Know Why You Want to Refinance

Refinancing can help you achieve financial goals, but it comes at a cost. Refinancing your mortgage will involve closing costs, which may cost up to 6% of your principal amount.

Let’s see when it makes sense to begin this process.

The first and most important step toward making refinancing work is knowing what you want to accomplish. If your goals are clear, you have a solid basis for deciding whether a refinancing option will meet your needs.

These are some of the most common reasons to refinance.

Lower Interest Rates

The best reason to refinance mortgages is to lower interest rates on your current loan. A fall in interest rates increases the rate at which homeowners can build home equity and increase overall savings.

Mortgage rates are currently rising steeply after a long period near record lows: at this writing, the average rate for a 30 year fixed-rate mortgage is 6.94%, the highest it’s been since 2002^[1]. That could make it difficult to find a new loan at a better rate than your old one. It could still be possible if your credit score has improved dramatically since you took out your existing mortgage.

Change Your Loan Term

Homeowners might want to change their loan terms for a variety of reasons. If you struggle to make mortgage payments, you can increase your loan term by refinancing the loan, resulting in lower monthly payouts. You can refinance a 20-year mortgage to a 30-year one and make lower monthly mortgage payments.

A longer loan term will mean higher total interest expense, but if you’re having trouble making your payments, it is still a legitimate option…

Alternatively, suppose you are generating enough cash flow to meet your monthly expenses and investments. In that case, it might be time to shorten your mortgage term. You’ll build equity faster and reduce your total interest expense.

This is also a viable move, but you’ll have to be sure that you have the means to make those higher payments, even if unexpected events occur.

Tap Your Home Equity

A cash-out refinance is a way to gain access to a portion of your home’s value to use for other purposes. You will take out a refinancing loan for more than the value of your mortgage and take the difference in cash.

The downside of this is that your new mortgage will be larger than your old mortgage balance.

The upside is that – using the above example – you are effectively borrowing $50,000 for a lower rate than you could get anywhere else. If you were considering a debt consolidation loan, for example, a cash-out refinance would allow you to consolidate debts at a lower rate than you’d get from an unsecured personal loan.

Of course, you’d have to be very careful to put that money to a good purpose, and you’d have to be sure that you have the capacity to pay that new, larger mortgage.

The proceeds of a cash-out refinance can be used in any way you like, but remember that this money is borrowed, not given. Use it wisely, or you’re likely to find yourself with bigger problems down the line.

It’s generally not a good idea to use a cash-out refinance unless you can get a better interest rate than you had on your previous mortgage. If you can’t, the cost is likely to be too high.

Change Your Mortgage Type

Another reason to refinance your mortgage is to convert the loan from a fixed-rate mortgage to an adjustable-rate mortgage (ARM) or vice versa. ARMs generally have lower interest rates than fixed-rate mortgages. But quarterly or yearly adjustments may easily result in rate increases over time, making ARMs more expensive.

So, it makes sense to convert the loan to a fixed-rate mortgage to lower interest rates and protect yourself from any fluctuations in future yields. On the other hand, if interest rates are falling, you can convert an ARM into a fixed-rate mortgage.

Remove a Cosigner

Imagine that you took out a mortgage ten years ago and asked your parents to cosign because you couldn’t get a good enough rate on your own.

Ten years down the line, your credit is solid, you’re financially stable, and your parents want to take out a new mortgage of their own. That cosigned loan could push their debt-to-income ratio to a point that scares lenders away.

You can refinance the mortgage on your own and set your cosigners free from their obligation.

Should You Refinance Your Mortgage?

You’ll shop for a refinancing loan in much the same way that you shopped for a mortgage. The offers you get will depend heavily on your credit score, your debt-to-income ratio, and other measures of your creditworthiness.

It’s important to consider multiple offers. Borrowers who shop around get consistently better rates and terms than those who take the first offer they get.

Once you have several offers in hand, assess them to see if they will allow you to meet your goals. You don’t have to take any of them: sticking with your current mortgage is always an option. Remember to consider the closing costs in your calculation.

If you’re convinced that the best offer meets your needs and gives you what you want from refinancing, then it’s time to refinance your mortgage!

The post When Should I Refinance My Mortgage? appeared first on FinMasters.

Many people need a financial advisor: in a recent survey approximately 71% of Gen Z and 72% of millennials indicated that they need financial advice^[1]. Many of them hesitate to reach out for professional financial advice, often because they don’t think they can afford it.

Many people don’t realize that professional financial advice is widely available and that it can even be free.

Who Should Use Financial Advisors?

There’s a long-standing myth that only the ultra-rich hire financial advisors. The misconception dates back to the days when the term “financial advisor” typically referred to wealth managers and investment advisers catering to high-net-worth clients.

Today that has changed, and there’s a much wider range of financial professionals providing advisory services to people from all walks of life, including those in financial distress.

If you’re facing financial problems that you don’t fully understand or that you don’t feel prepared to solve, you should consider using a financial advisor.

According to our recent survey, most people (75%) recognize that the potential of financial advice goes beyond delivering investment returns and into the realm of goal fulfillment.

Why Do You Need a Financial Advisor?

People seek financial advice to deal with many different problems, but those problems fall into three broad categories:

1. You’re Already On Top – Wealthy individuals hire professional advisers to manage their financial affairs. This is the traditional view of a financial advisor, and it’s one that most of us will never be able to afford.
2. You’re Moving Forward – Many of us start out with only one financial goal: getting to the next paycheck without running out of money. As we move to better-paying work and gain financial stability, we face new financial problems, often very complex ones.
   We may need to select investments, set up tax-advantaged retirement accounts, choose insurance, buy a home, set up special accounts to save for a child’s education, or plan our estates. Many of us seek financial advisers to help.
3. You’re Falling Behind – Many of us are gaining financial stability. In an age of static wages, soaring prices, and escalating interest rates, many Americans are barely keeping up, and many are falling behind, slipping into an overwhelming tide of debts and costs.
   Many of these people desperately need financial advice, and they are often the ones least likely to get it.

Types of Financial Advisors

1. Credit Counselors

Many people don’t think of credit counselors as financial advisors, but they are. Credit counselors typically work with individuals in financial distress, helping them learn to budget their resources and get their debts under control.

Credit counselors often work for non-profit credit counseling agencies, and many of these agencies provide free initial consultations. If your financial problems seem overwhelming, a free session with a credit counselor can be a great start toward taking control.

Many credit counselors carry a Certified Credit Counselor credential from the National Foundation for Credit Counseling (NFCC) or the National Association of Certified Credit Counselors (NACCC).

2. Financial Therapists

Financial therapists address the root causes of money issues, helping people recognize and address problems stemming from their fundamental thoughts, feelings, and attitudes toward money.

Financial therapy bridges two disciplines: financial planning and psychotherapy. It’s aimed less at goals like building a financial plan than at helping people understand (for example) why they never seem able to follow a financial plan.

If you feel that you can’t communicate about money issues, you suffer serious money anxiety, or you have recurring self-sabotaging financial behavior, a financial therapist might be able to help.

3. Certified Financial Planners

Certified Financial Planners (CFPs) are required to gain certification from the Certified Financial Planner Board of Standards in the United States by passing the requisite exam and having approximately 6,000 hours of professional financial planning experience. Applications with 4,000 hours of apprenticeship experience are also eligible for the highly-coveted CFP certification. 

CFPs are trained in financial planning, estate, and retirement planning, as well as tax and insurance calculations. With a 67% median pass rate, the Chartered Financial Planning exam is one of the most reputable courses for financial planners in the U.S.

