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Are ETFs Truly the Best Way to Invest?

September 24, 2021 By Lauri Salverda, CFA, CFP®, AIF®

There has been a lot of talk recently about how it is best for individual investors to invest in Exchange Traded Funds (ETFs) vs. Mutual Funds.  Although some of the rationale is strong, you need to know in what you are actually investing. Let’s start with the basics.

What is an ETF?

Exchange Traded Funds (EFTs) is an investment that pools money from investors and uses those funds to buy a basket of stocks, bonds or other securities. You purchase a share of an ETF just as you would purchase a share of a stock. ETFs typically track a market index or commodity, although actively managed ETFs are becoming more popular. An active fund manager tries to outperform an index by being more selective in the investments it owns. 

What is a Mutual Fund?

A mutual fund is an investment that pools money from investors and uses those funds to buy a basket of stocks, bonds or other securities. You purchase a mutual fund directly from the fund company. The manager of the fund and their analysts try to pick the best investments available rather that a set group of stocks or bonds.

Similarities and Differences

  • Pricing: The pricing difference can be significant. Mutual funds are priced once a day after the market closes and the value of the stocks at the end of the day. ETFs are traded while the market is open similar to stocks. The value of the EFT is determined by the bid and ask price, i.e., the price at which someone would pay for a share of that ETF vs. the price at which someone would sell that ETF.  If the market is volatile the difference between the bid and ask price could be significant. 
  • Expense Ratio: The internal costs or operating expenses of the fund expressed as a percentage of the funds value is the expense ratio.  This includes portfolio management, trading expenses, marketing, administrative and distribution expenses among others.  Although in the past it was typical for an ETF to have a lower expense ratio than a Mutual Fund, this trend, although still exists, is narrowing.  Mutual Funds are reducing expense ratios to be more competitive and as actively managed ETFs are becoming more popular some ETF expense ratios are increasing.
  • Holdings: I believe that what is actually held by a Mutual Fund or ETF can be the most important aspect of the fund.  Unfortunately, this research, although readily available, is not typically performed by purchasers. Here are a couple of examples:
    1. two seemingly identical Standard & Poor’s 500 stock index (a large company index) ETFs have very dissimilar returns. That is because one purchases the same number of shares of each stock in the index, while the other purchase an equal dollar amount of each stock in the index.
    2. I was just looking up a tech company in the Netherlands. It was a large company stock that had been over valued (the value of the stock vs. its price) by Morningstar (a rating company) for the last 4 years.  I then looked at the funds that had the largest holdings in this stock.  The top three funds were a low-priced stock Mutual Fund, a Standard & Poor’s 500 Index, and a mid-cap stock index.  By looking at the titles of these funds this stock, a member of the Standard & Poor’s 500, only should have been in the Standard & Poor’s 500 Index. The stock is not a low-priced stock nor is it a mid-cap stock.

The point of this is that you are responsible to know what you are purchasing and to make sure you are investing in what you are thinking you are.  Look at how much it is costing you to invest in the fund and that when you choose to buy or sell you are getting a fair price. You would not purchase a car without doing your research and looking under the hood, do the same with your investments.

Filed Under: Blog Posts

Castle Rock named one of Top Financial Advisors in St. Paul by Expertise for Third Year Running

August 1, 2021 By Lauri Salverda, CFA, CFP®, AIF®

Thanks to review specialist Expertise for ranking Castle Rock as one of the Best Financial Advisors in St. Paul for the third year in a row! Expertise reviewed more than 80 financial advisors serving the St. Paul area, rating across more than 25 variables to determine the best local experts. Castle Rock is thrilled to have made the shortlist of the Top 17 Financial Advisors in St. Paul! Thanks to the team at Expertise for their research, focus on quality, and commitment to ensuring all consumers can make confident decisions in the experts they select.

Filed Under: Blog Posts

Making Summer Jobs More Lucrative for Your Children and Young Adults

July 4, 2021 By Lauri Salverda, CFA, CFP®, AIF®

I have been thinking about the long-term impact of high school and college kids finding work during the summer.  One thing I think we can do as adults to encourage young adults to work is educate them about how a job is a form of investing in themselves and their future. 

Start with talking about saving for retirement.  (I know, what could be less interesting to kids than talking about retirement!)  One important piece of information to highlight is that there is a special account designed for them with many special benefits: we are talking about a Custodial Roth IRA.  Laugh as you may, but there can be some hidden benefits that would entice any kid to start saving.

Let’s talk about the benefits

  1. You can save up to the lesser amount of either earned income (i.e. W-2 wages) or $6,000 in 2021.
  2. Parents can make contributions to a custodial Roth IRA on behalf of their children as long as the total contribution, both parent and child, remains at the lesser amount of either earned income (i.e. W-2 wages) or $6,000 in 2021.
  3. The money goes into the account after taxes are paid, but the child typically has a 0% tax rate. And the interest earned or capital gains on the Custodial or regular Roth IRA are never taxed. 
  4. Once the account has been open for 5 years, the principal can be taken out without penalty.  The earnings have to be left in the account or there will be a 10% penalty due. The 5-year rule is based on a calendar year.  If the Roth is open on December 31st of 2021 on January 1st, 2026 the 5-year rule has been met.
  5. While it is expected that 20% of children’s assets are to be used each year to pay for college expenses each year when applying for financial aid via a FAFSA (Free Application for Student Aid) application, retirement assets are not included for either adults or student.

