about the insurance company you buy from as you do about your choice to buy. If you want to learn more about the types of annuities out there, check out the SEC's online guide to annuities.

Understanding Retirement Accounts


Of all of the topics that come up in my line of work, this has to be the one that creates the most confusion. We Americans are at the point where we have all heard about 401k's and pensions and probably about IRA's and Roth's. And for the most part, we are relying on these strange creatures to feed and house us in the last years (decades?) of our lives. But precious few of us really understand retirement accounts. This post is meant to give you a bit of a run-down on how retirement plans work with a  quick graphic at the end to get you thinking about the plans that might work for you.

The Magic of Tax Deferral

Let's start with the basics—anytime we call something a "retirement" account, we are actually saying that the account has some special mention in the IRS's regulations that will amount to a temporary tax break. You noticed the word "temporary", right? Except for the Roth, which I'll get to in a minute, retirement plans allow you to put a certain amount of your income into the account instead of paying taxes on it...for now. It's called tax deferral, and you not only get out of paying the taxes the year you earned them, you also don't have to pay any capital gains taxes when you sell investments in that account over the years. That gives you the ability to freely move in and out of investments without the usual tax consequences and lets the income you originally put in keep compounding—assuming those investments you chose are any good.

But you do have to pay taxes eventually. In the case of retirement accounts, this happens when you start taking money out— a process known as taking distributions. What's more, the IRS has something to say about when you will be doing this. In most cases, you will pay a penalty for "early withdrawal" if you take your first distribution before age 55. And you will be required to start taking your money at age 70 1/2, because after all, the IRS won't wait forever.

The Roth IRA (often just called a Roth) is a little different. Like 401k's and regular IRA's, your money can grow free of capital gains taxes over the years in a Roth. But if you open one of these accounts, you put your money in after paying the income taxes. This means you won't get that immediate tax break, but believe it or not, this might actually work out well for you. When you do go to take money out of the Roth account, you don't have to worry about the taxes on the money you first put in the account (you already paid those taxes, after all). This can reduce the strain of taxes in retirement and may even mean paying a lower tax rate on that money, say, if you are in a higher tax bracket in your mature years.

In reality, the most successful savers will use both Roths and whatever other accounts they can. The caps on how much you can contribute to a retirement account often mean layering accounts to the extent you are able.

Defined Benefit vs. Defined Contribution

This is the biggest change in the U.S. retirement system over the past 50 years. Defined benefit plans are exactly that—the plan defines in advance how much you will get in benefits. Most of us just call these pensions, and they were the most common type of retirement income for most of our history. Based on the length of time you've worked at a job and the amount you earned, your HR department will calculate how much you get in your monthly check during retirement. Nowadays, though, you are far more likely to be offered a defined contribution plan. These plans set terms for how much you can contribute and make no promises whatsoever about what you get back later.

This change is a big deal— and not just because people are less likely to contribute to the often-voluntary defined contribution plans. In the case of a pension (defined benefits) someone else is taking the risk that the markets will go down or that the beneficiaries (including you) will live longer than expected. If you have a defined contribution plan, that risk is all on you. This means that you need to do some careful calculating and some educated guessing to come up with a balance of investments that will grow enough to cover your needs and will likely be there when you need them. The change over from defined benefits to defined contributions has made it necessary for Americans to become smart investors.

The Magic of Timing

If you are worried about living for more than a few years after your retirement, you are going to want to focus on your timing when it comes to retirement accounts. I am not referring to when you start putting money away here—the earlier the better, of course. Honestly, though, most successful retirees started saving at the peak of their careers, not the beginning. Get started when you can and work from there.

But you should be strategic about which accounts you put money into first and which accounts you start withdrawing from when.

The timing of adding to accounts is relatively simple for most people. We always start by looking to see if a client's employer will "match" contributions. If so, we maximize that first (getting someone else to fund your retirement is always good). If the client has his or her own business, even if it is a "side" business, we have a lot more to play with and timing will often depend on the needs of the business, which is often itself part of the retirement solution.

Taking out the money is different matter. The trick here is to take advantage of the incentives that employers and the government give you and to recognize the requirements. Social security, for instance, gives you all sorts of incentives to wait until 70, so if you can draw from a 401k account or an IRA instead during your 60's, you probably should. Likewise, an old company pension might give you a much better monthly payment for waiting. But you can only wait so long on IRA's and 401k's—as I mentioned above, the IRS requires that you start taking at least some distributions when you reach 70 1/2. The Roth, always the exception, allows you to keep money in that account as long as you want. Choosing which accounts to draw from and when is a delicate game of knowing your income needs, getting the most you can from the incentives and keeping an eye on the taxes you will pay as your start taking that retirement income.

Which Retirement Accounts Should You Use?

Retirement accounts are only one piece of the puzzle when you are coming up with a plan for enjoying life after 65. But they are one of the most important pieces. Here is a quick graphic showing the most popular types of retirement accounts and which ones you might want to learn more about:

Retirement Plan Choices


Is It High Finance or Just Hormones?


