Friday, February 27, 2015

Financial Markets: Functions and Types

Financial Markets, their functions and their classifications
Financial marketsA Financial market is a market for creation and exchange of financial assets. Financial markets act as a forum to facilitate financial transactions through the creation, sale and transfer of financial securities. If you buy or sell financial assets, you will participate in financial markets in some way or the other.

Financial markets play a key role in the economy by stimulating growth influencing economic performance of the actors, affecting economic welfare. This is achieved by financial infrastructure, in which entities with funds allocate those funds to those who have potentially more productive ways to invest those funds. A financial system makes it possible a more efficient transfer of funds.

Functions of Financial Markets:
Financial markets play a pivotal role in allocating resources in an economy by performing three important functions.

1) Financial Markets facilitate Price Discovery:
The continual interaction among numerous buyers and sellers who throng financial markets helps in establishing the prices of financial assets. Well organized financial markets seem to be remarkably efficient in price discovery. That is why economists say: “If you want to know what the value of a financial asset is, simply look at its price in the financial market”.

2) Financial Markets provide liquidity to financial assets:
Investors can readily sell their financial assets through the mechanism of financial markets. In the absence of financial markets which provide such liquidity, the motivation of investors to hold financial assets will be considerably diminished. Thanks to negotiability and transferability of securities through the financial markets, it is possible for companies and other entities to raise long term funds from investors with short term and medium term horizons.  While one investor is substituted by another when a security is transacted, the company is assured of long term availability of funds.

3) Financial Markets considerably reduce the cost of transacting:
The two major costs associated with transacting are search costs and information costs. Search costs comprise explicit costs such as the expenses incurred on advertising when one wants to buy or sell an asset and implicit costs such as the effort and time one has to put in to locate a customer. Information costs refer to costs incurred in evaluating the investment merits of financial assets.

Classification of Financial Markets:
There are different ways of classifying financial markets. One way is to classify financial markets by the type of financial claim.
The Debt market is the financial market for fixed claims of debt instruments and the Equity market is the financial market for residual claims or equity instruments.

A second way is to classify financial markets by the maturity if claims. The market for short-term financial claims is referred to as Money Market and the market for long-term financial claims is called as Capital market. Traditionally, the cutoff between short-term and long-term financial claims has been one year – though the dividing line is arbitrary, it is widely accepted. Since short-term financial claims are invariably debt claims, the money market is the market for short-term debt instruments. The capital market is the market for long-term instruments and equity instruments.

A third way to classify financial markets is based on whether the claims represent new issues or outstanding issues. The market where issuers sell new claims is referred to as the Primary market and the market where investors trade outstanding securities is called the Secondary market.

A fourth way to classify financial markets is by the timing of delivery. A Cash or Spot market is one where the delivery occurs immediately and a Forward or Futures market is one where the delivery occurs at a pre-determined time in future.

A fifth way to classify financial markets is by the nature of its organizational structure. An Exchange-traded market is characterized by a centralized organization with standard procedures. An Over-the counter market is a decentralized market with customized procedures. 

Read more ...

Saturday, February 7, 2015

Return on Investment or ROI

Return on Investment or ROI

All investors want to make a positive return or profit on the money they commit to their investments. In a nutshell, this is the basis behind the term “Return on Investment”, also known as ROI. ROI is mathematically defined as (gains-cost)/cost, and is usually expressed as a percentage. 

Before we delve into some of the nuances of ROI, lets look at a simple example. You have $1000 you wish to invest on a promising stock. You research your idea and decide to buy $1000 worth of shares. Time goes by and your idea is working out: the stock rises in price and you sell your shares, receiving $1500 from the sale. Your initial investment was $1000, and your profit (before taxes and commissions) was $500. In the example cited, your return on investment, therefore, was 1500 + 1000/1000, for a return of 0.5, or 50%, on your investment.

ROI is used not only for stocks but for all kinds of investments and business endeavors. It is applied to investments in real estate, oil wells, collectibles, bonds, precious metals and any other form of investment.

As is often the case in the financial arena, there can be a number of factors to consider when calculating ROI, making some calculation more complicated than the simple example cited above. In the area of stocks and bonds, one would want to factor in dividends and interest received when calculating ROI. In the world of real estate, ROI calculations can become quite complex. The real estate investor must factor in rental income, appreciation, amortization, insurance and property upkeep.

Even collectibles, such as rare coins, paintings, and the like may have substantial maintenance costs, which need to be factored into ROI.

In some industries, Return of Capital Invested, or ROCI, is used instead of ROI. In the oil and gas industry for example, exploration and development expenditures are extremely high, and payoffs on investments may not be realized for many years. Hence ROCI is often used in businesses such as these instead of ROI.