Ways to discuss the benefits and teach financial concepts

  1. Help them to set up a budget to determine how much they can save.  Calculate what their expected earnings are, what are reasonable expenses and do they need additional money during the school year to pay for books or pizza.
  2. Take the opportunity to teach them about investing, such as:
    1. the difference between a stock (ownership in a company) and a bond (lending to an entity);
    1. the difference between a mutual fund (a group of stocks and/or bonds) and an ETF, Exchange Traded Fund, (a group of stocks and/or bonds that follow an index);
    1. the risk of declining or increasing in value; and
    1. the average on the S&P 500 (an index of 500 large capitalized firms) average annual market return is still 10% over the last 300 years.
  3. Take them to a meeting with your financial advisor and have them explain the markets, and how to select a stock, bond, mutual fund or ETF as their first opportunity to invest.  Alternatively, have them pick a company that they like or use their products, or think is cutting edge and let them buy that company’s stock.
  4. Offer to match what they put in as an incentive or gift them the first $100 to get them started.
  5. The 5-year rule is important simply because the money that is put into the account may be available to help pay student loans, put a down payment on a first apartment or the down payment on their first home.  Meanwhile the remaining earnings in the account can continue to grow.
  6. And best of all, if they leave the money alone, they will have a great start at funding their retirement.  Say they are going to be a senior in high school, if they invest $500 over the next 4 years, a $2,000 investment at an average annual return of 10% they will have $186,000 at their full retirement age of 67.  This also brings up the chance to teach the Rule of 72, take the number 72 and divide it by the expected return on your investment and the answer will tell you how long it takes for your money to double.  An example, if your expected return is 10% take 72/10=7.2, in 7.2 years your money will double in 14.4 years you will have 4x what was originally invested and in 21.6 years you will have 8x the original investment and that is without contributing a penny more.  The joy of compounding!

As adults, we can make it fun for your children and young adults to see the benefits of saving money for future needs, whether it is retirement or a down payment on a home.  It provides future freedom from financial worries and the ability to reach their goals.

Filed Under: Blog Posts

What is all the talk about NFTs?

April 5, 2021 By Lauri Salverda, CFA, CFP®, AIF®

Digital currency like Bitcoin has been around since 2009 and has widened our understanding of what currency looks like. Now there’s a new currency making waves: NFTs.

What is an NFT?

We’re all at least somewhat familiar with Bitcoin by now: it’s a digital currency, with balances kept on a public ledger and created through a mathematical encryption algorithm. The “encryption” part is what makes a digital currency also meet the definition of a cryptocurrency. Bitcoin uses huge amounts of computing power to verify transactions using complex mathematical equations. (In fact, the amount of computing power so massive, the annual carbon emissions from the electricity required to mine Bitcoin and process its transactions are equal to the amount emitted by all of New Zealand.)

But now, more than a decade after the launch of Bitcoin and the launch of many similar cryptocurrencies, the financial sector is seeing something new and exciting: the nonfungible token (NFT).

So, how does an NFT compare to Bitcoin?

  • Both are verified using blockchain technology, a unique network of computer recorded transactions that provides buyers proof of authentication and ownership.
  • Cryptocurrencies like Bitcoin are considered fungible tokens because they are identical to each other and therefore can be used as a form of currency—they are essentially “electronic cash.”
  • An NTF can take many forms including videos, .jpg, songs, or any digital asset. NTFs shift the crypto paradigm by making each token unique and irreplaceable.

Why are NFTs so popular?

Most importantly, NFTs provide artists who use digital mediums, who had been previously left out of the art sales market, a way to receive payment for their creations. For example, the artist Mike Winkelmann, also known as Beeple, just sold his NFT creation “Everydays – The First 5000 Days” at Christie’s for $69.3 million, the third highest price achieved by a living artist.

Other popular NTFs include Dapper Labs, who partnered with the NBA and in 2020 released their beta version of their TopShot collectable and tradable NFT app. In October of 2020, Dapper Labs released its full version to its fans and by February 28. 2021 reported over $230 million in gross sales.

One of the exciting elements of NTFs is that they appear to be forming new markets and forms of investment. In the future you may be able to break up parcels of land easily by taking pictures of the various areas within that parcel and sell each area as an NFT, rather than selling the entire parcel.

Are NFTs a good investment?

It is still a budding market having just started in 2017.  With the activity around the world and digital art auctions at Christie’s, it is clear that NTFs have taken the art market by storm.  It has started strong, but remains to be seen over the long haul, if value is retained.  As in all markets, there are always risks of booms and busts, but because of the newness of this market, no one can say for sure where we are now.