On this last day of the work week before the 4th of July weekend, I can't passing along this little tidbit.  A study published today in the journal Scientific Reports and picked up by Bloomberg Business News concludes that people—and by "people" I mean young men—with more testosterone and cortisol coursing through their veins were likely to make risky decisions about investments. Scientists ran a series of experiments involving make-believe stock market trading floors. After measuring hormone levels through saliva tests and setting the traders loose in groups of men, women or mixed-gender, the study found that young men, in particular, were prone to dodgy decision-making at higher hormone levels.  Here's what the scientists concluded: "Cortisol directly affected subjects’ willingness to take risks. Testosterone...was associated with significantly increased optimism regarding price change expectations, making subjects more likely to expect stock prices to increase." In other words, the hormones in our young, male traders might be destabilizing your retirement portfolio. As Oliver Staley from Bloomberg writes, "Want to calm financial markets? Add more women and older people to the young men on trading desks."

How To Choose An Investment

There is a vast sea of investment information out there— so much information, in fact, that it can be tough to know where to look. This post is going to tell you about the few key pieces of information you need to check before buying an ETF/Index or Mutual Fund and were to find that information on the internet. Let's start with some  screen shots from BlackRock's iShares S&P 500 Index, a popular ETF that has received a lot of attention in recent years.* Here's the header at the top of fund's web page—I've add the yellow comments to help things along:

Fund profile header

  Investment Objective

Ignore the price quotes with the pretty green and red arrows and look for the "Investment Objective." This tells us the goal of the fund, and it means you can immediately rule out funds that don't fit into your strategy regardless of where the arrows are pointing.

In this case, we are looking at a true index fund—the whole purpose of it is to invest in all or most of the large capitalization companies that make up the S&P 500. If you are trying to find a way to invest in a broad range of large U.S. companies, this might be right for you. But there are all sorts of other objectives out there. You will find funds trying to track small U.S. or international companies, track only energy companies, blend stocks and bonds, minimize taxes, minimize risk (i.e. "low volatility" funds) or even maximize risk in the search for higher returns. Just make sure the goal of the fund matches your goal as an investor.

And before you actually make a purchase, be sure to download and read that prospectus—fund companies are required by law to provide it to you.

Performance and Benchmarks

Assuming the objective matches yours, your next glance should be at performance. Online fund charts now often provide you up to the minute information on the fund's price, and the chart is almost always set to show you only the last year (and often, only the last day). A fund's past success never means that you can count on it to perform in the future, but the fund's performance over the past year is especially useless. Click on the 10 year (10Y) option to see how the fund has done over a much longer timeframe. And crucially, compare your fund's performance to its benchmark.

What is the benchmark? The benchmark will be the market index that best matches up with the fund's investment objective. If the fund tracks bonds, it will be a bond index; if it tracks technology companies, it should be a technology index. The benchmark gives us a better idea of how well the fund is doing at what is designed for.

Fund Profile Key Facts

 Fees: What are you paying?

Investors routinely miss this little statistic (I couldn't even find it on Google Finance or Yahoo Finance's page for IVV), but this one is a big part of your decision. The Expense Ratio will be a percentage, and it tells you how much of the money you put into the fund will go to paying for fund management fees every year. To find out what you personally will be paying every year to own the fund, multiply the percentage by the amount you plan to invest.

In this case, I've chosen to show you one of the least expensive funds out there—you won't find many this cheap. Mutual funds on average range between 1 and 2%, while Index Funds average somewhere around .5% (it takes more work to manage a collection of stocks than have your computer track an index!).

You will find plenty of cases where two funds with similar holdings and objectives vary wildly in price, so make sure you aren't losing you money to management fees right off the bat.

Holdings and Risk

Now let's look at the bottom of the fund profile page:

Fund Profile Holdings

If the fund has been clear and accurate with it's objectives, the holdings list at the bottom should not come as a surprise, but you should always take a quick glance at what you are buying. Does it overlap a lot with another fund you own? That's a warning sign that you may be paying for two funds where you only need one.

Now note the "Standard Deviation." This number will be a percentage, and it is meant as a quick indicator of how volatile the investment is likely to be—how much it's price will go up and down. Here we see that IVV's standard deviation is 9.58%, which is not coincidentally about the same deviation as the S&P 500 Index. Don't worry too much about how this number is calculated, just know that 9.58% puts IVV in the middle of the pack (deviation-wise) for publicly traded funds. At the riskier end are things like emerging markets, which might have standard deviations around 20% and "low" or "managed" volatility funds, which might have standard deviations of only 3% to 4%.

Standard Deviation is not the only indicator we use to determine whether an investment is risky (other common measures of riskiness include alpha, beta, Sharpe ratio, and R-Squared), but it does give the average investor some warning about how much an investment's price is likely to swing up and down.

One More Factor To Consider

If you are looking at a mutual fund, rather than an ETF, you may have to contend with minimum investments, especially if you are buying within another investment company. Check the sidebars of your fund profile to see if there is a minimum. And if you do see one, but like the fund, check the fund company's own website to see if it available directly through them without minimums.

*note that this does not constitute an investment recommendation for any of you out there—just an investment example.