by Erin Lowry
Find the tool at https://brokercheck.finra.org/.
INVESTMENT ADVISOR PUBLIC DISCLOSURE: The Securities and Exchange Commission (SEC) also provides a free tool for vetting investment advisors. It works in a similar way to FINRA’s Broker Check, and also pulls in information from Broker Check. You’ll receive details about any disciplinary actions taken against an advisor as well as his or her credentials.
Find the tool at https://www.adviserinfo.sec.gov/.
VERIFY A CFP: The certified financial planner (CFP) designation is the gold standard for financial planners. While financial planners and investment advisors are not always one and the same, you can seek out a CFP who also specializes in investments and estate planning. Should you want to work directly with a CFP, whether for general financial planning or for your investments, you can verify potential candidates through the CFP Board. The tool will tell you if the CFP is indeed certified, whether he or she has a history of disciplinary actions from the CFP Board, and any bankruptcy disclosures in the last decade.
Find the tool at https://www.cfp.net/utility/verify-an-individual-s-cfp-certification-and-background (or type “verify CFP” into a search engine and look for the landing page associated with the CFP Board).
Questions to Ask a Potential Advisor
You should take the time to ask a potential investment advisor questions before doing business.
What are your experience, certifications, and credentials?
There are plenty of certifications and credentials, so the ones you’re looking for depend largely on what you want out of an advisor. You’ll hear brokers and investment advisors refer to exams such as the Series 7 or Series 63. These licenses are required in order to be able to sell different types of securities. You can learn more about each one on FINRA’s website (http://www.finra.org/industry/qualification-exams).
Do you uphold the fiduciary standard?
The fiduciary standard means the advisor acts in your best interest. Suitability standard means the advisor just has to do only what is suitable for you.
How do you get paid?
As mentioned in chapter 6, commissions, a fee for assets under management, and a flat-rate fee are all ways in which your advisor may get paid. If he or she gets paid a commission, you should know exactly what that means for you and the products in your portfolio.
How often should I expect to hear from you?
At a bare minimum, you should have an annual meeting about your portfolio and goals, but maybe you’d prefer to meet once a quarter or get weekly newsletters or be able to get a response if you’re panicking about a market correction. You should be comfortable with the means and frequency of communication that you get from your advisor.
Will I be working directly with you or also with other people in the firm?
It’s a bummer to feel as though you have a rapport with someone only to find out that’s the pitch person to get your business, and you’ll really be dealing with intern Jim down the hall.
Questions to Ask About a Product
You can ask your investment advisor these questions directly, or you can ask them of yourself before you decide to invest in a new product.
How does this investment work and make me money?
What is my goal with this investment?
Is this aligned with my risk tolerance and values?
How is this helping me reach my (short/medium/long-term) goals?
Will I be okay if I lose all this money tomorrow?
INVESTMENTS YOU SHOULD QUESTION
First, you should always do your due diligence on any investment, no matter how “safe” it seems.
Second, before you skim this list, it’s important for you to understand something. The products you see listed here are not necessarily scams or nefarious products. Some of them make sense for a niche group of people at a particular phase in their lives.
However, many of the products listed below have the potential to be sold to you as smart investments because they pass the suitability test but not the fiduciary one. Some of these investments come with well-crafted sales pitches to make it sound like you’d be a fool to not get in now. You need to do your own research and see if an investment really does fit in your portfolio or if someone is trying to make a commission off you.
Cryptocurrency
“Bitcoin is gambling. If you want to gamble, that’s fine,” says Sallie Krawcheck, CEO of Ellevest. “Whatever money you put aside to go to Las Vegas, you can use to play around in Bitcoin. At some point, it may become a true asset class, but it is not there yet.”
Active Management
Active management, Krawcheck explains, is “the idea of buying and selling funds or stocks through a financial advisor or a broker, or on your own, with the promise of outperforming the market. The research tells us that despite the fact that this has been the value proposition in the industry for the longest period of time, the percent of active managers who consistently outperform over a five-year period is a single-digit percent. By some estimates, it’s less than 1 percent. This is a loser’s game. This continues in the industry because it makes so very much money from it and because the concept of outperforming is so tantalizing and so compelling.”
Whole-Life Insurance
“Buy term, and invest the difference,” advises Krawcheck. Whole life comes with steep premiums and fees. If you’re unable to pay those premiums, then you could lose some or all of that initial deposited sum. The returns on the invested funds probably aren’t great compared to putting the same money in a low-fee index fund. Plus, whole life is just frickin’ confusing, and as all the experts have recommended, only buy what you can understand.