Filed Under: Blog Posts

How do you value a bond?

January 7, 2021 By Lauri Salverda, CFA, CFP®, AIF®

Recently, someone asked me “How do you value a bond?” I thought others may have the same question.

First, we need to understand what a bond is. A bond is similar to a loan: you are lending an amount of money to a corporate or government borrower, who then issues you a bond. The issuer promises to pay you interest semi-annually and pay the principal back at maturity.  When looking at the value of the bond, there are five important questions which need to be asked.

  1. What is the face value of the bond, i.e., what is the “par” value of the bond?
  2. What is the interest rate that the bond states it will pay, i.e., what is the “coupon” rate?
  3. When does it mature?
  4. Can the bond be paid off early, i.e. is it “callable”?
  5. What is the current yield on a similar type of bond of equal quality?

While the first four questions will give us a sense of the technical parameters of my bond, the question of current yield varies with the market and requires we do more analysis.

Let’s use an example to explain.  I own a $1,000 bond that pays a 5% interest rate (coupon), matures in 10 years and cannot be paid off early (non-callable).  If current yields on a bond similar to mine are 5%, the value of my bond is $1,000. 

But what if current yields are higher or lower?

If a current yield on a similar bond is 3%, the value of my 5% bond is higher than the face value because my bond has a higher return. Let’s walk through it:

  • My 5% bond is paying me $25 semi-annually for a total of $50/year, while current 3% bonds are paying $15 semi-annually for a total of $30/year.
  • If I were to reinvest that $1,000 in a new bond, I would only receive a 3% annual yield. Therefore, I would want to sell that bond for more than $1,000 value it states on the bond (par), so I can reinvest my money to get the equivalent of my 5% return.
  • Thus, I would sell it for $1,667 so that if I reinvested that money at a 3% current return, I would receive an interest payment of $25 semi-annually and $50 annually.

Similarly, if current yields increase to 7%, no one would want my 5% bond because the returns on my bond would be lower. I would have to sell it at a discounted value compared so that the person buying it would receive a yield of 7%. 

A good way to think about the value of a bond is a teeter-totter. The chart below shows the value of my bond in different yield environments.

Now, what if we change some of the other technical parameters of the bond?

If my bond was callable prior to maturity, a buyer would have to evaluate whether it is likely that the bond would be paid off, or “called” by the issuer prior to its maturity date.  This means that the issuer pays the principal amount of the bond prior to its maturity and then stops paying interest.  Think of your mortgage, if current yields are lower than when you financed your mortgage, you would probably refinance your mortgage to pay a lower interest rate.  In some circumstances, an issuer has a bond that has the option to pay it off early (callable), they may choose to issue new bonds at a lower coupon and pay off the higher coupon bonds.  In the previous example, we were calculating how much I would pay if the bond continued paying its coupon until the maturity date.  If there is a possibility of paying the bond off early, I would figure out the price of it to the earliest day it can be paid off (call date) rather than its maturity date.

Another type of bond is a zero-coupon bond.  These are typically offered by the Treasury Department but can be issued by any issuer. These bonds do not pay any interest during the holding period, i.e. zero interest.  Therefore, I would purchase that bond at a discount based on current yields. If current yields were 5%, and it will pay $1,000 upon maturity 10 year from now, I would buy it for $610, which would provide me a yield of 5% on the money I invested.

Another issue affecting a bond would be the quality of the issuer of the bond and from what funds will it be paid. If I purchased a bond from a high-quality issuer which eventually erodes its ability to pay the bond at maturity, the value of that bond would drop.  I would need to receive a higher yield to take on the risk of the issuer. 

There can be many market conditions that can affect the value of the bond, but if you can answer the above 5 questions, you will be able to determine the current value at any point of time. 

Filed Under: Blog Posts Tagged With: bonds, valuation

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Recent Posts

  • Are ETFs Truly the Best Way to Invest? September 24, 2021
  • Castle Rock named one of Top Financial Advisors in St. Paul by Expertise for Third Year Running August 1, 2021
  • Making Summer Jobs More Lucrative for Your Children and Young Adults July 4, 2021
  • What is all the talk about NFTs? April 5, 2021
  • How do you value a bond? January 7, 2021
  • ESG Investing: the What and the Why October 1, 2020
  • Women financial planners group rings in 25th anniversary with $25,000 donation to promote women, diversity in the industry August 6, 2020
  • Planning Your Estate June 22, 2020
  • Castle Rock Named One of the 2020 “Top 16 Financial Advisors in Saint Paul” by Expertise June 2, 2020
  • Three Tips to Grow Your Impact: Vetting a Nonprofit or Charity December 1, 2019

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lauri@castlerockfp.com
651-294-0013

Recent Blog Posts

  • Are ETFs Truly the Best Way to Invest? September 24, 2021
  • Castle Rock named one of Top Financial Advisors in St. Paul by Expertise for Third Year Running August 1, 2021
  • Making Summer Jobs More Lucrative for Your Children and Young Adults July 4, 2021

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