29 April 2017

Three Reasons this is a Good Time to be an Investor

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The markets have had a rough ride in the past two decades. But in many ways, investors have never had it so good. But something surprising happened along the way: The financial world became a much kinder place for U.S. investors, thanks to legislation and competition that have led to a growing array of investment choices, falling investment costs and tumbling tax rates. By contrast, the investing landscape now offers many advantages to individual investors, though there also are potential pitfalls. Here is how to make the most of the innovations:

More choice. Today, individual investors can build portfolios that would have been the envy of many institutional investors two decades ago. Much of the credit goes to two developments.

First, in 1993, State Street  introduced the first U.S. exchange-traded index fund. While mutual funds can only be traded once a day and are purchased directly from the fund company involved, ETFs are listed on the stock market and can be bought and sold throughout the trading day.

The fund, known as SPDR S&P 500 ETF, seeks to mimic the performance of the S&P 500 and charges an annual fee of 0.09%, or $9 for every $10,000 invested. Other popular ETFs also track broad market indexes and charge far less than most actively managed mutual funds. What's more, the wide array of ETFs allows investors to fine-tune their portfolios. Investors also can buy ETFs that track a number of individual countries and industry sectors. In addition, ETFs have opened up the world of alternative investments to ordinary investors.

But be warned: The proliferation of ETFs may mean there are more ways to diversify, but it also means there are more ways to get into financial trouble.

The second major development that has given investors more choice came in 1997, when the Treasury introduced a new type of government bond that delivers returns linked to the inflation rate.

Investors could buy an investment that was backed by the federal government and also offered protection against rising consumer prices. Those twin virtues make Treasury inflation-protected securities, or TIPS, perhaps the safest long-term investment available.

Unfortunately, yields today are miserably low, with 10-year TIPS maturing in January 2025 recently yielding a tiny 0.3 percentage point more than inflation. Still, for home buyers, college savers and retirees who want to guarantee that the purchasing power of their money won't shrink in the years ahead, TIPS—or, alternatively, Series I savings bonds, can be a one-stop solution.

Cheaper investing. As investors increasingly shun actively managed mutual funds and instead put their money in market-tracking index mutual funds and ETFs, their investment costs have fallen sharply.

Do-it-yourself investors aren't the only beneficiaries. Many financial advisers, who at one time scorned index funds as guaranteeing mediocre performance, have embraced ETFs. One reason: They would rather cut fund costs than lower their own fees. All this has helped drive down costs for fund investors.

By favoring low-expense funds, investors can tilt the odds in their favor and keep more of whatever the markets deliver. The savings can be substantial, particularly as the benefits compound over decades.

The cost to trade individual stocks has also declined. There has been controversy about brokerage firms directing orders to exchanges and market makers that pay them the largest rebates, and concern that ordinary investors have been lulled into trading too much by tiny brokerage commissions, often less than $10 a trade. But it isn't just brokerage commissions that have fallen. Researchers have found that trading spreads, the difference between the price at which you can currently buy and the lower price at which you could sell, have narrowed substantially.

Bond investors also have benefited, though not in every part of the market. Before buying an individual bond, investors should to go to the Municipal Securities Rulemaking Board's website at MSRB.org and check out recent trading activity in the bond to learn about the price other investors have been paying.

Lower taxes. Often, the biggest investment expense isn't money-management fees and trading costs, but taxes. There, too, investors have seen significant improvements over the past two decades.

Last year, investors lost some ground, with the effective top federal capital-gains rate rising to 23.8%. Still, only those in the top 39.6% federal income-tax bracket, which kicks in at $406,750 of taxable income for singles and $457,600 for married couples this year, pay that rate. Most investors continue to pay 15% or less.

Given the large gap between the income-tax rate and the capital-gains rate, investors can reap big savings if they focus on building tax-efficient portfolios. Meanwhile, in your tax-sheltered retirement account, you might favor less tax-efficient investments, such as taxable bonds, actively managed stock funds, real-estate investment trusts and individual stocks you plan to trade.

Even as the lower capital-gains rate has made it cheaper for taxable-account investors, retirement-account investors also caught a break with the introduction of the Roth individual retirement account, which was made possible by 1997's tax law. Contributions to Roth IRAs aren't tax-deductible, but withdrawals can be tax-free. In a traditional IRA, by contrast, contributions can be tax-deductible but withdrawals are taxable as ordinary income.

Tax-free growth also is available to college savers now. Today, college savers don't have to bother with custodial accounts. Coverdell education-savings accounts, which offer tax-free savings for education expenses, were made possible by 1997's tax law. In 2001, withdrawals from 529 college-savings plans also were made tax-free if the money was used for qualifying education expenses. The result is that you should be able to save for college costs and pay nothing in taxes.

The bottom line: Stock and bond returns could be modest in the years ahead. But if you take advantage of changes since the 1980s to hold down costs, trim taxes and diversify broadly, you can improve your chances of capturing whatever gains the markets generate.

Click here for the full article from The Wall Street Journal.

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