Most wealth managers often have a CFP degree, and financial Planners with a CFP degree can meet a wide range of advisory needs.

4. Investment Advisers (FINRA Registered)

The Financial Industry Regulatory Authority, or FINRA, is a self-regulatory body under the purview of the SEC. So investment advisers must have multiple FINRA licenses (commonly Series 6 and 7) to ensure investors get proper and transparent investment guidance and complete disclosure. With authorization from Congress, FINRA currently monitors more than 624,000 brokers across the U.S.

Thus, FINRA-registered advisors are typically considered the top tier of investment advisors in the country. Though returns are not guaranteed, it is safe to assume that FINRA-registered financial planners can help you navigate the markets safely and deliver quality returns.

5. Broker-Dealers

Broker-dealers typically work for financial institutions and execute orders on behalf of clients. While they generally work as agents executing trades, broker-dealers often provide investment advice and guidance to investors. They can act as independent broker-dealers as well.

Investment advisors must register with the SEC and FINRA, with only a few exceptions.

Unlike FINRA-registered investment advisors, broker-dealers earn commissions from each trade successfully executed. Full-service broker-dealers often make money from their consulting services.

6. Investment Managers

Investment managers solely focus on managing clients’ investment portfolios. They generally have relatively high minimum investment requirements and percentage-based commissions and fees, and cater to clients with substantial funds. Leading investment management firms such as Blackrock Inc. and Fidelity Investments often charge incentive-based commissions on returns as well.

Investment managers often have decades of experience in their fields and custom-design a portfolio, keeping a client’s risk appetite and long-term goals in mind. Active investment managers also keep reorganizing portfolios depending on market conditions to deliver maximum returns.

7. Wealth Advisors

Wealth advisors provide comprehensive financial management services to high-net-worth individuals. Apart from specific investment advice, wealth advisors often act as accountants and provide estate, retirement planning, and tax management services. The consensus advisory fee charged by wealth advisors is usually around 1% of the total assets under management (up to $1 million).

They also set up and maintain trusts for their clients, which are essential to retirement planning. In addition, wealth managers take care of their client’s tax liabilities, considering they generally have higher payment obligations. Wealth advisors are often tasked with reducing or deferring clients’ tax liabilities through strategic investments.

As the number of ultra-wealthy individuals has risen substantially since 2020, the demand for wealth advisors has also risen simultaneously. As a result, by 2025, the global wealth management industry is expected to have an AUM of roughly $145.4 trillion.

8. Robo-Advisors

Taking investment advice from a machine might seem strange, but algorithmic trading makes headway in stock market investing. Robo-advisors deploy algorithms to determine the best investment pathways. As artificial intelligence gains traction, financial institutions are developing personalized algorithms to deliver market-beating returns.

According to a recent CNBC article, Robo-advisors in the U.S. might soon manage nearly $1 trillion in total wealth. Analysts are predicting the Robo-advisory industry to reach $1.2 trillion by 2024. As David Goldstone of Backend Benchmarking said about Robo-advisors, “They’re everywhere now … Just about every major bank and discount broker launched one in the past decade.”

Which Financial Advisor Should You Opt For?

The type of financial advisor you select will depend on your specific needs: a person struggling to get out of debt will need a different type of advice from someone who is building an investment portfolio.

If you are shopping for financial advice, however, there are two terms to keep in mind.

• Fee-only advisors are compensated only by client fees. That means they are not, for example, taking commissions from providers of products they might recommend.
• Fiduciaries are advisors with a sworn legal duty to work only in the interest of the client.

Using a fee-only advisor with fiduciary status gives you confidence that an advisor is working for you, not for someone who’s paying a commission.

Whatever type of advisor you choose, shop carefully. Always check an advisor’s credentials and reputation before signing on.

We said it at the start, but it’s worth repeating: financial advisors are not just for the rich. If you need to know more about money, decide what advice you need and look for it!

Read more: What’s the #1 Thing People Should Ask Their Financial Advisor (But Never Do)?

The post Navigating Financial Advice: 8 Types of Financial Advisors appeared first on FinMasters.

What is Identity Theft?

Before we delve into the details, let’s understand what identity theft means. The umbrella term covers crimes committed using a person’s personal identifying information (PII), such as social security numbers, driver’s licenses, debit and credit card details, passwords and PINs, banking information, and much more.

Identity thieves can exploit such data by opening new bank accounts and lines of credit using your information. Criminals could make unauthorized withdrawals or transfers from your account or make illicit and unauthorized purchases through stolen card details. They could obtain medical care using your insurance details or file a tax return in your name and claim your refund. They may simply sell your information to others.

You might not even realize that you are a victim of identity until much later when the damage is already done. Not only can this lead to substantial economic damage, but it might also even lead to an arrest warrant being issued in your name.

Many people assume that identity thieves are high-tech “hackers,” but that’s often not the case. Many thieves get personal information by raiding mailboxes, sifting through garbage, looking for discarded statements, or calling victims up and impersonating a representative of a financial institution.

There are multiple types of identity theft and methods thieves use to steal your identity. You can protect yourself by knowing the signs of identity theft and what to do if you’re a victim. Some people want or need additional protection, and that’s where identity theft protection services come into the picture.

Did you know: In 2021 alone, 1,434,698 Americans reported identity theft.

What Do Identity Theft Protection Services Include?

Identity theft protection services monitor public databases, social media, and the dark web to find out if a customer’s data is published there or not. They also monitor customers’ credit reports to identify unusual activity and send requisite alerts. Theft protection agencies typically offer three-bureau monitoring services to ensure prompt identification of any out-of-the-ordinary transactions or activity.

Identity theft protection services can detect many complex fraudulent activities that you might not pick up yourself, such as falsified invoice frauds, which will most likely pop up on a monitoring agency’s radar. Such theft agencies employ seasoned trackers that can generally sniff out any suspicious activity as soon as it occurs, thereby allowing clients to minimize losses.

Identity Theft Protection vs. Credit Monitoring: Which is Better?

Credit monitoring focuses exclusively on the surveillance of credit reports. The majority of personal identity theft involves financial data breaches, which are likely to appear on the victim’s credit reports.

Identity theft protection services provide much more comprehensive scrutiny. They can track and report identity theft before it appears on credit reports, making them more effective. They can also detect forms of personal identity theft that do not involve credit transactions, such as direct debits from bank accounts, crypto scams, tax identity theft, and the sale of personal information on the dark web.

Identity theft protection is also much more expensive than credit monitoring.

Credit monitoring is often free. You can monitor yourself directly simply by reviewing your credit reports on a regular basis. Many bank accounts, credit cards, and loans also bundle credit monitoring with their account perks. Before you pay for credit monitoring services, see if you’re entitled to get them for free.

The Bottom Line

If you believe you are a victim of identity theft or have had any confidential document stolen, or if you have reason to believe that you are at risk or that information has been compromised, it might make sense to opt for a comprehensive theft protection package. The platforms, which track social media, public databases, and the dark web, and monitor your personal accounts, can alert you instantly in case of any suspicious activity.

People who are not in immediate jeopardy should evaluate the pros and cons of both services before making a decision, as identity theft protection services are costly.

As more financial institutions have begun offering credit monitoring for free or bundled up with other services, low-risk individuals can protect themselves reasonably well by taking basic precautions and monitoring their credit.

The key to making the right decision for you is assessing your risk realistically and weighing it against the cost of full-scale identity theft protection.

The post Is Identity Theft Protection Worth It? appeared first on FinMasters.

You can use our loan refinance calculator to see how much you can save if you choose to refinance one of your loans.

