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18313344ae7f4438027129400e47f9e4 | https://www.investopedia.com/articles/markets/093014/how-wells-fargo-became-biggest-bank-america.asp | How Wells Fargo Became One of America's Biggest Banks | How Wells Fargo Became One of America's Biggest Banks
Wells Fargo (WFC) is among the top five banks in the United States, ranking in the third sport as of mid-2020, after JPMorgan Chase and Bank of America. According to the company, it has more than $1.97 trillion in assets. The bank serves more than 70 million customers across the country and has more than 266,000 employees. The bank had a market capitalization of $97.4 billion as of Aug. 21, 2020. Wells Fargo reported net income of $19.55 billion earnings for the 2019 fiscal year.
Banking is the ultimate intangible industry, moving assets from lower-valued to higher-valued uses in the most impalpable of ways. But that still leaves plenty that distinguishes Wells Fargo from its major U.S. competitors starting with its size and its reach. So how does the bank make money? One way is by lending out money at a higher rate than it borrows. But there's more to it than just earning money in interest. This article looks at how Wells Fargo earned its spot among the other big banks in the country.
Key Takeaways Wells Fargo is among the top five banks in the United States.In simple terms, the bank makes money by lending out at a higher rate than it borrows.Wells Fargo operates three divisions including Wealth and Investment Management, Wholesale Banking, and Community Banking.The company's Wholesale Banking unit is the most profitable, bringing in more money than the other two divisions.
Big, Regional Acquisitions
Wells Fargo was created by the merger of large super-regional banks. Founders Wells and Fargo created their namesake in 1852 to cater to the growing population of gold miners and related hangers-on in California, which back then was in the early stages of its transition from distant backwater to most populous and economically powerful state in the union.
After close to a century and a half of steady growth, Wells Fargo merged with Norwest Corp. in 1998. A decade later, Wells Fargo bought out East Coast giant Wachovia. Add them all together, and Wells Fargo can now claim over 70 million customers from coast to coast.
Today, Wells Fargo officially divides its operations into three categories for management reporting purposes.
Wealth and Investment Management
This segment services business clients and high-net-worth individuals (HNWIs) by offering them wealth management services, as well as investment and retirement products. Some of these services include financial planning, credit, and private banking.
Wholesale Banking
Wells Fargo's wholesale banking division tends to the financial needs of U.S.-based and global businesses. There are 13 different business lines that fall under this category including business banking, corporate banking, commercial real estate, insurance, and credit risk.
Community Banking
This part of the bank's operations services retail and small business clients with their everyday banking needs. Some of the services include checking and savings accounts, loans, mortgages. The bank serves these clients in its branches and by way of its automated teller machines (ATMs).
Serving the Rich and the Mass Market
Wealth and Investment Management means financial services for rich people. This end of Wells Fargo’s business doesn't just dispense advice, it also helps in other ways such as setting up foundations or solving inheritance issues before they arise. Every rich person knows—at least in the United States—that preserving one’s affluence can be almost as much work as it was to get wealthy in the first place. All told, Wells Fargo reported $2.7 billion of net income from wealth management, brokerage, and retirement in 2019. If that sounds substantial, it’s easily the least lucrative of the bank’s three areas of operations.
The word wholesale has a slightly different meaning in banking than it does elsewhere. Plenty of banks don’t even use the term. But at Wells Fargo, it’s a catch-all for underwriting and selling asset-backed securities along with other types of banking for large corporations and even other banks.
Not Just Retail Banking
Actually, that doesn't even begin to cover it. Wholesale Banking includes, for instance, equipment financing. If you want to buy a dragline for your surface mining project and don’t have the $35 million or so on hand to pay for it with cash, Wells Fargo can front you the money.
Wells Fargo also handles crop insurance, commercial real estate, energy syndicated loans, and more. Many of the Fortune 500 companies do at least some wholesale banking with Wells Fargo. That’s when they’re not transferring their risk.
You'd need annual revenues of at least $5 million in order to become a Wells Fargo wholesale customer.
When a multinational with tens of millions of dollars in cash on its balance sheet needs somewhere to store that cash, Wells Fargo's wholesale division is where they do business. To be a Wells Fargo wholesale customer, you need annual revenues of at least $5 million. Wells Fargo’s wholesale operations have even greater reach than its community operations do. The bank has wholesale offices in 42 states that are manned by more than 30,000 employees. That’s to say nothing of its wholesale offices across the globe, from Santiago to Seoul, Calgary to Cairo, and Sydney to St. Helier. All told, net income from wholesale banking totaled $10.7 billion in 2019—far more than wealth, brokerage, and retirement operations.
Community Banking, Above All
Now let's look at the community banking section. Community banking net income was $7.4 billion in 2019 on total annual revenue of $85 billion. That margin might seem high, but it really isn’t. If you’ve ever been skeptical of how you can possibly be so big a profit center to a bank, what with your modest checking account balance and your restrained use of your debit card, understand that community banking is more than just ordinary people depositing their paychecks and maybe buying the occasional mortgage.
According to the company, the community banking segment includes "checking and savings accounts, credit and debit cards, and automobile, student, mortgage, home equity and small business lending," in addition to "the results of our Corporate Treasury activities net of allocations (including funds transfer pricing, capital, liquidity, and certain corporate expenses) in support of other segments and results of investments in our affiliated venture capital and private equity partnerships."
Scandals
The Federal Reserve imposed a cap on Wells Fargo's assets worth more than $1.95 trillion due to its "widespread consumer abuses." The cap caused the bank to lose hundreds of billions of dollars in stock market value. Wonder why? Here's a long, but not exhaustive, list of the company's scandals.
In December 2013, the L.A. Times reported that desperate branch employees opened fake accounts and credit cards in order to meet their sales quotas. At the time of the story, the bank denied all the claims. It was only three years later in 2016 that the company admitted that over 3.5 million unwanted accounts were opened.
Here's why. In order to get bonuses, Wells Fargo employees needed to hit huge sales goals that many felt were unrealistic. Instead of finding real customers, employees just created accounts for existing Wells Fargo customers unbeknownst to them. The employees even used fake email accounts and personal identification numbers (PINs) to sign them up, seemingly hoping no one would notice. Small amounts of money were even transferred to these accounts to make them look real.
Wells Fargo promised to refund customers who had improper fees as a result of this business practice and fired 5,300 employees. Even the bank's chief executive officer (CEO) stepped down. According to the New York Times, Wells Fargo paid "more than $1.5 billion in penalties to federal and state authorities and $620 million to resolve lawsuits from customers and shareholders."
On April 20, 2018, it was announced that the Consumer Financial Protection Bureau (CFPB) and the Office of the Comptroller of the Currency fined Wells Fargo $1 billion for the mistreatment of its auto loans and mortgage consumers.
In June 2018, the Securities and Exchange Commission (SEC) revealed an investigation found Wells Fargo supported active trading by brokerage clients on high-fee debt products that were supposed to be held to maturity. Without admitting or denying guilt, the bank settled by agreeing to repay $1.1 million in ill-gotten gains and interest as well as $4 million in penalty.
In August 2018, the company paid a penalty of $2 billion for allegedly misrepresenting the quality of residential mortgage loans a decade earlier.
Wells Fargo CEO Tim Sloan, who spent 31 years at the company and was trying to restore trust in the brand, stepped down unexpectedly in March 2019. "It has become apparent to me that our ability to successfully move Wells Fargo forward from here will benefit from a new CEO and fresh perspectives," he wrote in a statement. Sloan faced pressure to resign from regulators and critics who saw him as too much of an insider to reform the bank's culture.
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137efc42ae87bf28134b9513b70b016e | https://www.investopedia.com/articles/markets/100214/inside-intel-look-mega-chipmaker.asp | Inside Intel: A Look At The Mega Chipmaker | Inside Intel: A Look At The Mega Chipmaker
Never has a corporation done so much with something so little. Founded in 1968, Intel Corp. (INTC) has been the world’s leading manufacturer of microprocessors and chipsets almost since its inception. Today Intel is easily the largest semiconductor company in the world, about half again as large as closest competitor, Samsung Electronics Co., Ltd., and more than triple the size of the next-largest domestic producer, Qualcomm Inc. (QCOM).
What separates Intel from most other semiconductor companies is that it fabricates its products in-house. The bulk of semiconductor “manufacturers” farm the actual work of creating the products out to foundries in China. Intel even fabricates chips for other companies, for the most part ones too small to be considered true competitors. Is that a conflict of interest? Not really. Fabrication plants can cost several billion dollars to build, and it makes sense for Intel to keep its busy. (For more, see: The Semiconductor Industry Handbook.)
Intel does indeed assemble chipsets in China, but at Intel-owned facilities. It is received wisdom among some American doomsayers that low labor costs make China the default base of manufacturing operations for U.S. corporations that want to save a few pennies per unit and “ship jobs overseas.” That claim is more accusatory than it is true. At the end of 2016 Intel had a multitudinous workforce of 106,000, approximately half of whom were employed in the United States. Almost half of Intel’s chipsets and microprocessors are manufactured at home, at facilities in the suburbs of Phoenix, Albuquerque, N.M., and Portland, Ore. Outside of China, most of the remaining Intel products are developed in Israel. (For more, see: A Primer for Investing in the Tech Industry.)
The Incestuous World of Chip-sourcing
Even given that Intel fabricates other companies’ chips at its facilities, the business of developing internal computer hardware, selling it, and branding it is more incestuous than you might think. For instance, as of 2007 Apple Inc. (AAPL) began using Intel chips exclusively in its Macs, supplanting the PowerPC CPUs that Apple itself helped develop as part of a consortium. In 2018, it was reported that Apple may use Intel chips exclusively in its new iPhones. By comparison, smaller companies subcontracting to Intel isn’t even that big of a deal.
Moore's Law
Intel’s surviving cofounder, Gordon Moore, lends his name to the most famous observation in all of technology. Formulated in 1965, Moore’s Law states that transistor density doubles every two years. Not only has the observation held ever since, but Intel has officially incorporated the law into its company strategy. The company is behind the development of 450mm wafers, the widest in existence, yet still less than a millimeter thick. Once in production, they should allow the exponential progress of Moore’s Law to continue for at least another generation.
So who’s buying all these Intel chips? In 2008, the answer was unambiguous. Hewlett-Packard Co. (HPQ), Dell and International Business Machines Corp. (IBM), not coincidentally the three-biggest computer manufacturers at the turn of the century, were together responsible for $3 of every $4 Intel took in. A mere six years later, with bulky personal computers no longer the devices of choice for a global clientele that values portability and speed, Intel now has eight major customers that are responsible for 75% of its revenues. In 2016, Intel's three largest customers were responsible for 31% of the firm's accounts receivable. Intel might obey Moore’s Law, but the Pareto Principle (a.k.a the 80/20 rule) is a different story.
Stagnant Revenue, Changing Market
Intel’s revenue growth has slowed dramatically since the beginning of the decade. Never mind the limits of integrated circuit density, has Intel come up against the limits of the growth to revenue? The people who run Intel are far from stupid, and the company’s transition from monolithic desktops to smaller devices has been underway for a while. Capitalizing on the leverage of its market-leading position, Intel has shifted its concentration to smaller devices and embedded systems. The latter refers to chips placed in something other than stand-alone computers, which can include everything from cars and planes, to traffic signals and factory assembly lines.
Like any corporation of its size ($205.7 billion market capitalization), Intel has an elaborate business organization. The company’s major divisions include the Client Computing Group; which includes desktop computers, notebooks, and tablets, the Data Center Group; which includes products for cloud communications and infrastructure, and the Internet of Things Group; which includes products designed for internet connectivity in areas like retail, transportation, industrial, video, buildings and smart cities. In addition to semiconductors and chips, Intel also produces security software products.
PCs Still King
The era of the 30-pound table-mounted mini tower might be fading, but it’s still very much active and will be for a while. 55% of Intel’s operating revenue comes from its Client Computing business, a ratio that lowers gradually from one year to the next.
Dell Inc. is the company’s biggest customer, accounting for 15% of Intel revenue. Right behind at 13% is Lenovo Group Ltd., which bought IBM’s personal computer business in 2005 and immediately became a huge Intel client, almost by default.
Intel grossed $62.8 billion in 2017. Its business is truly international, with the United States only its second-biggest market. The biggest customer is China, which bought nearly $14 billion worth of Intel products last year. The third-largest market is Singapore, which accounted for $12.7 billion of Intel's revenue.
The Bottom Line
Some companies dominate an industry, fail to innovate, and fall into irrelevance (e.g. Howard Johnson, Kodak.) Others have great ideas but never manage to capitalize on them. The company that can leverage intellectual firepower with commanding market share is the company that can stay both powerful and relevant for decades. Intel is the archetype, and is situated to continue to be, well into the future.
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88c898089237c3a93c144ed5805aff45 | https://www.investopedia.com/articles/markets/100515/how-start-your-own-private-equity-fund.asp | How to Start Your Own Private Equity Fund | How to Start Your Own Private Equity Fund
Private equity firms have been a historically successful asset class and the field continues to grow as more would-be portfolio managers join the industry. Many investment bankers have made the switch from public to private equity because the latter has significantly outperformed the Standard & Poor's 500 Index over the last few decades, fueling greater demand for private equity funds from institutional and individual accredited investors. As demand continues to swell for alternative investments in the private equity space, new managers will need to emerge and provide investors with new opportunities to generate alpha.
Key Takeaways Private equity firms are growing thanks to their outperformance of the S&P 500. Starting a private equity fund means laying out a strategy, which means picking which sectors to target. A business plan and setting up the operations are also key steps, as well as picking a business structure and establishing a fee structure. Arguably the toughest step is raising capital, where fund managers will be expected to contribute 1% to 3% of the fund’s capital.
Today's many successful private equity firms include Blackstone Group, Apollo Global Management, TPG Capital, Goldman Sachs Capital Partners, and the Carlyle Group. However, most firms are small to midsize shops and can range from just two employees to several hundred workers. Here are several steps managers should follow to launch a private equity fund.
Define the Business Strategy
First, outline your business strategy and differentiate your financial plan from those of competitors and benchmarks. Establishing a business strategy requires significant research into a defined market or individual sector. Some funds focus on energy development, while others may focus on early-stage biotech companies. Ultimately, investors want to know more about your fund's goals.
As you articulate your investment strategy, consider whether you will have a geographic focus. Will the fund focus on one region of the United States? Will it focus on an industry in a certain country? Or will it emphasize a specific strategy in similar emerging markets? Meanwhile, there are several business focuses you could adopt. Will your fund aim to improve your portfolio companies' operational or strategic focus, or will this center entirely on cleaning up their balance sheets?
Remember, private equity typically hinges on investment in companies that are not traded on the public market. It's critical that you determine the purpose of each investment. For example, is the aim of the investment to grow capital for mergers and acquisitions activity? Or is the goal to raise capital that will allow existing owners to sell their positions in the firm?
Business Plan, Operations Setup
The second step is to write a business plan, which calculates cash flow expectations, establishes your private equity fund's timeline, including the period to raise capital and exit from portfolio investments. Each fund typically has a life of 10 years, although ultimately timelines are up to the manager's discretion. A sound business plan contains a strategy on how the fund will grow over time, a marketing plan to target future investors, and an executive summary, which ties all of these sections and goals together.
Following the establishment of the business plan, set up an external team of consultants that includes independent accountants, attorneys and industry consultants who can provide insight into the industries of the companies in your portfolio. It's also wise to establish an advisory board and explore disaster recovery strategies in case of cyberattacks, steep market downturns, or other portfolio-related threats to the individual fund.
Another important step is to establish a firm and fund name. Additionally, the manager must decide on the roles and titles of the firm's leaders, such as the role of partner or portfolio manager. From there, establish the management team, including the CEO, CFO, chief information security officer, and chief compliance officer. First-time managers are more likely to raise more money if they are part of a team that spins out of a previously successful firm.
On the back end, it's essential to establish in-house operations. These tasks include the rent or purchase office space, furniture, technology requirements, and hiring staff. There are several things to consider when hiring staff, such as profit-sharing programs, bonus structures, compensation protocols, health insurance plans, and retirement plans.
Establish the Investment Vehicle
After early operations are in order, establish the fund’s legal structure. In the U.S., a fund typically assumes the structure of a limited partnership or a limited liability firm. As a founder of the fund, you will be a general partner, meaning that you will have the right to decide the investments that compose the fund.
Your investors will be limited partners who don't have the right to decide which companies are part of your fund. Limited partners are only accountable for losses tied to their individual investment, while general partners handle any additional losses within the fund and liabilities to the broader market.
Ultimately, your lawyer will draft a private placement memorandum and any other operating agreements such as a Limited Partnership Agreement or Articles of Association.
Determine a Fee Structure
The fund manager should determine provisions related to management fees, carried interest and any hurdle rate for performance. Typically, private equity managers receive an annual management fee of 2% of committed capital from investors. So, for every $10 million the fundraises from investors, the manager will collect $200,000 in management fees annually. However, fund managers with less experience may receive a smaller management fee to attract new capital.
Carried interest is commonly set at 20% above an expected return level. Should the hurdle rate be 5% for the fund, you and your investors would split returns at a rate of 20 to 80. During this period, it is also important to establish compliance, risk and valuation guidelines for the fund.
Raise Capital
Next, you will want to have your offering memorandum, subscription agreement, partnership terms, custodial agreement, and due diligence questionnaires prepared. Also, marketing material will be needed prior to the process of raising capital. New managers will also want to ensure that they have obtained a proper severance letter from previous employers. A severance letter is important because employees require permission to boast about their previous experience and track record.
All of this leads ultimately leads you to the biggest challenge of starting a private equity fund, which is convincing others to invest in your fund. Firstly, prepare to invest your own fund. Fund managers who had had success during their careers will likely be expected to provide at least 2% to 3% of their money to the fund's total capital commitments. New managers with less capital can likely succeed with a commitment of 1% to 2% for their first fund.
In addition to your investment track record and investment strategy, your marketing strategy will be central to raising capital. Due to regulations on who can invest and the unregistered nature of private equity investments, the government says that only institutional investors and accredited investors can provide capital to these funds.
Institutional investors include insurance firms, sovereign wealth funds, financial institutions, pension programs, and university endowments. Accredited investors are limited to individuals who meet a specified annual income threshold for two years or maintain a net worth (less the value of their primary residence) of $1 million or more. Additional criteria for other groups that represent accredited investors are discussed in the Securities Act of 1933.
Once a private equity fund has been established, portfolio managers have the capacity to begin building their portfolio. At this point, managers will start to select the companies and assets that fit their investment strategy.
The Bottom Line
Private equity investments have outperformed the broader U.S. markets over the last few decades. That has generated increased demand from investors seeking new ways to generate superior returns. The above steps can be used as a roadmap for establishing a successful fund.
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86ff85f2c62ab0b7995f4f265a9b50cd | https://www.investopedia.com/articles/markets/100715/6-biggest-russian-energy-companies.asp | The 6 Biggest Russian Energy Companies | The 6 Biggest Russian Energy Companies
Russia ranks high among the top energy-producing countries in the world. According to the most recent industry data available, Russia is the world's single biggest producer of crude oil, the second-biggest producer of natural gas and the sixth-biggest producer of coal. Russia also ranks as the fourth-biggest producer of both nuclear power and hydropower.
Most of Russia's biggest energy companies, including global giants such as Gazprom, Rosneft, and Lukoil, operate primarily in the oil and gas industry, with interests spanning the full length of the oil and gas supply chain. However, a hydroelectric power company, RusHydro, also makes a showing on this list of Russia's biggest energy companies by market capitalization.
1. Gazprom
Gazprom is Russia's biggest energy company by a substantial margin. The company controls the largest natural gas reserves in the world, from which it produced more than 2.6 billion barrel of oil equivalents (BOE) in 2014, accounting for 72% of Russia's total gas output for the year. Oil production amounted to about 257 million barrels. Additionally, Gazprom's gas turbine power plants account for about 15% of Russia's installed power generating capacity. Gazprom is ultimately controlled by the Russian government, which holds just over 50% of the company's outstanding shares. Its market capitalization is nearly $50.5 billion.
2. Rosneft
Rosneft is Russia's biggest oil producer, accounting for more than 40% of total output in 2014. The company reported production of more than 1.5 billion barrels, more than double the production of its closest competitor, Lukoil. Rosneft also produced over 345 million BOE of natural gas, making it the third-largest gas producer in the country. Rosneft has a market capitalization of more than $41 billion. Nearly 70% of its outstanding shares are held by the Russian state.
3. Lukoil
Lukoil produced about 707 million barrels of oil and more than 92 million BOE of natural gas in 2014 to place it firmly in the top tier of Russian energy giants. Like Gazprom and Rosneft, Lukoil controls large gas and oil reserves inside Russia in addition to substantial operations outside the country. Although the company's power generation assets have grown substantially in recent years, it accounts for less than 1% of the country's installed generation capacity. Lukoil has a market capitalization of more than $28.3 billion.
4. Surgutneftegas
Although Surgutneftegas has no substantial business operations outside Russia, it ranks among the world's largest 250 companies in any industry. It reported production of about 447 million barrels of oil and more than 55 million BOE of natural gas in 2014. The company also maintains a power generation business primarily to produce electricity for its own oil and gas production and processing operations. Surgutneftegas has a market capitalization of over $19.2 billion.
5. Tatneft
Tatneft is another integrated oil and gas company with primary operations focused on the domestic market. It is a far smaller producer than its Russian rivals, reporting production of about 193 million barrels of oil and about 5.5 million BOE of natural gas in 2014. Tatneft's production and refining operations are focused in Tatarstan, a republic in the Russian Federation. Roughly 36% of the company's outstanding shares are held by the Tatarstan government. Tatneft has a market capitalization of more than $10.6 billion.
6. RusHydro
RusHydro is the biggest hydroelectric power company in the Russian utilities industry. As of 2014, the company has a total installed electricity generation capacity of about 38.5 gigawatts, just less than Gazprom's 39 gigawatts of installed capacity. RusHydro also has ongoing wind, tidal and geothermal energy projects, many of which are still in the research and development phase. The Russian state holds nearly 67% of outstanding shares in RusHydro. The company has a market capitalization of nearly $3.5 billion.
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8be8b48933e84c59f4e68a7427d66215 | https://www.investopedia.com/articles/markets/100715/how-expensive-whole-foods-really.asp | Is Whole Foods Really that Expensive? | Is Whole Foods Really that Expensive?
The prices of Whole Foods Market (WFM) have earned the organic grocery store chain the joking nickname, "Whole Paycheck." While shopping for groceries at Whole Foods does not usually devour an entire paycheck, its prices are noticeably higher on average than the prices available at other grocery shopping venues, historically by 10% to 20% more.
However, since being purchased by Amazon (AMZN), prices at Whole Foods have been coming down, sometimes quite significantly. Moreover, Amazon Prime customers receive special promotions and discounts, and those that pay with an Amazon Prime-branded credit card can receive 5% cash-back on all store purchases.
Key Takeaways Whole Food has been slowly losing the nickname “Whole Paycheck” since being acquired by Amazon in 2017. Prior to its acquisition by Amazon, Whole Foods’ products sold for a premium of upwards of 20%, and as high as 40%-50% on some products. More recently, Whole Foods’ prices have come in at only a slight premium to more generic rivals like Kroger, with Whole Foods' produce actually coming in at a discount in many cases.
Whole Foods’ Past and Present
Before discussing potential negatives about Whole Foods, it is important to note that Whole Foods has been an entrepreneurial success story, characterized by simple responsiveness to changing consumer preferences in the marketplace. The chain began as a single store in Austin, Texas, going to market with the strategy of meeting the marketplace desire of consumers for healthier, organic food.
Even as the company went public in 1992, its Chief Executive Officer (CEO), Walter Robb, thought it optimistic to project the chain might eventually have 100 locations. As of 2020, Whole Foods had more than 500 locations worldwide.
However, the company has been hit hard by overpricing scandals and does not hold the same level of dominance it previously did in the market for healthy, organic foods, as more and more grocery store operations have substantially increased their offerings of organic foods.
There was a time when Whole Foods was the only grocery store for consumers who wanted organic produce. This is simply no longer the case. While Whole Foods retains its position as the original organic grocery store, it has lost much of its edge of exclusivity in the area of organics, and this represents a significant threat to the company's profit margins and overall financial soundness.
Whole Foods’ Past Prices
The question has often been raised as to whether shopping at Whole Foods is significantly more expensive than shopping for groceries elsewhere. In the past, there was a substantial premium to be paid for the Whole Foods experience. A number of studies have been done in the past that consistently show consumers pay an average of at least 10% to 20% more for groceries at Whole Foods compared to its major supermarket competitors such as Safeway, Inc., Wegmans Food Markets, Trader Joe's, Kroger (KR) or Walmart (WMT).
A 2015 MarketWatch price comparison check of grocery stores in the San Francisco area, comparing prices between Whole Foods, Trader Joe's, Safeway, and Target, found Whole Foods prices substantially higher across the board. Bananas, a major consumer staple item in the produce department, cost an average of 99 cents per pound at Whole Foods compared to about $0.70 to $0.80 a pound at competitors.
Peanut butter, another major staple, cost almost twice as much at Whole Foods as at Safeway, $2.69 versus $1.79 for a 16-ounce jar. Cheddar cheese went for nearly twice the price at Whole Foods, 58 cents per ounce versus an average of $0.35 per ounce at its competitors, with none of the competing stores charging more than $0.39 per ounce.
Another 2015 study, a straight comparison between Whole Foods' organic products and Safeway regular products, found a lower average premium for Whole Foods' shopping but a noticeable price difference nonetheless. A comparison of 10 commonly purchased organic produce items totaled $11.55 at Whole Foods as compared to a $9.56 total for the same 10 items of regular produce at Safeway.
Overpricing Scandal
In June 2015, Whole Foods Market became the focus of a major overpricing scandal in New York City. The city began an official probe into its pricing practices as a result of numerous inspections dating back at least five years that consistently found Whole Foods Market was overcharging customers.
One part of the investigation considered a list of 80 items purchased from several different Whole Foods locations around New York City. Each of the 80 items was weighed, and in every single instance, the weight labeled on the package by Whole Foods was inaccurate, and in most cases, the inaccuracy resulted in consumers being overcharged.
The Commissioner of the city's Department of Consumer Affairs characterized the situation as "the worst case of overcharges" the department's inspectors had ever seen. Whole Foods has already been fined for violations such as charging tax on nontaxable items and having checkout scanners that fail to accurately input prices, with the disadvantage commonly going to the customer. About the last thing Whole Foods needs, when it is already recognized as one of the most expensive grocery stores around, is accusations of deliberate overcharging.
Current Pricing Environment
Whole Foods is facing increasing, and lower-priced, competition at its own game, selling organic food. Nearly every grocery store chain, including even major discounter Walmart, has substantially increased its offerings of organic foods and generally at lower prices than those of Whole Foods.
Whole Foods’ prices are down 2.5% on average from last year, according to a report by Morgan Stanley. Since the 2017 buyout by Amazon, Whole Foods’ premium prices relative to peers has declined. While the premium used to be 20% or more, it’s fallen to closer to 10%. Morgan Stanley noted that Kroger is now only around one-quarter cheaper, on average, than Whole Foods, versus a historical 40% to 50% discount.
According to a Business Insider survey, prices at Whole Foods and Kroger are converging. In fact, the price of Whole Foods’ produce is 7% cheaper than Kroger’s. For Business Insider’s survey, it found that prices at a Whole Foods in Virginia were only 4% more expensive than a rival Kroger. Meanwhile, a 2015 survey from Business Insider showed a 40% premium.
The Bottom Line
Grocery retailers could see price wars intensify as Amazon may be gearing up to offer its Prime subscribers more perks and discounts at Whole Foods Markets. These efforts could ramp up sales at its hundreds of new brick-and-mortar locations and steal market share away from traditional industry leaders such as Kroger, Walmart, and Costco stores.
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5051cbac510012dbc8b250adcf00054c | https://www.investopedia.com/articles/markets/100715/what-makes-share-coke-campaign-so-successful.asp | Why the 'Share a Coke' Campaign Is So Successful | Why the 'Share a Coke' Campaign Is So Successful
The Coca-Cola Company, one of the world's largest multinational corporations in the non-alcoholic beverage space, is known for its innovative marketing initiatives. In 2014, it launched its "Share a Coke" campaign, in which it replaced its iconic brand name with one of the 250 most popular American names on the labels of 20-ounce bottles.
Consumers were encouraged to find bottles with names that held personal meaning to them, share them with friends and family, then tweet about their experiences using the hashtag #ShareaCoke.
Key Takeaways Consumers were prompted to convey a personal experience on social media. They posted 500,000 photos. Your name on a Coke bottle? That's personalization! "Share a Coke" is pure call-to-action advertising. The campaign continues to evolve in creative ways.
The "Share a Coke" campaign became a raging success in America, for four reasons.
1. Consumers Are Prompted to Create Online Media Content
Coca-Cola empowered consumers to discuss the product on social media platforms in a way that puts the control in the hands of customers. By reflecting on their personal experiences, consumers felt like their lifestyles were the center of the narrative, instead of feeling like they were mere tools in the company's promotional machine.
Consumers shared more than 500,000 photos via the #ShareaCoke hashtag within the first year alone. Coca-Cola gained roughly 25 million new Facebook followers that same year.
2. The Brand Connects With Consumers on a Personal Level
For Millennials, personalization is not just a fad but a way of life. The "Share a Coke" campaign enabled this set to express their individual stories and connect with friends and family. A girl who shares a name-branded Coke bottle with her mother feels as though she's connecting with her parent by creating a non-controversial topic of conversation.
Of course, not everyone's name was represented on the 250 altered bottles. Consequently, Coca-Cola created a 500-stop cross-country "Share a Coke" tour which invited fans to customize a mini can for themselves and a second one for someone special.
The company also provided alternative pre-printed options with monikers such as "Bestie," "Star" or "BFF," for those with more unusual names that were not represented.
3. The Campaign Has a Powerful Call to Action
The "Share a Coke" slogan is inherently a call-to-action to buy more product. Catchy and easy to remember, the phrase carries an embedded directive to purchase a bottle of Coke for the purpose of giving it to another.
The "Share a Coke" campaign was first introduced in Australia before it was brought to the United States.
4. The Campaign Continues to Change
The "Share a Coke" campaign has constantly expanded. In 2015, the company increased the personal names represented from 250 to 1,000.
Coca-Cola also opened an e-commerce shop where consumers could order personalized bottles.
Then, song lyrics were added to the bottles' packaging so that fans could share music in addition to names. In 2017, the company added a feature that let consumers listen to a short jingle with their name in it.
In 2018, Coke turned their now-iconic name labels into removable stickers that could be fastened to clothing, cell phones, notebooks, and other items.
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e7762bff173f1c09a544868ac6545b35 | https://www.investopedia.com/articles/markets/101215/top-4-companies-owned-comcast.asp | 5 Companies Owned by Comcast | 5 Companies Owned by Comcast
What Are the Top 5 Companies Owned by Comcast
Comcast Corp. (CMCSA) is a global media and technology conglomerate. The company was founded in 1963 when Ralph Roberts purchased American Cable Systems, a small subscriber cable system in Tupelo, Mississippi.
The cable company was subsequently incorporated under the name Comcast, had its first public stock offering in 1972, and has since grown into a world leader in media, entertainment, and technology. Now led by CEO Brian Roberts, the founder's son, Comcast boasts a market cap of $160.4 billion. In 2019, the company posted annual net income of $13.3 billion on revenue of $108.9 billion.
Understanding the Top 5 Companies Owned by Comcast
Comcast's growth from a small cable operator into a multi-billion dollar media and tech giant has been driven to a large extent by strategic acquisitions, both horizontal and vertical. Horizontal acquisitions have helped the company expand into a leading provider of high-speed internet, video, voice, wireless, and security and automation systems.
Part of this expansion is attributable to Comcast's in-house Xfinity brand. Comcast has used other acquisitions to strengthen and broaden the types of media content businesses the company is engaged in, including cable television, broadcast television stations, filmed entertainment, theme parks, and more.
Key Takeaways Comcast's growth from a small cable operator into a multi-billion dollar media and tech giant has been driven by strategic acquisitions. Comcast has used acquisitions to strengthen and broaden the types of businesses in which the company is engaged, including cable television, broadcast television stations, filmed entertainment, theme parks, and more. Five of the most important acquisitions Comcast has made are AT&T Broadband, NBCUniversal, Sky, DreamWorks Animation, and XUMO.
The company has not always been successful in snapping up every company that it has tried to acquire. In an attempt to acquire Fox two years ago, Comcast lost out to Walt Disney Co. (DIS). Comcast tried unsuccessfully to take over Disney in 2004.
AT&T Broadband
Type of Business: Broadband Services Provider Acquisition Price: $47.5 billion Acquisition Date: Nov. 18, 2002
AT&T has its origins in the 1876 invention of the telephone by Alexander Graham Bell. In the following year, Bell and his partners founded the Bell Telephone Company. AT&T was subsequently incorporated as a subsidiary of Bell.
In 1899 it became the parent company of the entire Bell system after purchasing all of Bell's assets. Fast forward more than 100 years later, when AT&T in 2000 restructured into separately traded companies, one of which was AT&T Broadband.
Comcast acquired AT&T Broadband in 2002 in hopes that the cable provider would become a leading communications, media, and entertainment company. The acquisition has helped Comcast to provide faster broadband speeds as well as offer more innovative television services throughout the U.S.
NBCUniversal
Type of Business: Mass Media Acquisition Price: $22.9 billion (see discussion below) Acquisition Date: Jan. 28, 2011 (51%) and Feb. 12, 2013 (49%) Annual Revenue (2019): $34.0 billion Annual Adjusted EBITDA (2019): $8.7 billion
NBCUniversal was the product of a 2004 merger of television network National Broadcasting Co. Inc., a subsidiary of General Electric Co. (GE), and French media conglomerate Vivendi Universal Entertainment. In 2011, Comcast acquired a 51% stake in the company from GE, thus forming a joint venture (JV). Comcast paid GE $6.2 billion in cash and contributed certain programming assets worth $7.25 billion to the JV. Comcast purchased the remaining 49% of NBCUniversal for $16.7 billion in 2013.
NBCUniversal is now a leading media and entertainment company that develops, produces, and distributes entertainment, news, information, sports, and a variety of other content for global audiences. The business also operates theme parks worldwide. NBCUniversal operates through four segments: Cable Networks, Broadcast Television, Filmed Entertainment, and Theme Parks.
Sky
Type of Business: Broadcast and Telecommunications Acquisition Price: Estimated at $40 billion Acquisition Date: Oct. 9, 2018 Annual Revenue (2019): $19.2 billion Annual Adjusted EBITDA (2019): $3.1 billion
Sky Broadcasting originated from an earlier merger between Rupert Murdoch's Sky Television and British Satellite Broadcasting. Comcast subsequently beat out rival Disney in securing control over Sky in 2018.
Sky is a leading European entertainment company, which provides video, high-speed internet, voice and wireless phone services. It also operates a content business, including entertainment networks, the Sky News broadcast network, and Sky Sports networks. The acquisition helped Comcast expand its international reach.
DreamWorks Animation
Type of Business: Animation Studio Acquisition Price: $3.8 billion Acquisition Date: Aug. 22, 2016
DreamWorks Animation originated as a division of DreamWorks SKG, which was founded in 1994 by Steven Spielberg, Jeffrey Katzenberg, and David Geffen, hence the "S", "K", and "G" in the company name. The company spun off DreamWorks Animation into a separate company in 2004. It was acquired 12 years later in 2016 by Comcast's subsidiary, NBCUniversal.
DreamWorks Animation now forms a part of Comcast's Filmed Entertainment business. The studio produces animated film and television content, expanding Comcast's kids and family media entertainment offerings.
XUMO
Type of Business: Online Video Streaming Acquisition Price: not disclosed; estimated at $100 million. Acquisition Date: Feb. 25, 2020
XUMO was found in 2011 as a JV between Viant Technology (then called Interactive Media Holdings) and Panasonic. The company was subsequently acquired by Comcast for an undisclosed amount earlier this year.
XUMO offers free streaming entertainment, news, sports, and more with more than 190 different channels. It will continue to operate as an independent business within Comcast Cable. The acquisition expands Comcast's video-streaming offerings and specifically provides free streaming content to consumers willing to watch advertisements that accompany that content.
Comcast Diversity & Inclusiveness Transparency
As part of our effort to improve the awareness of the importance of diversity in companies, we have highlighted the transparency of Comcast’s commitment to diversity, inclusiveness, and social responsibility. The below chart illustrates how Comcast reports the diversity of its management and workforce. This shows if Comcast discloses data about the diversity of its board of directors, C-Suite, general management, and employees overall, across a variety of markers. We have indicated that transparency with a ✔.
Comcast Diversity & Inclusiveness Reporting Race Gender Ability Veteran Status Sexual Orientation Board of Directors C-Suite General Management ✔ (U.S. Only) ✔ (U.S. Only) Employees ✔ (U.S. Only) ✔ (U.S. Only)
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46ea04df0f3b02227b8b051cdea22a59 | https://www.investopedia.com/articles/markets/101315/who-are-starbucks-main-competitors.asp | Who Are Starbucks’ Main Competitors? | Who Are Starbucks’ Main Competitors?
Starbucks has been fighting its competitors – Dunkin' Donuts and McDonald's – for the top position as coffee king for several years. The company, which began close to 50 years ago with a single location, has experienced phenomenal growth and success. In Q4 2018 alone, the company opened 604 new locations, bringing the coffee behemoth's global store count to over 29,000. With a Starbucks on every corner, the company is often considered the go-to coffee place to work and socialize, a concept that corresponds to the company's marketing approach.
From its humble beginnings as a Seattle-based coffee roaster, Starbucks has strived to create a "second home" for consumers, where they can stop on their way to and from work. In recent years, the company has invested heavily in its brick-and-mortar locations by expanding its food options, remodeling its restaurants, and revamping its rewards programs. If Q4 2018 earnings were any indicator, the company's efforts seem to be working.
Starbucks shares soared on November 2, 2018 after the company delivered an upbeat earnings report that beat Wall Street estimates. The company reported $6.3 billion in revenues that quarter, compared to $5.7 billion over the same period in 2017. With no end in sight for Starbucks' growth, here's how the company stacks up against its competitors. (For related reading, see "The Top 4 Starbucks Shareholders")
Dunkin' Donuts Giving Starbucks a Run for its Money
Dunkin' Brands-owned Dunkin' Donuts peacefully co-existed with Starbucks for decades. When the spokesman for the company's ad campaigns retired in the late 1990s, however, Dunkin began to transition away from coffee and in the direction of donuts. By the early 2000s, the company had introduced its first specialty coffee line and slowly began to make a name for itself as a destination coffee shop.
In 2006, Dunkin' upped the ante and declared war against Starbucks when it launched its "America Runs on Dunkin'" ad campaign. While Starbucks has created an intentionally chic and upscale environment, Dunkin' Donuts represents itself as an All-American brand. The tactic helped bolster Dunkin's Q3 2018 earnings, but the company's $350 million in revenues still fell significantly short of Starbucks' $6.3 billion that quarter. By November 2018, Dunkin Donuts operated 11,300 locations to Starbucks' 29,000.
McDonald’s Joins the Coffee Battle
McDonald's has long been known as a fast food restaurant, but the global franchise joined in on the emerging coffee craze by introducing flavored and iced coffees in the mid-2000s. With fiscal year 2017 revenues of $22.82 billion, McDonald’s outperformed both Starbucks and Dunkin' Donuts that year, though this was in large part because of the restaurant franchise's expanded menu.
After leaning on the "I'm Lovin' It" advertising campaign for more than 10 years, McDonald's recently found the slogan was not performing as well as it had when first introduced. New commercials and advertisements are slotted to roll out throughout 2019 and will fall in line with Dunkin' Donuts' approach, pushing McDonald's as a brand for the every-day American with emphasis placed on embracing people of every educational and cultural background.
Maxwell House and Folgers
Starbucks has also entered the coffee beans and ground coffee market by distributing its product line to retail and grocery stores around the world. In the process of expanding its retail segment, Starbucks has gained two new competitors: Maxwell House and Folgers. Maxwell House is one of the top-performing subsidiaries of Kraft Corporation, and Folgers is not far behind. While these two brands currently dominate the dry coffee goods market, they are not in direct competition with Starbucks due to their lack of brick-and-mortar stores.
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9713c6d3f99804f13cd42e86f682491f | https://www.investopedia.com/articles/markets/101415/4-best-alternatives-paypal.asp | The 4 Best Alternatives to PayPal | The 4 Best Alternatives to PayPal
PayPal (PYPL) is almost synonymous with online payments, but it is not alone in the growing digital money space. Nearly every consumer market is moving online. For example, consider how Amazon overtook Walmart as the world's largest retailer. Consumers are turning to online payment systems in record numbers every year.
The industry for online payment platforms is always innovating, and major players are starting to take notice, as there is a lot of room for competitor services. Apple, Google, and Samsung have all created rival platforms, and there are plenty of lesser-known alternatives already available in the online payments marketplace.
PayPal
PayPal was founded in 1998 as a libertarian experiment by a group of tech superstars, including Elon Musk, Max Levchin, and Peter Thiel. By 2002, it became the go-to brand name in online money management and was bought by eBay. Total PayPal payment volume hit a record in 2019 at $712 billion. In 2018, the volume was $578 billion and in 2012 it was $150 billion. This is significant growth in a short span of time. Despite its growth, PayPal is far from monopolizing the industry.
One advantage that PayPal has is that it is a huge, multi-service platform; competitors are not always as diverse. For example, Stripe is designed for online businesses. Other options compete on multiple fronts, including Google Pay Send. Each brings something unique to the table, so the best alternative likely depends on the individual consumer's online money habits. The following four companies are good alternatives to PayPal.
1. Skrill
Skrill is one of the best-known PayPal alternatives. The major area where Skrill touts its services over PayPal is in terms of transaction costs. PayPal earns 4.5% for a merchant transaction fee while Skrill charges 2.9%.
One area of concern for private users is the inactivity fees; if Skrill accounts are not used for 12 months, a small charge of $5 is assessed. PayPal's biggest advantage over Skrill is in terms of merchant acceptance. It is simply easier for many shoppers to use PayPal because almost every major retailer is PayPal accessible. For private users, though, Skrill is a good option as it has zero deposit fees, zero fees for withdrawals, and sending and receiving money is free.
2. Payoneer
Payoneer is one of the most popular electronic platforms in the world. It started around the same time as PayPal, and like PayPal, operates in more than 200 countries.
Payoneer has two types of accounts: one that is free and allows for money withdrawal directly into your bank account. The other account calls for a prepaid card that is only available to individuals and costs $29.95 a month. Payoneer charges a transaction fee of $1.50 for local bank transfers.
Payoneer also provides a service called Billing Service that allows for a business set up for requesting payments from customers. This is a 3% fee for credit cards and 1% for debit cards. Payoneer is a strong alternative to PayPal that provides a lot of functionality and services for both individuals and businesses.
3. Google Pay Send
Several big-name competitors could have been listed here, such as Amazon Pay, Apple Pay, or Samsung Pay; however, none of these services have quite the full range of options of PayPal, although they do not lack for resources and are all determined to be serious competitors in the future. Instead, Google Pay Send gets the nod for its ability to attach payments to Gmail messages, and the fact that Google is one of the few companies that dominate the online world.
Like PayPal, Google Pay Send is great for sending money to and from anywhere for virtually any reason, but Google Pay Send does not charge a fee on debit transactions, whereas PayPal charges 2.9%.
There are no setup or cancellation fees for Google Pay Send, and it is available for Android and iPhones. The biggest advantage for Google Pay Send is the merchant function that allows for a variety of tools to manage your business and incorporate loyalty programs and other advantages. It makes a big difference for businesses to be able to put a "Buy with Google" tab on their websites.
4. Stripe
Stripe competes against PayPal for online business customers but not much else. This service is only available to U.S. and Canada-based businesses, but payments can come in from any source. Fees are very clear; Stripe charges 2.9% plus 30 cents on every transaction. The checkout process for Stripe is self-hosted; it occurs on the business owner's site rather than sending customers to an external site such as PayPal, which saves businesses from monthly fees for the trouble.
Another convenience of using the Stripe platform is with bank account deposits. Suppose a customer purchases a product from a business through Stripe. The Stripe network automatically deposits the funds into an outside bank account; this means fewer manually initiated transfers, which is a constant hassle for many businesses, and fewer opportunities for disastrous events such as fraud or account holds.
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bb2f853e69ab93db918fe2a59a633f91 | https://www.investopedia.com/articles/markets/101415/4-best-sp-500-index-funds.asp | Top S&P 500 Index Funds | Top S&P 500 Index Funds
The Standard & Poor's 500 Index, or simply S&P 500, is a market-capitalization-weighted index of 505 large-cap U.S. companies that make up 80% of U.S. equity by market cap. It is widely regarded as the best gauge of large-cap U.S. equities and often referred to as “the market” because it is comprised of stocks that span all market sectors. Some of the S&P 500's largest components include Microsoft Corp. (MSFT), Apple Inc. (AAPL), Amazon.com Inc. (AMZN), Alphabet Inc. (GOOGL), and Facebook Inc. (FB).
There are many funds whose portfolio of stocks are designed to track those of the S&P 500 due to its popularity as a barometer of U.S. equity markets, including both mutual funds and exchange-traded funds (ETFs). The latter type of fund differs from traditional mutual funds in that they are listed on exchanges and trade throughout the day like ordinary stock.
Below we look at the top S&P 500 index funds, one with the lowest fees and the other with the highest liquidity. All data is below is as of May 21, 2020.
Key Takeaways Index investing has been gaining momentum over the past decade, with passive funds often outperforming for their active counterparts for lower cost.Among index investors, the S&P 500 has been the most widely watched benchmark index to track.Here we look at a few of the most highly rated, low-cost S&P 500 index funds.
Lowest Cost S&P 500 Index Fund: Fidelity 500 Index Fund (FXAIX)
FXAIX is a mutual fund. Because index-tracking funds will follow the performance of the Index, one of, if not the, biggest determinant of long-term returns is how much it charges in fees.
Expense Ratio: 0.015%2019 Return: 31.47%Yield: 2.25%Assets Under Management: $213.4 billionMinimum Investment: $0Inception Date: February 17, 1988 (Share Class Inception Date: May 15, 2011)Issuing Company: Fidelity
Lowest Cost Runner Up: Schwab S&P 500 Index Fund (SWPPX)
Schwab's S&P 500 index fund seeks to track the total return of the S&P 500® Index. The fund generally invests at least 80% of its net assets (including, for this purpose, any borrowings for investment purposes) in these stocks; typically, the actual percentage is considerably higher. It generally will seek to replicate the performance of the index by giving the same weight to a given stock as the index does.
Expense Ratio: 0.02%2019 Return: 31.44%Yield: 1.95%Assets Under Management: $40.2 billionMinimum Investment: $0Inception Date: May 18, 1997Issuing Company: Charles Schwab
Lowest Cost Runner Up: Vanguard 500 Index Fund Investor Shares (VFINX)
Vanguard was the original index fund and still has the largest assets under management, with around half a trillion dollars in its Vanguard 500 Index Fund. The investment seeks to track the performance of a benchmark index that measures the investment return of large-capitalization stocks. The fund employs an indexing investment approach designed to track the performance of the Standard & Poor's 500 Index.
Expense Ratio: 0.14%2019 Return: 31.33%Yield: 2.11%Assets Under Management: $496.5 billionMinimum Investment: $3,000Inception Date: Aug 30, 1976Issuing Company: Vanguard
Lowest Cost Runner Up: State Street S&P 500 Index Fund Class N (SVSPX)
Also in the running is State Street's offering, which also closely tracks the S&P 500 index. This fund, however, requires a minimum of $10,000 invested.
Expense Ratio: 0.16%2019 Return: 31.26%Yield: 1.84%Assets Under Management: $1.5 billionMinimum Investment: $10,000Inception Date: Dec 29, 1992Issuing Company: State Street
Most Liquid S&P 500 Index Fund: SPDR S&P 500 ETF (SPY)
SPY is an ETF, not a mutual fund, and it's not even the lowest cost S&P 500 ETF. It is, however, the most liquid S&P 500 fund. Liquidity indicates how easy it will be to trade an ETF, with higher liquidity generally meaning lower trading costs. Trading costs are not a big concern to people who want to hold ETFs long term, but if you’re interested in trading ETFs frequently, then it’s important to look for high liquidity funds to minimize trading costs.
2019 Return: 31.22%Expense Ratio: 0.095%Annual Dividend Yield: 1.99%Assets Under Management: $265 billionInception Date: January 22, 1993Issuing Company: State Street SPDR
The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. While we believe the information provided herein is reliable, we do not warrant its accuracy or completeness. The views and strategies described on our content may not be suitable for all investors. Because market and economic conditions are subject to rapid change, all comments, opinions, and analyses contained within our content are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment, or strategy.
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90bb1e389c87ad3305165ed4bd18bef5 | https://www.investopedia.com/articles/markets/101415/top-6-companies-owned-starbucks.asp | 5 Companies Owned by Starbucks | 5 Companies Owned by Starbucks
Starbucks Corp. (SBUX) was founded nearly five decades ago, in 1971, with one store in Seattle's Pike Place Market. The company went public in 1992 and has grown into a global coffee roaster and retailer with about 30,000 coffeehouses in more than 80 countries. Today, Starbucks has a market capitalization of about $92.0 billion as of June 4, 2020. In the fiscal year ending September 29, 2019, the company reported a 5% gain in global same store sales and net revenue of $26.5 billion.
To fuel its growth, Starbucks has used niche acquisitions to enhance its menu offerings, including buying tea and coffee chains, fruit juice makers, a bakery chain, and a bottled water company. Rather than operate these acquisitions as separate subsidiaries, Starbucks often has shuttered the acquired companies' stores, bringing their products into Starbucks' own coffeehouses to further bolster the core brand.
Below, we'll take a look at 5 of the most important acquisitions Starbucks has made in the past two decades. Note that Starbucks does not report annual revenue or profit for individual subsidiaries.
Teavana
Type of business: Tea and Accessories Acquisition price: $620 million Date purchased: December 31, 2012
Teavana was a retail chain specializing in brewed and packaged loose-leaf tea, as well as tea accessories and related products. The first Teavana teahouse opened in 1997. By the time Starbucks acquired it in 2012, the fast-growing retail chain had stores in hundreds of locations, all located in malls. Under Starbucks, Teavana had expanded to 379 retail locations by 2017, when Starbucks announced it would shut down all Teavana retail stores. Instead, Starbucks sells loose-leaf teas and tea-related products under the Teavana brand in its stores and online.
La Boulange
Type of business: Bakery Chain Acquisition price: Reported $100 million Date purchased: June 4, 2012
La Boulange was a bakery chain in the San Francisco area at the time of its acquisition by Starbucks in 2012. Starbucks purchased Bay Bread Group, the owner of the bakery chain, in an apparent attempt to increase its food offerings at its own retail stores. La Boulange was founded by Pascal Rigo, who opened his first bakery in San Francisco in 1996. By 2012, Rigo had expanded La Boulange to approximately two dozen locations around the Bay Area; Starbucks initially announced plans to expand the chain to roughly 400 locations nationwide. However, Starbucks later shifted course and moved to close all independent La Boulange locations. As with Teavana, Starbucks continues to sell La Boulange products in its own retail shops.
Evolution Fresh
Type of business: Bottled Fruit Juices Acquisition price: $30 million Date purchased: November 10, 2011
Evolution Fresh is a manufacturer of bottled fruit juices, and vegetable and fruit juice blends. The company was founded by Jimmy Rosenberg, the original founder of the popular Naked Juice brand. Evolution Fresh products are sold at Starbucks locations and other grocery stores and retailers. The company's products cater to health-conscious customers by focusing on fruits and vegetables, as well as a production process designed to minimize nutrient loss.
Starbucks acquired Evolution Fresh at a time when the health and wellness space was a $50 billion industry. At the time, Starbucks planned to build out the brand nationwide with retail stores. After opening only a handful of locations, Starbucks decided to close Evolution Fresh stores in 2017. The company still carries Evolution Fresh branded products today.
Seattle Coffee Co.
Type of business: Packaged and Brewed Coffee Acquisition price: $72 million Date purchased: July 14, 2003
Starbucks purchased Seattle Coffee Co. in 2003 from AFC Enterprises Inc., which owned Popeyes Chicken. The acquired company owned several brands, including Seattle's Best Coffee. Starbucks in 2010 used Seattle's Best to counter an invasion into the parent company's core specialty-coffee market. Starbucks had been losing sales as McDonald's and Dunkin' Donuts started selling inexpensive espresso drinks. In response, Starbucks started marketing Seattle's Best as a less expensive, mass-market coffee brand compared with the more expensive, trendier Starbucks brand. It made deals to sell Seattle's Best at Burger King, Subway, and AMC Theaters, as well as convenience stores nationwide.
Ethos Water
Type of business: Bottled Water Acquisition price: Reported $8 million Date purchased: April 11, 2005
Founded in 2001, Ethos Water is a Starbucks subsidiary designed to raise awareness about water access issues for people in developing countries. The company also funds charitable grants for groups working to alleviate such problems, with five cents from each bottle of Ethos Water going to the Ethos Water Fund. As of 2020, the fund has distributed more than $12.3 million in grants to water-stressed countries.
Ethos Water is unique among the Starbucks acquisitions on this list because Starbucks did not make an effort to launch or shutter Ethos-branded retail locations. Rather, Starbucks carries Ethos products in its stores. While Ethos does have a charitable component, the product contributes to Starbucks' profit. Additionally, the company has been the target of criticism over the years, particularly when news broke that Ethos sourced water from a drought-ridden portion of California in 2015.
Starbucks Diversity & Inclusiveness Transparency
As part of our effort to improve the awareness of the importance of diversity in companies, we have highlighted the transparency of Starbucks’s commitment to diversity, inclusiveness, and social responsibility. The below chart illustrates how Starbucks reports the diversity of its management and workforce. This shows if Starbucks discloses data about the diversity of its board of directors, C-Suite, general management, and employees overall, across a variety of markers. We have indicated that transparency with a ✔.
Starbucks Diversity & Inclusiveness Reporting Race Gender Ability Veteran Status Sexual Orientation Board of Directors C-Suite General Management ✔ (U.S. Only) ✔ (U.S. Only) Employees ✔ (U.S. Only) ✔ (U.S. Only)
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efe5b37dfaf704f9c9200b458ffa2b17 | https://www.investopedia.com/articles/markets/101515/4-best-total-market-index-funds.asp | The 4 Best Total Market Index Funds | The 4 Best Total Market Index Funds
A total stock market index fund is a mutual fund or exchange-traded fund (ETF) that tracks an equity index such as the Russell 3000 Index, the S&P 500, or the Wilshire 5000 Total Market Index, as its benchmark. By investing in stocks linked to a given index, a total market index fund's performance aims to mirror that of the index in question.
The underlying stocks that these types of funds invest in are often highly diverse and may include both large-cap stocks issued by well-known corporations, as well as small-cap stocks issued by lesser-known companies.
Below are four of today's most prominent ones. Total assets, Morningstar rating, and expense ratio figures are current as of December 2020.
Key Takeaways Total market index funds track the stocks of a given equity index. The major broad-based indexes used as benchmarks are the Russell 3000, the S&P 500, and the Wilshire 5000 Total Market Index. The best total market index funds by popularity include the Vanguard Total Stock Market Index (VTSMX), the Schwab Total Stock Market Index Fund (SWTSX), the iShares Russell 3000 (IWVB), and the Wilshire 5000 Index Investment Fund (WFIVX).
Vanguard Total Stock Market Index (VTSMX)
The Vanguard Total Stock Market Index (VTSMX) seeks to track the investment results of the CRSP U.S. Total Market Index, comprising approximately 100% of the investable U.S. stock market. Its companies, which represent a cross-section of market capitalizations, primarily trade on the New York Stock Exchange and NASDAQ.
Technology companies account for the largest share of VTSMX's portfolio, at 23.44%. Healthcare companies have a 14.54% allocation, while financial services have 12.55%. Consumer cyclical and industrial companies round out the top five sectors, with 12.06% and 9.21% allocations, respectively.
The Vanguard Total Stock Market Index is considered a large-cap blend, evidenced by its top five holdings: Apple, Inc., Microsoft Corp., Amazon.com, Facebook Inc A, and Alphabet Inc A. In fact, 23% of VTSMX's assets lie within its top 10 holdings.
Assets under management: $194.1 billion 2019 return: 30.65% Expense ratio: 0.14% Morningstar rating: 4 stars
Schwab Total Stock Market Index (SWTSX)
The Schwab Total Stock Market Index (SWTSX) tracks the total return of the entire U.S. equity market as measured by the Dow Jones U.S. Total Stock Market Index. SWTSX currently focuses on technology (23.81% allocation), healthcare (14.39%), financial services (12.58%), cyclical consumer (12.05%), and communication services (10.54%).
Almost identical to the aforementioned Vanguard Total Stock Market Index fund, SWTSX's top holdings are in Microsoft, Apple, Amazon, Facebook Inc A, and Berkshire Hathaway Inc B, with also its top 10 holdings comprising 23% of the portfolio.
Assets under management: $13.3 billion 2019 return: 30.88% Expense ratio: 0.03% Morningstar rating: 4 stars
iShares Russell 3000 ETF (IWV)
The iShares Russell 3000 (IWV) is an exchange-traded fund that tracks the performance of the Russell 3000 Index, which measures the investment results of the broad U.S. equity market.
Like its peers, IWV uses an indexing approach to select a sample of stocks that represent the underlying benchmark. IWV's sector allocations and top holdings are similar to those of the Vanguard and Schwab funds.
IWV is led by investments allocated 23.76% in technology, 14.01% in healthcare, 13.04% in financial services, and 12.06% in consumer cyclical. Similar to the previous two funds, it also has 23% of its assets weighted in its top 10 holdings, including Apple Inc, Microsoft Corp, Amazon.com Inc, Facebook Inc A, and Alphabet Inc. A.
Assets under management: $10.6 billion 2019 return: 30.78% Expense ratio: 0.20% Morningstar rating: 4 stars
Small stocks listed in a total market index fund are often thinly traded, which may result in high trading spreads and significant transaction costs.
Wilshire 5000 Index Investment Fund (WFIVX)
The Wilshire 5000 Index Investment Fund (WFIVX) is a mutual fund that tracks the investment results of the Wilshire 5000 Index, a capitalization-weighted index of the market value of all actively traded U.S.-headquartered stocks.
While the index consists of around 3,115 companies, the fund typically holds 1,000 to 2,500 stocks. The fund emphasizes large market-cap companies with market values greater than $10 billion.
Like the other funds on the list, WFIVX targets technology, financial services, healthcare, consumer cyclical, and industrial sectors, though its top ten holdings comprise 26% of its portfolio. Unlike the other funds, WFIVX alone includes Alphabet Inc Class C in its top quintet of stock holdings.
Assets under management: $211.9 million 2019 return: 29.74% Expense ratio: 0.63% Morningstar rating: 3 stars
Comparing 4 Total Stock Market Index Funds Total Stock Market Index Fund Assets Under Management 2019 Return Expense Ratio Morningstar Rating Vanguard Total Stock Market Index (VTSMX) $194.1 billion 30.65% 0.14% 4 stars Schwab Total Stock Market Index (SWTSX) $13.3 billion 30.88% 0.03% 4 stars iShares Russell 3000 ETF (IWV) $10.6 billion 30.78% 0.20% 4 stars Wilshire 5000 Index Investment Fund (WFIVX) $211.9 million 29.74% 0.63% 3 stars
Total Stock Market Funds FAQs
What Is a Total Stock Market Index Fund?
A total stock market index fund is a mutual fund or exchange-traded fund (ETF) that tracks an equity index such as the Russell 3000 Index, the S&P 500, or the Wilshire 5000 Total Market Index, as its benchmark.
How Many Stocks Are in the Vanguard Total Stock Market Index Fund?
The Vanguard Total Stock Market Index Fund has a total of 3,576 equity holdings in stocks, two in bonds, and 13 in other holdings.
How Do I Invest in a Total Market Index Fund?
Investors can easily invest in a total market index fund by purchasing shares of ETFs including the Vanguard Total Stock Market Index (VTSMX), the Schwab Total Stock Market Index Fund (SWTSX), the iShares Russell 3000 (IWVB), and the Wilshire 5000 Index Investment Fund (WFIVX).
What Companies Are in the Vanguard Total Stock Market Index Fund?
With more than 23% of its portfolio invested in the technology sector, companies in the Vanguard Total Stock Market Index Fund (VTSMX) include Apple, Inc., Microsoft Corp., Amazon.com, Facebook Inc A, and Alphabet Inc A.
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77df346cd88fbbf8025a74856c52f29a | https://www.investopedia.com/articles/markets/102115/top-10-companies-owned-amazon.asp | 5 Companies Owned by Amazon | 5 Companies Owned by Amazon
Amazon.com, Inc. (AMZN) is a leader in e-commerce and cloud computing, and one of the largest companies in the world. It has a market capitalization as of this writing of $949.8 billion. The company was launched by founder Jeff Bezos in 1994 as an online bookstore, but has diversified into an e-commerce giant that sells virtually everything, including electronics, apparel, furniture, food, toys, and much more. In addition to e-commerce, Amazon's revenue comes from subscription services, cloud computing services, Whole Foods grocery sales, and other areas. It also builds and sells its own consumer electronics such as the Amazon Kindle and Amazon Echo. For FY 2019, Amazon reported net sales of $280.5 billion and net income of $11.6 billion.
In early February 2021, Amazon.com's CEO Jeff Bezos announced that he planned to leave his post later in the year, turning the role of CEO over to the company’s top cloud executive, Andy Jassy. Bezos will be transitioning to executive chairman of Amazon.com’s board.
Below, we look in detail at 5 of Amazon's most important acquisitions. The company does not provide a breakdown of how much profit or revenue each acquisition currently contributes to Amazon.
Whole Foods Market
Type of Business: Organic grocery store Acquisition price: $13.7 billion Date it was purchased: August 28, 2017
Whole Foods is a prominent grocery store chain with the distinction of being the only USDA-Certified Organic grocer in the United States. The company was founded in 1978 as SaferWay. At the time of its acquisition by Amazon, Whole Foods was an independent company with a market cap of almost $10 billion. It was ranked #176 in the 2017 Fortune 500 list. Since then, Amazon has lowered prices on key food items and has integrated its Prime service into the Whole Foods customer experience.
Whole Foods is Amazon's biggest reported acquisition in terms of price, and it also was Amazon's first major step into bricks-and-mortar retailing. Whole Foods has hundreds of stores.
Amazon has combined the ordering sites for is free delivery service, Amazon Fresh, and Whole Foods Market, making it a simple matter for customers to place their orders. Prime members also receive free delivery when ordering from Whole Foods.
Zappos
Type of Business: Footwear and apparel retailer Acquisition price: $1.2 billion Date it was purchased: November 2, 2009
Zappos is the leading footwear and apparel website in the world. The name comes from the word zapatos, which means "shoes" in Spanish. The company was founded in 1999 and grew rapidly, remaining independent until the time of its acquisition by Amazon in 2009. The company is famed for its customer service, and its CEO Tony Hsieh released a bestseller in 2010 that details his management style, called Delivering Happiness. While Amazon does not provide revenue figures on Zappos, Forbes indicated in 2015 that it generated more than $2 billion in revenue annually.
Zappos stands out among Amazon's many acquisitions because it was one of the company's first major expansions into a retail area beyond books.
Kiva Systems
Type of Business: Robotics Acquisition price: $775 million Date it was purchased: March 19, 2012
Kiva Systems, now rebranded as Amazon Robotics, was one of Amazon's largest purchases at the time of its acquisition in 2012. Founded in 2003, the company develops and manufactures robotic systems for a variety of uses and was independent at the time of its acquisition. Compared with Amazon's other deals, Kiva Systems is unique. Amazon has not integrated Kiva's products into its platform of e-commerce offerings in the way it has done with other acquisitions. While Kiva's role is unclear, its specialization in automated storage and retrieval systems could provide major support to Amazon's logistics operations, which include thousands of robots that aid the company's delivery services.
PillPack, Inc.
Type of Business: Online pharmacy Acquisition price: $753 million Date it was purchased: June 28, 2018
PillPack, Inc., is an online pharmacy company that was founded in 2013. Amazon acquired the company in 2018 in a move that was seen as an effort to expand into the online prescription business. Aided by Amazon's extensive delivery network, the company's purchase of PillPack allows it to ship prescription medications overnight to locations across the country. Like Amazon's purchases of Whole Foods and Zappos, PillPack has retained its brand within Amazon's larger umbrella of subsidiaries.
Twitch Interactive
Type of Business: Live-streaming video Acquisition price: $970 million Date it was purchased: August 25, 2014
Twitch Interactive's popular live-streaming video platform, called Twitch, was launched in 2011. In July of 2014, just prior to Amazon's acquisition, Twitch had 55 million unique visitors. This platform is popular among video game enthusiasts in particular and aided Amazon's expansion into the video game and streaming industries.
Amazon Diversity & Inclusiveness Transparency
As part of our effort to improve the awareness of the importance of diversity in companies, we have highlighted the transparency of Amazon's commitment to diversity, inclusiveness, and social responsibility. The below chart illustrates how Amazon reports the diversity of its management and workforce. This shows if Amazon discloses data about the diversity of its board of directors, C-Suite, general management, and employees overall, across a variety of markers. We have indicated that transparency with a ✔.
Amazon Diversity & Inclusiveness Reporting Race Gender Ability Veteran Status Sexual Orientation Board of Directors C-Suite General Management ✔ (U.S. Only) ✔ Employees ✔(U.S. Only) ✔
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936869466cc7401c0e774be407aa36a0 | https://www.investopedia.com/articles/markets/102715/how-lockheed-martin-makes-its-money-lmt.asp | How Lockheed Martin Makes Money | How Lockheed Martin Makes Money
Lockheed Martin Corp. (LMT) is a global security and aerospace company engaged in research, design, development, manufacturing, integration and sustainment of advanced technology systems, products and services. The company also provides management, engineering, cybersecurity, and a range of other services. It operates through four main business segments: Aeronautics, Missiles and Fire Control, Rotary and Mission Systems, and Space.
Lockheed competes both in the U.S. and internationally. Some of its big-name competitors include aircraft manufacturer Boeing Co. (BA), defense firm Raytheon Co. (RTN), defense and aerospace company BAE Systems Inc., and global defense company Northrop Grumman Corp. (NOC).
Key Takeaways Lockheed Martin provides advanced technology systems, products, and services related to the aerospace and defense industry. The biggest share of Lockheed's sales come from the aeronautics business. Lockheed Martin announced in December that it has agreed to acquire aerospace and defense firm Aerojet Rocketdyne. The company completed its acquisition of Integration Innovation's Hypersonics portfolio in late November 2020.
Lockheed Martin's Financials
Lockheed Martin posted net income of $6.8 billion on $65.4 billion of revenue during its 2020 fiscal year (ended December 31, 2020) for a net profit margin of 10.4%. As much as 75%, or $49.0 billion, of revenue originated domestically. The remaining 25% came from other regions across the globe, including Asia Pacific (8%), Europe (10%), the Middle East (6%), and Other (1%). The U.S. government is the company's biggest client, accounting for 74%, or $48.5 billion, of total revenue.
Net income grew 9.7% in 2020 while revenue rose 9.3%. Lockheed Martin noted that favorable contract award timing, strong operational performance, and lower travel and overhead expenditures due to the COVID-19 pandemic helped to partially offset the negative impacts of the pandemic on its financial results for the year.
Lockheed Martin's Business Segments
Lockheed Martin operates four main business segments: Aeronautics, Missiles and Fire Control, Rotary and Mission Systems, and Space. The company breaks down its revenue and operating income in the four main segments below.
Aeronautics
Lockheed's Aeronautics business engages in the research, design, development, manufacture, integration, sustainment, support and upgrade of advanced military aircraft, unmanned air vehicles, and related technologies.
The Aeronautics segment posted $26.3 billion in revenue and $2.8 billion in operating profit in 2020, comprising about 40% of the company's total revenue and 40% of its total business segment operating profit of $7.2 billion. The segment's revenue grew by 10.9% while its operating income rose 12.8% during the year.
Missiles and Fire Control
Lockheed's Missiles and Fire Control business offers a diverse range of products and services, including air and missile defense systems, logistics, fire control systems, mission operations support, engineering support and integration services, manned and unmanned ground vehicles, energy management solutions, and more.
The segment posted $11.3 billion in revenue and $1.5 billion in operating income in 2020, comprising 17% of the company's total revenue and 22% of its total operating profit. The segment's revenue grew by 11.1% in 2020. Operating income rose 7.2% during the year.
Rotary and Mission Systems
Lockheed's Rotary and Mission Systems business provides design, manufacture, service, and support for areas such as military and commercial helicopters, surface ships, sea and land-based missile defense systems, radar systems, simulation and training solutions, cybersecurity, and more.
The segment posted $16.0 billion in revenue and $1.6 billion in operating profit in 2020, comprising 24% of the company's total revenue and 23% of its total operating profit. The segment's revenue grew by 5.7% as its operating income rose 13.7% during the year.
Space
Lockheed's Space business engages in a broad range of activities including the development and production of satellites, space transportation systems, and defensive systems. The segment is also responsible for various classified systems and services in support of vital national security systems.
The Space segment posted $11.9 billion in revenue and $1.1 billion in operating income in 2020, comprising 18% of the company's total revenue and 16% of total operating profit. Despite revenue growth of 9.4%, operating income fell 3.5% in 2020.
Lockheed Martin's Recent Developments
On December 20, 2020, Lockheed Martin announced that it had entered into an agreement to acquire Aerojet Rocketdyne Holdings Inc. (AJRD) in a transaction valued at $4.4 billion. The company said that acquiring Aerojet Rocketdyne will help to maintain and strengthen a key component of its domestic defense industrial base and reduce costs for its clients. The transaction is expected to close in the second half of 2021.
On November 25, 2020, Lockheed Martin announced the completion of its acquisition of Integration Innovation Inc.'s Hypersonics portfolio. The acquisition expands Lockheed's ability to design, develop, and produce integrated hypersonic weapons.
On June 15, 2020, Lockheed Martin announced the appointment of James D. Taiclet to the roles of president and Chief Executive Officer (CEO). Mr. Taiclet is a Gulf War veteran and pilot who first joined the company's board in 2018 and will continue to serve on the board. He succeeds Marilyn A. Hewson who has served as Lockheed Martin's chairman, president, and CEO since 2014 and president and CEO since 2013. Ms. Hewson will become executive chairman of the board.
How Lockheed Martin Reports Diversity & Inclusiveness
As part of our effort to improve the awareness of the importance of diversity in companies, we offer investors a glimpse into the transparency of Lockheed Martin and its commitment to diversity, inclusiveness, and social responsibility. We examined the data Lockheed Martin releases to show you how it reports the diversity of its board and workforce to help readers make educated purchasing and investing decisions.
Below is a table of potential diversity measurements. It shows whether Lockheed Martin discloses its data about the diversity of its board of directors, C-Suite, general management, and employees overall, as is marked with a ✔. It also shows whether Lockheed Martin breaks down those reports to reveal the diversity of itself by race, gender, ability, veteran status, and LGBTQ+ identity.