Term life is simple, with lower prices, so you get the coverage you need and can invest the difference. Plenty of life insurance agents are happy to sell you a whole-life insurance product, and in fact will probably give you a hard pitch to take it—even if it’s not the ideal fit.
Generally, whole-life insurance is recommended for high-net-worth individuals doing everything they can to minimize the impact of estate taxes. For the average Broke Millennial, it’s not a fit.
Annuities
“I adore the concept, because if I describe an annuity to anybody, they always say, ‘That sounds amazing.’ You know, what if [you] could put money in, earn a return, and not outlive your money,” says Krawcheck. “Unfortunately, the industry has so overcharged for annuities that [they’ve] gotten a bad name.”
Annuities are one of those products that are easy to build a strong sales pitch for, but that doesn’t mean they’re a good fit for your financial life and goals. Don’t be wowed by a flashy presentation until after you’ve looked under the hood and investigated the fees and restrictions, and then see if an annuity still fits into your plan.
CHECKLIST FOR SNIFFING OUT SCAMS
☐ After asking all your questions, do you understand what the investment does and how it earns money?
☐ If it’s a speculative investment, are you financially and emotionally prepared to lose all the money you invest?
☐ Do you feel like you’re being given a sales pitch or does this product make sense with your portfolio’s overall goals?
☐ Did you properly vet a broker/financial advisor/investment advisor by asking all the necessary questions and checking the SEC and FINRA databases?
☐ It’s cliché, but what’s your gut telling you?
Chapter 13
So, You’re Ready to Sell an Investment
FOR TWELVE CHAPTERS NOW, we’ve discussed why you should invest and the ways in which you can. There’s been a significant emphasis on the buy-and-hold strategy, but at some point, you’re going to want to sell your investments or a
t least start to take withdrawals from the accounts.
I held on to my first investment for five years before I sold. It was that original mutual fund I opened up via my bank. This wasn’t the shrewdest investing decision, especially given its rather high expense ratio, but I left it alone to grow for five years nonetheless.
The right time to sell came a few months before Peach and I got married. Years prior to our engagement, I’d mentally earmarked that mutual fund as a wedding gift to him. Not that I would hand him some sort of paperwork transferring it to his name or anything. No, my idea was to liquidate the fund and use it to make a large payment toward his student loan debt.
You may be wondering why I’d do that after I spent all of chapter 5 waxing poetic about the importance of investing while carrying student loan debt. The logic, for me, was twofold.
One of Peach’s student loans carried a 7.75 percent interest rate. The math on that just didn’t really add up to be investing over paying it off quickly. As the experts in chapter 5 mention, it’s usually a good strategy to save for retirement first and then focus additional funds on paying off student loans carrying interest rates above 5 percent.
It felt like a symbolic gesture of us coming together as a financial team. It would no longer be “your money” and “my money” or “your student loans,” but rather “our money” and “our student loans.”
There was just one snafu. I didn’t know how to even go about cashing out of my mutual fund, and I needed to learn more about the tax implications of such a move. Did it really make sense to sell and pay taxes on the capital gains in order to put it toward debt?
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THIS CHAPTER DEALS specifically with selling an investment in a taxable account—not a tax-deferred account like an IRA or 401(k). If you take money out of a retirement account and you’re under fifty-nine and a half, it could be subject to ordinary taxes in addition to a penalty for early withdrawal. That’s a whole lot worse than what you’d pay on regular taxable investments.
WHEN TO SELL AN INVESTMENT
Ah, if only I had a really prescriptive answer to that question! There is a variety of reasons you might elect to sell an investment. It could be as simple as tax-loss harvesting or rebalancing your portfolio. Maybe your investment is like my mutual fund example: the time horizon has come to its natural conclusion and you’re ready to use the investment for its intended purpose. Or perhaps your risk tolerance has changed and you want to be more or less aggressive and need to off-load the investment to achieve that purpose. Or maybe it’s just a dud and you’ve given it time to perform and are ready to cut it loose.
HOW TO SELL AN INVESTMENT
This depends on what the investment is and how you’re investing. Maybe you have an advisor or broker you can call up and ask to make the sale for you. But if you’re a DIY investor or use a robo-advisor or app, then you generally just log in and request to make a sale or withdrawal. Just be sure you list it as a “market sell order” and don’t accidentally end up buying more!
You could “dollar-cost-average” your way out of the market, which means you don’t take it all out in one lump sum. Instead, you take portions out over the span of weeks, months, or even years. You’d do this in order to hedge your bets on the value going up while you start moving the money to a more conservative investment (or cash). That way, as you continue to divest, you’re selling it at higher and higher prices. Obviously, this can backfire and you could dollar-cost-average out and hit the market at lower points.