Refinancing Rules for Conventional Mortgages

Conventional mortgages are offered by private lenders such as banks, mortgage companies, and credit unions.

The waiting period is six months if you want to refinance your conventional mortgage through the same lender. If you change your mortgage lender you can refinance whenever you want.

The rules are slightly different for cash-out refinances, which allow you to convert your home equity into cash. You use your home as collateral and apply for a new loan that is more than your initial mortgage amount. The difference is paid to you in cash.

You must own your home for a minimum of six months before applying for a cash-out refinance.

Refinancing Rules for FHA Loans

A Federal Housing Administration or FHA loan is insured by the federal government. This home mortgage is issued by an approved bank and generally requires a lower down payment than a conventional mortgage.

There are two ways to refinance an FHA.

If you choose to refinance with another FHA loan, using the FHA Streamline Refinance process, you will have to wait until you have made six consecutive on-time payments, so a minimum of six months.

If you want a regular refinance with no cash out, there’s no waiting period but your maximum Loan-to-Value (LTV) ratio will be 85%, meaning that you may not be able to refinance the entire mortgage. If you wait a year, the maximum LTV is 97.5%.

If you want to refinance the FHA loan with a conventional loan, you’ll follow the rules for refinancing conventional mortgages, as explained above.

Refinancing Rules for VA Loans

A VA mortgage loan is available via a program established by the U.S. Department of Veteran Affairs. The VA offers several refinance programs, all of which require a minimum of six on-time mortgage payments or 212 days, whichever is less.

If you refinance with a conventional mortgage you’ll follow conventional mortgage rules.

Refinancing Rules for USDA Loans

The U.S. Department of Agriculture (USDA) offers two mortgage programs serving rural homeowners.

To refinance a guaranteed USDA loan you need to have made a minimum of 12 loan payments. There is no waiting period to refinance direct USDA loans.

Refinancing Rules for Jumbo Loans

A jumbo loan overshoots the financing limits set by the FHFA (Federal Housing Finance Agency). Jumbo loans will not be guaranteed by regulatory bodies such as Fannie Mae and Freddie Mac. Jumbo loans are provided to finance luxury properties in expensive real estate markets.

In terms of refinancing, jumbo loans are similar to conventional mortgages. They can be refinanced whenever a homeowner wishes to do so. As jumbo loans are not securitized, the underwriting process is quite comprehensive compared to other mortgage options discussed here. You will have to have good credit and a low debt-to-income ratio to be approved.

Why Should You Refinance Your Mortgage?

There are several reasons to refinance your mortgage.

• Reduce your interest rate. If your credit has improved or rates have gone down you may be able to refinance at a lower rate.
• Reduce your monthly payment. Refinancing with a longer term can reduce your monthly payment but will increase your interest costs.
• Reduce your loan repayment period. This will increase your monthly payment but reduce your interest expense.
• Change your mortgage type. You can shift from a fixed-rate mortgage to an adjustable-rate mortgage or vice versa.
• Remove a cosigner. If you have a cosigner on your original loan, refinancing can free your cosigner from their obligation.

Remember that refinancing involves considerable effort and you will pay closing costs. Be sure to consider those factors before deciding to refinance!

The post How Soon Can You Refinance a Mortgage? appeared first on FinMasters.

With over 3,300 brokerage firms registered with FINRA in 2022, the choice can be overwhelming. However, focusing on a fairly small number of online discount brokers makes this task more manageable.

Not every broker is best for everyone. Your choice will depend on your investment goals, risk appetite, and market experience.

Comparison of Online Brokers

Broker	Commission	Premium Account Charges	Fractional Shares	Paper Trading	Robo-Advisor	International Markets
Fidelity	$0	Fidelity Go: $3/month				25 markets
Charles Schwab	$0	Schwab Intelligent Portfolios Premium: $30/month				12 markets
Robinhood	$0	Robinhood Gold: $5/month
E*TRADE	$0	Core Portfolios: 0.3%/month (for accounts with market value over $500)
Interactive Brokers	$0	IBKR PRO: Tiered Pricing				150 markets

1. Fidelity – Best For Novice Investors

With over 40 million individual investor accounts and more than $11 trillion in assets under administration, Fidelity Investments is the largest brokerage firm in the U.S. It is one of the most popular discount stock brokers as well, with zero commission fees and low administrative costs.

Fidelity does not charge any commission on equity and ETF trades. It permits investments in U.S. treasuries, corporate bonds, and other popular debt instruments, making it ideal for risk-averse investors.

The platform is renowned for its extensive research and assistance features. It features several best-in-class portfolio analysis tools and stock and asset screeners. All customers with Fidelity accounts have free access to the platform’s highly regarded research articles and partner content from more than 25 industry-leading websites.

Through a Fidelity account, you can invest in international markets across 25 countries in 16 different currencies.

However, Fidelity Investments doesn’t permit futures, options on futures, commodities, or crypto trading. This is not likely to be an issue for novice investors or buy-and-hold investors, but it might hinder the investment goals of active traders and expert investors. 

Only U.S. residents can open and maintain accounts with Fidelity, so it’s not an option for non-U.S. citizens.

Visit Website

2. Charles Schwab – Best for Intermediate Investors

Founded in 1971, Charles Schwab is one of the largest brokerage firms in the U.S., with more than $6.6 trillion in client assets. The platform charges $0 in commissions for equities and ETF investments, while options trades bear a $0.65/contract commission charge. Schwab facilitates cryptocurrency trades as well.

Charles Schwab announced its plans to acquire popular brokerage firm TD Ameritrade Holding Corporation for approximately $26 billion in 2019. Thanks to its growing popularity among the masses, Schwab added $115 billion in core net new assets in the third quarter of 2022, reflecting a 7% annualized growth year-over-year.

After receiving the green flag from the Antitrust Division of the Department of Justice in 2020, the platforms are currently in the process of merging their operations. Charles Schwab estimates the merger to conclude by 2024. Through this acquisition, Schwab aims to become “the most trusted leader in investment services”.

Besides its discounted brokerage services, Charles Schwab provides automated advisory and other premium services. Its Intelligent Portfolios platform comprises Robo-advisory services, including automated portfolio creation, monitoring, and rebalancing. Investors can avail of the benefits from Schwab’s Robo-advisor with a minimum investment of $5,000.

Schwab employs certified financial planners to provide unlimited investment guidance to investors using its Premium service.

Charles Schwab’s customizable option screeners allow investors to pinpoint the best options contracts to invest in depending on their preferences. With a competitive $0.65/contract commission, it is one of the best brokers for derivatives traders.

Visit Website

3. Robinhood – Best for Commission-Free Equity and Crypto Investing

Robinhood shot to fame during the pandemic’s early days thanks to the increased interest in stock market investing. Its commission-free trading model has disrupted the U.S. brokerage industry.

The platform aims to “democratize finance for all” by making it accessible to users all over the country. Founded in 2014, the start-up charted a steep growth over eight years, thanks to its no-fee model and minimal trading restrictions. It also facilitates fractional share and cryptocurrency trading.

As of August 31, 2022, Robinhood had 13.3 million monthly active users and $71 billion in total assets under custody.  Further, the platform’s net cumulative funded accounts, which reflect user growth, increased 2% year-over-year as of August.

The trading platform’s parent company Robinhood Financial LLC also supports cash management services, which allows investors to earn interest on uninvested funds held with the Robinhood app.

The platform offers a 1.25% annual percentage yield (APY) variable interest on funds, at par with several popular online savings accounts. With no monthly service fees and FIDC insurance of up to $1.25 million, Robinhood’s cash management services set it apart from many other online trading and investing platforms in the U.S.