Lockheed Martin Diversity & Inclusiveness Reporting Race Gender Ability Veteran Status Sexual Orientation Board of Directors ✔ (U.S. Only) C-Suite General Management ✔ (U.S. Only) ✔ (U.S. Only) ✔ (U.S. Only) ✔ (U.S. Only) Employees ✔ (U.S. Only) ✔ (U.S. Only)
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4eaa6a70d645b08689d60482c45e63a4 | https://www.investopedia.com/articles/markets/102815/biggest-risks-investing-tesla-stock.asp | 6 Big Risks of Investing in Tesla Stock | 6 Big Risks of Investing in Tesla Stock
Pegged by many as a high-risk, high-reward stock, Tesla Motors, Inc. (TSLA) ranks among the most interesting public companies in the world. Founder Elon Musk is a controversial superstar in the technology industry, and Tesla's Silicon Valley roots have boosted investor expectations. Tesla attracted even more attention in the summer of 2018 after Musk began talking about taking the company private—something that, after much controversy, the company announced it is not doing.
The future of Tesla cars has exciting potential but remains difficult to predict. TSLA investors should temper their expectations and consider how the risk factors that Tesla may face over the next five to 10 years could jeopardize future returns.
Key Takeaways The electric vehicle (EV) maker, Tesla, has a number of key risks that it will face in the next 5-10 years. Notable risks include Tesla cars being too expensive with tax breaks and that the construction of its Gigafactory (battery factory) taking longer than expected. More broadly speaking, Tesla faces risks from low gas prices and a rise in EV competition.
1. Tesla Cars Will Remain Too Expensive
Even with generous government incentives, such as tax breaks for alternative technology, potential consumers of Tesla's Model S are still faced with a large price tag that starts at $75,000. Even Tesla's new lower-cost option, Model 3, is $35,000 before tax incentives and gas savings—which is still a steep price for many people.
The cars are not only expensive for consumers to purchase, but they're also costly for Tesla to make. Vertical Group analyst Gordon Johnson estimated that the company loses roughly $14,000 on each of the Model 3 vehicles it sells.
2. Tesla Could Run Out of Batteries
One of the early problems Tesla executives ran into was a lack of batteries to power their products. Tesla's world-renowned Gigafactory, which is still under construction as of Oct. 2019 in Sparks, Nev., is supposed to solve the company's battery crisis. The lithium-ion superstructure, which has a footprint of more than 1.9 million square feet, projects to help ramp production to more than 500,000 Tesla cars annually.
Major projects such as the Gigafactory are often plagued with logistical or regulatory hurdles, and it remains to be seen if the factory can be completed on time. The Nevada government has given the green light to the Gigafactory will produce $100 billion in additional economic activity over the subsequent decades, but growth projections for the company suggest it cannot afford a long hiccup in construction.
Musk has even hinted the company will need several gigafactories to handle battery demand, at least according to Tesla Powerwall estimates. It is going to take an incredible amount of capital expenditures (CapEx) to keep the company fully charged and shareholders happy.
3. Low Gas Prices
When gas prices tumbled in 2014 and 2015, Tesla lost some of its luster. After all, gasoline-powered cars compete with Tesla's products, and declining gas prices make gasoline-powered cars more economically attractive. Gas prices do not have to remain at decade lows to damage TSLA stock prices; gas just has to remain inexpensive relative to driving a Tesla product.
TSLA's gas quandary comes from two angles at once. The first problem is increased global production in oil; the once-dominant "peak oil" theory seems to be debunked, with global oil production increasing every year from 2009 through 2018. Oil companies are getting better at finding oil and, with the help of hydraulic fracturing and horizontal drilling, they are also more effective at extracting oil.
Petroleum supplies are increasing and, at the same time, internal combustion engines are more fuel-efficient. According to the Bureau of Transportation Statistics, the average fuel efficiency of light-duty passenger cars in the U.S. continues to improve.
If Tesla is going to transition into a mainstream auto manufacturer and generate consistent cash flow, it needs to sell a lot more cars. Consumers are less likely to transition to electric cars if petroleum-based fuels remain a far cheaper alternative.
4. Increased Electric Vehicle Competition
Tesla is not the first company to create electric cars. Interestingly, the first electric automobiles were probably created as early as 1834 by Thomas Davenport, but Tesla seems to be the most successful, thus far.
Two notable competitors, the Chevrolet Bolt and the Nissan Leaf, failed to gain early traction because of high retail prices and limited driving range. But last year, Nissan announced a new Leaf that starts at $29,999, with a range of up to 226 miles.
The newest Bolt, at $36,000 with a range of 259 miles, offers more than the 220-mile range of Tesla's standard Model 3. Other companies plan to enter the electric car market in the next few years, including Mercedes-Benz, Volkswagen, Subaru, Ford and BMW. If this happens, then Tesla's market share may start to get crowded.
Some tech companies may also join the fray; Apple, Inc. and Google, Inc. believe they can challenge Tesla in the futuristic transportation industry. Tesla is admittedly concerned about businesses with broader existing consumer bases.
5. Tesla May Never Recoup Massive CapEx
Musk once famously noted about his company, "We are going to spend staggering amounts of money on CapEx." Lots of investors like to see high capital expenditures, but there has to be a payoff on the other end. This seems particularly true in an infant industry paved with failed startups.
Development for the Model 3 and Model X cars has already received billions in CapEx. The battery factory comes with its own hefty price tag. Tesla spends about one-fourth as much on CapEx as General Motors Company, despite the fact that GM generates much more revenue.
6. A Part-Time CEO
Hidden in a 2015 Tesla 10-K filing was a note about Tesla's over-reliance on the genius of Elon Musk. This is not particularly shocking, especially in the technology sector; think Steve Jobs and Apple. What is disturbing is what immediately followed in the report. The report reads, "We are highly dependent on the services of Elon Musk" and in the very next sentence highlights, "he does not devote his full time and attention to Tesla."
Musk is a very active executive. He was once CEO of PayPal before starting Tesla and has since become CEO and Chief Technical Officer (CTO) of Space Exploration Technologies. He is also Chairman of SolarCity, which installs expensive solar equipment.
Wall Street investors are increasingly sensitive to "key person risk," or the threat of losing a crucial member of a company. The critical question is: How many investors would still hold Tesla stock at current prices if Elon Musk were no longer involved in the company?
For example, Berkshire Hathaway has Charlie Munger and a long-standing board to take over if something happens to Warren Buffett. Tesla does not have a "Plan B" if Musk is unable to devote enough time to keep the company moving forward.
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823b387f8a30c01db52dcf21a45473de | https://www.investopedia.com/articles/markets/102915/top-5-companies-owned-disney.asp | 5 Companies Owned by Disney | 5 Companies Owned by Disney
Walt Disney (DIS) has grown into a household name in family entertainment and a leading international media conglomerate. Founded in 1923 as the Disney Brothers Cartoon Studio by brothers Walt and Roy Disney, the company now boasts a market capitalization of $174.9 billion and generated annual net income of $11.6 billion on annual revenue of $69.6 billion during its 2019 fiscal year (FY), which ended September 28, 2020. Under the leadership of Bob Chapek, who took over from Robert Iger as the company's CEO in February 2020, the company operates through the following business segments: Media Networks; Parks, Experiences and Products; Studio Entertainment; and Direct-to-Consumer and International.
Acquisitions are a major vehicle of growth for Disney—and have been over the past three decades. Studio Entertainment, the foundation upon which the company was built, is an example. While Disney produces high-quality video content under its own name, it has used acquisitions to become the owner of intellectual property rights to its blockbuster film and TV franchises. It bought Lucasfilm (owner of the "Star Wars" franchise), Marvel Entertainment (owner of a long list of Marvel heroes including Spider-Man and Iron Man), and Pixar (which created "Toy Story," "Cars" and other hits.) The company also distributes content through three major acquired brands—ABC, ESPN, and 21st Century Fox—as well as through its own Disney Channel. The purchase of 21st Century Fox in March 2019 has been the lynchpin in the company's launch of digital-content streaming service Disney+.
Below, we look in more detail at the company's five largest acquisitions.
Key Takeaways Acquisitions have helped Disney expand its reach in media and entertainment including 21st Century Fox, which it acquired in 2019 for $71 billion. Disney became the first media company to have a presence in filmed entertainment, cable television, broadcasting, and telephone wires after it bought Capital Cities/ABC. Disney acquired "Toy Story" creator Pixar in 2006 for $7.4 billion. The company became the owner of the "Star Wars" and "Indiana Jones" franchises following the purchase of Lucasfilm in 2012. In August 2009, Disney bought Marvel Entertainment for $4 billion.
21st Century Fox (TFCF Corp.)
Type of Business: Global Media and Entertainment Acquisition Price: $71 billion Acquisition Date: Mar. 20, 2019
21st Century Fox emerged from the 2013 split of News Corp., the sprawling publishing and entertainment empire owned by media mogul Robert Murdoch. In the breakup, the publishing arm of the company retained the name News Corp. (NWS) while the entertainment division, including 20th Century Fox studio, was spun off into a separate company named 21st Century Fox.
When Disney acquired the company in 2019 for $71 billion, the entertainment business was renamed TFCF Corp., and many of the news assets were spun off into a new, separately owned public company called Fox Corp. (FOX). Through that series of deals, Disney became the owner of a basket of prized global franchises, including Twentieth Century Fox film and TV studios, cable networks FX and National Geographic, international TV business Star, and a 30% interest in Hulu LLC. Disney also retained perpetual rights to certain Fox brands, including Twentieth Century Fox and Fox Searchlight. The acquisition significantly augmented Disney's ability to provide more content and entertainment options to meet growing consumer demand.
Capital Cities/ABC
Type of Business: Media Acquisition Price: $19 billion Acquisition Date: July 31, 1995
Capital Cities/ABC was formed in 1985 when media firm Capital Cities Communications acquired American Broadcasting Companies for $3.5 billion. Disney's $19 billion purchase of the company in 1995 was considered the second-largest corporate takeover ever, bringing together two of the world's leading media and family entertainment companies.
Through the deal, Disney acquired TV stations, radio stations, a percentage of ESPN, The History Channel, A&E Network, Lifetime Television, and a publishing group. It transformed Disney into the first media company with a major presence in the four key distribution systems of filmed entertainment, cable television, broadcasting, and telephone wires (through a joint venture with three regional phone companies). The deal also expanded Disney's overseas presence as Capital Cities/ABC was already distributing ESPN abroad.
Disney launched its Disney+ streaming service in Nov. 2019, a paid subscription service that competes with the likes of Netflix, Hulu, and Apple TV.
Pixar Animation Studios
Type of Business: Computer Animation Studio Acquisition Price: $7.4 billion Acquisition Date: Jan. 24, 2006
Pixar was created in 1986 when Steve Jobs, the legendary co-founder of Apple, bought the computer animation division from Lucasfilms, which made major progress in perfecting animated film technology. Under Jobs, Pixar turned into the world's premier animated film producer. It created "Toy Story," the world's first computer-animated feature film, as well as movies such as "Finding Nemo." Disney's $7.4 billion purchase of Pixar in 2006 made it an instant leader in animated films. Under Disney, Pixar has produced films such as "Cars," "Ratatouille," "WALL•E," and several sequels to "Toy Story."
Lucasfilm Ltd.
Type of Business: Film and TV Production Company Acquisition Price: $4.1 billion Acquisition Date: Oct. 30, 2012
Lucasfilm was founded in the San Francisco Bay Area in 1971 by filmmaker George Lucas. The studio is best known for creating and producing the blockbuster "Star Wars" and "Indiana Jones" franchises and has been a leader in developing special effects, sound, and computer animation.
Disney's acquisition of the company in 2012 gave it access to the distribution rights of those high-grossing franchises. Disney also has leveraged those franchises through its theme parks and resorts, such as the "Star Wars: Galaxy's Edge"-themed entertainment area at several Disneyland World locations.
Marvel Entertainment
Type of Business: Entertainment Acquisition Price: $4 billion Acquisition Date: Aug. 31, 2009
The precursor to what would become Marvel Entertainment was founded in the 1930s under the name Timely Comics. The comic-book publisher went through various name changes, different ownerships, filed for bankruptcy, and developed into a premier creator and publisher of entertainment media with a library of 5,000 characters, including Spider-Man, Iron Man, X-Men, Captain America, and the Fantastic Four.
Disney leveraged its $4 billion purchase of the company to accelerate the number of movie releases starring Marvel characters, including box-office hits such as "The Avengers" (2012), "Iron Man 3" (2013), "Black Panther" (2018), and many more.
Disney Diversity & Inclusiveness Transparency
As part of our effort to improve the awareness of the importance of diversity in companies, we have highlighted the transparency of Disney's commitment to diversity, inclusiveness, and social responsibility. The below chart illustrates how Disney reports the diversity of its management and workforce. This shows if Disney discloses data about the diversity of its board of directors, C-Suite, general management, and employees overall, across a variety of markers. We have indicated that transparency with a ✔.
Disney Diversity & Inclusiveness Reporting Race Gender Ability Veteran Status Sexual Orientation Board of Directors C-Suite General Management Employees ✔ (U.S. Only) ✔
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740047fecd0dd91a83c2d3ccecc291ad | https://www.investopedia.com/articles/markets/103015/biggest-companies-silicon-valley.asp | The Biggest Companies in Silicon Valley (AAPL, GOOGL) | The Biggest Companies in Silicon Valley (AAPL, GOOGL)
When people think of the largest companies in Silicon Valley, computer and digital giants such as Apple (AAPL), Alphabet/Google (GOOGL), and Facebook (FB) are the first that come to mind. However, successful public companies within Silicon Valley extend beyond the technology sector—especially if you extend the traditional Silicon Valley borders a bit to the north and northeast to include Contra Costa County and the city of San Francisco itself.
If you do, you can count Wells Fargo & Co. (WFC), Visa, Inc. V) and Chevron Corporation (CVX), as non-tech, multinational majors firms that all have their headquarters in Silicon Valley.
Let's look at the Big Six of Silicon Valley, incorporating three traditional types of public companies (that is, high-tech) and three non-tech (from other sectors). All data is current as of April 21, 2020.
key takeaways While best-known as a center of the high tech sector, Silicon Valley is actually home to all sorts of corporate giants. The Big Six of Silicon Valley firms consist of three tech firms—Apple, Alphabet (Google), and Facebook—and three in other industries: Visa, Wells Fargo, and Chevron.
1. Apple
Ah, the golden Apple. One of the most successful companies on the planet, it makes its headquarters in the heart of the Valley: Cupertino, in Santa Clara County. The company has a current market cap of $1,174 billion and a price-earnings (P/E) ratio of 21.20.
Apple designs, manufactures and sells mobile devices, personal computers, and digital music players, and it also sells numerous related software, services, networking solutions, and digital content and applications. The company's primary products include the iPhone, iPad, and Mac computers—along with the operating system software and application software to run them. In 2019, it also entered the fields of entertainment streaming services (with Apple TV+) and financial services (with the Apple Card).
2. Alphabet/Google
Alphabet Inc. is the holding company of Google, the most widely used internet search engine in the world. It has a current market cap of $833 billion, giving the company a P/E ratio of 24.65.
The company has reached success on a massive scale since its inception and has business units that go beyond its search capabilities. It now offers a range of products and services across multiple screens and multiple device types, from browsers like Chrome to phones like Android to the G Suite of cloud-based word-processing apps. Google is headquartered in Mountain View, in Santa Clara County.
Its products and services are offered in more than 50 countries in more than 100 languages. However, the company's biggest moneymaker is its offering of brand advertising and performance advertising. Google offers a self-serve platform for advertisers, agencies, and publishers allowing them to power their digital marketing across desktop display, mobile, and video.
3. Facebook
Facebook is arguably the world's original social networking company; it's certainly one of the most successful. Based in Menlo Park, in San Mateo County—the geographic center of the Valley—the company has a current market cap of $488 billion and a P/E ratio of 26.57.
Facebook was launched in 2004 by Mark Zuckerberg as a college social networking website, but it has since expanded to allow any person above the age of 13 to create a social profile. The company boasts literally billions of users, connecting them through posts, messages, status updates, photo and video sharing, and notification updates. The massive scale of the company has allowed it to offer highly targeted advertising, resulting in billions of dollars in annual revenue and, of late, some controversy.
4. Wells Fargo
Wells Fargo breaks the Silicon Valley mold in a couple of ways. For one thing, it wasn't born around the turn of the 21st century or even the 20th century. For another, its field isn't technological, but financial.
Headquartered in San Francisco, Wells Fargo was founded in 1852 (two years after California became a state) and, after a series of mergers with other regional banks on both coasts, has grown to become the third-largest bank in the United States in terms of assets. It is one of the largest U.S. banks by market cap, which is currently $110 billion. Its P/E ratio is 9.48.
Technically, Wells Fargo is a holding company that consists of three banking and financial services subsidiaries: community banking, wholesale banking, and wealth and investment management. Although plagued by a series of consumer-abuse scandals throughout the 2010s, resulting in the payment of billions in penalties, the financial institution still clocked $85 billion in revenues on its 2019 annual income statement.
5. Visa
Known for its ubiquitous credit cards, Visa is another multinational financial services company based in Silicon Valley. The company moved its headquarters to Foster City, in San Mateo County in 2012. Its current market cap is $356 billion, and its current P/E ratio is 29.29.
Visa doesn't actually issue cards or extend lines of credit; instead, it provides banks, credit unions, and other financial institutions with products (i.e., credit or debit cards) that they can offer to their customers. Technically speaking, it's a retail electronic payment network that specializes in the facilitation of funds transfers through its credit card and debit card services.
6. Chevron
Chevron is a bit of an outlier in our group, both figuratively—it's the sole energy company—and literally: Its HQ is in San Ramon, in Contra Costa County (a bit north of the Valley proper). The company has a current market cap of $152 billion and a current P/E ratio of 54.07.
Like Wells Fargo, Chevron is a corporation with roots reaching back to the 19th century. Incorporated in 1906, it has grown from a small oil refiner into a multinational energy giant. Also like Wells Fargo, Chevron is technically a holding company made up of upstream and downstream segments. Upstream deals with crude oil and natural gas exploration and production; Downstream with the refining of crude oil into petroleum products, and the subsequent marketing of them. Combined, these segments combine to give Chevron control of the entire supply chain of energy.
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c979c7604201c717f45c30d8128abd3c | https://www.investopedia.com/articles/markets/111015/apple-vs-microsoft-vs-google-how-their-business-models-compare.asp | Apple vs. Microsoft Business Model: What's the Difference? | Apple vs. Microsoft Business Model: What's the Difference?
Apple Business Model vs. Microsoft Business Model: An Overview
More than any other American companies, Apple, Inc. (NASDAQ: AAPL) and Microsoft Corporation (NASDAQ: MSFT) dominate the intersection of technology and consumer access. Even though they compete across a huge range of sub-industries, such as computing software, hardware, operating systems, mobile devices, advertising, applications, and Web browsing, each firm takes a different approach from an organizational and philosophical perspective.
As of May 2020, AAPL had a market cap of around $1.35 trillion. Apple used to be the largest company in the world, but MSFT edges Apple out with a market cap of $1.40 trillion, riding on the strength in the growth of its cloud computing business.
Key Takeaways Apple and Microsoft are two of the biggest companies in the world, alternating the title of the world's most valuable company.Both companies have boasted a market cap of over $1 trillion.Apple's business model is based on innovation and consumer-centric devices. They are able to keep their base due to easy-to-use designs and data migration to new product lines.Microsoft built its success on the licensing of software such as Windows and Office Suite. Their business model has shifted, and they are releasing their own devices to compete with Apple's.Both companies are run differently with a different end purpose. They are both extremely successful and have revolutionized their respective industries.
The Apple Business Model
It is difficult to recall a modern American business so thoroughly dominated by the ideas and personality of one individual as Apple was under the tutelage of Steve Jobs. Jobs' remarkable innovations propelled Apple to unprecedented heights until his passing from cancer in 2011.
During Steve Jobs' second reign—he was fired in 1985, returning in 1997—Apple returned to relevancy and revolutionized multiple subindustries. It took over the Walkman industry from Sony and completely redefined mobile phones when the iPhone was released in 2007.
Apple easily bests its competitors in terms of hardware sales and high-end gadgets. Thanks to the company's early 2000s reputation as a nonconformist response to Microsoft, millennials grew up using Macs in large numbers. This is buoyed by the company's brilliant insistence on integrating its products, making it easier to keep using new Apple products and thus more difficult to switch to a competitor's interface; this is sometimes referred to as the "Apple Ecosystem Lock."
The weakness in the Apple's business model lies in the historic success of the company's golden invention: the iPhone. Nearly three-quarters of all Apple revenue comes from iPhone sales, and no new, comparable innovation has taken off since its former CEO died and was replaced by Tim Cook. However, Cook has done a good job of preserving Jobs' legacy and has propelled Apple stock to all-time highs.
The Microsoft Business Model
For years, Microsoft dominated the computer industry with its Windows software; Apple was an afterthought for more than a generation of operating products. Before Google Web browsing began to dominate the market, Microsoft gave away Internet Explorer for free, driving Netscape and other similar companies out of business.
The Microsoft revenue model historically relied on just a few key strengths. The first, and most important, is the licensing fees charged for use of the Windows operating system and the Microsoft Office suite. After a few years of increasing irrelevance in the race against Google and Apple, Microsoft unveiled a new vision in April 2014, instantly shifting focus to make Windows software more compatible with competitor products, such as the iPad. Microsoft also has a few successful products, highlighted by the Microsoft Surface and Surface Pro, that battle Apple devices such as the iPad.
Moving forward, however, Microsoft realized that paid software is a more difficult sell in an age of low-cost alternatives. Additionally, tablets and phones are replacing PCs. A newer Microsoft business model has been telegraphed by CEO Satya Nadella, one that emphasizes product integration, a "freemium" software package, and a concentration on its cloud computing business.
For example, Microsoft wants customers to be more engaged and fixated on its products. In 2015, CMO Chris Capossela explained this concept with a simple example: "Rather than using Skype on Sunday night to phone home, you are using Skype for messaging 15, 20, 30 times every single day. That's engagement."
Special Consideration: Google's Business Model
Unsurprisingly, the heart and soul of the Google revenue stream is its search engine and Web advertisements. While Google is not the only company to give away free services and bundle them with other goods, few do it as well or as successfully.
Google services do not cost the user anything. Instead, Google lures in users and collects their data, and then sells access to eager buyers across the planet. Every marketing firm in the world wants the kind of information and repeat usage Google enjoys. Moreover, the company keeps getting better and more sophisticated at targeting consumers and businesses, syncing preferences and playing economic matchmaker.
This no-fee model is not just profitable, it is very disruptive to Apple and especially to Microsoft. While Apple and Microsoft keep competing to find better and more innovative products to charge consumers, Google is all too happy to find a way to monetize activities for which users are eager to stop paying.
Google does not charge for Android, which is one of the chief reasons manufacturers are so drawn to it. The Google Web apps, which bear a striking resemblance to Microsoft Office programs, are also free. Since Google began offering a free operating system and computer software, sales for Microsoft Windows and Office have slowed.
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f439c7d5d8860e72bf7b99ba29ec56e8 | https://www.investopedia.com/articles/markets/111015/does-weather-affect-stock-market.asp | Does Weather Affect the Stock Market? | Does Weather Affect the Stock Market?
Despite the best efforts of many highly trained economists and market specialists, there is no widespread consensus about how, or even if, weather affects the performance of the stock market.
It seems like commonsense that it must have some impact, since weather is a ubiquitous phenomenon from which traders are never fully isolated. On the other hand, there isn't a clear-cut, logical reason to expect that rain on Wall Street or a hurricane in Mexico should systematically change valuations or trader optimism. Ultimately it's an interesting question, but one that financial economics isn't really equipped to answer.
Key Takeaways When the market drops following a weather event like a hurricane or blizzard, some people say blame it on the weather. Property damage, injuries, or lost sales due to business closure or consumers who choose to stay at home are often the culprits identified that link inclement weather to poor market performance. Financial research, however, produces mixed results - with some studies showing such a link between weather and stocks, and others showing no such link at all.
What the Research Says
As a practical matter, it isn't difficult to test the correlation between stock market performance and weather pattern data. Meteorologists and climatologists chart everything from average sunshine to ocean currents, and stock market performance is a matter of public record.
The trick is trying to pick the right data to compare. Peer-reviewed studies have disparate and conflicting results. One famous example was "Weather-Induced Mood, Institutional Investors, and Stock Returns," which came out of Case Western Reserve University in Cleveland in 2014. It found that relatively cloudier days increased perceived overpricing in individual stocks and, subsequently, led to more selling by institutions.
"Stock Returns and The Weather Effect" was published in the Journal of Financial Economics in 1980. It seemed to find a very large impact factor, 3.72, under what was referred to as a "calendar time hypothesis." However, further review found that weather was a much smaller predictive variable than whether or not the trading day was a Monday.
Another study, "Stocks and the Weather: An Exercise in Data Mining or Yet Another Capital Market Anomaly?" appeared in Empirical Economics in 1997. This study attempted to replicate a 1993 study that showed that stock prices were "systematically affected by the weather." The 1997 study could not reject the null hypothesis, ultimately conceding "that no systematic relationship seemed to exist."
The Problem With Empiricism
The scientific method works wonderfully in physics or chemistry, where independent tests are controlled and variables are isolated, but nobody can run controlled tests on the ecosystem or the global economy. The systems are too large to replicate and too monstrously complex to fully understand. Data has its limits, and the best a market analyst can hope for is to show correlation, not causation.
Most causal models in economics or environmental science are regression-based. Modelers have to identify which factors seem relevant or irrelevant, and they need to have reliable and comparable data on all of the relevant factors. They also need to weight the relevant variables and add controls for possible corruption or biases. Many of these models are sophisticated and mathematically beautiful, but they can never accurately account for every potentiality.
Theories
One reasonable theory about weather and Wall Street suggests that severe weather interrupts business processes, supply chains and consumer movements, among other factors. In fact, the financial media often blames a sluggish quarter of gross domestic product (GDP) growth or stock market performance on weather problems. Though a popular idea, not everyone agrees.
One skeptic is Gemma Godfrey, head of investment strategy at Brooks Macdonald, who said that "the markets are insulated" from weather problems. "Markets have priced this in so there has been little downside reaction in the markets ... and less upside room when the weather warms." Many agree with her, arguing that meteorologists are good enough now that markets can anticipate fluctuations well in advance.
One alternative theory, an offshoot of behavioral finance, states that weather clearly affects mood, and mood clearly affects investor behavior. This link appears like a good argument for weather-influenced stock returns, but it's probably not as strong as its proponents make it sound.
For instance, it's not enough to demonstrate that weather affects mood; it must be demonstrated that weather affects mood in ways that alter decision-making about securities transactions (or, alternatively, alters saving and spending habits enough where securities volume is substantially different). Despite several studies in this area, economists don't really have the answers.
One such study, conducted between 2009 and 2011 on the Borsa Istanbul Stock Market in Turkey, found that investor behavior wasn't impacted by sunny days, overcast days or sunshine duration, but that it was probably affected by "the level of cloudiness and temperature."
A different U.C. Berkeley study, published in the Undergraduate Economic Review in 2011, concluded that "sunshine affects mood and mood can shape behavior" and found a "significant relationship" between sunshine and stock prices over the preceding half-century.
One study finds no effect from sunny days in Turkey, but a competing study argues that sunshine affects Wall Street performance. It's theoretically possible that sunshine affects Turkish traders differently than New Yorkers, but the far more reasonable conclusion is that model-based regression economics isn't really prepared to handle such an intricate causal relationship.
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08fb09559e9093f8b5219262cae3ada5 | https://www.investopedia.com/articles/markets/111115/if-you-had-invested-qualcomm-right-after-its-ipo.asp | If You Had Invested in Qualcomm Right After Its IPO (QCOM) | If You Had Invested in Qualcomm Right After Its IPO (QCOM)
Qualcomm, Inc. (QCOM) has solidified itself as one of the most innovative companies involved in the development of wireless technology. It has become the world's largest publicly-traded communication equipment company in the world in just over 20 years. As of Nov. 27, 2019, Qualcomm has a market capitalization of $96.83 billion. With the ever-growing wireless technology industry, Qualcomm is likely to continue its growth. If you had been lucky enough to purchase 100 shares of Qualcomm during its initial public offering (IPO) in 1991, after adjusting for stock splits and including dividend payments, your investment would be worth nearly $200,000 today.
Qualcomm is a global leader in wireless technology and communication equipment, with a market cap of over $96 billion. Founded in 1985, the company went public in 1991; its Nasdaq IPO was priced at $16 per share. As of November 2019, Qualcomm is selling for around $84 a share; its stock has increased by nearly 12,000%, and an initial investment of $1,600 would be worth over $195,000, after adjusting for stock splits.
The Qualcomm Story
Qualcomm was started in 1985 by Dr. Irwin M. Jacobs, Dr. Andrew Viterbi, Harvey White, Franklin Antonio, Andrew Cohen, Klein Gilhousen, and Adelia Coffman. These seven veterans of the telecommunications industry gathered in Dr. Jacobs' den and came up with the idea to build quality communications for the masses. Qualcomm opened its first office in La Jolla, Calif., and landed its first contract, as well as began working with CDMA, which is used for secure communications, during 1985.
Qualcomm IPO and Stock Splits
Qualcomm filed its IPO with the Securities & Exchange Commission (SEC) in September 1991. It expected to raise $50 million during this offering. According to Qualcomm's treasurer, it sought to offer its 3.5 million shares of common stock at between $14 and $16 per share. In December 1991, Qualcomm issued its IPO and sold 4 million shares of its common stock at $16 per share on the Nasdaq.
As of November 2019, after adjusting for stock splits, Qualcomm's stock price has increased by a colossal 11,954% since it went public in 1991.
If you had been able to just purchase 100 shares of Qualcomm at $16 per share, you would now own over 3,000 shares after its stock splits and spinoff. Qualcomm's four stock splits and one spinoff allowed its stock to remain attractive to the average investor. A stock split is commonly used to market a company's stock by increasing the number of shares outstanding and simultaneously decreasing its stock price by the same factor. A spinoff occurs when an independent company is created through the distribution or sale of new shares of the parent company.
Qualcomm experienced its first two-for-one stock split in February 1994. Consequently, if you had 100 shares of Qualcomm, you would have owned 200 shares after its split. After its spinoff of Leap Wireless International in 1998, you would have owned 204 shares. On May 11, 1999, Qualcomm split its stock two for one, so you would have owned 408 shares at $109.50 per share.
During the Internet bubble, Qualcomm's stock price experienced a spectacular rise to $734 at the open of the market on Dec. 30, 1999, but it closed at $647 per share at the end of the trading day. On Dec. 31, 1999, Qualcomm split its stock four for one, so you would have owned 1,632 shares at $176.13 per share, and your investment would have been worth $287,444.16. Between its two stock splits in 1999, your investment would have gone from a 2,382% increase to a 15,869.12% increase. Qualcomm went through its fourth stock split in August 2004; after the split, you would have owned 3,264 shares.
Present-Day Value of a Qualcomm IPO Investment
As of Nov. 27, 2019, Qualcomm was trading at $84 per share. Currently, the initial investment of just $1,600 would be worth $195,840. In addition to profiting from Qualcomm's alluring stock performance, you would have received dividend payments since 2003. Qualcomm currently pays a quarterly dividend of 62 cents per share. On an annualized basis, you would have received $6,266.88.
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2c7fdd95809e3760da4b3b8c29f1f385 | https://www.investopedia.com/articles/markets/111315/top-6-apps-financial-news.asp | Top 8 Apps for Financial News | Top 8 Apps for Financial News
When it comes to investing and stock trading, news and reaction time can make or break an investor. These are the best apps for up-to-date financial news.
1. CNBC Breaking Business News App
The CNBC Breaking Business News app (available on iPhone and Android) is NBC's flagship financial news app. It gives users access to actionable business news, financial information and market data. The app keeps its users up to date with breaking news alerts that are pushed through even when the app is closed.
The tool allows users to monitor real-time stock quotes and to view interactive charts, receive global business news coverage and watch full episodes of CNBC shows such as "Mad Money" and "American Greed." The app allows for a customizable watch list to track specific stocks and gain real-time access to associated business news headlines.
2. TheStreet App
TheStreet started as an online informational website but has since rolled out an app for both iPhone and Android. The app provides access to financial news, analysis and stock-picking insights from experts associated with the company.
The app supplies up-to-date market news, opinions and commentaries, technical analyses and actionable data. It also delivers detailed quotes and analysis of stocks and offers a proprietary stock rating model called TheStreet Ratings. The app aims to aggregate information to provide a multimedia financial experience based on data, articles, and videos.
3. Bloomberg: Business News App
The Bloomberg: Business News app gives access to the company's global business and financial news, up-to-date market data and proprietary portfolio tools. Bloomberg sets its app apart with articles written by the award-winning business and financial journalists at Bloomberg.
The app (available on iPhone and Android) allows users to receive the latest market data, which can be filtered by specific regions or sectors. Bloomberg's watchlist lets users track securities and other investments, and the company's audio and video services allow users to receive pertinent financial information with their media channel of choice.
When it comes to investing and stock trading, news and reaction time can make or break an investor.
4. Fox Business App
The Fox Business app (available on iPhone and Android) lets users stay connected to the constantly changing business world. The app can track financial markets and send financial alerts to its users. Users can search for stocks by ticker symbol and create watchlists by adding stocks to the app's My Stocks Page.
Additionally, users can access up-to-the-minute news and market data through the use of live Fox business broadcasts and watch clips from their favorite Fox Business Network shows. The app's users can also repost and share articles and videos from the Fox Business app on most social media outlets.
5. Barron's App
Barron's is known as the premier investing news magazine, providing financial analysis and insight in print, and more recently through its mobile app. Available on iPhone and Android, Barron's subscribers can access the company's articles every weekend from this app, along with commentary from Barron's Online edition seven days a week and analysis every weekday.
In 2019, a subscription to Barron's cost around $19.99 a month and gave subscribers access to the app and Barron's website. Users can save articles on the mobile app and access them on the website, and vice versa.
6. MarketWatch App
The MarketWatch app (on iPhone and Android) gives its users access to the latest business news, financial data and market information. Through the use of the app, people can receive breaking news coverage, the most recent market data, and market alerts. The tool also provides an opportunity to create a watchlist and track MarketWatch stories related to the user's stock picks.
7. The Wall Street Journal App
Historically, The Wall Street Journal is one of the most reputable and reliable sources for financial information. Through the Wall Street Journal, both iPhone and Android using subscribers can customize news and notifications to fit their preferences. The publication requires a subscription that cost just under $40 a month as of early 2019.
8. SeekingAlpha Portfolio App
SeekingAlpha is offered to subscribers for free or on a premium basis. Available on iPhone and Android, It is one of the financial industry’s top sources for stock news alerts. It also provides in-depth research on a full range of publicly traded stocks and managed funds. Subscribers can receive stock alerts throughout the day on companies and funds that they are following.
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a6919af6e9cd2bc6a1da2e0ac4485a7e | https://www.investopedia.com/articles/markets/111615/analyzing-porters-5-forces-facebook.asp | Analyzing Porter's 5 Forces on Facebook (FB) | Analyzing Porter's 5 Forces on Facebook (FB)
Investors and analysts like to use the Porter five forces model because its methodology is simple but powerful. By following through each of the five forces that Harvard Business School professor Michael E. Porter identified in his 1979 Harvard Business Review article, "How Competitive Forces Shape Strategy," an analyst or potential investor can gain a better comprehension of where a company stands relative to its industry.
This understanding can help that person make a more informed decision about whether to recommend or invest in the company based on how it stands relative to its rivals. It is particularly useful in situations where rivalry may not be direct as, for example, the fast food competition between McDonald's and Burger King or the ongoing struggles for soft drink domination between Pepsi and Coca-Cola.
Facebook, Inc. (NASDAQ: FB) is a prime example. The company has several platforms, from its original social networking site to its other offerings such as Messenger, Instagram and WhatsApp. While there have been some competitors who have tried to break into the space, including Alphabet's Google Plus network and Yahoo's Tumblr, none (as yet) have really put a dent in Facebook's user numbers or usage. However, that does not mean that Facebook is not vulnerable. An analysis framework such as Porter's five forces helps to clarify those threats.
Understanding Current Competitors
The Porter five forces model begins by looking at the current competition. Facebook is in competition with a variety of social networks, from full-featured ones such as Google Plus or Tumblr to more niche sites such as Twitter and LinkedIn.
Facebook has several different platforms, which helps it compete more directly with those competitors, but they do not appeal to all demographics equally. For instance, many younger users prefer Facebook's WhatsApp or its rival Snapchat, while professional users may look more towards LinkedIn, Twitter or Facebook Pages. In this sense, Facebook faces a moderately high risk.
Facebook's Customer Bargaining Power
Moreover, many people have and use accounts on several different social media platforms. The more a user engages outside the Facebook family, the less time he spends on Facebook or its other platforms.
This gives Facebook’s customers quite a fair amount of bargaining power. After all, Facebook is free to use, so it does not cost anything for a user to switch networks – and social media platforms are not exclusive.
Even if Facebook can keep its users checking in at least once in a while, the company needs them to be actively using the site if it is to make any money on ad space or the market research that can come from all the data Facebook collects. In other words, Facebook has to work extra hard to keep users actively using its services. That can mean limiting the number of ads, spending money on research and development (R&D) to create more robust features and working hard to create integrations with Facebook and other sites or services.
Assessing the Threat of New Entrants
The world of smartphone applications and platforms is fairly inexpensive to enter, so the threat of new entrants is definitely present. All you need is an excellent programmer and a secure server. The trick is in getting enough brand recognition to attract users, inspiring enough confidence that users feel safe to share their personal information on the platform, and creating enough economies of scale and economies of scope to compete effectively with a company as large as Facebook.
So far, Facebook has been king, but all it takes is one new entrant that beats the odds. More importantly, it would not mean that all users need to abandon Facebook. In fact, it would just take a single demographic, such as teenagers. That is why Facebook’s share price takes a dip almost every time a new report comes out saying that teens are not active on the network. If an app comes out that really trends with teenagers, that could be all it takes to really hit Facebook hard. The risk here is moderately low – for now.
Determining Supplier Bargaining Power
Facebook's suppliers also have bargaining power. Suppliers in this sense include everyone from the people who build and maintain their servers to the software that runs Facebook's different social media platforms.
Obviously, Facebook is large enough and powerful enough that supplier bargaining power is less of an issue than it may be for a smaller company, but that does not mean the issue is completely negated. Suppliers in this sense can also be complements that allow Facebook to operate as it does, such as the Internet.
For instance, if Internet usage becomes capped or very expensive after reaching a set limit, users could be forced to reduce the time they spend on social media, even if Facebook does everything right. The cost and availability of fast Internet speeds could impact the amount of time Facebook users spend on the site.
Another factor could be the sites and services that offer Facebook login for identification purposes. This helps provide Facebook with new information every time a user logs into an outside site this way, but if that technology were to go out of favor or be replaced by a more secure identifier, such as a thumbprint reader, Facebook could lose out on that integration.
Facebook's Threat of Substitutes
Facebook has an enormous user base, but social networking as a whole is very vulnerable to new technologies and shifting trends. If social networking becomes unfashionable, Facebook will lose many of those current participants.
Similarly, much of Facebook’s competition comes from niche sites. It could happen that instead of users switching to a more direct competitor, they simply choose a substitute. New parents may opt to share photos about their baby on a parenting site instead of Facebook or cooking enthusiasts may want to interface more on recipe websites than Facebook.
Besides, as companies such as Apple could develop services that allow families and groups to share photos and messages easily (and securely) among themselves, some close-knit groups may be less likely to use Facebook and choose this type of inter-family messaging instead.
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675a9c82bd36dfe96e0cfccd3e8751e9 | https://www.investopedia.com/articles/markets/112515/how-does-cocacola-actually-make-money.asp | How Coca-Cola Makes Money | How Coca-Cola Makes Money
The Coca-Cola Company (KO) has a unique business model that has served it well since the first bottling in 1894. Coca-Cola sells syrup to bottling companies that do the hard work of manufacturing and distributing the product to consumers; it refers to this portion of its business as "concentrate operations." The company also generates revenue from the sale of finished beverages to retailers, distributors, and wholesalers.
John Stith Pemberton, a pharmacist living in Atlanta, created the flagship soda Coca-Cola in 1886. The company was incorporated in 1892, having operated under a franchise distribution model since 1889. Today, Coca-Cola has risen to global prominence and is currently the largest nonalcoholic beverage company in the world. Besides the original Coca-Cola product and a host of related beverages, the Coca-Cola Company now produces roughly 500 beverages grouped into categories such as sparkling soft drinks, sports drinks, juices, energy drinks, and tea and coffee.
Coca-Cola released its 2018 annual report in Feb. 2019. The beverage distributor and manufacturer reported net operating revenues of nearly $31.9 billion for the year 2018, compared to $35.4 billion over the same period last year. As of July 9, 2019, the company's market capitalization is just under $224 billion.
Important The Coca-Cola Company primarily produces syrup concentrates, which are then sold to affiliated bottling companies around the world.
The Coca-Cola Company's Business Model
In 1894, Mississippi businessman Joseph Biedenharn installed bottling machinery behind his soda fountain store. The idea was to make Coca-Cola portable. Five years later, three entrepreneurs in Tennessee purchased the exclusive rights to bottle and sell Coca-Cola for $1. The number of Coca-Cola bottlers soon exploded to over 1,000 plants. This posed many problems for the company from imitations by competitors and the need for consistency across the product line. In 1916, Coca-Cola bottlers agreed to the famous contour design bottle that still remains iconic today. As of Nov. 2015, the company had over 900 bottling and manufacturing facilities located around the globe. Those facilities are owned by over 250 independent franchises and Coca-Cola.
Coca-Cola reports its net revenue in two segments: concentrate operations and finished product operations.
Key Takeaways The Coca-Cola Company generates revenue by selling concentrates and syrups to bottling facilities around the world, and by selling finished products to retailers and other distributors. Unlike many other beverage companies, Coca-Cola does not complete and bottle the majority of its products. Coca-Cola owns four of the five top nonalcoholic sparkling soft drink brands: Coca-Cola, Diet Coke, Fanta, and Sprite.
The Coca-Cola Company's Concentrate Business
Coca-Cola manufactures and sells syrup to authorized bottlers to make finished Coca-Cola products, and to manufacture fountain syrups. This revenue is reported under the company's concentrate operations.
Coca-Cola has supported the consolidation occurring among its bottlers. Having too many small independent bottlers created several challenges for the company. Challenges can stem from micro- to macroeconomic factors and they vary around the globe. When faced with economic challenges, some smaller, independent bottlers lacked the financial assets to continue operations and fund necessary investments. When bottlers face financial problems, it creates logistical and image issues for Coca-Cola.
To solve this problem, Coca-Cola created the Bottling Investments Group (BIG). The goal of BIG is to identify and help bottling franchises that need financial and institutional support. BIG targets struggling franchises and provides them with the resources they need to remain a part of the Coca-Cola franchise network. Coca-Cola then sends in teams of experts and resources to drive growth and return the franchise to profitability. Once profitability and stability in the local market is achieved, the company finds a qualified bottler to assume operations.
The BIG program operates in dozens of countries and is responsible for managing over 25% of the total system bottling volume. Combined, the BIG program is the largest global bottler in the company. In 2004, bottlers in the BIG program took in $11 billion in revenue. In Q3 2018, Coca-Cola completed refranchising company-owned bottling operations in North America, which cost $275 million.
The Coca-Cola Company's Finished Product Business
The company also manufactures its own fountain syrups, manages several bottling operations, and collects revenue on finished products. This revenue is reported under the finished product operations.
In 2018, 36% of Coca-Cola's business was categorized as finished product operations, while 64% was classified as concentrate operations. This was significantly more biased toward concentrates over 2017, when the division was 51% concentrate operations and 49% finished product.
Of the roughly 61 billion servings of all beverages consumed worldwide on a daily basis, close to two billion are Coca-Cola products.
Future Plans
The unique franchise bottling system developed over 100 years ago continues to be a valuable asset for Coca-Cola. A long-term company goal is to end the BIG program by having zero need and further consolidate its bottlers. Ideally, bottlers should be profitable and possess the financial assets to fund investments and help drive growth for the parent company.
A Greener Coca-Cola
As global revenue in sugary soft drinks falls, it will be important to ensure bottlers have the financial means to transition with consumer tastes. Coca-Cola has set several sustainability goals to achieve by 2020 that will require commitments from bottlers. These goals include a reduction in carbon emissions, recycling 75% of the bottles and cans used in developed markets, improving water efficiency, and returning the equivalent of 100% of the water used in bottling to communities and nature.
Key Challenges
One of the Coca-Cola Company's biggest challenges is the obesity epidemic and corresponding shifts in public taste away from sugary beverages. The company must focus its product development and other efforts on matching customer tastes as they change. Additionally, the nonalcoholic beverage industry is a highly competitive one. Although Coca-Cola enjoys brand recognition that is essentially unrivaled on a global scale, the company must nonetheless be vigilant in ensuring that it continues to connect with potential customers.
Water Cycle Worries
Because nearly every Coca-Cola product is made using water, issues with water supplies and quality could also impact the business. Finally, because Coca-Cola relies on retail distribution to ensure that it is able to deliver its products to consumers worldwide, disruptions to or transformations of the retail landscape could introduce new challenges as well.
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e5f7e7579cc261e0650292079b4109c6 | https://www.investopedia.com/articles/markets/113015/if-you-had-invested-right-after-amgens-ipo.asp | If You Had Invested Right After Amgen's IPO (AMGN) | If You Had Invested Right After Amgen's IPO (AMGN)
Amgen, Inc. (AMGN) went public on June 17, 1983, for $18 per share. Since its initial public offering (IPO), the stock has split five times. If you had invested $1,000 at the time of Amgen's IPO, your investment would have grown to be worth $780,692 as of April 17, 2020, without reinvesting dividends. This is an annual rate of 19.81%.
The History of Amgen
Amgen began as AMGen, which stood for Applied Molecular Genetics, in 1980. In the early years, the company attempted a wide variety of scientific breakthroughs, such as organisms that could extract oil from shale, cloning the light source of fireflies, making specialty chemicals, and growing chickens faster.
By 1983, the company began to focus on treating and curing diseases. By finding and cloning the erythropoietin gene, the company created its foundational product, Epogen. Epogen was approved by the Food and Drug Administration (FDA) in 1989 to treat low red blood cell counts caused by kidney disease. In 1985, the research that enabled the company's second very successful product, Neupogen, was complete. In 1991, the FDA approved the use of Neupogen to support cancer patients' immune systems.
Amgen has made several key acquisitions. In 2002, the company acquired Immunex, the developer of Enbrel, which is used to treat five major diseases. Amgen also acquired a manufacturing plant in Rhode Island and quickly met the demand for Enbrel. In 2011, the company acquired the developers of talimogene laherparepvec, BioVex, which is used to treat melanoma tumors. In 2012, Amgen acquired deCODE Genetics, a leader in human genetics. Then in 2015, it bought Dezima Pharma and Catherex. In 2019, the company made two additional acquisitions: Nuevolution, a pharmaceutical company focused on cancer and anti-inflammatory drugs, and Otezla, an arthritis drug made by Celgene.
Current Products
As of 2019, eight products make up the vast majority of revenue for Amgen.
Enbrel is the company's biggest seller, with sales of $5.2 billion in 2019; 30% of Amgen's revenues. The drug treats severe arthritis and other inflammatory diseases. Neulasta is the second biggest seller, with $3.2 billion in revenue; 19% of total revenue. The drug is used as a white blood cell stimulant. Enbrel and Neulasta make up approximately half of Amgen's sales.
Xgeva and Prolia are both used as therapies for osteoporosis and bone protection, and both account for 27% of Amgen's revenues. Aranesp is used to treat low red blood cell counts caused by chronic kidney disease and makes up 10% of revenues. Epogen caters to dialysis patients, used to treat anemia caused by CKD and is 5% of revenues. Kyprolis is a cancer treating drug that accounts for 6% of revenues. Both Sensipar and Mimpara help with the management of parathyroid hormones, phosphorus, and calcium, and are the smallest contributors to Amgen at 3.2% of revenues.
Dividends and Splits
Amgen began paying its quarterly dividend in 2011 and has increased it annually ever since. Due to the late start for the company's dividend, it would not have increased an investor's return significantly. Dividends are paid quarterly and started at $0.28 in 2011 and as of March 2020, are $1.60.
By investing $1,000 during Amgen’s IPO, you would have held 55.55 shares. Adjusted for the five stock splits (four two-for-one and one three-for-one), you would hold 2,666.66 shares today, not accounting for dividend reinvestment.
The Future
Amgen continues to serve patients by using biotechnology and science to create treatments that can cure diseases, save lives, prolong life expectancies, and improve a patient's quality of life. Amgen continues to look for strategic acquisitions and to improve its manufacturing capabilities, which could boost margins.
As of 2020, the company has 20 products in its phase three pipeline. By remaining on the cutting edge of biotechnology and science, Amgen can continue to develop treatments for major diseases that have few available treatments. This allows the company to serve a niche with little competition and also charge a premium for its products.
From chronic heart failure to asthma, lung cancer, and episodic migraines, Amgen continues to pioneer treatments for cases where treatment is either ineffective in significantly prolonging the life of the patient or where previous treatments do not provide patients with a proper quality of life.
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cf211c2b0fb379f48f6c1908973040e8 | https://www.investopedia.com/articles/markets/113015/if-you-had-invested-right-after-ciscos-ipo.asp | If You Had Invested Right After Cisco's IPO | If You Had Invested Right After Cisco's IPO
What if You Had Invested Right After Cisco's IPO?
Cisco Systems, Inc. (NASDAQ: CSCO) began making routers before most people knew what they were or even how to use the Internet. On Feb. 16, 1990, the company held its initial public offering (IPO). Cisco's IPO is considered one of the greatest of all time because of the company's explosive growth in subsequent years. It was the top company on Forbes' list of best-performing IPOs during the 1990s.
If you had invested $1,000 during Cisco's IPO, you would have received 55.55 shares. Adjusted for stock splits, today you would hold 15,998.4 shares, and your investment would be worth $567,965 as of market close on March 17, 2020.
Understanding an Investment in Cisco Right After Its IPO
Company History
Cisco was founded in 1984 by Len Bosack and Sandy Lerner. The couple was married, and both headed different departments at Stanford University. Bosack and Lerner were interested in connecting computers around the university to share information.
Key Takeaways Cisco's IPO in early 1990 is considered one of the most important IPOs of all time.With an initial price under a dollar, Cisco's stock price has varied from an all-time high in the $75 range during the dot-com bubble of the 1990s and early 2000, to trading in the low $20 range during the 2008 financial crisis. If you had invested $1000 in Cisco's IPO, then held it until today, it would be worth over half a million dollars as of March 2020.
Bosack was forced to resign in 1986 on charges of violating Stanford's intellectual property copyright. Cisco went on to design its own multi-protocol router. In 1987, the company acquired the original license for the router it duplicated at Stanford and the two computer boards it was using at the time.
In 1987, Cisco received $2 million in funding from Sequoia Capital. John Morgridge joined the company as president and chief executive officer (CEO) and would lead until John Chambers took over in 1995.
Over 40% of Cisco's revenues by that time came from international markets. Cisco began making strategic acquisitions of networking companies, such as TransMedia Communications, Telesend, Netspeed, and Stratacom. Cisco quickly became the worldwide leader in networking Internet traffic.
The Dot-Com Bubble
On its first day of trading in 1990, Cisco's shares rose 24%. The unprecedented gains didn't end for another 10 years. The dot-com bubble, also known as the Internet bubble, was a huge period of speculation in Internet and Internet-related companies from 1997 to 2000. If you had sold your Cisco shares during the height of the dot-com bubble, your initial IPO investment of $1,000 would have been worth $1.264 million, representing a CAGR of over 104%.
As the dot-com bubble began to burst, Cisco lost 80% of its value from March 2000 to March 2001. While their price rose to about 75% of its peak in July of 2019, as of early 2020, the company still trades nearly 50% below its all-time high.
Dividend Reinvestments
The company began paying a dividend in 2011 after pressure from shareholders. Reinvestment of dividends would not have had a significant impact on your CAGR since they have only been paid for a short period of time and missed the extremely high-growth years. In comparison, Coca-Cola has been paying a quarterly dividend since 1920, which has aided its annual growth rate by over 4.2%.
The Future
Cisco continues to be a world leader in networking and services related to communications and information technology. Since the recession of 2008 the company’s stock has doubled, it initiated its quarterly dividend program, and it has made massive share repurchases.
CEO John Chambers resigned in July 2015 after serving in that role for the past 20 years. He now serves in the chairman emeritus role, and Chuck Robbins, who had been with Cisco for the past 20 years, serves as CEO and Chairman.
The company has been through years of restructuring that began in 2011. The new CEO has stated that Cisco will begin to move away from selling the individual switches and routers that made the company so successful. Instead, Cisco's future will hinge on software and integrated parts and services.
In general, the industry has been moving more towards cloud computing. Innovation has propelled Cisco through one of the greatest IPOs in history. With a market cap of more than $172 billion as of September 2020, Cisco has the financial means to become a leader in the next wave of innovation.
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bbc59a8e28e2f32333a1e903f581e576 | https://www.investopedia.com/articles/markets/120115/if-you-had-invested-right-after-disneys-ipo.asp | If You Had Invested Right After Disney's IPO | If You Had Invested Right After Disney's IPO
Investors in the Walt Disney Company's (DIS) initial public offering (IPO) who held onto their investments would be very happy with their returns. If you had invested $1,000 in Disney's IPO on November 12, 1957, not including dividend reinvestment, your investment would be worth $4.78 million as of December 23, 2020. This represents a compound annual growth rate (CAGR) of over 14%.
Key Takeaways Disney traded over the counter (OTC) until November 12, 1957, when it debuted its initial public offering on the New York Stock Exchange. A $1,000 investment in Disney in 1957 would have grown to be worth over $4.78 million as of December 23, 2020. From its IPO to the present day, the company is reporting a 14.2% compound annual growth rate.
The Disney Story
Disney began in the early 1920s when Walt Disney, the company's founder, signed a contract to produce a series of Alice Comedies. By the late 1920s, the first Mickey Mouse cartoons were released, and Minnie Mouse was introduced. In the early 1930s, Disney premiered its first full-color cartoon, and Donald Duck made his first appearance. In 1937, Disney's first feature-length animated film, Snow White and the Seven Dwarfs, premiered.
The significance of Snow White for Disney cannot be understated. The film was the first animated feature film in the world and a huge financial risk for the company. The film was made during the Great Depression, and Walt Disney stated, "There could be no compromising on money, talent, or time."
After running over budget, Disney was forced to preview Snow White early to Bank of America Vice President Joseph Rosenburg. The gamble paid off when Snow White became the most profitable film of all time. Adjusted for inflation, Snow White grossed more than $1.7 billion. Fresh off the heels of Snow White, Disney moved its movie studios to Burbank, California to begin work on future classics.
In 1940, Walt Disney Productions issued its first stock through 6% cumulative convertible preferred shares. Through the 1940s, Disney released its highly regarded film Fantasia and formed the Walt Disney Music Company. Disney went on to release several other award-winning films and TV shows and opened Disneyland in 1955. In 1971, Walt Disney Resort opened with the Magic Kingdom near Orlando, Florida. In the 1980s, Disney expanded its theme parks internationally and continued to add parks near Orlando. Disney also expanded further into television and storefronts.
In the 1990s, Disney Publishing released its first book, and Disney released several other hit films. Disney agreed to purchase Capital Cities/ABC in 1995 and expanded online. Disney later merged with ABC and debuted ESPN Magazine. Disney expanded to cruises and radio, and it purchased the Anaheim Angels.
The Math Behind the Numbers
Disney's common stock traded over the counter prior to its IPO debut on the New York Stock Exchange (NYSE) in 1957. Investors who purchased common stock OTC would have seen significantly higher returns. The company traded for $3 per share in 1949 and rose to $52 per share before splitting two for one. Disney paid its first common stock dividend in 1956.
The company held its IPO in 1957 and sold each share for $13.88. If you had invested $1,000 at the time, you would have been able to purchase 72 whole shares. Disney has had six stock splits in company history after its IPO. Your original 72 shares would equal 27,648 shares today. On December 23, 2020, Disney stock was trading at $173 a share, making your initial $1,000 investment worth roughly $4.78 million. Given the long dividend history of Disney and the pace of share price appreciation, if you had chosen to reinvest your dividends, you would have seen significantly higher returns.
The Present and the Future
In the 2000s, Disney continued to expand its parks internationally, built upon the success of its cruise ship lines, and diversified the company's media interests. In 2006, the company acquired the Pixar Animation Studio, which produced films such as Toy Story, Cars, and Finding Nemo. In 2009, Marvel Entertainment joined the Disney family, bringing along its famous comic book superheroes. In 2012, Disney completed the acquisition of Lucasfilm, putting the legendary Star Wars franchise under its control. In the 21st century, the company has released nearly 200 films.
As of March 2020, the company reported the following four main business segments: Media Networks; Parks, Experiences, and Products; Studio Entertainment; and Direct-to-Consumer & International. In 2020, the company was hit hard by the coronavirus pandemic as a top leader in the S&P 500 consumer discretionary market. It released an announcement in May 2020 reporting it would forgo its semi-annual dividend payment to shareholders for the first half of its fiscal year. Prior to 2020, the company had been paying steady semi-annual dividends, which began in 2015.
Following a judge's decision in June 2018 that allowed for the AT&T and Time Warner merger, Disney competed with Comcast (CMCSA) to purchase 21st Century Fox Inc. (FOXA). In July of 2018, 21st Century Fox was sold to Disney for $71.3 billion.
In 2019, Disney entered the streaming war with the launch of Disney+. In November 2019, Disney+ signed up 10 million users on its first day of availability. A year later, the company reported over 86 million subscribers.
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e0a8b1d956da2b3935128c39ed9bbce2 | https://www.investopedia.com/articles/markets/120115/quick-look-rite-aids-history.asp | Rite Aid History: A Quick Look | Rite Aid History: A Quick Look
Rite Aid (RAD) was founded by Alex Grass in 1962 in Scranton, Pennsylvania, as a health and beauty store, originally called Thrift D Discount Center. The company changed its name to Rite Aid Corporation in 1968 ahead of its initial public offering (IPO) on the American Stock Exchange (AMEX). In 1970, the company's stock jumped to the New York Stock Exchange (NYSE).
Here's a look at what came next for Rite Aid, including highlights of its growth, scandals, and deals with Walgreens and Albertsons.
Key Takeaways Alex Grass founded Rite Aid in 1962 originally as Thrift D Discount Center.Rite Aid acquired Envision Pharmaceutical Services for $2 billion in 2007.Former Rite Aid executives admitted to overstating net income between 1997 and 2000.Rite Aid abandoned two prospective merger deals—the first with Walgreens in 2017 and the second with Albertsons in 2018.
Financial Performance
Rite Aid reported full-year earnings for the 2019 fiscal year in April 2019. The company reported revenue from continuing operations of $21.6 billion for the year, an increase from $21.5 billion from the previous year. Rite Aid reported a net loss from continuing operations for the year of $667 million. The company's loss increased from 2018, which was $349.5 million.
In January 2019, Rite Aid announced that it received notice from the NYSE that it was no longer in compliance with its standard listing rules. That's because the average closing price of Rite Aid's common stock was below the required $1 per share threshold during a consecutive 30-day trading period. The company's share price dropped following the announcement of two failed merger attempts. That changed after Rite Aid executed a 1-for-20 reverse stock split which brought its stock price above $1.
Acquisitions Fuel Growth
Within 10 years of opening its first store, Rite Aid grew to 267 locations in 10 states. The company first achieved $1 billion in sales in 1983. In 1987, with the acquisition of Gray Drug—420 stores in 11 states—Rite Aid became the largest drugstore chain in the U.S., with more than 2,000 stores.
By 1996, Rite Aid doubled in size to 4,000 stores after several acquisitions, including Read’s Drug Store, Lane Drug, Hook's Drug, Harco, K&B, Perry Drug Stores, and Thrifty PayLess.
The company formed a partnership with General Nutrition Companies in 1999. This allowed GNC to open mini-stores within Rite Aid locations. In addition, Rite Aid partnered with drugstore.com, offering Rite Aid customers the ability to place prescription orders online and get same-day, in-store pickup. Also in 1999, Rite Aid acquired pharmacy benefits manager PCS Health Systems.
Rite Aid added more than 1,500 stores in 2007 with its acquisition of the Brooks and Eckerd drug store chains. Eight years later, it acquired pharmacy benefits manager Envision Pharmaceutical Services for $2 billion.
Accounting Scandal
In 1999, Rite Aid began restating earnings from prior years due to accounting irregularities. Six former Rite Aid senior executives were convicted of conspiracy in 2003 regarding a wide range of accounting fraud and false filings with the U.S. Securities and Exchange Commission (SEC).
These executives included former chief executive officer (CEO) Martin Grass, the son of company founder Alex Grass. The former executives admitted to drastically overstating net income from 1997 to 2000 through multiple schemes.
Grass was sentenced to eight years in prison—one of the harshest punishments ever given in connection to an accounting-related crime at the time. Rite Aid was forced to restate its earnings by $1.6 billion.
Deals With Walgreens and Albertsons
In October 2015, Walgreens (WBA) announced it would acquire Rite Aid for $9 per share. Rite Aid’s shareholders approved the deal a few months later in February 2016.
However, the deal got hung up on regulatory approval complications from Walgreen’s side. The two companies extended talks into 2017 until they ultimately vacated the merger deal.
Although Rite Aid shareholders approved a merger deal with Walgreens in 2016, the two companies abandoned talks in 2017.
Instead of the merger, Walgreens and Rite Aid agreed to a $4.3 billion deal for Walgreens to buy 1,932 Rite Aid stores and three distribution centers. The deal was approved by the Federal Trade Commission (FTC) in September 2017 and completed in March 2018.
Shortly after the Walgreens deal, Albertsons and Rite Aid began merger talks. On Feb. 20, 2018, the companies announced that supermarket retailer Albertsons agreed to acquire Rite Aid in a deal valued at $24 billion.
However, the companies called the deal off on Aug. 8, 2018, the night before the scheduled shareholder vote, citing opposition from Rite Aid's individual and institutional shareholders.
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8647fefbe2e72b162256cf0bc839ff75 | https://www.investopedia.com/articles/markets/120115/ups-vs-fedex-comparing-business-models-and-strategies.asp | UPS vs. FedEx: What's the Difference? | UPS vs. FedEx: What's the Difference?
United Parcel Service, Inc. (UPS) and FedEx Corp. (FDX) are two leading delivery services companies and main competitors to each other, at least in the public eye. However, to those following them closely, the two companies are quite different in their business models and strategies. Here we review and contrast how the two companies approach a variety of business challenges, such as online commerce, logistics, express services, and ground delivery.
UPS vs. FedEx: An Overview
While UPS is widely known for its domestic ground package delivery, FedEx is mostly recognized for its global air express freight. The two companies also differ in terms of their approaches to serving customers, how they have fared in the e-commerce environment, and the different business structures unique to each company.
Package delivery and express service are where the two companies have made names for themselves. Each company has other delivery services that make everything they do seemingly overlap.
UPS is also a common carrier in air freight, and FedEx has a similar package delivery unit called FedEx Ground. In reality, UPS's ground package business and FedEx's air express operations are, respectively, the bread and butter for each company.
Key Takeaways UPS and FedEx have both been pioneers in the express package delivery service.UPS specializes in domestic ground delivery services.FedEx specializes in time-sensitive international air freight.
UPS
United Parcel Service, Inc. (UPS) delivers packages worldwide on every day except Sunday. In 2019, UPS delivered around 21.9 million packages and documents each day, which totaled 5.5 billion, according to its 2019 annual report—a number unmatched by anyone else in the business.
The UPS Store and FedEx Office are retail outlets set up by the two companies to bring in individual shipping orders for their respective package delivery and express services. Having such stores and offices also represents the different approaches by UPS and FedEx to serve their customers.
While both outlets provide shipping, packaging, and certain office supply services such as copying and printing, they attract different kinds of customers because of the different nature of each company's underlying delivery business. The UPS Store is often a relatively small retail setting, independently owned by franchisees. It primarily serves retail customers and small businesses for their small package delivery needs plus certain postal and shipping-related services.
Electronic Commerce and Logistics
The ongoing e-commerce development has played right into UPS's core business of small package delivery. As more people make purchases regularly online, merchants on the Internet are increasingly pressured to make their offline delivery of goods on time to customers.
They see logistics as having a much bigger role in retail success, and to help themselves better navigate through the e-commerce way, online merchants rely on package delivery companies such as UPS to make the final connections to their customers. As a result, UPS has seen increased demand for its business and has even struggled to keep up its capacity during times of heavy shipping orders.
UPS manages all its businesses, such as air, ground, domestic, international, commercial, and residential through a single pickup and delivery network. The single network structure has allowed UPS to gain competitive strengths by maximizing network efficiency and asset utilization.
FedEx
FedEx Corp. (FDX) moves more than 15 million shipments each business day to more than 220 countries and territories around the world, according to the FedEx Corporate Brochure for 2019. When it comes to business models, the two companies have each found their different business niches, with UPS focusing on small package delivery and FedEx specializing in time-sensitive express service.
As for stores, FedEx Offices usually occupy large spaces, really resembling big offices, and are corporate-owned. FedEx Office can provide sophisticated equipment such as digital photo kiosks, laser printers, or desktop access with an image scanner and Adobe design software. FedEx mostly attracts retail customers and corporate clients, who prefer and can afford the kind of express services offered.
Express and Long-Haul Delivery
Online purchases require mostly regular local and regional deliveries as opposed to express, long-haul deliveries, which is more what FedEx does the best. With cost-efficiency in mind, online merchants are more likely to sell through their regional fulfillment centers or local chain stores to avoid long-distance deliveries that can be time-consuming and cost-laden. As a result, FedEx's strength does not play into e-commerce development. To catch on with e-commerce's demand for shorter-distance delivery, FedEx may have to realign its business model more toward its FedEx Ground while keeping its express advantage.
FedEx's strategy is for its different business units—such as express, ground, freight, and services—to operate independently. However, 96.8% of FedEx's clients use two or more of the company's separate operating units, according to its investor relations page, providing a different kind of competitive advantage.
The Bottom Line
Because FedEx has more dissimilar operations—from express to ground to freight—a single network strategy would not work. However, for UPS, the different businesses it has are essentially all about small package delivery, and sharing a single network makes the most sense. It may be surprising to see that two delivery services companies can be so different in so many aspects of their operations. To many people, they look the same.
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88f1536787c3232123be82734944cdad | https://www.investopedia.com/articles/markets/120215/starbucks-vs-dunkin-donuts-comparing-business-models.asp | Starbucks vs. Dunkin': What's the Difference? | Starbucks vs. Dunkin': What's the Difference?
Starbucks vs. Dunkin': An Overview
Starbucks Corp. (SBUX) and Dunkin' Brands (DNKN) are the two largest eatery chains in the U.S. that specialize in coffee. Both companies offer similar coffee options—although different food options—and both have similar overall strategies. Nonetheless, there are key differences in their business models related to scale, store ownership, and branding.
Despite being founded 20 years after Dunkin' Donuts, Starbucks grew aggressively and is a substantially larger company. Starbucks generates over $26 billion a year in revenue, while Dunkin' Brands' annual revenues are just under $1.5 billion.
Starbucks has a larger footprint, with over 30,000 locations worldwide, compared to Dunkin' Brands' 11,300 locations. In the U.S., Starbucks leads with about 15,000 locations compared to the nearly 8,500 Dunkin' Donuts locations.
Starbucks has expanded beyond the U.S. more extensively. Dunkin' Brands has a substantial international presence, though many of its international locations are Baskin-Robbins ice cream stores rather than Dunkin' Donuts stores.
Dunkin' Donuts' international revenue contributes only a small part to total sales, while over 25% of Starbucks' revenues are generated outside the U.S. Dunkin' has announced aggressive international and domestic expansion plans with the hope of challenging its main competitor's footprint, but the difference in scale stems from variations in expansion strategy.
Key Takeaways Starbucks and Dunkin' are the two biggest coffee-focused eatery chains in the U.S.Starbucks is a bigger company in terms of market capitalization and the number of stores globally. Starbucks has also built a more premium brand, has stores that look more like a comfortable coffee house, has a more extensive menu, and greater product customization.Dunkin' stores resemble more traditional fast-food eateries and they offer more competitive pricing relative to Starbucks.Most of Dunkin's stores are franchises, where it has greater exposure to franchise and rental income.
Starbucks
Starbucks brands itself primarily as a beverage provider that offers a more typical coffee house dining experience. Starbucks' locations are designed with the comfort of customers in mind. Free internet access and inviting decor are meant to offer a more enticing option for those looking for a place to read, relax, or chat with friends. This also makes going to Starbucks a potential social activity, turning the store into a destination rather than a simple distribution location. This appeals to customers seeking a premium experience.
Typically, such customers have higher disposable incomes and are more willing to pay extra for higher quality materials. In economic downturns, people with lower disposable incomes are more likely to alter their consumption habits than people with larger financial cushions. While Starbucks is undeniably impacted by the macroeconomic environment, it is firmly established with a more resilient and less price-sensitive customer base, which helps to dampen the blows brought on by economic cycles.
Like Dunkin' Donuts, Starbucks has also shifted focus to include more products aimed at afternoon and evening customers. These include small plates and sandwiches as well as wine and beer. Both companies have doubled down on strategic tech initiatives like mobile ordering and delivery, explaining Dunkin' Donuts' partnering with Alphabet Inc.'s (GOOG) navigation app Waze.
Just like Dunkin', in mid-2018, Starbucks reorganized management. Starbucks announced Howard Schultz's departure from the company in 2018. Myron E. Ullman was appointed the next chair of the Starbucks board of directors, and Mellody Hobson was appointed vicechair.
Dunkin'
Dunkin' Donuts markets itself primarily as a coffee seller that also offers donuts and food, a fact made apparent by a coffee cup prominently featured on the company's logo and executive management's explicit assertion that Dunkin' Donuts is a beverage company. Despite building an identity as a coffee seller, food is still an important element of Dunkin' Donuts' offering.
In recent years, Dunkin' Donuts has focused increasingly on nontraditional food options with the hopes of attracting customers outside of breakfast hours. The introduction of steak to its menu in 2014 was a step toward incorporating heartier food items alongside a growing number of sandwich options. Dunkin' Donuts' interiors are designed differently from Starbucks stores, with the former often resembling fast food stores in furnishings and decor.
David Hoffman was named CEO of Dunkin' Brands in 2018. In 2016, Hoffman joined Dunkin' Brands as president of Dunkin' Donuts U.S. He led the company's U.S. business and directed the coffee chain's new concept store. Hoffman will replace Nigel Travis, 68, who is retiring from his role. Travis began as CEO in 2009. He will serve as executive chairman of the board and focus on developing the international business.