DO YOU NEED TO BUY NEW INVESTMENTS TO KEEP YOUR PORTFOLIO DIVERSIFIED?
Rebalancing your portfolio is one reason to sell an investment. Let’s look at the example of me selling my mutual fund. In that case, the mutual fund was moderately aggressive and invested in large-cap growth funds. By selling the fund, I didn’t put my overall portfolio out of whack because I had other index funds that were moderately aggressive to aggressive and invested in similar large-cap companies.
But let’s look at an overly simplistic example for the sake of demonstrating when you may need to buy a new investment:
You own stock in large-cap companies covering five different sectors: energy, technology, health care, real estate, and consumer staples. You decide to sell your technology-sector stock. Now your portfolio is missing investment in a major sector of the stock market, so it would be prudent to replace that investment with a different tech stock.
Remember, diversification is about more than stocks versus bonds versus cash equivalents. It’s also about owning in different sectors of the market.
THE TAX IMPLICATIONS OF SELLING OR MAKING A WITHDRAWAL
Sorry to say, but selling investments for a profit means Uncle Sam is going to come calling. You’ve made income, and now the IRS wants its cut. You can be taxed on dividends, capital gains, or interest income. You don’t have to pay taxes at the moment of the sale or withdrawal. That bill will come at tax time, when your brokerage sends you a 1099-B form and/or a 1099-DIV. It’s important that you have a rough estimate of how much you’ll owe on your taxes, so you have that money set aside and earmarked for tax season. This is especially critical if you’re used to getting a refund and therefore don’t normally have a stash of cash to pay what you owe in taxes. That could be a most unpleasant surprise.
In a point on the scoreboard for online financial advisors (aka robo-advisors): Investing via a robo-advisor generally means it does some of the heavy lifting when it comes to minimizing taxes. Betterment, for instance, offers a Tax Impact Preview, so you can see approximately how much your potential move will cost you.
The amount you’ll owe in taxes depends on your tax bracket, how much you earned on the sale, the type of investment it was, and when you sold the investment relative to its purchase date.
When Did You Buy the Investment?
The sale of an investment that’s less than a year old could mean you owe short-term capital gains tax.
Capital Gains
Capital gains are the profit you made on your investment, assuming you sold it for a profit. The tax rate for long-term capital gains is usually 15 to 20 percent, depending on your tax bracket.* Short-term capital gains are taxed at the same rate as ordinary income, from 10 percent all the way up to 37 percent.
Dividends
Your mutual fund, index fund, ETF, or stock may pay you dividends for being a shareholder. You can take these dividends as income and pay taxes on them, or you can reinvest them to purchase more shares. Dividends can be “qualified” or “nonqualified.” Dividends are qualified if you hold the investment for sixty days or more and if they are a payment from the common stock of a US corporation. Qualified dividends are taxed like capital gains, at 0, 15, and 20 percent, depending on your tax bracket, while nonqualified dividends are taxed at your ordinary income tax bracket. Tax law is subject to change, so you should always check IRS .gov for recent information about current tax law with regard to capital gains and dividends.
Interest Income
This is just like how you owe money earned on interest sitting in your savings account. Any interest earned on bonds, CDs, money market products, or similar cash equivalents is subject to tax. This interest will be reported on either a 1099-DIV or a 1099-INT form.
Can You Deduct a Loss?
If your losses outweighed your gains, then you may be able to write them off on your taxes. Moments like this are when it can pay to hire someone who knows all the ins and outs of tax code in relation to investing.
Foreign Stock
Having foreign stock in your portfolio, which most well-diversified portfolios do, could also mean you owe foreign taxes on any dividends earned. Oftentimes your brokerage will handle this for mutual funds and ETFs and the taxes owed will be taken out of your dividends.
WILL YOU OWE ANY FEES?
There may be more than tax implications attached to sell
ing an investment. Don’t forget to review your brokerage’s fees. With “trade fees” on your stocks and back-end-load mutual funds, you’ll need to sell enough and have a strong enough profit to cover not just the taxes you’ll owe but also the fee your brokerage will charge when you sell.
CHECKLIST FOR SELLING YOUR INVESTMENTS
☐ Have you given your investment enough time to perform, or are you getting trigger happy and contemplating selling after a few months?
☐ Do the math and determine approximately how much you may owe in capital gains tax, then put that money aside for your tax bill. (Be aware that selling in less than a year means paying more in taxes due to short-term capital gains.)
☐ How much are the fees you’ll need to pay (if any)?
☐ Should you replace this investment with something else to stay diversified?
Chapter 14
Tactics the Wealthy Use to Make and Preserve Money