The Robinhood platform remains popular among retail investors, despite the GameStop controversy in early 2021.  The discount broker restricted trading of GME and other popular meme stocks when prices were skyrocketing, citing market volatility as the primary reason.  This resulted in a barrage of negative publicity. It also came into the crosshairs of the SEC and was subsequently required to pay a $70 million fine.

Robinhood is one of the earliest adopters of the latest market trends, given its younger tech-savvy and prone to risk-taking clientele. It is currently in the process of rolling out a decentralized finance (Defi) wallet for storing a multitude of digital assets, including cryptocurrencies and NFTs.

Visit Website

4. E*TRADE – Best for Derivatives Trading

E*TRADE is a subsidiary of Morgan Stanley, one of the largest investment banks in the U.S. The platform, established in 1982, is one of the pioneers of online brokerages.

It also has significant exposure to high-volume derivatives trading, thanks to its acquisition of OptionsHouse’s parent company Aperture New Holdings, Inc., in 2016. It charges no commission on equities and ETF trades.

On the other hand, options trading bears a fee ranging from $0.50 to $0.65 depending on the contract volume and monthly trading history.  Foreign stock trades, over-the-counter (OTC) trades and large-block transactions will incur charges.

E*TRADE also operates as a full-service broker, providing Robo-advisor and professional planning and consulting services. Account holders with an initial investment as low as $500 can avail of E*TRADE’s Robo-advisory services, which include automated account services, portfolio construction, and cash management. Its expansive educational content and research material make it a top choice for novice investors and experts.

However, the platform does not permit trading on international exchanges or crypto investing. Investors looking to branch out from domestic equities into foreign markets and alternate asset classes might benefit from other comprehensive online brokerage firms.

Visit Website

5. Interactive Brokers – Best for Experienced Traders and Foreign Markets

Interactive Brokers facilitates trading and investing across asset classes in over 150 international markets. As of September 30, 2022, the platform has approximately 2.01 million customer accounts and client equity worth $287.10 billion. The platform features individual investment and professional accounts for businesses and institutional investors.

While Interactive Brokers is smaller than some industry leaders, including Charles Schwab and Fidelity Investments, its top-notch features and services make it one of the best options for a seasoned investor.

The platform’s portfolio management system, PortfolioAnalyst, is not limited to investments. It also tracks all financial accounts, including checking, savings, and debt. It features 49 predetermined screeners for major asset classes and different risk tolerances. Interactive Brokers also has a Tax Optimizer tool, allowing investors to plan their investments for maximum tax savings.

Its extensive research tools include Traders Academy, which covers rigorous finance topics for investors wanting to expand their knowledge base. Interactive Brokers also have tied up with top financial news outlets and real-time data platforms to ensure clients have access to updated market data at their fingertips.

Interactive Brokers provides clients free access to technical, macro, and quantitative data from Reuters Stockreports+, Edison Investment Research, and MorningStar Equity Ownership, to name a few.

The platform allows trading on a uniquely wide range of international stock exchanges, as well as fractional share investing. You can also set up a direct dividend reinvestment plan, ensuring immediate reinvestment of dividends earned without requiring constant monitoring of accounts.

Interactive Brokers is one of the most sophisticated online brokers in the U.S. However, the platform’s interface and technical features might be daunting for an unseasoned investor.

Visit Website

What Should You Look For in an Online Broker?

Technology has revolutionized investing, with online brokerages gaining traction across the U.S. and worldwide. Besides significantly lower transaction fees and annual maintenance charges, online brokers facilitate instantaneous transaction processing, allowing traders to leverage sudden intraday price spikes and stock dips.

Let’s look at some of the key criteria that will drive your decision.

The Cheapest Isn’t Always the Best

Most investors opt for the broker with the lowest brokerage fee. In many cases, that fee is now zero: commission-free trading is now the norm. That’s helpful, but don’t overlook other vital characteristics, including broker assistance, access to information on various investments, and investment restrictions pertaining to location, citizenship, etc.

It’s also important to remember that zero-commission brokers still have to make money. They often do that through “payment for order flow”, which routes trades to the market maker that pays the most to the broker, not to the one that offers you the best price.

If you’re a frequent trader it’s important to have zero-commission trades if possible, but that shouldn’t be your only consideration, especially if you’re a buy-and-hold investor.

Watch Out for Excessive Gamification

Several online brokers often “gamify” their platforms to lure novice investors and promote frequent trading. While gamification features might seem appealing, it often drives less experienced investors to be swayed by the herd mentality in herd mentality, leading to significant losses when the hype dies down.

The European Securities and Markets Authority explains, “Gamification techniques in trading apps and personal recommendations on social media may cause retail investors to engage in trading behavior without understanding the risks involved.”

The U.S. stock market watchdog Securities and Exchange Commission (SEC), is currently scrutinizing the latest gamification trends.

Look For Platform Restrictions

Online brokers often provide add-on services, such as investment in international markets, paper trading tools, and curated research newsletters. Depending on your investing style, you should look into the additional benefits offered to reap maximum benefits from your broker.

If you want to invest in stock markets outside the US, look for a broker that provides international market investment options at attractive brokerage fees.

Also, check whether they provide fractional share investing. Fractional shares can open up access to shares you couldn’t otherwise afford.

For example, investing in Warren Buffet’s Berkshire Hathaway stock might be unfeasible, as the stock is currently trading above $420,000. However, investing in $1,000 worth of Berkshire stock can still allow you to get a piece of the action.

Furthermore, beginners should opt for online brokers that provide effective, user-friendly analysis and research tools to help them make informed investments.

Know Your Needs

Many of the best online brokers offer enormous ranges of investing tools and capabilities. That doesn’t mean you should be swayed by those offerings. The best broker for you is the one that meets your individual needs. Very complicated or comprehensive systems can even be an obstacle to investors, especially those embracing a basic buy-and-hold investment strategy. Not everyone is an active trader and not everyone should be!

Which Brokerage is Best For You?

While the brokerages mentioned above are some of the best for all classes of investors, your choice will be based on your level of investing expertise, your short and long-term investment goals, your risk appetite, and other personal factors.

There is no absolute “right choice” for a broker. Assessing your needs accurately is just as important as reviewing what different brokers have to offer, and it can be more difficult: many investors overrate their own expertise and their own needs.

Defining your needs accurately is the first step, and reviewing brokers is the second. The list above should give you a place to start!

The post 5 Best Online Brokers For Stock Trading of 2023 appeared first on FinMasters.

Last May, President Joe Biden announced the proposed budget for fiscal 2022, which runs between October 1, 2021, and September 30, 2022. The budget proposal is executed under the guidance of the White House Office of Management and Budget (OMB). The governing body defines the government’s financial necessities for the fiscal year, and Congress reviews the budget before passing it.

Government spending has risen consistently over the years. In 2020, the federal budget rose to $6.55 trillion, driven by federal benefits launched by the government to combat the COVID-19 pandemic.

Total outlays of the U.S. government in fiscal years 2000 to 2027

The spending increase seems radical, but if we look at spending as a percentage of GDP, the trend was relatively consistent up until the COVID-19 pandemic. Spending grew at roughly the same rate as the economy.

Federal outlays as a share of GDP over time

So, what does the federal budget consist of, and where do all the funds finally go?

Types of Federal Spending

The U.S. Treasury splits federal spending into three categories: discretionary spending, non-discretionary or mandatory spending, and interest on the national debt.