Key Differences
Nearly all of Dunkin' Brands' locations are franchises. Licensed Starbucks stores are disproportionately located outside the U.S., as corporate-owned and operated stores account for roughly 60% of stores in the U.S and half of its locations overseas.
Dunkin' Donuts' higher exposure franchises leading to a fundamentally different business than Starbucks' largely owner-operator model, which has major implications for revenue streams, cost structure, and capital spending.
Company-operated stores have different operational and capital expense structures from franchised locations. Cost of goods sold (COGS) and store operating expenses are a much larger percentage of sales for Starbucks than Dunkin'. Because COGS is so much more prominent in Starbucks' expense structure, its profits are more severely impacted by changes in coffee bean prices. Starbucks also has a higher capital expense burden than Dunkin' Donuts, which is not obligated to purchase kitchen equipment for franchise locations.
Starbucks has built a more premium brand than Dunkin' Donuts. Starbucks offers a more extensive menu and more product customization, which is reinforced by writing each customer's name on the side of their cup. The company offers a comfortable and quiet environment with free wireless internet access, encouraging customers to stay to socialize, work, study, browse media, or listen to music while consuming their Starbucks product. Taken together, these factors form a more premium experience and command a higher price point.
Dunkin' Donuts has more competitive pricing, focusing on the middle class. In company filings and earnings conference calls, Dunkin' Donuts' management has described its intent to be the lowest cost provider in the market while maintaining quality above an acceptable minimum.
Because Starbucks operates its own stores, it has tighter margins than Dunkin' Donuts. Dunkin' Donuts has typically had a lower capital expense burden than Starbucks.
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f6e763c74371cda92e37813c491c5675 | https://www.investopedia.com/articles/markets/121615/cargill-stock-doesnt-exist-heres-why.asp | Cargill Stock Doesn’t Exist. Here's Why. | Cargill Stock Doesn’t Exist. Here's Why.
Cargill is the largest private company in the United States. Since its founding in 1865 by William W. Cargill, the company has maintained its status as a private company mainly owned by family heirs. Cargill is one of the largest players in the agricultural, livestock, and processed foods markets. Through a series of acquisitions, Cargill grew from a single grain mill into a company generating more than $120 billion in annual revenue.
Key Takeaways Cargill is the largest private company in the United States.The company avoided going public because of its size and the number of assets it holds.Investors can buy shares in Cargill's rivals—Bunge Limited and Archer-Daniels-Midland.
Tight Family Control
Since its founding by William W. Cargill, the company has remained a family-owned private company. Cargill had two children—a son, Austen, and a daughter, Edna, who married John MacMillan, one of her father's business partners. To date, more than 100 family members own about 90% of Cargill shares.
In the early days, the company allowed the family to have total control of Cargill. Over time, it diversified away from family management. The year 1960 marked the first time a nonfamily member became the company's chief executive officer (CEO). The 17-member board of directors only has six family members, with the rest coming from other company directors and outside personnel.
Pressure for an IPO Averted
Cargill stockholders have pushed for an initial public offering (IPO) several times. But because of its massive size and huge assets, Cargill was able to avert the pressure to go public. In 1993, it started an employee stock plan that allowed owners of stock to cash in on parts of their shares. This kept the pressure of an IPO at bay, with nearly 90% of the company remaining in the hands of the many family shareholders.
Another cry for an IPO came in the late 2000s. Cargill faced pressure from the shareholders and charitable trusts that owned stock in the company. On paper, they were worth a lot but were very illiquid. The company decided to spin off its 64% ownership of The Mosaic Company—one of the largest fertilizer companies in the world. This move allowed shareholders to trade Cargill stock for Mosaic shares. This spinoff also afforded Cargill a chance to pay down more debt.
Massive Size a Factor in Being Private
Forbes magazine has published an annual list of the largest private companies in America for 35 years, with Cargill claiming the top spot in all but two of those years. The company ranked number one on Forbes' list in 2019 with a total of $113.5 billion in revenue. This total puts Cargill in the top 15 on the Fortune 500 list of highest revenue-producing companies.
The massive size of the company and its continued focus on paying down debt has helped it maintain a good debt rating. Cargill has an A-rating with both Standard & Poor's (S&P) and Fitch, and an A2 rating from Moody’s. With these good ratings, it can continue to raise money at low-interest rates without needing to seek capital through an equity offering. The company’s debt has shrunk from $12.3 billion in 2015 to $9.6 billion in 2019.
Cargill's focus on paying down its debt has helped it earn an A-rating with Standard & Poor's (S&P) and Fitch, and an A2 rating from Moody’s.
Publicly-Traded Rivals
While you can't invest in Cargill, you can invest in two of the company's largest rivals on the open market. Bunge Limited and the Archer Daniels Midland Company are publicly-traded companies in the food processing and agricultural industries. As of 2019, in the last fiscal year, Bunge had revenue of $41.1 billion and a market capitalization of $4.8 billion. Archer Daniels Midland reported revenue of $64.7 million for the 2019 fiscal year and a market capitalization of $18.2 billion.
The stock performances of both companies has been rather lackluster over the last five- and 10-year periods, which might give Cargill pause to go public. Bunge shares fell 58% in the last five years and dropped 44% in the last 10 years. Archer Daniels Midland has performed better with a five-year loss of 32% and 10-year gain of 9%.
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3c3c2665366974cba77e0524c47bd210 | https://www.investopedia.com/articles/markets/121715/bloomberg-stock-doesnt-exist-here-why.asp | Here's Why Bloomberg Stock Doesn’t Exist | Here's Why Bloomberg Stock Doesn’t Exist
What Is Bloomberg?
If you work in the business world, there's a very good chance you've heard of Bloomberg LP. The company is among the leading providers of financial news and information. It also provides price data, analyst coverage, analysis tools, and other services. it's probably best known for its print and broadcast news services—it owns BusinessWeek magazine and the Bloomberg TV station, as well as several radio stations—along with its flagship Bloomberg Terminal. All of this makes it a sure-fire winner.
As an investor, you may be interested in getting in on the action. But you can't. That's because it's impossible to buy stock in Bloomberg, which is a privately owned company. This article highlights a brief history of the company, how it makes its money, and why it remains privately-held.
Key Takeaways Bloomberg was founded by Michael Bloomberg in 1981.The company's Bloomberg Terminals are what bring in the majority of its $10 billion of annual revenue.Along with financial technology, Bloomberg is also a media company with broadcast, print, and digital assets.As a private company, Bloomberg's ownership is limited, it isn't under the scrutiny of financial regulators, and it doesn't have to report its financials to the public.
History of Bloomberg
In 1981, Michael Bloomberg received a $10 million check as severance when he was let go with Wall Street firm Phibro Corporation, which was being taken over by Salomon Brothers. Bloomberg used this money to team up with Thomas Secunda, Duncan MacMillan, and Charles Zegar to create a new company called Innovative Market Solutions. The company was meant to bring more transparency to the financial system.
IMS developed the Bloomberg Terminal, which it first called the Market Master, to track financial market information and calculate the price of financial instruments. It caught the eye of Merrill Lynch, which invested $30 million in the company in 1984. Renamed Bloomberg LP in 1986, about 10,000 of the company's terminals were installed on the desks of financial professionals by 1991. The terminals are now part of the professional services division, which brings in the majority of the company's estimated $10 billion of annual revenue.
Bloomberg LP bought back one-third of Merrill Lynch's stake in 1996 for $200 million. Bloomberg, which manages Michael Bloomberg's assets, bought Merrill's remaining stake for a reported $4.43 billion in 2008.
Michael Bloomberg holds an 88% stake in the company. He served as its chief executive officer (CEO) until he stepped aside to run for mayor of New York City in 2001, and he returned to that position in early 2015 at age 73.
More Than Just Bloomberg Terminals
According to the company's website, there are 325,000 terminals in use in the global financial industry. This service is provided by Bloomberg Professional Services, which charges users $2,000 per month per terminals. But there's more to Bloomberg than simply financial technology.
The company also has numerous other subscription services, including Bloomberg Law, which competes with LexisNexis, Bloomberg Government, where users can get detailed updates on congressional and regulatory changes and schedules. The latter publishes updated information almost instantaneously.
Aside from the terminals, Bloomberg is probably best known as a media company. It owns and operates television and radio broadcasts, and also has a series of print and digital publications that report financial, lifestyle, and sports news.
Bloomberg TV
Bloomberg Television is a 24-hour cable news network established in 1994. Initially, it was only available on DirecTV, but it soon moved to cable television. Although the network runs more live programming than either CNBC or Fox Business News, it continues to struggle for viewers.
The network went through its largest-ever round of layoffs in September 2015, after which a number of producers resigned. Bloomberg's radio station is available in four markets—New York, Washington, D.C., Boston, and San Francisco.
Magazines
The company purchased BusinessWeek magazine from McGraw Hill Financial in 2009 and renamed it Bloomberg Businessweek. The magazine was established shortly before the 1929 stock market collapse. Originally aimed at business people, it was later reoriented toward consumers. The magazine hit a high of six million readers in the mid-1970s, but it has faded since then. It's best known for its annual ranking of MBA programs.
Bloomberg Markets magazine ceased publication as a standalone news publication in late 2015. The magazine had long been sent to all terminal subscribers, but the company decided that it outlived its usefulness.
The company continues to provide financial and other news through its website, bloomberg.com. Readers can also get live, real-time data on stocks and other securities.
Competitors
Bloomberg's closest competitor is Thomson Reuters Corporation (TRI), which also leases proprietary financial information terminals. This company, though, is publicly-traded. It reported revenue of $5.9 billion for the 2019 fiscal year, primarily from subscription sales to its financial news and analysis services. However, the company's Thomson Reuters Eikon platform does not offer anything comparable to Bloomberg's securities analysis, pricing, and trading services.
The next-closest competitor is Morningstar, a publicly-traded company that also offers subscription-based data, research, and proprietary pricing tools but not trading capabilities. Both companies offer detailed investment advice, but only Morningstar provides credit ratings and an investment consulting component. Both have their own publications, but Morningstar does not have a television or radio station.
You can invest in Bloomberg-like companies that provide similar services such as Thomson Reuters and Morningstar.
So Why Does Bloomberg Remain Private?
Going public has many advantages. One of the most notable benefits is that companies can raise capital to fund research, expansion, and other growth strategies. But companies like Bloomberg often remain private for a number of reasons.
For instance, remaining private limits ownership. If Bloomberg went public and offered shares on the open market, that would dilute ownership, spreading it across multiple shareholders. This also means the company would have to answer to these parties about the direction of the company.
Going public also brings more scrutiny to the company by regulators, including the Securities and Exchange Commission (SEC). By remaining private, the company doesn't answer to another party, giving the owners full discretion on how the company is run.
And by remaining private, Bloomberg doesn't have to report its financials to the public. It also isn't required to complete the forms and filings required by public companies such as annual reports.
The Bottom Line
If you're an investor who is intrigued by how diverse Bloomberg seems and how much money it makes, you may want to sit back and relax. The company was private when it was founded in 1981 and has remained that way ever since. If you're still stuck on a company like Bloomberg, consider investing in one of its competitors like Thomson Reuters or Morningstar.
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29b4d243f882bf09b8b95b964879488b | https://www.investopedia.com/articles/markets/122215/top-5-companies-owned-pepsi-pep.asp | 5 Companies Owned By Pepsi | 5 Companies Owned By Pepsi
PepsiCo (PEP) is best known for its ubiquitous carbonated cola beverage, Pepsi, and its rivalry with Coca-Cola. (KO). But what most people don't know is that the company's expansion goes far beyond beverages—a strategy that began in 1965. That year, PepsiCo was born out of a merger between Pepsi-Cola and snack-food company Frito-Lay. Since then, it's grown into a global leader, providing packaged foods, snacks, and beverages with a market capitalization of $164.2 billion. In 2019, the company posted an annual net income of $7.4 billion on annual revenue of $67.2 billion, with food accounting for 54% of the company's sales.
For more than 50 years, Pepsi has used acquisitions to expand its core businesses, constructing a large portfolio of popular brands, including potato chip brands (Doritos, Fritos, Lay's, Ruffles, and Tostitos), Aunt Jemima table syrup, Cap'n Crunch and Life cereal brands, Quaker Chewy granola bars, bottled-water brand Aquafina, sports-drink brand Gatorade, and soft-drink brands 7UP and Mountain Dew. Pepsi continues to add to that list. In March 2020, the company announced plans to acquire Rockstar Energy for $3.85 billion. The acquisition is part of a strategic pivot toward the energy-drink market as soda consumption in the U.S. wanes.
Below, we look at five of Pepsico's most important acquisitions in more detail. Pepsico breaks out revenue and profit for Frito-Lay and Quaker Oats but does not do so for the other three deals listed below.
Key Takeaways PepsiCo began making strategic acquisitions beyond the beverage market in 1965 when it purchased Frito-Lay.In 2001, Pepsi acquired Quaker Oats for $13.8 billion.Pepsi purchased Tropicana in 1998 in what was its largest acquisition to date.The company went into a joint venture with Sabra Dipping Company in 2008.The financial terms of Pepsi's 2007 acquisition of Naked Juice were not disclosed.
Frito-Lay
Type of Business: Snack Food ProducerAcquisition Price: approximately $213 millionAcquisition Date: 1965Frito-Lay North America Annual Revenue (2019): $17.1 billionFrito-Lay North America Annual Operating Profit (2019): $5.3 billion
Frito-Lay was the product of a 1961 merger between the manufacturer of Fritos corn chips and the snack-food delivery company started by Herman W. Lay. Four years later, the company merged with Pepsi-Cola to form PepsiCo. From that day, Pepsi would be known as more than just a beverage company.
The acquisition of Frito-Lay marked Pepsi's first venture beyond the beverage market.
Under PepsiCo's ownership during the past 55 years, Frito-Lay has grown dramatically in size to become Pepsi's biggest profit producer by far. In fiscal year (FY) 2019, Frito-Lay North America accounted for 45% of operating profit, more than double any other division. The share may be larger because that number does not include international sales. Frito-Lay gets that profit stream from 29 different snack brands, including Lay's, Doritos, Cheetos, Fritos, Sun Chips, Tostitos, Cracker Jack, Miss Vickie's, Rold Gold, Ruffles, Smartfood, and more.
Quaker Oats Company
Type of Business: Branded Foods ProducerAcquisition Price: $13.8 billionAcquisition Date: Aug. 2, 2001Quaker Foods North America Annual Revenue (2019): $2.5 billionQuaker Foods North America Annual Operating Profit (2019): $0.5 billion
The Quaker Oats brand name is more than 140 years old. The company trademarked its product in 1877 with the U.S. Patent Office as a breakfast cereal labeled with its now famous figure of a man in Quaker Garb, which represented quality and honest value. The company, then called German Mills American Cereal, would later merge with the largest American oats millers to become the American Cereal Company in 1888, and eventually the Quaker Oats Company in 1901.
Exactly 100 years later, the company was acquired by Pepsi. The acquisition bolstered Pepsi's portfolio of food brands with additions such as Aunt Jemima mixes and syrups, Cap'n Crunch and Life cereals, Pasta Roni, Quaker grits, oatmeal, granola, and rice cakes. Quaker Oats also enriched PepsiCo's beverage portfolio with the popular sports-drink brand Gatorade.
Tropicana
Type of Business: Juice ProducerAcquisition Price: $3.3 billionAcquisition Date: July 20, 1998
Tropicana was founded in 1947 by Anthony Rossi, who first immigrated from Sicily to the U.S. in 1921. The company sold fruit gift boxes in Florida, then expanded into a producer of freshly squeezed, 100% pure orange juice.
In 1998, Pepsi purchased the Tropicana juice business from the Seagram Company in what was its largest acquisition to date. The acquisition meant that Pepsi would be competing in the market for orange juice with rival Coca-Cola, which owns Minute Maid.
Sabra Dipping Company (Joint Venture)
Type of Business: Food ProducerAcquisition Price: Value of joint venture deal undisclosed.Acquisition Date: 2008
Sabra Dipping Company was founded in 1986 with the goal of providing American consumers tasty and healthy Mediterranean cuisine, such as hummus, eggplant spreads, and vegetarian side dishes. In 2005, Strauss Group purchased a 51% stake in the company. Then in 2008, it signed a 50/50 partnership agreement with Pepsi. Through the partnership, the two companies agreed to develop, manufacture, and market refrigerated dips and spreads throughout the U.S. and Canada. In 2012, PepsiCo and Sabra extended their partnership and announced the launch of a new global Dips & Spreads product line under the Obela brand.
Naked Juice
Type of Business: Juice and Smoothie ProducerAcquisition Price: Takeover price undisclosed by PepsiAcquisition Date: January 2007
Naked Juice was founded in Santa Monica in 1983. The juice and smoothie maker was then acquired by North Castle Partners in 2000. Six years later, Pepsi announced plans to acquire the company and the purchase was finalized in 2007 for an undisclosed amount. The acquisition bolsters Pepsi's portfolio of beverage brands by adding a line of drinks for more health-conscious consumers, including nutritious juice and juice smoothie beverages.
PepsiCo Diversity & Inclusiveness Transparency
As part of our effort to improve the awareness of the importance of diversity in companies, we have highlighted the transparency of PepsiCo's commitment to diversity, inclusiveness, and social responsibility. The below chart illustrates how PepsiCo reports the diversity of its management and workforce. This shows if PepsiCo discloses data about the diversity of its board of directors, C-Suite, general management, and employees overall, across a variety of markers. We have indicated that transparency with a ✔.
PepsiCo Diversity & Inclusiveness Reporting Race Gender Ability Veteran Status Sexual Orientation Board of Directors C-Suite General Management ✔ Employees
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1ad1c4e1de081e477334c5dda84fb8f0 | https://www.investopedia.com/articles/markets/123015/ford-vs-chevy-comparing-business-models-and-strategies-f-gm.asp | Ford vs. General Motors: What's the Difference? | Ford vs. General Motors: What's the Difference?
Ford vs. General Motors: An Overview
Ford Motor Company (NYSE: F) and Chevrolet, which is owned by General Motors Company (NYSE: GM), are the two largest automobile brands in the United States. Both Ford and GM are leaders and fierce competitors in the global automobile industry. Ford’s largest brand is its namesake, Ford, while GM’s largest brand is Chevrolet.
At first glance, the two large car makers may appear to have similar business models. However, potential investors who dive deeper will find key differences as well as many similarities between the two companies. The following is a comparison of Ford and GM’s business models, which describes critical factors for potential investors.
Key Takeaways Ford and General Motors are the two biggest automakers in the United States and are also big players on the world stage. General Motors leads in market share. Both companies were hit by the credit crisis of 2008. GM took a government bailout, while Ford declined; both companies have recovered in the years since. Ford's brand strategy has been to scale back; Ford and Lincoln are the automaker's only significant brands globally. GM owns a variety of brands of automobiles.
GM Leads U.S. Market Share
GM remains the largest market shareholder in the United States, with 17% of the industry’s total sales as of early 2019. Next, is Toyota, with 14.7%, followed closely by Ford at 14.4%.
In terms of the worldwide market, neither Ford nor GM lead the way. As of 2019, Toyota held the largest global market share at 9.5%, followed by Volkswagen Group at 7.4%. Ford was third with 5.8%.
The global market is highly competitive and diversified. As emerging economies with large populations such as India, China, and Brazil continue to develop, establishing a significant presence in these areas is critical for the future growth of both Ford and GM.
GM vs. Ford: Recent Performances
GM is a smaller company than Ford. GM’s total revenue for 2018 was $147 billion, a 1% increase from the previous year. Ford’s total revenue was $160.3 billion, a 2.3% increase from the previous year. Both companies have achieved significant revenue growth since the economic crisis of 2008 and 2009, but neither has returned to its previous total sales volume. Each company has experienced serious financial difficulties in the past 10 years.
Ford’s product line fell behind its competition in the early 2000s, and it began losing market share. It reported substantial net operating losses in 2006, 2007, and 2008. During this period, under the leadership of CEO Alan Mulally, Ford began initiatives to consolidate operations and create more appealing car models. These plans to become more efficient and innovative were already in process when the economic recession hit in 2008. Although the decreased demand for cars during the recession hurt Ford, the company refused a government bailout offer, avoided bankruptcy, and emerged from the recession a stronger company.
GM became insolvent in 2008 and required government bailout assistance and a Chapter 11 bankruptcy reorganization in 2009 to keep the company operational. The company has since fully repaid its bailout loan and returned positive net income to shareholders since then. GM is making strategic investments to produce more innovative, efficient, and technologically savvy vehicles, which it believes drive future growth. It is also investing significantly in emerging markets such as China.
Revenue and profit generation through vehicle financing and leasing arrangements are critical to both Ford and GM's business models. Ford runs Ford Credit and GM wholly owns the General Motors Financial Company.
Ford vs. General Motors: Brand Strategy
One of the main differences between these two competitors is the number of brands owned and marketed by each company. Ford’s “One Ford” plan, which was implemented during difficult years for the company leading up to the economic crisis of 2008, included reducing the total number of brands it owns and operates worldwide.
Ford’s only significant brands on the global market are Ford and Lincoln. Recent divestitures or discontinuations of brands include the following:
Aston Martin (sold in 2007) Jaguar (sold in 2008) Land Rover (sold in 2008) Volvo (sold in 2010) Mazda (controlling interest sold in 2010 (minority interest remains) Mercury (discontinued in 2011)
Ford’s belief is that by reducing the number of brands and consolidating the number of vehicle platforms upon which various models are built, it can become more efficient and more innovative. In 2007, Ford had 27 different vehicle platforms across the world; in 2015, it had 12, and in 2018, it announced plans to reduce them to five.
General Motors owns and operates a plethora of automobile brands across the globe. These brands include Chevrolet, Buick, GMC, Cadillac, Baojun, Holden, Isuzu, Jiefang, Opel, Vauxhall, and Wuling. GM also has equity stakes in various Chinese joint ventures. While this may seem like a huge brand lineup, GM, similar to Ford, has divested or discontinued several brands, including the following:
Oldsmobile (discontinued in 2004) Pontiac (discontinued in 2010) Daewo (discontinued in 2011) Saturn (discontinued in 2010) Hummer (discontinued in 2010) Saab (sold in 2010)
GM’s belief is that its different brands are essential to serving different market segments. It has created or purchased brands to compete in certain international markets rather than attempting to market its existing brands in those new markets.
Many of its discontinued brands were shut down due to poor performance rather than strategic planning. In mid-2017, after 16 consecutive yearly losses in Europe, GM sold its European division to French automaker PSA Groupe.
Special Considerations: Fuel Efficiency and New Technologies
Both Ford and GM recognize the importance of improving fuel efficiency and leveraging technology to keep their product lines popular among customers. Many countries, including the United States, have strict laws requiring improvements in fuel efficiency and the amount of environmental pollution created by vehicles. Both companies have significantly reduced the fuel consumption of their overall fleets.
GM embraced the hybrid electric vehicle trend and produced the Chevrolet Volt, which won awards for efficiency and innovation. Ford has also produced hybrid models of several of its vehicles, such as the Escape and Focus. Both companies have also found additional efficiencies in their gas-powered cars through the use of different engine technologies, lighter materials, and reduced overall size of cars.
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036505170cb2541b6b31cc3f953e98d5 | https://www.investopedia.com/articles/mortages-real-estate/11/the-truth-about-the-real-estate-market.asp | The Truth About Real Estate Prices | The Truth About Real Estate Prices
Real estate has traditionally been considered a safe investment. But recessions and other disasters are testing that theory—making investors and would-be homeowners think twice.
Key Takeaways Home values tend to rise over time, but recessions and other disasters can lead to lower prices. Following slumps, home values can increase in some areas of the country because of strong demand and low supply, while other areas struggle to rebound. Potential homebuyers shouldn't focus on national trends, as prices vary between states and even neighboring cities. Low mortgage rates have an indirect effect on home prices, as consumers are willing to take on more debt when credit is cheap.
Historical Prices
Prior to 2007, historical housing price data seemed to indicate that real estate prices could continue to rise indefinitely. In fact, with few exceptions, the average sale price of homes sold in the U.S. climbed steadily each year from 1963 to 2007—when the housing bubble burst and the financial crisis of 2008 ensued.
Rebound after the Financial Crisis
By 2013, the average sales price of homes sold in the U.S. had rebounded to pre-crisis levels. For the next several years, the uptrend looked promising, until 2018 when prices flattened, and then began to fall slightly in 2019.
Of course, real estate prices depend heavily on the market (location, location, location), and national trends can tell only part of the picture. A boom in California can mask a bust in Detroit.
Even within the same city, numbers can vary widely. Areas that experience new growth or gentrification can show significant price appreciation, while areas across town can be in decline. The chart below shows how the south, west, northwest, and midwest regions experience different trends in real estate prices.
When looking at the national and regional statistics, be sure to account for the reality of the market in your local area. Rising prices at the national level may not help you if your city, state, or neighborhood is in decline.
Current Home Prices
It's too soon to tell what will happen to home prices in 2020 and 2021, but if history repeats itself, we can expect a drop in home prices as a result of the COVID-19 recession. As of March 2020, purchase contracts started to fall amid mortgage troubles, a lack of buyer interest, and even a decline in available appraisers and other professionals needed to execute transactions.
At the same time, potential construction changes and delays have become a very real concern. Again, it's too soon to know what will happen, but it's possible that new starts and renovations will take a hit into 2021.
Home Trends
Of course, it's important to consider that factors other than supply and demand can affect real estate prices. For example, even before the numbers began to go the wrong way in 2008, the National Association of Home Builders reported that the average home size in America was 983 square feet in 1950, 1,500 square feet in 1970, and peaked at 2,740 in 2015.
This trend continued in the first half of the 2000s, after which it began to decline somewhat. Still, with homes getting bigger and inflation adding to the cost of building materials, it is only logical that home prices would rise. Other trends can drive prices up, too, such as buyer preferences for more expensive flooring, appliances, fixtures, and the like.
National trends may not give you the whole picture, as real estate values and prices vary between states and neighboring cities.
Homes as Investments
Because home prices tend to rise over time, buying a home has traditionally been viewed as a safe investment. Still, an important point to consider when looking at a home as an investment is that it won't ever pay off unless you sell it.
From a practical standpoint, even if your primary residence doubles in value, it probably just means that your real estate taxes have gone up. All of the gains you experience are on paper until you sell the property. Of course, for many homeowners, that's alright. A home that doubles in value is a nice asset to pass on to the kids and grandchildren.
Downsizing
If you decide to sell and buy another home in the same area, remember that the prices of those other homes have probably risen, too. To truly book a gain from your sale, you will likely need to move to a smaller home in the same area, or move out of the area and find a less expensive place to live.
Of course, downsizing is an attractive option for many retirees and those who no longer have children living at home. Aside from the potential financial gains, a smaller home is easier to take care of (at least in theory), and it can address future mobility issues.
Home Equity Loans
While it is possible to tap the equity in your home by taking out a loan against it, using your house as an automated teller machine (ATM) is not always a good strategy.
Not only does the interest you pay eat into your profits, but the loan payment takes away from your financial stability. If real estate prices decline, you may find yourself in the unenviable position of owing more on the loan than the house is worth.
Mortgage Rates
Mortgage rates generally rise during periods of economic growth. When this happens, the job market is healthy and people's wages rise, too. Conversely, mortgage rates tend to fall during economic slowdowns as the Federal Reserve tries to make it easier to spend and borrow.
The average 30-year fixed-rate mortgage rate has been below 5% since 2010 (keep in mind that even tiny changes in rates can have a huge impact on the overall cost of your home). This chart from the Federal Reserve Bank of St. Louis shows historical prices for 30-year fixed-rate mortgages, starting in 1971.
So how does this play out for real estate prices? Lower mortgage rates don't necessarily have a direct relationship to home prices, even though we'd like to think they do. But they may have an indirect effect on them. When rates are low, consumers are more willing and can afford to take on more debt. That's because the cost of credit—i.e. interest—is cheap. Rising interest rates, though, tends to lead to weaker demand from buyers.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau and/or with the U.S. Department of Housing and Urban Development (HUD).
Is Buying a Home a Good Investment?
The idea that a home is a good investment stems from the fact that real estate prices tend to rise, at least historically speaking. Since there's no way to predict the future real estate market, it's important to avoid getting in over your head. A home is a good investment only if you can afford it.
Of course, while you are unlikely to see any profits that you can spend if you plan to live in the same house all of your life. But if you buy with an exit strategy in mind, there is a much better chance of realizing a cash profit.
First, consider your motivation for buying a home. If you want to live in it, then you probably don't need to think about your home in terms of profits and losses. If you're hoping to make money, then you need to enter the transaction with an exit strategy. This also means you should have a selling price in the back of your mind, all while keeping the purchase price of the property at the forefront.
When the market reaches your price point, you sell the property just as you would a stock that has appreciated. This may not be a practical approach for your primary residence, depending on your lifestyle, but it is exactly what many real estate investors do when they purchase properties—renovate and sell them. Just remember that prices don't always move up.
The Bottom Line
With history as a guide, most would-be homeowners would do well to buy a place they actually hope to inhabit, pay off the mortgage quickly, live there until retirement, then downsize and move to a less expensive home. It's not a sure bet, but this strategy does increase the likelihood of making a profit.
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82892d237adf80cd260757f4d97ac11d | https://www.investopedia.com/articles/mortgages-real-estate/08/buy-rental-property.asp | Top 10 Features of a Profitable Rental Property | Top 10 Features of a Profitable Rental Property
Are you looking to purchase a residential rental property to boost your investment portfolio? Investment properties can be exciting and very rewarding if you make the right choice. But income and rewards aside, investing in real estate can be daunting for a first-time investor.
Real estate is a tough business and the field is peppered with land mines that can obliterate your returns. That's why it's important to do detailed research before you dive in so you're on top of all the pros and cons of real estate investing. Here are the most important things to consider when shopping for an income property.
Key Takeaways Vet the neighborhood thoroughly—its livability and amenities are key.A neighborhood with a high vacancy rate is not a good sign.Know the area's selling prices to get a sense of local market value.Research the average rent in the neighborhood and work from there to determine if buying a rental property is financially feasible for you.
Starting Your Search
Begin your search for a property on your own before bringing a professional into the picture. An agent can pressure you to buy before you have found an investment that suits you best. And finding that investment is going to take some sleuthing skills and some shoe leather.
Doing this research will help you narrow down several key characteristics you want for your property—such as type, location, size, and amenities. Once you've done that, then you may want a real estate agent to help you complete the purchase.
Your location options will be limited by whether you intend to actively manage the property or hire someone else to do that for you. If you intend to actively manage it yourself, you don't want a property that's too far from where you live. If you are going to get a property management company to look after it, proximity is less of an issue.
Top 10 Features to Consider
Let's take a look at the top 10 things you should consider when searching for the right rental property.
1:59 Top 10 Features Of A Profitable Rental Property
1. Neighborhood
The neighborhood in which you buy will determine the types of tenants you attract and your vacancy rate. If you buy near a university, chances are that students will dominate your pool of potential tenants and you could struggle to fill vacancies every summer. Be aware that some towns try to discourage rental conversions by imposing exorbitant permit fees and piling on red tape.
2. Property Taxes
Property taxes likely will vary widely across your target area, and you want to be aware of how much you'll be losing. High property taxes are not always a bad thing—in a great neighborhood that attracts long-term tenants, for example, but there are unappealing locations that also have high taxes.
The municipality's assessment office will have all the tax information on file, or you can talk to homeowners in the community. Be sure to find out if property tax increases are probable in the near future. A town in financial distress may hike taxes far beyond what a landlord can realistically charge in rent.
3. Schools
Consider the quality of the local schools if you're dealing with family-sized homes. Although you will be mostly concerned about monthly cash flow, the overall value of your rental property comes into play when you eventually sell it. If there are no good schools nearby, it can affect the value of your investment.
4. Crime
No one wants to live next door to a hot spot of criminal activity. The local police or public library should have accurate crime statistics for neighborhoods. Check the rates for vandalism, and for serious and petty crimes, and don't forget to note if criminal activity is on the rise or declining. You might also want to ask about the frequency of a police presence in your neighborhood.
5. Job Market
Locations with growing employment opportunities attract more tenants. To find out how a specific area rates for job availability, check with the U.S. Bureau of Labor Statistics (BLS) or visit a local library. If you see an announcement about a major company moving to the area, you can be sure that workers in search of a place to live will flock there. This may cause housing prices to go up or down, depending on the type of business involved. You can assume that if you would like that company in your backyard, your renters will as well.
6. Amenities
Tour the neighborhood and check out the parks, restaurants, gyms, movie theaters, public transportation links, and all the other perks that attract renters. City Hall may have promotional literature that can give you an idea of where the best blend of public amenities and private property can be found.
7. Future Development
The municipal planning department will have information on developments or plans that have already been zoned into the area. If there is a lot of construction going on, it is probably a good growth area. Watch out for new developments that could hurt the price of surrounding properties. Additional new housing could also compete with your property.
8. Number of Listings and Vacancies
If a neighborhood has an unusually high number of listings, it may signal a seasonal cycle or a neighborhood in decline—you need to find out which it is. In either case, high vacancy rates force landlords to lower rents to attract tenants. Low vacancy rates allow landlords to raise rents.
9. Average Rents
Rental income will be your bread-and-butter, so you need to know the area's average rent. Make sure any property you consider can bear enough rent to cover your mortgage payment, taxes, and other expenses. Research the area well enough to gauge where it might be headed in the next five years. If you can afford the area now but taxes are expected to increase, an affordable property today could mean bankruptcy later.
10. Natural Disasters
Insurance is another expense you will have to subtract from your returns, so you need to know just how much it's going to cost you. If an area is prone to earthquakes or flooding, insurance coverage costs can eat away at your rental income.
Getting Information
Official sources are great, but you'll want to talk to the neighbors to get the real scoop. Talk to renters as well as homeowners. Renters will be far more honest about the negative aspects of a neighborhood because they have no investment in it. Visit the area at different times on different days of the week to see your future neighbors in action.
Choosing a Property
The best investment property for beginners is generally a single-family dwelling or a condominium. Condos are low maintenance because the condo association takes care of external repairs, leaving you to worry about the interior. Condos, however, tend to garner lower rents and appreciate more slowly than single-family homes.
Single-family homes tend to attract longer-term renters. Families or couples are sometimes thought of as better tenants than single people because there is a perception that families could be financially stable and pay the rent regularly.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
When you have the neighborhood narrowed down, look for a property with appreciation potential and good projected cash flow. Check out properties that are more expensive than you can afford as well as those within your reach. Real estate often sells below its listing price.
Watch the listing prices of other properties and check town records for the final selling prices to get an idea of what the market value really is in a neighborhood.
For appreciation potential, look for a property that—with a few cosmetic changes and minor renovations—would attract tenants who can pay higher rents. This will also raise the value of the property if you choose to sell it after a few years.
Of course, to ensure a profitable venture it's important to buy a reasonably priced property. The recommendation for rental property is to pay no more than 12 times the annual rent you expect to get.
Determining the Rent
How is the potential rent determined? You are going to need to make an informed guess. Don't get carried away with overly optimistic assumptions. Setting the rent too high and ending up with an empty unit for months quickly chips away at the overall profit. Start with the average rent for the neighborhood and work from there. Consider whether your place is worth a bit more or a bit less, and why.
To figure out if the rent number works for you as an investor, calculate what the property will actually cost you. Subtract your expected monthly mortgage payment, property taxes divided by 12 months, insurance costs divided by 12, and a generous allowance for maintenance and repairs.
Don't underestimate the costs to maintain the property. These expenses depend on the property's age and how much upkeep you plan to do yourself. A newer building probably will require less work than an older one. An apartment in a retirement community likely would not be subject to the same amount of damage as off-campus college housing.
Doing your own repairs cuts costs considerably, but it also means being on call 24-7 for emergencies. Another option is to hire a property management firm, which would handle everything from broken toilets to collecting rent each month. Expect to pay around 10% of the gross rental income for this service.
If all these figures come out even or, better yet, with a little money left, you can now get your real estate agent to submit an offer.
Making the Purchase
Banks have tougher lending requirements for investment properties than for primary residences. They assume that if times get tough, people are less inclined to jeopardize their homes than a business property. Be prepared to pay at least 20% to 30% for a down payment, plus closing costs. Have the property thoroughly inspected by a professional and have a real estate lawyer review everything before signing.
Don't forget to pay for sufficient insurance. Renter's insurance covers a tenant's belongings, but the building itself is the landlord's responsibility, and the insurance may be more expensive than for a similar owner-occupied home. The property's mortgage interest, insurance, and depreciation are all tax-deductible up to a certain amount.
The Bottom Line
Every state has good cities, every city has good neighborhoods, and every neighborhood has good properties. It takes a lot of footwork and research to line up all three. When you end up finding your ideal rental property, keep your expectations realistic, and make sure your own finances are healthy enough that you can wait for the property to start generating cash.
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605778599282151c5321c11f7755ce81 | https://www.investopedia.com/articles/mortgages-real-estate/08/diy-home-projects.asp | Do-It-Yourself Projects to Boost Home Value | Do-It-Yourself Projects to Boost Home Value
Whole house renovations can add value to your home, but there are ways to upgrade your home without going into debt or ransacking your savings. Painting, re-grouting tile, and power washing the outside of your home won’t cost a lot of money, but these do-it-yourself home improvements can add real value to your home.
With some sweat equity, a DIY attitude, and a few dollars, you can list your home for more money if you’re ready to sell. And if you’re not quite ready to put your home on the market, you can enjoy having a more beautiful place to live. Here are some low cost, high value home improvement projects to consider.
Key Takeaways Typically, kitchens are the most expensive room in a house to renovate, according to the Houzz & Home renovation trends study for 2018 and 2019. The study found that master bathrooms are the second most expensive room in a house to renovate. Experts recommend limiting do-it-yourself home renovations to cosmetic improvements, such as painting, landscaping, and changing out fixtures.
Seven Simple Interior Updates
1. Freshen up the walls
If your walls have scratches and dirty paint, an outdated color, or fading wallpaper, a little elbow grease and a few cans of paint can make a dramatic difference. To maximize the value of your home for a sale, choose a neutral color scheme that unifies the entire house, makes space look more prominent, and appeals to a wide variety of potential buyers.
2. Install crown molding
Putting in crown molding is a surprisingly easy task that can add character to your rooms. Buy the molding from a home improvement store, cut it to the size that fits your room (or have the store cut it for you), and attach it to the top of the wall with a nail gun. These decorative strips may even come already painted. Installing crown molding does involve a bit of woodworking skill as well as the right tools, but it is very inexpensive to do yourself.
3. Update fixtures
Switch plates, outlet covers, curtain rods, light fixtures, and doorknobs are often boring or overlooked, but you can add significant pizzazz for just a few dollars. Attractive metal switch plates and outlet covers can cost as little as $5 apiece but look much more expensive. Light fixtures and decorative curtain rods can be a little pricier, but sometimes you can make an inexpensive one look elegant with a can of spray paint. Again, if you plan to sell, be sure to choose items in colors and finishes that will appeal to a broad audience.
4. Install ceiling fans
Everyone likes to save money on electricity bills, which makes ceiling fans an appealing addition to any home. Ceiling fans cut down on air conditioning costs, and they can also reduce heating costs by circulating warm air away from the ceiling. A primary fan costs about $50, and you can get a nice one for no more than a couple of hundred dollars. If you don’t already have wiring from overhead lighting, you may need to hire a professional, which can significantly escalate the cost of this project.
5. Improve window treatments
The cheap vertical plastic blinds, paper shades, or horizontal aluminum blinds that may have come with your house don’t add value to your home. Consider replacing them with plantation shutters, wooden blinds, or drapes. Again, if you are selling, choose neutral options that can help you get a better price for your home.
6. Reveal and restore hardwood floors
Older homes, in particular, are likely to have hardwood floors lurking beneath carpet. Squeaky floors are a sign that you may have wood floors. If you’re not sure, pull up your carpet in an unnoticeable corner and check. If you do have wood floors, there’s a good chance you’ll have to refinish them to restore them to their original splendor, but it will be much less expensive than installing new flooring from scratch.
7. Clean fireplace brick
If you have a brick fireplace and burn wood in it, chances are some of the brick is stained with soot and creosote. Because a beautiful fireplace can be a significant selling point in a home, make yours look as attractive as possible. Use a damp rag to wipe away some of the soot, then follow with a fireplace cleaner designed to remove creosote. It will take some scrubbing with a stiff brush and possibly several applications, but you’ll have that brick looking spiffy when you’re finished.
Some homeowners take out a home equity line of credit (HELOC) to pay for renovations, but it's possible to spruce up a home without taking on debt.
Basic Bathroom Upgrades
1. Redo the bathroom floor
DIY installation can save you a lot of cash. If you don’t know how to install flooring, look for a class at your local home improvement store. Saving money on labor will allow you to choose more beautiful flooring than you could otherwise afford. Opt for a neutral-colored tile to add the most value.
2. Update fixtures
If you have generic, cheap, or outdated fixtures, replacing them with newer, more customized versions can make your bathroom sparkle and look more high-end. For about $40 to $100, you can substitute a shabby bathroom vanity or ceiling light fixture with something elegant. A similar cash outlay will get you a new sink faucet. A spa-style chrome shower head adds a touch of luxury for about $80. Towel bars are a cheap and easy fix at about $20 to $30. Sometimes an upgrade can be more energy efficient, increasing not only the aesthetics of your home but “greening” it up as well.
Quick Fixes to Keep the Kitchen Current
1. Paint or stain kitchen cabinets
You could buy all new cabinets and save money by purchasing prefabricated (rather than custom) cabinets and installing them yourself, but that’s more work and money than painting or staining your existing cabinets. White cabinets will brighten a kitchen, don’t usually go out of style, and are easy for a future owner to repaint if they want something different. You’ll need to remove all the hardware from your cabinets, including the doors. You’ll also need to clean the cabinets first, so dirt and greasy residues won’t ruin your work. Consider sprucing up your bathroom cabinets as well.
2. Upgrade cabinet knobs and drawer handles
It’s surprising how a seemingly innocuous element such as a cabinet doorknob can make your kitchen look cheap or dated. Updating this hardware can give your kitchen a facelift, whether you redo your cabinets or not.
Seven Ways to Save When You Refresh the Exterior
It may be easy for you to ignore your home’s exterior when you spend most of your time inside, but it’s the first and sometimes only impression that others get of your house. Here are a few simple ways to make it look its best.
1. Install a new front door
A fundamental steel front door costs about $100, but for another $100 to $200 you can get a door with a lot more character and improve your home’s curb appeal. If you can’t afford a new door, a fresh coat of paint in an attractive color may be all you need.
2. Replace the front doormat
When you’ve had the same doormat for years, it can be easy to overlook how worn out or dirty it’s become. As it’s one of the first impressions people get of your home, this is one place where $20 can make a big difference.
3. Clean the gutters
This task relates more to maintaining your home’s value than increasing it, but it’s essential. Without properly functioning gutters, which are designed to carry water away from your home, rain may seep inside or pool around the foundation, causing problems such as mold and mildew. Eventually, water damage can compromise the house’s structural integrity, leading to costly repair bills.
4. Power wash the exterior of your home
For less time and money, a good pressure washing can make your home’s exterior look almost as good as a fresh coat of paint.
5. Repaint the exterior
If washing the exterior of your home didn’t brighten it up as much as you’d hoped, consider a new paint job. With the ladders and heights involved, this may not be a DIY task for everyone, but even if you have to hire others to do this job, it’s still pretty inexpensive as far as home improvements go and can make your house look almost new from the outside.
6. Power wash the driveway, walkways, and patio
As long as you’re renting the power washer, you might as well clean your driveway, patio, and any walkways. You may be surprised by how new they’ll look afterward.
7. Upgrade landscaping or clean up existing landscaping
Flowers and other plants are a great way to brighten your home’s exterior. Use greenery in front of your house and/or along walkways to draw attention to your home. To get the most for your dollars, choose perennial plants, which come back year after year, rather than annuals, which, as their name suggests, last a year or less. Patch any bald spots in the yard with fresh sod (or plant grass seed if you have time) and trim existing trees and bushes to complete the yard’s new look.
The Bottom Line
Upgrading your home doesn’t have to be expensive or complicated, and it doesn’t have to involve contractors. A variety of projects for all price ranges and levels of skill and enthusiasm can improve your home’s value, whether for future buyers or, perhaps more important, for you. Putting a few of these home improvement ideas into action will help you get the most value out of one of your most significant assets, whether you’re planning to stay or selling.
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ce8c012d56483f2d024a5773defe926e | https://www.investopedia.com/articles/mortgages-real-estate/08/downmarket-buying.asp | 8 Tips for Recession House Hunters | 8 Tips for Recession House Hunters
When real estate sales are slow and there is a glut of homes for sale, buyers have an opportunity to pick up a house on the cheap. The operative word here is "opportunity." There are times when you should pounce and times when you should show restraint and avoid an impulse buy. Knowing the difference could save you thousands of dollars. In this article, we will give you eight tips to follow if you have the good fortune to be house hunting during a housing market downturn.
Key Takeaways Real estate investors looking to purchase homes for cheap can find advantageous opportunities when house hunting in a market downturn. The key "first steps" for house hunting during a recession is to do your homework, have financing and resources in line, and learn how to spot motivated sellers. Next, house hunters should be prepared to negotiate with realtors and search titles but avoid bidding wars. Buyers should not be afraid to walk away from a deal and be sure to know why they're buying.
1. Do Your Homework
Buyers generally have the advantage in a down market, but this doesn't mean you should go into a transaction blind. Prospective buyers should search the internet for listings and inquire with a realtor or real estate agent. Realtor.com is a good resource, and many national and local realtors also make their listings available on the internet.
The objective of this research is to get to know the price range for the area. You want to learn what is considered excessive and what is considered low. This research will help you make a reasonable bid and provide insight into the bargaining room for a particular home.
2. Get Your Ducks in a Row
Remember, you are probably not the only bargain hunter out there. You may have an edge on the sellers, but another buyer could snap up your great deal if you delay the buying process.
To make sure that you're able to pounce on a deal at a moment's notice, it makes sense to get pre-approved for a mortgage and to have an attorney on retainer to handle the closing paperwork.
It also makes sense to line up a home inspector and an insurance agent. These professionals provide valuable information and let a buyer know early on in the process, during the attorney review period, what items might need repair as well as what the home will cost to insure.
3. Watch for Motivated Sellers
Some homeowners may want to sell their homes in a hurry, which gives you additional bargaining power. In a situation like this, it makes sense to ask if the seller will throw in the lawnmower, furniture, or fixtures that you like. You can also ask them to cover some or all of the closing costs. Of course, the listing price is always negotiable as well.
Here are a couple of signs that the seller is motivated:
The home has been on the market for several months and has undergone a number of price reductions. The home is empty at the showing, which suggests the seller has moved and might be holding two mortgages.
It's always difficult to determine exactly how much leverage you have since a homeowner can decide to sell for any number of reasons. Your agent can give you a general idea of the seller's motivation, though. Agents have access to the Multiple Listing Service (MLS) and can track down the original list price versus the selling price for similar homes in the area. They can also find out how long the house has been on the market and determine any price reductions that have occurred.
Many states make deed records and home-sale information available to the general public on the internet. This information will tell you what the seller paid for the home, which, in turn, lets you know how much profit they stand to make for the asking price.
4. Negotiate with the Realtor
When houses are selling at a slow pace, real estate agents are also struggling. In such an environment, both agents and firms may be inclined to knock a percentage point or two off of their commission schedule to get a deal done.
But isn't it the seller's job to pay the real estate agent? Why should you care what the commission is?
The commission is important to the buyer because the seller probably listed the home at a high price so they could pay the commission to the agent and still profit. Buyers can get their real estate agents to ask the listing agent to lower his or her commission so that the deal gets done, and both the seller and their agent still walk away happy.
Consumerist.com offers these tips for increasing your leverage when negotiating with a real estate agent:
You may be able to get a discount by using the same agent to sell your current house and buy a new one. Smaller real estate firms may be able to approve lower commission rates more quickly because they have fewer layers of bureaucracy. If one agent won't negotiate, find another who will. Consider using the internet instead of a real estate agent. There are services available online that give house hunters direct access to the Multiple Listing Service, allowing them to find potential properties themselves.
5. Make Sure the Title Is Clear
In trying times, sellers may want to unload their homes because they are in over their heads. In some cases, the property itself may be encumbered by a lien from a contractor, service provider, bank, or other lending institution.
For this reason, it always makes sense to use a title insurance company and to have a lawyer do a title search to make sure the property can be transferred without risk. The last thing you want is to have to absorb any of those liabilities. Lenders typically require title insurance and a title search if a mortgage is going to be taken out on the home, but cash buyers should make use of these services as well.
For more information about title insurance, you should speak to your insurance representative. The web also contains a wealth of information on the subject, and many states have websites that discuss title insurance policies.
6. Avoid a Bidding War
When shopping in a down market, the last thing you want to do is let your emotions get the best of you. A bidding war is almost always an unnecessary waste of time and, in the end, money. Down markets are all about getting a really good deal, so to fritter away that possibility because of ego is foolish.
The best advice for avoiding a bidding war is to set a price limit and stick to it. There are plenty of other deals out there to be had.
7. Don't Be Afraid to Walk Away
Real estate prices usually drop as inventory increases. In a down market, there are a variety of choices available. If you are not getting the deal you feel you deserve, walk away and look at the next home on your list.
Remember that a down market is a buyer's market. Some sellers fail to understand that they are at a disadvantage and refuse to accept anything less than what they feel their home is worth. Stick to the price you decided on at the outset; if you cannot make the deal, try again next time.
8. Know Why You're Buying
Prospective buyers have an edge in a down market, but that doesn't mean you're guaranteed to make money on a given property. Ask yourself some hard questions about why you're buying the home.
A quick flip may not be possible in a prolonged down market, and so you should be prepared to live in the new home, or at least to hold on to it for an extended period of time. Being prepared and organized and relying on trained professionals for guidance can help you get a great deal in a struggling real estate market.
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833f8b0c208eee1402a57a190f947cc6 | https://www.investopedia.com/articles/mortgages-real-estate/08/fair-price-on-home.asp | 10 Tips for Getting a Fair Price on a Home | 10 Tips for Getting a Fair Price on a Home
All home buyers have one thing in common: They don’t want to get ripped off. Whatever the state of the housing market, it’s especially important to make sure you pay a fair price. Yet how do you know that you’re getting a good deal—even in a tight market—before you make an offer? You need to know how to evaluate the price of any home, so you can make a sound investment decision. The following 10 tips will show you how to get a great deal on a house.
Key Takeaways When shopping for a home, it’s important to get a sense of the market by looking at recently sold homes, comparable homes on the market and available for viewing, and comparables taken off the market because they didn’t sell. You should also try to determine whether you are in a buyer’s or seller’s market and if the neighborhood is appreciating or depreciating in desirability. Be sure to pay attention to your real estate agent’s advice on price. Be prepared to negotiate rather than just accepting the seller’s asking price.
1. Consider Recently Sold Properties
A comparable property is one that is similar in size, condition, neighborhood, and amenities to the one you’re buying. One 1,200-square-foot, recently remodeled, one-story home with an attached garage should be listed at roughly the same price as a similar 1,200-square-foot home in the same neighborhood. That said, you can also gain valuable information by looking at how the property you’re interested in compares in price with different houses. Is it considerably less expensive than larger or nicer properties? Is it more expensive than smaller or less attractive houses?
Your real estate agent is the best source of accurate, up-to-date information on comparable properties (also known as “comps” or “comparables”). You can also look at comparables that are currently in escrow, meaning that the property has a buyer, but the sale has not yet been completed.
2. Check Out Comparable Properties on the Market
In this case you can actually visit other homes and get a tactile sense of how their size, condition, and amenities compare with the property you’re considering. You can then compare prices and see what seems fair. Reasonable sellers know that they must price their properties similarly to market comparables if they want to be competitive.
3. Look at Unsold Comparables
If the house you’re considering is priced similarly to homes taken off the market because they didn’t sell, the house in question may be overpriced. Also, if there are many similar properties on the market, prices should be lower, especially if those properties are vacant.
Check out the unsold inventory index for information about current supply and demand in the housing market. This index attempts to measure how long it will take for all the homes currently on the market to be sold, given the rate at which homes are currently selling.
4. Learn About Market Conditions, Appreciation
Have prices been going up or down recently? In a seller’s market properties will likely be somewhat overpriced, and in a buyer’s market properties are apt to be underpriced. It all depends on where the market currently sits on the real estate boom-and-bust curve.
Even in a seller’s market, properties may not be overpriced if the market is on the upswing and not near its peak. Conversely, properties can be overpriced even in a buyer’s market if prices have only recently begun to decline. Of course, it can be difficult to see the peaks and valleys until they’re history. Also, consider the impact of mortgage interest rates and the job market on the economy.
Be skeptical of for-sale-by-owner (FSBO) properties, as they are likely to be overpriced by their excessively emotional sellers.
5. Be Wary of for-Sale-by-Owner Properties
A for-sale-by-owner (FSBO) property should be discounted to reflect the fact that there is no 2.5% to 3% (on average) seller’s agent’s commission, something that many sellers don’t take into consideration when deciding how to set a price for a house. Another potential problem with FSBOs is that the seller may not have had an agent’s guidance in setting a reasonable price in the first place, or they may have been so unhappy with an agent’s suggestion as to decide to go it alone. In any of these situations, the property may be overpriced.
6. Explore the Expected Appreciation
The future prospects for your chosen neighborhood can have an impact on price. If positive development is planned, such as a major mall being built, the extension of light rail to the neighborhood, or a large new company moving to the area, the prospects of future home appreciation look good. Even small developments, such as plans to add more roads or build a new school, can be a good sign.
On the other hand, if grocery stores and gas stations are closing down, the home price should be lower, so as to reflect that, and you should probably reconsider moving to the area. The development of new housing can go either way. It can mean that the area is hot and likely to be in high demand in the future, thus increasing your home’s value, or it can result in a surplus of housing, which will lower the value of all the homes in the area.
The Fair Housing Act prohibits discrimination in housing and rentals due to race, color, national origin, religion, sex, familial status, and disability. If you feel that you are being discriminated against in your search for a home, report it promptly to the U.S. Department of Housing and Urban Development.
7. Ask Your Real Estate Agent
Without even analyzing the data, your real estate agent is likely to have a good gut sense (thanks to experience) of whether the property is priced appropriately or not and what a fair offering price might be.
8. Ask Yourself: Does the Price Feel Fair?
If you’re not happy with the property, the price will never seem fair, even if you get a bargain. Even if you pay a little over market value for a home you love, you won’t really care in the end.
9. Test the Waters
Even in a seller’s market, you can always make an offer below list price, just to see how the seller reacts. Some sellers list properties for the lowest price they’re willing to take, because they don’t want to negotiate. Others list their homes for higher than they expect to earn, because they either expect to negotiate downward or want to see if someone will make an offer at the higher price. If such a seller accepts your price or counteroffer, you’ll get an indication that the property probably wasn’t worth what it was listed for, and you have a good chance at getting a fair deal.
On the other hand, some sellers may underprice their properties in the hope of generating lots of interest and sparking a bidding war. Unlike on eBay, however, the seller doesn’t have to simply sell to the highest bidder; sellers can reject any and all offers that don’t meet their expectations.
If you have your heart set on the property, be warned that some sellers could be offended by lowball offers and may refuse to work with you should you choose to employ such a tactic. Also, when you offer less than the list price, you may increase your risk of being outbid by another buyer.
Making an artificially low bid, a negotiating tactic know as “lowballing,” can backfire if doing so insults the seller and they refuse to do business with you.
10. Get an Appraisal and an Inspection
Once you’re under contract, the lender will have an appraisal of the property done (typically at your expense) to protect its financial interests. The lender wants to make sure that if you stop making your mortgage payments, it’ll be able to get a reasonable amount of its money back when it forecloses on your home. If the appraisal comes in at considerably less than your offering price, you may not be getting a fair deal. In fact, the lender may not even let you purchase the home unless the seller is willing to lower the price.
A home inspection, also completed after you’re under contract, will give you another way to gauge your offering price. If the home needs many expensive repairs, you’ll want to ask the seller to either make the repairs for you or discount the purchase price so you can make them yourself.
The Bottom Line
When you’re shopping for a home, it’s important to understand how housing is priced, so you can make a sound investment and reach a fair agreement with the seller. Using these tips, you’ll be able to make a confident and well-informed offer on any home in any market.
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56cd16c79ec13fd4dc80dd3e8625b47d | https://www.investopedia.com/articles/mortgages-real-estate/08/foreclosures.asp | Buying a Foreclosed House: Top 5 Pitfalls | Buying a Foreclosed House: Top 5 Pitfalls
Buying a house that is in foreclosure is often touted as a way for both owner-occupants and investors to get a great deal on a property. However, the potential financial rewards are not arrived at without a significant amount of hard work.
Foreclosed properties have some common problems. In addition, there are some standard difficulties you may encounter in purchasing one. While foreclosures can be great investments as fixer-uppers, either to live in or resell, they often come with baggage.
Key Takeaways However, the potential financial rewards of buying a foreclosed property are not arrived at without a significant amount of hard work. Many homes in foreclosure have been poorly maintained and may have structural issues, or water or mold damage; some may be in violation of codes or other standards.Vandalism can also be an issue, with thieves or the prior owners sometimes taking fixtures, appliances, windows, or anything else of value.There may be problems with lenders who don't want to fund the purchase of foreclosed homes; purchasing with all cash may be a buyer's only option.
1:25 The Pitfalls Of Buying A Foreclosed House
Problems With the Property
The most important thing to keep in mind before deciding to shop in the foreclosure market is that these properties are given up by owners who can't afford their mortgage payments anymore. In these cases, the house has often been poorly maintained—after all, if the owner can't make the payments, they are likely falling behind on paying for regular upkeep as well.
Also, some people who are forced into foreclosure are embittered by their situation and take out their frustrations on their home before the bank repossesses. This often involves removing appliances and fixtures, and sometimes even outright vandalism. After the occupants leave, foreclosures sit abandoned, often inviting criminal activity.
Maintenance and Condition
Maintenance and condition can be a problem in foreclosed properties because of the circumstances under which the previous owner moved out and the amount of time the house may have been unoccupied. Some of the main concerns include the following.
Lack of Cleanliness
Bank-owned properties are sometimes disgustingly dirty because of time spent sitting empty, intentional neglect by the previous owner, or occupancy by vagrants. When a home is locked up with no air circulating for months, built-up dirt can cause the entire home to smell.
Bad Renovations
The previous owner may have made changes to the home without obtaining the proper permits. A common example is converting the garage into a living space so more people can live in the home. These changes may be undesirable to new owners or create headaches for them with city government officials.
If the previous owner started to improve the home but then fell on hard times, there may be partially finished work in the house. The bathrooms may be redone while the kitchen has not been updated in 40 years, or there may be new floors in the living room while the bedrooms still sport ancient carpeting.
Additionally, if any repairs were made, they may have been done by the owners themselves or by unlicensed professionals—in other words, people who may not necessarily have done the work correctly.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
No Electricity
With no one living in the home, the electricity may be off unless the bank has intentionally kept it on. With no light, it can be hard to see what you are buying in some rooms, particularly basements and windowless bathrooms.
Water Damage
A small leak under the kitchen sink can lead to a mold problem, and a roof leak or burst pipe can lead to major water damage. With no one around to take care of issues as they occur, small problems can quickly turn into big problems, and big problems can turn into disasters.
Lack of Basic Maintenance
If the previous owner couldn't afford the mortgage payments, you can bet they also could not afford to repair leaks, termite damage, a broken garbage disposal, or anything else.
Dead or Overgrown Grounds
Depending on the climate where the home is located, the lawn and landscaping may be totally dead or extremely overgrown. Banks usually do not pay for gardeners to maintain the yard of a foreclosed home.
Personal Property Left Behind
Sometimes foreclosed homeowners are locked out of the property before they can move their belongings and, in some cases, they do not take everything with them. Many real estate-owned (REO) properties contain furniture, trash, clothes, and other items that you will be responsible for disposing of when you become the property owner.
Vandalism and Neglect
Damage is not uncommon in foreclosure properties, and it may be caused by vandals or the former owner.
Random Vandalism
Sometimes when a property sits vacant, especially if it is in a moderate-to-high crime area, new owners will have to contend with graffiti, broken windows, and other damage.
Owner Vandalism
Broken windows can be common in REOs for several reasons. As mentioned previously, vandalism could be a cause. Also, when banks lock out owners while taking possession of the property, the former owner may break a window or door to retrieve belongings. Previous owners may also purposely inflict damage at the bank's expense by putting holes in walls or tearing off baseboards and crown molding.
Removal of Valuable Items
To inflict revenge against the bank and to make an extra buck, the previous homeowner might remove items of value, including appliances, fixtures, doors, copper pipes, and more. Anything the homeowner does not take might be taken by thieves. Either way, many bank-owned properties are missing things that generally come with seller-owned properties.
Problems With the Purchase
Despite all of these potential problems, foreclosures can still be a good deal. If you are willing to fix problems that most people don't want to deal with, you can purchase a home at a significant discount. However, you may encounter additional issues when it comes to actually purchasing the property and improving it to move-in condition.
Issues With Lenders
Buying a home from a lender has its issues as a result of the increased level of bureaucracy and the limited transparency afforded to those who buy foreclosures.
Financing
Lenders will not give a homebuyer money for a dwelling they consider uninhabitable or that appraises below the purchase price. If you are an investor paying cash, of course, this will not be a problem. The HUD Section 203(k) program can also help in some circumstances.
Time Delays With the Owner Bank
Common sense says that banks should want to unload REOs as quickly as possible, but in reality, banks sometimes drag their heels in considering offers and throughout the escrow process.
No Seller Disclosures
Since no one from the bank has ever lived in the house, they are unlikely to have any knowledge of existing problems with the property. You will have to uncover everything yourself, either during the home inspection, by asking neighbors, or through experience after you become the homeowner.
Competition
Because foreclosures can be great deals, they are attractive to investors looking to flip properties or use them as rentals. Since investors can make all-cash offers with fewer or no contingencies and fast closings, their offers may be more attractive to the bank than those from would-be owner-occupants.
The Bottom Line
There is money to be made in foreclosures, but you should know the challenge you are undertaking ahead of time and choose your property carefully. Don't overlook the fundamentals that make a property desirable just because the purchase price is a bargain. You should also extensively research financing options for foreclosed homes.
While you can go the traditional route of using a private lender as you would for a conventional home, lenders can sometimes be reluctant to finance a foreclosed home, so it is worth looking into loans from the Federal Housing Administration (FHA) or Freddie Mac.
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071e9c4f0dd0cbf6abd846936234f579 | https://www.investopedia.com/articles/mortgages-real-estate/08/home-inspection.asp | Importance of Home Inspection Contingency | Importance of Home Inspection Contingency
Before you buy a home, one of the things you should do is to have it checked out by a professional home inspector. Yes, we can hear your objection: "Buying a home is expensive enough as it is! Why would I choose to fork over hundreds more if I'm not required to?" In this article, we'll delve into what a home inspection can reveal and whether it's worth the investment.
The Home Inspection Contingency
Home inspections are used to provide an opportunity for a buyer to identify any major issues with a home prior to closing. Your first clue that a home inspection is important is that it can be used as a contingency in your contract with the seller. This contingency provides that if significant defects are revealed by a home inspection, you can back out of your purchase offer, free of penalty, within a certain timeframe. The potential problems a home can have must be pretty serious if they could allow you to walk away from such a significant contract.
In some situations, realtors are also known to include home inspection clauses in contracts, such as those for a newly built residence. In new home construction, inspections generally cover:
Foundations: Checking before the concrete is poured (once poured, there’s very little that can be corrected). Pre-drywall: Checking the structure and mechanics before the drywall is laid. Full inspection: A full walk-through is performed of the completed home.
What a Home Inspection Covers
Inspectors vary in experience, ability, and thoroughness, but a good inspector should examine certain components of the home and then produce a report covering their findings. The typical inspection lasts two to three hours and you should be present for the inspection to get a firsthand explanation of the inspector's findings and, if necessary, ask questions. Also, any problems the inspector uncovers will make more sense if you see them in person instead of relying solely on the snapshot photos in the report.
The inspector should note:
Whether each problem is a safety issue, major defect, or minor defect Which items need replacement and which should be repaired or serviced Items that are suitable for now but that should be monitored closely
A really good inspector will even tell you about routine maintenance that should be performed, which can be a great help if you are a first-time homebuyer.
(see. Top Tips for first-time home buyers)
While it is impossible to list everything an inspector could possibly check for, the following list will give you a general idea of what to expect.
Exterior Inspection
The inspector will complete a full inspection of the outside of the structure. This will include climbing into any crawlspaces under the home and using a ladder to reach and inspect the roof and other items.
Exterior walls
The inspector will check for damaged or missing siding, cracks and whether the soil is in excessively close contact with the bottom of the house, which can invite wood-destroying insects. However, the pest inspector (yes, you might want to engage one of those too), not the home inspector, will check for actual damage from termites, etc. The inspector will let you know which problems are cosmetic and which could be more serious.
Foundation
If the foundation is not visible, and it usually is not, the inspector will not be able to examine it directly, but they can check for secondary evidence of foundation issues, like cracks or settling.
Grading
The inspector will let you know whether the grading slopes away from the house as it should. If it doesn't, water could get into the house and cause damage, and you will need to either change the slope of the yard or install a drainage system.
Garage or Carport
The inspector will test the garage door for proper opening and closing, check the garage framing if it is visible and determine if the garage is properly ventilated (to prevent accidental carbon monoxide poisoning). If the water heater is in the garage, the inspector will make sure it is installed high enough off the ground to minimize the risk of explosion from gasoline fumes mingling with the heater's flame.
Roof
The inspector will check for areas where roof damage or poor installation could allow water to enter the home, such as loose, missing or improperly secured shingles and cracked or damaged mastic around vents. They will also check the condition of the gutters.
Interior Inspection
The inspector will also complete a thorough inspection of the interior of the home. He will inspection everything from the ceiling to the cabinets under the sink.
Plumbing
The home inspector will check all faucets and showers, look for visible leaks and test the water pressure. They will also identify the kind of pipes the house has if any pipes are visible. The inspector may recommend a secondary inspection if the pipes are old to determine if or when they might need to be replaced and how much the work would cost. The inspector will also identify the location of the home's main water shutoff valve.
Electrical
The inspector will identify the kind of wiring the home has, test all the outlets and make sure there are functional ground fault circuit interrupters (which can protect you from electrocution, electric shock, and electrical burns) installed in areas like the bathrooms, kitchen, garage and outdoors. They will also check your electrical panel for any safety issues and check your electrical outlets to make sure they do not present a fire hazard.
Heating, Ventilation, and Air Conditioning (HVAC)
The inspector will look at your HVAC system to estimate the age of the furnace and air conditioner, determine if they function properly and recommend repairs or maintenance. An inspector can also give you an idea of the age of the home's ducting, whether it might have leaks if your home has sufficient insulation to minimize your energy bills and whether there is any asbestos insulation.
Water heater. The home inspector will identify the age of the heater and determine if it is properly installed and secured. The inspector will also let you know what kind of condition it is in and give you a general idea of how many years it has left.
Kitchen Appliances
The inspector will sometimes check kitchen appliances that come with the home to make sure they work, but these are not always part of the inspection. If you think you'll want to keep them, be sure to ask which ones are not included so that you can test them yourself.
Laundry Room
The inspector will make sure the laundry room is properly vented. A poorly maintained dryer-exhaust system can be a serious fire hazard.
Fire Safety
If the home has an attached garage, the inspector will make sure the wall has the proper fire rating and that it hasn't been damaged in any way that would compromise its fire rating. They will also test the home's smoke detectors.
Bathrooms
The inspector will check for visible leaks, properly secured toilets, adequate ventilation, and other issues. If the bathroom does not have a window and/or a ventilation fan, mold and mildew can become problems and moisture can warp wood cabinets over time.
Not Covered in a Home Inspection
A home inspection can't identify everything that might be wrong with the property; it only checks for visual cues to problems. For example, if the home's doors do not close properly or the floors are slanted, the foundation might have a crack, but if the crack can't be seen without pulling up all the flooring in the house, a home inspector can't tell you for sure if it's there.
Some areas inspectors won’t look at include:
Inside walls (won’t cut open drywall or insulation) Inside pipes or sewer lines Inside chimneys Behind electrical panels
Furthermore, most home inspectors are generalists – that is, they can tell you that the plumbing might have a problem, but then they will recommend that you hire an expert to verify the problem and give you an estimate of the cost to fix it. Of course, hiring additional inspectors will cost extra money. Home inspectors also do not specifically check for issues like termite damage, site contamination, mold, asbestos engineering problems, and other specialized problems.
If they have reason to suspect, though, they'll likely give you a heads up. Some inspectors offer radon testing as an add-on; some will recommend asbestos testing services if your home appears to be at risk.
However, problems without visual cues – pests, radon, lead – may crop up after the inspection.
After the Inspection
Once you have the results of your home inspection, you have several options.
If the problems are too significant or too expensive to fix, you can choose to walk away from the purchase, as long as the purchase contract has an inspection contingency. For problems large or small, you can ask the seller to fix them, reduce the purchase price, or to give you a cash credit at closing to fix the problems yourself. This is where a home inspection can pay for itself several times over. If these options aren't viable in your situation (for example, if the property is bank-owned and/or being sold as-is), you can get estimates to fix the problems yourself and come up with a plan for repairs in order of their importance and affordability once you own the property.
Worth the Investment?
The average cost to hire a home inspector is $324, but that varies greatly, depending on the size of the home and the region; the range is roughly $300-500. Of course, that can go much higher, if the general inspection's findings lead to more specialized inspectors being called in. Ask ahead of time how an inspector charges.
It's important to put things in perspective. Remember that an inspection is:
Not the sole determinant for buying a house. Maybe you’re willing to make some renovations on the house with these problems. The inspection will help you determine exactly how many you’ll need to do. Never free and clear of problems. An inspection will always find a problem with a home. Even new home constructions will have small issues that need to be addressed. Not about getting all the fixes done. No seller is going to fix everything for you. They may negotiate on some of them, but expecting resolution of all issues is unreasonable.
The Bottom Line
A home inspection will cost you a little bit of time and money, but in the long run, you'll be glad you did it. The inspection can reveal problems that you may be able to get the current owners to fix before you move in – or else, prevent you from inadvertently buying a money pit. For new home construction, it’s an imperative part of the home buying process. If you are a first-time homebuyer, an inspection can give you a crash course in home maintenance and a checklist of items that need attention to make your home as safe and sound as possible. Whatever the situation, addressing issues early through a home inspection can save you tens of thousands of dollars down the road.
See also "10 Reasons You Shouldn't Skip a Home Inspection."
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a546e81a26a532ba518836e7cba30990 | https://www.investopedia.com/articles/mortgages-real-estate/08/home-ownership.asp | Homeownership as an Investment | Homeownership as an Investment
Homeownership has always been part of the American Dream. Because of that, many people accept owning a home as the right, even obligatory, thing to do without considering the benefits and the risks. If you are contemplating buying a home, you should know and review the pros and cons of the investment you are about to make—as you would any investment decision—before signing on the dotted line.