Another metric related to ROI is Compound Annual Growth Rate, or CAGR. This is a calculation made to approximate the annual return on an investment that pays out over a number of years and at a variable rate. It is not a Return on Investment, but rather an attempt to show how an investment would grow over time if it grows at a steady rate.

A final nuance to consider is the role of leverage in investments. Many people buy stock on margin (a form of leverage) and most business finance their investments by borrowing (potentially another form of leverage). The effect of leverage should be incorporated in ROI calculations.

In summary, ROI is a very useful concept to keep in mind. It enables the investor to calculate how well an investment has performed. Consideration of likely outcomes for any investment can be viewed through the lens of the ROI calculation to help in the assessment of potential investments going forward.

Read more ...

Sunday, February 1, 2015

401k Contribution Limits for 2015

401k Contribution Limits for 2015

401k contribution limits for 2015

A 401(k) plan is a tax qualified retirement savings plan that is contributed to by your employer. Employees can save and invest a portion of their paycheck into the 401(k) account before taxes are taken out. This serves two beneficial purposes: to potentially bump them down a tax bracket and to provide their savings compounding interest for many years with delayed taxation. The earnings from investing in a 401(k) are also tax deferred. 

A benefit of the 401(k) is that the investor is allowed control of how their money is invested. Most 401(k) plans offer a selection of mutual funds comprised of securities such as bonds, stocks and other assets. However, the most common option are Target-Date Funds. Target-Date Funds address some date in the future, usually retirement in order maximize investment returns. It is structured to gradually become more and more conservative as the investor reaches retirement.

The 401(k) plan is full of restrictions. For the most part, investors must work for their employer for a certain amount of time before they can gain access to their employer’s contributions. Usually employers match 3% of their employees’ salary for their 401(k) contributions. The best plan is to at least invest enough to get the full amount that the company matches. Other restrictions include early withdrawal penalties (usually 10%) which penalize for withdrawing money before retirement. 

However, there are a few emergency withdrawal options:
• Hardship withdrawals
• Loans
• 72(t) withdrawals

Generally speaking, there are only these three emergency withdrawal options. Hardship withdrawals are allowed for certain qualified hardships. Unfortunately there is usually still a withdrawal penalty and taxes owed on these withdrawals. Loans against the 401(k) are usually allowed as long as the loan is repaid with interest. 72(t) withdrawals are withdrawals that are usually allowed based on an individual’s life expectancy. These withdrawals eliminate the 10% early withdrawal penalty and require that withdrawals must be taken for at least 5 years or until the age 59 and a half has been reached. Taxes still must be paid on the amount withdrawn, however. 

There are two 401(k) options offered, the traditional and the Roth. The main difference being that the Roth 401(k) is comprised of contributions that have already been taxed and thus no taxes are paid upon withdrawal. The Roth also usually has more flexibility in accessing money invested.

In October of 2014, the IRS announced that adjustments to retirement plans that affected the dollar limitations had been made. 
The adjustments for the 401(k) plan are as follows:

• Elective deferral contribution limit was raised from $17,500 to $18,000
• Employees aged 50 or older can contribute a total of $24,000
• The total contribution limit to a 401(k) by both the employer and employee was raised to $53,000
• The total contribution limit to a 401(k) by both the employer and employee aged 50 or older was raised to $59,000
• The total employee compensation that can be considered for calculation contributions was increased from $260,000 to $265,000
• The highly compensated employee definition was raised from $115,000 to $120,000

Overall, contribution to a 401(k) is a great investment option for anyone who is concerned about having enough money once retired. Always remember to try to make the maximum contribution to the 401(k) each year and to at least contribute enough to get the full amount that the company matches. 

Read more ...

Wednesday, January 28, 2015

Four Reasons People Avoid Estate Planning

Estate planning is an essential part of your personal finances, but even those who understand this, may have done little or nothing to plan ahead for their death. A surprising number of people do not even have a will. There are many reasons why an individual will avoid estate planning, and many of the reasons people have are based upon a misunderstanding of the process involved. The following are four of the most common explanations heard from people as to why they avoid estate planning. 

They don’t have enough assets to be concerned about it
Many people believe that they simply do not have enough wealth to engage in estate planning. These same people don’t want to be bothered with the thought of drawing up a will or anything else related to estate planning. The truth is that you don’t have to have a lot of wealth to have the need for estate planning, owning something as simple as a house can create problems after your death. Probate can be long and cumbersome, but this can be avoided with estate planning today.

They don’t have the time
This reason borders on an excuse. It is true that you may be a busy person, but the fact is that there are certain things that you must make time for, and estate planning is one of them. You owe it to your family and others to make sure your financial affairs are in order. Not only will your wishes be carried out, but the process will be more orderly with the planning that you do today. What makes estate planning easy and less time consuming is using the services of an estate planner. After a consultation with an estate planner, your wishes will be understood, and all that is needed is for the proper paperwork to be drawn up. This work is all done by an estate planning attorney, so you are not spending a lot of your time. 