Federal spending fiscal year 2021

As you can see from the chart above, mandatory spending accounts for a large majority of federal government expenditures. The chart below shows that mandatory spending has increased significantly over time.

What is Mandatory or Non-Discretionary Spending?

Mandatory or non-discretionary spending is spending that is required by law. The government cannot raise or lower this spending.

Major don-discretionary spending programs include Medicare, Social Security, Medicaid, and unemployment compensation.

In 2020, due to COVID-19-related relief programs, mandatory spending stood at $5.2 trillion, significantly higher compared to historical figures. The government ramped up spending to offset rising unemployment rates and provide liquidity to millions of residents.

The government does not set aside a budget for Social Security programs. Instead, it assists those eligible for the payout each year and covers these costs, whatever the amount.

What is Discretionary Spending?

Discretionary spending is allocated each year by the U.S. Congress through an appropriations process. Each appropriations sub-committee is authorized to propose funding for a particular federal government sector.

In 2020, the U.S. Congress set aside $1.6 trillion in discretionary spending for fiscal 2021. Military spending was the largest category, accounting for 46.5% or $752.06 billion of total discretionary spending. In the past years, spending on the country’s military has surpassed 50% of total discretionary spending several times. 

The other top categories in discretionary spending include:

• Education: 9.82% or $158.7 billion
• Health: 9.12% or $147.38 billion
• Veteran’s Benefits: 6.48% or $104.78 billion

Discretionary spending is proposed by the executive branch and approved by Congress, and often becomes politically contentious.

A Look at the Federal Budget for Fiscal 2022

For fiscal 2022, President Biden has proposed to spend close to $6 trillion, which accounts for 23.5% of the country’s GDP (gross domestic product). Around $4.8 trillion will, however, be financed by federal revenues, and the rest will be funded via borrowing. In addition, the budget proposal disclosed that non-defense discretionary spending would increase, in contrast to the previous decade.

Total discretionary and non-discretionary spending account for over 90% of the federal budget. The interest on debt makes up for the rest of the total spending. In fiscal 2021, when the federal budget stood at $7 trillion, interest on debt accounted for 4.27% or $303 billion of total spending.

Let’s now see what will drive federal spending in fiscal 2022.

Health Insurance

There are four health insurance programs funded by the U.S. government. These include Medicare, the CHIP (Children’s Health Insurance Program), the ACA (Affordable Care Act), and Medicaid.

The spending for the four programs is forecast at $1.4 trillion or 25% of the total budget. Further, spending on the Medicare program might stand at $733 billion, accounting for almost 50% of total health insurance costs. Medicare provides coverage to 80 million residents, and Medicare spending is expected to increase significantly as the population ages.

Social Security

In fiscal 2022, Social Security may account for $1.2 trillion or 21% of the federal budget. The average monthly retirement benefit of $1,538 will be paid to 49 million retired workers. It will also cover benefits offered to three million spouses and children of the retired workforce, nine million disabled workers (and dependents), and six million surviving dependents of deceased workers.

Like Medicare, Social Security outlays will inevitably increase as the baby boom generation gets older.

Defense

The third largest expense on the U.S. government’s balance sheet is allocated to defense. In fiscal 2022, around 13% of the federal budget, amounting to $768 billion, will be poured to shore up the country’s military capabilities.

The three largest categories account for 59% of the total U.S. federal budget in fiscal 2022.

Economic Security Programs

In addition to health insurance and Social Security, the U.S. has allocated 11% or $665 billion of the budget to help families and individuals facing financial hardships. These economic security programs include Earned Income Tax Credit and Child Tax Credit, which provide cash payments to eligible residents.

In-kind assistance includes school meals, child care assistance, the Supplemental Nutrition Assistance Program, and low-income housing assistance, among others. The economic security programs lifted 34 million individuals, including six million children, above the poverty line in 2019.

Veteran’s Benefits

In 2022, 7% or $420 billion is allocated to provide benefits to military veterans. Approximately 90% of these benefits are disability or medical care payments. There are about 19 million veterans in the U.S. military, of which 2.2 million are retired and earn pensions or survivor benefits each month.

Interest on Debt

The amount borrowed by the federal government comes at a cost, as the debt needs to be serviced by making regular interest payments. The net federal debt is forecast to touch $21.7 trillion by the end of fiscal 2022. Interest payments will rise to almost $400 billion or about 6.8% of the total budget.

These six categories account for 3/4th of total spending by the U.S. government. The rest of the funds are distributed towards education, infrastructure (building roads, bridges, airports, etc.), and maintaining the natural resources of the nation.

A small portion of federal spending supports several other public services. For instance, around 1% of the budget is allocated towards international programs such as offering financial or humanitarian aid to countries or maintaining overseas government offices like consulates and embassies.

The post Understanding the US Federal Budget: Key Facts and Figures appeared first on FinMasters.

There are several ways a company can list on the stock exchanges. Three of the most common are initial public offerings (IPOs), special purpose acquisition companies (SPACs), and direct listings. Let’s take a look at each of these listing options in detail.

The IPO: High Profile, High Cost

In an initial public offering or IPO, the company creates additional shares underwritten by an investment bank that acts as an intermediary. The investment bank charges a fee to the company and works closely to ensure the IPO process is successful.

There are several regulatory requirements a company needs to follow during an IPO. Before an IPO can proceed the company must submit a detailed registration statement called a form S-1 to the SEC, with up-to-date financials and other information investors need to assess the company’s prospects. The SEC may comment on the statement and request further information before approving the IPO.

The investment bank helps the company set an initial offer price for its shares. The bank then purchases these shares from the company, which are then sold to retail and institutional investors via a network of distributors. This network encompasses other investment banks, mutual funds, insurance companies, and brokers.

Individual investors may have a difficult time purchasing IPO shares. You will need to have an account with a broker that has a share allocation and follow the broker’s procedure. The broker may have requirements for participation.

Before the IPO, the company and the underwriter partner to conduct a roadshow, similar to a marketing campaign. In a road show, the primary focus is creating interest and demand for the company’s shares, which will soon be listed.

The underwriter can then evaluate if the roadshow successfully captures investor attention, allowing them to set a realistic IPO price for the listing. Generally, an underwriter guarantees the company the number of shares it will sell to the public at the IPO price, and may also cover the shortfall in some cases.

There are two ways to distribute shares to prospective investors. One is by book-building, where you invite institutional investors to provide bids for the number of shares, and the price one is willing to pay for the same. The other method is auctioning, when investors bid above the offer price to participate in the IPO.

The fees charged by the underwriters make the IPO process expensive. Underwriting fees may range between 3.5% and 7% of the offering total. So, if the company raises $1 billion, it will pay between $35 million and $70 million as underwriting fees, which is quite significant.

IPO shares typically have a lockup period, meaning that they cannot be sold for a fixed time after the IPO. The lockup period is typically 90 to 180 days.

Several companies went public through the IPO process last year. Some of the big-ticket names include Affirm, Poshmark, and Coupang.

An IPO is a high-profile and high-cost move to public status. It’s often chosen by relatively high-value companies that are in a position to hit the public markets with an attention-drawing splash.

Smaller, lower-profile companies may consider a direct listing or even a SPAC.

Stay up to date with all upcoming IPOs: IPO Calendar

What is a SPAC and How Does it Work?

A Special Purpose Acquisition Company or SPAC is also known as a blank check company. They have existed for several decades but have gained popularity in recent years. A company with no commercial operation is formed and raises funds via an IPO solely to acquire or merge with an existing entity.