Key Takeaways If you are considering homeownership, be aware of and review the advantages along with any potential risks you may face before you close the deal. The benefits of investing in a home include appreciation, home equity, tax deductions, and deductible expenses. Risks and caveats of investing in a home can include high upfront costs, depreciation, and illiquidity.
Attractive Long-Term Investment
Appreciation represents the increase in home values over time. Real estate prices are cyclical, and homeowners shouldn't expect the property's value to increase drastically in the short-term. But if you stay in your home long enough, there's a very good likelihood you will be able to sell your home for a profit because of appreciation later in the future.
In fact, buying a home is one of the best long-term investments you can make. Despite dramatic dips such as 2008 Housing Crash, residential real estate tends to rise in value. Median home prices in the U.S. rose from $298,900 in fourth quarter of 2014 to $346,800 in the fourth quarter of 2020—a more than 16% increase in value in six years. Go back a decade, when the median sales price was $219,000 (Q4 2009), and you have a 42.7% increase. That’s not a bad return on an investment (ROI) that also provides you with a place to live.
Real estate appreciates primarily because of the land on which the home sits, while the actual structure depreciates as time goes by. So the expression "location, location, location" is not just a real estate catch-phrase, but a very important consideration when buying a home. The neighborhood with the amenities it brings—school districts, parks, condition of roads, etc.—and the city where the home is located all factor into the property's appreciation.
Consider a home that is rundown and dilapidated to the point that it's uninhabitable. The land underneath the home may still be worth a significant amount of money—more than the residence, in this case. A seller may consider selling it as is (with the structure still intact) or spending a little extra to demolish the home and sell the land at a higher price on its own.
Building Equity
Home equity represents the difference between how much you still owe on your mortgage and the market price or value of your home. Home equity and appreciation may be considered together. As noted above, your home likely would grow in market value over time.
Your equity also grows as you pay down your mortgage, with less of your payment going toward interest and more toward lowering the balance on your loan.
Appreciation is the change in the value of your home over time, while home equity is the difference between the balance on your mortgage and your home's market value.
Building equity does take some time because it takes time to lower the principal balance owing on the mortgage loan—unless, of course, you make a large down payment or regular prepayments.
One thing to keep in mind, though, is that the length of time you have your home is a big factor in how much equity you build and the appreciation you can realize. The longer you keep it, the more equity you obtain.
As you pay down your mortgage and reduce the amount you owe, without realizing it, you are saving as the value of your home is increasing—just as the value of your savings account increases with interest. When you sell, you likely would get back every dollar you paid out and more, assuming you stay in your house long enough. Over time, the average 6% return (interest rate) on your savings should more than cover your outlay.
Another plus is that home equity provides flexibility to get a loan that is tied to the amount of your home equity. Many investors follow their home equity and home appreciation simultaneously. If an investor believes their home value is greatly appreciating, they may put off a home equity loan to have a better opportunity to realize a seller’s appreciation.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
Location, Location, Location
While paying down your mortgage works the same no matter where you live, market-value growth varies with location. According to the Federal Housing Finance Agency (FHFA) House Price Index (HPI), real estate prices rose an average of 32.88% over the five-year period ending Dec. 31, 2019, in the U.S. overall. However, prices in the Middle Atlantic census division rose by only 23.21%, and prices in the Pacific census division climbed by an average of 40.39%.
To see how this might affect prices where you plan to buy, check out the full FHFA chart below:
Percent Change in U.S. Home Prices, Period Ended Aug. 31, 2019 Division Division Ranking One-Year Quarter Five-Year Since Q1 1991 USA 4.94% 1.11% 32.93% 174.44% Mountain 1 6.91% 1.77% 47.18% 276.71% Pacific 2 4.45% 1.08% 41.04% 218.63% South Atlantic 3 4.96% 1.02% 36.39% 177.94% West South Central 4 4.65% 1.02% 30.75% 188.76% East South Central 5 5.27% 0.99% 29.59% 149.60% East North Central 6 5.16% 1.15% 30.25% 128.07% New England 7 4.67% 1.35% 24.41% 152.51% West North Central 8 4.78% 1.16% 28.60% 171.64% Middle Atlantic 9 4.04% 0.76% 22.26% 146.18%
Source: FHFA U.S. House Price Index - 3Q 2019.
Capital Gains Exclusion
Eventually, you will sell your home. When you do, the law allows you to keep the profits and pay no capital gains taxes. Well, not necessarily all the profits. The Internal Revenue Service (IRS) allows a tax-free profit of as much as $250,000 for single homeowners and $500,000 for married couples—for your main residence only, not for a second home or vacation property.
There are a few requirements you need to meet in order to qualify for this exclusion. You must own the home for at least two years—24 months—within the last five years up to the closing date. The residence requirement dictates that you should have lived in the home for at least two years during the five-year period leading up to the sale. The final requirement, the look-back requirement, outlines that you didn't profit from selling another primary residence during the two-year period leading up to the most recent sale.
Tax Deductions
After appreciation, the benefit of homeownership that is cited most often is tax deductions or savings. When you buy a home, you can deduct some of the expenses of owning that home from the taxes you pay to the government. This includes mortgage interest on both your principal residence and a second home, which can amount to thousands of dollars per year.
Interest on home-equity loans, or home-equity lines of credit (HELOC), is also deductible if the funds are used to improve your home substantially. You can also deduct as much as $10,000 in state and local (SALT) taxes, including property taxes.
The Tax Cuts and Jobs Act's Effect
The Tax Cuts and Jobs Act made substantial changes to the parts of the tax code that have to do with homeownership. Unless a future Congress amends the law, all provisions will expire after Dec. 31, 2025. But for now, changes in that law have reduced the value of owning a home.
The law limits mortgage interest deductions to $750,000 of total mortgage debt, including for a first and second home and any home-equity or HELOC loans. However, the higher limitation of $1 million in mortgage debt still applies for indebtedness incurred before December 16, 2017.
The law also set the SALT deduction limit to $10,000. Other new provisions include restrictions on claiming casualty losses except for federally declared disasters. The moving expenses deduction no longer exist, except for the active-duty military moving for reasons of work.
All these changes have lowered the value of owning a home—including the fact that, with the near doubling of the standard deduction (another feature of the Act), fewer people will have enough deductions to file Schedule A instead of taking the standard deduction.
So the fact that you are eligible for a tax deduction does not mean that it will end up being useful to you. The severe limiting of the SALT deduction will be particularly detrimental in lowering available deductions for people who live in highly taxed states.
High Upfront Costs
The cost of investing in a home can be high—there's more to your expenses than the property's selling price and the interest rate on your mortgage. For starters, you can expect to pay anywhere from 2% to 5% of the purchase price in closing costs. Some of the most common closing costs include an application fee, appraisal fee, attorney fees, property taxes, mortgage insurance, home inspection, first-year homeowner’s insurance premium, title search, title insurance, points (prepaid interest), origination fee, recording fees, and survey fee.
Experts say you should plan to stay in your house at least five years to recover those costs.
Potential Depreciation
Not all homes grow in value. The housing crisis of 2008 resulted in many homeowners being underwater, which means owing more on your mortgage than your home is worth. It doesn’t take a housing crisis for home prices to stagnate or drop. Regional or local economic conditions can result in home values that don’t keep up with inflation.
Remember, too, that the actual structure you live in will depreciate over time. This can be a result of wear and tear on the property, or a lack of maintenance and repairs.
Pride and Financial Responsibilities
One often-cited benefit of homeownership is the knowledge that you own your little corner of the world. You can customize your house, remodel, paint, and decorate without the need to get permission from a landlord.
Ownership comes with responsibilities, however. You must pay your mortgage or risk losing your home and the equity you’ve built. Maintenance and upkeep are your responsibility. You can’t call the landlord at 2:00 a.m. to have a leaky water pipe repaired. If the roof is damaged, you must repair it—or have it repaired—yourself. Lawn mowing, snow removal, homeowners insurance, and liability insurance all fall on you.
Illiquidity
Unlike stock, which can be sold within a matter of days, homes typically take much longer to unload. The fact that you might have access to $500,000 in tax-free capital gains doesn’t mean that you have ready access. Meanwhile, you still must make mortgage payments and maintain the house until you sell it.
The Bottom Line
A home is an investment that comes with many investment benefits but also risks, which makes it an investment that is not for everyone. Weighing the investment benefits against the risks is important. A rational comparison of pros and cons can help you decide whether to put your money into a home investment or potentially find better returns elsewhere.
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c676409c876c3b42b38f58db8df030e0 | https://www.investopedia.com/articles/mortgages-real-estate/08/homeowners-associations-tips.asp | 9 Things to Know About Homeowners Associations | 9 Things to Know About Homeowners Associations
Many residential communities have a homeowner's association (HOA) structure to help maintain a clean and cohesive atmosphere in the neighborhood. Also, when you buy a condominium, townhouse, or single-family home within "a planned development" you may also encounter the HOA structure.
While the HOA will at times spare the homeowner from some responsibilities they can also come with some homeowner obligations. Before you buy a home that makes you part of an HOA, here's what you need to know, and the questions you should ask both the association and you and your family.
Key Takeaways Many condos, co-ops, and even some neighborhoods have homeowner's associations (HOAs) made up of member residents.HOA members are elected from among the residents and serve to maintain grounds, master insurance, community utilities, as well as the overall finances of the building complex or community.Most HOAs will require all unit owners to pay a monthly maintenance charge and may also demand special one-time assessments to cover large community expenses.The HOA's bylaws will spell out which responsibilities are the associations and which are the unit owners'.
Planned Development HOAs
Moving into a planned development often requires you to join the community's HOA and pay its fees to help cover the upkeep of common areas, shared structures, and exteriors. Membership also binds you to the association's covenants, conditions, and restrictions (CC&R). Those rules could thwart your dream of having a purple front door, say, or of leaving your RV in the driveway since the CC&Rs typically include stipulations about the appearance of your home and the vehicles you can park outside it.
Statistically speaking, Americans have a one in five chance of living in a home that's part of an HOA, according to a data analysis by applied microeconomist Wyatt G. Clarke. Since Clarke's estimate was drawn up (in 2017), properties with HOAs have further surged.
Is life in a planned development a good option for you? And, if so, which ones have HOAs that may suit you best? The answers to those questions depend not only your finances but your enthusiasm for shared amenities, tolerance for rules and regulations, and comfort with self-government—since most HOAs are overseen by volunteers who live in the development.
1:56 9 Tips for Handling Homeowners’ Associations
1. Fees Range Widely
A Trulia study which used American Community Survey records, found monthly HOA fees averaged $331 a month in 2015. Averages ranged from a low of $218 month in Warren, Mich., to a high of $571 in New York City. Trulia found dues to be generally higher in older buildings and complexes with more units overall.
The number and size of the development’s amenities also affect rates, according to Nate Martinez, a real estate agent at RE/MAX Professionals in Glendale, Ariz. For example, a development that’s guarded by a gate, and has a clubhouse and golf course is likely to levy higher fees than one that offers minimal security and only a modest common area.
Fees can differ even within a development, due to variations in square footage, location, and orientation, all of which can affect how much upkeep the property will require.
Most multiple listing services (MLSs) include HOA fees in the property listing. That should ensure you can access the information through REMAX.com, Zillow.com, Realtor.com, and other listing sites, according to Martinez.
You should also find out how often fees have increased over time, and by how much. If you can, obtain a printed history of HOA dues by year for the past 10 years. Martinez says that the fees for an HOA are typically increased no more than annually. In Martinez’s experience, HOA increases are customarily mapped out three to five years in advance, using estimates of the future costs of utilities, labor, maintenance, and more.
Examine these projections if they’re available. Since they're only estimates, Martinez suggests you also check the amount by which fees are permitted to increase every year under the HOA's bylaws. In a new complex, that research can help determine whether initial HOA fees have been attractively, even artificially, underpriced in order to attract homeowners and are liable to increase significantly over time to cover the gap between revenue and costs.
Alternatively, the opposite can also be the case—that is, HOA fees for new development may actually go down slightly over time as more homes are added to the development and more homeowners are available to share the HOA’s fixed costs.
2. What You Get Varies, Too
When you buy a home in a managed community, you’re actually buying a bundle of legal obligations and entitlements in addition to physical living space, says John Manning, managing broker at RE/MAX on Market in Seattle. The precise rights, services, and amenities for which the HOA is responsible may range as widely as the fees being charged. “A gated community may have gate maintenance as the only agreement between homeowners, or there may be an HOA in place with a legal authority to manage much more,” he says.
Look at what is included (and not included) that will affect your household finances. Will you have to pay for garbage pickup, for example? Are utilities included? Which ones? What about cable and/or internet service?
Keep in mind you’ll pay for perks, such as recreational facilities, whether you use them or not. Find out the hours for amenities, such as pools and tennis courts, to determine if they’ll work with your schedule. If you’d think you'll want to share these facilities with friends or family, check the rules and fees that pertain to guest use.
Line up the fees—and their inclusions and exclusions—against those of other developments in the area, especially those that are already on your shortlist. “If you want to know about HOA ranges for your region, the best resource would be through a professional real estate broker who’s knowledgeable about homeowners associations,” says broker Manning.
3. Additional Fees May Apply
An HOA may adopt one of several approaches to financial management. These choices especially affect how it funds unexpected expenses and such capital investments as replacing an HVAC system.
According to John Manning, managing broker at RE/MAX on Market in Seattle, "Some associations prefer a large cash reserve on hand to meet maintenance, legal, or management obligations as they arise. Others have lower fees and rely on special assessments—funds levied outside of HOA fees—for repairs and maintenance." These levies are similar to the tax assessments sometimes levied by local governments.
Here's how the assessment route works: When a major expense, such as replacing a roof or elevator, comes up—and the HOA's reserves lack the funds to pay for it—the association may charge each homeowner a special assessment. These levies can run into thousands of dollars.
According to Manning, the size of the reserve fund will depend not only on the HOA’s approach but also on the building's age, condition, and amenities. Developments often draw up multiyear plans for repairs and capital investments, including their annual costs and the expected balance in the reserve fund at the time the outlays will be required.
Ask to see those documents, paying special attention to how well the needed expenditures line up with the balance of the reserve fund. Professional help can be valuable when poring over these spreadsheets. His company's, Manning says, is to "have the clients discuss the financial statements with a CPA [who is an] expert in analyzing [developments'] financials."
The HOA should be able to provide such a list. Ask, too, if any special assessments are planned in the future. Note that economies of scale may mean that special assessments for a certain capital expense may be smaller in HOAs that have many members and higher in smaller HOAs, where a similar expense will have fewer homeowners to fund it.
4. Fees and Your Mortgage Approval
When contemplating a property purchase in a planned development, you'll of course factor the impact of its HOA dues into your overall finances. So, too, will prospective mortgage lenders.
As they do with property taxes (which, by the way, are not included in HOA fees at most developments), banks will consider your monthly HOA fees when deciding how large a mortgage you’ll be able to afford. As a result, you may wrestle with vexing tradeoffs as you decide among properties. Higher HOA fees could leave you with a smaller approved amount to spend on your house compared with choosing an alternative property with low or no fees.
Interestingly, the presence of fees doesn't necessarily reduce the value of a property; if anything, there's evidence of the opposite effect. The research by microeconomist Clarke found that, after equalizing for home size and location, properties that were part of an HOA sold for an average of about 4% more than those who weren’t in an association. The premium is highest, he found, when the house and development are new; it declines with age.
Your prospective lender can provide the mortgage-payment figure, and you should already have the property-tax and HOA-fee numbers. If you’re just starting on your home search—and don’t yet have relationships with any lenders—use an online mortgage calculator to estimate the likely mortgage payment for the principal you’re seeking, and to enter other relevant information, including your planned downpayment.
Again, any lender you’re talking with can provide this. Alternatively, many online mortgage calculators, including the one we linked to above, also allow you to request quotes from mortgage lenders on rates and maximum approved amounts.
5. The Covenants Count
Since the rules and regulations of any particular HOA may be unique, don't rely on second-hand information or past experience at other developments to learn what an HOA's rules and covenants are. And think hard about whether you’ll be able to live with them.
If you can’t find the CC&Rs online, at the HOA's website, ask your real estate agent to acquire them for you or obtain them through contacting the HOA directly. Be sure to check if the document is up-to-date before you proceed too far into the buying process.
You could find you're restricted in more ways than you might assume. In addition to governing door color and the like, CC&Rs may limit how tall your grass can grow, whether you can plant or remove trees, which types of vehicles you can park on the street or in your driveway (bans on parking RVs are not uncommon, for example), how high fences can be, and which types of coverings you can use on street-facing windows.
If environmentally friendly living is a personal priority, check the HOA's green provisions, beginning with what can be planted around your home, and how that vegetation may be maintained.
For example, some HOAs do not allow xeriscaping, an environmentally friendly form of landscaping for arid climates, and may limit the size and composition of any garden you plant. The rules may also dictate the use of particular fertilizers, pesticides, or sprinkler systems to maintain the yard and ban the likes of compost piles and solar panels.
Check for any language that might prevent you from, or even just complicate, renting out your property. What’s considered customary can depend on the jurisdiction. “In the Seattle area, it is common to find prohibitions on short-term [vacation] rentals. HOAs have an interest in limiting the percentage of non-owner-occupied units, as mortgage lenders may be reluctant to lend on buildings that have high rental occupancy,” says Manning.
6. Conflict Management
As in any community, disagreements arise within a planned development, sometimes over certain residents bending or breaking the rules. Before you buy, explore how rules are set and enforced and what penalties are imposed against rule-breakers.
Sanctions can be strict. In some HOAs, the outcomes may include being fined or sued or having the HOA place a lien on your home. Pay particular attention to whether the HOA can foreclose on your property for nonpayment of HOA dues or nonpayment of fines resulting from CC&R violations.
Ask about the process for resolving any conflicts, as well as how the HOA manages additions to or amending the rules.
Request a list or other accounting of conflicts and rule violations the association has had to resolve. If that information doesn’t detail lawsuits, ask about those. Be sure to check for any past, present, or pending lawsuits in which the HOA is involved. Also, review the outcome of any such cases.
7. The HOA's Reputation
Since the association essentially serves as a hyper-local government for the community, it pays to look into who runs it and how well those people function together.
It's very common for HOAs to be overseen by community residents who hold their positions as volunteers and are elected by association members. However, some associations are entirely managed professionally. If a private company manages the HOA, investigate its reputation before you buy. If the HOA has some employees, or companies to which it contracts out tasks, ask about these entities and the work they do.
Talk if you can to some of the building’s current owners—preferable ones who are not on the HOA board and have lived in the building for several years. How collegially does the board function? Are differences in opinion usually handled civilly and constructively? Be alert for indications of frequent, even perpetual, drama. As with some other governing bodies, HOAs can be hampered by egotism, power plays, and petty politics.
Schedule time to speak with the HOA president, to get a sense of whether you want this person making decisions on your behalf about the development. Ask the president, too, about interest among residents in serving on the board: Is there high motivation to do so, or relative indifference? This conversation may also motivate you (or not) to serve on the board yourself one day, a move that would require getting elected and giving up some free time for your new responsibilities.
8. Compliance with the HOA
Don’t rely on being properly alerted to any lingering issues between the association and the current owner of a house that interests you. Failure to ask about these problems in a timely way could result in you inheriting them when you take possession of the property.
Some potential issues may be obvious, such as dead or overgrown landscaping or flaking paint. Conversely, has the owner made exterior improvements or other changes to the property without getting HOA approval? If these changes are not in compliance with the rules, what could happen to you if you owned the property? You may be able to force the owner to fix the problems as part of the sale agreement or provide cash at closing.
9. Insurance Responsibilities
As with the ownership of property, insurance provisions within a planned development can be divided, too, with the HOA covering some perils or areas and the homeowner responsible for others.
These are often mandated by state law. In Florida, for example, a condominium HOA must insure all common property, which includes every part of the building up to a unit's unfinished drywall. Meanwhile, the homeowner is responsible for insuring all personal property within their unit, including appliances, flooring, cabinetry, window treatments, and the like.
Check the law for the state you'll be living in to for the precise division of requirements. Confirm the HOA for the property you’re considering is adhering to those requirements.
Catastrophe insurance is particularly important if you’re considering a condo or townhouse purchase in an area prone to major natural disasters, such as floods, earthquakes, blizzards, wildfires, tornadoes, or hurricanes. “In the Pacific Northwest, earthquake insurance is very common [in planned developments], though not required,” says Manning.
Check whether the HOA provides additional coverage as a perk for owning within the development. “[A] forward-thinking HOA can make a condo building more attractive” in this way, says Manning. They might add “earthquake and other types of hazard insurance, [which] will be reflected in the homeowner’s HOA dues.” You should, of course, confirm if such additional coverage also extends to the areas that are the homeowner’s legal responsibility, or only to those under the HOA’s purview.
The Bottom Line
Living in a planned development—and being governed in part by the rules of an HOA—can be a mixed blessing. It offers the prospect of exchanging some control over your home for the reduced responsibilities of maintaining it, and for the benefit of enjoying shared amenities and security. It can, however, also trade the diverse look of a typical neighborhood for a more uniform appearance, albeit one with a lower chance of a neighbor's decorating taste or sloppy maintenance habits becoming a problem for you.
How well you embrace those tradeoffs will contribute to how happy you'll be in a condominium or other “planned home.” If you decide to proceed with a purchase, be sure to engage professionals, including a real estate agent, who is familiar with planned developments and HOAs since there are a number of unusual aspects to these compared with buying a single-family home.
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c00406c9adacbe4102b6f8ac83da1255 | https://www.investopedia.com/articles/mortgages-real-estate/08/housing-appreciation.asp | Top Things that Determine a Home's Value | Top Things that Determine a Home's Value
Many first-time home buyers believe the physical characteristics of a house will lead to increased property value. But in reality, a property's physical structure tends to depreciate over time, while the land it sits on typically appreciates in value. Although this distinction may seem trivial, understanding how prospective land values influence property returns lets investors make better choices.
Quite simply, land appreciates because it's in limited supply. After all, no one is producing any more earth. Consequently, as the population increases, so does the demand for land, driving its price up over time. Therefore, investors should consider how land appreciation can offset the depreciation of a home, which requires capital infusion for maintenance, as it ages. The Internal Revenue Service (IRS) even acknowledges this inevitability by allowing the depreciation of a physical structure to reduce tax obligations for a business or investment.
The degree of depreciation and/or physical obsolescence varies from one property to another, but if left alone, properties continue to depreciate until they no longer add any value to the land. Some owners even raze physical structures to maximize the value of their parcels.
Key Takeaways Many first-time home buyers believe the physical characteristics of a house will lead to increased property value. But in reality, a property's physical structure tends to depreciate over time, while the land it sits on typically appreciates in value.Understanding how prospective land values influence property returns allows investors to make better choices. Land appreciates because it is limited in supply, consequently, as the population increases, so does the demand for land, driving its price up over time.
1:40 Top 4 Things That Determine a Home’s Value
Implications for Investment
Once an investor understands the impact of land value on total appreciation, the time-honored real estate mantra of "location, location, location" takes on even greater meaning. Savvy home buyers look past the physical attributes of a home and focus on its physical site, taking the following elements into consideration:
Locations within neighborhoods will affect land values.
Not all spots within a given area are considered equal. A home by a cul-de-sac is usually in higher demand than a home situated near a busy roadway because the former has less traffic and is safer for young children. Also, most middle- and upper-class, single-family-home neighborhoods have new construction limits that are set when developers purchase most of the available land, on which to construct the subdivisions. Consequently, most neighborhoods evolve their own social, cultural and demographic characteristics that impact demand for houses.
The average age of neighbors can provide clues to appreciation.
New home buyers with small children often avoid locations with older homeowners who will not provide playmates for their little ones. Also, specific public schools can influence the demand for homes in particular school districts.
Future development can change the value of a property for better or for worse.
Homeowners should not only be cognizant of current local amenities, but they should also be aware of the prospective commercial and municipal developments in the area, such as plans for new schools, hospitals, and public infrastructure, that may impact land values.
Single-family property investors should also consider the possible development of condominiums in their neighborhoods. Because condo complexes may contain multiple units on small parcels of land, the increased supply could potentially drive down prices for all area homes.
The Bottom Line
Successful real estate investors look beyond the stylistic attributes of prospective home purchases and concentrate on a property's potential for land appreciation. This requires overlooking the most attractive houses in a target location and concentrating on those that provide opportunities for improvement, which may enhance the value of the land. Investors may track appreciation by visiting the Federal Housing Finance Agency (FHFA). (For related reading, see "6 Things You Think Add Value To Your Home — But Don't")
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2bf9697b53591705be4b3d25786a1dcc | https://www.investopedia.com/articles/mortgages-real-estate/08/interest-rates-affect-property-values.asp | How Interest Rates Affect Property Values | How Interest Rates Affect Property Values
Interest rates have as profound an effect on the value of income-producing real estate just like they do on any other investment vehicle. This is especially true about the rates on interbank exchanges and Treasury bills (T-Bills). Because their influence on an individual's ability to purchase residential properties (by increasing or decreasing the cost of mortgage capital) is so profound, many people make the incorrect assumption that the only deciding factor in real estate valuation is the current mortgage rate.
But mortgage rates are only one interest-related factor that influences property values. Because interest rates also affect capital flows, the supply and demand for capital, and investors' required rates of return on investment, interest rates drive property prices in a variety of ways.
Key Takeaways Interest rates can drive property prices in a variety of ways.Similar to the discounted cash flow analysis conducted on equity and bond investments, the income approach takes the net cash flow into account.Interest rates can affect the cost of financing and mortgage rates—changes in capital flows can also have a direct impact on the supply and demand dynamics for a property.The most evident impact of interest rates on real estate values is in the derivation of discount or capitalization rates, as they are equal to the risk-free rate plus a risk premium.
Valuation Fundamentals
Real estate values are generally influenced by the supply and demand for properties as well as the replacement cost of developing new properties. But there's more to valuation than that, especially when you consider how government-influenced interest rates, capital flows, and financing rates affect property values. To understand these dynamics, it's important to have a basic understanding of the income approach—the most common valuation technique for investors. The income approach—provided by commercial property appraisers and by underwriters for real-estate backed investments—is very similar to the discounted cash flow analysis conducted on equity and bond investments.
The valuation starts by forecasting property income, which takes the form of anticipated lease payments or, in the case of hotels, anticipated occupancy multiplied by the average cost per room. After accounting for all property-level costs, the analyst arrives at the net operating income (NOI) or cash flow that remains after all of the operating expenses.
By subtracting any associated capital costs, investment capital to maintain or repair the property, and other non-property-specific expenses from NOI, we end up with the net cash flow (NCF). Because properties don't usually retain cash or have a stated dividend policy, NCF equals cash available to investors—just like cash from dividends—which is used for valuing equity or fixed-income investments. By capitalizing dividends or by discounting the cash flow stream (including any residual value) for a given investment period, the property value is determined.
2:05 How Interest Rates Affect Property Values
Capital Flows
Interest rates can significantly affect the cost of financing and mortgage rates, which affects property-level costs and, therefore, values. However, supply and demand for capital and competing investments have the greatest impact on required rates of return (RROR) and investment values. As the Federal Reserve Board has moved the focus away from monetary policy and more toward managing interest rates as a way to stimulate the economy or stave off inflation, its policy has had a direct effect on the value of all investments.
As interbank exchange rates decrease, the cost of funds is reduced, and funds flow into the system. Conversely, when rates rise, the availability of funds decreases. As for real estate, the changes in interbank lending rates either add or reduce the amount of capital available for investment. The amount of capital and the cost of capital affect demand as well as supply—that is, the money available for real estate purchases and development. For example, when capital availability is tight, capital providers tend to lend less as a percentage of intrinsic value, or not as far up the capital stack. This means loans are made at lower loan-to-value (LTV) ratios, thus reducing leveraged cash flows and property values.
These changes in capital flows can also have a direct impact on the supply and demand dynamics for a property. The cost of capital and capital availability affect supply by providing additional capital for property development and also influence the population of potential purchasers seeking deals. These two factors work together to determine property values.
The cost of capital and capital availability affect supply by providing additional capital for property development.
Discount Rates
The most evident impact of interest rates on real estate values is visible in the derivation of discount or capitalization rates. The capitalization rate can be viewed as an investor's required dividend rate, while a discount rate equals an investor's total return requirements. K usually denotes RROR (required rate of return), while the capitalization rate equals (K - g), where g is the expected growth in income or the increase in capital appreciation.
Each of these rates is influenced by prevailing interest rates because they are equal to the risk-free rate plus a risk premium. For most investors, the risk-free rate is the rate on U.S. Treasuries. Guaranteed by federal government credit, they are considered risk-free because the probability of default is so low. Because higher-risk investments must achieve a commensurably higher return to compensate for the additional risk borne, when determining discount rates and capitalization rates, investors add a risk premium to the risk-free rate to determine the risk-adjusted returns necessary on each investment considered.
Because the discount rate (K) is equal to the risk-free rate plus a risk premium, the capitalization rate is equal to the risk-free rate plus a risk premium, less the anticipated growth (g) in income. Although risk premiums vary as a result of supply and demand and other risk factors in the market, discount rates will vary due to changes in the interest rates that make them up. When the required returns on competing or substitute investments rise, real estate values fall; conversely when interest rates fall, real estate prices increase.
The Bottom Line
It is important to focus on mortgage rates because they have a direct influence on real estate prices. If you're a prospective homeowner or real estate investor, an easy way to research current interest rates is to use a mortgage calculator.
That said, it's important to note that changing interest rates affect numerous aspects of real estate. Beyond the price of your new home, interest rates also affect the availability of capital and the demand for investment. These capital flows influence the supply and demand for property and, as a result, they affect property prices.
Also, interest rates also affect returns on substitute investments and prices change to stay in line with the inherent risk in real estate investments. These changes in required rates of return for real estate also vary during destabilization periods in the credit markets. As investors foresee increased variability in future rates or an increase in risk, risk premiums widen, putting stronger downward pressure on property prices.
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4baba7fa679aa8d562a2c39ebf1a9ab7 | https://www.investopedia.com/articles/mortgages-real-estate/08/mortgage-closing-costs-fees.asp | Watch Out for ‘Junk’ Mortgage Fees | Watch Out for ‘Junk’ Mortgage Fees
For most people, buying a home is daunting. After all, real estate transactions are usually a once- or twice-in-a-lifetime experience so there's little hands-on opportunity to become intimately familiar with the process. You'll have mountains of paperwork to sign, industry jargon to decipher, and a host of fast-talking salespeople—from real estate agents to mortgage brokers—to contend with.
Somewhere between the elation of purchasing property and the boredom from signing forms, it’s easy to lose track of what you’re paying for and how much you’re spending. Aside from the mortgage, most other expenses get lumped into a category called “closing costs.” Paying attention to these costs before you get to the closing can help you understand where your money is going and maybe even save you a few hundred dollars.
Key Takeaways Recurring closing costs are expenses that you pay at closing and each month thereafter, such as real estate taxes.Nonrecurring closing costs are one-time payments, such as points, loan fees, and home inspection fees.Be on the lookout for these five “junk fees”: excessively high application, underwriting, mortgage rate lock, and loan processing fees, as well as broker rebates.Some lenders offer an all-in-one flat-rate fee that covers all closing costs, saving you from worrying over the fairness of each fee individually.
Closing Costs: What Are They?
The term “closing costs” is shorthand for the total cost of several dozen potential expenses associated with purchasing and financing real estate. These expenses can be categorized as “recurring” and “nonrecurring.”
Recurring Costs
Recurring costs are paid at closing and monthly thereafter. These include real estate taxes, homeowners insurance, and—if you’re putting down less than 20% of the purchase price—private mortgage insurance (PMI), which you will want to avoid paying if possible. (The Consumer Financial Protection Bureau (CFPB) offers advice on PMI and how to get it removed.)
These expenses must be funded in advance at the time of purchase, which is done by putting funds into an account to cover the next year’s obligations. This is known as “putting the money in escrow.” Depending on your closing date, it may also be necessary to prepay interest to cover your first few days or weeks in the home.
Nonrecurring Costs
Nonrecurring costs are also paid at closing. They may include:
PointsAn application fee (profit for the lender)A series of loan fees (these may include an origination fee, an appraisal fee, a credit report fee, a tax service fee, an underwriting fee, a document preparation fee, a wire transfer fee, office administration fees, et al.),A broker’s service fee (if you are working with a mortgage broker)Any lender-required home inspections (e.g., pest inspection)The cost of a lender-required home appraisal (in which someone is paid to verify that the property is worth at least as much as the selling price)
Other Costs at Closing
Closing costs may also include:
Federal Housing Administration (FHA) feesVeterans Administration (VA) feesRural Housing Service (RHS) fees associated with mortgages guaranteed by the governmentA flood determination fee to investigate whether the property is in an area prone to floodingA land survey to verify the property’s boundariesTitle charges (which may include a title settlement fee, title search fee, title examination fee, closing service letter fee, deed preparation fee, notary fees, title insurance fee, and any attorney’s fees)
A host of other miscellaneous costs may include a courier/delivery fee, endorsements, recording fee, transfer tax, and an optional home warranty.
How Much Are Closing Costs?
Fees vary widely based on the lender, the geographic location of the property, and the price of the home. Consult “Your Home Loan Toolkit,” prepared by the Consumer Financial Protection Bureau, as a guideline when evaluating fees. Business Insider has also broken down average closing fees by state in 2019; referring to its chart can give you a benchmark, depending on your home’s location.
What Are ‘Junk’ Fees?
Garbage fees, also known as “junk fees,” are tacked on to most mortgages. There is no way to completely avoid them, but you can often minimize them.
Look out for excessive processing and documentation fees in the following five categories:
Application feeUnderwriting feeMortgage rate lock feeLoan processing feeBroker rebate
If any of these fees seem to be unusually high, ask about them, as they can often be negotiated. This advice also applies to other fees. If it looks funny, ask about it. Often the mere act of questioning the fee will result in the fee being lowered or eliminated.
If you think a fee is too high, try to negotiate it downward. Often simply questioning a fee will get it reduced or eliminated.
All-In-One Closing Cost Pricing
Realizing that consumers are overwhelmed by fees and frustrated at the process of trying to determine whether the fees are fair, some lenders now offer an all-in-one, flat-rate fee that includes all closing costs. The “all-in-one” terminology is also used to describe other mortgage products, such as mortgages that are tied to checking accounts. Take care when shopping for these products, making sure that you purchase the one that applies strictly to mortgage closing costs and not to other banking relationships or products.
As a general rule, you can expect to spend from 3% to 6% of the purchase price in closing costs.
Minimize the Pain
If the real estate market in your area is favorable to buyers, you may be able to ask the seller to pay closing costs. If that isn’t an option, getting an all-in-one mortgage is probably the best way to minimize the feeling that you are being taken advantage of during the closing process. While you are still paying the fees, you won’t need to despair over them one fee at a time.
Comparison shopping is another way to get comfortable with the process and get a better feel for the costs. Ask half a dozen lenders to provide loan estimates and compare the results. This will help you learn the terminology and get a sense of the range of closing fees in your area. Once you choose a lender and have a loan estimate in hand, save it. It will come in handy later.
The Bottom Line
The official form that includes a breakdown of all closing costs is called a “closing statement” or “closing disclosure.” You have a right to see this document at least three business days in advance of closing. Request it and compare it with the loan estimate. If the numbers aren’t reasonably close, ask questions.
By spending the time to comparison shop and carefully review all documentation in advance, you can minimize the expense and anxiety associated with the closing costs you incur when purchasing real estate.
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7fe2b79c5a6b91cfd4ed703bdec5e47e | https://www.investopedia.com/articles/mortgages-real-estate/08/offset-mortgage.asp | Using an All-In-One Mortgage to Reduce Interest | Using an All-In-One Mortgage to Reduce Interest
Do you want to own your own home, but don't want to drain your entire savings to accomplish this? You may want to consider an all-in-one mortgage. This product allows you to combine your mortgage and savings. Let's take a look a look at how it works.
Key Takeaways All-in-one mortgages allow for the combining of a mortgage and savings. They require the combination of a checking account, home equity loan, and mortgage into one. The benefits of an all-in-one mortgage include—seamlessly using extra cash flow to pay off a mortgage, as well as having increased liquidity beyond typical home equity loans. Extra principal payments made on an all-in-one mortgage can be reversed and retrieved anytime. All-in-one mortgages typically charge a $50 to $100 annual fee and are 30-year adjustable rate mortgages.
What Is an All-in-One Mortgage?
The IRS will not allow taxable interest paid and interest received to cancel each other out as in the United Kingdom and Australia; each must be reported separately. Therefore, the "offset" loans available in the U.S. cannot technically be called by this name. In order for these loans to meet IRS guidelines, they must combine a checking account, home equity loan, and mortgage into one account. One account does not truly offset the other as it does in the UK. The single account offers all of the amenities of a normal bank account, such as an ATM and debit cards, automatic bill payments, and a checkbook. But it allows every spare dollar the homeowner has to be used to pay down the mortgage until it is used.
This unique feature benefits the homeowner in several ways. First, because the homeowner's bank account is built directly into the mortgage, the homeowner will receive a much higher return on their deposits. That’s because the money is being used to reduce the amount of interest assessed on the loan, which will almost always be at a much higher rate than what traditional demand deposit accounts can offer.
Second, this type of account still offers instant liquidity in a way that traditional mortgages, or even home equity lines of credit, cannot. While some home equity lines of credit do offer access via checkbook or even debit card, they do not have the flexibility of this hybrid product. If the homeowner does not have the cash to make a payment on the loan in a given month, then no minimum payment is required because the minimum interest due is simply advanced from the available credit line.
Finally, all-in-one loans are fully reversible; extra principal paid can be retrieved anytime, which solves a major problem inherent in trying to accelerate traditional "one-way" mortgages or even the offset loans available overseas.
Most all-in-one mortgages require a FICO score of around 700 or higher, only benefiting borrowers with steady positive cash flow.
Example of an All-in-One Mortgage
Dan needs a $400,000 mortgage at 6%. He has a net monthly income of $7,000. If he does a conventional 30-year fixed loan, his monthly payment will be $2,398. After all expenses, such as day-to-day living, the mortgage, etc., he will be able to save $1,000 per month. But if he uses an all-in-one, or "offset," mortgage, the $1,000 per month he saves will be used to reduce the mortgage balance for interest payment calculations as well.
Assuming that the rate on the accelerated loan stays constant at 6%, it is possible for Dan to pay off his loan in just under 15 years and still have the $1,000 he saved each month as well. It would not actually go into the mortgage. The lender would merely borrow it while the loan was being paid off to reduce the principal balance. Perhaps most importantly, this type of mortgage can motivate borrowers to reduce their spending, because they can see their funds being used to pay down their loans.
All-in-One Mortgage Fees and Rates
Most offset and all-in-one mortgage lenders charge a $50 to $100 annual fee on top of other standard loan expenses, and higher rates usually apply for accelerated mortgages. Most accelerated loans are 30-year adjustable-rate vehicles that are tied to the LIBOR index. The adjustable-rate for this type of loan could be 1% higher than conventional loans unless the borrower opts to pay additional points upfront instead. But at the heart of the matter is the question of what is more important: rates and fees or the total amount of interest paid over the life of the loan?
Obviously, a key issue to consider here is the lifespan of the loan. A slightly higher interest rate could be worthwhile if the loan is paid off several years sooner than a lower-rate loan. Remember that the time for repayment for an accelerated loan is not fixed. Therefore, the borrower's projected surplus cash flow must be taken into account when making this comparison.
All-in-One Mortgage Suitability
One of the main caveats of this type of loan is that most lenders who offer accelerated mortgages require borrowers to have FICO scores of at least 680 to 700 in order to qualify. This is because this type of mortgage will only benefit a borrower who has a consistent positive cash flow, with surplus funds available to reduce the principal of the loan on a regular basis.
The Bottom Line
Although the benefits of this type of loan can be substantial, suitability is still a key concern, just as with any other loan product. Financially undisciplined borrowers may want to steer clear of taking one of these loans. Possessing too much available credit through the equity line aspect of the account could trigger spending sprees for some people, which will add to the debt's principal.
Another way to decrease mortgage-related debt is to secure a mortgage with a low-interest rate. It's important to shop around as different lenders may offer different interest rates on the same type of mortgage and in the long-run securing a mortgage with a lower interest rate could save you thousands of dollars.
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23bd3165798e7ee7014601e8cf39295f | https://www.investopedia.com/articles/mortgages-real-estate/08/real-estate-attorney.asp | Do You Need a Lawyer to Buy a House? | Do You Need a Lawyer to Buy a House?
"Why do I need a lawyer?" many a do-it-yourself-oriented homebuyer often asks. "Can't real estate agents see me through?" Well, they can in most states. That doesn't necessarily mean that they should. Although using an attorney can cost thousands of dollars, it is often money well spent. Read on to find out how a real estate lawyer will help you close the deal and avoid the pitfalls.
Key Takeaways It's often worth it to spend money on a real estate attorney, but it is not legally required in most states.Attorneys make sure all paperwork is properly drawn up and filed with the authorities.Attorneys do title searches and can negotiate should a search uncover a problem.Ideally, buyers and sellers in a real estate deal should be represented by lawyers to safeguard their rights and watch their interests.While lawyers can help if you face discrimination when buying a home, there are also less expensive options.
Contracts
Most individuals can negotiate face-to-face with another party. However, the terms of the deal must be properly recorded in a contract for them to be legally binding. Attorneys can negotiate on your behalf and also make sure that the contract adheres to all state laws. Furthermore, they can address any specific issues that might affect the future use of the property.
In many states, the buyer and the seller have three days to review a real estate contract before it becomes legally binding. Some buyers and sellers aren't aware of this. A lawyer will make the client aware of it, review the contract for legal glitches, make necessary changes, and insert useful contingencies.
Title Searches
Another vital service that attorneys perform is called a title search. Its purpose is to ensure that the property is free of any encumbrances, such as liens or judgments. The title search is essential because it reveals whether the seller has the legal right to sell the property. Although anyone can do a title search, an attorney will be able to do it faster and better. If they don't do it themselves, they'll often have working relationships with title search companies specializing in this service.
If the search uncovers something problematic, your attorney can counsel you on how to proceed. Suppose a title search reveals that the sellers must pay a lien or outstanding court judgment before selling their home. A lawyer might negotiate a price reduction on the property to compensate you for the delay. The lawyer may also provide the seller with suggestions or sources for financing so that they can satisfy claims.
Furthermore, attorneys can secure proof that judgments or liens have been resolved. That is important if you ever plan to obtain a mortgage or loan against the property.
Property Transfers
When one or more parties are corporations, trusts, or partnerships, the contract preparation and the ensuing negotiations are complicated. An attorney understands these different types of business arrangements and their legal boundaries within your state's law. The attorney will ensure that the contract is consistent with the law and the partnership's, trust's, or corporation's charter agreements.
Filings
Real estate deeds often need to be filed at the county and state levels. An attorney will be able to do this quickly and efficiently. In some cases, the transaction might involve property in an area where certain types of construction are not allowed. If that happens, an attorney will be able to navigate the maze of state regulations so that you can complete the transaction.
If the transaction revolves around commercial property, securing an attorney is even more critical. The attorney will be able to cut through government red tape to establish your corporation or sole proprietorship as a valid business entity for state tax purposes. An attorney can also secure your actual business license through the municipality.
Failing to file the appropriate documents at the state or the county level may result in dire consequences, such as:
If a deed is not transferred correctly, it could lead to income or estate taxes for buyers and sellers.If building permits are not filed on wetlands, certain structures may have to be rebuilt, or owners may incur fines.If it is a commercial transaction, and the business is not correctly registered at the state level, the business might be forced to close.
Sellers Need Attorneys Too
If you're selling a property, having an attorney represent your interests isn't a legal requirement in most states. However, not having one increases your chances of being sued by the opposing party for failure to disclose certain information. That is because an attorney must review the home inspection and disclose relevant facts about the property to the other party.
Suppose the other party is a corporation or a partnership, and the transaction is improperly completed. Then, they might sue you for not clearing the title to the property, failing to disclose certain defects, violating a corporate charter, or something else. While having a lawyer will not insulate you entirely from such litigation, obtaining legal counsel will certainly reduce your risk. An attorney will be much more likely to secure a clear title and make the appropriate disclosures.
Dealing With Discrimination
Lawyers can certainly help if you face discrimination during the home buying process. Even though most real estate lawyers do not specialize in that area, they will probably know an attorney who does. However, don't let anyone convince you that you need to have lots of money or a high-priced legal team to respond to discrimination. Laws exist to protect everyone, regardless of income.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
The Bottom Line
Having legal counsel makes good business sense because of the complexities that come with real estate transactions. Experienced real estate attorneys can help to protect your interests. They ensure that your transaction adheres to the applicable rules of your state and municipality. That way, the closing process can work to the satisfaction of all involved.
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31de8c25a2e1e7791bce4dc79e2f15f2 | https://www.investopedia.com/articles/mortgages-real-estate/08/real-estate-mistakes.asp | 8 Mistakes Real Estate Investors Should Avoid | 8 Mistakes Real Estate Investors Should Avoid
If you're just getting started in real estate investing, don't expect to become an expert overnight. Yes, it's true that you can make money buying and selling properties. However, it takes knowledge, determination, and skill. It also helps to know some of the classic mistakes that others make when they start investing in property to help you avoid making them too. Here is a look at eight of these pitfalls.
Key Takeaways People who are new to real estate investing tend to make a number of classic mistakes. It's important to start with a buying strategy so that you can align your purchases with your long-term goals. Be sure to do your due diligence on the neighborhood and on the specific property you intend to buy. Assemble a team of professionals, such as a real estate agent, an attorney, and a handyman, to help you succeed. Do a careful estimation of the costs such as mortgage payments, insurance, renovation, and upkeep to make sure you don't overbid and can afford the property you bid on.
Failing to Make a Plan
The last thing you want to do is buy a house and then decide afterward what you want to do with it. When there's a hot market, it can be hard to resist buying frenzy. But it's important that you do.
Before getting a mortgage or plunking down cash, you need to decide on an investment strategy. What type of house are you looking for, for example—one-family or multi-family, vacation destination or not? Figure out your purchase plan, then look for properties that fit that plan.
Skimping on Research
Before buying a car or a television set, most people compare different models, ask a lot of questions, and try to determine whether the purchase they are considering is worth the money. The due diligence that goes into purchasing a house should be even more rigorous.
There are also research considerations for each type of real estate investor—whether a personal homeowner, a future landlord, a flipper, or a land developer.
Not only does it make sense to ask a lot of questions about the property, but you should also inquire about the area (neighborhood) in which it is located. After all, what good is a nice home if just around the corner is a college frat house known for its all-night keg parties? Unless, of course, you're targeting student renters.
The following is a list of questions that would-be investors should ask regarding properties they are considering:
Is the property near a commercial site, or will long-term construction be occurring in the near future? Is the property located in a flood zone or in a problematic area, such as ones known for radon or termite problems? Does the house have a foundation or permit "issues" that will need to be addressed? What is new in the house and what must be replaced? Why is the homeowner selling? How much did the previous owners pay for the home and when? If you are moving into a new town, are there any problem areas in town?
Doing Everything on Your Own
Many buyers think that they know it all, or that they can close a real estate transaction on their own. While you might have completed a number of deals in the past that went well, the process may not go as smoothly in a down market—and there is no one you can turn to if you want to fix an unfavorable real estate deal.
Real estate investors should tap every possible resource and befriend experts who can help them make the right purchase. A list of potential experts should, at a minimum, include a savvy real estate agent, a competent home inspector, a handyman, a good attorney, and an insurance representative.
Such experts should be able to alert the investor to any flaws in the home or neighborhood. Or, in the case of an attorney, they may be able to warn you of any defects in the title or easements that could come back to haunt you down the line.
Forgetting That All Real Estate Is Local
You need to learn about the local market in order to make purchase decisions that are likely to help you turn a profit. That means drilling down on land values, home values, levels of inventory, supply and demand issues, and more. Developing a feel for these parameters will help you decide whether or not to buy a particular property that comes up for sale.
Overlooking Tenants' Needs
If you intend to purchase property that you'll rent, you need to keep in mind who your renters are likely to be—for example, singles, young families, or college students. Families will want low crime rates and good schools, while singles may be looking for mass transit access and nearby nightlife. If your planned purchase will be a vacation rental, how near is it to the beach or other local attractions? Try to match your investment to the kinds of tenants most likely to rent in that area.
Getting Poor Financing
Though the real estate bubble in North America ostensibly popped in 2007, there are still a large number of exotic mortgage options. The purpose of these mortgages is to allow buyers to get into certain homes that they might not otherwise have been able to afford using a more conventional, 30-year mortgage agreement.
Unfortunately, many buyers who secure adjustable or variable loans or interest-only loans eventually pay the price when interest rates rise. Don't let that be you. Make sure that you have the financial flexibility to make the payments (if rates go up) or a back-up plan to convert to a more conventional fixed-rate mortgage down the line.
Ideally, you'll start out with a fixed-rate mortgage or pay cash for your investment house so that you can avoid these problems.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
Overpaying
This issue is somewhat tied to the point about doing research. Searching for the right house can time-consuming and frustrating. When a prospective buyer finally finds a house that actually meets their needs and wants, they are naturally anxious to have the seller accept their bid.
The problem with being anxious is that anxious buyers tend to overbid on properties. Overbidding on a house can have a waterfall effect of problems. You may end up overextending yourself and taking on too much debt, creating higher payments than you can afford. As a result, it may take years to recoup your investment.
To find out whether your dream investment has a too-high price tag, start by searching what other similar homes in the area have sold for in recent months. A real estate broker should be able to provide this information with relative ease (particularly with their access to a multiple listing real estate agent database).
But as a fallback, simply look at the prices of comparable homes on real estate databases or even in the local newspaper. Logic dictates that unless the home has unique characteristics that are likely to enhance its value over time, you should try to keep your bids consistent with other home sales in the neighborhood.
There will always be other opportunities. Even if the negotiation process becomes bogged down or fails, the odds are in your favor that there's another house out there that will meet your needs. It's just a matter of being patient in the searching process.
Consider your return on investment in making improvements—it may be hard to recoup your money on a high-end bathroom renovation if the house still has a leaky roof.
Underestimating Expenses
Every homeowner can attest to the fact that there is way more to owning a house than just making the mortgage payment. It's no different, of course, for real estate investors. There are costs associated with yard upkeep and ensuring that appliances (such as the oven, washer, dryer, refrigerator, and furnace) are in working order, not to mention the cost of installing a new roof or making structural changes to the house. You also have to take into account insurance and property taxes.
The best advice is to make a list of all of the monthly costs associated with running and maintaining a house (based upon estimates) before actually making a bid on one. If you plan to have tenants, once those numbers are added up and you add in the monthly rent, you can calculate an ROI that will give you a better idea of whether the income will cover your mortgage and maintenance costs. This will tell you whether you can really afford the property.
Determining expenses prior to purchasing a property is also critical for house flippers. That's because their profits are directly tied to the amount of time it takes to purchase the home, improve it, and resell it.
In any case, investors should definitely form such a list. They should also pay particular attention to short-term financing costs, prepayment penalties, and any cancellation fees (for insurance or utilities) that might be borne when the home is flipped in short order.
The Bottom Line
The reality is that if investing in real estate was easy, everybody would be doing it. Fortunately, many of the struggles investors endure can be avoided with due diligence and proper planning before a contract is signed.
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ef17e6e9700bf25ba669583d48aa66c6 | https://www.investopedia.com/articles/mortgages-real-estate/08/real-estate-mutual-fund.asp | Add Some Real Estate to Your Portfolio | Add Some Real Estate to Your Portfolio
With real estate becoming a firm part of the capital asset allocation matrix for both institutional and retail investors, real estate funds have seen steady growth recently. Due to the capital-intensive nature of real estate investing, its requirement for active management, as well as the rise in global real estate opportunities, institutions seeking efficient asset management are gradually moving to specialized real estate funds of funds (FOF).
The same is now true for retail investors, who can benefit from access to a much larger selection of real estate mutual funds than before, allowing for efficient capital allocation and diversification.
Like any other investment sector, real estate has its pros and cons. It should, however, be considered for most investment portfolios, with real estate investment trusts (REITs) and real estate mutual funds seen as possibly the best methods of filling that allocation.
Key Takeaways Retail and institutional investors alike should consider real estate investment trusts (REITs) and real estate mutual funds for a diversified investment portfolio.REITs typically own and operate real estate properties such as residential units, shopping centers, malls, commercial office space, and hotels.Real estate mutual funds, which themselves invest primarily in REITs and real estate operating companies, can provide diversified exposure to real estate with a relatively small amount of capital.Many retail investors do not realize that they may already be investing in real estate directly by owning a home.
Barriers to Real Estate Investing
Real estate investment has long been dominated by large players such as pension funds, insurance companies, and other big financial institutions. Thanks to the globalization of real estate investing and the emergence of new offshore opportunities that allow for a greater degree of diversification as well as return potential, there is now a trend toward real estate having a permanent place in institutional portfolio allocations.
The permanent allocation of real estate capital comes with certain unique hurdles. First and foremost, it is highly capital intensive. Unlike stocks that can be purchased in small increments, commercial real estate investments typically require substantial sums upfront, and direct investment often results in lumpy or illiquid portfolios and idiosyncratic risks based on location or property type.
Real estate also requires active management and maintenance, which is labor-intensive and costly. Compared to managing traditional investments, managing a real estate allocation requires significant resources and planning.
As a result of these issues, institutions tend to gravitate toward real estate funds and funds of funds. These same advantages can be achieved by retail investors through real estate investment trusts, or REITs. While individual REITs often own several properties, even greater diversification can now be achieved via REIT exchange traded funds (ETFs), and real estate mutual funds that each invest in several different REITs.
Nowadays, even retail investors can easily add real estate investments to their portfolios. Here are several ways for retail investors to access the return potential of real estate and obtain exposure to the asset class.
Direct Investment
This strategy relates to investors directly selecting specific properties and purchasing them as investments. Often, these will include income properties that generate rental income in addition to any increases in market value.
The great advantage of this strategy is control. Direct ownership of property allows for the development and execution of strategy, as well as direct influence over return. However, direct investment makes it very difficult to create a well-diversified real estate portfolio. It also involves becoming a landlord along with all the additional costs, risks, and management headaches that it can bring.
For most retail investors, the real estate allocation is not large enough to allow the purchase of enough properties for true diversification. It also increases exposure to the local property market, as well as property-type risks.
Home Ownership
Many retail investors who have not considered real estate allocations for their investment portfolios fail to realize that they may already be investing in real estate by owning a home. Not only do they already have real estate exposure, but most are also taking additional financial risks by having a home mortgage. For the most part, this exposure has been beneficial, helping many amass the capital required for retirement.
Real Estate Investment Trusts (REITs)
REIT shares represent private and public equity stock in companies that are structured as trusts that invest in real estate, mortgages, or other real estate collateralized investments. REITs typically own and operate real estate properties. These may include multifamily residential properties, grocery-anchored shopping centers, local retail properties and strip centers, malls, commercial office space, and hotels.
Real estate investment trusts are run by a board of directors that makes investment management decisions on behalf of the trust. REITs pay little or no federal income tax as long as they distribute 90% of taxable income as dividends to shareholders. Even though the tax advantage increases after-tax cash flows, the inability of REITs to retain cash can significantly hamper growth and long-term appreciation. Apart from the tax advantage, REITs provide many of the same advantages and disadvantages as equities.
REIT managers provide strategic vision and make the investment- and property-related decisions, thus addressing management-related issues for investors. The greatest disadvantages of REITs for retail investors are the difficulty of investing with limited capital and the significant amount of asset-specific knowledge and analysis required to select them and forecast their performance.
REIT investments have a much higher correlation to the overall stock market in comparison to real estate investments, which leads some to downplay their diversification characteristics. Volatility in the REIT market has also been higher than in direct real estate. This is due to the influence of macroeconomic forces on REIT values and the fact that REIT stocks are continuously valued, while direct real estate is influenced more by local property markets, and is valued using the appraisal method, which tends to smooth investment returns.
Investors who don't have the desire, knowledge, or capital to buy land or property on their own can participate in the income and long-term growth potential of real estate via real estate funds.
Real Estate Mutual Funds
Real estate mutual funds themselves invest primarily in REITs and real estate operating companies using professional portfolio managers and expert research. They provide the ability to gain diversified exposure to real estate using a relatively small amount of capital. Depending on their strategy and diversification goals, they provide investors with a much broader asset selection than can be achieved by buying REIT stocks alone, and they also provide the flexibility of easily moving from one fund to another.
Flexibility is also advantageous to the mutual fund investor because of the comparative ease in acquiring and disposing of assets on a systematic and regulated exchange, as opposed to direct investing, which is arduous and expensive. More speculative investors can tactically overweight certain property or regional exposure in order to maximize return.
Creating exposure to a broad base of mutual funds can also reduce transaction costs and commissions relative to buying individual REIT stocks. Another significant advantage for retail investors is the analytical and research information provided by the funds on acquired assets, as well as management's perspective on the viability and performance of real estate, both as specific investments and as an asset class.
Mutual funds, however, may be less liquid and carry higher management fees than REITs or REIT ETFs. Although real estate mutual funds bring liquidity to a traditionally illiquid asset class, naysayers believe they cannot compare to direct investment in real estate.
The Bottom Line
Although retail investors can and should take into account home ownership when making their portfolio allocations, they might also consider additional, more-liquid investments in real estate.
For those with the requisite trading skills and capital, REIT investing provides access to some of the benefits of real estate investing without the need for direct ownership. For others, who are considering a smaller allocation, or for those who don't want to be saddled with asset selection, but who require maximum diversification, real estate mutual funds would be an appropriate choice.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
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fe40e08c360df6861f9281dc30dabe47 | https://www.investopedia.com/articles/mortgages-real-estate/08/rental-property.asp | Sell Your Rental Property for a Profit | Sell Your Rental Property for a Profit
Unlike shares of stock, investment properties can't be unloaded in a few seconds with a click of your mouse. The time between the decision to sell and the actual date of sale is often measured in weeks or months. Selling your own home can be an intimidating process if you don't know where to start, but selling an investment property requires even more work.
The amount of capital and the taxation issues surrounding the realization of that capital are complex when dealing with investment real estate. It is not, however, impossible to accomplish on your own. In this article, we'll look at the process of selling an investment property and focus on how to limit taxes on the gains.
Why Sell?
The reasons for selling a rental property vary. Landlords who personally manage their properties may move and want to invest in something near their new residence. Or a landlord may want to cash in on the appreciation of a rental property rather than accumulating money through rent. It may even be a case of a property that is losing money, either through vacancy or not enough rent to cover the expenses. Regardless of the reason, real estate investors looking to sell will have to deal with taxes.
The Tax Man Cometh
The capital gains taxes on a rental property sale are much steeper compared to the straightforward sale of personal-use property. The basic capital gains that you have to pay on the profit from the sale are increased by any depreciation you claimed against the property. This means that if the property lost money and you used the loss against your tax bill in previous years, you will have a larger tax bill when the sale goes through.
Example – Capital Gains Tax and Depreciation
Let's say you have a rental property that you bought for $150,000 and it sells for $200,000. Usually, this means that you pay capital gains on $50,000. If you deducted $20,000 in depreciation over the time that you owned the property, however, you owe the difference between the sale price and your purchase price minus depreciation: $200,000 – ($150,000 – $20,000). Instead of owing capital gains on $50,000, you now owe capital gains on $70,000.Note: This shouldn't discourage you from claiming depreciation losses. It is almost always better to realize tax breaks sooner rather than later.
Rolling Over
The Internal Revenue Code Section 1031 allows real estate investors to avoid taxes on their gains by re-investing them in like-kind property. With the help of a lawyer or a tax advisor, you can set up the sale so that the proceeds are put into an escrow account until you are ready to use them to buy a new property. There is a time limit of 45 days to choose the new property and six months to complete the transaction. If you intend to do a rollover, you should start looking for the new property before you sell the old one.
The 1031 exchange works great if you intend to reinvest in another property. If you merely want to stop being directly involved, you can either hire a professional property manager for your current place or sell it and buy a professionally-managed property. If your goal is purely to raise capital, however, you will just have to eat the capital gains tax.
Incorporating as a Shield
Incorporation is becoming increasingly popular for real estate investors. By incorporating, investors can lessen their liability making the corporation act as a shield between you and the potential that a tenant may sue you. Your house and personal finances cannot be claimed in any kind of court action or legal proceedings when you incorporate. Corporations also have different tax rules that are quite favorable, especially with the capital gains from selling a property.
For a certain type of real estate investor, incorporation makes sense. If you are employing people to find and manage a wide range of income-producing properties and making significant profits at it, incorporation will lessen your tax bill, and then you will see the profits through the share structure of your corporation. For most real estate investors, there are better ways to get the benefits of incorporation without complicating how income is realized.
Incorporation can create a barrier between you and the earnings from your property so that if you depend on that income in any way, you may not be able to access it as easily as you'd like – particularly with large profits such as those from selling a property. It is comparatively easy to incorporate, requiring only some professional advice and paperwork, but getting your properties out of a corporation (for example, to sell them off and retire) is more complex because you are walking the line of intentional tax evasion/fraud unless you sell the corporation instead of the properties that make it up. This is, of course, much harder than selling a house.
In contrast, if you are personally managing two or three properties and have even one or two more that are professionally managed, you may not benefit from incorporation. If the income from your rentals isn't outpacing your expenses for each property by a large margin, you are better to hold them as is and use depreciation and write-downs where you can or change your real estate holdings into a small business.
In addition to using small business as an alternative to incorporation, some states allow real estate investors to open a separate limited liability company for each property they own. While this doesn't necessarily lessen the taxes, it does protect your finances, as well as each property, from any litigation that may be carried against one of your properties.
The Bottom Line
Selling a rental property can be challenging, and it is even harder if you are hoping to avoid a large tax bill on the proceeds. If you are selling to invest in a different property, then you can simply do a 1031 rollover and put off the tax bill. If you are selling because you need the capital, you will have to pay some taxes.
The best-case scenario, as with stocks, is to put off selling an investment property, especially a rental that is breaking even or better, unless you are offsetting credits or losses to take some of the bite out of the capital gains tax. This way, you will have a chance of reducing your overall tax bill and pocketing more of the proceeds.
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1ad741200b1b64717c8ca96f057ef14c | https://www.investopedia.com/articles/mortgages-real-estate/08/self-employed-mortgage.asp | How to Get a Mortgage When Self Employed | How to Get a Mortgage When Self Employed
While getting a mortgage as a W-2 employee may be easier than if you're self-employed, you don't have to go running back to your cubicle to qualify for one. Some lenders may be concerned that you won't earn a steady enough income to make your monthly payments, and others may simply not want to deal with the additional paperwork that can be involved in providing a mortgage to a self-employed person.
But don't worry—if you're self-employed, there are steps you can take to make yourself a more attractive loan candidate.
Key Takeaways Self-employed borrowers can improve their prospects by increasing their credit score, offering a larger down payment, or paying down debt, among others. Problems that self-employed individuals run into when trying to get a loan is that they use business expenses to reduce taxable income. Conventional loans, FHA loans, and bank statement loans are among the mortgage options for the self-employed. It's also possible to take out a joint mortgage or enlist a cosigner.
Disadvantages of Getting a Mortgage While Self-Employed
Lenders don't always see the self-employed as ideal borrowers. Borrowers who are employees can be considered to be particularly creditworthy because of their steady, easily verifiable incomes, especially if they also have excellent credit scores. Self-employed borrowers will have to provide more paperwork to document income when compared to traditional employees who can produce a W-2.
Another problem self-employed borrowers encounter is that they tend to use a lot of business expenses to reduce taxable income on tax returns, forcing lenders to wonder if the borrower makes enough money to afford a home. Finally, banks may want to see a lower loan-to-value (LTV) ratio, meaning the borrower will need to come up with a larger down payment.
Due to the economic fallout caused by the COVID-19 pandemic, many lenders are requiring higher credit scores, larger down payments and more documentation to approve mortgages and other loans. This applies to all borrowers, not just the self-employed, and requirements vary depending on thelender.
Become an Attractive Candidate
Borrowers who know they can make the payments can do some or all of the following to improve their chances of getting a loan:
Establish a self-employment track record
If you can show that you know how to play the self-employment game and win, lenders will be more willing to take a chance on you. You should have at least two years of self-employment history. The longer the better as this shows that your income is stable.
Max out the credit score
In any type of borrowing situation, a higher credit score will make a borrower a more attractive candidate to get the loan in the first place and qualify for lower interest rates.
Offer a large down payment
The higher the equity in the home, the less likely a borrower is to walk away from it during times of financial strain. A bank will see the borrower as less of a risk if they put a lot of cash into the purchase up front.
Have significant cash reserves
In addition to a large down payment, having plenty of money in an emergency fund shows lenders that even if the business takes a nosedive, the borrower will be able to keep making monthly payments.
Pay off all consumer debt
The fewer monthly debt payments you have going into the mortgage process, the easier it will be for you to make your mortgage payments. If you pay off your credit cards and car loans, you may even qualify for a higher loan amount because you'll have more cash flow.
Provide documentation
Being willing and ready to fully document your income through previous years' tax returns, profit and loss statements, balance sheets and the like will increase your chances of qualifying for a loan. Your lender may also ask for some or all of the following:
List of debts and monthly payments Bank statements List of assets (savings accounts, investment accounts, etc.) Additional sources of income (alimony, Social Security, etc.) Proof of your business or employment (business license, lettersfrom clients, statement from your accountant, etc.)
Self-employed borrowers fill out the same loan application as everyone else.
Self-Employed Mortgage Options
If you are self-employed and don't qualify for a conventional mortgage, some lenders still offer loans that might be a fit. Conventional mortgages are not guaranteed by the federal government, so they typically have stricter lending requirements. Here are some other options:
FHA loan
A Federal Housing Administration (FHA) loan is a mortgage that is insured by the Federal Housing Administration (FHA) and issued by an FHA-approved lender. FHA loans are designed for low-to-moderate-income borrowers. They require a lower minimum down payment—as low as 3.5%—and lower credit scores than many conventional loans.
Because FHA loans are federally insured—which means that lenders are protected in the event that a borrower defaults on their mortgage—these lenders can offer more favorable terms to borrowers who might not otherwise qualify for a home loan, including lower interest rates. This means it's also easier to qualify for an FHA loan than for a conventional loan.
Bank statement loan
Bank statement loans, also known as alternative document loans, allow borrowers to apply for a loan without submitting the traditional documents that prove income, such as tax returns and W-2s. Instead, lenders look at 12 to 24 months of your bank statements to determine yourbusiness income. This type of loan may make sense if you don't have income tax returns or others ways to verify your income.
The interest rates on bank statement loans tend to be higher, as the lender is taking on more risk.
Joint mortgage
Getting a joint mortgage with a co-borrower who is a W-2 employee, such as a significant other, spouse, or trusted friend, is another way to improve your prospects of getting approved for a mortgage if you are self-employed. This provides more assurance to your lender that there is a steady income to pay back the debt.
Enlist a co-signer
Finally, a parent or other relative might be willing to cosign your mortgage loan. Keep in mind that this person will need to be willing and able to assume full responsibility for the loan if you default.
The Bottom Line
If a W-2 employee loses a job, their income will drop to zero in the blink of an eye in the absence of unemployment insurance benefits. Those who are self-employed often have multiple clients and are unlikely to lose all of them at once, giving them more job security than is commonly perceived.
Of course, self-employed individuals are already used to having to work extra hard to file additional tax forms, secure business licenses, get new clients, and keep the business running. Armed with a little knowledge and patience, they can also find ways to qualify for a mortgage.
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c569ea0b62c931843aded7fd78b0e193 | https://www.investopedia.com/articles/mortgages-real-estate/08/sell-down-market.asp | 6 Tips to Sell Your Home Fast | 6 Tips to Sell Your Home Fast
If you're ready to sell your home, you may have reason to want to sell it fast—such as a new job that starts soon in a different city. How do you generate interest in your house? After all, the more potential buyers you can attract, the better your chances of selling at a good price. Whatever your reasons for selling, here are six ways to sell a house quickly, even in a slow market.
Key Takeaways To sell your home quickly, price it competitively. And be ready to lower the price if you don't have any offers by a certain date. Clean the whole house, remove clutter, and hide personal items so buyers can picture themselves in the space. Boost the curb appeal to make the right first impression. Clear away the cobwebs, paint the front door, and plant flowers. Offer terms that might sweeten the deal for buyers—such as paying part of the closing costs.
1. Find the Right Real Estate Agent
If you want to sell your home fast, the first step is to hire a real estate agent. The ideal person will know the local market and have a sales record that proves they know how to sell.
Keep in mind that a real estate agent will help with the entire process, from hiring a professional photographer who will take top-notch photos of your home to negotiating for the best price. They will also write up a real estate listing that sells, schedule and host showings, and market your property to get it seen.
2. Price It to Sell
One of the most effective ways to sell your home fast is to price it competitively. If you price it too high, your home will spend more time on the market. Also, if your home is overpriced, you may end up selling it for less eventually—it will just take a lot longer.
Your real estate agent will research comparable homes (aka "comps") in your area to set a realistic price. If you really need to sell fast, consider pricing your home a little lower to attract interest (and maybe even spark a bidding war). If you haven't received any offers by a certain date, knock the price down.
It's also helpful to think about the price points that buyers search for in your area. If you list your home for $302,000, for example, you'll miss all the potential buyers who are looking for homes under $300,000. It's probably not worth asking for the extra $2,000 if it means fewer buyers will see the home.
3. Clean, Declutter, and Depersonalize
Buyers need to be able to picture themselves in the space, and they won't be able to if your house is a mess. Give your home a thorough cleaning from top to bottom, get rid of clutter, and hide the family photos and other personal items.
While you're at it, rearrange the furniture so your home looks inviting and so buyers can move through your home without bumping into anything. If necessary, put bulky items in storage. A crowded room looks like a small room.
Consider hiring a stager to help you showcase your home's best assets, impress potential buyers, and sell it quickly for the best possible price. Staging isn't cheap, but the National Association of Realtors (NAR) estimates that, on average, staged homes sell 88% faster and for 20% more than non-staged homes.
4. Boost Your Curb Appeal
If you want to sell quickly, it's essential to make a good first impression. And the first thing a buyer sees is a home's exterior and how it fits into the surrounding neighborhood. To boost your home's curb appeal:
Paint the front door Plant flowers Sweep away any spiderwebs and debris from windows, eaves, and porches Wash the windows Fix broken light fixtures and mailboxes Make sure the trees, shrubs, and lawn are nicely manicured
Keep in mind that a tidy exterior not only looks nice, it also signals to potential buyers that you've taken good care of the place.
5. Take Care of Quick Repairs
You won't have time for any major renovations, so focus on quick repairs to address things that could deter potential buyers. Survey the house and take care of the easy fixes:
Fix loose tiles Tighten leaky faucets Touch up paint Tighten door knobs and handles Remove carpet stains
Depending on how much time and money you want to spend getting the home ready, you might also want to update fixtures, buy new appliances, install new hardware on the cabinets, and give the interior a fresh coat of (neutral) paint.