A family will work everything out
It is amazing how often people think that everything will work out financially if they were to die. Family attorneys tell a different story. Siblings, who get along fine, suddenly are at odds over a family asset or money. Children and surviving parents will fight as well. The family of the surviving spouse may try to prevent children from an inheritance if they were from a previous marriage. There are many circumstances that only manifest themselves after your death. Estate planning prevents this fighting from happening.

They have been putting it off

Procrastination is something everyone has a problem with now and then, but you cannot afford to put off something as important as estate planning. No one can know the future, but there is a certain chance that something could happen to you very soon, and then there is nothing you can do. Keep in mind that you can have medical issues that incapacitate you. You can have an accident or perhaps a sudden stroke. Your mental faculties are such that you can no longer make decisions. Estate planning can help you in advance, even in situations where you have become mentally impaired. 

The first step in estate planning is to find a good legal firm that specializes in estate planning. There are several in the area. Hennion & Walsh is one example. You can get more information from them at their website or the Hennion & Walsh'sTwitter page.
Read more ...

Friday, January 23, 2015

Top 10 Warren Buffett Investment Strategies

Warren Buffett Investment StrategiesWhat lessons can we learn from Warren Buffett’s Investing strategies. Whether you like him or not, his investment strategies are the best, which made him one of the richest people in the world. Warren Buffett‘s investment advice or his investing strategies are priceless and if you can grasp these strategies you should do well as an investor. We know there are other investment strategies out there, but his strategies are both easy to follow and have been successful for several years.

1.    Turn Snowballs into Snow Forts
Above everything else, Warren Buffett believes in the power of compounding over time with patience. In investing, this means starting as early as possible avoiding short term risk even if it means lower returns and letting investing returns build upon themselves. Buffett bought his first stock when he was just 11 years old.

2.    Look for companies with moat
Moat means competitive advantage that one company has over the other companies in the same sector. Warren buffett coined this term. Buffet always looks for firms with sustainable competitive advantages. The stronger the company’s moat, the most likely it will lead for decades like Coco-cola. Companies with greater competitive advantages have the ability to outperform in good and challenging times.

3.    Margin of Safety
This is one of the advices Buffet got from his mentor Benjamin Graham, the father of value investing. Margin of safety refers to buying securities when the market price is significantly below its intrinsic value. Buying securities with a margin of safety reduces risk and provides allowance for uncertain negative events.

4.    Invest in what you understand
One of the personal investing advices of buffet is to invest in the business which you understand and never invest in anything in which you don’t have any knowledge. This is the reason he refrained from the technology stocks. If you understand a business, you could have an upper hand when it comes to buying the stock.

5.    Hold on to your Stock
Buffett holds his stocks for a long time when he finds a gem. Buffett personally recommends holding on to your stock for a long term. Buying and selling securities frequently will cost you commission charges which you have to pay to the broker. The important thing in investing is finding great investments and holding it for long term.

6.    Buy Companies Cheap
Buffett doesn’t give much attention to EPS (Earnings per Share), a measure of a company’s profitability for each stock. Instead he considers companies with good return on equity, companies which generate a lot of cash, companies with solid operating margins and reasonable or no debt. He likes to invest in companies with consistent operating history and also looks to measures how well a company performs in different kinds of market including good and hard times.

7.    Invest in Quality Companies
Buffett believes in quality companies not in stock symbols. Most investors invest in the symbols or brands of successful companies without analyzing the business they invest in. As Buffet says “Invest like you are buying the whole company or business”. Treat investing as if you are buying the entire company. Investors are expected to know with the following before buying the stock. What are the company’s products? Who are its competitors? What differentiates it from them? What is risk in owning the company stock?

8.    Stay away from so-called ‘glitter’ stocks
An intelligent investor should analyze whether the stock in news has real value or it is just glittering at the moment. It is always beneficial to do your homework before investing in each and every company. It is wise to diversify your investments across sectors and in different asset classes.

9.    Become a conscious Investor
“It takes decades to build a reputation and minutes to spoil it. If you think about it, you’ll do things differently”.
It is necessary for the investors to think logically while investing and researching a stock.  You should keep on asking yourself why you want to buy a particular stock and should eliminate decision making based on emotions, intuition and herd mentality. As advised by Buffett – avoid the noise, do your own research and constantly update your knowledge and stock picking skills. Be a Smart Investor.

10. Know when to Quit
Once, when Buffett was a teen, he went to the racetrack. He bet on a race and lost. To regain his money back, he bet on another race. He lost again, leaving him nothing. He felt sick as he had lost nearly a week's earnings. He never repeated that mistake. You should Know when to walk away from a loss, and don't let anxiety or your emotions fool you into trying again.

Read more ...