A SPAC is generally created by those with expertise in a particular sector and aims to pursue partnerships or acquisitions in that space. Of course, it’s entirely possible for a SPAC to already have a target acquirer in mind, but these details are not revealed during the IPO.

The funds raised by SPACs in the IPO are placed in a trust account and can be used only to complete an acquisition. If the SPAC fails to identify a target company within the stipulated period, it is liquidated, and funds are returned to investors.

Unlike an IPO, a SPAC listing may take just a few months to complete. The promoters of the target company may be in a position to negotiate a premium valuation as the deal has to be completed within a specific time frame. If well-known executives back the SPAC, the target company may benefit from an experienced team and improved market visibility.

A SPAC investor investing in the IPO is betting that the promoters will successfully acquire or merge with a target company. But as the regulatory requirements are lower for SPACs, retail investors may buy shares of overhyped entities. The registration statement describes a company with no operations and investors don’t know what the acquisition will be, so a pre-acquisition purchase of shares in a SPAC is purely based on confidence in the management team.

In March 2021, the Securities and Exchange Commission cautioned investors as many celebrities ranging from athletes to entertainers were promoting SPACs aggressively. As a result, the investor alert advised investors to refrain from purchasing SPACs just based on celebrity involvement.

SPACs were on an absolute tear in 2021. The number of companies going public via SPACs rose to 613 in 2021, up from 247 in 2020 and 59 in 2019. The volume of SPAC deals has declined dramatically in 2022.

A SPAC is similar to a reverse merger, which was once a common way to go public. In a reverse merger, a private company would acquire an inactive but still listed company, called a shell, and merge into it. Reverse mergers flourished in the late 90s and early to mid-00s, but the SEC introduced strict rules to deal with dubious practices in the reverse merger market and they faded from popularity. Some analysts believe that SPACs will have the same fate.

Direct Listings: Cheap and Simple

A direct listing process is a good bet if a company wants to minimize its listing costs, avoid diluting existing shareholder wealth by creating new shares, or avoid lockup agreements.

A direct listing process, called a DLP, allows a company to sell shares directly to investors without involving intermediaries. There is no underwriter. No additional shares are issued, and there is no lockup period as well. In a DLP, existing shareholders (investors, employees, and co-founders) can directly sell their shares to investors in the stock market.

Because it does not involve the issuance of new shares, a direct listing will not raise substantial new funds for the company. It is used by companies that wish to list publicly and don’t need to raise capital.

A direct listing will have to meet requirements set by the exchange on which the company plans to list. The current rules of the New York Stock Exchange (NYSE), for example, require that a Company must have at least 1.1 million public shares valued at a minimum of $4 per share.

Companies planning a direct listing must also file an S-1 form with the SEC.

While it’s a relatively low-cost process, going public via a DLP carries certain risks. As there is no road show, investor sentiment might be subdued, resulting in tepid demand for the company’s shares. In addition, no underwriter guarantees the sale of shares, and there may also be lesser participation from institutional investors, which might increase the volatility of share prices after the listing.

While direct listings are usually associated with smaller companies, several relatively high-profile firms have used gone public through a direct listing process, including Coinbase, Spotify, and Slack.

Which Listing Process Is Best?

What’s best for the company and the investor, an IPO, SPAC, or direct listing? Companies use different listing processes for different reasons. From an investor’s perspective – particularly long-term investors – the health and prospects of the underlying company are more important than the method used to go public.

2021 saw a record number of companies going public, driven by a late-stage bull market with soaring stock prices. In 2022 that pattern has been reversed, with IPOs, SPACs, and direct listings all spiraling downward. A FactSet report states that IPOs in Q1 of 2022 declined 87.6% year-over-year to 57 and fell by 82.5% year-over-year in Q2 to 35. 

In fact, gross proceeds from IPOs in Q2 stood at $3 billion, the lowest since Q1 of 2016.

Similarly, the number of SPAC IPOs fell over 90% in the first six months of 2022 to just 27.

The ideal listing process depends on the needs and resources of a particular company. An IPO, SPAC, or direct listing does not guarantee success or failure: they are appropriate for different companies.

For those looking to raise capital and create brand awareness by engaging with their investor base, IPOs are a good bet. Alternatively, a direct listing should be the priority of companies that don’t want to raise capital but want to list on the exchange at a low cost.

Many investors prefer IPO companies, simply because the IPO process indicates that the company has enough credibility and resources to attract an underwriter and go through the IPO process. The underwriter’s due diligence does not substitute for your own, but it is at least an indication that the Company has been through a vetting process.

How Do You Evaluate Early-Stage Companies?

An IPO, SPAC, or direct listing are all viable ways for a company to go public. Before investing in any of them, you’ll need to evaluate the company’s financials, its management team, and the key trends and drivers which will impact its revenue and earnings over time.

Business valuation is extremely tricky as no two companies are the same, and the companies may have limited track records. It’s easier to value mature businesses that generate steady and predictable sales and profits and have extended operating histories.

Valuing early-stage companies or unprofitable startups with little or no revenue is much more difficult. The complexities increase if these companies are creating an entirely new market, such as Uber or Airbnb.

Investors also have to consider the regulatory burden of going public, especially for smaller companies. Public companies have significant compliance requirements that can occupy a great deal of time, attention, and resources.

Let’s look at the different ways you can evaluate early-stage private companies.

Comparable Company Analysis

Comparable company analysis is one of the easiest ways to value a private company. You need to identify publicly listed companies similar to the private entity. So, the public company should ideally be a competitor of a similar size and grow at a comparable rate.

Analysts can also include several companies in the same sector, and calculate the averages of their valuation multiples to see if the private company is reasonably valued relative to its publicly traded peers.

Discounted Cash Flow

Discounted cash flow, or DCF, is a highly detailed and comprehensive evaluation method. First, you estimate the revenue growth of the private company by calculating the average growth rates of peers that are listed. Similarly, you need to estimate operating margins, working capital requirements, capital expenditures, and taxes to calculate free cash flow.

Further, analysts and investors should look at tax rates, the average beta, the weighted average cost of capital (WACC), and debt-to-equity multiples. The WACC provides a discount rate used to discount the company’s future cash flows, allowing you to arrive at a fair valuation.

Uncertainty and Risk

Valuing an early-stage company is complex. The process is full of assumptions, estimates, and peer averages. The lack of transparency and access associated with private entities makes it difficult to obtain an accurate valuation.

The registration statement of any company in the process of going public will be the primary source of information, and a thorough review of the statement is an essential first step toward an investment decision.

Investing in newly listed companies carries significant risks, and these stocks are exceptionally volatile in the initial years. Investors need to consider their risk-reward profile before investing in an IPO, SPAC, or direct listing.

The post IPO vs. SPAC vs. Direct Listing: An In-Depth Comparison appeared first on FinMasters.

Much of the confusion is due to differing definitions of a recession. One widely accepted definition of a recession is when the GDP (gross domestic product) of a country declines for two consecutive quarters. By that definition, the US entered a recession after the 2nd quarter of 2022.

The National Bureau of Economic Research (NBER), which is officially responsible for defining recessions and other components of the business cycle, uses a different definition of recession. The NBER is among the most prestigious non-profit institutions in the U.S. 38 current or former board members have won a Nobel Prize in Economics.

The panel was established to keep politics out of economic data analysis. In order to preserve the autonomy of the council, the economists meet in secret. Former committee member Jeffrey A. Frankel, who served on the NBER for 26 years, said, “The subject of politics never came up once.”

How Does the NBER Define a Recession? 