6. Sweeten the Deal
Another way to make the home and deal more attractive is to offer something to sweeten the pot. You could offer, for example, to pay some or all of the closing costs. Particularly in a down market, buyers are looking for a deal, so do your best to make them feel they get one.
Another tip is to offer a transferable home warranty, which provides discounted repair and replacement services for household appliances and systems. A potential buyer may feel more at ease knowing the home is protected, which could make your home more attractive than a competing home.
The Bottom Line
Selling a home can be stressful, and even more so if you're on a tight deadline. Fortunately, whether you need to sell fast because of a new job, a life event (e.g., a divorce), or financial reasons, there are ways to speed up the process.
If you don't have a big budget to get your home sell-ready, focus on that first impression. Buyers can make a decision within seconds—a few from the curb and a few when they step inside the front door. Make those seconds count with a tidy yard, a sparkling home, and, if you can swing it, a fresh coat of paint.
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99cf2c72245eb45ff5d19f644bb754f8 | https://www.investopedia.com/articles/mortgages-real-estate/08/tax-deductible-mortgage-canada.asp | Creating a Tax-Deductible Canadian Mortgage | Creating a Tax-Deductible Canadian Mortgage
The tax law for Canada's homeowners is very different from the system in the U.S. Notably, the interest on a mortgage for a principal private residence is not tax deductible. However, all capital gains upon selling the home are tax exempt.
But there is a way Canadians can effectively deduct that mortgage interest.
The Financial Goal
First, a couple of basic definitions:
Your net worth is your assets minus any liabilities. To increase your net worth, you must either increase your assets or decrease your liabilities, or both. Your free cash flow is the amount of cash that is left over after all expenses and debt payments have been made. To increase your cash flow, you must spend less, get a better paying job, or pay less tax.
Let's take a look at a strategy to help you increase your assets by building an investment portfolio, decrease your debts by paying off your mortgage faster, and increase your cash flow by paying less tax. Effectively, you would be increasing your net worth and cash flow simultaneously.
The Strategy
Every time you make a mortgage payment, a portion of the payment is applied to interest and the rest is applied to the principal. That principal payment increases your equity in the home and can be borrowed against, usually at a lower rate than for an unsecured loan.
If the borrowed money is then used to purchase an income-producing investment, the interest on the loan is tax-deductible, which makes the effective interest rate on the loan even better.
This strategy calls for the homeowner to borrow back the principal portion of every mortgage payment, and invest it in an income-producing portfolio. Under the Canadian tax code, interest paid on monies borrowed to earn an income is tax deductible.
As time progresses, your total debt remains the same, as the principal payment is borrowed back each time a payment is made. But a larger portion of it becomes tax-deductible debt. In other words, it's "good" debt. And, less remains of non-deductible debt, or "bad" debt.
To explain this better, refer to the example below, where you can see that the mortgage payment of $1,106 per month consists of $612 in principal and $494 in interest.
Image by Julie Bang © Investopedia 2019
As you can see, each payment reduces the amount owed on the loan by $612. After every payment, the $612 is borrowed back and invested. This keeps the total debt level at $100,000, but the portion of the loan that is tax deductible grows by each payment. You can see in the above figure that after one month of implementing this strategy, $99,388 is still non-deductible debt, but $612 is now tax-deductible.
This strategy can be taken a step further: The tax-deductible portion of the interest paid creates an annual tax refund, which could then be used to pay down the mortgage even more. This mortgage payment would be 100% principal (because it is an additional payment) and could be borrowed back in entirety and invested in the same income-producing portfolio.
The steps in the strategy are repeated monthly and yearly until your mortgage is completely tax deductible. As you can see from the previous figure and the next figure, the mortgage remains constant at $100,000, but the tax-deductible portion increases each month. The investment portfolio, on the side, is growing also, by the monthly contribution and the income and capital gains that it is producing.
Image by Julie Bang © Investopedia 2019
As seen above, a fully tax-deductible mortgage would occur once the last bit of principal is borrowed back and invested. The debt owed is still $100,000; however, 100% of this is tax deductible now. At this point, the tax refunds that are received could be invested as well, to help increase the rate at which the investment portfolio grows.
The Benefits
The goals of this strategy are to increase cash flow and assets while decreasing liabilities. This creates a higher net worth for the individual implementing the strategy. It also aims to help you become mortgage-free faster and to start building an investment portfolio faster than you could have otherwise.
Let's look at these a bit closer:
Become mortgage-free faster. The point at which you are technically mortgage-free is when your investment portfolio reaches the value of your outstanding debt. This should be faster than with a traditional mortgage because the investment portfolio should be growing as you make mortgage payments. The mortgage payments made using the proceeds of the tax deductions can pay down the mortgage even faster. Build an investment portfolio while paying your house down. This is a great way to start saving. It also helps free up cash that you might otherwise not have been able to invest before paying off your mortgage.
A Case Study
Here's a comparison of the financial impact on two Canadian couples, one paying a mortgage off in the traditional way and another using the tax-deductible strategy.
Couple A bought a $200,000 home with a $100,000 mortgage amortized over 10 years at 6%, with a monthly payment of $1,106. After the mortgage is paid off, they invest the $1,106 that they were paying for the next five years, earning 8% annually.After 15 years, they own their own home and have a portfolio worth $81,156.
Couple B bought an identically-priced home with the same mortgage terms. Every month, they borrow back the principal and invest it. They also use the annual tax return that they receive from the tax-deductible portion of their interest to pay off the mortgage principal. They then borrow that principal amount back and invest it. After 9.42 years, the mortgage will be 100% good debt and will start to produce an annual tax refund of $2,340 assuming a marginal tax rate (MTR) of 39%. After 15 years, they own their own home and have a portfolio worth $138,941. That's a 71% increase.
A Word of Caution
This strategy is not for everyone. Borrowing against your home can be psychologically difficult. Worse, if the investments don't yield expected returns this strategy could yield negative results.
By re-borrowing the equity in your home, you are removing your cushion of safety if the real estate or investment markets, or both, take a turn for the worse.
By creating an income-producing portfolio in an unregistered account, you may also face additional tax consequences.
You should consult with a professional financial advisor to determine whether this strategy is for you. If it is, have the professional help you tailor it to you and to your family's personal financial situation.
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af8d2cebf13bce4c0bae549aa9d95e71 | https://www.investopedia.com/articles/mortgages-real-estate/09/federal-housing-authority.asp | Insuring Federal Housing Administration Mortgages | Insuring Federal Housing Administration Mortgages
If you lend money to someone with a less-than-perfect borrowing track record, you'd want a guarantee that you'd get repaid. That is the underlying principle behind mortgage insurance. Although mortgage insurance protects lenders from loss, you may consider it a nuisance. After all, it is another cost you have to shoulder to realize your dream of becoming a homeowner. But if it didn't exist, lots of people probably wouldn't qualify for loans at all until they had higher down payments.
Many people find paying mortgage insurance premiums a better option than waiting several years until they have a high enough down payment to avoid it. While there are many different kinds of mortgage insurance, this article looks at the basics of Federal Housing Administration (FHA) mortgage insurance.
Key Takeaways FHA mortgage insurance protects lenders from losses that result from default.Borrowers with an FHA loan must purchase FHA mortgage insurance.Those getting a mortgage must pay an upfront mortgage insurance premium of 1.75% plus annual premiums, both of which are based on the loan's value.The length of time you must pay for FHA mortgage insurance depends on your amortization period and your loan-to-value ratio.
FHA Mortgage Insurance: An Overview
Federal Housing Administration loans (FHA loans) are attractive to many consumers, especially first-time homebuyers. That's because they have lower down payment requirements—as low as 3.5%—as well as lower thresholds for income and credit. That means someone with a credit score as low as 580 may qualify.
All FHA loans require borrowers to take out mortgage insurance, especially when they put down less than 20%. FHA mortgage insurance protects the lender because borrowers—particularly new ones—pose a higher risk of default when they have minimal equity in their homes. In essence, you don't have that much to lose by walking away and letting the bank foreclose on the property.
The Federal Housing Administration (FHA) requires two types of mortgage insurance on FHA loans. Borrowers must pay upfront mortgage insurance (UFMI)—1.75% of the loan balance—along with annual mortgage insurance premiums (MIPs) based on the total value of the loan. Annual MIPs range from 0.8% to 0.85% for base loan amounts of $625,500 or less. For those exceeding this amount, the annual MIPs vary between 1% and 1.05%. These rates apply to loan terms of more than 15 years. Mortgages that are financed for 15 years or less come with rates of 0.45% to 0.95%.
To demonstrate, here's how much you'd pay in FHA mortgage insurance with a $300,000 loan:
Mortgage amount: $300,000Down Payment: $10,500 (3.5% of $300,000)Loan Amount: $289,500UFMI: $5,066.25Annual MIP: $2,460.75 each year or $205.06 per month
Keep in mind that this scenario assumes you pay the UFMI right off the bat. But you do have the option to roll the amount into your total mortgage amount. It's a good idea to pay it in full at the beginning if you can afford to do so. But if you decide to include it in your loan, you'll pay more in the long run. Not only does it increase your loan amount, but it also increases your annual mortgage insurance premium payment.
FHA Mortgage Insurance Terms
According to the U.S. Department of Housing and Urban Development (HUD) website, the length of time FHA mortgage insurance premiums must be paid vary based on the amount and length of the mortgage. A loan-to-value ratio (LTV ratio) equal to or less than 90% requires mortgage insurance for 11 years.
When you first start paying your mortgage, you're at a higher risk of default, so your premiums will be higher. That's because, as mentioned above, you don't have much equity built into your home. So you only lose the $10,500 down payment if you default in the first year on that $300,000 home. Your premium payments decrease the longer you pay your mortgage. You'll be less likely to want to leave your house and default on your loan later on.
Avoiding or Getting Rid of FHA Mortgage Insurance
Because FHA mortgage insurance adds a significant expense to the cost of homeownership, you're probably wondering if there's anything you can do to reduce or avoid it, and at what point are you allowed to get rid of it.
The easiest way to avoid mortgage insurance is to put down 20%. You can do this by waiting to buy until you've saved more, or in some cases, by purchasing a less-expensive property. Of course, if you're looking at an FHA loan with 3.5% down, you're probably walking a fine line between being able to afford any mortgage at all and having to keep renting.
If home prices significantly appreciate after you buy, you may be able to refinance your way out of PMI. For this to work, your home's value will need to appreciate enough to give you 22% equity in the house. If you can't refinance to increase your LTV ratio, consider paying down your principal balance. Not only will this help you get rid of mortgage insurance more quickly, but it will also help you pay your house off faster. That reduces the amount of interest you'll pay over the long run. If you take this route, you will need to contact your lender to get your mortgage insurance canceled.
Some lenders may offer special loan programs that don't require monthly mortgage insurance premium payments, despite allowing a small down payment. That makes it vital to shop around.
Your lender is supposed to automatically drop mortgage insurance when you hit the appropriate loan-to-value ratio.
FHA vs. Private Mortgage Insurance (PMI)
There is an alternative to FHA mortgage insurance—private mortgage insurance (PMI). You may be required to buy PMI as a condition if you have a conventional mortgage. As suggested by the name, it is provided by a private insurance company and is arranged by the lender. Just like FHA mortgage insurance, PMI protects the lender, not the borrower.
You must purchase PMI if your down payment is less than 20% of the total loan. Many lenders also require PMI when you refinance your mortgage with a conventional loan and the equity is less than 20% of the property value. But there's a big difference between FHA mortgage insurance and PMI—not all lenders require an upfront mortgage insurance payment.
PMI can cost anywhere between 0.5% to 1% of the total loan value annually. So a mortgage of $200,000 will cost you as much as $2,000 more each year at the maximum rate of 1%. Of course, your rate depends on your credit score—the better your credit, the lower the rate. If your credit score is lower, you will need a larger down payment before you're offered any type of insurance.
FHA mortgage insurance only requires a minimum credit score of 580 to be eligible for a 3.5% down payment. However, most private lenders require a credit score of 620 to 640, which still allows you to buy a home sooner. So if you have to have mortgage insurance, FHA mortgage insurance can be the lesser of two evils.
Furthermore, there has been some debate over the impact of redlining and other forms of discrimination in the private mortgage insurance industry. Although many private mortgage insurers do not discriminate, be aware that it can happen and report it promptly.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report with the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).
The Bottom Line
When considering a loan with a small down payment, think about whether the upfront mortgage insurance and the monthly mortgage insurance premiums are worth it to you to get a house sooner. It's hard to calculate because you can't predict what housing prices will be when you have more money for a down payment later. It may be best to decide on a psychological basis whether you are comfortable with paying the extra money required for mortgage insurance.
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c4d2f5eeae0fc94d5216ddc1997518ae | https://www.investopedia.com/articles/mortgages-real-estate/09/new-homeowner-tips.asp | 7 Smart Steps Every New Homeowner Should Take | 7 Smart Steps Every New Homeowner Should Take
Few things are more exciting than leaping from being a renter to being a first-time homeowner. Getting swept up in all the excitement is a wonderful feeling, but some first-time homeowners lose their heads and make mistakes that can jeopardize everything they've worked so hard to earn. Following a series of practical steps early in the homeowning experience can save new owners time, money, and effort later down the road.
Key Takeaways Following a plan for affording your first home can save you time, money, and effort down the road.A home inspection is a critical part of buying your first house.The price of a new house isn't just the home itself. When you buy a home, you will have to pay closing costs, moving expenses, and fees.Owning a home comes with a host of expenses you may not have paid for as a renter. Your taxes will change when you purchase your first home. It is essential to learn the tax laws for homeowners or, better yet, hire an accountant who does.
Don't Overspend to Personalize
You've just handed over a large portion of your life savings for a down payment, closing costs, and moving expenses. Money is tight for most first-time homeowners. Not only are their savings depleted, but their monthly expenses are also often higher as well, thanks to the new costs that come with homeownership, such as water and trash bills and extra insurance.
Everyone wants to personalize a new home and upgrade what may have been temporary apartment furniture for something nicer, but don't go on a massive spending spree to improve everything all at once. Just as crucial as getting your first home is staying in it, and as nice as solid maple kitchen cabinets might be, they aren't worth jeopardizing your new status as a homeowner.
Give yourself time to adjust to homeownership's expenses and rebuild your savings—the cabinets will still be waiting for you when you can more comfortably afford them.
Don't Ignore Important Maintenance
One of the new expenses that accompany homeownership is making repairs. There's no landlord to call if your roof is leaking or your toilet is clogged. To look at the positive side, there's also no rent increase notice taped to your door on a random Friday afternoon.
While you should exercise restraint in purchasing the nonessentials, you shouldn't neglect any problem that puts you in danger or could worsen over time. Delay can turn a relatively small problem into a much larger and costlier one. One way to protect yourself against potential maintenance issues is to have a potential home inspected before buying it.
Hire Qualified Contractors
Don't try to save money by making improvements and repairs you aren't qualified to make. This may seem to contradict the first point slightly, but it doesn't. Your home is both the place where you live and an investment. It deserves the same level of care and attention you would give to anything else you value highly.
There's nothing wrong with painting the walls yourself, but if there's no wiring for an electric opener in your garage, don't cut a hole in the wall and start playing with copper wiring. Hiring professionals to do work you don't know how to do is the best way to keep your home in top condition and avoid injuring—or even killing—yourself. Also, be sure to check with the local building authority and pull any necessary permits to complete the work.
Get Help With Your Tax Return
Even if you hate the thought of spending money on an accountant when you usually do your tax returns yourself, it can pay off. And even if you are feeling broke from buying that house, don't scrimp on tax preparation. Hiring an accountant to ensure you complete your return correctly and maximize your refund is a good idea. Homeownership significantly changes most people's tax situations and the deductions they are eligible to claim.
Just getting your taxes done by a professional for one year can give you a template to use in future years if you want to continue doing your taxes yourself.
Keep Receipts for Improvements
When you sell your home, you can use these costs to increase your home's basis, which can help you maximize your tax-free earnings on your home's sale. In 2008, you could have earned up to $250,000 tax-free from the sale of your home if it was your primary residence and you had lived there for at least two of five years before you sold it.
This deduction assumes that you owned the home alone—if you owned it jointly with a spouse, you could each have gotten the $250,000 exemption.
Let's say you purchased your home for $150,000 and were able to sell it for $450,000. You've also made $20,000 in home improvements over the years you've lived in the home. If you haven't saved your receipts, your basis in the house, or the amount you originally paid for your investment, it is $150,000. You take your $250,000 exemption on the proceeds and are left with $50,000 of taxable income on the sale of your home.
However, if you saved all $20,000 of your receipts, your basis would be $170,000, and you would only pay taxes on $30,000. That's a considerable saving. In this case, it would be $5,000 if your marginal tax rate is 25%.
Repairs vs. Improvements
Unfortunately, not all home expenses are treated equally to determine your home's basis. The IRS considers repairs to be part and parcel of homeownership, which preserves the home's original value but does not enhance its value.
This may not always seem true. For example, if you bought a foreclosure and had to fix a lot of broken stuff, the home is worth more after you fix those items, but the IRS doesn't care—you did get a discount on the purchase price because of those unmade repairs, after all. It's only improvements, like replacing the roof or adding central air conditioning, which will help decrease your future tax bill when you sell your home.
For gray areas (like remodeling your bathroom because you had to bust open the wall to repair some old, failed plumbing), consult IRS Publication 530 or your accountant. And on a non-tax-related note, don't trick yourself into thinking it's OK to spend money on something because it's a necessary "repair" when in truth, it's a fun improvement. That isn't good for your finances.
Get Properly Insured
Your mortgage lender requires you not only to purchase homeowners insurance but also to purchase enough to fully replace the property in the event of a total loss. But that's not the only insurance coverage you need as a homeowner.
If you share your home with anyone who relies on your income to pay the mortgage, you'll need life insurance with that person named as a beneficiary so that they won't lose the house if you die unexpectedly.
Similarly, you'll want to have disability-income insurance to replace your income if you become so disabled that you can't work.
Also, once you own a home, you have more to lose in the event of a lawsuit, so you'll want to make sure you have excellent car insurance coverage. If you are self-employed as a sole proprietor, you may want to consider forming a corporation, which will give you significant legal protection of your assets.
You may also want to purchase an umbrella policy that picks up where your other policies leave off. If you are found at fault in a car accident with a judgment of $1 million against you and your car insurance only covers the first $250,000, an umbrella policy can pick up the rest of the slack. These policies are usually issued in units of $1 million.
The Bottom Line
With the great freedom of owning your own home comes significant responsibilities. It would help if you managed your finances well enough to keep the house and maintain the home's condition well enough to protect your investment and keep your family safe. Don't let the excitement of being a new homeowner lead you to bad decisions or oversights that jeopardize your financial or physical security.
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474031cf17de2c2195a150955840e643 | https://www.investopedia.com/articles/mortgages-real-estate/09/owning-real-estate-canada.asp | Canada: A New Frontier For Real Estate Investors | Canada: A New Frontier For Real Estate Investors
Owning property in Canada can be profitable if you understand the Canadian tax laws that apply to real estate investments.
There is no residency or citizenship requirement for buying and owning property in Canada. You can occupy a Canadian residence on a temporary basis, but you will need to comply with immigration requirements if you wish to have an extended stay or become a permanent resident. Non-residents can also own rental property in Canada, but need to file annual tax returns with the Canada Revenue Agency (CRA).
Property Taxes
When you buy a property, you pay a provincial transfer tax that varies from province to province, but can be around 1% on the first $200,000 and 2% on the balance. Some exemptions apply if this is your first property purchase in Canada. Municipalities also levy annual property taxes, based on the assessed property value, which reflects the market value. School and other taxes are included in this municipal tax. Information on the current municipal tax on a specific property is generally readily available.
New home purchases are subject to the federal Goods and Services Tax (GST), but a partial rebate can be obtained for new or builder-renovated homes, if you plan to live in the home. The GST doesn't apply to resale homes.
Taxes on Rental Property
The Canadian Income Tax Act requires that 25% of the gross property rental income is remitted each year. However, non-residents can elect to pay 25% of the net rental income (after expenses) by completing an NR6 form. If the rental property incurs net losses, then you may reclaim previously paid taxes. Your income will be treated differently depending on whether you're a co-owner or a partner and whether it's considered rental or business income.
You can deduct two types of incurred expenses to earn rental income: current operating expenses and capital expenses. The latter provides longer-term benefit. The cost of furniture or equipment for a rental property cannot be deducted against your rental income for that year. However, the cost can be deducted over a period of years, as these items depreciate in value. The deduction is called the capital cost allowance (CCA).
Property taxes and mortgage, bank loan or line of credit interest are tax deductible in Canada if the property is an investment property. To learn more about using your mortgage for investment purposes, be sure to read Creating A Tax-Deductible Canadian Mortgage.
Selling Canadian Property
When a non-resident sells a Canadian property, the Canadian government takes 50% of any sale as a withholding tax. American residents must also report the capital gain to the Internal Revenue Service (IRS). However, if the gain has been taxed in Canada, it can be claimed as a foreign tax credit. When a non-resident sells a Canadian property, the seller must provide the buyer with a clearance certificate prepared by the CRA. Without this certificate, the buyer can keep a portion of the purchase price, as the buyer could be personally liable to the CRA for any of the non-resident's unpaid taxes.
If you are a resident of Canada and the Canadian property is your principal place of residence, you aren't taxed on the capital gains when you sell the property. You can designate any residence as a principal residence as long as you "ordinarily inhabit" it. The designation can apply to seasonal dwellings such as a cottage or mobile home. For a family unit, only one principal residence is allowable each year. This requirement has important implications. For example, if you own more than one property, you must decide which to designate as a principal residence based on the capital gains for that year.
If you are a resident, but the property was not your principal residence for all the years you owned it, you must prorate the capital gain for the years in which you didn't designate the property as your principal residence. A change in use, from rental to principal residence, could result in a "deemed disposition," triggering taxable capital gains. However, you could elect to defer recognizing this gain until you actually sell the house.
When you leave Canada, there's a "deemed disposition" of capital property. In other words, if you owned Canadian assets that have appreciated in value, you'll pay tax on those gains if and when you leave the country. This "deemed disposition" also may apply when a non-resident property owner dies or when a property is transferred from an individual to the individual's company or relative, even though no money has been paid.
Home Equity Loans
You can get equity out of your Canadian residential property with a reverse mortgage or home equity line of credit (HELOC).
A reverse mortgage isn't for everyone but, they allow homeowners who are 60 years or older to take out regular payments that total up to 40% of the home's current appraised value. No repayment is required and proceeds are tax-free. The funds can be invested, the interest expense can be written off (if the funds are invested in an income-producing asset) and the homeowner can live in the home as long as desired. The loan ends when the homeowner dies or sells the house, at which point it is paid off with the proceeds of the sale.
A HELOC is a second mortgage on your home to secure a loan or a credit line. It offers greater payment flexibility than a conventional mortgage as you can pay off any amount of the principal at any time, without penalty. The interest rate on a line of credit is generally higher than mortgage rates but, are usually lower than unsecured debt.
Alternative Real Estate Investments
Real estate investment trusts (REITs) are publicly traded companies that invest in a portfolio of real estate assets. Most Canadian-based REITs trade on Canada's benchmark Toronto Stock Exchange (S&P/TSX).
As trusts, they must distribute most of their taxable income to shareholders. In 2007, Canada's federal government legislated that income trusts must convert to ordinary tax-paying corporations by January 1, 2011, but many REITS were spared from this legislation. The new trust rules require an REIT to maintain 95% of its income from passive revenue sources (rent from real properties, interest, capital gains from real properties, dividends and royalties), and 75% of its income from the rent and capital gains portion of the previous rule. If the REIT maintains this structure, it will remain under the previous trust tax laws. For more on this type of income structure, read The Basics Of REIT Taxation.
Conclusion
In sum, Canadian laws are quite liberal when it comes to owning real estate. You don't need to be a Canadian citizen or even live in the country, and property taxes and interest expenses are tax deductible. To invest profitably, however, you should be aware of the tax implications of every stage of the investment, from owning the property and inhabiting or renting it, to eventually selling it.
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9650283346147a5378974200274416b7 | https://www.investopedia.com/articles/mortgages-real-estate/10/applying-fha-403k-loan.asp | Applying for an FHA 203(k) Loan | Applying for an FHA 203(k) Loan
The FHA 203(k) loan is a unique product that allows would-be homeowners who don't have a lot of cash to buy a property in need of repairs. But when you combine the red tape of government agencies with the additional financial risks associated with average people (people who aren't experienced with home rehabs) buying a property in poor condition, the 203(k) loan can be one of the most challenging mortgages to get approved for. Outlined below is the process and what to expect.
Key Takeaways An FHA 203(k) allows a homeowner to finance repairs and is one of the only loans offering such a capability. There are two types of 203(k) loans, a regular and streamlined. Regular 203(k) loans are for properties that need structural repairs, while a streamlined loan only needs non-structural repairs.203(k) loans are not very common, so many lenders either won't know how to process them or won't want to deal with the extra paperwork and hassle involved.203(k) loans require a rehab proposal that describes the work to be done on the property and provides an itemized cost estimate for each repair or improvement.
Have Enough Cash
As of 2020, you only have to come up with a down payment of 3.5% of the home's purchase plus repair costs if you have a credit score of at least 580. If your credit score is between 500 and 579, you'll have to put down 10%. So if you were buying a house with an asking price of $150,000 and needed repairs of $15,000, you would need 3.5% of $165,000, or $5,775, as your down payment.
Be a Solid Loan Candidate
Of course, you'll also have to meet the usual borrower requirements for a Federal Housing Administration (FHA) loan, like having a steady, verifiable income and a good credit score.
But otherwise, as long as you can make the monthly payments on the property you want to purchase, there are no further special requirements to qualify for this loan. Just remember that it's for owner-occupants only, not investors.
Pick a 203(k) Loan
Before you apply, determine which type of loan you'll need. There are actually two types of FHA 203(k) mortgages: the first is called "regular," and it's meant for properties that need structural repairs.
The second is called "streamlined" or "modified." It's designed for properties that need only non-structural repairs. Your real estate agent or lender can help you make this determination. Of course, if you don't know the difference between structural and non-structural repairs, a rehab project might be too much to take on.
Choose a Lender
When applying for a government-subsidized mortgage, whether it's a VA loan, FHA loan, green mortgage, or FHA 203(k) loan, your choice of lenders will be somewhat limited. FHA 203(k) loans in particular are not very common, so many lenders either won't know how to process them or won't want to deal with the extra paperwork and hassle involved. Since the loan application process for 203(k) loans is complex, you definitely want to work with a lender who has experience with this specialty loan product.
Not all lenders are approved to handle 203(k) loans. The FHA must grant lenders permission to offer them. To find an approved lender, see the approved lender search tool on the Department of Housing and Urban Development (HUD) website. Make sure to check the box at the end of the page to limit your search to lenders who have done 203(k) loans in the last 12 months.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
Create Your Rehab Proposal
In addition to the usual mortgage loan application requirements, such as proof of income, proof of assets, and credit reports, the 203(k) loan application requires the creation of a rehab proposal.
The rehab proposal must describe the work to be done on the property and provide an itemized cost estimate for each repair or improvement. Architectural exhibits, such as a plot plan and proposed interior plan, are required for any structural repairs.
HUD's checklist will help guide you through the items your proposal should address. The checklist covers every area of the home that might need repairs, from gutters and driveways to flooring and windows.
You don't have to hire professionals to do the repairs, but the FHA says that the work must be completed to professional standards and in a timely manner. Also, if you plan to do the repairs yourself, you can't use the loan to pay yourself for your labor. You can only use the loan toward the cost of materials if you'll be doing the work yourself.
If this sounds like a bum deal, remember that borrowed money, even at a low-interest rate, is not free money—it's money that you'll have to pay back, with interest. So as long as you know what you're doing and can afford to spend the time on the project, you can come out ahead by doing the work yourself. Also, you may be able to use the money you save by not hiring contractors to make additional improvements to the property that you couldn't otherwise afford.
Even if you are going to do the work yourself, your proposal must still include the cost of labor. Why? Because if something goes wrong and you have to hire professionals, the FHA wants you to have the money to hire them.
Get an Appraisal
The home you want to buy must be appraised as it would be for any loan, except that the appraiser must estimate what the value of the home will be once the repairs and improvements are made. An as-is appraisal may also be required, but sometimes the purchase price can stand in for the as-is appraisal.
Hire Help
Some people choose to hire a specialist called a 203(k) consultant to help them complete all the extra paperwork required for this type of loan, such as preparing architectural exhibits. The fee to hire such a consultant can be included in the mortgage, provided it does not exceed limits established by HUD.
For example, for a home requiring $15,000 to $30,000 of repairs, HUD does not expect the consultant to charge more than $600. However, it is perfectly acceptable to complete all the paperwork yourself, although you'll probably want some input from your potential contractors.
The Bottom Line
The FHA 203(k) application process is a lot of work, to be sure. If it seems like too much trouble, you might be better off continuing to search for a home that's closer to move-in ready or continuing to save until you can afford a nicer place. But if you have the time, energy, and patience, the 203(k) loan is often the only way to finance the purchase of a property needing significant repairs. Otherwise, you'll need to have enough cash to pay for the property and the repairs outright.
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ff8a105d6f0ecba64866757e95d6ba95 | https://www.investopedia.com/articles/mortgages-real-estate/10/closing-home-process.asp | 12 Steps of a Real Estate Closing | 12 Steps of a Real Estate Closing
A real estate deal is generally a long and stressful exercise that involves many steps and procedural formalities. Closing occurs when you sign the papers that make the house yours, but before that fateful day arrives, a long list of things has to happen. This article describes the 12 steps that must be taken between the moment your offer is accepted and when you get the keys to your new home.
Key Takeaways Real estate deals are generally completed over a span of weeks and have many moving parts. Deals start with opening an escrow account and end with a final walk-through before signing on the dotted line. The complexity of real estate closings is a good reason to hire an attorney to guide you through the process. Buyers who have been pre-approved for a mortgage are typically able to close sooner.
Why Mortgage Pre-Approval Is a Good Idea
Unless you are an all-cash buyer, it is a good idea to get pre-approved for a mortgage before you start searching for a home. While being pre-approved is not necessary to close a deal, most sellers expect buyers to have a pre-approval letter. Having one can make the process quicker and give you more bargaining power when negotiating. It signals to the seller that you have strong financial backing. It also offers you a rate lock, which means that you are more likely to secure a favorable interest rate.
Getting pre-approved for a mortgage also lets you know the limit up to which you can go for purchasing a property. It saves time and effort, allowing you to search only for real estate that fits your budget.
Finally, mortgage pre-approval gives you more time to respond to possible discrimination. Suppose you feel a potential lender discriminated against you. In that case, you can seek financing from other sources and pursue legal action later. Getting pre-approved prevents a single biased lender from ruining a good deal and delaying your dreams.
Mortgage lending discrimination is illegal. Suppose you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age. In that case, there are other steps you can take. One such step is to file a report with the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).
Once you've found the perfect home and a buyer has accepted your offer, the following are the steps you'll need to take to close the deal.
1:51 12 Steps To Closing A Real Estate Deal
1. Open an Escrow Account
An escrow account is held by a third party on behalf of the buyer and seller. A home sale involves multiple steps taken over a span of weeks. Therefore, the best way to prevent either the seller or the buyer from being cheated is to bring in a neutral third party. This third party can hold all the money and documents related to the transaction until everything has been settled. Once all procedural formalities are over, the money and documents are moved from the escrow account to the seller and buyer, thus guaranteeing a secure transaction.
2. Title Search and Insurance
A title search and title insurance provide peace of mind and a legal safeguard. They ensure that when you buy a property, no one else can try to claim it later. A title search is an examination of public records to determine and confirm a property’s legal ownership and find out what claims, if any, exist on the property. If there are any claims, they may need to be resolved before the buyer gets the property.
Title insurance is indemnity insurance that protects the holder from financial loss sustained from defects in a title to a property. It protects both real estate owners and lenders against loss or damage stemming from liens, encumbrances, or title defects.
3. Hire an Attorney
While getting legal aid is optional, it's always better to get a professional legal opinion on your closing documents. The complicated jargon in them can be difficult to understand, even for well-educated individuals. For an appropriate fee, opinion from an experienced real estate attorney can offer multiple benefits, including hints of any potential problems in the paperwork.
In some states, you may be required to hire an attorney to handle the closing. Check your state's laws.
4. Negotiate Closing Costs
From opening an escrow account to hiring a real estate attorney, all involved services and entities cost money. These costs can snowball into a lot of cash if you aren't careful. For instance, home and pest inspections are crucial to prevent you from buying a property with hidden—and costly—problems. But many such services take advantage of consumers’ ignorance by charging high fees. Even fees for legitimate closing services can be inflated.
Junk fees are charges that a lender imposes at the closing of a mortgage, which are often unexpected by the borrower and not clearly explained by the lender. These fees can add up to a big bill. Junk fees include administrative fees, application review fees, appraisal review fees, ancillary fees, processing fees, and settlement fees.
If you're willing to speak up and stand your ground, you can usually get junk fees and other charges reduced or eliminated before you go to closing.
5. Complete the Home Inspection
A physical home inspection is a necessary step to discover any potential problems with the property and get a look at its surroundings. If you find a serious problem with the home during the inspection, you'll have an opportunity to back out of the deal or ask the seller to fix it. You can also have the seller pay you to have it fixed (as long as your purchase offer included a home-inspection contingency).
6. Get a Pest Inspection
A pest inspection is separate from the home inspection. It involves a specialist making sure that your home does not have any wood-destroying insects, such as termites or carpenter ants. Pests can be devastating for properties made primarily of wooden material. Many mortgage companies mandate that even minor pest issues be fixed before you can close the deal.
A small infestation can spread to become very destructive and expensive to fix. Wood-destroying pests can be eliminated, but you'll want to make sure the issue can be resolved for a reasonable fee. Better yet, you might be able to get the seller to pay and have pests eliminated before you complete the purchase. Pest inspections are legally required in some states and optional in others.
7. Renegotiate the Offer
Even when your purchase offer has already been accepted, you may want to renegotiate the price to reflect the cost of any necessary repairs revealed by inspections. You could also keep the purchase price the same, but try to get the seller to pay for repairs. Even if you're purchasing the property "as is," there is no harm in asking. You can also still back out without penalty if a major problem is found that the seller can't or won't fix.
8. Lock in Your Interest Rate
Interest rates, including those offered on the mortgage, can be volatile and subject to change. Rates are subject to multiple factors, such as geographic region, property type, type of loan applied for, and the applicant's credit score.
If at all possible, it is advisable to lock in the interest rate for the loan in advance. That prevents you from being at the mercy of market fluctuations, which could cause rates to rise before you finalize your property purchase. Even a 0.25% rate hike can significantly increase your monthly payments and the amount of time it takes to repay the mortgage.
9. Remove Contingencies
Your real estate offer should be contingent upon the following five things:
Obtaining financing at an interest rate not to exceed what you can afford The home inspection not revealing any major problems with the home The seller fully disclosing any known issues with the home The pest inspection not showing any major infestations or damage to the home The seller completing any agreed-upon repairs
Such contingencies must be removed in writing by specific dates stated in your purchase offer, a process known as active approval. However, in some purchase agreements contingencies are subject to passive approval (also known as constructive approval). That means they are considered approved if you don’t protest them by their specified deadlines. Buyers must understand the approval process and take the necessary actions by the required dates.
10. Meet Funding Requirements
You most likely deposited earnest money when you signed the purchase agreement. Earnest money is a deposit made to a seller indicating the buyer’s good faith, seriousness, and genuine interest in the property transaction. If the buyer backs out, the earnest money goes to the seller as compensation. If the seller backs out, the money is returned to the buyer.
To complete your purchase, you'll have to deposit additional funds into escrow. As the original earnest money is generally applied to the down payment, it is crucial to arrange for the various other required payments before the deal is closed. Failure to do so can lead to the sale getting canceled, with the earnest money going to the seller. Furthermore, you could still be charged for the various services you used before the deal fell apart.
11. Final Walk-Through
One of the last steps before you sign your closing papers should be to look over the property one last time. You want to make sure that no damage has occurred since your last home inspection. You should also verify that the seller has completed the required fixes and no new problems came up. Finally, check to see that nothing included in the purchase agreement was removed.
Closing on a home can take from a week to 60 days, depending on the property type and whether you are paying cash or financing the purchase.
12. Understand the Paperwork
Paperwork is critical to closing a property deal. Despite there being a stack of papers filled with complex legal terms and jargon, you should read all of it yourself. If you don’t understand something, consult a real estate attorney. Your agent will also be helpful in making sense of any complex legal language.
Although you may feel pressured by the people who are waiting for you to sign your papers—such as the notary or the mortgage lender—read each page carefully, as the fine print can have a major impact for years to come.
In particular, make sure the interest rate is correct and all other agreed terms are clearly mentioned. More generally, compare your closing costs to the good faith estimate you received at the beginning of the process. Vigorously dispute any fees you think are illegitimate.
The Bottom Line
Though it may seem like the closing process is a lot of work, it is worth the time and effort to get things right instead of hurrying up and signing a deal you don't understand. Be wary of any pressure to close the deal fast. Real estate agents and other entities helping you will want their cut, but they won't be around to care about the problems you could face in the long run from a bad deal.
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1f4f636749675ea49ab6fa9afe72f8ff | https://www.investopedia.com/articles/mortgages-real-estate/10/habits-of-effective-real-estate-investors.asp | 10 Habits of Highly Effective Real Estate Investors | 10 Habits of Highly Effective Real Estate Investors
Real estate has long been regarded as a sound investment. Wholesaling and management of commercial and residential properties are just two of the many ways investors can profit from real estate, but it does take a certain savvy to become successful in this competitive arena.
While some universities offer coursework and programs that specifically benefit real estate investors, a degree is not a prerequisite for profitable real estate investing. Whether an investor has a degree or not, there are certain characteristics that top real estate investors commonly possess.
1. Treat Investments as Businesses
It is important for real estate investors to approach their real estate activities as a business in order to establish and achieve short- and long-term goals. A business plan allows real estate investors to not only identify objectives but also determine a viable course of action leading to their attainment. A business plan also allows investors to visualize the big picture, which helps maintain focus on the goals rather than on any minor setback. Real estate investing can be complicated and demanding, and a solid plan can keep investors organized and on task.
2. Know Their Markets
Effective real estate investors acquire an in-depth knowledge of their selected market(s). The more an investor understands a particular market, the more qualified he or she will be to make sound business decisions. Keeping abreast of current trends, including any changes in consumer spending habits, mortgage rates, and the unemployment rate, to name a few, enables savvy investors to take in current conditions and plan for the future. Being familiar with specific markets allows investors to predict when trends are going to change, creating potentially beneficial opportunities.
3. Maintain High Ethical Standards
Realtors are bound by a code of ethics and industry standards, while real estate agents are held to the rules and standards of each state's real estate commission. On the other hand, unless they are associated with membership-based organizations, and as long as they operate within the boundaries of the law, real estate investors are not typically required to maintain ethics-based practices. While it would be easy to take foul advantage of this, most successful real estate investors maintain high ethical standards. Since real estate investing involves actively working with people, an investor's reputation is likely to be far-reaching. The consequences for an investor lacking in ethics can be damaging, particularly over the long haul. Effective real estate investors know it is better to conduct business fairly, rather than seeing what they can get away with.
4. Develop a Focus or Niche
Because there are so many ways to invest in real estate, it is important for investors to develop a focus in order to gain the depth of knowledge essential to becoming successful. This involves learning everything about a certain type of investment—whether it is wholesaling or commercial real estate—and becoming confident in that arena. Taking the time to develop this level of understanding is integral to the long-term success of the investor. Once a particular market is mastered, the investor can move on to additional areas. Savvy investors know that it is better to do one thing well than five things poorly.
5. Get Good at Customer Service
Referrals generate a sizable portion of a real estate investor's business, so it is critical that investors treat others with respect. This includes business partners, associates, clients, renters, and anyone with whom the investor has a business relationship. Effective real estate investors are good at customer service, particularly at paying attention to detail, listening and responding to complaints and concerns, and representing their business in a positive and professional manner.
6. Stay Educated
As with any business, it is imperative to stay up to date with the laws, regulations, terminology, and trends that form the basis of the real estate investor's business. Keeping current requires work, but it can be viewed as an investment in the future of the business. Investors who fall behind risk not only losing momentum in their businesses but also legal ramifications if laws are ignored or broken. Successful real estate investors take the time and make the effort to stay educated, adapting to any regulatory changes or economic trends.
7. Understand the Risks
Those choosing to invest in the stock or futures markets are inundated with myriad warnings regarding the inherent risks involved in investing. Numerous agencies, such as the Commodity Futures Trading Commission, require disclaimers to warn potential market participants about the possibility of a loss of capital. While much of this is legalese, it has made it clear to people that investing in the stock or futures markets is risky; meaning that one can lose a lot of money. Greenhorn real estate investors, however, are more likely to be bombarded with advertisements claiming just the opposite—that it is easy to make money in real estate. Prudent real estate investors understand the risks associated with the business—not only in terms of real estate deals but also the legal implications involved—and adjust their businesses to reduce any risks.
8. Work With a Reputable Accountant
Taxes comprise a significant portion of a real estate investor's yearly expenses. Understanding current tax laws are not easy and take time away from the business at hand. Sharp real estate investors retain the services of a qualified, reputable accountant to handle the business's books. The costs associated with the accountant can be negligible when compared to the savings a professional can bring to the business.
9. Find Help When They Need It
Real estate investing is complicated and requires a great deal of expertise to engage in the business profitably. Learning the business and the legal procedures is challenging to someone trying to go it alone. Effective real estate investors often attribute part of their success to others—whether a mentor, lawyer, accountant, or supportive friend. Rather than risk time and money solving a difficult problem on their own, successful investors know it is worth the additional costs to find help when they need it, and embrace other peoples' expertise.
10. Build a Network
A network can provide important support, and create opportunities for new and experienced real estate investors alike. This group of associates can be comprised of a well-chosen mentor, business partners, clients, or a non-profit organization whose interest is in real estate. A network allows investors to challenge and support one another and can aid significantly in advancing one's career through shared knowledge and new opportunities. Because much of real estate investing relies on experiential-based learning, rather than on book knowledge, savvy real estate investors understand the importance of building a network.
The Bottom Line
Despite ubiquitous marketing materials claiming that investing in real estate is an easy way to grow wealthy, it is, in fact, a challenging business requiring expertise, planning, and focus. In addition, because the business revolves around people, investors benefit in the long run by operating with integrity and respect for clients and associates. Though it may be relatively simple to enjoy short-lived profits, developing a viable real estate investing business that can last requires additional skills and effort. Whether focusing on apartment buildings or commercial property, highly effective real estate investors share the 10 essential habits above.
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aad08c1917b45b50ce28791e28516238 | https://www.investopedia.com/articles/mortgages-real-estate/10/increase-your-real-estate-net-worth.asp | How to Increase Your Real Estate Net Worth With Leveraging | How to Increase Your Real Estate Net Worth With Leveraging
Investing in real estate has become a popular way to diversify your investment portfolio. Everywhere we look, we're constantly reminded of the benefits of buying property, from the many infomercials about real estate seminars, or the home shows that tote the incredible value of managing or flipping rental properties.
But it isn't that easy. After all, buying a rental property isn't like investing in stocks—you can't just put down a little here and there and become a property owner. You need capital to make that purchase. And the process can often be long and drawn out. Not to mention all the risks involved, especially if you don't do your research. But is there a way to get into the market by increasing your net worth? Try using leverage to your advantage. By doing this, you can put little to no money down, and use debt to help you realize a return.
Read on to learn more about how you can use leverage to increase you real estate's net worth, as well as some of the risks involved. (For more, see Investopedia's Net Worth Tracker.)
Key Takeaways Leverage uses borrowed capital or debt to increase the potential return of an investment.In real estate, the most common way to leverage your investment is with your own money or through a mortgage.Leverage works to your advantage when real estate values rise, but it can also lead to losses if values decline. Avoid leveraging risks by making sound investment decisions and accounting for mortgage payments, vacancies, and a tough economy.
What Is Leverage?
Leverage is the use of various financial instruments or borrowed capital—in other words, debt—to increase the potential return of an investment. It commonly used on both Wall Street and Main Street when talking about the real estate market. Leverage is a technique used by both people and companies to expand the potential for returns, while equally expanding the downside of any risks involved if things don't work out.
While the potential for a good return is possible—like when real estate prices rise—using leverage can be a double-edged sword. That's because it can also lead to losses if the investment moves in the opposite direction. In the case of real estate prices, losses happen when prices decline.
Ways to Access Leverage
The easiest way to access leverage is to use your own money. In the case of a mortgage, a standard 20% down payment gets you 100% of the house in which you want to live. Some financing programs let you put even less money down.
If you purchase the property as an investment, you may be in a position where your partners furnish some—or even all—of the money. Similarly, some sellers may be willing to finance some of the purchase price of the property they wish to sell. Under such an arrangement, you can purchase a property with little money down and, in some cases, no money down at all.
2:04 Leverage: Increasing Your Real Estate Net Worth
Example of Leveraging
Consider the common real estate purchase requirement of a 20% down payment. That's $100,000 on a $500,000 property. By putting down only 20% of the money down and borrowing the rest, the buyer essentially uses a relatively small percentage of his or her own funds to make the purchase. The majority, therefore, is provided by a lender. That's why real estate investors often refer to the remaining 80% of the purchase price as other people's money.
Let's assume the property appreciates at a rate of 5% per year. This means the borrower's net worth grows to $525,000 in just 12 months. Comparing this gain to the gain from a purchase made outright, without any loan, highlights that value of the leveraging strategy. For example, the same borrower could have used the $100,000 to make a paid-in-full purchase of a $100,000 property.
Assuming the same 5% rate of appreciation, the buyer's net worth from the purchase on an all-cash $100,000 property would increase $5,000 over the course of 12 months, versus $25,000 for the more expensive property. The $20,000 difference demonstrates the potential net worth increase provided through the use of leverage. Now, picture that 5% gain every year for 20 years. Over time, the use of leverage can have a very significant and very positive impact on your net worth.
The Dangers of Leverage
Now for the bad news. All this sounds great, but there's a downside. Leverage can work against you, just as much as it can work in your favor. To show how, let's revisiting our earlier example. If you use a $100,000 down payment to purchase a $500,000 home, and real estate prices in your area decline consecutively for several years, leverage works in reverse. After year one, your $500,000 property could be worth $475,000, if it depreciates by 5%. If prices continue on that same trajectory, soon your property could be worth $451,250—a loss in equity of $48,750.
Just as leverage can work in your favor, it can also work against you.
Under that same 5% price-decline scenario, if that $100,000 was used for an all-cash purchase of a $100,000 home, the buyer would have lost just $5,000 the first year home prices fell—much less than that more expensive home.
In real estate markets where prices fall significantly, homeowners can end up owing more money than the house is actually worth. For investors, declining prices can reduce or even eliminate profits. If rents fall too, the result can be a property that cannot be rented at a price that will cover the cost of the mortgage and other expenses. If you are contemplating becoming a landlord, there are many factors to consider.
Cons Leveraging Many Properties
The problems get even bigger when multiple units are involved, as commercial real estate investors often put down as little money as possible. The goal is to leverage your money by taking control of 100% of the assets while only putting down 20% of the value. Consider the $500,000 in our previous example. only let's say it's a small apartment building. Since it was purchased with $100,000 as a down payment, if the value of the building declines by 30%, the property is worth just $350,000, but the investor still must pay interest and principal on the full value of the $400,000 loan.
Should the amount the investor gets in rent decline too, the result could be default on the property. If the investor uses cash flow from that property to pay the mortgage on other properties, the loss of income could produce a domino effect that can end with an entire portfolio in foreclosure over one bad loan on one property.
Avoiding Leveraging Risks
Now that you've learned about the basics of leveraging in real estate as well as some of the pitfalls, you may think it's impossible to make a good return using this technique. Don't fret—it's just a matter of using common sense. Just like any investment, real estate comes with risk. Although you can use leverage to your advantage, there are a few key things you want to make sure you avoid to give you a better edge in the market.
First, don't assume what will happen before it happens. You can't always use past performance as an indicator of what will happen in the future—especially with the housing market. If you see that property values have risen in a specific area by 5% to 10% over a certain period of time, that doesn't mean they will continue on the same path.
Next, budget yourself accordingly and know what you're getting into. If you put down a lower down payment, the amount of your loan will be higher. That means you'll have to make a larger mortgage payment. You may have to account for lower vacancy rates, a tougher economy, bad tenants—all of which will fall on you. Ultimately, you're still responsible for the mortgage payment, so you have to make sure you can keep yourself afloat in any situation.
The Bottom Line
Images of such leveraged purchases bring to mind those late-night infomercials where smooth-talking pitchmen suggest that you can earn millions of dollars buying properties with no money down. While it is possible, we don't recommend going this route.
Happily, you don't need to. Less exotic ways to use leverage do exist, enabling you to buy real estate with a relatively small amount down—even no money at all. In fact, although they may not think about it as leverage, most people do so if they take out a mortgage when they buy a home. They pay back the loan over a period of years or decades, while enjoying the use of the property. The moral of the story is that leverage is a common tool that works well – when used prudently.
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ce6f2f0efae65760a1d8d3afba561a96 | https://www.investopedia.com/articles/mortgages-real-estate/10/out-of-state-property.asp | Investing in Out-of-State Property | Investing in Out-of-State Property
Buying and owning property is rarely easy or simple. When the property in question is in a distant location, the challenges multiply. Nevertheless, investing in out-of-state property might seem appealing if you live in an area where real estate is expensive. It might also be attractive if you already own your home but want to diversify your investments. You may just want to own a vacation home. Or your motives might combine all of these reasons and more.
Key Takeaways Buy in a town you know, or get to know the town before you buy. Finding a property management company and a maintenance worker are as important as finding a real estate agent. Don't just tour the property. Get an inspection.
Regardless, here are the issues to consider before you make an offer.
1:58 Investing In Out-Of-State Property
Reasons to Buy
If you live in a place where prices are sky-high, such as San Francisco or New York City, local real estate investing or even local homeownership might be out of the question. You want to look at areas where the market fundamentals are sound but property costs are significantly lower.
On the other hand, if you live in an area with depressed or falling real estate prices, you may prefer to rent a home and invest in real estate elsewhere.
ROI Is the Key
In either case, you may find that the return on investment (ROI) is better elsewhere than it is at home. That is a big reason why many buy outside the region where they live. Purchase price, appreciation rates, mortgage expenses, taxes, housing regulations, rental market conditions, and more factors might be more favorable in another state and will contribute to a property's potential ROI.
Challenges to Consider
You won't have the same intimate, day-to-day knowledge of a distant market that you have of the market in which you live. You don't have an in-depth understanding of the best neighborhoods—or the worst. You will have to rely on research, word of mouth, gut instinct and the opinions of any professionals you hire.
Understanding the laws and regulations regarding property ownership and property taxes in your target area is another challenge. Even if you read every line of the local codes and ordinances, what it says on paper and what happens in the real world don't always match. Talk with property owners in the area to get a true understanding of local challenges.
Networking Out-of-State
You'll need good contacts in the area to make your investment plan successful. That doesn't only mean a real estate agent. You may need a property manager, a maintenance worker, and a contractor before long.
The secret to many out-of-state investors' success is finding and hiring an excellent property management company. It will be their job to fill vacancies, collect rent, make repairs and handle emergencies.
If you lived in the area, you might choose to manage the property yourself. If you live far away, professional property management is an extra expense you simply must incur to safeguard your investment.
Experienced builder and property manager Rusty Meador notes, "No matter how good of a real estate deal you find, it is only as good as its ability to be managed well."
The Complications
Even with a property management company on your payroll, you'll still need to make an occasional visit to your property to make sure that what managers and tenants tell you matches reality. This is an additional time and money cost that must be considered.
Also, when purchasing a rental property, especially rental property out-of-state, you're likely to encounter higher homeowners insurance rates, higher mortgage interest rates, and higher down payment requirements. Lenders consider rentals riskier than owner-occupant mortgages.
You'll also complicate your tax situation by owning rental property and earning income in more than one state. You may need to hire an income tax professional to keep you in the good graces of the tax authorities.
How Far to Go
After considering all of these factors, you may find that being an owner-occupant or purchasing investment property close to home is a much simpler and less expensive proposition.
In fact, think that through. Even San Francisco and New York City are within a couple of hours of less expensive real estate, and even places where prices are depressed have solid neighborhoods fairly close by.
Before You Buy Out of State
If you're still intent on buying out-of-state, be sure to heed these additional warnings. Do not buy sight unseen. Online information on a property can be out-of-date or incomplete. A local real estate agent or property owner might lie to close a sale.
If you unwittingly become the owner of a nuisance property that violates health and safety laws, you can be on the hook for code violations that are time-consuming and expensive to fix. If a property has been vacant for long enough, it can develop maintenance issues that can be solved only with a bulldozer, and you might be on the hook for the demolition bill.
Get an Inspection
Make sure you see the property in person and hire a professional to make an inspection.
Finding quality tenants is particularly important for absentee landlords. You won't be there to keep a close eye on your tenants' behavior or their treatment of the property, or to pressure them to pay if the rent is past due. In addition to hiring a top-notch property management company, you want to have tenants that won't cause you or your management company headaches.
Get Pre-Approved
While you're visiting, take the time to meet with various lenders and research the various mortgage types and interest rates available locally. It is best to get pre-approved for a mortgage, as this will cut down on the time it will take to close the deal once you've found your dream out-of-state home.
Finally, if you've never owned property, buying your first property out-of-state is extra risky. No matter how many books you read on property ownership, there is no substitute for experience.
How to Make it Work
If you are going to buy out-of-state, consider buying in an area you are familiar with, perhaps your college town or your hometown. It helps to have some knowledge of the area.
You'll need a network of local professionals to help you manage your property.
As a bonus, if you buy in an area that you visit anyway, your leisure travel can become at least partly tax-deductible because you will be adding a business component to those trips to check up on your property.
Dos and Don'ts
Buy in an area with some similarities to the area where you live, such as climate, demographics, or property age so that you have some idea of what you're dealing with. If you have lived in a 1960s suburb of California your entire life, don't buy a Victorian in Boston.
Don't buy a high-risk property. Buy in a primarily owner-occupied neighborhood to attract tenants who are a lower economic risk, says Ryan L. Hinricher, a founding partner of the investment home sales company Investor Nation. A high-quality property will typically have less maintenance and upkeep, he notes. "These properties also rent more quickly, as they usually have modern layouts and an adequate count of bedrooms and bathrooms."
Finally, as mentioned earlier, it's crucial to build a great network of professionals to help you and to occasionally visit your property yourself.
Out-of-State Alternatives
There are other ways to invest in real estate elsewhere. One option is a real estate investment trust (REIT) or a REIT exchange-traded fund (ETF). This is similar to investing in a stock and you can choose a REIT with a risk/return profile that fits what you're looking for.
Just as a stock owner doesn't have to make decisions about running the company, when you own shares of a REIT you won't have any of the headaches that are associated with actually owning property.
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dccbf3febe4a160f6fb7576b75a0a313 | https://www.investopedia.com/articles/mortgages-real-estate/10/walk-away-mortgage-foreclosure.asp | When to Walk Away From Your Mortgage | When to Walk Away From Your Mortgage
If you have a mortgage for an amount greater than the value of your property, what do you do? If you’re the owner of the largest residential property in Manhattan, you might decide to walk away, leaving the mess to your creditors while you go on about your business.
In fact, that's precisely what happened when Tishman Speyer, the American company that invests in real estate, abandoned the 11,000-unit Stuyvesant Town and Peter Cooper Village in Manhattan in 2010. It was one of the largest defaults in history—and the company still managed to remain in business. Tishman Speyer was merely following in the path of many commercial real estate enterprises that had gone before it.
However, if you’re a residential mortgage holder, walking away from a mortgage will likely look different than this (it is unlikely to be as clean and easy). Still, it may surprise you to hear this advice: Mathematically speaking, walking away can sometimes be the most prudent choice.
Key Takeaways There are times when walking away from a residential mortgage is the best option.During the Great Recession, many homeowners—even those with enough income to cover their mortgages—decided to walk away after their homes lost value.Some experts claim that it can make sense to walk away from a mortgage anytime it is possible to rent a similar place for less than the mortgage payment.Holders of adjustable-rate mortgages who own homes that have lost value are more likely to abandon their mortgages during periods of rising interest rates.If walking away is the best option, be prepared, and have a plan for your next place to live.
When Walking Away Makes Sense
Prior to the national housing bubble of the late 2000s, real estate prices could generally be counted on to increase over time. While a few geographical regions would occasionally see declining values, on a national basis, homes gained in value over time. Up until this point, this had been the long-term trend in the U.S.
However, in 2008 and 2009, property values plunged (at times, posting double-digit declines in value). As 2009 came to a close and the year 2010 opened, approximately 25% of all mortgages nationwide were underwater—the amount owed on the mortgages was greater than the value of the homes. At this point, what was previously unthinkable to some actually occurred: Borrowers who could still afford to make their mortgage payments decided not to do so.
If you can rent a similar-type house for less than the cost of the mortgage, some experts suggest that walking away from a house is a sound financial move. In a scenario where you are underwater on your mortgage and facing rising interest rates (due to an adjustable-rate mortgages), the incentive to walk away may be even more appealing. (When a housing crisis strikes, the big winners are often renters.)
Calculating the Cost of Walking Away From a Mortgage
The calculation for comparing the cost of rent to the cost of a mortgage is a simple calculation. One tool to estimate your monthly mortgage payments is a mortgage calculator. Determining the amount of time it will take your home to recover its lost value is a slightly more complex effort. Using a 5% yearly increase in value will provide a ballpark figure based on national averages. A little research can help you make adjustments for regional and local markets. Consider an example:
Original price: $200,000Today’s value: $150,000Loss in value: 25%
Year Beginning Value +5% 1 $150,000 $157,500 2 $157,500 $165,375 3 $165.375 $173,643 4 $173.643 $182,325 5 $182,325 $191,442 6 $191,442 $201,014
If real estate values climb at an average of 5% per year, it will take six years for this home to reach its sales price. This gets the owner to a break-even level—but there is no profit to show (and the owner has paid interest on the loan every year). If prices fall another 10%, recovery will take even longer. (Obviously, home price appreciation is not assured.)
Original price: $200,000Value after 25% decline: $150,000Value after another 10% decline: $135,000
Year Beginning Value +5% 1 $135,000 $141,750 2 $141,750 $148,837 3 $148,837 $156,279 4 $156,279 $164,093 5 $164,093 $172,297 6 $172,297 $180,912 7 $180,912 $189,958 8 $189,958 $199,456 9 $199,456 $209,429
The recovery time is now more than eight years.
Methods for Getting out of a Mortgage
Three of the most common methods of walking away from a mortgage are a short sale, a voluntary foreclosure, and an involuntary foreclosure. A short sale occurs when the borrower sells a property for less than the amount due on the mortgage. The buyer of the property is a third party (not the bank), and all proceeds from the sale go to the lender. The lender either forgives the difference or gets a judgment against the borrower. Then, the borrower is required to complete the payment of all—or part of—the difference between the sale price and the original value of the mortgage.
Not all lenders will agree to a short sale, but if they will, the short sale provides an alternative to foreclosure.
In a voluntary foreclosure, the homeowner turns the property over to the lender willingly. To arrange a voluntary foreclosure, talk to your bank, and make arrangements to deliver the keys to the property. While this process will have a negative impact on a homeowner’s credit rating, additional payments on the mortgage are no longer required.
Involuntary foreclosure is initiated by the lender for non-payment. The lender uses the legal system to take possession of the property. While the homeowner is often allowed to live in the property for months (free of charge) while the foreclosure process takes place, the lender will be making an active effort to collect on the debt and, in the end, the homeowner will be evicted.
The Double Standard
Companies routinely cut their staffing levels and restructure their debt. This can hurt (and sometimes destroy) the suppliers they don’t pay. However, these are considered "good" business moves; stock prices for these companies usually rise in the aftermath.
However, when an individual homeowner attempts to make the same decision, the legal system is set up to protect the lender’s profits. While only a minority of banks will agree to a short sale for a homeowner, all of them are willing to foreclose.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
A level playing field for consumers and businesses would mean that homeowners should feel no remorse about walking away from a loan than businesses that default or have properties foreclosed. As the field is not level, borrowers who walk away need to be willing to accept the consequences, which can include damaged credit, harassment by collection agencies, and difficulty obtaining credit for years.
The Bottom Line
After completing your research, if walking away is your best option, be prepared. To make sure you have a place to live, buy a new, smaller home—or rent an apartment—before you walk away from your current home. Purchase a car and any other big-ticket items that require financing before your credit score is downgraded, and set aside some cash to help smooth the transition.
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b1d1d1db268d373f6d81ae5e2d06779e | https://www.investopedia.com/articles/mortgages-real-estate/11/fha-minimum-property-standards.asp | The FHA's Minimum Property Standards | The FHA's Minimum Property Standards
Homebuyers looking to finance a home purchase with a Federal Housing Administration (FHA) loan are sometimes surprised they are not allowed to purchase a particular property because it doesn't meet FHA requirements for a property.
The FHA has put these minimum property standard requirements into place in order to protect lenders.
Key Takeaways Federal Housing Administration (FHA) loans have requirements, including minimum property standards, which help protect lenders. Federal Housing Administration (FHA) loans must meet safety, security, and soundness standards, which includes areas like roofs, electrical, water heaters, and property access, among others. The Federal Housing Administration (FHA) does not require the repair of cosmetic or minor defects, deferred maintenance, and normal wear if they do not affect the safety, security, or soundness of the home. Workarounds for meeting the standards include having the seller make repairs themselves before selling the property. Alternatively, buyers that can't qualify for an FHA loan may use another loan product, such as an FHA 203(k) loan, which allows the purchase of a home that has significant problems.
Federal Housing Administration (FHA) Minimum Property Standards
When a homebuyer takes out a mortgage, the property serves as collateral for the loan. In other words, if the borrower stops making the mortgage payments, the mortgage lender will eventually foreclose and take possession of the house. The lender will then sell the house as a way of reclaiming as much of the money still owed on the loan as possible.
Requiring that the property meet minimum standards protects the lender. It means that the property should be easier to sell and command a higher price if the lender has to seize it.
At the same time, this requirement also protects the borrower: It means they will not be burdened with costly home repair bills and maintenance from the start. In addition, with a fundamentally sound place to live, the borrower may have more of an incentive to make their payments in order to keep the home.
What Are the FHA's Minimum Property Standards?
According to the U.S. Department of Housing and Urban Development (HUD), the FHA requires that the properties financed with its loan products meet the following minimum standards:
Safety: the home should protect the health and safety of the occupants. Security: the home should protect the security of the property. Soundness: the property should not have physical deficiencies or conditions affecting its structural integrity.
The HUD then describes the conditions the property must meet to fulfill these requirements. An appraiser will observe the property's condition during the required property appraisal and report the results on the FHA's appraisal form. Property appraisals are one of the many requirements that buyers fulfill before settling on a deal.
For single-family detached homes, the appraiser is required to use a form called the Uniform Residential Appraisal Report. The form asks the appraiser to describe the basic features of the property, such as the number of stories, the year it was built, square footage, number of rooms, and location. It also requires the appraiser to "describe the condition of the property (including needed repairs, deterioration, renovations, remodeling, etc.)" and asks, "Are there any physical deficiencies or adverse conditions that affect the livability, soundness, or structural integrity of the property?"
The condominium unit appraisal form is similar but has condominium-specific questions about the common areas, homeowners association, the number of owner-occupied units, etc.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
The FHA does not require the repair of cosmetic or minor defects, deferred maintenance, and normal wear if they do not affect the safety, security, or soundness of the home. The FHA says that examples of such problems include, but are not limited to, the following:
Missing handrails Cracked or damaged exit doors that are otherwise operable Cracked window glass Defective paint surfaces in homes constructed post-1978 (because of lead paint hazards) Minor plumbing leaks (such as dripping faucets) Defective floor finishes or coverings (worn through the finish, badly soiled carpeting) Evidence of previous (non-active) wood-destroying insect/organism damage where there is no evidence of unrepaired structural damage Rotten or worn-out countertops Damaged plaster, sheetrock or other wall and ceiling materials in homes constructed post-1978 Poor workmanship Trip hazards (cracked or partially heaving sidewalks, poorly installed carpeting) Crawl spaces with debris and trash Lack of an all-weather driveway surface
Most Common Property Safety, Security, and Soundness Problems
However, there are many areas where the FHA does require problems to be remedied in order for the sale to close. Here are some of the most common issues that homebuyers are likely to face:
Electrical and Heating
The electrical box should not have any frayed or exposed wires. All habitable rooms must have a functioning heat source (except in a few select cities with mild winters).
Roofs and Attics
The roofing must keep moisture out. The roofing must be expected to last for at least two more years. The appraiser must inspect the attic for evidence of possible roof problems. The roof cannot have more than three layers of roofing. If the inspection reveals the need for roof repairs, and the roof already has three or more layers of roofing, the FHA requires a new roof.
Water Heaters
The water heater must meet local building codes and must convey with the property.
Hazards and Nuisances
A number of conditions fall under this category. They include but are not limited to the following:
Contaminated soil Proximity to a hazardous waste site Oil and gas wells located on the property Heavy traffic Airport noise and hazards Other sources of excessive noise Proximity to something that could explode, such as a high-pressure petroleum line Proximity to high-voltage power lines Proximity to a radio or TV transmission tower
Property Access
The property must provide safe and adequate access for pedestrians and vehicles, and the street must have an all-weather surface so that emergency vehicles can access the property under any weather conditions.
Structural Soundness
Any defective structural conditions and any other conditions that could lead to future structural damage must be remedied before the property can be sold. These include defective construction, excessive dampness, leakage, decay, termite damage, and continuing settlement.
Asbestos
If an area of the home contains asbestos that appears to be damaged or deteriorating, the FHA requires further inspection by an asbestos professional.
Bathrooms
The home must have a toilet, sink, and shower. (This requirement might sound silly, but you'd be surprised what people will take with them when they're foreclosed on, and what vandals will steal from a vacant house.)
Appliances
Anecdotal evidence suggests that the FHA requires properties to have working kitchen appliances, particularly a working stove. However, FHA documents do not mention any requirements regarding appliances.
Remedies for Properties Below Minimum Standards
There are options for homebuyers who have fallen in love with a property that has one of these potentially deal-killing problems.
The first step should be to ask the seller to make the needed repairs. If the seller can't afford to make any repairs, perhaps the purchase price can be increased so that the sellers will get their money back at closing. Usually, the situation works the other way around—if a property has significant problems, the buyer will request a lower price to compensate. However, if the property is already priced below the market or if the buyer wants it badly enough, raising the price to ensure the repairs are completed (and the transaction closed) could be an option.
If the seller is a bank, it may not be willing to make any repairs. In this case, the deal is dead. The property will have to go to a cash buyer or a non-FHA buyer whose lender will allow them to buy the property in the present condition.
Many homebuyers will simply have to keep looking until they find a better property that will meet FHA standards. This reality can be frustrating, especially for buyers with limited funds and limited properties in their price range.
Some homebuyers may be able to gain approval for a different loan product. A non-FHA loan may provide more leeway on what condition the property can be in, but the lender will still have its own requirements. So, this approach may not be successful. Another option is to apply for an FHA 203(k) loan, which allows the purchase of a home that has significant repair and maintenance problems.
The Bottom Line
FHA loans make it easier for borrowers to qualify for a mortgage, but they don't necessarily make it easier to buy a property. If a property does not meet the minimum standards for an FHA loan, many homebuyers will simply have to keep looking until they find a better property that does meet FHA standards—a process that can be frustrating, especially for buyers with limited funds and few properties in their price range.
However, FHA borrowers who know what to expect when home shopping can restrict their search to properties that are likely to meet FHA guidelines, or at least avoid setting their hopes on a fixer-upper property before having it appraised.
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fc5574c0f85f795a834f931c3c976457 | https://www.investopedia.com/articles/mortgages-real-estate/11/forming-homeowners-association.asp | How to Form a Homeowners' Association | How to Form a Homeowners' Association
Homeowner's Associations (HOAs) manage issues affecting the entire community, such as safety and security, lack of property maintenance, local nuisances, or the provision of services not taken care of by the local government.
HOAs are generally formed by developers when a new community is constructed. As a condition of acquiring property in many communities, buyers must join the HOA. As a result, many people wind up joining HOAs without truly understanding what they are or how they work, just because they fall in love with a particular home.
Growth in HOAs
Homeowner associations (HOAs) have become more and more prevalent. When speaking to this explosive growth in the formation of condominiums, homeowners' associations, and cooperatives public policy professor, Robert H. Nelson, states:
As recently as 1970 represented only about 1% of U.S. housing. By 2010, however, there were more than 300,000 community associations housing more than 60 million Americans, 20% of the U.S. population...Between 1980 and 2000, half the new housing in the United States was built and organized under the private governance of a community association.
Learn Local Laws on HOAs
State property codes set forth the legal guidelines for establishing a homeowners' association. In Texas, for example, property code chapter 204 says a three-person committee must form to petition for the formation of a property owners association (POA).
The committee must file official written notice that it intends to create a POA with mandatory membership. All of the record owners in a subdivision must be notified, and the owners of at least 60% of the property must sign and approve the petition within one year. Once the POA exists, it can create restrictions through a separate petition process that requires the approval of the owners of at least 75% of the subdivision's property.
HOAs also can be a source of major strife because of the power they wield over homeowners.
Establishing the HOA
The process for establishing an HOA depends on where the HOA is located, but the following steps will probably be required.
Establishing a business structure by forming an LLC or nonprofit corporation. Creating covenants, conditions, and restrictions (CC&Rs) that describe how the HOA will operate and what rules homeowners must abide by. Establishing a procedure for future modification of the CC&Rs. Writing rules and regulations that put the CC&Rs into easy-to-understand language for community residents. Drawing up governing documents, such as articles of incorporation and bylaws, which outline meeting frequency, voting guidelines, the election of HOA leaders and other operating procedures. Electing qualified officers/board members. For example, the treasurer actually needs to understand how to keep books and manage money, for example.
If the people establishing the HOA are not experts in real estate law, hiring an attorney with HOA expertise would be a sound decision at this stage. The HOA will not be able to enforce its rules if they are challenged and found not to be legal. A good attorney can also point out key issues HOA leaders should pay attention to, such as fair housing laws, to avoid legal problems once the association is up and running. Federal, state, and local government regulations have precedence over HOA rules.
(For related reading, see: How To Pick The Right Lawyer.)
Key Takeaways Housing developers often create homeowner associations (HOAs), as part of newly constructed neighborhoods or gated communities. It is crucial that HOA officers keep up-to-date financial records of operations. Homeowner associations (HOAs) rules do not deflect federal, state, and local government regulations. An HOA has a board of directors who oversee the operation of the HOA and enforce the HOA's rules and bylaws. If you belong to an HOA, you will pay dues in return for services offered in your community.