The NBER states that “a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months”. How they establish that is a little more complex. One NBER document states that the economists consider “real personal income less transfers, nonfarm payroll employment, employment as measured by the household survey, real personal consumption expenditures, wholesale-retail sales adjusted for price changes, and industrial production”.

The NBER does not announce its conclusions immediately. They wait “until sufficient data are available to avoid the need for major revisions to the business cycle chronology”. In practice, NBER typically takes nearly a year to declare a recession in the U.S. and has never reversed a call.

Bloomberg’s Chief Economist, Anna Wong, said, “The committee’s current methodology is sound. Q1’s contraction is mainly due to strong imports (due to strong demand) after slowdown inventory building due to combination of supply bottlenecks and gangbuster inventory building in Q4 last year. It’s hard to interpret that as a weakness-driven contraction.”

The Current Economic Scenario 

One of the major reasons why there is widespread debate about whether the U.S. is officially in a recession is the mixed economic data. The country’s GDP declined by 1.6% in the first quarter of 2022 and by 0.9% (on an annualized basis) in the second quarter. The consecutive decline in two quarters has driven Wall Street analysts to raise recessionary flags. 

However, other economic parameters such as labor market data and increased manufacturing activity remain strong. For example, the U.S. economy added 528,000 jobs in July, reaching pre-pandemic levels. The unemployment rate stood at 3.5%, lower than the Dow Jones consensus estimate of 3.6%. An economy cannot have such a strong labor market and be in recession, at least by NBER’s standards. 

The U.S. manufacturing numbers increased for the 26^th consecutive month in July, indicating strong economic activity. However, the growth rate was slightly lower than in June, indicating signs of a slowdown. In fact, the Purchasing Managers’ Index (PMI) came in at 52.8% in July, marking the lowest reading since June 2020. 

What Causes a Recession?

Past recessions in the U.S. have been triggered by a variety of reasons. The 2020 recession was due to the global lockdown resulting in a sharp decline in output. The NBER declared the last recession within a few months since the pandemic outburst in March 2020, as the U.S. GDP and economic activity plummeted sharply, along with 22 million lost jobs. 

While the global lockdown triggered a worldwide recession, a sharp decline in output and rising unemployment for several months caused the majority of economies to enter a recession. 

However, NBER’s Business Cycle Dating Committee announced that the 2020 recession lasted just two months, making it the shortest U.S. recession ever recorded. Prior to this, the shortest U.S. recession lasted in 1980, which lasted six months.

Recessions can be caused by multiple factors, often interacting, and there’s no consistent rule on what causes a recession.  

Major Recessions in U.S. History

According to the recessions in the U.S. timeline – there have been 11 recessions since 1948. On average, the U.S. has been in a recession every six years, with each downturn lasting nearly 12-15 months on average. 

Let’s look some recent U.S. recessions and their causes. 

The Financial Crash of 2008 

The recession in 2008 began with the collapse of the Lehman Brothers, one of the biggest banks in the U.S. While the Lehman Brothers collapse was the trigger, the underlying cause was a major asset bubble focused on the real estate market and speculation in mortgage-backed securities. 

In the early to mid 00s, ultra-low interest rates caused investors to veer toward real estate based on the long-standing expectation that housing prices never go down. Real estate seemed like a highly secure investment to traders burned in the late 90s tech stock boom.

Banks and lending institutions began giving mortgage loans to “sub-prime” borrowers (with poor credit history), albeit at slightly higher interest rates. Inevitably, the sub-prime borrowers began defaulting on the loans. This exposed a much larger bubble in the trading of mortgage-backed securities.

Lehman Brothers, one of the biggest U.S. banks at the time, had immense exposure to the U.S. housing market. When the housing bubble popped, Lehman Brothers suffered extensive losses and eventually filed for bankruptcy. 

The collapse of one of the biggest U.S. banks had ramifications on the U.S. economy as well as the rest of the world. This economic downturn, known as the global economic slowdown of 2008, was triggered by the unchecked growth of the U.S. housing market and by the explosion of trading in housing-related derivatives. As the saying goes, “When America sneezes, the world catches a cold.”

In the aftermath of the 2008 recession, several amendments were made to the global financial sector to prevent such a market crash. The Switzerland-based Basel Committee on Banking Supervision rolled out Basel III. The accord has strengthened the resilience capacity of individual banks in case of an industry-wide shock. Under Basel III, banks are expected to maintain substantial capital in hand in order to cushion losses in the event of market headwinds. 

The Infamous Dot-Com Bubble

The dot-com bubble was an entirely separate economic phenomenon. Tech stocks were gaining prominence since the late 1990s, causing the Nasdaq Composite index to increase five-fold in just five years. However, the bullish sentiment surrounding tech stocks was not backed by fundamentals, causing the sector to trade at sky-high valuations.

In fact, many of the tech start-ups had no solid business plans and were mere speculative investments. However, these companies spent a fortune on marketing and brand creation to attract investors. At the same time, the rise of online trading platforms brought millions of inexperienced investors into the market. Many of them threw all of their capital into emerging tech stocks. Confidence surged as paper profits mounted, and investors took on more and more risk.

Some start-ups spent up to 90% of their total budget on advertising. The sudden interest of venture capitalists also aided this unprecedented tech growth, as approximately 39% of all venture capital investments were in internet companies by 1999. 

However, institutional investors soon began liquidating their portfolio when the Nasdaq crossed the 5,000-mark, as they realized that large numbers of the underlying companies had little hope of churning out profits. 

As investors bailed out, speculative tech companies that relied on stock sales to fund operations collapsed. Trillions in investments were wiped out while unemployment levels soared. Thus, millions were left with no jobs and immense losses on equity investments. 

Is a Recession Coming? Is One Already Here?

The global economy has come a long way since the decade-long Great Depression of 1929 – the longest and worst recession in modern history. Governments understand recessions better and have learned more about mitigating them (though they don’t seem to have learned how to prevent them).

Today’s macroeconomic scenario does carry unknowns. As in 2001 and 2008, an extended asset bubble is deflating, with prices of growth stocks, cryptocurrencies, and other assets plunging. Post-COVID supply chain disruptions and high commodity prices driven by the Russia-Ukraine war have added the highest inflation since the 70s to the mix.

Will that combination drive a recession? So far, strong employment and industrial production figures have kept the economy out of recession territory – at least by the NBER’s criteria – but nobody’s sure how long that will last. With the Federal Reserve determined to cut inflation by raising rates, which traditionally cools economic activity, there is a real possibility of a recession.

If the economy does sink into an NBER-defined recession, there is one saving grace: historically, a recession is a temporary condition, and the end of a recession typically ushers in a new growth cycle. Recessions aren’t pleasant, but they are an inherent part of the economic cycle, and they do not last forever!

The post Is the US in a Recession? appeared first on FinMasters.

There are several ways investors can gain exposure to the equity market while limiting risk. For example, individuals can invest passively in stocks via exchange-traded funds or ETFs, providing more diversification than any portfolio of individual stocks.

Alternately, they can also identify individual stocks with the potential to deliver respectable gains with limited downside. A popular investment strategy is to invest in blue chip stocks, which will help market participants derive consistent returns without the volatility associated with more speculative growth-oriented stocks.

What are Blue Chip Stocks?

Blue chip stocks are stocks of well-established industry-leading companies. These companies are typically household names, with a global market presence, a wide economic moat, and substantial market share. 

With decades of experience and a portfolio of well-established products, these companies have robust cash flows, solid profit margins, and stable revenue growth. 