Protect the HOA
The officers and board of directors are in charge of running and overseeing the HOA. Along with this high level of responsibility comes a high level of risk. The HOA needs a way to protect itself if a homeowner decides to sue.
Why might a homeowner sue? In Elk Grove, Calif., a resident sued his HOA over its suggested changes to neighborhood parking rules. A Houston man sued his HOA because it wanted him to remove the burglar bars from his home despite the high crime rate in the area.
A fair housing organization sued a condominium association in Florida for refusing to allow children to live in the building. A board member could be sued for violating his or her fiduciary duty toward the HOA's residents and could be held personally liable.
Directors and officers insurance provides financial protection to the people running the HOA. It covers both legal defense costs and damages. However, it does not cover intentional misconduct. Employee theft insurance can protect the association if a director, officer or property manager embezzles HOA funds.
Keep Sound Financial Records
An HOA needs money to function, and that money comes from the community's residents. Some of the money funds the HOA's administration (e.g., legal, accounting and management services), but most of the money goes toward the upkeep of common areas.
It might pay for landscaping services, pool maintenance, and even garbage collection. A portion of the money is spent every month, and the rest is set aside in a reserve fund. Sometimes a major expense will arise that can't be paid for out of the HOA's reserve fund. In that case, the HOA will require residents to pay an extra fee called a special assessment.
A new HOA will need to perform a funding analysis and construct a budget to determine how much to collect in monthly dues from the owner(s) of each property. The analysis is based on which expenses will be paid by community members, how much they will cost, how much will be allocated to the reserve fund, and the percentage of the community's property owned by each resident.
Also, the reserve fund must be managed and invested to keep the HOA financially sound (for example, the fund's value must be preserved against inflation).
Keep Homeowners Informed
As members of the community who pay dues and are affected by the HOA's decisions, residents must be kept informed of the HOA's activities and any issues affecting the community.
HOAs must hold regular meetings and notify residents far enough in advance that everyone has the opportunity to attend. They must also hold elections for directors and officers and ensure everyone has the opportunity to vote. A community newsletter, email and/or website can also help keep homeowners in the loop.
HOA officers and directors should keep detailed records of their activities, such as minutes from community meetings. Associations should disclose important financial information to community members on a regular basis. Members should be aware of their rights to view HOA records and be granted access upon request.
(For more, see: Dealing With Your Condo Board.)
Enforcing Rules
HOAs are rule-based communities, so from time to time, they must enforce rules community members are breaking. HOAs must also handle complaints from residents about existing rules they don't like or rules they feel should be added to solve an ongoing problem.
HOAs must enforce rules quickly and consistently. Homeowners refusing to comply should be fined. If a homeowner refuses to comply, the HOA may need to send the account to collections or sue the homeowner. HOAs should avoid selective enforcement—in other words, they shouldn't play favorites with HOA leaders or community residents with whom they are friends. Biased behavior can lead to a lawsuit.
Hiring a professional management company can reduce the burden on an HOA's officers and directors and eliminate a potential source of conflict between HOA leaders and other members of the community. The management company can take over much of the administrative work and deal with unpleasantries such as enforcing rules and collecting dues. It can also use its expertise in property management to ensure the smooth operation of the community and avoid mistakes inexperienced officers and directors might make. However, professional management costs money, which means homeowners' monthly HOA fees will be higher.
The worst-case scenario for rule enforcement involves foreclosing on a homeowner's property for nonpayment of dues or special assessments. This extreme measure can create a contentious situation between the homeowner and the HOA. Foreclosures also bring down property values, which isn't good for the other residents in the neighborhood.
Host Community Gatherings
HOAs can be strictly about business, but they don't have to be. An occasional fun activity allows HOA members to get to know each other on a friendly, social basis, not just in the potentially adversarial setting of an HOA meeting. If neighbors know each other personally, the community can be a more pleasant place to live and conflicts can be easier to resolve.
The Bottom Line
Forming and managing a homeowners association is a huge task with significant responsibilities and major implications. If you're considering buying a property in an HOA, understand what you're getting into before you buy.
(For further reading, see: 9 Things You Need To Know About Homeowners' Associations.)
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bf6f89f5a5b1fbebd1daf1d3c9d48bc6 | https://www.investopedia.com/articles/mortgages-real-estate/11/home-warranty-worth-it.asp | Do You Need a Home Warranty? | Do You Need a Home Warranty?
When you purchase a home, even a home that isn’t new, there is a very good chance that you will be offered a home warranty as a safety net against expensive, unforeseen repairs. It may sound like a great form of financial protection—but is it really the safety net that homeowners expect? Let’s find out if home warranties are worth it.
Key Takeaways A home warranty reassures a homebuyer and provides the seller with a measure of protection against complaints about home defects that arise after the sale closes. The improper maintenance clause common to warranties can mean the new homeowner isn’t really protected if something goes wrong and the previous owner hadn’t maintained the system properly. The homeowner may have little or no say in the model or brand of a replacement component, or may not like the job the company-designated contractor does. Rather than get a home warranty, it may make more sense to put premium payments into an emergency fund to use for any repairs that do come up.
What Is a Home Warranty?
A home warranty is not the same thing as homeowners insurance, which covers major perils such as fires, hail, property crimes, and certain types of water damage that could affect the entire structure and/or the homeowner’s personal possessions. A home warranty is a contract between a homeowner and a home warranty company that provides for discounted repair and replacement service on a home’s major components, such as the furnace, HVAC, plumbing, and electrical systems. A home warranty may also cover major appliances, such as washers and dryers, refrigerators, and swimming pools.
Often homeowners insurance doesn't cover these components. Or, the cost of fixing them (while expensive) wouldn't meet the policy's deductible—the dollar point at which insurance coverage kicks in.
Most plans have a basic component that provides all homeowners who purchase a policy with certain coverages. Homeowners can also purchase one or more optional components that provide additional coverage at additional cost.
Home warranties often come up when purchasing a home. The seller may offer to purchase one on your behalf to provide peace of mind that any component of the home can be fixed affordably; if not, you will likely receive numerous mail solicitations to purchase a home warranty once the sale closes.
Home warranty companies have agreements with approved service providers. When something that is covered by a home warranty breaks down, the homeowner calls the home warranty company, which sends one of its service providers to examine the problem. If the provider determines that the needed repair or replacement is covered by the warranty, they complete the work. The homeowner only pays a small service fee, plus the money already spent to purchase the warranty.
What Does a Home Warranty Cost?
A home warranty costs several hundred dollars a year, paid up-front (or in installments, if the warranty company offers a payment plan). The plan’s cost varies depending on the property type—single-family detached, condo, townhouse, or duplex—and whether the homeowner purchases a basic or an extended plan.
The cost usually does not vary with the property’s age, unless the home is brand new, which increases the cost of coverage. The home’s square footage also does not affect the price in most cases, unless the property is more than 5,000 square feet. Separate structures, such as guest houses, usually are not covered by the basic policy but can be covered for an additional fee. However, garages should be included as a standard feature of a warranty.
In addition to an annual premium, home warranties charge a service call fee (also called a trade call fee) of around $75 to $125 every time the warranty holder requests that a service provider come out to the house to examine a problem. If the problem requires more than one type of contractor to visit (e.g., a plumber and an electrician), the homeowner may have to pay the service fee for each.
Having a home warranty doesn’t mean the homeowner will never have to spend a penny on home repairs. Some problems won’t be covered by the warranty, whether because the homeowner didn’t purchase coverage for that item or because the warranty company doesn’t offer coverage for that item. Also, home warranties usually don’t cover components that haven’t been properly maintained. (More about this drawback below.) Furthermore, if the warranty company denies a claim, the homeowner will still have to pay the service fee and will also be responsible for repair costs.
The Benefits of a Home Warranty
Like all warranties, a home warranty is supposed to protect against expensive, unforeseen repair bills and provide peace of mind. For a homeowner who doesn’t have an emergency fund or wants to reserve it for other things, a home warranty can act as a buffer. Home warranties also make sense for people who aren’t handy or don’t want to worry about tracking down a contractor when they have a problem. Warranties can also make sense for people with expensive tastes in appliances.
The subject of home warranties often comes up during the sale and purchase of a home. A home warranty can provide reassurance to a home buyer who has limited information about how well the home’s components have been maintained or—in the case of new construction—how well the home has been built. A warranty can also be helpful for people who have just depleted their savings to buy a home and want to avoid any additional major expenses.
For home sellers, offering the buyer a paid-up, one-year home warranty with the purchase may provide a measure of protection against buyer complaints about any discovered problems or defects that arise after the sale closes. However, providing a home warranty does not exempt the seller from the legal requirement to disclose any known problems with the home.
The Drawbacks of Home Warranties
One major problem with a home warranty is that it will not cover items that have not been properly maintained. What is considered proper maintenance can be a significant gray area and is the source of many disagreements between home warranty companies and warranty holders. In a worst-case scenario, unscrupulous warranty companies may use the improper maintenance clause as an excuse to deny valid claims. In another scenario, the homeowner and the contractor who makes the house call may simply disagree over what constitutes proper maintenance.
Another common problem is that when a homeowner purchases a used home, it might come with a 10-year-old furnace that the previous owner did not maintain. At that point, no matter how well the new homeowner tries to care for the furnace going forward, the previous neglect can’t be corrected and any damage can’t be undone. In addition, warranties have numerous exclusions, as well as dollar limits per repair and per year.
Home warranties aren’t expensive compared to the cost of repairing or replacing most of a home’s important components, and this fact is one of a warranty’s major selling points. However, there may be many years when nothing at all breaks down or wears out in the home. In these years the homeowner gets nothing (except, perhaps, peace of mind) in exchange for her premium. If that money had been put into an emergency fund, it would’ve earned some interest at least. Also, a homeowner who tries to use the warranty and has the claim denied will probably feel like the money spent on the premium and the service call fee was wasted.
Home warranties do eliminate the need to find a contractor when something breaks. However, they also eliminate the freedom to choose your own expert—an independent contractor—if you want the warranty to pay for the repair or replacement. If you don’t like the contractor or the work that’s done, you’re stuck. Also, the homeowner may have little or no say in the model or brand of areplacement component, though the warranty contract should provide for an item of similar or equivalent quality.
Furthermore, the whole process may be more complicated when a third party (the home warranty company) is involved than if a homeowner is dealing directly with a contractor.
The Bottom Line
A home warranty is not a perfect solution to the risks and hidden costs homeowners face. If a seller wants to give you one, it won't hurt, certainly. Before you purchase one, though, read the fine print in the home warranty contract and carefully consider whether the warranty is likely to pay off.
Homeowners/buyers who would feel more comfortable having a home warranty—and home sellers who want to offer a warranty to a buyer—should also do careful research to find a reputable home warranty company that uses reputable contractors and will actually pay for legitimate repairs when they are needed.
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0dc0d32b449c51a23ddab5b33a70ad28 | https://www.investopedia.com/articles/mortgages-real-estate/11/how-to-value-real-estate-rental.asp | 5 Ways to Value a Real Estate Rental Property | 5 Ways to Value a Real Estate Rental Property
There are several questions investors ask must themselves when it comes to investing their hard-earned money. How much will the investment return? What does it cost? But more importantly, investors should be concerned with its value. This is especially true when you consider purchasing an investment property.
Income from investment-related property is at a historical high. Rents offer an increasing source of revenue, and it's a steady way to make money. But before getting into the real estate rental game, how does one go about making evaluations?
Read on to find out some of the most common ways to value high-level rental property.
Key Takeaways Determining the cost of and the return on an investment property are just as important as figuring out its value. Investors can use the sales comparison approach, the capital asset pricing model, the income approach, and the cost approach to determine property values. There isn't a one-size-fits-all solution, so a combination of these factors may need to be applied.
1:48 4 Ways To Value A Real Estate Rental Property
1. The Sales Comparison Approach
The sales comparison approach (SCA) is one of the most recognizable forms of valuing residential real estate. It is the method most widely used by appraisers and real estate agents when they evaluate properties.
This approach is simply a comparison of similar homes that have sold or rented locally over a given time period. Most investors will want to see an SCA over a significant time frame to glean any potentially emerging trends.
The SCA relies on attributes or features to assign a relative price value. These values may be based on certain characteristics such as the number of bedrooms and bathrooms, garages and/or driveways, pools, decks, fireplaces—anything that makes a property unique and noteworthy.
Price per square foot is a common and easy-to-understand metric all investors can use to determine where their property should be valued. In other words, if a 2,000-square-foot townhouse is renting for $1/square foot, investors can reasonably expect income in that ballpark, provided comparable townhouses in the area are going for that, too.
Example of Sales Comparison Approach
Keep in mind that SCA is somewhat generic—that is, every home has a uniqueness that isn't always quantifiable. Buyers and sellers have unique tastes and differences. The SCA is meant to be a baseline or reasonable opinion, and not a perfect predictor or valuation tool for real estate. It's also a method that should be used to compare to relatively similar homes.
So it doesn't work if you're going to value the property you're interested in, which is 2,000 square feet with a garage, swimming pool, six bedrooms, and five full bathrooms with another property that has half the number of bedrooms, no pool and is only 1,200 square feet.
It is also important for investors to use a certified appraiser or real estate agent when requesting a comparative market analysis. This mitigates the risk of fraudulent appraisals, which became widespread during the 2007 real estate crisis.
2. The Capital Asset Pricing Model
The capital asset pricing model (CAPM) is a more comprehensive valuation tool. The CAPM introduces the concepts of risk and opportunity cost as it applies to real estate investing.
This model looks at the potential return on investment (ROI) derived from rental income and compares it to other investments that have no risk, such as United States Treasury bonds or alternative forms of investing in real estate, such as real estate investment trusts (REITs).
In a nutshell, if the expected return on a risk-free or guaranteed investment exceeds potential ROI from rental income, it simply doesn't make financial sense to take the risk of rental property. With respect to risk, the CAPM considers the inherent risks to rent real property.
Risk Factors
For example, all rental properties are not the same. Location and property age are key considerations. Renting older property means landlords will likely incur higher maintenance expenses.
Property for rent in a high-crime area will likely require more safety precautions than a rental in a gated community.
This model suggests factoring in these risks before considering your investment or when establishing a rental pricing structure. CAPM helps you determine what return you deserve for putting your money at risk.
3. The Income Approach
The income approach focuses on what the potential income for rental property yields relative to the initial investment. The income approach is used frequently for commercial real estate investing.
The income approach is used frequently with commercial real estate investing because it examines potential rental income on a property relative to the initial outlay of cash to purchase the real estate.
The income approach relies on determining the annual capitalization rate for an investment. This rate is the projected annual income from the gross rent multiplier divided by the current value of the property. So if an office building costs $120,000 to purchase and the expected monthly income from rentals is $1,200, the expected annual capitalization rate is: 14,400 ($1,200 x 12 months) ÷ $120,000 = 0.12 or 12%
This is a very simplified model with few assumptions. More than likely, there are interest expenses on a mortgage. Also, future rental incomes may be more or less valuable five years from now than they are today.
Many investors are familiar with the net present value of money. Applied to real estate, this concept is also known as a discounted cash flow. Dollars received in the future are subject to inflationary as well as deflationary risk, and are presented in discounted terms to account for this.
4. Gross Rent Multiplier Approach
The gross rent multiplier (GRM) approach values a rental property based on the amount of rent an investor can collect each year. It is a quick and easy way to measure whether a property is worth the investment. This, of course, is before considering any taxes, insurance, utilities, and other expenses associated with the property, so it should be taken with a grain of salt.
While it may be similar to the income approach, the gross rent multiplier approach doesn't use net operating income as its cap rate, but gross rent instead.
The gross rent multiplier's cap rate is greater than one, while the cap rate for the income approach is a percentage value. In order to get an apples-to-apples comparison, you should look at the GRMs and rental income of other, similar properties to the one in which you're interested.
Example of Gross Rent Multiplier Approach
Let's say a commercial property sold in the neighborhood you're looking at for $500,000, with an annual income of $90,000. To calculate its GRM, we divide the sale price by the annual rental income: $500,000 ÷ $90,000 = 5.56.
You can compare this figure to the one you're looking at, as long as you know its annual rental income. You can find out its market value by multiplying the GRM by its annual income. If it's higher than the one that sold recently—i.e. for $500,000—it may not be worth it, so consider moving on.
5.The Cost Approach
The cost approach to valuing real estate states that property is only worth what it can reasonably be used for. It is estimated by combining the land value and the depreciated value of any improvements.
Appraisers from this school often espouse the highest and best use to summarize the cost approach to real property. It is frequently used as a basis to value vacant land.
For example, if you are an apartment developer looking to purchase three acres of land in a barren area to convert into condominiums, the value of that land will be based upon the best use of that land. If the land is surrounded by oil fields and the nearest person lives 20 miles away, the best use and therefore the highest value of that property is not converting to apartments, but possibly expanding drilling rights to find more oil.
Another best use argument has to do with property zoning. If the prospective property is not zoned for residential purposes, its value is reduced, as the developer will incur significant costs to get rezoned. This approach is considered most reliable when used on newer structures and less reliable for older properties. It is often the only reliable approach when looking at special use properties.
The Bottom Line
There is no one way to determine the value of a rental property. Most serious investors look at components from all of these valuation methods before making investment decisions about rental properties. Learning these introductory valuation concepts should be a step in the right direction to getting into the real estate investment game.
Then, once you've found a property that can yield you a favorable amount of income, find a favorable interest rate for your new property using a mortgage calculator. Using this tool will also give you more concrete figures to work with when evaluating a prospective rental property.
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b85b0e985901967e4beb549c18bbc287 | https://www.investopedia.com/articles/mortgages-real-estate/11/make-money-in-real-estate.asp | How to Make Money in Real Estate | How to Make Money in Real Estate
Whether you're curious about the investment potential of real estate or you're simply sick of infomercials promising little-known ways to "profit from your property," it's worth learning, for real, how real estate creates wealth.
Rather than providing obscure strategies for investing in real estate or a primer on homeownership for first-time buyers, this article will focus on how to make money through real estate. It will cover both the basic methods that haven't changed in centuries, no matter what kind of gloss the gurus of the moment try to put on them, as well as specific opportunities that have arisen relatively recently.
Key Takeaways The most common way to make money in real estate is through appreciation—an increase in the property's value that is realized when you sell. Location, development, and improvements are the primary ways that residential and commercial real estate can appreciate in value. Inflation can also play a role in increasing a property's value over time. You can also make money in the form of income from rents for both residential and commercial properties, and companies may pay you royalties on raw land, for example, for any discoveries, such as minerals or oil. Real estate investment trusts (REITs), mortgage-backed securities (MBSs), mortgage investment corporations (MICs), and real estate investment groups (REIGs) are investment alternatives within the real estate sector.
Real Estate Profits From Increasing Property Value
The most common way real estate offers a profit: It appreciates—that is, it increases in value. This is achieved in different ways for different types of property, but it is only realized in one way: through selling. However, you can increase your return on investment on a property in several ways. One way—if you borrowed money to buy the property—is to refinance the loan at lower interest. This will lower your cost basis for the property, thus increasing the amount you clear from it.
Emily Roberts {Copyright} Investopedia, 2019.
The most obvious source of appreciation for undeveloped land is, of course, developing it. As cities expand, land outside the limits becomes increasingly valuable because of the potential for it to be purchased by developers. Once developers build houses or commercial buildings, it raises that value even further.
Appreciation in land can also come from discoveries of valuable minerals or other commodities—provided the buyer holds the rights to them. An extreme example of this would be striking oil, but appreciation can also come from gravel deposits, trees, and other natural resources.
When looking at residential properties, location is often the biggest factor in appreciation. As the neighborhood around a home evolves, adding transit routes, schools, shopping centers, playgrounds, and more, these changes cause the home's value to climb. Of course, this trend can also work in reverse, with home values falling as a neighborhood decays.
Home improvements can also spur appreciation. Putting in an extra bathroom, heating a garage, and remodeling a kitchen with state-of-the-art appliances are just some of the ways a property owner may try to increase the value of a home.
Commercial property gains value for the same reasons as raw land and residential real estate: location, development, and improvements. The best commercial properties are perpetually in demand.
The Role of Inflation in Property Values
When considering appreciation, you have to factor in the economic impact of inflation. An annual inflation rate of 10% means that your dollar can only buy about 90% of the same goods the following year, and that includes property. If a piece of land was worth $100,000 in 1970 and it sat dormant and undeveloped for decades, it would still be worth many times more today. Because of runaway inflation throughout the 1970s and a steady pace since, it would likely take more than $500,000 to purchase that land now, assuming $100,000 was fair market value at the time.
Thus, inflation alone can lead to appreciation in real estate, but it is a bit of a Pyrrhic victory. While you may get five times your money due to inflation when you sell, many other goods cost five times as much to buy too, so purchasing power in your current environment is still a factor.
Real Estate Profits From Income
The second big way real estate generates wealth is by providing regular payments of income. Generally referred to as rent, income from real estate can come in many forms.
Raw land income
Depending on your rights to the land, companies may pay you royalties for any discoveries or regular payments for any structures they add. These include, for example, pump jacks, pipelines, gravel pits, access roads, and cell towers. Raw land can also be rented for production, usually agricultural production, and land tracts with trees may be valuable for the timber that can be periodically harvested.
Residential property income
The vast majority of residential property income comes in the form of basic rent. Your tenants pay a fixed amount per month—which will go up with inflation and demand—and you take out your costs from it, claiming the remaining portion as rental income. A desirable location is critically important to ensure that you can secure tenants easily.
Commercial property income
Commercial properties can produce income from the aforementioned sources, with basic rent again being the most common, but can also add one more in the form of option income. Many commercial tenants will pay fees for contractual options like the right of first refusal on the office next door. Tenants pay a premium to hold these options whether they exercise them or not. Options income sometimes exists for raw land and even residential property, but they are not common.
Residential Real Estate: Paths to Profits
Here is a closer look at some of the many ways that you can earn income from residential properties.
Buy and hold
This is one of the more traditional ways of earning income from real estate. There are a number of ways to accomplish this: You can buy a single-family home and rent it out; buy a multi-family home and live in one of the units while renting the others—ideally to cover the mortgage and your own housing expenses; or purchase a multi-family home and rent all of the units—either managing the property yourself or hiring a management company to handle renting units, collecting rent, addressing needed repairs, and so on.
Flipping
Property flippers specialize in adding high-return fixes to houses in a short time and then selling them. Flipping can be lucrative if you know how to find properties to fix up, you have the necessary skills to do the renovations yourself or oversee a crew to carry them out, and you have a sense of a property's underlying costs and potential value.
Airbnb and vacation rentals
Although the COVID-19 pandemic has put the breaks on it for now, the demand for home-away-from-home rentals had taken off in recent years as many travelers preferred this option to staying in a hotel. Homeowners could earn income by renting out a house or even just a room on a short-term basis, especially if the property is in area that's a well-known tourist destination. It's unclear when that market will return. But should it reappear, keep in mind that short-term rentals are regulated and sometimes even banned in certain cities. Check your city's bylaws before listing a property on a website such as Airbnb, VRBO, or HomeAway. And also figure in what additional deep cleaning and sanitizing between guests will add to the costs.
Alternative Real Estate Income Sources
Real estate investment trusts (REITs)s, mortgage-backed securitie(MBSs), mortgage investment corporations (MICs), and real estate investment groups (REIGs) are investment alternatives within the real estate sector. They are generally considered vehicles for deriving real estate income but they have varying processes for doing so and varying processes for entry.
REITs
With a REIT, the owner of multiple commercial properties sells shares (often publicly-traded) to investors (usually to fund the purchase of more properties) and then passes on the rental income in the form of a distribution. The REIT is the landlord for the tenants (who pay rent) but the owners of the REIT record income once the expenses of operating the buildings and the REIT are taken out. There's a special method to assessing a REIT.
MBSs, MICs, and REIGs
These are even a further step removed, as they invest in private mortgages rather than the underlying properties. MICs are different from MBSs in that they hold entire mortgages and pass on the interest from payments to investors, rather than securitizing portions of principal and/or interest. Still, both are not so much real estate investments as they are debt investments. REIGs are usually private investments with their own unique structuring, offering investors equity investments or partnership servicing.
Several credible real estate alternatives are available for making money in the sector but they come with varying caveats and entry points.
Other Ways to Invest in Real Estate
One option is an informal residential real estate option, which requires that you pay a fee, or premium, to have the right to buy a house for a specified period for an agreed-upon price. You then find investors who will pay more than your option price for the property. In this case, the premium you get is essentially a finder's fee for matching a person looking for an investment with a person looking to sell—no different than a real estate agent's commission, really. Although this is income, it doesn't come from owning (i.e. holding the deed to) a piece of real estate.
Other options include:
Short sales—this involves purchasing a home from a lender when the mortgagee is behind on payments. Short sales can be a time-consuming and complicated proposition. Lease options—these are what the name implies. When you lease with an option to buy in a bull real estate market, where prices are rising, you may be able to complete the purchase later at a lower, pre-set price, or make a profit by selling your purchase rights. Contract flipping—instead of flipping houses, this type of flipping involves the transfer of the rights of a purchase contract to another buyer. If you can locate distressed sellers and motivated buyers and bring them together, you may be able to make a profit this way.
The Bottom Line
There are several proven strategies for making money in real estate. Appreciation, inflation, and income rank high on the list but several alternative real estate investments also exist. Understanding your investments, risks, and whether the overall process is worth it or not is up to you.
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339e29176206823b58ea4a28d72d30b3 | https://www.investopedia.com/articles/mortgages-real-estate/11/valuing-real-estate.asp | How to Value Real Estate Investment Property | How to Value Real Estate Investment Property
The methods for analyzing the value of a real estate investment are analogous to those used in the fundamental analysis of stocks. Because real estate investment is typically not a short-term trade, analyzing the cash flow, and the subsequent rate of return, is critical to achieving the goal of making profitable investments. To profit, investors must know how to value real estate and make educated guesses about how much profit each will make, whether through property appreciation, rental income, or both. Accurate real estate valuations can help investors make better decisions when it comes to buying and selling properties.
Key Takeaways Real estate valuation is a process that determines the economic value of a real estate investment. The capitalization rate is a key metric for valuing an income-producing property. Net operating income (NOI) measures an income-producing property's profitability before adding costs for financing and taxes. The two key real estate valuation methods include discounting future NOI and the gross income multiplier model. On the downside, because the property markets are less liquid and transparent than the stock market, it can be difficult to obtain the necessary information.
Equity valuation is typically conducted through two basic methodologies: absolute value and relative value. The same is true for real estate property valuation.
Discounting future net operating income (NOI) by the appropriate discount rate for real estate is similar to discounted cash flow (DCF) valuations for stock. Meanwhile, integrating the gross income multiplier model in real estate is comparable to relative value valuations with stocks. Below, we'll take a look at how to value a real estate property using these methods.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
The Capitalization Rate
One of the most important assumptions a real estate investor makes when performing real estate valuations is to choose an appropriate capitalization rate, also known as the cap rate.
The capitalization rate is the required rate of return on real estate, net of value appreciation, or depreciation. Put simply, it is the rate applied to NOI to determine the present value of a property.
For example, assume a property is expected to generate NOI of $1 million over the next ten years. If it were discounted at a capitalization rate of 14%, the market value of the property would be:
$ 7 , 1 4 2 , 8 5 7 ( $ 1 , 0 0 0 , 0 0 0 0 . 1 4 ) where: \begin{aligned}&\$7,142,857\bigg(\frac{\$1,000,000}{0.14}\bigg)\\&\textbf{where:}\\&\text{Market value}=\text{Net operating income}/{\text{cap rate}}\end{aligned} $7,142,857(0.14$1,000,000)where:
The $7,142,857 market value is a good deal if the property sells at $6.5 million. But, it is a bad deal if the sale price is $8 million.
Determining the capitalization rate is one of the key metrics used to value an income-generating property. Although it is somewhat more complicated than calculating the weighted average cost of capital (WACC) of a firm, there are several methods that investors can use to find an appropriate capitalization rate, including the following:
Build-up method Market-extraction method Band-of-investment method
The Build-Up Method
One common approach to calculating the cap rate is the build-up method. Start with the interest rate and add the:
Appropriate liquidity premium—arises due to the illiquid nature of real estate Recapture premium—accounts for net land appreciation Risk premium—reveals the overall risk exposure of the real estate market
Given a 6% interest rate, a 1.5% non-liquidity rate, a 1.5% recapture premium, and a 2.5% rate of risk, the capitalization rate of an equity property is 11.5% (6% + 1.5% + 1.5% + 2.5%). If net operating income is $200,000, the market value of the property is $1,739,130 ($200,000 / 0.115).
It is very straightforward to perform this calculation. However, the complexity lies in assessing accurate estimates for the individual components of the capitalization rate, which can be a challenge. The advantage of the build-up method is that it attempts to define and accurately measure individual components of a discount rate.
The Market-Extraction Method
The market-extraction method assumes that there is current, readily available NOI and sale price information on comparable income-generating properties. The advantage of the market-extraction method is that the capitalization rate makes the direct income capitalization more meaningful.
It is relatively simple to determine the capitalization rate. Assume an investor might buy a parking lot expected to generate $500,000 in NOI. In the area, there are three existing comparable income-producing parking lots:
Parking lot 1 has NOI of $250,000 and a sale price of $3 million. The capitalization rate is 8.33% ($250,000 / $3,000,000). Parking lot 2 has NOI of $400,000 and a sale price of $3.95 million. The capitalization rate is 10.13% ($400,000 / $3,950,000). Parking lot 3 has NOI of $185,000 and a sale price of $2 million. The capitalization rate is 9.25% ($185,000 / $2,000,000).
Taking the average cap rates for these three comparable properties an overall capitalization rate of 9.24% would be a reasonable representation of the market. Using this capitalization rate, an investor can determine the market value of the property they're considering. The value of the parking lot investment opportunity is $5,411,255 ($500,000 / 0.0924).
The Band-of-Investment Method
With the band-of-investment method, the capitalization rate is computed using individual rates of interest for properties that use both debt and equity financing. The advantage of this method is that it is the most appropriate capitalization rate for financed real estate investments.
The first step is to calculate a sinking fund factor. This is the percentage that must be set aside each period to have a certain amount at a future point in time. Assume that a property with NOI of $950,000 is 50% financed, using debt at 7% interest to be amortized over 15 years. The rest is paid for with equity at a required rate of return of 10%. The sinking fund factor would is calculated as:
S F F = i ( 1 + i ) n − 1 where: SFF = Sinking fund factor i = Periodic interest rate, often expressed as an i = annual percentage rate \begin{aligned}&SFF=\frac{i}{(1+i)^n-1}\\&\textbf{where:}\\&\text{SFF}=\text{Sinking fund factor}\\&i=\text{Periodic interest rate, often expressed as an}\\&\phantom{i=}\text{annual percentage rate}\\&n=\text{Number of periods, often expressed in years}\end{aligned} SFF=(1+i)n−1iwhere:SFF=Sinking fund factori=Periodic interest rate, often expressed as ani=annual percentage rate
Plugging in the numbers, we get:
0.07 / (1 + 0.07)15 – 1
This computes to 3.98%. The rate at which a lender must be paid equals this sinking fund factor plus the interest rate. In this example, this comes out to 10.98% (0.07 + 0.0398).
Thus, the weighted average rate, or the overall capitalization rate, using the 50% weight for debt and 50% weight for equity is:
10.49% [(0.5 x 0.1098) + (0.5 x 0.10)]
As a result, the market value of the property is:
$9,056,244 ($950,000 / 0.1049)
1:55 How To Value A Real Estate Investment Property
Valuation Methods
Absolute valuation models determine the present value of future incoming cash flows to obtain the intrinsic value of an asset. The most common methods are the dividend discount model (DDM) and discounted cash flow (DCF) techniques.
On the other hand, relative value methods suggest that two comparable securities should be similarly priced according to their earnings. Ratios such as price-to-earnings (P/E) and price-to-sales are compared to other companies within the same industry to determine whether a stock is under or over-valued.
As in equity valuation, real estate valuation analysis should implement both procedures to determine a range of possible values.
Discounting Future NOI
The formula for calculating real estate value based on discounted net operating income is:
Market Value = N O I 1 r − g = N O I 1 R where: N O I = Net operating income r = Required rate of return on real estate assets g = Growth rate of N O I \begin{aligned}&\text{Market Value}=\frac{NOI_1}{r-g}=\frac{NOI_1}{R}\\&\textbf{where:}\\&NOI=\text{Net operating income}\\&r=\text{Required rate of return on real estate assets}\\&g=\text{Growth rate of }NOI\\&R=\text{Capitalization rate }(r-g)\end{aligned} Market Value=r−gNOI1=RNOI1where:NOI=Net operating incomer=Required rate of return on real estate assetsg=Growth rate of NOI
NOI reflects the earnings that the property will generate after factoring in operating expenses—but before the deduction of taxes and interest payments. However, before deducting expenses, the total revenues gained from the investment must be determined.
Expected rental revenue can initially be forecast based on comparable properties nearby. With proper market research, an investor can determine what prices tenants are paying in the area and assume that similar per-square-foot rents can be applied to this property. Forecast increases in rents are accounted for in the growth rate within the formula.
Since high vacancy rates are a potential threat to real estate investment returns, either a sensitivity analysis or realistic conservative estimates should be used to determine the forgone income if the asset is not utilized at full capacity.
Operating expenses include those that are directly incurred through the day-to-day operations of the building, such as property insurance, management fees, maintenance fees, and utility costs. Note that depreciation is not included in the total expense calculation. The net operating income of a real estate property is similar to the earnings before interest, taxes, depreciation, and amortization (EBITDA).
Discounting NOI from a real estate investment by the cap rate is analogous to discounting a future dividend stream by the appropriate required rate of return, adjusted for dividend growth. Equity investors familiar with dividend growth models should immediately see the resemblance.
Gross Income Multiplier
The gross income multiplier approach is a relative valuation method that is based on the underlying assumption that properties in the same area will be valued proportionally to the gross income that they help generate.
As the name implies, gross income is the total income before the deduction of any operating expenses. However, vacancy rates must be forecast to obtain an accurate gross income estimate.
For example, if a real estate investor purchases a 100,000-square-foot building, they may determine from comparable property data that the average gross monthly income per square foot in the neighborhood is $10. Although the investor may initially assume that the gross annual income is $12 million ($10 x 12 months x 100,000 sq. feet), there are likely to be some vacant units in the building at any given time.
Assuming there is a 10% vacancy rate, the gross annual income is $10.8 million ($12 million x 90%). A similar approach is applied to the net operating income approach, as well.
The next step to assess the value of the real estate property is to determine the gross income multiplier and multiply it by the gross annual income. The gross income multiplier can be found using historical sales data. Looking at the sales prices of comparable properties and dividing that value by the generated gross annual income produces the average multiplier for the region.
This type of valuation approach is similar to using comparable transactions or multiples to value a stock. Many analysts will forecast the earnings of a company and multiply its earnings per share (EPS) by the P/E ratio of the industry. Real estate valuation can be conducted through similar measures.
Roadblocks to Real Estate Valuation
Both of these real estate valuation methods seem relatively simple. However, in practice, determining the value of an income-generating property with these calculations is fairly complicated. First of all, it may be time-consuming and challenging to obtain the required information regarding all of the formula inputs, such as net operating income, the premiums included in the capitalization rate, and comparable sales data.
Secondly, these valuation models do not properly factor in possible major changes in the real estate market, such as a credit crisis or real estate boom. As a result, further analysis must be conducted to forecast and factor in the possible impact of changing economic variables.
Because the property markets are less liquid and transparent than the stock market, sometimes it is difficult to obtain the necessary information to make a fully informed investment decision.
That said, due to the large capital investment typically required to purchase a large development, this complicated analysis can produce a large payoff if it leads to the discovery of an undervalued property (similar to equity investing). Thus, taking the time to research the required inputs is well worth the time and energy.
The Bottom Line
Real estate valuation is often based on strategies that are similar to equity analysis. Other methods, in addition to the discounted NOI and gross income multiplier approach, are also frequently used. Some industry experts, for example, have an active working knowledge of city migration and development patterns.
As a result, they can determine which local areas are most likely to experience the fastest rate of appreciation. No matter which approach is used, the most important predictor of a strategy's success is how well it is researched.
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d2569aaed6c2a38178c63031e0b834dd | https://www.investopedia.com/articles/mortgages-real-estate/12/playing-hardball-when-selling-your-home.asp | 5 Negotiating Strategies When Selling Your Home | 5 Negotiating Strategies When Selling Your Home
Selling your home is likely one of the biggest financial transactions you’ll undertake in your lifetime, and the price you agree on with a buyer, along with the real estate commissions you pay, will determine how much money you walk away with. These negotiating strategies could put you in the driver’s seat and help you get top dollar in any market.
Key Takeaways One hardball tactic is sticking to your list price in your first counteroffer or even rejecting an offer without making a counteroffer. To foster a sense of competition, you should only accept offers after an open house. When making a counteroffer, put an expiration date on it to force a speedy response. If you agree to pay closing costs, then increase the purchase price.
1. Counter at Your List Price
As a seller, you probably won’t want to accept a potential buyer’s initial bid on your home if it’s below your asking price. Buyers usually expect a back-and-forth negotiation, so their initial offer will often be lower than your list price—but it may also be lower than what they’re actually willing to pay.
At this point most sellers will make a counteroffer with a price that’s higher but still below their list price, because they’re afraid of losing the potential sale. They want to seem flexible and willing to negotiate to close the deal. This strategy does indeed work in terms of getting the property sold, as thousands of sellers can attest, but it’s not necessarily the best way to get top dollar.
Instead of dropping your price, counter by sticking to your listed purchase price. Someone who really wants to buy will remain engaged and come back to you with a higher offer. Assuming that you’ve priced your property fairly to begin with, countering at your list price says that you know what your property is worth and you intend to get the money you deserve.
Buyers may be surprised, and some will be turned off by your unwillingness to negotiate. You do risk having a buyer walk away when you use this strategy. However, you’ll also avoid wasting time on buyers who make lowball offers and won’t close any deal unless they can get a bargain.
A variation on countering at your list price is to counter just slightly below it, conceding by perhaps $1,000. Use this approach when you want to be tough but are afraid that appearing too inflexible will drive away buyers.
2. Reject the Offer
If you’re gutsy enough, you can try a negotiation tactic that’s more extreme than countering at your list price: Reject the buyer’s offer—but don’t counter at all. To keep them in the game, you then ask them to submit a new offer. If they’re really interested, and you haven't turned them off, they will.
This strategy sends a stronger signal that you know your property is worth what you’re asking for it. If the buyer resubmits, they’ll have to make a higher offer—unless they decide to play hardball back and submit the same or even a lower offer.
When you don’t counter, you’re not ethically locked into a negotiation with a particular buyer, and you can accept a higher offer if it comes along. For the buyer, knowing that someone may make a better offer at any moment creates pressure to submit a more competitive offer quickly if they really want the property. This strategy can be particularly useful if the property has only been on the market for a short time or if you have an open house coming up.
3. Try to Create a Bidding War
Speaking of open houses: Make them an integral part of your process. After listing the home on the market and making it available to be shown, schedule an open house for a few days later. Refuse to entertain any offers until after the open house.
Potential buyers will expect to be in competition and may place higher offers as a result. If you get multiple offers, you can go back to the top bidders and ask for their highest and best offers. Of course, the open house may yield only one offer, but the party offering it won’t know that, so you’ll have a psychological edge going forward with counteroffers, etc.
While it is possible to field multiple offers on a home from several buyers simultaneously, it is considered unethical to accept a better offer from a new buyer while in negotiations with any other buyer.
4. Put an Expiration Date on Your Counteroffer
Say a buyer submits an offer that you don’t want to accept, and you counter their offer. You’re then involved in a negotiation with that party, and generally it is considered unethical to accept a better offer from another buyer if one comes along, though it is not illegal.
It is possible, as noted above, to be involved in multiple negotiations with several buyers at the same time. It is the seller’s prerogative to disclose or not disclose this information to the prospective buyers. Disclosure can result in higher offers, but it can also frighten off a buyer. The seller is legally allowed to counter more than one offer at the same time, but they must include appropriate language letting all the parties know of the situation.
In the interest of selling your home quickly, consider putting an expiration date on your counteroffers. This strategy compels the buyer to make a decision, so you can either get your home under contract or move on. Don’t make the deadline so short that the buyer is turned off, but consider making it shorter than the default time frame in your state’s standard real estate contract. If the default expiration is three days, you might shorten it to one or two days.
In addition to closing the deal quickly, there’s another reason to push sellers to make a fast decision. While the counteroffer is outstanding, your home is effectively off the market. Many buyers won’t submit an offer when another negotiation is underway. And if the deal falls through, you’ve added time to the official number of days your home has been on the market. The more days your home is on the market, the less desirable it appears, and the more likely you are to have to lower your asking price to get a buyer.
5. Agree to Pay Closing Costs
It seems like it’s become standard practice for buyers to ask the seller to pay their closing costs. These costs can amount to about 3% of the purchase price and cover what seem to be a lot of frivolous fees. Buyers are often feeling cash-strapped from the down payment, moving expenses, the prospect of redecorating costs—and maybe even from paying the closing costs on the home they sold. Some buyers can’t afford to close the deal at all without assistance for closing costs.
While many buyers don’t have or don’t want to spend extra cash up front to get into the home, they can often afford to borrow a little bit more. If you give them the cash they want for closing costs, the transaction may be more likely to proceed.
When a buyer submits an offer and asks you to pay the closing costs, counter with your willingness to pay but at an increased purchase price, even if it means going above your list price. Buyers sometimes don’t realize that when they ask the seller to pay their closing costs, they’re effectively lowering the home’s sale price. As the seller, of course, you’ll see the bottom line very clearly.
You can increase your asking price by enough to still get as high as your list price after paying the buyer’s closing costs. If your list price is $200,000, and the buyer offers $190,000 with $6,000 toward closing, you would counter with something between $196,000 and $206,000, with $6,000 for closing costs. A catch is that the price plus closing costs must be supported when the home is appraised; otherwise, you’ll have to lower it later to close the deal, because the buyer’s lender won’t approve an overpriced sale.
The Bottom Line
The key to executing these negotiating strategies successfully is that you have to be offering a superior product. The home needs to show well, be in excellent condition, and have something that competing properties do not if you want to have the upper hand in negotiations. If buyers aren’t excited about the property you’re offering, your hardball tactics won’t cause them to up their game. They’ll just walk away.
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7c24424ece2bd9c8723bd96a2742dd3f | https://www.investopedia.com/articles/mutualfund/03/030503.asp | Socially Responsible Mutual Funds | Socially Responsible Mutual Funds
Some people believe that unscrupulous means are sometimes necessary for making gains in a portfolio. However, it is possible to profit while using an ethical investment strategy – and you don't need to join Greenpeace in order to do it. Here we'll take a look at socially responsible investing (SRI) and how you can use socially responsible mutual funds to activate this strategy in your portfolio.
Important The U.S. Department of Labor released a new regulation in late October 2020 that may limit or eliminate socially responsible investing in retirement plans. While the rule was revised to remove explicit references to environmental, social, and governance (ESG) factors, it mandates that fiduciaries of retirement plans choose investment strategies based entirely on how those strategies affect financial performance. This ruling may have a significant impact on funds and investments classified under ESG and socially responsible investing.
What Is Socially Responsible Investing?
A socially responsible investing strategy is one that views successful investment returns and responsible corporate behavior as going hand in hand. SRI investors believe that by combining certain social criteria with rigorous investment standards, they can identify securities that will earn competitive returns and help build a better world.
SRI analysts gather information on industry and company practices and review these in the context of a country's political, economic, and social environment.
Generally, these seven areas are the focus of socially responsible investors:
Corporate governance and ethics Workplace practices Environmental concerns Product safety and impact Human rights Community relations Indigenous peoples' rights
It should be noted that socially responsible investing is essentially interested in promoting adherence to the positive aspects of these areas with publicly-held companies. However, SRI also gets a lot of attention for industries and companies that it opposes as "bad" for society. The latter would include, among others, businesses involved in gambling, tobacco, weapons, and alcohol. These so-called "sinful" investment categories are often eliminated through SRI screening.
What Are Socially Responsible Mutual Funds?
Socially responsible mutual funds hold securities in companies that adhere to social, moral, religious, or environmental beliefs. To ensure the stocks chosen have values that coincide with the fund's beliefs, companies undergo a careful screening process. A socially responsible mutual fund will only hold securities in companies that adhere to high standards of good corporate citizenship.
Because people hold such a wide variety of values and beliefs, fund managers have quite a challenge in determining the stocks that reflect the optimal combination of values for attracting investors. The specific criteria used when screening for stocks all depend on the values and goals of the fund.
For example, funds with a strong sensitivity toward issues of environmental concern will specifically pick stocks in companies that go beyond fulfilling minimal environmental requirements.
Many socially responsible mutual funds will also partition a portion of their portfolios for community investments. A common misconception is that these investments are donations. This is not the case. These investments allow investors to give to a community in need while making a return on their investment. Many community investments are put toward community development banks in developing countries or in lower-income areas in the U. S. for affordable housing and venture capital.
Ownership Is Taken Seriously
Shareholder activism is one of the most important issues for socially responsible funds. SRI funds use their ownership rights to influence management through policy change suggestions. This advocacy is achieved by attending shareholder meetings, filing proposals, writing letters to management, and exercising voting rights.
Because it is difficult for fund shareholders to exercise their votes, voting is achieved by proxy; fund shareholders assign management to vote on their behalf. Most socially responsible mutual funds have a strict policy to maintain transparency in their decisions and disclose all proxy voting policies and procedures to their shareholders.
Proof that individuals can make a difference is illustrated by the proposal the Securities and Exchange Commission (SEC) passed in Jan. 2003, which states that all mutual fund companies must disclose proxy voting policies and procedures and the actual votes to their shareholders. The SEC's decision was brought about by the thousands of proposal requests sent to them by socially responsible investors.
Does Good Triumph Over All?
As an investor, you cannot be completely philanthropic and expect nothing in return for your investment other than that pure feeling of having invested in a company that reflects your own values. So how does the performance of socially responsible mutual funds measure up to that of a regular portfolio? On average, its performance has been close to that of regular mutual funds. There are several indexes that track the performance of stocks considered to be socially responsible investments. According to KLD Indexes, the annualized returns for the MSCI KLD 400 Social Index (initially called the Domini Social 400 Index) between May 1994 (its inception) and June 2018 was 10.01%. Over the past 10 years, the index has delivered a 10.63% annualized return compared to a 10.17% annualized return from the S&P 500.
The Price of Doing Good
Socially responsible mutual funds tend to have higher fees than regular funds. These higher fees can be attributed to the additional ethical research that mutual fund managers must undertake. In addition, socially responsible funds tend to be managed by smaller mutual fund companies and the assets under management are relatively small. Under these circumstances, it is difficult for SRI funds to make use of the economies of scale available to their larger rivals.
Keep a Level Head
Before you let your emotions become your investment advisor, it is wise to maintain a level head. Here are some important tips to follow in order to maximize your chances of earning decent returns and investing in qualified socially responsible funds:
Get Informed – Learn about socially responsible investing, which funds qualify, and where you can buy them. Know Your Values – Everybody's values are different. Some may feel strongly about environmental causes while others are more concerned with social programs. Rank your concerns. Once you have established a few top values, you may narrow your fund choices down to a few select funds whose values closely match your own. Go Beyond Your Values – Research the fundamentals and fees of the funds in which you are interested. Some items to consider include the level of the management expense ratio, the cost of load fees, the fund manager's track record and how the fund has performed over the last few years. There is no need to sacrifice investment quality when considering an SRI fund. Do your homework as you would for any fund investment. Diversify – A consequence of investing in SRI funds is that you may be limiting your investment to a few companies who have a lot in common socially, ethically and financially. Think of a sector fund with a portfolio formed mainly from stocks in the internet industry. If you had all of your eggs in this basket during the internet market crash, all your eggs would have been broken. If your investment is placed strategically in different types of investments, the possibility of losing all of your investment is minimal. If you want to be a socially responsible investor, it is still possible to diversify your portfolio with other stocks, bonds or Treasuries without going against your values. Investing in socially responsible securities with values that differ somewhat from the specific focus of your chosen fund can help.
The Bottom Line
Socially responsible investing opportunities suggest that investors need not compromise their values to make money. If you approach socially responsible mutual funds like any other investment, you may be able to put your money into something that both supports your values and lines your pocketbook.
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08dd128361d735c9a319750201819759 | https://www.investopedia.com/articles/mutualfund/03/061103.asp | The Hidden Differences Between Index Funds | The Hidden Differences Between Index Funds
Index funds, which track an underlying market index have grown in popularity with investors over the years. A fund might track the S&P 500 or Dow Jones Industrial Average, allowing investors to own each of the holdings within those indices.
Although index funds should replicate their respective indices, no fund's performance is guaranteed to be the same as similar funds; nor will a fund necessarily replicate the index it tracks. Although the differences between index funds can be subtle, they can have a major impact on an investor's return over the long term.
Key Takeaways Index funds, which track an underlying market index have grown in popularity with investors over the years.Fees and expenses ratios or operating expenses can vary between index funds and erode an investor's return.An index fund might not track the underlying index or sector exactly causing tracking errors or variances between the fund and the index.Some index funds might only hold a few components, and the lack of diversification can expose investors to risk of losses.
Understanding the Hidden Differences Between Index Funds
An index fund is a type of exchange-traded fund (ETF) that contains a basket of stocks or securities that track the components of an existing financial market index. For example, there are index funds that track the Standard & Poor's 500 Index. Although investors can't buy an index per se, they can invest in index funds that are designed to mirror the index. In other words, an index fund tracking the S&P would have all 500 stocks from the S&P 500 in the fund. Index funds tend to provide investors with broad market exposure or exposure to an overall sector.
As a result, index funds are passive investments, meaning that a portfolio manager is not actively stock picking by buying and selling securities for the fund. Instead, a fund manager selects a combination of assets for a portfolio intended to mimic an index. Because the fund's underlying assets are held and not actively traded, operating expenses are usually lower than actively-managed funds.
At the onset, it might be reasonable that the index fund should track the index with little difference and other funds tracking the same index should all have the same performance. However, a deeper look uncovers numerous disparities across fund types.
Expense Ratios
Perhaps the most distinctive hidden difference between index funds is a fund's operating expenses. These are expressed as a ratio, which represents the percentage of expenses compared to the amount of annual average assets under management.
Investors who invest in index funds should, theoretically, expect lower operating expenses since the fund manager doesn't have to select or manage any securities. However, operating expenses can vary between funds. Expenses are very important to consider when investing since expenses can erode an investor's return.
Consider the following comparison of 10 S&P 500 funds and their expense ratios as of April 2003:
Image by Sabrina Jiang © Investopedia 2020
The different bars in this chart represent different funds. Bear in mind that the yearly return of the S&P 500 as of the end of April 2003 was approximately 5%, taking into specific account that expense ratios range from 0.15% to almost 1.60%. If we assume that the fund tracks the index closely, a 1.60% expense ratio will reduce an investor's return by about 30%.
Fees
Index funds with nearly identical portfolio mixes and investing strategies can have different fee structures. Some index funds charge front-end loads, which are commissions or sales charges applied upfront when the initial purchase of an investment occurs. Other funds charge back-end loads, which are charges and commissions that occur when the investment is sold. Other fees include 12b-1 fees, which are annual distribution or marketing fees for the fund. However, the 12b-1 fee can be charged separately or be embedded within the fund's expense ratio.
The fees, along with the expense ratio, should be considered before buying an index fund. Some funds may appear to be a better buy since they might charge a low expense ratio, but they might charge a back-end load or a 12b-1 fee separately. The fees and expense ratio, when taken cumulatively, can dramatically impact an investor's return over time.
Typically, larger, more established funds, such as the Vanguard 500 Index fund (VFINX) tend to charge lower fees. The lower fees could be the result of management experience in tracking indexes, a larger asset base, which could enhance the ability to use economies of scale in purchasing the securities. Economies of scale are cost savings and advantages reaped by large companies when they can buy in bulk, thus lowering the per-unit cost.
Tracking Errors
Another method for effectively assessing index funds involves comparing their tracking errors and quantifying each fund's deviation from the index it mimics.
Tracking error measures how much divergence occurs between the fund's value and that of the index the fund it's tracking. The tracking error is usually expressed as a standard deviation, which shows how much variance or dispersion exists between the fund's price and the average or mean price for the underlying index. Sizable deviations indicate large inconsistencies between the return of an index fund and the benchmark.
This large divergence could be an indication of poor fund construction, high fees or operating expenses. High costs can cause the return on an index fund to be significantly lower than the index's return, resulting in a large tracking error. As a result, any deviation can create smaller gains and larger losses for the fund.
The figure below compares the S&P 500's return (red), the Vanguard 500 (green), the Dreyfus S&P 500 (blue) and the Advantus Index 500 B (purple). Notice the index fund's divergence from the benchmark increase as expenses increase.
Image by Sabrina Jiang © Investopedia 2020
A Fund's Holdings
Just because a fund says index fund in its name, doesn't necessarily mean it tracks the underlying index or sector exactly. When screening for an index fund, it's important to remember that not all index funds labeled "S&P 500" or "Wilshire 5000" only follow those indexes. Some funds can have divergent management behavior. In other words, a portfolio manager may add stocks to the fund that are similar to what's in the index.
Take for example the Devcap Shared Return fund, which is a socially responsible S&P 500 index fund. As of Jun. 4, 2003, it had an expense ratio of 1.75% and charged a 12b-1 fee of 0.25%. Another fund, the ASAF Bernstein Managed Index 500 B, was categorized as an S&P 500 index fund, but it actually sought to outperform the S&P 500.
Image by Sabrina Jiang © Investopedia 2020
Sector index funds that track a sector in the economy are often open to subjectivity by the investment manager as to what's included in the fund. For example, the SPDR S&P Homebuilders exchange-traded fund (XHB) is known for tracking stocks in the homebuilding industry. An investor buying the fund might assume it contains only homebuilders. However, some holdings are stocks of companies related to the industry. For example, Whirlpool Corporation (WHR), the appliance manufacturer, the home supply store, Home Depot (HD), as well as Aaron's Inc., which is a rent to own furniture retailer, are all included.
Also, if a portfolio manager for an index fund performs additional management services, the fund is no longer passive. In other words, a fund might have the goal to outperform the index, such as the S&P 500, leading to holdings that include companies and securities outside the index being tracked. As a result, funds with these added selling features typically have fees well above average.
It's important for investors to analyze the holdings of an index fund before investing to determine whether it's a true index fund or a fund that has an index-like name.
Lack of Diversification
Within the index fund category, not all funds listed are as diversified as those tracking an index such as the S&P 500. Many index funds have the same properties as focused, value, or sector funds. However, please remember that focused funds tend to hold fewer than 30 stocks or assets within the same sector. The lack of diversification in sector funds can expose investors to higher risk than a fund tracking the S&P 500, which is comprised of 500 companies within various sectors of the economy.
Special Considerations
Careful investigation of index funds before buying includes making sure that are little-to-no tracking errors and that fees and expenses ratios are low. Also, it's important to understand the investment manager's goal for the index fund and what holdings or investments are included in order to reach that goal. If the goal is considered aggressive, the fund's investments might deviate from the underlying index.
The need to consider fees becomes even more important relative to increased risk factors—fees reduce the amount of return received for the risks taken. Consider the following comparison of Dow 30 index funds:
Image by Sabrina Jiang © Investopedia 2020
An investor's risk tolerance and time horizon can impact the choice of investments. A retiree would likely seek index funds that are conservative or low risk since the goal might be to maintain the portfolio and provide income. A millennial, on the other hand, might choose a fund that has a more aggressive investment strategy designed to offer growth since the millennial has more time to make up for any market downturns. Risk tolerance and time horizon are both important considerations when it comes to choosing an index fund.
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e4cf7b4ccb66806b2585be4920c4a8b3 | https://www.investopedia.com/articles/mutualfund/05/062705.asp | An Inside Look at ETF Construction | An Inside Look at ETF Construction
How Is an ETF Created?
Some people are happy to use a range of devices like wristwatches and computers, and trust that things will work out. Others want to know the inner workings of the technology they use and understand how it was built. If you fall into the latter category and as an investor have an interest in the benefits that exchange-traded funds (ETFs) offer, you'll definitely be interested in the story behind their construction.
In a sense, ETF are similar to mutual funds. However, ETFs offer lots of benefits that mutual funds don't. With ETFs, investors can enjoy the benefits associated with this unique and attractive investment product without even being aware of the complicated series of events that make it work. But, of course, knowing how those events work makes you a more educated investor, a key to being a better investor.
Understanding How an ETF is Created
An ETF has many advantages over a mutual fund, including costs and taxes. The creation and redemption process for ETF shares is almost the exact opposite of that for mutual fund shares.
Key Takeaways Exchange-traded funds (ETFs) are similar to mutual funds, though they offer some benefits mutual funds don't. The ETF creation process begins when a prospective ETF manager (known as a sponsor) files a plan with the U.S. Securities and Exchange Commission to create an ETF. The sponsor then forms an agreement with an authorized participant, generally a market maker, specialist, or large institutional investor. The authorized participant borrows stock shares, places those shares in a trust, and uses them to form ETF creation units—bundles of stock varying from 10,000 to 600,000 shares. The trust provides shares of the ETF, which are legal claims on the shares held in the trust (the ETFs represent tiny slivers of the creation units), to the authorized participant. Once the authorized participant receives the ETF shares, they are sold to the public on the open market just like stock shares.
When investing in mutual funds, investors send cash to the fund company, which then uses that cash to purchase securities, and in turn, issues additional shares of the fund. When investors wish to redeem their mutual fund shares, they are returned to the mutual fund company in exchange for cash. Creating an ETF, however, does not involve cash.
The process begins when a prospective ETF manager (known as a sponsor) files a plan with the U.S. Securities and Exchange Commission to create an ETF. Once the plan is approved, the sponsor forms an agreement with an authorized participant, generally a market maker, specialist, or large institutional investor, who is empowered to create or redeem ETF shares. In some cases, the authorized participant and the sponsor are the same.
The authorized participant borrows stock shares, often from a pension fund, places those shares in a trust, and uses them to form ETF creation units. These are bundles of stock varying from 10,000 to 600,000 shares, but 50,000 shares are what is commonly designated as one creation unit of a given ETF.
Then, the trust provides shares of the ETF, which re legal claims on the shares held in the trust (the ETFs represent tiny slivers of the creation units), to the authorized participant. Because this transaction is an in-kind trade—that is, securities are traded for securities—there are no tax implications.
Once the authorized participant receives the ETF shares, they are sold to the public on the open market just like stock shares.
When ETF shares are bought and sold on the open market, the underlying securities that were borrowed to form the creation units remain in the trust account. The trust generally has little activity beyond paying dividends from the stock held in the trust to the ETF owners and providing administrative oversight.
This is because the creation units are not impacted by the transactions that take place on the market when ETF shares are bought and sold.
Redeeming an ETF
When investors want to sell their ETF holdings, they can do so by one of two methods. The first is to sell the shares on the open market. This is generally the option chosen by most individual investors. The second option is to gather enough shares of the ETF to form a creation unit, and then exchange the creation unit for the underlying securities.
This option is generally only available to institutional investors due to a large number of shares required to form a creation unit. When these investors redeem their shares, the creation unit is destroyed, and the securities are turned over to the redeemer. The beauty of this option is in its tax implications for the portfolio.
We can see these tax implications best by comparing the ETF redemption to that of a mutual fund redemption. When mutual fund investors redeem shares from a fund, all shareholders in the fund are affected by the tax burden.
This is because to redeem the shares, the mutual fund may have to sell the securities it holds, realizing the capital gain, which is subject to tax. Also, all mutual funds are required to pay out all dividends and capital gains on a yearly basis.
Therefore, even if the portfolio has lost value that is unrealized, there is still a tax liability on the capital gains that had to be realized because of the requirement to pay out dividends and capital gains.
ETFs minimize this scenario by paying large redemptions with stock shares. When such redemptions are made, the shares with the lowest cost basis in the trust are given to the redeemer.
This increases the cost basis of the ETF's overall holdings, minimizing its capital gains. It doesn't matter to the redeemer that the shares it receives have the lowest cost basis because the redeemer's tax liability is based on the purchase price it paid for the ETF shares, not the fund's cost basis.
When the redeemer sells the stock shares on the open market, any gain or loss incurred has no impact on the ETF. In this manner, investors with smaller portfolios are protected from the tax implications of trades made by investors with large portfolios.
The Role of Arbitrage
Critics of ETFs often cite the potential for ETFs to trade at a share price that is not aligned with the underlying securities' value. To help us understand this concern, a simple representative example best tells the story.
Assume an ETF is made up of only two underlying securities:
Security X, which is worth $1 per share Security Y, which is also worth $1 per share
In this example, most investors would expect one share of the ETF to trade at $2 per share (the equivalent worth of Security X and Security Y). While this is a reasonable expectation, it is not always the case. The ETF can trade at $2.02 per share or $1.98 per share or some other value.
If the ETF is trading at $2.02, investors are paying more for the shares than the underlying securities are worth. This would seem to be a dangerous scenario for the average investor, but in reality, this sort of divergence is more likely in fixed-income ETFs that, unlike equity funds, are invested in bonds and papers with different maturities and characteristics. Also, it isn't a major problem because of arbitrage trading.
The ETF's trading price is established at the close of business each day, just like any other mutual fund. ETF sponsors also announce the value of the underlying shares daily. When the ETF's price deviates from the underlying shares' value, the arbitrageurs spring into action. The arbitrageurs' actions set the supply and demand of the ETFs back into equilibrium to match the value of the underlying shares.
Because ETFs were used by institutional investors long before the investing public discovered them, active arbitrage among institutional investors has served to keep ETF shares trading at a range close to the underlying securities' value.
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630ee20023289385c90247dacb0d8737 | https://www.investopedia.com/articles/mutualfund/05/062805.asp | Evaluating Bond Funds For Performance and Risks | Evaluating Bond Funds For Performance and Risks
When it comes to bond funds, knowing what information is most important can be confusing regardless of whether you are looking at a research service like Morningstar or a mutual fund company's website or prospectus.
As an example, we'll use these factors to compare two of the industry's largest bond funds: PIMCO Total Return Fund (PTTRX) and Vanguard Total Bond Market Index Fund (VBMFX). The first represents the extreme of active management while the latter represents the extreme of passive management. Barclays Capital Aggregate Bond Index is the benchmark for both of these funds.
Key Takeaways Bond mutual funds are a great way to hold a diversified portfolio of fixed-income securities, which can provide a steady flow of interest income with lower relative risk than stocks in general.While more conservative, bond funds still have to be evaluated in terms of risk and return, with several unique risk factors applicable to bond investing.Interest rates, credit events, geo-political risk, and liquidity issues are all of interest to investors of bond funds.Investors should also be cognizant of the fees and potential taxable events generated by owning an actively-managed bond portfolio.
Understanding a Bond Fund's Risks
Understanding the risk of a bond fund should, of course, be a high priority in your analysis. There are many types of risks associated with bonds. Here, for example, are some of the risks the prospectus for the PTTRX lists: interest rate, credit, market, liquidity, foreign investment (or country) risk, foreign exchange risk, leverage, and management risk. But before you conclude bonds are no longer a safe investment, remember most domestic investment-grade bond funds are sufficiently diversified against these kinds of risks, with interest rate risk being the main exception.
Interest Rate Risks
Bond fund returns are highly dependent on the changes in general interest rates; that is, when interest rates increase, the value of bonds decreases, which in turn affects bond fund returns. To understand interest rate risk, you must understand duration.
Duration, in the simplest terms, is a measure of a bond fund's sensitivity to interest rate changes. The higher the duration, the more sensitive the fund. For example, a duration of 4.0 means a 1% interest rate rise causes about a 4% drop in the fund. Duration is considerably more complex than this explanation, but when comparing one fund's interest rate risks to another, duration offers a good starting point.
As an alternative to duration, weighted average maturity (WAM), also known as "average effective maturity," is an easier metric to comprehend. WAM is the weighted average time to maturity of the bonds in the portfolio expressed in years. The longer the WAM, the more sensitive the portfolio will be to interest rates. However, WAM is not as useful as duration, which gives you a precise measurement of interest sensitivity, while WAM gives you only an approximation.
Credit Risks
Given the amount of U.S. Treasuries and mortgage-backed securities in the Barclays Capital Aggregate Bond Index, most bond funds benchmarked against this index will have the highest credit rating of AAA.
Although most bond funds diversify credit risk well enough, the weighted average credit rating of a bond fund will influence its volatility. While lower-credit-quality bonds bring higher yields, they also bring higher volatility.
Bonds that are not investment grade, also known as junk bonds, are not part of the Lehman Aggregate Bond Index or most investment-grade bond funds. However, as PTTRX is allowed to have up to 10% of its portfolio in non-investment-grade bonds it could end up being more volatile than your average bond fund.
Additional volatility is not only found in junk bonds. Bonds rated as investment-grade can sometimes trade like junk bonds. This is because rating agencies, such as Standard & Poor's (S&P) and Moody's, can be slow to downgrade issuers because of their agency conflicts (the ratings agency's revenue comes from the issuer they are rating).
Many research services and mutual funds use style boxes to help you initially see a bond fund's interest rate and credit risk. The funds being compared—PTTRX and VBMFX—both have the same style box, shown below.
Figure 1 - Vertical axis represents credit quality.
Foreign Exchange Risk
Another cause of volatility in a bond fund is foreign currency exposure. This is applicable when a fund invests in bonds not denominated in its domestic currency. As currencies are more volatile than bonds, currency returns for a foreign currency bond can end up dwarfing its fixed-income return. The PTTRX, for example, allows up to 30% foreign currency exposure in its portfolio. To reduce the risk this poses, the fund hedges at least 75% of that foreign currency exposure. Just as with non-investment-grade exposure, foreign currency exposure is the exception, not the rule, for bond funds benchmarked against Barclays Capital Aggregate Bond Index.
Return
Unlike stock funds, past absolute performance for bond funds will likely give little or no indication of their future returns because the interest rate environment is forever changing. Instead of looking at historical returns, you are better off analyzing a bond fund's yield to maturity (YTM), which will give you an approximation of the bond fund's projected annualized return over WAM.
When analyzing the return of a bond fund, you should look also at the different fixed income investments the fund holds. Morningstar segments bond funds into 12 categories, each with its own risk-return criteria. Rather than trying to understand the differences between these categories, look for a bond fund that holds material portions of these five fixed-income categories:
Government CorporateInflation-protected securitiesMortgage-backed securities Asset-backed securities
Because these bond types have different interest rate and credit risks, they complement each other, so a mixture of them helps the risk-adjusted return of a bond fund.
For example, the Barclays Capital Aggregate Bond Index does not hold material weightings in inflation-protected securities and asset-backed securities. Therefore, an enhanced risk-return profile could likely be found by adding them into a bond fund. Unfortunately, most bond indexes mimic the capitalization of their market rather than focusing on an optimum risk-return profile.
Understanding the makeup of your fixed-income benchmark can make evaluating bond funds easier, as the benchmark and the fund will have similar risk-return characteristics. For the retail investor, index characteristics can be tough to find; however, if there is a corresponding bond exchange-traded fund (ETF), you should be able to find the applicable index information through the ETF's website. Since the goal of an ETF is to minimize tracking error against its benchmark, its makeup should be representative of its benchmark.
Costs
While the above analysis gives you a feel for the absolute return of a bond fund, costs will have a big impact on its relative performance, particularly in a low interest rate environment. Adding value above the expense ratio percentage can be a difficult hurdle for an active bond manager to overcome, but passively managed bond funds can really add value here because of their lower expenses. The VBMFX, for example, has an expense ratio of only 0.2%, which takes a smaller chunk out of your returns. Also, look out for front- and back-end loads, which, for some bond funds, can be devastating to returns.
Because bond funds are constantly maturing and being called and intentionally traded, bond funds tend to have higher turnover than stock funds. However, passively managed bond funds tend to have lower turnover than actively managed funds and, therefore, may provide better value.
The Bottom Line
Evaluating bond funds does not have to be complex. You need only to focus on a few factors giving insight into risk and return, which will then give you a feel for the fund's future volatility and return.
Unlike stocks, bonds are black and white: you hold a bond to maturity and you know exactly what you get (barring default). Bond funds are not quite as simple because of the absence of a fixed maturity date, but you can still get an approximation of returns by looking at the YTM and WAM.
The biggest difference between the two funds comes down to fees. In a low interest rate environment, this difference is even further accentuated. The addition of non-investment-grade bonds and unhedged currency in the PTTRX will likely increase its volatility, while higher turnover will also increase its trading costs when compared to VBMFX.
Armed with an understanding of these metrics, evaluating bond funds should be far less intimidating.
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e47da4aa0a15cb6ae2402d87400a3533 | https://www.investopedia.com/articles/mutualfund/05/etfindexfund.asp | ETFs vs. Index Funds: What's the Difference? | ETFs vs. Index Funds: What's the Difference?
ETFs vs. Index Funds: An Overview
Exchange-traded funds (ETFs) have become increasingly popular since its inception in 1993. But despite investors' love affair with ETFs, a closer look shows that index funds are still the top choice for the majority of retail index investors. Here we will look at the reasons why ETFs have become so popular and analyze whether they make sense—from a cost, size, and time-horizon standpoint—as an alternative to index funds.
As with many financial decisions, determining which investment vehicle to commit to comes down to the numbers. Given the comparison of costs, the average passive retail investor will decide to go with index funds. For these investors, keeping it simple can be the best policy. Passive institutional investors and active traders, on the other hand, will likely be swayed by qualitative factors in making their decision. Be sure you know where you stand before you commit.
Key Takeaways Because ETFs are flexible investment vehicles, they appeal to a broad segment of the investing public. Passive retail investors often choose index funds for their simplicity and low cost to own. Typically, the choice between ETFs and index funds will come down to management fees, shareholder transaction costs, taxation, and other qualitative differences.
ETFs
Because ETFs are flexible investment vehicles, they appeal to a broad segment of the investing public. Passive investors and active traders alike find ETFs attractive.
Passive institutional investors love ETFs for their flexibility. Many see them as a great alternative to futures. For example, ETFs can be purchased in smaller sizes. They also don't require special documentation, special accounts, rollover costs, or margin. Furthermore, some ETFs cover benchmarks where there are no futures contracts.
Active traders, including hedge fund traders, love ETFs for their convenience because they can be traded as easily as stocks. This means they have margin and trading flexibility that is unmatched by index funds. Ironically, ETFs are exempt from the short sale uptick rule that plagues regular stocks (the short sale uptick rule prevents short sellers from shorting a stock unless the last trade resulted in a price increase).
Index Funds
Passive retail investors, for their part, will love index funds for their simplicity. Investors do not need a brokerage account or deposit with index funds. They can usually be purchased through the investor's bank. This keeps things simple for investors, a consideration that the investment advisory community continues to overlook.
2:01 ETFs Vs Index Funds: Quantifying The Differences
Key Differences
ETFs and index funds each have their own particular advantages and disadvantages when it comes to costs associated with index tracking (the ability to track the performance of their respective index) and trading. The costs involved in tracking an index fall into three main categories. A direct comparison of how these costs are handled by ETFs and by index funds should help you make an informed decision when choosing between the two investment vehicles.
First, the constant rebalancing that occurs with index funds because of daily net redemptions results in explicit costs in the form of commissions and implicit costs in the form of bid-ask spreads on the subsequent underlying fund trades. ETFs have a unique process called creation/redemption in-kind (meaning shares of ETFs can be created and redeemed with a like basket of securities) that avoids these transaction costs.
Second, a look at cash drag—which can be defined for index funds as the cost of holding cash to deal with potential daily net redemptions—favors ETFs once again. ETFs do not incur this degree of cash drag because of their aforementioned creation/redemption in-kind process.
Third, dividend policy is one area where index funds have a clear advantage over ETFs. Index funds will invest their dividends immediately, whereas the trust nature of ETFs requires them to accumulate this cash during the quarter until it is distributed to shareholders at end-of-quarter. If we were to return to a dividend environment like that seen in the 1960s and 1970s, this cost would certainly become a bigger issue.
Non-tracking costs can also be divided into three categories: management fees, shareholder transaction costs, and taxation. First, management fees are generally lower for ETFs because the fund is not responsible for the fund accounting (the brokerage company will incur these costs for ETF holders). This is not the case with index funds.
Second, shareholder transaction costs are usually zero for index funds, but this is not the case for ETFs. In fact, shareholder transaction costs are the biggest factor in determining whether or not ETFs are right for an investor. With ETFs, shareholder transaction costs can be broken down into commissions and bid-ask spreads. The liquidity of the ETF, which in some cases can be material, will determine the bid-ask spread.
Finally, the taxation of these two investment vehicles favors ETFs.
In nearly all cases, the creation/redemption in-kind feature of ETFs eliminates the need to sell securities; with index mutual funds, it is that need to sell securities that trigger tax events.
ETFs can rid themselves of capital gains inherent in the fund by transferring out the securities with the highest unrealized gains as part of the redemption in-kind process.
Special Considerations
Typically, the choice between ETFs and index funds will come down to the most important issues: management fees, shareholder transaction costs, taxation, and other qualitative differences.
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6da85120eb260b4ca8850120a53332c1 | https://www.investopedia.com/articles/mutualfund/05/etfstrategy.asp | 4 Ways to Use ETFs in Your Portfolio | 4 Ways to Use ETFs in Your Portfolio
Exchange traded funds (ETFs) are an investing innovation that combine the best features of index mutual funds with the trading flexibility of individual securities. ETFs offer diversification, low expense ratios and tax efficiency in a flexible investment that can be adapted to suit many objectives. However, in order to reap the true benefits of investing in ETFs, you need to use them strategically.
1. Index Investing with ETFs
From a strategic standpoint, the first and most obvious use of ETFs is as a tool to invest in broad market indexes. On the equity side, there are ETFs that mirror the S&P 500, the Nasdaq 100, the Dow Jones Industrial Average (DJIA) and just about every other major market index. On the fixed-income front, there are ETFs that track a variety of long-term and short-term bond indexes including the Lehman 1-3 Year Treasury, the Lehman 20-Year Treasury and the Lehman Aggregate Bond Index.
Using ETFs to cover the major market sectors, you can quickly and easily assemble a low-cost, broadly diversified index portfolio. With just two or three ETFs, you can create a portfolio that covers nearly the entire equity market and a large portion of the fixed-income market. Once the trades are complete, you can simply stick to a buy-and-hold strategy, as you would with any other index product, and your portfolio will move in tandem with its benchmark.
2. Actively Managing a Longer-Term Portfolio with ETFs
In a similar fashion, you can create a broadly diversified portfolio but choose an active management strategy instead of simply buying and holding to track the major indexes (which is passive management). While the ETFs themselves are index funds (meaning there is no active management on the part of the money manager overseeing the portfolio), this doesn't stop investors from actively managing their holdings. For example, say you believe that short-term bonds are set for a meteoric rise; you could sell your position(s) in the broader bond market and instead buy an ETF that specializes in short-term issues – you could also do the same for your expectations for equities.
Of course, the major market indexes represent only a portion of the many investment opportunities that ETFs provide. If your core portfolio is already in place, you can augment your core holdings with more specialized ETFs, which provide entry into a wide array of small-cap, sector, commodity, international, emerging-market and other investing opportunities. There are ETFs that track indexes in just about every area, including biotechnology, healthcare, REITs, gold, Japan, Spain and more.
By adding small positions in these niche holdings to your asset allocation, you add a more aggressive supplement to your portfolio. Once again, you can buy and hold to create a long-term portfolio, but you can use more active trading techniques too. For example, if you think REITs are poised to take a tumble and gold is set to rise, you can trade out of your REIT position and into gold in a matter of moments at any time during the trading day.
3. Active Trading with ETFs
If actively managing a long-term portfolio isn't spicy enough for your tastes, ETFs may still be the right flavor for your palette. While long-term investors might eschew active- and day-trading strategies, ETFs are the perfect vehicle if you are looking for a way to move frequently into and out of an entire market or a particular market niche. Since ETFs trade intraday, like stocks or bonds, they can be bought and sold rapidly in response to market movements, and unlike many mutual funds, ETFs impose no penalties when you sell them without holding them for a set period of time.
While it is true that you must pay a commission each time you trade ETFs, if you are aware of this cost and the dollar value of your trade is high enough, it is nominal.
Also, because ETFs trade intraday, they can be bought long or sold short, used in hedge strategies and bought on margin. If you can think of a strategy that can be implemented with a stock or bond, that strategy can be applied with an ETF – but instead of trading the stock or bond issued by a single company, you are trading an entire market or market segment.
4. Wrap Investing with ETFs
For investors who prefer fee-based investments as opposed to commission-based trading, ETFs are also part of various wrap programs. While ETF wrap products are still in their infancy, it's a safe bet that more are coming soon.
The Bottom Line
Overall, ETFs are convenient, cost efficient, tax efficient and flexible. They are easy to understand and easy to use, and they are gaining in popularity at such a rapid pace that some experts anticipate that they will one day surpass the popularity of mutual funds. If ETFs haven't found a place in your portfolio yet, there is a pretty good chance that they will in the future.
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1e801a467542dd5ac36f9e76a75f9205 | https://www.investopedia.com/articles/mutualfund/05/mfhistory.asp | A Brief History of the Mutual Fund | A Brief History of the Mutual Fund
Mutual funds didn't really capture the attention of American investors until the 1980s and 1990s, when investors in them hit record highs and realized incredible returns. They are now mainstream investments and form the core of individual retirement accounts. However, the idea of pooling assets for investment purposes has been around for centuries.
Key Takeaways The first modern mutual fund was launched in the U.S. in 1924. The oldest mutual fund still in existence is the Vanguard Wellington Fund, established in 1929. The exchange-traded fund, a modern variation, has taken the market by storm since the Great Recession of 2007–2009.
Here we look at the evolution of this investment vehicle, from its beginnings in the Netherlands in the 19th century to its status as a global industry, with fund holdings accounting for trillions of dollars in the U.S. alone.
The First Mutual Funds
Historians are uncertain of the origins of investment funds, although many look to the Dutch as the early innovators who created the first closed-end investment companies.
Subhamoy Das, in his economics textbook "Perspectives on Financial Services," traces an early appearance of the mutual fund to Dutch merchant Adriaan van Ketwich, who created an investment trust in 1774. "Van Ketwich probably believed that diversification would appeal to investors with minimal capital. The name of van Ketwich's fund, Eendragt Maakt Magt, translates into 'unity creates strength,'" the book explains.
Other examples followed, including an investment trust launched in Switzerland in 1849 and similar vehicles formed in Scotland in the 1880s.
U.S. Innovations
The idea of pooling resources and spreading risk using closed-end investments found its way to the U.S. by the 1890s. The Boston Personal Property Trust, formed in 1893, was the first closed-end fund in the U.S. According to Collins Advisors, the investments were primarily in real estate and the vehicle might today be described as a hedge fund rather than a mutual fund.
The creation of the Alexander Fund in Philadelphia in 1907 was an important step toward what we know as the modern mutual fund. The Alexander Fund featured semiannual issues and allowed investors to make withdrawals on demand.
The Arrival of the Modern Fund
The creation of the Massachusetts Investors' Trust in Boston marked the arrival of the modern mutual fund in 1924, according to Bianco Research. The fund was opened to investors in 1928, eventually spawning the mutual fund firm known today as MFS Investment Management. State Street Investors' Trust was the custodian of the Massachusetts Investors' Trust.
$4 Trillion The estimated total amount currently invested in exchange traded funds.
The year 1929 saw the launch of the Wellington Fund, which was the first mutual fund to include stocks and bonds. The Vanguard Wellington Fund is still in existence today and claims to be America's oldest balanced fund.
Regulation and Expansion
By 1929, there were 19 open-ended mutual funds competing with nearly 700 closed-end funds. With the stock market crash of 1929, the dynamic began to change as highly leveraged closed-end funds were wiped out and small open-end funds survived.
Government regulators also began to take notice of the fledgling mutual fund industry. The creation of the Securities and Exchange Commission (SEC), the passage of the Securities Act of 1933, and the enactment of the Securities Exchange Act of 1934 all were designed to safeguard investors from unscrupulous or reckless operators. Mutual funds are now required to register with the SEC and to provide full disclosure of their holdings and performance in the form of a prospectus.
The Investment Company Act of 1940 put in place additional regulations that require more disclosures and minimize conflicts of interest.
The mutual fund industry continued to expand. At the beginning of the 1950s, the number of open-end funds topped 100. In 1954, the financial markets finally overcame their pre-1929 crash peak, and the mutual fund industry began to grow in earnest, adding some 50 new funds over the course of the decade.
Hundreds of new funds were launched throughout the 1960s although the bear market of 1969 cooled the public appetite for mutual funds for some time. Money flowed out of mutual funds as quickly as investors could redeem their shares, but the industry's growth later resumed.
Recent Developments in Mutual Funds
In 1971, William Fouse and John McQuown of Wells Fargo established the first index fund, a concept that John Bogle would use as a foundation on which to build The Vanguard Group, a mutual fund powerhouse renowned for low-cost index funds.
The 1970s also saw the rise of the no-load fund. This lower-cost investing option had an enormous impact on the way mutual funds were sold.
The Big Bull Market
With the 1980s and '90s came an unprecedented bull market and previously obscure fund managers like Max Heine, Michael Price, and Peter Lynch became household names.
The collapse of the tech bubble in 1997 and several scandals involving big names in the industry took their toll on the industry, as did the Great Recession of 2007.
The Rise of the ETF
In the 21st century, a new tweak to the mutual fund has emerged: the exchange traded fund (ETF).
These new funds, with their ultra-low expense ratios and ease of trading, have made a huge mark on the investment industry. About $4 trillion is now invested in these funds, and most of it has poured in since the Great Recession receded.
The Bottom Line
Despite the 2003 mutual fund scandals and the global financial crisis of 2008-09, the story of the mutual fund is far from over. In fact, the industry is still growing. In the U.S. alone there are more than 10,000 mutual funds, and if one accounts for all share classes of similar funds, fund holdings are measured in the trillions of dollars.
Despite the launch of separate accounts, exchange traded funds, and other competing products, the mutual fund industry remains healthy and fund ownership continues to grow.
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62d51513c99e3216bbb4faa7173001bf | https://www.investopedia.com/articles/mutualfund/05/shareclass.asp | The ABCs of Mutual Fund Share Classes | The ABCs of Mutual Fund Share Classes
In mutual fund investing, the old adage that high costs indicate quality couldn't be further from the truth. There is no proof that paying a higher fee results in higher returns. If anything, the mutual fund manager of a high-cost fund might take more risks in the attempt to produce a higher return. If the manager's risky moves don't pan out, you've forked over more money in costs and taken capital losses.
To avoid paying high fees only to suffer losses, it is essential to consider which class of mutual fund shares is suitable for you. The class of shares helps to determine what kind of fees you will be paying when you invest in a mutual fund. Here we give an overview of these different classes.
1:40 The ABCs of Mutual Fund Classes
KEY TAKEAWAYS Class A shares charge upfront fees and have lower expense ratios, so they are better for long-term investors.Class A shares also reduce upfront fees for larger investments, so they are a better choice for wealthy investors.Class B shares charge high exit fees and have higher expense ratios, but they convert to A-shares if held for several years.Class C shares have higher expense ratios than A-shares and a small exit fee, which is usually waved after one year.Class C shares are popular with retail investors, and they are best for short-term investors.
What Are Mutual Fund Classes?
While stock classes indicate the number of voting rights per share, mutual fund classes indicate the type and number of fees charged for the shares in a fund.
Mutual fund companies can have seven or more classes of shares for a particular fund. However, there are three main types of mutual fund classes: A, B, and C. They are also known as A-shares, B-shares, and C-shares. Each of these classes has various benefits and drawbacks. Let's examine each in turn.
Class A Shares
A-shares charge an upfront sales fee, or front-end load, that is taken off your initial investment.
Pros
Lower 12b-1 Fees: Class A shares tend to have lower 12b-1 fees, which are marketing and distribution fees included in the fund's expense ratio. If you plan on holding these shares for several years, then a front-end load might be beneficial in the long run.Breakpoints: These provide a discount off regular front-end load rates each time your investment reaches a certain amount in a series. If the first breakpoint is $25,000, you could invest that amount initially to receive the first discount. Breakpoints clearly favor those with more money to invest.Right of Accumulation: This allows you to receive a discount on the front-end load if you reach the first breakpoint with the second installment. Suppose that the first breakpoint is $25,000, but your initial investment was $10,000. If you invest another $15,000 to reach the breakpoint on the second installment, you will receive a discounted front-load fee. That is helpful when saving for retirement because working-age adults are often able to invest more each year.Letter of Intent: Some companies also offer front-end load discounts upfront to individuals who initially express the intent to invest more. They must indicate the intention to invest an amount over a specific breakpoint by a particular point in time.
Cons
High Initial Investment: Investors who do not have the funds to reach a breakpoint before the deadline indicated by a letter of intent will have to pay regular front-end fees.Long Time Horizon: These funds are not optimal for investors with a short time horizon. Suppose that your initial investment is $4,750 after $250 in front-load fees, and your investment increases by 3% during the course of a year. If you sell at the end of the year, you would have actually lost money: ($4,750 x 1.03) - $5000 = - $107.50, or a loss of 2.15%.
Class B Shares
The B-shares are classified by their back-end or contingent deferred sales charge. This fee is paid when you sell shares a specified period of years after the original purchase. These shares are typically good for investors with little investment cash and a long investment horizon.
Pros
No Front-End Fees: Your entire initial investment contribution benefits from capital gains and interest income. That is a substantial benefit for new investors saving for retirement because of compound returns. Consider a stock fund that earns 10% per year over thirty years. Then, the initial investment will be worth over 17 times as much at the end. A few hundred dollars saved in front-end fees means a few thousand dollars in retirement.Deferred Sales Charges: The longer you hold the shares, the lower your deferred sales charge. That is another benefit for investors with long time horizons.Conversion to Class A: Class B shares automatically convert to Class A shares after a specific holding period. This conversion is beneficial because Class A shares have a lower yearly expense ratio than Class B shares (see below).
Cons
Long Time Horizon Required: If you withdraw funds within a certain period of time, then you are charged a back-end or deferred sales charge. One must typically remain in the fund five to eight years to avoid the exit fee.No Breakpoints: Class B shares do not provide breakpoints on the deferred sales charge. Regardless of how much you invest, there is no discount on these charges. That can be a significant drawback for wealthy investors.Higher Expense Ratios: Class B shares charge higher expense ratios than both Class A and C shares until shares are eligible to be converted to Class A.
Class C Shares
Class C shares are a type of level-load fund, which charges an annual fee. This class works well for individuals who will be redeeming shares in the short term.
Pros
No Front-End Fees: Your entire initial investment contribution earns interest income.Small Back-End Load: The back-end load is typically only 1%.Opportunity to Avoid Back-End Load: The back-end load is usually removed after the shares have been held for one year.
Cons
Back-End Load: A back-end load—although small—is typically charged if funds are withdrawn within the first year.Higher Expense Ratios: Even though the expense ratios of Class C shares are lower than those of Class B shares, they are still higher than those for Class A shares.No Conversion: Unlike Class B shares, Class C shares cannot be converted into Class A shares. That removes the opportunity for lower expense ratios. If you have a long time horizon, Class C shares are not optimal for you as the higher management fees continue indefinitely. Unfortunately, your investment returns will be reduced the longer you stay invested because the fees will add up over time.No Discounts: Class C shares do not offer discounts on expenses when the account reaches certain levels.
The Disappearing Middle Class
Although we've looked at all three classes, the middle class of mutual funds—the B-shares—have been disappearing from the mutual fund industry. There are several reasons for this, but chief among them was more regulatory focus on fees. 12b-1 fees have been under attack, acting as a source of shareholder lawsuits against fund companies for alleged misuse. Many funds are dropping these fees and shrinking the class offerings to compete with exchange-traded funds (ETFs). ETFs themselves put pressure on Class B shares by providing a low-fee alternative for investors with limited investment capital. In short, Class B shares still exist, but they are a dying breed.
Applying the Pros and Cons
Let's look at how the characteristics and pros and cons described above work in the following share classes of the hypothetical ABC Company Bond Fund.
ABC Company Bond Fund, A Versus C Comparison
Class Symbol Front End Back End 12b-1 Fees Details A PAEMX 3.75% 1% 0.25% - 2017 total yearly return = 8.86%- expense ratio = 1.2%- $1,000 min investment C PEBCX n/a 1% 1.00% - 2017 total yearly return = 9.35%- expense ratio = 1.95%- $2,500 min investment
Source: Hypothetical bond fund, based on a model from PIMCO
In this example, you can see how these two different share classes are better for different types of investors and situations. Suppose that you plan on investing in this fund for retirement and your retirement is 20 years away. Class A shares would work best because they offer costs that decline over time. If you plan to invest just one lump-sum amount and it is enough to qualify for a breakpoint discount, Class A would also be the best over time. With a large initial investment, you would get a discount on the load. Your yearly expense ratio and 12b-1 fees would also be very low, allowing your investment to grow.
Class C shares would work best if you are planning to invest for a limited period of more than one year but less than three. In this way, you avoid both front-end and back-end loads. Although your expense ratio will typically be higher than Class A shares, your full investment will gain interest while it is invested. Since you are only in the fund for a few years, the yearly fees do not have a chance to pile up.
The Bottom Line
When deciding which class of mutual fund shares to choose, remember to read the prospectus. In addition, you must take into account your investment horizon and the amount you have available to invest. The frequency of your investments and the probability that you will need to withdraw funds early are also essential considerations.
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048f9ad607efe90db6934865277863a5 | https://www.investopedia.com/articles/mutualfund/07/leveraged_etfs.asp | Leveraged ETFs: Are They Right For You? (SSO, DDM) | Leveraged ETFs: Are They Right For You? (SSO, DDM)
The appeal of exchange-traded funds (ETFs) is simple: They mix the diversification benefits of mutual funds with the ability to trade on an intraday basis. There are now thousands of ETFs to choose from and more are being added on a regular basis.
Tutorial: ETF Investing
The purpose of a leveraged ETF is to increase the exposure to and impact from the underlying index or investments in the ETF. For example, the leveraged ETF may attempt to double the return of an index on a daily basis. (To learn more about indexes, see The ABCs Of Stock Indexes and Index Investing.)
Leveraged ETFs provide another tool for investors to access leverage in the financial markets. And because purchasing an ETF is as simple as issuing a buy order through your trading account, it is a much simpler process for most than using options, futures and trading on margin. In this article, we'll show you some key considerations to watch out for when purchasing leveraged ETFs.
In June 2006, ProShares introduced the first wave of leveraged ETFs, referred to by the company as "Ultra ProShares." The ultra ETFs were designed to double the daily performance of the underlying indexes they tracks. For example, the ProShares Ultra Dow 30 ETF (NYSEARCA:DDM) is structured to gain 2% when the Dow Jones Industrial Average gains 1%.
More companies such as Direxion followed suit and according to data from Morningstar there are now more than 170 leveraged ETFs with over $30 billion in assets under management at the end of September, 2016. These funds use a number of instruments to hold positions across asset classes including equity, debt, commodities and derivatives. These investments can also be highly concentrated on sectors, for example ProShares UltraPro Nasdaq Biotechnology (UBIO,) or focused on certain geographies like Direxion Daily FTSE China Bull 3X ETF (NYSEARCA:YINN).
Do They Deliver?
The idea behind such funds is to take advantage of quick day-to-day movements in different financial markets. ProShares Ultra S&P 500 (NYSEARCA:SSO) was launched in 2006 with the aim of doubling the returns of the underlying S&P 500. The prospectus of the fund clearly lays out that the intention is to double the daily return and not over the long term. In fact it goes on to say that for periods longer than a single day, the fund could lose money if the underlying index remains flat or even sometimes when it rises. For example, one a day in October 2016 when the S&P returned 0.48%, the fund gave back 0.82%. A similar trend exists for the performance over 1 week, but anything longer a disparity emerges.
On a daily basis, the return of the ultra ETFs has been fairly accurate, but over the long term there are some issues.
In theory, a leveraged ETF that returns twice that of the S&P 500 would have generated annual returns of over 13% over the last ten years. The performance of ProShares Ultra S&P 500 fund has been a far cry from its target. Let alone double, the fund's 10 year return as on October 25th, 2016 at 6.73% struggled to even match the S&P's 6.83% over the same period.
This divergence can be explained by a short example. Assume the Nasdaq falls 2% in one day and rebounds with a 1% gain the following session. The index will have a two-day loss of 1.02%. An ETF that gives investors double the index will result in a 2.08% loss after two days. If the ETF returned exactly twice the index, the return should be -2.04%. Granted the difference is small in the example, but it can increase drastically over time with compounding. If a stock falls 2%, it must rally 2.04% to get back to even. Over time, this takes a toll on performance.
Regulators SEC and FINRA in a 2009 alert clarifying this for individual investors said, "Some investors might invest in these ETFs with the expectation that the ETFs may meet their stated daily performance objectives over the long term as well. Investors should be aware that performance of these ETFs over a period longer than one day can differ significantly from their stated daily performance objectives."
Keep Costs in Mind
While an investor shells out about 0.9% on average annual management fees for such funds, there's another factor that could impact the actual returns. There are transaction costs associated with every time the fund buys or sells securities, and taxes if these transactions are taxable. These costs are typically not accounted for in the annual expenses but are reflected in the fund's performance. Funds that rely on daily rebalancing to make the most of the movements in the market would typically have higher portfolio turnover or more transactions. The ProShares Ultra S&P 500 in its latest prospectus reveals a 7% portfolio turnover of the average value of its fund during the most recent fiscal year.
Strategic Leveraging
Leveraged ETFs are typically best used by investors who are using a short-term trading strategy. Traders who are seeking to capitalize on daily movements - either in the market or in a specific sector - are able to use the ultra ETFs to gain leverage. Because the ultra ETFs give short-term traders the leverage needed on a daily basis without the negative compounding error, most will get in and out within a day.
The ultra ETFs can also be helpful to investors who would like to gain overexposure to a specific sector or index, but do not have the required capital. For example, suppose that an investor is 95% invested in a diversified allocation, but is lacking exposure to the utility sector. The investor's goal is to invest 10% of his or her portfolio into semiconductors; however, with only 5% in cash it might appear impossible. The investor can use the 5% cash available to purchase a leveraged ETF that invests in semiconductors such as Direxion Daily Semicondct Bear 3X ETF (SOXS) and, in reality, give the portfolio a 10% allocation to the sector. (To learn more about asset allocation, see Five Things To Know About Asset Allocation, Choose Your Own Asset Allocation Adventure and Asset Allocation Strategies.)
Wrapping It UpTo recap, the advantages of the leveraged ETFs are:
They offer a way to use leverage without using options or margin.They are available in retirement accounts.They are a great trading tool for short-term traders.
The negatives associated with leveraged ETFs include:
Aims to generate daily returns not long-term performanceThe impact of negative compounding can result in long-term inaccuracy.High portfolio turnover could dampen returns furtherLeveraged ETFs are a high-risk investment that could be dangerous to the uneducated investor
Overall, leveraged ETFs may be useful only to savvy investors, all others should perhaps stay away or do their due diligence before investing.
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4034d16b0e142d533931d5d83afbaf89 | https://www.investopedia.com/articles/mutualfund/07/mf_safe.asp | Is Your Mutual Fund Safe? | Is Your Mutual Fund Safe?
Like millions of investors, there's a good chance you own mutual funds that you believe are conservative by nature. These could include diversified stock funds and bond funds. However, managers might hold derivatives in your fund's portfolio, and you might not even be aware of it. Why should that matter? Well, the good news is that derivatives can boost returns. The not-so-good news is that they also come with increases in risk and tax liabilities. (See also: Mutual Funds.)
Three Common Derivatives
Institutional investors, such as hedge funds and banks, have used derivatives for years; however, now the following three derivatives are showing up in many stock and bond funds owned by small investors.
Credit Default Swaps
A credit default swap is a type of credit risk insurance against a company or country defaulting on its debt. Its price is based on the probabilities that the debtor will default on its creditors or experience a change in its credit rating.
The swap buyer pays a fee to the seller, and the seller agrees to pay the buyer in case of a default. Therefore, a credit default swap provides the buyer with protection against specific risks. For example, a big corporate bond investor, such as a pension fund, might buy credit default swaps for protection against a default by the issuers of corporate bonds it holds.
Some mutual fund managers, though, have gotten creative in their use of swaps; they have found that swaps can be easier and cheaper to trade than corporate bonds. And by going long or short, it's a simple way to make money or increase or decrease their portfolio's credit risk.
The problem is that swaps are not securities. They are generally agreements between a mutual fund and a Wall Street firm and typically don't trade on an exchange. This means that there is no way for outsiders, such as the Securities and Exchange Commission, to know how much risk any given institution has taken on.
Consequently, as the popularity of using swaps increases, the risk goes up that the banks selling the swaps will not be able to meet their obligations if a major default occurs. (See also: Corporate Use of Derivatives for Hedging.)
Covered Calls
A covered call, or writing a covered call, is nothing new for investors. You sell a call option on a stock you own. The option gives the buyer the right, but not the obligation, to buy your stock within a set time at a specified strike price. (See also: Come One, Come All—Covered Calls.)
There are fund managers who are now getting in on covered calls. They probably see it as a way to boost their fund's income, which can be especially attractive when interest rates are low. Plus, it provides a little downside protection in case of a minor market dip.
But suppose the stock blasts off? The fund would give up all of the stock's profit above the strike price as the call holder exercises the option. (See also: Using LEAPS in a Covered Call Write, An Alternative Covered Call: Adding a Leg and An Alternative Covered Call Options Trading Strategy.)
Index Tracking
Is your fund manager's goal to outperform an index, such as the S&P 500? It's possible then, that the manager might invest most of the fund's money in bonds and a small portion in index derivatives, such as options or futures contracts. (See also: You Can't Judge an Index Fund by Its Cover.)
But what if your manager's goal is loftier? (See also: The Lowdown on Index Funds.)
For instance, some funds seek to outperform daily index returns by a multiple, like two times, or track commodity prices. In such cases, they're most likely using derivatives. And even though small upward market movements can dramatically increase your fund's value, such a strategy could also backfire during a broad market downturn because index losses will be amplified. (See also: The ABCs of Stock Indexes.)
Tax Concerns
Funds that use derivatives frequently trade their holdings. This can mean more short-term gains for shareholders, but you could lose up to 35% of those gains to federal income tax.
Does Your Fund Manager Use Derivatives?
You can go through your fund's prospectus to see whether its manager is allowed to use derivatives and how they may be used. In addition, the quarterly reports should show derivative investments held in the fund. (See also: Don't Forget to Read the Prospectus!)
You can also check out the fund company's website or the SEC's Filings and Forms site. But, make sure you look beyond the percentages. For example, suppose your fund shows that 72% of its assets are in derivatives, but when you look closer, you find that 70% is in U.S. Treasury futures and 2% in credit default swaps. That's a heck of a lot less risky than if those numbers were reversed. (See also: Digging Deeper: The Mutual Fund Prospectus.)
Shrewd Strategy or Smoke and Mirrors?
Derivatives in a mutual fund can reduce risks and boost returns. However, this strategy generally works best in flat markets, not markets that are swinging wildly.
Nevertheless, you can expect their use to increase as yield-hungry baby boomers retire and seek higher income from their investments. And with more than 8,000 mutual funds out there, managers often think it's not good enough to match a market's index. They want to beat it—and they are willing to bet your money that they can do it, even if it means bypassing the older, simpler products and betting on derivatives.
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5ab107118dea033f6830fc357dfb77e1 | https://www.investopedia.com/articles/mutualfund/07/money_market_savings.asp | Money Market Fund vs. Savings Account: What’s the Difference? | Money Market Fund vs. Savings Account: What’s the Difference?
Once you've started to accumulate some savings, you may be wondering where you should keep that money, especially given that most traditional savings accounts offer pretty nominal interest rates. If you want to keep your funds liquid, one alternative is a money market fund. This type of investment account allows you to write checks and easily transfer money to your savings account, but has higher returns than a savings account.
Key Takeaways Savings accounts and money market deposit accounts are backed by the Federal Deposit Insurance Corporation (FDIC). Meanwhile, money market mutual funds have no such FDIC guarantee. Both types of money market accounts have high liquidity and accessibility, but money market funds tend to offer higher returns. When picking a money market mutual fund it’s best to focus on ones with low operating costs.
Money Market Mutual Funds
A relatively low-risk investment, money market mutual funds pool money from lots of individuals and invest in high quality, short-term securities. While they are technically investments, they act more like cash accounts since the money is easily accessible. They may not yield as high a return as investing in the stock market, but they carry much less risk and still tend to have better returns than an interest-bearing savings account (though there is no guarantee on returns).
The performance of money market funds is closely tied to the interest rates set by the Federal Reserve. When interest rates are very low, these funds may not outperform a savings account once you take fees into account. So it's important to do your research before moving your money into a money market fund.
Money market mutual funds may have a minimum initial investment, as well as balance requirements and transaction fees. There are also associated fees that bank accounts do not incur, including the expense ratio, which is a percentage fee charged on the fund for management expenses.
The dividends in mutual funds can be taxable or tax-free, depending on what the fund invests in. They are not insured by the Federal Deposit Insurance Corporation (FDIC), though they are carefully regulated by the Securities and Exchange Commission (SEC).
Money Market Deposit Accounts
While money market accounts sound very similar to money market mutual funds (and people often confuse the two), these are actually more similar to savings accounts, with some of the benefits of a checking account as well.
Money market accounts often have higher minimum investments and balances than regular savings accounts but offer higher returns. They also allow account holders to write a limited number of checks or make limited debit card purchases from the account each month (up to six total). They may have monthly fees attached, but if you do your research you should be able to find one with no monthly fees.
One important difference: Money market accounts are held at banks or credit unions. They are FDIC insured if they are at a bank and insured by the National Credit Union Administration (NCUA) if they are at a credit union.
Interest rates, fees, and balance requirements can vary widely. Spending time to find an account with good returns and minimal fees can save you money in the long run.
Savings Accounts
Savings accounts at banks or credit unions are a safe, convenient place to store money as you save up for a big purchase or for the future. (Many people use traditional savings accounts to hold their emergency funds.)
Savings accounts are interest-bearing, which means that they earn money, growing over time. They tend to pay lower interest rates than money market deposit accounts or mutual funds, though some online banks offer high-yield savings accounts that have more competitive interest rates. Like money market deposit accounts, they are FDIC or NCUA insured.
Which Account Is Right for You?
Deciding whether to hold your money in a money market mutual fund, a money market deposit account, or a traditional savings account will depend on the amount of money you have to save and how frequently you need to access it. Investigating the details on different options within each group will help you avoid high fees and account minimums.
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0aa80aa742a7ac6db947547c3c6c92e9 | https://www.investopedia.com/articles/mutualfund/07/private_equity.asp | How to Invest in Private Equity | How to Invest in Private Equity
Private equity is capital made available to private companies or investors. The funds raised might be used to develop new products and technologies, expand working capital, make acquisitions, or strengthen a company's balance sheet. Unless you are willing to put up quite a bit of cash, your choices in investing in the high-stakes world of private equity are minimal.
Key Takeaways Private equity investing includes early-stage, high-risk ventures, usually in sectors such as software and healthcare. These investors try to add value to the companies they invest in by bringing in new management or selling off underperforming parts of the business, among other things. The minimum investment in private equity funds is relatively high—typically $25 million, although some are as low as $250,000. Investors should plan to hold their private equity investment for at least 10 years. However, there are non-direct ways to invest in private equity, such as funds of funds, ETFs, and special purposes acquisition companies.
Why Invest in Private Equity?
Institutional investors and wealthy individuals are often attracted to private equity investments. This includes large university endowments, pension plans, and family offices. Their money becomes funding for early-stage, high-risk ventures and plays a major role in the economy.
Often, the money will go into new companies believed to have significant growth possibilities in industries such as telecommunications, software, hardware, healthcare, and biotechnology. Private equity firms try to add value to the companies they buy and make them even more profitable. For example, they might bring in a new management team, add complementary companies, aggressively cut costs, or spinoff parts of the business that are underperforming.
You probably recognize some of the companies below that received private equity funding over the years:
A&W Restaurants Harrah's Entertainment Inc. Cisco Systems Intel Network Solutions (the world's largest domain name registrar) FedEx
Without private equity money, these firms might not have grown into household names.
Minimum Investment Requirement
Private equity investing is not easily accessible for the average investor. Most private equity firms typically look for investors who are willing to commit as much as $25 million. Although some firms have dropped their minimums to $250,000, this is still out of reach for most people.
Fund of Funds
A fund of funds holds the shares of many private partnerships that invest in private equities. It provides a way for firms to increase cost-effectiveness and reduce their minimum investment requirement. This can also mean greater diversification since a fund of funds might invest in hundreds of companies representing many different phases of venture capital and industry sectors. In addition, because of its size and diversification, a fund of funds has the potential to offer less risk than you might experience with an individual private equity investment.
Mutual funds have restrictions in terms of buying private equity directly due to the SEC's rules regarding illiquid securities holdings. The SEC guidelines for mutual funds allow up to 15% allocation to illiquid securities. Also, mutual funds typically have their own rules restricting investment in illiquid equity and debt securities. For this reason, mutual funds that invest in private equity are typically the fund of funds type.
The disadvantage is there is an additional layer of fees paid to the fund of funds manager. Minimum investments can be in the $100,000 to $250,000 range, and the manager may not let you participate unless you have a net worth between $1.5 million to $5 million.
Private Equity ETF
You can purchase shares of an exchange-traded fund (ETF) that tracks an index of publicly traded companies investing in private equities. Since you are buying individual shares over the stock exchange, you don't have to worry about minimum investment requirements.
However, like a fund of funds, an ETF will add an extra layer of management expenses you might not encounter with a direct, private equity investment. Also, depending on your brokerage, each time you buy or sell shares, you might have to pay a brokerage fee.
Special Purpose Acquisition Companies (SPAC)
You can also invest in publicly traded shell companies that make private-equity investments in undervalued private companies, but they can be risky. The problem is the SPAC might only invest in one company, which won't provide much diversification. They may also be under pressure to meet an investment deadline, as outlined in their IPO statement. This could make them take on an investment without doing their due diligence.
The Bottom Line
There are several key risks in any private equity investing. As mentioned earlier, the fees of private-equity investments that cater to smaller investors can be higher than you would normally expect with conventional investments, such as mutual funds. This could reduce returns. Additionally, the more private equity investing opens up to more people, the harder it could become for private equity firms to locate excellent investment opportunities.
Plus, some of the private equity investment vehicles that have lower minimum investment requirements do not have long histories for you to compare to other investments. You should also be prepared to commit your money for at least ten years; otherwise, you may lose out as companies emerge from the acquisition phase, become profitable and are eventually sold.
Companies that specialize in certain industries can carry additional risks. For instance, many firms invest only in high technology companies. Their risks can include:
Technology risk: Will the technology work? Market risk: Will a new market develop for this technology? Company risk: Can management develop a successful strategy?
Despite its drawbacks, if you are willing to take a little more risk with 2% to 5% of your investment portfolio, the potential payoff of investing in private equity could be big.
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b974cc718cdf6b3417943ef5fbeb1808 | https://www.investopedia.com/articles/mutualfund/08/fund-of-funds.asp | A Fund of Funds: High Society for the Little Guy | A Fund of Funds: High Society for the Little Guy
Buying a mutual fund is a bit like hiring someone to fix the brakes on your car. Sure, you could do the research, buy the tools and fix the car yourself (and many people do), but often it's not only easier but also safer to let an expert handle the problem. Mechanics and mutual funds may cost you a little more in fees, but there is nothing inherently wrong with paying extra for peace of mind.
Some investors prefer even more peace of mind. By purchasing a mutual fund that invests in other mutual funds, they get the added protection of multiple money managers and much more diversity than one fund would give them. A fund of funds (FOF) is an investment product made up of various mutual funds—basically, a mutual fund for mutual funds. They are often used by investors who have smaller investable assets, limited ability to diversify or who are not that experienced in choosing mutual funds. In short, an FOF gives the little guy the professional management and diversification that have often been reserved for the wealthy. In this article, we will explore the advantages, disadvantages and risks of an FOF.
Benefits of a Fund of Funds
An FOF spreads out risk. Whereas owning one mutual fund reduces risk by owning several stocks, an FOF spreads risk among hundreds or even thousands of stocks contained in the mutual funds it invests in. FOFs also provide the opportunity to reduce the risk of investing with a single fund manager.
Because each mutual fund has a minimum investment threshold to buy in—usually $1,000—the individual may not be able to afford to meet the minimums for several mutual funds at once. Buying a mutual fund that invests in other funds means the individual does not have to meet that minimum.
The emergence of FOFs is being pushed by demand from investors to have more safety while trying to keep up with or beat the market. However, it must be said that the benefit of more safety is not endless. If the overall market takes a tumble, so may mutual funds and the FOFs that have invested in them.
Fees and Expenses
An investor who purchases an FOF must pay two levels of fees. Just like an individual fund, an FOF may charge management fees and a performance fee, although the performance fees are typically lower than individual mutual funds to reflect the fact that most of the management is delegated to the sub-funds themselves.
FOF Advantages
An FOF serves as an investor's proxy, providing professional due diligence, manager selection, and oversight over the mutual funds in its portfolio. The professional management provided by an FOF can give investors the ability to spread their dollars among thousands of stocks with a single purchase, while counting on expertise that investors themselves may not have. Rather than assuming the risk of selecting one individual manager, the FOF provides a portfolio of managers with a single investment.
Most FOFs have a formal due-diligence process and will conduct background checks before selecting new managers. In addition to searching for a disciplinary history within the securities industry, this work can include researching the backgrounds, verifying the credentials and checking the references provided by a fund manager of any individual fund that is being considered as an investment.
FOF Disadvantages
Overall, fees for FOFs are typically higher than those of individual funds because they include both the management fees charged by the FOF and those of the underlying funds. This doubling up of fees can be a significant drag on the overall return an investor receives.
Since an FOF buys many funds (which themselves invest in a number of securities), the FOF may end up owning the same stock or other security through several different funds, thus reducing the potential diversification.
The Bottom Line
FOFs can be a pain-free entrance into professional diversification for investors with limited funds, or for those who have limited experience, but this doesn't mean every FOF will be the perfect fit. An investor should read the fund's marketing and related materials prior to investing so that the level of risk involved in the fund's investment strategies is understood. The risks taken should be commensurate with your personal investing goals, time horizons and risk tolerance. As is true with any investment, the higher the potential returns, the higher the risks.
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9c544d3f7918f064371b94bf6b88fbf2 | https://www.investopedia.com/articles/mutualfund/08/managed-separate-account.asp | Should You Have a Separately Managed Account? | Should You Have a Separately Managed Account?
The investment management world is divided into retail and institutional investors. Products designed for middle-income individual investors, such as the retail classes of mutual funds, have modest initial investment requirements: $1,000 or even less. In contrast, managed accounts or funds for institutions have imposing minimum investment requirements of $25 million or more.
Between these ends of the spectrum, however, is the growing universe of separately managed accounts (SMA) targeted toward wealthy (but not necessarily ultra-wealthy) individual investors. Whether you refer to them as "individually managed accounts," "separate account," or "separately managed accounts," these individual-oriented managed accounts have gone mainstream.
Key Takeaways A separately managed account (SMA) is a portfolio of assets managed by a professional investment firm. SMAs are increasingly targeted toward wealthy (but not ultra-wealthy) retail investors, with at least six figures to invest. SMAs offer more customization in investment strategy, approach and management style than mutual funds do. SMAs offer direct ownership of securities and tax advantages over mutual funds. Investors must do due diligence before committing to a money manager whose discretionary services cost 1% to 3% of assets in the portfolio.
What Is a Separately Managed Account?
An SMA is a portfolio of assets managed by a professional investment firm. In the United States, the vast majority of such firms are called registered investment advisors and operate under the regulatory auspices of the Investment Advisors Act of 1940 and the purview of the U.S. Securities and Exchange Commission (SEC). One or more portfolio managers are responsible for day-to-day investment decisions, supported by a team of analysts, plus operations and administrative staff.
SMAs differ from pooled vehicles like mutual funds in that each portfolio is unique to a single account (hence the name). In other words, if you set up a separate account with Money Manager X, then Manager X has the discretion to make decisions for this account that may be different from decisions made for other accounts. Mutual funds cannot offer, due to their structure as investments shared by a group of investors, the benefit of customized portfolio management. Separate accounts overcome this barrier.
Say, for example, that a manager oversees a diversified core equity strategy including 20 stocks. The manager decides to launch a mutual fund investing in these stocks as well as a separately managed account offering. Assume that at the outset, the manager chooses the same investments and the same weights for both the mutual fund and the SMA. From a client's perspective, the beneficial interests in either vehicle are identical at the outset, but the statements will look different. For the mutual fund client, the position will show up as a single-line entry bearing the mutual fund ticker—most likely a five-letter acronym ending in "X." The value will be the net asset value at the close of business on the statement's effective date. The SMA investor's statement, however, will list each of the equity positions and values separately, and the total value of the account will be the aggregate value of each of the positions.
From this point, the investments will begin to diverge. Decisions the manager makes for the mutual fund—including the timing for buying and selling shares, dividend reinvestment and distributions—will affect all fund investors in the same way. For SMAs, however, decisions are made at the account level and will, therefore, vary from one investor to another.
How Separately Managed Accounts Are Customized
The high level of customization is one of the main selling points for SMAs, particularly when it comes to individual taxable accounts. Portfolio transactions have expense and tax implications. With managed accounts, investors may feel like they have a greater degree of control over these decisions, and that they are more closely attuned to the objectives and constraints set forth in the investment policy statement.
So what is the price of entry for this extra level of customized attention? Given technological advances, money-management firms have been able to significantly reduce their minimum investment requirements to well below the traditional $1million level. But there is still no single answer for the several thousand managers that make up the SMA universe. As a general rule of thumb, the price of entry starts at $100,000. SMAs targeted to high-net-worth retail investors tend to set account minimum balances between $100,000 and $5 million. For strategies designed for institutional managers, minimum account sizes may range from $10 million to $100 million.
For style-based investors who seek exposure to several different investment styles (e.g., large-cap value, small-cap growth) the price of entry goes up, as there will be a separate SMA, and a separate account minimum, for each style chosen. For example, an investor seeking style-pure exposure in the four corners of the style box—large-cap, small-cap, value, and growth—might need to have at least $400,000 available to implement an SMA-based strategy. Other investors may prefer an all-cap blend (or core) approach that could be accessed through a single manager.
In addition, investors can impose restrictions on how the account is managed. For example, a client might not want to invest in alcohol or tobacco companies or they may wish to invest only in companies that are committed to some greater good, such as helping the environment. Separately-managed accounts are ultimately designed to provide individual investors with the kind of personalized money management that was formerly reserved for institutions and corporate clients.
Separately Managed Accounts and Direct Ownership
The ability to have an individual cost basis on the securities in your portfolio is the key to those benefits. To understand the significance, consider the nature of the mutual fund. In its most basic form, a mutual fund is a company that invests in other companies by purchasing the stocks and bonds issued by those companies. When you purchase shares of a mutual fund, you share ownership of the underlying securities with all of the other investors in the fund. You do not have an individual cost basis on those securities.
As an example, say XYZ Mutual Fund holds shares of Company 1 and Company 2. You purchase 100 shares of XYZ Mutual Fund. While you own those 100 shares of XYZ, you do not own any shares of Company 1 or Company 2. Those shares are owned by the mutual fund company. Since you are an investor in XYZ—the company—you can buy or sell shares in that firm, but you have no ability to control XYA's decision to buy or sell shares in Company 1 or Company 2.
However, in a separately managed account, you do own those shares. If a separate account portfolio includes shares of Company 1 and Company 2, the money manager purchases shares in each of those companies on your behalf.
To avoid the "mutual" nature of mutual funds, you could choose to purchase individual stocks and bonds to build your own portfolio, but that is a time-consuming proposition and denies you the benefit of professional portfolio management, which is the primary reason most investors put their money in mutual funds. To obtain the benefits of professional portfolio management without the hindrance of mutual ownership of the underlying securities, an increasing number of investors are turning toward separate accounts.
Tax Benefits of Separately Managed Accounts
One of the most significant benefits of separate accounts involves tax gain/loss harvesting, which is a technique for minimizing capital gains tax liability through the selective realization of gains and losses in your separate account portfolio. Consider, for example, a separate account portfolio in which two securities have been purchased at similar prices. Over time, one of the securities has doubled in value while the other has fallen by half.
By instructing the money manager to sell both securities, the gains generated by the security that has doubled in value are offset by the losses in the other security, eliminating any capital gains tax liability. The proceeds from the sale can be reinvested, maintaining the balance in your account. In a similar fashion, if you sold some real estate, art or other investments at a profit, but have unrealized losses in your separate account, you could realize the losses and use them to offset the gains from the sale of your other investments.
Another tax benefit that comes with SMAs is the lack of embedded capital gains, a common issue with mutual funds. Since mutual funds are "mutual," all investors share the tax liability on the capital gains incurred by the fund, which must pay them all out once a year. So, for example, if the fund doubled in value from January through November, investors purchasing into the fund in December did not get the benefit of any of those gains, but they do inherit the tax liability because the gains are embedded in the portfolio. Separate account investors, thanks to individual cost basis on the underlying securities, would not be liable for capital gains generated prior to the day they invested in the portfolio.
Fee Structures of Separately Managed Funds
One of the difficulties inherent in making an apples-to-apples comparison among investment offerings is that fee structures vary. This is even trickier for SMAs than for mutual funds, for reasons explained below.
Mutual fund fees are fairly straightforward. The key number is the net expense ratio, including the management fee (for the professional services of the team that runs the fund), miscellaneous ancillary expenses, and a distribution charge called a 12(b)1 fee for certain eligible funds. Many funds also have different types of sales charges. Funds are required to disclose this information in their prospectuses and show explicitly how the fund expenses and sales charges would affect hypothetical returns over different holding periods. Investors can easily obtain a fund prospectus from the fund's parent company, either online or through the mail.
Professional money managers' fees typically run from 1% to 3% of assets under management.
A prospectus is not issued for a separate account. Managers list their basic fee structures in a regulatory filing called a Form ADV Part 2. An investor can obtain this document by contacting the manager, but they tend not to be as widely available through unrestricted online downloads as mutual fund prospectuses. Moreover, the published fee schedule in the ADV Part 2 is not necessarily firm—it is subject to negotiation between the investor (or the investor's financial advisor) and the money manager. Often, it is not a single fee but a scale in which the fee (expressed as a percentage of assets under management) decreases as the asset volume (the amount invested) increases.
The Importance of Due Diligence
Because SMAs do not issue registered prospectuses, investors or their advisors need to rely on other sources for investigating and evaluating the manager. In investor-speak, this is referred to as due diligence. Comprehensive due diligence will elicit sufficiently detailed information regarding all of the following areas:
Performance Data
A manager should be prepared to share performance data (annual and preferably quarterly returns achieved) since the inception of the strategy. The information is contained in a composite—a table showing aggregate performance for all fee-paying accounts in that strategy. A good question to ask here is whether the composite complies with the Global Investment Performance Standards set by the CFA Institute and whether a competent third-party auditor has provided a letter affirming compliance with the standards.
Philosophy and Approach
Each manager has a unique investment philosophy and method of applying that philosophy to an investment approach. You will want to know whether the manager has a more active or passive style, a top-down or bottom-up approach, how alpha and beta risk are managed, the strategy's performance benchmark, and other pertinent information.
Investment Process
Find out who makes the decisions and how they are implemented; the roles and responsibilities of portfolio managers, analysts, support staff and others; who's on the investment committee; and how often it meets. Then sell discipline and other key aspects of the process.
Operations
Some managers have extensive in-house trading platforms, while others outsource all non-core functions to third-party providers like Schwab or Fidelity. You also need to understand transaction expenses and how they can affect your bottom line. Another useful area of information here is client and account services. Among other things, you can find out about net client activity—the number of clients joining and leaving the firm.
Organization and Compensation
How the firm is organized and how it pays its professionals—especially the managers whose reputations and track records are the big draw—are extremely important aspects of the investment. Understand the calculations behind incentive compensation. Are the manager's incentives aligned with those of the investor? This is an essential feature.
Compliance History
Red flags include prominent infractions with the SEC or other regulatory bodies, fines or penalties levied and lawsuits or other adverse legal situations. The SEC considers separate account managers to be investment advisors subject to the provisions of the Investment Advisors Act of 1940.
Much of this information can be obtained from the manager's Form ADV Parts 1 and 2 (Part 2 includes more details on strategy, approach, and fees as well as biographical information on the principal team members). Performance data should be available directly from the manager, either online or through personal contact with a management representative. The representative should also be able to coordinate phone or in-person meetings with key team members and direct your questions regarding compliance and other issues to the appropriate personnel.
The Bottom Line
Given the account minimums, separately managed accounts are not for every investor. If you have the means, they can be a useful alternative to mutual funds or other pooled vehicles and more closely align with your own specific return objectives, risk tolerance, and special circumstances. To maximize the benefits separate accounts offer, most investors work with a professional investment advisor. The advisor assists with asset-allocation decisions and money-manager selection, as well as coordinates portfolio customization and gain/loss harvesting.
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87f1751b8e62470dcf5608d7e8014b5e | https://www.investopedia.com/articles/mutualfund/08/money-market-break-buck.asp | Why Money Market Funds Break The Buck | Why Money Market Funds Break The Buck
Money market funds are often thought of as cash and a safe place to park money that isn't invested elsewhere. Investing in a money market fund is a low-risk, low-return investment in a pool of very secure, very liquid, short-term debt instruments.
Money market funds seek stability and security with the goal of never losing money and keeping net asset value (NAV) at $1. This one-buck NAV baseline gives rise to the phrase "break the buck," meaning that if the value falls below the $1 NAV level, some of the original investment is gone and investors will lose money.
However, this only happens very rarely, but because money market funds are not FDIC-insured, meaning that money market funds can lose money.
Insecurity in the (Money) Market
While investors are typically aware that money market funds are not as safe as a savings account in a bank, they treat them as such because, as their track record shows, they are very close. But given the rocky market events of 2008, many did wonder if their money market funds would break the buck.
In the history of the money market, dating back to 1971, less than a handful of funds broke the buck until the 2008 financial crisis. In 1994, a small money market fund that invested in adjustable-rate securities got caught when interest rates increased and paid out only 96 cents for every dollar invested. But as this was an institutional fund, no individual investor lost money, and 37 years passed without a single individual investor losing a cent.
In 2008 however, the day after Lehman Brothers Holdings Inc. filed for bankruptcy, one money market fund fell to 97 cents after writing off the debt it owned that was issued by Lehman. This created the potential for a bank run in money markets as there was fear that more funds would break the buck.
Key Takeaways In a money market fund, investors are buying securities, and the brokerage is holding them. In a money market deposit account, investors are depositing money in the bank. In a money market deposit account, the bank is investing it for itself and paying the investor the agreed-upon return. The FDIC does not insure money market funds. It does guarantee money market deposit accounts.
Shortly thereafter, another fund announced that it was liquidating due to redemptions, but the next day the United States Treasury announced a program to insure the holdings of publicly offered money market funds so that should a covered fund break the buck, investors would be protected to $1 NAV.
Many brokerage accounts sweep cash into money market funds as a default holding investment until the funds can be invested elsewhere.
A Track Record of Safety
There are three main reasons that money market funds have a safe track record.
The maturity of the debt in the portfolio is short-term (397 days or less), with a weighted average portfolio maturity of 90 days or less. This allows portfolio managers to quickly adjust to a changing interest rate environment, thereby reducing risk. The credit quality of the debt is limited to the highest credit quality, typically 'AAA' rated debt. Money market funds can't invest more than 5% with any one issuer, except the government, so they diversify the risk that a credit downgrade will impact the overall fund. The participants in the market are large professional institutions that have their reputations riding on the ability to keep NAV above $1. With only the very rare case of a fund breaking the buck, no firm wants to be singled out for this type of loss. If this were to happen, it would be devastating to the overall firm and shake the confidence of all its investors, even the ones that weren't impacted. Firms will do just about anything to avoid breaking the buck, and that adds to the safety for investors.
Readying Yourself for the Risks
Although the risks are generally very low, events can put pressure on a money market fund. For example, there can be sudden shifts in interest rates, major credit quality downgrades for multiple firms and/or increased redemptions that weren't anticipated.
Another potential issue could occur if the fed funds rate drops below the expense ratio of the fund, which may produce a loss to the fund's investors.
To reduce the risks and better protect themselves, investors should consider the following:
Review what the fund is holding. If you don't understand what you are getting into, then look for another fund. Keep in mind that return is tied to risk—the highest return will typically be the riskiest. One way to increase return without increasing risk is to look for funds with lower fees. The lower fee will allow for a potentially higher return without additional risk. Major firms are typically better funded and will be able to withstand short-term volatility better than smaller firms. In some cases, fund companies will cover losses in a fund to make sure that it doesn't break the buck. All things being equal, larger is safer.
Confusion in the Money Market
Money market funds are sometimes called "money funds" or "money market mutual funds," but should not be confused with the similar-sounding money market deposit accounts offered by banks in the United States.
The major difference is that money market funds are assets held by a brokerage, or possibly a bank, whereas money market deposit accounts are liabilities for a bank, which can invest the money at its discretion—and potentially in (riskier) investments other than money market securities.
If a bank can invest the funds at higher rates than it pays on the money market deposit account, it makes a profit. Money market deposit accounts offered by banks are FDIC insured, so they are safer than money market funds. They often provide a higher yield than a passbook savings account and can be competitive with money market funds, but may have limited transactions or minimum balance requirements.
The Bottom Line
Prior to the 2008 financial crisis, only a couple of small institution funds broke the buck in the preceding 37 years. During the 2008 financial crisis, the U.S. government stepped in and offered to insure any money market fund, giving rise to the expectation that it would do so again if another such calamity were to occur.
It's easy to conclude then that money market funds are very safe and a good option for an investor that wants a higher return than a bank account can provide, and an easy place to allocate cash awaiting future investment with a high level of liquidity. Although it's extremely unlikely that your money market fund will break the buck, it's a possibility that shouldn't be dismissed when the right conditions arise.
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27ed586c9dd88d95cce2866a99c306d7 | https://www.investopedia.com/articles/mutualfund/08/morningstar.asp | Morningstar: A Premier Mutual Fund Source | Morningstar: A Premier Mutual Fund Source
Investors who enter the mutual fund market are often confronted with a bewildering array of information and jargon that leaves them unsure of where to begin. Mutual fund websites are filled with information about large-cap funds, small-cap funds, sector funds, alpha, beta, style boxes, and other esoteric concepts.
Brokers and financial planners readily recommend any number of funds and fund families for their clients, but some investment companies have much better track records than others. So where can customers go to get sound, unbiased information about a given fund or fund family? Read on to find out.
A Definitive Resource
For decades, Morningstar has been regarded as the premier source of information on mutual funds in the financial industry. The first mutual fund sourcebook was published in 1984, and this resource has come to be used worldwide by millions of investors and thousands of financial advisors. Morningstar ranks, rates and analyzes thousands upon thousands of mutual funds, both load and no-load, as well as variable annuity subaccount funds. Many local public libraries offer access to the Morningstar service.
One of the major tools that Morningstar offers to investors is its one-page fund fact sheet. This sheet is packed with pertinent information about a given fund that allows investors to quickly evaluate its potential. Some of the data featured on this sheet include those listed below.
Morningstar Style Box
This common tool classifies mutual funds into one of nine different categories, with separate sets of categories for equity and fixed-income funds. For example, a stock fund could be classified as a large-cap growth fund or a small-cap value fund, depending on its capitalization and investment objectives.
Vital Statistics
Every fact sheet lists the fund's contact information, inception date, total assets under management and minimum initial and subsequent purchase amounts at the bottom of the page, along with a complete breakdown of the fund's sales charge schedule (if there is one) for all share classes. All management and 12b-1 fees are included here as well.
Historical Performance
Morningstar fund fact sheets always display the average annual total return of the fund for the last three and six months, one, three, five, and 10 years, as well as since the fund's inception. These numbers are run both with and without any pertinent sales charges being assessed for all classes of retail shares (and even institutional share classes as well in some cases). Cumulative total return numbers are also posted. Quarterly returns are shown for the previous five years.
Growth of $10,000
Each report contains a graph that charts the growth of a $10,000 initial investment made at the inception of the fund until the present, factoring in all sales charges and other expenses.
Star and Category Ratings
These are often the first indicators that investors look at when choosing a fund. The star rating ranks funds according to past performance within four broad asset classes, while the category rating is a more specific comparison of funds within the same style box.
Fund Composition and Holdings
A percentage breakdown of the individual security holdings within the fund by both asset class and sector is listed in detail. Each fact sheet also lists the fund's top 10 holdings by company. Bond and other fixed-income funds also contain a breakdown of the average duration and maturity of the individual securities held by the fund.
Investment Objective
Every fact sheet prints the stated investment objective of the fund and the general investment strategy that will be used to achieve this objective.
Morningstar's Take
This portion of the fact sheet offers a brief commentary on the fund and the performance of its portfolio managers, and generally offers an opinion of the future performance of the fund for both the short and long term.
Technical Data
Morningstar analyzes a number of technical indicators for each fund, such as its Sharpe ratio, beta, alpha, and other mathematical quantifications of the fund's risk, volatility and reward. These are always listed in a separate section as well.
Special Considerations
There has been an important change to the rules surrounding annuity investments in retirement accounts. In 2019, the U.S. Congress passed the SECURE Act, which made rule changes to annuities in retirement plans. Annuities are now more portable, meaning your 401(k) annuity can be rolled over into another plan when you change jobs.
The law also reduces legal risks for annuity providers by imposing limitations on whether an account holder can sue the provider in the event the company can't make the payments due to bankruptcy. Investors should consult a financial professional to review the new rules as a result of the SECURE Act.
Reinventing Itself
Morningstar went public in 2005. Since then, the company has continually refined and expanded its suite of products and services. Its services now extend beyond simple analysis and include sophisticated money management software for financial planners and X-ray portfolio analysis services that allow planners and investors to see the potential overlap of holdings within their investment portfolios, adding additional tools to investors' arsenal.
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f6fa1a1426bcabbfb4d7bd1895c0e778 | https://www.investopedia.com/articles/mutualfund/08/real-estate-sector-funds.asp | The Risks of Real Estate Sector Funds | The Risks of Real Estate Sector Funds
For many securities-oriented investors, real estate provides an ideal way to diversify their overall portfolios (and indeed, real estate comprises one of only two asset classes that have outperformed inflation over the long term). However, owners of individual properties face the same risk as owners of individual stocks: If the value of the asset declines, then they can lose big.
Fortunately, investors have an alternative method of participating in the real estate market through real estate sector funds. This article examines the risks and rewards inherent in real estate funds, as well as some of the winners and losers in this category.
Key Takeaways Real estate funds and real estate investment trusts (REITs) are used to invest in the housing sector or diversify a portfolio to include property investments. A real estate fund is a type of mutual fund that primarily focuses on investing in securities offered by publicly traded real estate companies such as builders, developers, and property owners. A REIT is a corporation, trust, or association that invests directly in income-producing real estate or mortgages and is traded like a stock.
What Is a Real Estate Fund?
A real estate fund is a professionally managed portfolio of diversified holdings. Most real estate funds invest in commercial or corporate rental properties, although they do occasionally dabble in residential investments. This type of fund can invest in properties directly or indirectly through real estate investment trusts (REITs). Like stock funds, real estate funds can invest domestically, internationally or both.
Real estate funds allow small investors to participate in the profits from large-scale commercial real estate enterprises, such as corporate office parks and skyscrapers. They also provide the usual benefits of mutual funds, such as professional management and diversification. This last characteristic is key for these funds, as most investors do not have a sufficient asset base to participate in commercial real estate in any direct sense, unlike stocks, which may be purchased as individual shares at a much more reasonable cost.
Real Estate Funds' Historical Performance
Real estate funds generally follow the mainstream economy in terms of performance; during periods of inflation and economic growth, real estate will usually post strong returns, while it usually fizzles in periods of recession. Since the late '60s and early '70s, real estate funds have outperformed the stock market in some periods and underperformed it in others. The real estate sector goes through periods of expansion and contraction, just like all other sectors of the economy.
As with all other sector funds, real estate funds tend to be more volatile than broader-based growth funds or income funds. Investors can generally expect to be hit hard in these funds when the real estate market collapses, as they were in the subprime meltdown of 2008 that triggered the Great Recession. A long-term view is definitely required.
Real Estate Funds: The Pros and Cons
Although real estate funds are usually either growth- or income-oriented, investors can generally expect to receive both dividend income and capital gains from the sale of appreciated properties within the portfolio. Real estate funds can defer capital gains through special rules, and funds that invest in REITs can benefit from certain tax advantages. For this reason, tax-conscious investors may be pleasantly surprised when they receive their annual capital gains distributions.
While they offer more protection than individual holdings, real estate funds face several kinds of risk that are inherent in this sector of the market. Liquidity risk, market risk, and interest rate risk are just some of the factors that can influence the gain or loss that is passed on to the investor. Liquidity and market risk will tend to have a greater effect on funds that are more growth-oriented, as the sale of appreciated properties depends upon market demand. Conversely, interest rate risk impacts the amount of dividend income that is paid by income-oriented funds.
The Bottom Line
The real estate market offers opportunities for both growth and income investors seeking long-term returns outside of the stock market. Real estate sector funds allow the small investor to participate in large-scale enterprises that would normally be far out of reach. Investors should understand the specific risks and rewards presented by real estate sector funds, but those who are willing to stay in for the long haul have historically reaped superior returns and competitive dividend income over time.
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9af14af28bfba02c4559a033884b8b08 | https://www.investopedia.com/articles/mutualfund/08/sector-fund-introduction.asp | An Introduction to Sector Mutual Funds | An Introduction to Sector Mutual Funds
There are several different ways one can diversify a portfolio, such as the different categories of the Morningstar style box, which contain several different asset classes. But another common way to diversify is between the various sectors of the economy. This is usually accomplished with mutual funds that concentrate in one of the major sectors, such as natural resources or utilities.
This article will examine the nature and composition of sector funds and the advantages and disadvantages that they present to investors.
What Is a Sector Mutual Fund?
As the name implies, a sector fund is a mutual fund that invests in a specific sector of the economy, such as energy or utilities. Sector funds come in many different flavors and can vary substantially in market capitalization, investment objective (i.e., growth and/or income), and a class of securities within the portfolio. Sector funds do not fall into a particular category in the Morningstar style box, such as large-cap value or mid-cap growth; instead, Morningstar ranks and analyzes sector funds in the following eight categories.
1. Natural Resources Funds: These funds invest in oil and gas and other energy sources, as well as timber and forestry. These funds are usually appropriate for long-term growth investors.
2. Utility Funds: These funds invest in securities of utility companies. They are usually designed to pay steady dividends to conservative fixed-income investors, although they may have a growth element as well.
3. Real Estate Funds: These funds provide a way for smaller investors to participate in the gains from real estate without having to actually buy real property. They often provide both growth and income.
4. Financial Funds: These funds invest in the financial industry. Holdings will include securities of investment, insurance, banking, mortgage, and accounting firms.
5. Health Care Funds: These funds can cover any kind of for-profit medical institution, such as pharmaceutical companies. Many of these funds also focus on biotechnology and the companies that make pioneering advances in this industry.
6.Technology Funds: These funds seek to provide exposure in the tech sector. This sector focuses primarily on computers, electronics, and other informational technology that is used in a wide range of applications.
7. Communications Funds: These funds focus on the telecommunications sector, but can include internet-related companies as well.
8. Precious Metals Funds: These funds provide exposure to a variety of metals, such as gold, silver, platinum, palladium, and copper.
Some sector funds focus on a specific subsector of the economy, such as banking or semiconductors. Morningstar classifies these funds into larger peer groups for analytical purposes.
Historical Performance
Investors who are considering sector funds should be prepared to accept greater risk and volatility than what they will endure in the broad-based funds and index funds. The various sectors of the U.S. economy have historically had higher highs and lower lows than the economy as a whole.
Subsectors, such as biotechnology, can be even more volatile. Sectors do perform differently at various points in the overall economic cycle. Some sectors do well in bull markets but poorly in bear markets, while others can grow earnings even during sluggish periods and recessions. Sector funds also tend to have higher turnover than other types of funds, so tax-conscious investors should pay close attention to capital gains distribution rates.
Why Invest in Sector Funds?
Sector funds are designed to provide market participation for investors whose portfolios lack exposure in a given sector. They can also provide a greater measure of diversification within a given sector than may be otherwise possible. The main reason that an investor would want to consider a sector fund is the same as for a particular individual stock: The investor feels that the sector is about to experience a period of strong growth.
Instead of investing directly in the stock of a company that has just released a revolutionary new technology, the investor could consider allocating assets to a technology fund that holds that company's stock in its portfolio. Sector funds can also serve to hedge a portfolio, as some sectors tend to move opposite the economy as a whole. For example, high energy prices can be a drain on the rest of the economy but a boon to the energy companies themselves. Investors seeking to profit from this condition would benefit from investing a small portion of their portfolios in an energy fund.
Sensible Sector Fund Investing
Important thresholds for any investor considering focused sector bets is to own a diversified mainstream portfolio. In order to diversify efficiently, planners should carefully examine the possible overlap between any potential sector fund and the client's current portfolio, so that any sector fund that is chosen contains the fewest possible stocks that are already held outright or held in another fund.
Many of the security holdings within a sector fund are also often found in the mainstream funds of that fund family. For example, major oil stocks, such as ExxonMobil, are likely to be found not only in a given fund company's energy sector fund but its flagship large-cap value fund as well. Therefore, sector funds that invest in a specific subsector, such as alternative energy sources, may provide greater diversification than a broader-based fund in some cases.
Averaging Into Sector Funds
Investors who add sector funds to their portfolios should also be aware that timing specific sectors of the market can be riskier and more difficult than trying to time the market as a whole. As mentioned previously, subsector funds are even more volatile by nature than broader-based funds, as their narrower focus will render them even more vulnerable to the economic cycles that can affect a specific industry, such as banking or mortgages.
Morningstar recommends that investors limit their exposure to any given sector to 5% of their portfolio. The use of such asset and sector allocation strategies as dollar-cost averaging or periodic portfolio rebalancing is also highly recommended. These methods can effectively reduce the volatility inherent in sector funds. However, sector funds tend to be appropriate for more aggressive investors seeking higher returns over time.
Perhaps most importantly, sector fund investors should be prepared to stay invested for at least 5-10 years, so that they can experience the entire cyclical rise and fall of the sector. Investors with time frames shorter than five years face substantial market risks.
Sector Fund Costs and Fees
Sector fund investors should closely monitor what they pay in terms of sales charges and annual expenses for sector funds, which run higher than funds in more general categories. This is because sector funds (in any category) lack the asset base that is found in mainstream funds, such as a flagship growth or income funds. As a result, they do not enjoy the subsequent economic scale pricing that larger funds can offer.
Investors who are participating in market-timing strategies would be wise to explore the world of sector spiders and exchange-traded funds (ETFs) that are available. These provide similar diversification to mutual funds, but trade like stocks and can be purchased much more cheaply than traditional open-end funds. Many of these can also be shorted for those investors who use short sales as part of an overall hedging or investing strategy.
The Bottom Line
Sector funds are appropriate for aggressive investors seeking exposure within either an entire sector of the economy or a specific subsection thereof. Overexposure to any given sector of the market can subject investors to undue risk and volatility, and appropriate measures should be taken to avoid this.
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05528de5471b342d3439215e236ffb2f | https://www.investopedia.com/articles/mutualfund/08/top-mutual-fund-managers.asp | Top 5 All-Time Best Mutual Fund Managers | Top 5 All-Time Best Mutual Fund Managers
Great money managers are the rock stars of the financial world. While Warren Buffett is a household name to many, to stock geeks, the names of Benjamin Graham, John Templeton, and Peter Lynch are cause for extended discourses on investment philosophies and performance.
The greatest mutual fund managers have produced long-term, market-beating returns, helping myriad individual investors build significant nest eggs.
Criteria
Before arriving at our list of the best of the best, let's take a look at the criteria used to choose the top five:
Long-term performers. We only consider those managers with a long history of market-beating performance.Retired managers only. We include only managers who have finished their careers.No team-managed funds. These were not evaluated because the teams might change midway through the performance period. Besides, as John Templeton put it, "I am not aware of any mutual fund that was run by a committee that ever had a superior record, except accidentally."Contributions. The top managers must have made contributions to the investment industry as a whole, not just to their own companies.
Benjamin Graham
He is known as the father of security analysis, although few would think of Benjamin Graham as a fund manager. He still qualifies for our list, however – from 1936 to 1956 he managed the modern equivalent of a closed-end mutual fund with partner Jerome Newman.
Investment Style: Deep value investing.
Best Investment: GEICO (NYSE:BRK.A). It spun off to Graham-Newman shareholders at $27 per share and rose to the equivalent of $54,000 per share. Although not an obvious fit with Graham's deep discount strategy, the GEICO purchase would become his most successful investment. Most of Graham's positions were sold in under two years, but he held GEICO stock for decades. His main investments were numerous low-risk arbitrage positions.
Major Contributions: Graham wrote Security Analysis with fellow Columbia professor David Dodd (1934), The Interpretation of Financial Statements (1937), and The Intelligent Investor (1949), which inspired Warren Buffett to seek out Graham, then study under him at Columbia University, and later to work for him at the Graham-Newman Corporation.
Graham also helped start what would eventually become the CFA Institute. Starting on Wall Street in 1914, long before securities markets were regulated by the Securities and Exchange Commission (SEC), he saw the need to certify security analysts—thus the CFA exam.
In addition to mentoring Buffett, Graham had numerous students who went on to have fabulous investment careers of their own, although they never achieved the cult status of their teacher or most famous fellow pupil.
Estimated return: Reports vary in accordance with the time period in question and the calculation methods used, but John Train reported in The Money Masters (2000) that Graham's fund, the Graham-Newman Corporation, earned 21% annually over 20 years. "If one invested $10,000 in 1936, one received an average of $2,100 a year for the next 20 years, and recovered one's original $10,000 at the end."
Sir John Templeton
Dubbed "the dean of global investing" by Forbes magazine, Templeton was knighted by Queen Elizabeth II for his philanthropic efforts. In addition to being a philanthropist, Templeton was also a Rhodes Scholar, CFA charterholder, benefactor of Oxford University, and a pioneer of global investing who excelled at finding the best opportunities in crisis situations.
Investment Style: Global contrarian and value investor. His strategy was to buy investment vehicles when, in his words, they hit "the point of maximum pessimism." As an example of this strategy, Templeton bought shares of every public European company trading for less than $1 per share at the outset of World War II, including many that were in bankruptcy. He did this with $10,000 of borrowed money. After four years, he sold them for $40,000. This profit financed his foray into the investment business. Templeton also sought out underappreciated fundamental success stories around the world. He wanted to find out which country was poised for a turnaround before everyone else knew the story.
Best Investments:
Europe, at the start of World War IIJapan, 1962Ford Motors (NYSE:F), 1978 (it was near bankruptcy)Peru, 1980sShorted technology stocks in 2000
Major Contributions: Built a major part of today's Franklin Resources (Franklin Templeton Investments). Templeton College at Oxford University's Saïd Business School is named in his honor.
Estimated Return: He managed the Templeton Growth Fund from 1954 to 1987. Each $10,000 invested in the Class A shares in 1954 would have grown to more than $2 million by 1992 (when he sold the company) with dividends reinvested, translating to an annualized return of ~14.5%.
T. Rowe Price, Jr.
T. Rowe Price entered Wall Street in the 1920s and founded an investment firm in 1937, but didn't start his first fund until much later. Price sold the firm to his employees in 1971, and it eventually went public in the mid-1980s. He is commonly quoted as saying, "What is good for the client is also good for the firm."
Investment Style: Value and long-term growth.
Price invested in companies he saw as having good management, being in "fertile fields" (attractive long-term industries), and positioned as industry leaders. Since he preferred to hold investments for decades, Price wanted companies that could show sustained growth over many years.
Best Investments: Merck (NYSE:MRK) in 1940; he reportedly made over 200 times his original investment. Coca-Cola (Nasdaq:COKE), 3M (NYSE:MMM), Avon Products (NYSE:AVP), and IBM (NYSE:IBM) were other notable investments.
Major Contributions: Price was one of the first to charge a fee based on assets under management rather than a commission for managing money. Today, this is common practice. Price also pioneered the growth style of investing by aiming to buy and hold for the long term, combining this with wide diversification. He founded publicly traded investment manager T. Rowe Price (Nasdaq:TROW) in 1937.
Results: Individual fund results for Price are not very useful, as he managed a number of funds, but two were mentioned in Nikki Ross' book Lessons from the Legends of Wall Street (2000). His first fund was started in 1950 and had the best 10-year performance of the decade—approximately 500%. Emerging Growth Fund was founded in 1960 and was also a standout performer, with such names as Xerox (NYSE:XRX), H&R Block (NYSE:HRB) and Texas Instruments (NYSE:TXN).
John Neff
The Ohio-born Neff joined Wellington Management Co. in 1964 and stayed with the company for more than 30 years, managing three of its funds. One of John Neff's preferred investment tactics was to invest in popular industries via indirect paths. For example, in a hot homebuilders' market, he may have looked to buy companies that supplied materials to homebuilders.
Investment Style: Value, or low P/E, high-yield investing.
Neff focused on companies with low price-earnings ratios (P/E ratios) and strong dividend yields. He sold when investment fundamentals deteriorated, or the price met his target. The psychology of investing was an important part of his strategy.
He also liked to add the dividend yield to the growth in earnings and divide this by the P/E ratio for a "you get what you pay for" ratio. For example, if the dividend yield was 5% and the earnings growth was 10%, he would add these two together and divide by the P/E ratio. If this was 10, he took 15 (the "what you get" number) and divided it by 10 (the "what you pay for" number). In this example, the ratio is 15/10 = 1.5. Anything over 1.0 was considered attractive.
Best investment: In 1984-1985, Neff began acquiring a large stake in Ford Motor Company; three years later, it had increased in value to nearly four times what he'd originally paid.
Major Contributions: Neff authored an investing how-to book covering his entire career year by year, titled John Neff on Investing (1999).
Results: John Neff ran the Windsor Fund for 31 years ending in 1995, earning a return of 13.7%, versus 10.6% for the S&P 500 over the same time span. This amounts to a gain of more than 55 times on an initial investment made in 1964.
Peter Lynch
A graduate of Penn's Wharton School of Business, Lynch practiced what he called "relentless pursuit." He visited company after company to find out if there was a small change for the better that the market hadn't picked up on yet. If he liked it, he'd buy a little, and if the story got better, he'd buy more, eventually owning thousands of stocks in what became the largest actively managed mutual fund in the world—the Fidelity Magellan Fund.
Investment Style: Growth and cyclical recovery.
Lynch is generally considered to be a long-term growth style investor but is rumored to have made most of his gains through traditional cyclical recovery and value plays.
Best Investments: Pep Boys (NYSE:PBY), Dunkin' Donuts, McDonald's (NYSE:MCD); they were all "tenbaggers."
Major Contributions: Lynch made Fidelity Investments into a household name. He also wrote several books, specifically, One up on Wall Street (1989) and Beating the Street (1993). He gave hope to do-it-yourself investors, saying: "Use what you know and buy to beat Wall Street gurus at their own game."
Results: Lynch is widely quoted as saying that a $1,000 invested in Magellan on May 31, 1977, would have been worth $28,000 by 1990.
The Bottom Line
These top money managers amassed great fortunes not only for themselves but also for those who invested in their funds. One thing they all have in common is that they often took an unconventional approach to investing and went against the herd. As any experienced investor knows, forging your own path and producing long-term, market-beating returns is no easy task. Given this, it's easy to see how these five investors carved a place for themselves in financial history.
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ea810d047e0c9f7fa1023b9cabb0859d | https://www.investopedia.com/articles/mutualfund/09/commodity-mutual-funds.asp | Commodity Funds 101 | Commodity Funds 101
Commodities get a lot of attention from the media. The price of oil, gold, corn, soy and hogs are in the national news nearly every day. While investing in the commodities markets is a fairly sophisticated endeavor, commodity mutual funds provide an opportunity for almost any investor to get a piece of the action.
A Variety of Fund Types
The generic label "commodity fund" actually captures several distinct types of investments. These include:
Commodity FundsThese funds are true commodity funds in that they have direct holdings in commodities. For example, a gold fund that holds gold bullion would be a true commodity fund. Commodity Funds That Hold FuturesHolding commodity-linked derivative instruments is a much more common mutual fund strategy for investing in the commodities markets. Most investors have no desire to take delivery of hogs, corn, oil or any other commodity, they simply want to profit from price changes. Purchasing futures contracts is one way to achieve this objective. (To learn more about futures, see Futures Fundamentals.) Natural Resource FundsFunds that invest in companies that are engaged in businesses that operate in commodity-related fields, such as energy, mining, oil drilling and agricultural businesses, are often referred to as natural resource funds. While they often hold neither actual commodities nor commodity futures, they provide exposure to the commodities markets by proxy.Combination FundsSome funds invest in a combination of actual commodities and commodity futures. Gold funds, for example, may have underlying holdings that include both bullion and futures contracts.
A Variety of Investment Strategies
In addition to a variety of formats, commodity funds also offer a variety of investment strategies, including active management and passive management. Active portfolios buy and sell in an effort to outperform a benchmark index. Passive portfolios seek to replicate a benchmark index and match its performance. Passive strategies can be implemented using index funds or exchange-traded funds (ETFs). (For more information on ETFs, see ETFs Provide Easy Access To Energy Commodities.)
Pros and Cons of Investing in Commodity Funds
Commodities offer portfolio diversification. Investing in futures contracts or actual commodities provides a portfolio component that is not a traditional stock, bond, or a mutual fund that invests in stocks and/or bonds. Historically, commodities have had a low correlation to traditional equity markets, meaning that they do not always fluctuate in tandem with market movements. For many investors, achieving this low correlation is the primary objective when seeking to add diversification to a portfolio. (For more information on diversification, see The Importance of Diversification.)
Commodities also offer upside potential. The raw materials used in construction, agriculture and many other industries are subject to the laws of supply and demand. When demand rises, prices generally follow, resulting in a profit for investors.
Finally, commodities offer a hedge against inflation. (Commodities: The Portfolio Hedge explains how these diverse asset classes provide both downside protection and upside potential.)
On the Other Hand
The commodities markets can be volatile and subject to wild, short-term price swings and long lulls. Over the course of just a few days, prices can go from record highs to record lows. For a closer look at the range of price movements, research the price of gold over the past 30 years and the price of copper in 2008.
Another item of note is the composition of various mutual funds and the benchmark indexes that they track. In many commodities indexes, energy is often the heavyweight, taking up more than half of the index. When a mutual fund seeks to directly replicate the index, more than half of the fund's assets will be in energy. Some funds place limits on the percent of the portfolio invested in a single commodity to avoid an over-concentration in a single investment. (For more information on investing in commodities, see How To Invest In Commodities.)
Look Before You Leap
While commodities provide access to some interesting investments and strategies, the commodities markets are complex, and not as familiar to most investors as the stock market or bond market. Before you invest in commodities funds, read the fund's prospectus and annual report, and be sure that you understand what you are buying and the role it plays in your portfolio. Likewise, pay attention to the fund's holdings. Make sure that you are aware of how much of the fund's assets are weighted to a particular market sector and plan accordingly for other parts of your portfolio. Keep in mind the volatile nature of the commodities markets and limit holdings to a small percentage of your total portfolio.
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613b25421bcbf7155f29e66e85903867 | https://www.investopedia.com/articles/mutualfund/09/mutual-fund-liquidation.asp | Liquidation Blues: When Mutual Funds Close | Liquidation Blues: When Mutual Funds Close
Mutual fund liquidations, also referred to as "full closures," are never good news. Liquidation involves the sale of all of a fund's assets and the distribution of the proceeds to the fund shareholders. At best, it means shareholders are forced to sell at a time, not of their choosing. At worst, it means shareholders suffer a loss and pay capital gains taxes too.
Standard & Poor's, in a 2016 report on the performance of funds compared to their index benchmarks, noted that nearly a quarter of all U.S. and international stock funds had been merged or liquidated in the then-past five years.
Most dead funds are merged into another in the fund family. This route is easier for shareholders because their money is immediately invested in a similar (and often more successful) fund.
The Thrill Is Gone
Still, liquidations do occur, usually after a fund has dropped in value. This forces investors who bought when the fund was more expensive to sell at a loss. Worse yet, the fund may have embedded capital gains, which can have an immediate impact on investors holding the fund in a taxable account. This occurs when a fund doesn't sell a stock that has risen in value since it was purchased.
For investors, this means that although the stock may have been purchased by the fund before some investors bought in, the tax liability for those gains is not passed on to investors until the stock is sold and the gains are realized and paid into current shareholders' accounts. This occurs because of the "mutual" ownership aspect of mutual funds. Therefore, when the fund is liquidated, the investor not only sells the fund for less than the purchase price but also still pays tax on capital gains that they did not get to benefit from. This can be particularly damaging to investors holding the fund in taxable accounts, as the taxes cannot be deferred the way they could be in a tax-deferred investment, such as a 401(k) plan.
Let the Good Times Roll
Funds are liquidated for a variety of reasons, with poor performance ranking as one of the primary causes. Poor performance reduces asset flows, as investors choose not to buy into a fund that isn't doing well. It also brings down the mutual fund management firm's track record. If the firm has five funds and four of them are doing well, closing the poor performer gives the firm a track record based on four successful funds.
Poor performance also results in bad publicity, which can lead to large redemptions. As the asset base falls, the costs of doing business increase. Funds operate on economies of scale, with bigger being better from a cost-savings perspective. As costs increase, it can become unprofitable to operate a fund.
If investors are losing money, the fund is likely to stay open as long as the fund can be operated profitably, but when the fund company starts to feel the heat, the fund is terminated. After all, fund companies are in business to make a profit.
The 'How Long?' Blues
Fund terminations are common, particularly among new funds. If a fund doesn't gain popularity and grow during its first three years, it is likely to close. Several hundred funds closed nearly every year during the late 1990s and the early 2000s. Niche funds are particularly vulnerable, as they are often invested in fads, or focused on such a small aspect of an industry that there is a risk the concept will never catch on with investors.
Signs that a fund is a candidate for closure include a big drop in performance that is sustained without recovery. A poor track record over several years is another warning. Because poor long-term performance simply isn't appealing to investors, heavy redemptions are another possible indicator.
When You're Down and Out
If you've got the feeling that your fund is going away, what should you do? There are different strategies for different funds. If you're invested in an open-end mutual fund, and the signs of the end are coming, it's time to head for the exit as fast as you can. When investors all want to sell a particular fund, the selling pressure tends to lower the fund's price. Getting out sooner rather than later can help you get a better price for your shares and salvage as much of your investment as possible.
If you are invested in a closed-end fund, look at the underlying assets. If the fund is selling at a premium, sell to maximize your payout. If the fund is trading at a discount, you may want to hold because you will get paid on the full value of the assets when the fund liquidates them.
The Bottom Line
Mutual fund closures are not extraordinary events. They happen all the time as part of the fund industry's natural business cycle. You can minimize your exposure to these occurrences by investing in funds with long track records of success and carefully monitoring your exposure to niche products. When a closure occurs, it's not the end of the world. Take appropriate action, learn from the experience, and redeploy your assets to keep your long-term investment goals on track.
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028a450949e35185e253e600ddc39afd | https://www.investopedia.com/articles/mutualfund/10/a-safer-money-market-2a7.asp | How Money Market Funds Got Safer With Rule 2a-7 | How Money Market Funds Got Safer With Rule 2a-7
At their inception in the 1970s, money market funds were marketed as "safe" investments. Essentially, their pitch was this: "If your investments in the stock market are keeping you from sleeping at night, it's time to learn about the safer alternatives in money market funds."
The focus on safety and solid returns were justified, as money markets traditionally maintained a net asset value (NAV) of $1 per share and paid a higher rate of interest than checking accounts. The combination of a stable share price and a good interest rate made them good places to store cash. This positioning held true until September 2008 when the Reserve Fund broke the buck—a financial services industry phrase used to describe the scenario when a money market fund has its NAVs fall below $1 per share.
While the Reserve Fund's meltdown directly hurt a relatively small number of investors, it revealed that the safety investors had relied on for decades was an illusion. If the Reserve Fund, which had been developed by Bruce Bent (a man often referred to as the "father of the money-fund industry"), couldn't maintain its share price, investors began to wonder which money market fund was safe.
The failure of the Reserve Fund called into question the definition of "safe" and the validity of marketing money market funds as "cash equivalent" investments. It also served as a stark reminder to investors about the importance of understanding their investments.
Rule 2a-7
The Securities And Exchange Commission (SEC) recognized the threat to the financial system that would be caused by a systemic collapse of money market funds and responded with Rule 2a-7. This regulation requires money market funds to restrict their underlying holdings to investments that have more conservative maturities and credit ratings than those previously permitted to be held. From a maturity perspective, Rule 2a-7 stated that the average dollar-weighted portfolio maturity of investments held in a money market fund cannot exceed 60 days. From a credit rating perspective, no more than 3% of assets can be invested in securities that do not fall within the first or second-highest ranking tier.
Increased liquidity requirements also got more stringent as part of Rule 2a-7. For one, taxable funds must hold at least 10% of their assets in investments that can be converted into cash within one day. At least 30% of assets must be in investments that can be converted into cash within five business days. In addition, no more than 5% of assets can be held in investments that take more than a week to convert into cash.
Funds must undergo stress tests as well under Rule 2a-7 to verify their ability to maintain a stable NAV under adverse conditions. They are required to track and disclose the NAV based on the market value of underlying holdings and to release that information on a 60-day delay after the end of the reporting period.
Impact on Industry and Investors
In reality, the enactment of Rule 2a-7 had no significant impact on investors. The NAV disclosure requirement has been a non-event, as investors must go find the historical information. Fund companies are not required to provide it proactively. Yields on money market funds may be lower than they would be if the funds could invest in more aggressive options, but the difference is only a few basis points.
In 2016, reforms required money market funds to allow their NAV to "float" or fluctuate. That means money market funds may not have a stable NAV of $1 at any given time.
The Bottom Line
If a money market fund's NAV drops below the $1 share price, this can cause investors to lose money. Since the interest rate differential between a money market fund and a checking or savings account is generally small, investors have to watch the NAV closely to make sure they are getting the full benefit of their interest rate. In other words, the loss of NAV could eat up the gains from interest, making the passing of Rule 2a-7 just one tactic to address this risk.
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bad1bc031645d2d1498a988abb256e9d | https://www.investopedia.com/articles/mutualfund/10/floating-rate-mutual-funds.asp | Floating-Rate Mutual Funds: Rewards and Risks | Floating-Rate Mutual Funds: Rewards and Risks
Floating rate mutual funds invest in bonds and other fixed-income securities that have variable, as opposed to fixed, interest rates. When interest rates are low, fixed-income investors search for creative, sometimes riskier, ways to grab extra income.
For this reason, floating-rate mutual funds attract the attention of both yield-hungry investors and the mutual fund companies that love to feed them. Read on to learn more about floating-rate mutual funds and some of the important points to consider before taking your first bite.
Key Takeaways A floating rate fund is a mutual fund that invests in financial instruments, such as bonds and bank loans, paying a variable or floating interest rate. Most floating rate funds invest in relative short-term obligations, meaning they have relatively lower duration than other fixed-income mutual funds.These funds are able to more nimbly navigate a changing interest rate environment and there offer investors a unique layer of diversification.Floating rate funds could have holdings that include corporate bonds that are close to junk status or loans that have default risk. Investors should evaluate the riskiness of a fund's portfolio before investing.
Floating Rate Funds
Floating-rate mutual funds can be both open and closed-end. Buyers beware: Some floating-rate funds allow you to purchase shares daily but will only allow you to redeem your shares monthly or quarterly.
Floating-rate funds usually invest at least 70-80% of their investment holdings in floating-rate bank loans. The other 20-30% of the fund's holdings are commonly invested in things like cash, investment-grade and junk bonds, and derivatives. Many of these funds attempt to boost their yields by using financial leverage. You are more likely to see large amounts of financial leverage used in a closed-end floating-rate fund than an open-ended one.
Yields offered by floating-rate funds typically fall somewhere between yields on investment-grade bond funds and high-yield bond funds. Every mutual fund is structured differently with regard to its use of leverage, investment strategy, expenses and rules for both purchasing and redeeming your shares. As always, it is important to carefully read a mutual fund's prospectus before you invest.
Floating-Rate Bank Loans 101
When investing in floating-rate funds, it is important to understand the basics of floating-rate loans. Floating-rate loans are variable-rate loans made by financial institutions to companies that are generally considered to have low credit quality.
They are also known as syndicated loans or senior bank loans. Borrowers enter into these loans to raise capital for things like recapitalizations, debt refinancing or to make acquisitions. After banks originate the loans, they sell them to hedge funds, collateralized loan obligations (CLO) and mutual funds.
The loans are called "floating-rate" because the interest paid on the loans adjusts periodically, usually every 30 to 90 days, based on changes in widely accepted reference rates, such as London Interbank Offered Rate (LIBOR), plus a predetermined credit spread over the reference rate. The size of the credit spread depends on things like the credit quality of the borrower, the value of the collateral backing the loan and the covenants associated with the loan.
Floating-rate loans are classified as senior debt and are usually collateralized by specific assets, like the borrower's inventory, receivables or property. The word "senior debt" is especially important here. It means that the loans are typically senior to bondholders, preferred stock holders and common stock holders in the borrower's capital structure.
Not all floating-rate loans "float" all of the time. Some of the loans can be originated with options, like interest rate floors, which can affect the interest rate risk involved with owning the loan.
Key Qualities of Floating-Rate Funds
Junk Status and Seniority
Because they generally invest in the debt of low-credit-quality borrowers, floating-rate funds should be considered a riskier part of your portfolio. Most of the income earned by the funds will be compensation for credit risk. Some of the credit risk involved with investing in the debt of low-credit-quality companies is offset by a floating-rate loan's capital structure "seniority" and the collateral backing it.
Historically, default recovery rates on floating-rate loans have been higher than that of high-yield bonds, which has meant lower potential credit losses for investors. A diverse portfolio of floating-rate loans should perform well when the economy is recovering and credit spreads are tightening.
Limited Duration
A floating-rate fund's net asset value (NAV) should be less sensitive to movements in short-term borrowing rates than other income-producing mutual funds, like long-term bond funds. The maturity of a floating-rate loan is around seven years, but the underlying interest rate on most loans will adjusts every 30-90 days, based on changes in the reference rate.
For this reason, the market value of a floating-rate loan will be less sensitive to changes in short-term borrowing rates relative to most fixed-rate investments. This makes floating-rate funds attractive to income investors in periods when the economy is recovering and short-term borrowing rates are expected to rise.
Diversification and a Niche Market
Floating-rate funds can offer diversification benefits to income investors. Because floating-rate loans are uniquely structured, they traditionally have low correlations with most major asset classes like stocks, government bonds, high-grade corporate bonds and municipal bonds.
However, price correlations between floating-rate loans and other risky asset classes have been known to converge during periods of financial market stress. The floating-rate loan market is a fairly untapped, niche market to which most investors do not have direct access.
These less-scrutinized markets can have their benefits. The less efficient the market, the bigger the opportunity for good fund managers to generate superior risk-adjusted returns. For this reason, it is especially important to check the investment manager's performance track record, tenure at the fund and experience investing in alternative assets before investing in a floating-rate fund.
The Bottom Line
Low-interest rate environments can encourage investors to reach for extra yield with little understanding of the risk that they are assuming. The growing popularity of income-producing financial products, like floating-rate funds, makes it important for investors to be familiar with the basics of alternative asset classes.
Floating-rate funds can provide income investors with diversification and some protection from interest rate risk. They can be an alternative (albeit riskier) way to add some extra income to your yield-starved portfolio. Just make sure that you are comfortable with their risks, and don't bite off more than you can chew.
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a43f85a297e633825970c90941b6c23c | https://www.investopedia.com/articles/mutualfund/13/12b1-understanding-mutual-fund-fees.asp | 12b-1: Understanding Mutual Fund Fees | 12b-1: Understanding Mutual Fund Fees
As with any for-profit business enterprise, the mutual fund industry charges fees for the services it offers. In their most basic form, these services consist of managing a pool of commingled assets in accordance with an investment strategy. That strategy may include outperforming an index over time. In fact, this strategy is the lifeblood of the actively managed fund component of the industry.
A well-managed fund will tend to grow in popularity and earn more investors over time. However, for several decades now, and for reasons that used to make much more sense than they do today, mutual funds have charged existing investors for marketing and promoting their services to prospective investors. These charges are known as 12b-1 fees.
Key Takeaways A 12b-1 fee is an annual marketing or distribution fee on a mutual fund charged to investors. The 12b-1 fee is considered to be an operational expense and, as such, is included in a fund's expense ratio. It is generally between 0.25% and 0.75% (the maximum allowed) of a fund's net assets and must be disclosed on the fund's prospectus.
The Basics of the 12b-1 Fee
A mutual fund charges its investors a 12b-1 fee to pay for marketing and promotion expenses. According to a discussion of 12b-1 fees on the website for the Securities and Exchange Commission (SEC), "these fees are deducted from a mutual fund to compensate securities professionals for sales efforts and services provided to the fund's investors."
It also details that 12b-1 fees first emerged in the 1970s during a period when mutual funds were seeing significant redemptions and wanted an avenue to help attract new assets. The funds needed sufficient assets to protect existing investors from the fund managers' having to make forced sales at depressed asset prices or when stocks and bonds were not trading at favorable levels. The fee's official name stems from a 1980 SEC rule implemented to authorize its use.
Fast forwarding approximately half a century, the ability for funds to charge 12b-1 fees has grown more controversial. Mutual funds are much more popular these days, which makes the original motivation for creating the fee much less meaningful. Funds are also much larger, with the largest managing hundreds of billions of dollars in assets. 12b-1s also have a percentage fee, such as 25 basis points or 0.25% of all the assets managed in a fund. With billions under management, it is difficult to see the need to charge investors to market the fund to other potential investors. Estimates of 12b-1 fees have been around $10 billion annually in recent years across all funds that charge the fee. Additionally, while 12b-1 fees vary across individual funds, one study estimated an average annual fee of 13 basis points, or 0.13%. It is also estimated that around 70% of mutual funds charge 12b-1 fees in at least one share class.
Where to Find the 12b-1 Fee
The 12b-1 fee is a component of a mutual fund's total expense ratio. Websites including Morningstar and Yahoo! Finance generally list the total expense ratio by fund. However, to get the most accurate and current expense ratios, it is necessary to dig into a mutual fund prospectus. The prospectus must list specific fees and charges by each mutual fund class offered.
The mutual fund prospectus will have one or more sections detailing fees and expenses. Generally, the fund's annual operating expenses will be broken down into components. The largest fee is usually the management fee, which is what the portfolio managers charge to run the fund. The distribution fee, or 12b-1 fee, will also be listed. Other fees and expenses may include sales charges such as front-end and back-end sales loads that investors incur when they buy or sell a fund. There may also be other operating expenses, such as account administration fees, recordkeeping fees and networking fees to wholesalers and other financial intermediaries that also help to sell the fund.
There are other selling fees beyond the 12b-1 marketing and promotion charges. These will be explicitly broken down and detailed in either the mutual fund prospectus or a corresponding document called a statement of additional information.
Important Considerations
Investors may question whether it is appropriate for a mutual fund to charge its existing investors a fee to market and promote the fund to other potential investors. Controversy has bubbled up from time to time over this issue, especially following the credit crisis and ensuing Great Recession that called into question many aspects of how the financial services industry operates and charges its clients.
SEC proposals at the time looked to cap the 12b-1 fee at 25 basis points and to make the fee more transparent to investors who might not even know that they are being charged for marketing, promotion and related sales activities.
The Bottom Line
Many mutual funds warrant criticism for their high fees and uneven performance. That being said, many worthwhile funds with great performance records charge very reasonable fees. In fact, 30% of mutual funds don't charge 12b-1 fees, since their managers find them unnecessary or would rather protect the financial interests of their existing investors.
To find the best funds and balance the risks against the rewards of funds that charge 12b-1 fees, investors should read the mutual fund's prospectus and SAI, and then make an educated decision over whether the fund is likely to earn a sufficient return for the fee it will charge.
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bd8d770b1b042a6c4338fa9aac477854 | https://www.investopedia.com/articles/mutualfunds/09/hedge-fund-due-diligence.asp | Hedge Fund Due Diligence | Hedge Fund Due Diligence
Thinking about buying into a hedge fund? Once a hedge fund has been chosen for further evaluation, the first step in the due diligence process is the information-gathering phase. Information can be obtained from the hedge fund manager or third-party sources, depending on the type of information and the required level of detail.
In most cases, when requesting information from a hedge fund manager, an investor must be able to identify themselves as an accredited investor or a registered investment advisor (RIA). This requirement is also becoming mandatory for obtaining information from many third-party sources. Some hedge fund managers require as little as a signed document stating that the investor is attesting to their accredited investor status, while others may go as far as requesting personal financial statements. In other words, you can't investigate a hedge fund carefully unless you have the resources to buy in. Assuming you do have the resources and experience required to invest in a hedge fund, it's important to conduct your due diligence to ensure that you're putting your money in the most productive place possible. Find out what you need to know to make your decision and where to find that information.
All investors should conduct due diligence before making an investment - that is, carefully collecting and analyzing information about the investment and its risks.
Key Takeaways Due diligence is especially important when considering a hedge fund investment, as hedge funds tend to be more complex and opaque than ordinary investments while having less regulatory oversight.Request key documents such as the fund's pitchbook, investment mandate, and performance track record.Be sure to understand the fee structure and get further information through conference calls with portfolio managers or even make a visit to the fund's HQ.
Document Request
One of the simplest documents to review is what is often called a pitchbook. A pitchbook is a presentation that describes the firm and its fund strategy, and often provides details on the manager's strategy and process, biographies of firm personnel and performance history.
The pitchbook is a great resource for a preliminary determination of whether full-fledged due diligence is warranted. Up to this point, much of what an investor knows about the hedge fund is performance data, so the detailed explanation of the fund's strategy can enable an investor to determine whether it's a fund worth pursuing. Pitchbooks can vary greatly from one hedge fund to another. Some pitchbooks contain a variety of visual aids, like graphs and tables, to explain the manager's strategy and investment methodology. Others may differ in the level of detail provided, from short summaries of their investment strategy to a discussion of the portfolio and position details. Once reviewed, the pitchbook will give an investor an adequate description of the fund.
If the fund looks interesting, an investor would then review the offering memorandum and subscription documents. Both are legal documents, and an investor should pay close attention when reviewing them. Two important areas to peruse are the stated investment objectives and the description of securities in which the hedge fund is allowed to invest. Hedge funds are becoming more flexible, which allows investment in securities outside of the fund's core capabilities and historical trends. By allowing a broader mandate, funds can make opportunistic investments in temporarily attractive sectors or shift focus when their investment style is out of favor. Although this could give a hedge fund manager more opportunities to invest, it could also raise risk management issues for the investor.
An investor should feel comfortable with the level of flexibility inherent in the investment mandate. If an investor is looking for a merger arbitrage hedge fund manager, for example, they should be wary of an investment mandate that also allows the hedge fund manager to invest in commodities, futures, or private equity, which are not necessarily merger arbitrage-type investments. Broader investment mandates can potentially change the risk or return expectations of a hedge fund and may have liquidity implications. Be wary of very broad mandates.
Investment Terms
An investor should also review the investment terms. Investment terms include minimum investment amounts, share classes, fee terms, redemption terms and notice periods, among others.
Minimum Investment: Not only can an investor determine estimates of their own allocation amounts, but the minimum investment can also give an investor an idea of the types of investors in the fund. Higher minimums indicate a greater number of institutional investors or ultra-high net worth individuals compared to lower minimums, which would indicate a higher number of individual investors.Share Classes: Some funds will only have one share class. Others, however, will have multiple share classes that may have different investment terms, fee structures or investment mandates. It's important to note that some share classes allow for less liquid investments than other share classes.Fee Terms: The industry norm is "two and 20." That means a fund charges 2% of assets under management (management fee) and 20% of the profits (incentive fee). The fee terms should also include a high-water mark, which requires a hedge fund to exceed any prior high before collecting incentive fees.Redemption Terms and Notice Period: While some funds allow for monthly withdrawals, others will only allow quarterly, semiannual or annual redemptions. These terms have critical implications for liquidity and the portfolio management process. However, an investor should evaluate the terms relative to the investment strategy of the fund and determine their compatibility. Infrequent redemption periods are not necessarily a disadvantage as an investor might prefer to ensure that large, frequent investor redemptions will not occur. Some funds will be punished by frequent investor redemptions.
Conference Call
Before a conference call, an investor should obtain all of the information they need to make an investment decision. To prepare for a conference call, an investor should complete the following activities:
Develop a list of relevant questions that should be answered during the entire due diligence process.Make sure to review the pitchbook, offering memo and performance analysis data. This information will be the foundation upon which to build a conversation and may answer many of your questions prior to the conference call.Schedule a convenient time for the call and take into consideration that the hedge fund manager may not want to speak until after market hours.Make sure all of the right people are on the call so time isn't wasted looking for others. The call shouldn't last more than an hour and you want to maximize this time.If more than one person will be on the call from the investor point of view, make sure to coordinate the conversation so it does not become a chaotic question and answer session. The goal is to have an in-depth dialogue with the hedge fund manager, not just fill out a questionnaire.Have the fund manager describe their past experiences, how their strategy has evolved, and what their vision is for the future. The manager should be able to tell a story that leads to their current investment process and how it will provide above-average returns in the current and future environment.Ask the manager to describe specific past investments that were a success and those that were failures. A manager should be able to describe failures and lessons learned from them.Describe your decision-making process and next steps.Introduce the possibility of an office visit and determine the appropriate contact person to organize a visit.
Office Visit
Depending on the type of hedge fund strategy and the amount of outsourcing a hedge fund has implemented, an office visit should range from as short as a few hours to as long as a couple of days. Many hedge funds are increasingly outsourcing their back office operations, so an office visit may not include an assessment of back-office capabilities.
Office visits should be conducted annually. Although communication should be occurring on a regular basis throughout the year, it is important to make periodic visits to not only build the relationship with a hedge fund manager, but also to visually assess any changes in the office environment, personnel, or even the physical appearance of the hedge fund manager to determine any changes that may indicate high levels of stress or poor health.
When conducting an office visit, it is important to meet with all relevant personnel and spend enough time with each to assess their capabilities and the fund's exposure to certain risks.
Investment Decision Makers: The most important person to meet with, during an office visit, is obviously the person or people making investment decisions. This is a great time to go into detail about topics discussed during the initial conference call or issues that have come up during the continuing due diligence process.Idea Generators: Hedge fund managers may develop ideas on their own, rely on a team of analysts to uncover new opportunities or use a combination of the two in either an individual or team-based approach. It is important for the investor to interview everyone who contributes to the idea and investment process in the event that a top contributor leaves the firm.Risk Manager or Committee: Ideally, a fund will have separate investment and risk teams with the risk team responsible for monitoring the portfolio and ensuring it is maintained within the targeted risk parameters.CFO/Operations Manager: The back-office manager should be able to describe all of the firm's processes, and the investor's focus should be on financial controls such as signing authority, compliance, trade execution processes, and financial reporting, among others.
Some of the specific functions might include:
IT: This includes trading software and systems, portfolio risk analysis software, database and storage systems and contingency planning in the event of disaster.Accounting: This includes net asset value calculations, fund auditing and fund administration.References: Investors who are currently or have been invested in the fund in the past can provide a good idea of a manager's communication, honesty, and consistency.
Other Information
Finally, there are public and fee-based sources that can be used to gather additional information about a fund and its principals. Online and print news sources such as The Wall Street Journal, Google, FINalternatives, hedgefund.net, Yahoo, LexisNexis and a variety of other sources can be used to search for announcements or news about the firm or the individual principals.
The Bottom Line
Proper hedge fund due diligence hinges on being able to effectively gather and analyze information about the fund. A hedge fund may offer up information that is not requested, but an investor should assume that only requested information will be provided. Therefore, a proper list of documents, questionnaires and interviews will ensure that an investor is properly informed about a fund before making an investment decision. Keep in mind that the information-gathering process presumes a hedge fund manager's honesty in providing complete and accurate information, and that intentional fraud will more likely be uncovered through a thorough due diligence process.
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1cf831653080aea7366369c2ae83f6d9 | https://www.investopedia.com/articles/optioninvestor/02/021302.asp | The Importance of Time Value in Options Trading | The Importance of Time Value in Options Trading
Most investors and traders new to options markets prefer to buy calls and puts because of their limited risk and unlimited profit potential. Buying puts or calls is typically a way for investors and traders to speculate with only a fraction of their capital. But these straight option buyers miss many of the best features of stock and commodity options, such as the opportunity to turn time-value decay (the reduction in value of an options contract as it reaches its expiration date) into potential profits.
When establishing a position, option sellers collect time-value premiums paid by option buyers. Rather than losing out because of time decay, the option seller can benefit from the passage of time, and time-value decay becomes money in the bank even if the underlying asset is stationary.
Before explaining the importance of time value with respect to option pricing, this article takes a detailed look at the phenomenon of time value and time-value decay. First we'll look at some basic option concepts that apply to the concept of time value.
Options and Strike Price
Depending on where the underlying asset is in relation to the option strike price, the option can be in, out, or at the money. At the money means the strike price of the option is equal to the current price of the underlying stock or commodity. When the price of a commodity or stock is the same as the strike price (also known as the exercise price) it has zero intrinsic value, but it also has the maximum level of time value compared to that of all the other option strike prices for the same month. The table below provides a table of possible positions of the underlying asset in relation to an option's strike price.
The Relationship of the Underlying to the Strike Price Put Call In-the-money option The price of the underlying is less than the strike price of the option. The price of the underlying is greater than the strike price of the option. Out-of-the-money option The price of the underlying is greater than the strike price of the option. The price of the underlying is less than the strike price of the option. At-the-money option The price of the underlying is equal to the strike price of the option. The price of the underlying is equal to the strike price of the option. Note: Underlying refers to the asset (i.e. stock or commodity) upon which an option trades.
This table shows that when a put option is in the money, the underlying price is less than the option strike price. For a call option, in the money means that the underlying price is greater than the option strike price. For example, if we have an S&P 500 call with a strike price of 1,100 (an example we will use to illustrate time value below), and if the underlying stock index at expiration closes at 1,150, the option will have expired 50 points in the money (1,150 - 1,100 = 50).
In the case of a put option at the same strike price of 1100 and the underlying asset at 1050, the option at expiration also would be 50 points in the money (1,100 - 1,050 = 50). For out-of-the-money options, the reverse applies. That is, to be out of the money, the put's strike would be less than the underlying price, and the call's strike would be greater than the underlying price. Finally, both put and call options would be at the money when the underlying asset expires at the strike price. While we are referring here to the position of the option at expiration, the same rules apply at any time before the options expire.
Time Value of Money
With these basic relationships in mind, we take a closer look at time value and the rate of time-value decay (represented by theta, from the Greek alphabet). If we ignore volatility, for now, the time-value component of an option, also known as extrinsic value, is a function of two variables: (1) time remaining until expiration and (2) the closeness of the option strike price to the money. All other things remaining the same (or no changes in the underlying asset and volatility levels), the longer the time to expiration, the more value the option will have in the form of time value.
But this level is also affected by how close to the money the option is. For example, two call options with the same calendar month expiration (both having the same time remaining in the contract life) but different strike prices will have different levels of extrinsic value (time value). This is because one will be closer to the money than the other.
The table below illustrates this concept and indicates when time value would be higher or lower and whether there will be any intrinsic value (which arises when the option gets in the money) in the price of the option. As the table indicates, deep in-the-money options and deep out-of-the-money options have little time value. Intrinsic value increases the more in the money the option becomes. And at-the-money options have the maximum level of time value but no intrinsic value. Time value is at its highest level when an option is at the money because the potential for intrinsic value to begin to rise is greatest at this point.
Intrinsic Value vs. Time Value In-the-money Out-of-the money At-the-money Put/Call Time-value decreases as the option gets deeper in the money; intrinsic value increases. Time-value decreases as option gets deeper out of the money; intrinsic value is zero. Time-value is at a maximum when an option is at the money; intrinsic value is zero. Note: Intrinsic value arises when an option gets in the money.
Time-Value Decay
In the figure below, we simulate time-value decay using three at-the-money S&P 500 call options, all with the same strikes but different contract expiration dates. This should make the above concepts more tangible. Through this presentation, we are making the assumption (for simplification) that implied volatility levels remain unchanged and the underlying asset is stationary. This helps us to isolate the behavior of time value. The importance of time value and time-value decay should thus become much clearer.
Taking our series of S&P 500 call options, all with an at-the-money strike price of 1,100, we can simulate how time value influences an option's price. Assume the date is February 8. If we compare the prices of each option at a certain moment in time, each with different expiration dates (February, March, and April), the phenomenon of time-value decay becomes evident. We can witness how the passage of time changes the value of the options.
The figure below illustrates the premium for these at-the-money S&P 500 call options with the same strikes. With the underlying asset stationary, the February call option has five days remaining until expiry, the March call option has 33 days remaining, and the April call option has 68 days remaining.
As the figure below shows, the highest premium is at the 68-day interval (remember prices are from February 8), declining from there as we move to the options that are closer to expiration (33 days and five days). Again, we are simply taking different prices at one point in time for an at-the-option strike (1100), and comparing them. The fewer days remaining translates into less time value. As you can see, the option premium declines from $38.90 to $25.70 when we move from the strike 68 days out to the strike that is only 33 days out.
Image by Julie Bang © Investopedia 2019
The next level of the premium, a decline of 14.7 points to $11, reflects just five days remaining before expiration for that particular option. During the last five days of that option, if it remains out of the money (the S&P 500 stock index below 1,100 at expiration), the option value will fall to zero, and this will take place in just five days. Each point is worth $250 on an S&P 500 option.
One important dynamic of time-value decay is that the rate is not constant. As expiration nears, the rate of time-value decay (theta) increases (not shown here). This means that the amount of time premium disappearing from the option's price per day is greater with each passing day.
The concept is looked at in another way in the figure below: The number of days required for a $1 (1 point) decline in premium on the option will decrease as expiry nears.
Image by Julie Bang © Investopedia 2019
This shows that at 68 days remaining until expiration, a $1 decline in premium takes 1.75 days. But at just 33 days remaining until expiration, the time required for a $1 loss in premium has fallen to 1.28 days. In the last month of the life of an option, theta increases sharply, and the days required for a 1-point decline in premium falls rapidly.
At five days remaining until expiration, the option is losing 1 point in just less than half a day (0.45 days). If we look again at the Time-Value Decay figure, at five days remaining until expiration, this at-the-money S&P 500 call option has 11 points in premium. This means that the premium will decline by approximately 2.2 points per day. Of course, the rate increases even more in the final day of trading, which we do not show here.
The Bottom Line
While there are other pricing dimensions (such as delta, gamma, and implied volatility), a look at time-value decay is helpful to understand how options are priced.
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1d65665eb62e75ff5e8901281a55cfba | https://www.investopedia.com/articles/optioninvestor/03/021403.asp | Options Trading Strategies: Understanding Position Delta | Options Trading Strategies: Understanding Position Delta
In this article, we discuss various risk measures for options such as delta, gamma, theta, and vega, which are summarized in figure 1 below. We take a closer look at delta as it relates to actual and combined positions—known as position delta—which is a very important concept for option sellers. Below is a review of the risk measure delta, and an explanation of position delta, including an example of what it means to be position-delta neutral.
Key Takeaways Delta is a ratio—sometimes referred to as a hedge ratio—that compares the change in the price of an underlying asset with the change in the price of a derivative or option.Delta is one of the four measures options traders use for analyzing risk; the other three are gamma, theta, and vega.For options traders, delta indicates how many options contracts are needed to hedge a long or short position in the underlying asset.
Understanding Simple Delta
Let's review some basic concepts before jumping right into position delta. Delta is one of four major risk measures used by options traders. The other measures are gamma, theta, and vega.
Delta measures the degree to which an option is exposed to shifts in the price of the underlying asset (i.e., a stock) or commodity (i.e., a futures contract). Values range from 1.0 to –1.0 (or 100 to –100, depending on the convention employed).
For example, if you buy a call or a put option that is just out of the money (i.e., the strike price of the option is above the price of the underlying asset if the option is a call, and below the price of the underlying asset if the option is a put), then the option will always have a delta value that is somewhere between 1.0 and –1.0. Generally speaking, an at-the-money option usually has a delta at approximately 0.5 or -0.5.
Vega Theta Delta Gamma Measures the impact of a change in volatility. Measures the impact of a change in time remaining. Measures the impact of a change in the price of underlying. Measures the rate of change of delta.
Figure 1: The four dimensions of risk—also known as "the Greeks."
Delta is just one of the major risk measures skilled options traders analyze and make use of in their trading strategies. You can learn the other forms of risk and take strides to become a successful options trader by taking Investopedia Academy's Options for Beginners Course. Learn the same knowledge successful options traders use when deciding puts, calls, and other option trading essentials.
Examples of Delta Values
Figure 2 contains some hypothetical values for S&P 500 call options that are at, out, and in the money (in all these cases, we will be using long options). Call delta values range from 0 to 1.0, while put delta values range from 0 to –1.0.
As you can see, the at-the-money call option (strike price at 900) in figure 2 has a 0.5 delta, while the out-of-the-money (strike price at 950) call option has a 0.25 delta, and the in-the-money (strike at 850) has a delta value of 0.75.
Keep in mind, these call delta values are all positive because we are dealing with long call options, a point to which we will return later. If these were puts, the same values would have a negative sign attached to them. This reflects the fact that put options increase in value when the underlying asset price falls. An inverse relationship is indicated by the negative delta sign. As you'll see below, the story gets a bit more complicated when we look at short option positions and the concept of position delta.
Strikes Delta 950 0.25 900 0.5 850 0.75
Note: We are assuming that the underlying S&P 500 is trading at 900.
Figure 2: Hypothetical S&P 500 long call options.
Interpreting Delta Values
At this point, you might be wondering what these delta values are telling you. Let's use the following example to help illustrate the concept of simple delta and the meaning of these values. If an S&P 500 call option has a delta of 0.5 (for a near or at-the-money option), a one-point move (which is worth $250) of the underlying futures contract would produce a 0.5 (or 50%) change (worth $125) in the price of the call option.
A delta value of 0.5, therefore, tells you that for every $250 change in the value of the underlying futures, the option changes in value by about $125. If you were long this call option and the S&P 500 futures move up by one point, your call option would gain approximately $125 in value, assuming no other variables change in the short run. We say "approximately" because as the underlying moves, delta will change as well.
Be aware that as the option gets further in the money, delta approaches 1.00 on a call and –1.00 on a put. At these extremes, there is a near or actual one-for-one relationship between changes in the price of the underlying asset and subsequent changes in the option price. In effect, at delta values of –1.00 and 1.00, the option mirrors the underlying in terms of price changes.
Also, keep in mind that this simple example assumes no change in other variables. The following holds true about delta:
Delta tends to increase as you get closer to expiration for near or at-the-money options.Delta is not a constant, a concept related to gamma (another risk measurement), which is a measure of the rate of change of delta given a move by the underlying.Delta is subject to change given changes in implied volatility.
Long vs. Short Options and Delta
As a transition into looking at position delta, let's first look at how short and long positions change the picture somewhat. First, the negative and positive signs for values of delta mentioned above do not tell the full story. As indicated in figure 3 below, if you are long a call or a put (that is, you purchased them to open these positions), then the put will be delta negative and the call delta positive. However, our actual position will determine the delta of the option as it appears in our portfolio. Note how the signs are reversed for short put and a short call.
Long Call Short Call Long Put Short Put Delta Positive Delta Negative Delta Negative Delta Positive
Figure 3: Delta signs for long and short options.
The delta sign in your portfolio for this position will be positive, not negative. This is because the value of the position will increase if the underlying increases. Likewise, if you are short a call position, you will see that the sign is reversed. The short call now acquires a negative delta, which means that if the underlying rises, the short call position will lose value. This concept leads us to position delta. Many of these intricacies involved in trading options are minimized or eliminated when trading synthetic options.
Position Delta
By understanding the concept of a hedge ratio, you can gain a better understanding of position delta. Essentially, delta is a hedge ratio because it tells us how many options contracts are needed to hedge a long or short position in the underlying asset. For example, if an at-the-money call option has a delta value of approximately 0.5—which means that there is a 50% chance the option will end in the money and a 50% chance it will end out of the money—then this delta tells us that it would take two at-the-money call options to hedge one short contract of the underlying.
In other words, you need two long call options to hedge one short futures contract. (Two long call options x delta of 0.5 = position delta of 1.0, which equals one short futures position). This means that a one-point rise in the S&P 500 futures (a loss of $250), which you are short, will be offset by a one-point (2 x $125 = $250) gain in the value of the two long call options. In this example, we would say that we are position delta neutral.
By changing the ratio of calls to a number of positions in the underlying, we can turn this position delta either positive or negative. For example, if we are bullish, we might add another long call, so we are now delta positive because our overall strategy is set to gain if the futures rise. We would have three long calls with a delta of 0.5 each, which means we have a net long position delta by 0.5.
On the other hand, if we are bearish, we could reduce our long calls to just one. This would give us a net short position delta. This means that we are net short the futures by -0.5. Once you're comfortable with these aforementioned concepts, you can take advantage of advanced strategies, such as position-delta neutral trading.
The Bottom Line
To interpret position delta values, you must first understand the concept of the simple delta risk factor and its relation to long and short positions. With these fundamentals in place, you can begin to use position delta to measure how net-long or net-short the underlying you are when taking into account your entire portfolio of options (and futures). Remember, there is a risk of loss in trading options and futures, so only trade with risk capital.
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b35a750064c510428f45f109fefebf7b | https://www.investopedia.com/articles/optioninvestor/03/073003.asp | Getting Acquainted With Options Trading | Getting Acquainted With Options Trading
What Is Stock Options Trading?
Trading options is very different from trading stocks because options have distinct characteristics from stocks. Investors need to take the time to understand the terminology and concepts involved with options before trading them.
Options are financial derivatives, meaning that they derive their value from the underlying security or stock. Options give the buyer the right, but not the obligation, to buy or sell the underlying stock at a pre-determined price.
Key Takeaways Options give a buyer the right, but not the obligation, to buy (call) or sell (put) the underlying stock at a pre-set price called the strike price. Options have a cost associated with them, called a premium, and an expiration date. A call option is profitable when the strike price is below the stock's market price since the trader can buy the stock at a lower price. A put option is profitable when the strike is higher than the stock's market price since the trader can sell the stock at a higher price.
Understanding Stock Options Trading
Trading stocks can be compared to gambling in a casino: You're betting against the house, so if all the customers have an incredible string of luck, they could all win.
Trading options is more like betting on horses at the racetrack: Each person bets against all the other people there. The track simply takes a small cut for providing the facilities. So trading options, like betting at the horse track, is a zero-sum game. The option buyer's gain is the option seller's loss and vice versa.
One important difference between stocks and options is that stocks give you a small piece of ownership in a company, while options are just contracts that give you the right to buy or sell the stock at a specific price by a specific date.
It's important to remember that there are always two sides to every option transaction: a buyer and a seller. In other words, for every option purchased, there's always someone else selling it.
Types of Options
The two types of options are calls and puts. When you buy a call option, you have the right, but not the obligation, to purchase a stock at a set price, called the strike price, any time before the option expires. When you buy a put option, you have the right, but not the obligation, to sell a stock at the strike price any time before the expiration date.
When individuals sell options, they effectively create a security that didn't exist before. This is known as writing an option, and it explains one of the main sources of options since neither the associated company nor the options exchange issues the options.
When you write a call, you may be obligated to sell shares at the strike price any time before the expiration date. When you write a put, you may be obligated to buy shares at the strike price any time before expiration.
There are also two basic styles of options: American and European. An American-style option can be exercised at any time between the date of purchase and the expiration date. A European-style option can only be exercised on the expiration date. Most exchange-traded options are American style, and all stock options are American style. Many index options are European style.
Option Pricing
The price of an option is called the premium. The buyer of an option can't lose more than the initial premium paid for the contract, no matter what happens to the underlying security. So the risk to the buyer is never more than the amount paid for the option. The profit potential, on the other hand, is theoretically unlimited.
In return for the premium received from the buyer, the seller of an option assumes the risk of having to deliver (if a call option) or taking delivery (if a put option) of the shares of the stock. Unless that option is covered by another option or a position in the underlying stock, the seller's loss can be open-ended, meaning the seller can lose much more than the original premium received.
Please note that options are not available at just any price. Stock options are generally traded with strike prices in intervals of $0.50 or $1, but can also be in intervals of $2.50 and $5 for higher-priced stocks. Also, only strike prices within a reasonable range around the current stock price are generally traded. Far in- or out-of-the-money options might not be available.
Option Profitability
When the strike price of a call option is above the current price of the stock, the call is not profitable or out-of-the-money. In other words, an investor is not going to buy a stock at a higher price (the strike) than the current market price of the stock. When the call option strike price is below the stock's price, it's considered in-the-money since the investor can buy the stock for a lower price than in the current market.
Put options are the exact opposite. They're considered out-of-the-money when the strike price is below the stock price since an investor wouldn't sell the stock at a lower price (the strike) than in the market. Put options are in-the-money when the strike price is above the stock price since investors can sell the stock at the higher (strike) price than the market price of the stock.
Expiration Dates
All stock options expire on a certain date, called the expiration date. For normal listed options, this can be up to nine months from the date the options are first listed for trading. Longer-term option contracts, called long-term equity anticipation securities (LEAPS), are also available on many stocks. These can have expiration dates up to three years from the listing date.
Options expire at market close on Friday, unless it falls on a market holiday, in which case expiration is moved back one business day. Monthly options expire on the third Friday of the expiration month, while weekly options expire on each of the other Fridays in a month.
Unlike shares of stock, which have a two-day settlement period, options settle the next day. In order to settle on the expiration date, you have to exercise or trade the option by the end of the day on Friday.
Stock Option Trading FAQs
What Is a Stock Options Contract?
A stock option contract entitles the owner of the contract to 100 shares of the underlying stock upon expiration. So, if you purchase seven call option contracts, you are acquiring the right to purchase 700 shares. And, if the owner of a call option decides to exercise their right to buy the stock at a particular price, the option writer must deliver the stock at that price.
What Do Stock Options Cost?
Options contracts usually represent 100 shares of the underlying security, and the buyer will pay a premium fee for each contract. For example, if an option has a premium of $0.55 per contract, buying one option would cost $55 ($0.55 x 100 = $55).
How Do You Make Money Trading Options?
You can make money by being an option buyer or an option writer. If you are a call option buyer, you can make a profit if the underlying stock rises above the strike price before the expiration date. If you are a put option buyer, you can make a profit if the price falls below the strike price before the expiration date.
Is Options Trading Better Than Stocks?
Options trading can be riskier than trading stocks. However, when it is done properly, it can be more profitable for the investor than traditional stock market investing.
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bab0e74abfe475df93d2063f88cb6bcd | https://www.investopedia.com/articles/optioninvestor/05/011905.asp | Options Arbitrage Opportunities via Put-Call Parity | Options Arbitrage Opportunities via Put-Call Parity
An important principle in options pricing is called put-call parity. This parity states that the value of a call option, at a specified strike price, implies a particular fair value for the corresponding put option, and vice versa. Thus, the price of a call and put should always hold a price relationship between one another.
The theory behind this pricing relationship relies on the possible arbitrage opportunity that would result if there is a divergence between the value of calls and puts with the same strike price and expiration date. Knowing how these trades work can give you a better feel for how put options, call options, and the underlying stocks intermingle.
Key Takeaways Put-call parity is a principle that defines the relationship between the price of put and call options of the same on the same underlying asset with the same strike price and expiration date.If the price of one of these options is out of line in relation to the parity equation, it presents a low-risk arbitrage opportunity to put the prices back in line.Common parity trades include establishing synthetic positions, boxes, and reversal-conversions.
Put-Call Parity
The equation expressing put-call parity is:
C + PV(x) = P + S
where:
C = price of the European call optionPV(x) = the present value of the strike price (x), discounted from the value on the expiration date at the risk-free rateP = price of the European putS = spot price or the current market value of the underlying asset
Adjustments for American Options
This pricing relationship was developed to describe European-style options, but the concept also applies to American-style options, adjusting for dividends and interest rates.
If the dividend increases, the puts expiring after the ex-dividend date will rise in value, while the calls will decrease by a similar amount. Changes in interest rates have the opposite effects. Rising interest rates increase call values and decrease put values.
The Synthetic Position
Option-arbitrage strategies involve what are called synthetic positions. All of the basic positions in an underlying stock, or its options, have a synthetic equivalent. What this means is that the risk profile (the possible profit or loss), of any position, can be exactly duplicated with other, but, more complex strategies. The rule for creating synthetics is that the strike price and expiration date, of the calls and puts, must be identical.
For creating synthetics, with both the underlying stock and its options, the number of shares of stock must equal the number of shares represented by the options. To illustrate a synthetic strategy, consider a fairly simple option position: the long call. When you buy a call, your loss is limited to the premium paid while the possible gain is unlimited. Now, consider the simultaneous purchase of a long put and 100 shares of the underlying stock. Once again, your loss is limited to the premium paid for the put, and your profit potential is unlimited if the stock price goes up. Below is a graph that compares these two different trades.
If the two trades appear identical, that's because they are. While the trade that includes the stock position requires considerably more capital, the possible profit and loss of a long-put/long-stock position is nearly identical to owning a call option with the same strike and expiration. That's why a long-put/long-stock position is often called a "synthetic long call." In fact, the only difference between the two lines, above, is the dividend that is paid during the holding period of the trade. The owner of the stock would receive that additional amount, but the owner of a long call option would not.
Arbitrage Using Conversion and Reversals
You can use this idea of the synthetic position to explain two of the most common arbitrage strategies: the conversion and the reverse conversion (often called simply by reversal). The reasoning behind using synthetic strategies for arbitrage is that since the risks and rewards are the same, a position and its equivalent synthetic should be priced the same.
A conversion involves buying the underlying stock, while simultaneously buying a put and selling a call. (The long-put/short-call position is also known as a synthetic short stock position.) For a reverse conversion, you short the underlying stock while simultaneously selling a put and buying a call (a synthetic long stock position). As long as the call and put have the same strike price and expiration date, a synthetic short/long stock position will have the same profit/loss potential as shorting/owning 100 shares of stock (ignoring dividends and transaction costs).
Remember, these trades guarantee a profit with no risk only if prices have moved out of alignment, and the put-call parity is being violated. If you placed these trades when prices are not out of alignment, all you would be doing is locking in a guaranteed loss. The figure below shows the possible profit/loss of a conversion trade when the put-call parity is slightly out of line.
This trade illustrates the basis of arbitrage – buy low and sell high for a small, but fixed, profit. As the gain comes from the price difference, between a call and an identical put, once the trade is placed, it doesn't matter what happens to the price of the stock. Because they basically offer the opportunity for free money, these types of trades are rarely available. When they do appear, the window of opportunity lasts for only a short time (i.e. seconds or minutes). That's why they tend to be executed primarily by market makers, or floor traders, who can spot these rare opportunities quickly and do the transaction in seconds (with very low transaction costs).
The Bottom Line
Put-call parity is one of the foundations for option pricing, explaining why the price of one option can't move very far without the price of the corresponding options changing as well. So, if the parity is violated, an opportunity for arbitrage exists. Arbitrage strategies are not a useful source of profits for the average trader, but knowing how synthetic relationships work, can help you understand options while providing you with strategies to add to your options-trading toolbox.
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fe398c2e137e643854267b21d1118d19 | https://www.investopedia.com/articles/optioninvestor/05/020205.asp | Option Price-Volatility Relationship: Avoiding Negative Surprises | Option Price-Volatility Relationship: Avoiding Negative Surprises
Whether you are planning to purchase a put or call option, it pays to know more than just the impact of a move of the underlying on your option's price. Often option prices seem to have a life of their own even when markets move as anticipated. A closer look, however, reveals that a change in implied volatility is usually the culprit.
While knowing the effect volatility has on option price behavior can help cushion against losses, it can also add a nice bonus to trades that are winning. The trick is to understand the price-volatility dynamic—the historical relationship between directional changes of the underlying and directional changes in volatility. Fortunately, this relationship in equity markets is easy to understand and quite reliable.
The Price-Volatility Relationship
A price chart of the S&P 500 and the implied volatility index (VIX) for options that trade on the S&P 500 shows there is an inverse relationship. As Figure 1 demonstrates, when the price of the S&P 500 (top plot) is moving lower, implied volatility (lower plot) is moving higher, and vice versa.
S&P 500 daily price chart and implied volatility (VIX) daily price chart. Price and VIX move inversely. Buying calls at market bottoms, for example, amounts to paying very rich premiums (loaded with implied volatility) that can evaporate as market fears subside with market upturns. This often undermines call buyers' profit performance. Source: Created Using OptionVue5 Options Analysis Software.
The Impacts of Price and Volatility Changes on Options
The table below summarizes the important dynamics of this relationship, indicating with "+" and "-" signs how movement in the underlying and associated movement in implied volatility (IV) each impacts the four types of outright positions. For example, there are two positions that have "+/+" in a particular condition, which means they experience positive impact from both price and volatility changes, making these positions ideal in that condition: Long puts are affected positively from a fall in S&P 500 but also from the corresponding rise in implied volatility, and short puts receive a positive impact from both price and volatility with a rise in the S&P 500, corresponding to a fall in implied volatility.
Impact of price and volatility changes on long and short option positions. A "+" mark indicates positive impact and a "-" mark indicates a detrimental impact. Those marked with "+/+" indicate the ideal position for the given market condition. Image by Julie Bang © Investopedia 2020
But in the opposite to their "ideal" conditions, the long put and short put experience the worst possible combination of effects, marked by "-/-". The positions showing a mixed combination ("+/-" or "-/+") receive a mixed impact, meaning price movement and changes in implied volatility work in a contradictory fashion. Here is where you find your volatility surprises.
For example, say a trader feels the market has declined to a point where it is oversold and due for at least a counter-trend rally. (See Figure 1 where an arrow points to a rising S&P 500.) If the trader correctly anticipates the turn in market direction (that is, picks a market bottom) by purchasing a call option, they may discover that the gains are much smaller or even non-existent after the upward move (depending on how much time has elapsed).
Remember from Table 1 that a long call suffers from a fall in implied volatility, even though it profits from a rise in price (indicated by "+/-"). And Figure 1 shows that the VIX levels plunge as the market moves higher: Fear is abating, reflected in a declining VIX, leading to falling premium levels, even though rising prices is lifting call premium prices.
Long Calls at Market Bottoms Are "Expensive"
In the example above, the market-bottom call buyer ends up purchasing very "expensive" options that in effect have already priced-in an upward market move. The premium can decline dramatically due to the falling levels of implied volatility, counteracting the positive impact of a rise in price, leaving the unsuspecting call buyer miffed over why the price did not appreciate as anticipated.
Figures 2 and 3 below demonstrate this disappointing dynamic using theoretical prices. In Figure 2, after a quick move of the underlying up to 1205 from 1185, there is a profit on this hypothetical out-of-the-money February 1225 long call. The move generates a theoretical profit of $1,120.
Figure 2: Long call profit/loss with no change in implied volatility.
Source: Created Using OptionVue5 Options Analysis Software
But this profit assumes no change in implied volatility. In making a speculative call purchase near a market bottom, it's safe to assume that at least a 3 percentage point drop in implied volatility occurs with a market rebound of 20 points.
Figure 3 shows the outcome after the volatility dimension is added to the model. Now the profit from the 20-point move is just $145. And if meanwhile some time-value decay occurs, then the damage is more severe, indicated by the next lower profit/loss line (T+9 days into the trade). Here, despite the move higher, the profit has turned into losses of about $250!
Figure 3: Long call profit/loss with decline by three percentage points in implied volatility
Source: Created Using OptionVue5 Options Analysis Software
One way to reduce the damage from changes in volatility in a case such as this is to purchase a bull call spread. More aggressive traders might want to establish short puts or put spreads, which have a "+,+" relationship with a rise in price. Note, however, that a decline in price has a "-/-" impact for put sellers, meaning that the positions will suffer not only from price decline but also rising implied volatility.
Long Puts at Market Tops Are "Cheap"
Now let's take a look at the purchase of a long put. Here picking a market top by entering a long put option has an edge over picking a market bottom by entering a long call. This is because long puts have a "+/+" relationship to price/implied volatility changes.
In Figure 4 and 5 below, we set up a hypothetical out-of-the-money February 1125 long put. In Figure 4, you can see that a quick 20-point drop in price to 1165 with no change in implied volatility leads to a profit of $645. (This option is more distant from the money, so it has a smaller delta, leading to a smaller gain with a 20-point move compared to our hypothetical 1225 call option, which is closer to the money.)
Figure 4: Long put profit/loss with no change in implied volatility
Source: Created Using OptionVue5 Options Analysis Software
Figure 5: Long put profit/loss with rise in implied volatility by three percentage points.
Source: Created Using OptionVue5 Options Analysis Software
Meanwhile, looking at Figure 5, which shows a rise in implied volatility by three percentage points, we see that profit now increases to $1,470. And even with the decay of time value occurring at T+9 days into the trade, the profit is nearly $1,000.
Therefore, speculating on market declines (that is, trying to pick a top) by purchasing put options has a built-in implied volatility edge. What makes this strategy more attractive is that at market tops, implied volatility is typically at extreme lows, so a put buyer would be buying very "cheap" options that don't have too much volatility risk embodied in their prices.
The Bottom Line
Even if you correctly forecast a market rebound and attempt to profit by buying an option, you may not receive the profits you were expecting. The fall in implied volatility at market rebounds can cause negative surprises by counteracting the positive impact of a rise in price. On the other hand, buying puts at market tops has the potential to provide some positive surprises as falling prices push implied volatility levels higher, adding additional potential profit to a long put bought very "cheaply." Being aware of the price-volatility dynamic and its relation to your option position can significantly affect your trading performance.
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846269ff942040658b44275f21a4f426 | https://www.investopedia.com/articles/optioninvestor/05/030105.asp | What To Do When Your Options Trade Goes Awry | What To Do When Your Options Trade Goes Awry
Successful options trading is not about being correct most the time, but about being a good repair mechanic. When things go wrong, as they often do, you need the proper tools and techniques to get your strategy back on the profit track. Here we demonstrate some basic repair strategies aimed at increasing profit potential on a long call position that has experienced a quick unrealized loss.
Defense Is Just as Important as Offense
Repair strategies are an integral part of any trading plan. I always review a well-thought-out set of "what-if" scenarios before putting any money at risk. Too often, though, beginner options traders give little thought to potential follow-up adjustments or possible repair strategies before establishing positions. Having a great strategy is important, but making a profit is highly correlated with how well losing trades are managed. "Play good defense" is my options-trading mantra.
Fixing a Long Call
Many traders will buy a simple call or put only to find that they were wrong about the expected movement of the underlying stock. An out-of-the-money long call position, for example, would experience immediate unrealized losses should the stock drop. What should the trader do in this situation?
Let's examine a simple long call example, which demonstrates a concept that you can apply also to a long put. Suppose it is currently the middle of February and we believe that IBM, which at 93.30, is poised to make a move above resistance at about 95. We have good reason to jump in early with the purchase of a July 95 near-the-money call. With about 150 calendar days left until expiration, there is plenty of time for the move to occur.
Figure 1—IBM daily price chart showing medium support/resistance levels. Image by Sabrina Jiang © Investopedia 2020
But suppose, not long after we enter the position, IBM gets a downgrade and drops suddenly, perhaps even below medium-term support at 91.60 (the lower green line in Figure 1) to about 89.34. The price of the July 95 call would now be worth about $1.25 (assuming some time-value decay), down from $3, rendering an unrealized loss of $175 per option. Figure 2 below presents the profit/loss profile of this trade.
Figure 2—IBM July 95 long call profit/loss. Image by Sabrina Jiang © Investopedia 2020
With so much time remaining until expiration, however, it's still possible that IBM may reach and surpass the strike price of 95 by Jul 16, but waiting could add additional losses and present additional opportunity costs, which result from our forgoing any other trade with profit potential during the same period.
Initial IBM Price July 95 Call Purchase Price Lower IBM Price Lower July 95 Call Price July 90 Call Price 93.30 $3.00 89.30 $1.25 $2.75 Table 1—Options prices before and after IBM price change.
One way to address unrealized loss is to average down by purchasing more options, but this only increases risk should IBM keep falling or never return to the price of 95. Actually, the breakeven on the original July 95 call, which was purchased for $3, is 98. This means that the stock would have to rise by nearly 10% to get to the breakeven point. Averaging down by purchasing a second option with a lower strike price, such as the July 90 call, lowers the breakeven point, but adds considerable additional risk, especially since the price has broken below a key support level of 91.60 (indicated in Figure 1).
One simple method to lower the breakeven point and increase the probability of making a profit without increasing risk too much is to roll the position down into a bull call spread. This is a strategy presented by options educator, Larry McMillan, in his book, "Options as a Strategic Investment," a must-have standard reference on options trading.
To implement this method we would place an order to sell two of the July 95 calls at the new price of $1.25, which amounts to going short the July 95 call option since we are long one option already (selling two when we are long one, leaves us short one). At the same time, we would buy a July 90 call, selling for about 2.90. Table 2 presents the price details:
Transactions Debits/Credits Cumulative Net Debits/Credits Buy July 95 call -$300 -$300 Sell 2 July 95 calls +$250 -$50 Buy 1 July 90 call -$275 -$325 Table 2—Transaction details of rolling down into a bull call spread.
The net result of this adjustment into a bull call spread is that our total risk has increased only slightly, from $300 to $325 (not counting commissions). But our breakeven point has been lowered considerably from 98 to 93.25, a drop of 4.75%.
Suppose now that IBM manages to trade higher, back to the starting point of 93.30. Our bull call spread would now be just above breakeven, with a potential profit as high as 95, although limited to just $175 per option. We have, therefore, lowered our breakeven point without adding much additional risk, which makes good sense.
Alternative Repair Approach
Another repair attempt (which can perhaps be combined with the one above) is to roll down into a butterfly spread when IBM falls to 90. With this strategy we sell two July 90 calls, which would be going for about $4 each, and keep the July 95 long call, and then buy a July 85 call for about $7.30 (assuming a little bit of time-value decay in these numbers).
Transactions Debits/Credits Cumulative Net Debits/Credits Buy July 95 Call -$300 -$300 Sell 2 July 90 Calls +$800 +$500 Buy 1 July 85 Call -$730 -$230 Table 3—Transaction details for roll to a butterfly spread.
The total risk actually decreases on the downside since the total debits fall to $230, but there is some limited upside risk should IBM move back above 92.65 (breakeven). If IBM goes nowhere, however, the trade actually produces a nice profit, occurring between 87.30 and 92.65. The profit/loss table below presents our different scenarios for this repair strategy:
IBM Price At Expiration Profit/Loss 85.00 -$225 87.30 Breakeven 90.00 +$264 92.65 Breakeven 95.00 -$235 100.0 -$235 Table 4—Profit/loss details for butterfly spread repair strategy.
Meanwhile, maximum potential losses are $235 (upside) and $225 (downside). Maximum potential profit is at 90 with $264, and profit decreases marginally as you move toward the upper and lower breakeven points, as seen in Figure 3.
Figure 3—Butterfly Profit/Loss Profile. Image by Sabrina Jiang © Investopedia 2020
Combining the Repair Strategies
Since this is a butterfly spread, maximum profit by definition is at the strike of the two short calls (July 90 calls), but movement away from this point eventually leads to losses. Therefore, the best overall approach might be to mix our two repair strategies in a multi-lot repair approach. This combination can preserve the best odds of producing a profit from a potential loser: the bull call-spread repair has a profit from 93.25 up to 95. And, there are ways to adjust a butterfly spread given moves of the underlying (a topic that would require a separate article).
The Bottom Line
We've looked at two ways (which might best be combined) to adjust a long call position gone awry. The first involves rolling down into a bull call spread, which significantly lowers overhead breakeven while preserving reasonable profit potential (albeit this potential is limited, not unlimited as in the original position). The cost poses only a tiny increase in risk. The second approach is to roll into a butterfly spread by keeping our original July call, selling two at-the-money call options and buying an in-the-money call option. Whether used alone or in tandem, these repair strategies offer some flexibility in your trading plans.
There will always be losses in options trading, so each trade must be evaluated in light of changing market conditions, risk tolerance and desired objectives. That said, by properly managing the potential losers with smart repair strategies, you stand a better chance of winning at the options game in the long run.
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