Due to their colossal size, blue chip companies tend to be major constituents of benchmark stock indices, such as the Dow Jones Industrial Average (DJIA) or the S&P 500. This attracts stable ownership from index funds that automatically buy stocks that belong to those categories.

While there are no established classification criteria that define such companies, a going concern with a market cap greater than $10 billion with strong fundamentals, and a dominant competitive position may generally be regarded as a blue chip stock.

Why Invest in the Best Blue Chip Stocks?

Most equity portfolios of retail and institutional investors tend to contain some blue chip stocks. Many risk-averse investors hold a substantial amount of their total portfolio value in blue chip stocks, thanks to their relatively stable nature. 

Long-term investors may look to purchase blue chip stocks and hold them for years on end, generating solid returns through share price appreciation and dividends. 

Investing in blue chip stocks has the following advantages:  

Ride Out Market Volatility

Stock markets can be volatile, and we’ve seen several market crashes in the last two decades. In mid-2022 stock markets have been correcting since the beginning of the year due to surging inflation rates, hawkish monetary policies, decelerating economic growth, and extended geopolitical tensions. As a result, U.S. indices such as the S&P 500 have slumped nearly 20% in 2022, while the tech-heavy Nasdaq Composite Index is down 28% year-to-date, wiping almost all of its post-pandemic gains. 

Blue chip stocks will fall during a general correction, but they generally fall much less than shares in less established companies. They can shield you from such market fluctuations and are ideal investments during a bear market. You can compare blue chip stocks to safe-haven assets such as gold.

These companies typically have strong financials and can withstand market downturns or even an economic recession. In addition, given their decades of experience in their respective industries, blue chip companies tend to have a diversified revenue base, allowing them to hedge their operations from fluctuations in one particular sector.

Blue Chip Dividend Stocks can Help You Generate Passive Income

Unlike small and mid-cap companies, most blue chip companies pay substantial dividends to their shareholders. Blue chip companies don’t offer the kind of exponential growth potential that new companies advertise, so they use dividends to attract investors.

Fundamentally strong stocks often expand revenue and profit margins over the long term, allowing them to increase dividend payouts without compromising operational efficiency.

On the other hand, small and mid-cap companies generally reinvest a majority of their profits back into the business to expand their operations.

As blue chip companies enjoy a broad multi-national customer base, their revenues tend to be relatively stable. Moreover, with sizable cash flows and retained earnings, most blue chip companies maintain their dividend payments despite market downturns. Income-seeking investors can easily create a passive income stream by investing in dividend-paying blue chip stocks.

Read more: How Much Do You Need to Invest to Live Off Dividends?

Dividend income can also act as a hedge against inflation, as blue chip companies typically raise dividends periodically. With global inflation rates hovering around record highs, investing in the best blue chip stocks with dividends can help investors generate considerable real returns. 

Dividends are also a reason why blue-chip stocks decline less during market downturns. As stock prices fall dividend yields rise, drawing in buying from income-focused investors.

Robust Total Shareholder Returns

Besides dividend income, blue chip stockholders stand to gain from the share price appreciation. Historically, the shares of blue chip companies have risen consistently. These companies typically show slow but consistent growth over time.

While several stocks are trading at depressed valuations in 2022, investors can view the pullback as a buying opportunity and purchase quality stocks at a steep discount. Yes, bear markets are extremely scary, but generational wealth is created in periods of economic volatility.

As the equity markets rebound from the bear territory, undervalued blue-chip stocks are bound to gain momentum, thereby generating substantial capital gains for stockholders. 

Some Sample Blue Chip Companies

Below is a list of blue chip stocks you can add to your watchlist right now.

Apple

There are blue chip stocks in every economic sector, and tech is no exception. One of the largest companies in the world, Apple is valued at a market cap of $2.35 trillion. While the tech giant generates most of its sales from its iPhone business, it is a market leader in categories including wearables and music streaming. 

Apple’s Services business is its second-largest segment and a key revenue driver for the firm. It now has various subscription offerings, including Apple Music, Apple Care, Apple Arcade, and Apple TV+, allowing the company to generate recurring sales across business cycles.

Apple pays investors annual dividends of $0.92 per share, translating to a forward yield of 0.63%. AAPL stock has entered the bear market territory and is down 20% from all-time highs. However, it has returned 685% in dividend-adjusted gains to investors in the last ten years. Comparatively, the S&P 500 index has gained 250% since July 2012.

Fortis Inc. 

With a $28.48 billion market cap, Fortis is one of Canada’s largest electric and gas utility distributors. Founded in 1885, it is among the oldest electric utility companies operating across Canada, the United States, and other Caribbean countries. 

Fortis is a Dividend Aristocrat stock, as it has increased its dividend payouts every year for the past 48 years. It currently offers a juicy forward yield of 3.5%. Moreover, the stock is currently trading at only 2.78 times its forward sales and 8.72 times its forward cash flows, which is reasonable. 

Fortis is one of the best blue chip stocks with an impressive dividend payout history and is poised to weather the current market downturn as well as a potential recession.

Berkshire Hathaway

One of the most prominent players in the insurance industry, Berkshire Hathaway commands a market cap of $615 billion. It offers multiple lines of personal and commercial insurance via subsidiaries such as GEICO. 

Berkshire also owns a utility business, a restaurant chain, and a railroad company making Berkshire Hathaway among the most diversified businesses globally. 

While Berkshire Hathaway does not pay investors dividends, its stock has returned 235% in the last ten years.

Coca-Cola

Coca-Cola is a Dividend King and has increased dividends for 60 consecutive years. One of the most recognizable brands in the world, Coca-Cola has managed to increase its revenue at an annual rate of 5% in the last 30 years. In Q1, its revenue surged by 16% year over year to $10.5 billion, while earnings soared by 16% to $0.64 per share. 

Its stellar top-line growth allowed the consumer products heavyweight to improve operating margins from 32.5% in Q1, compared to 30% in the year-ago period. It’s also a top stock to hold amid rising inflation rates, given Coca-Cola enjoys significant pricing power.

In 2022, Coca-Cola forecasts sales growth between 7% and 8%, while adjusted earnings are estimated to rise by 6% this year. It’s on track to report a free cash flow of $10.5 billion in 2022, which indicates further dividend increases are on the cards.

J.P. Morgan

While banking companies are cyclical in nature, J.P. Morgan is well poised to benefit from rising interest rates. In fact, J.P. Morgan expects net interest income to touch $56 billion in 2022, up from $44.5 billion in 2021, due to higher interest rates. 

However, these gains will be offset by falling home loan originations which were already down 37% year over year in Q1. 

J.P. Morgan has a solid balance sheet and ended Q1 with a cash balance of $625 billion, an increase of 24% year over year.

J.P. Morgan offers investors a dividend yield of over 3% above its 10-year average yield of 2.6%. The stock is also trading at nine times forward earnings which is quite reasonable. J.P. Morgan is a cheap blue-chip stock with significant upside potential. 

Limitations of Investing In Blue Chip Stocks

Investing in blue chip stocks is ideal for those looking to generate consistent returns. They are less likely to generate the kind of exponential gains sought by more aggressive investors. Blue-chip companies tend to be mature businesses that already dominate their industries, so they do not have the potential for explosive growth.

While these companies showcase their durability in bear markets, they may significantly trail growth stocks in a bull market. 

The Dow Jones Industrial Average Index can be considered a proxy for investors to gain exposure to blue chip stocks. Between January 2012 and January 2022, the Dow Jones Index returned 241% to investors. Comparatively, the tech-heavy Nasdaq Composite index, which comprises some of the fastest-growing tech stocks, rose close to 476% in the 10-year period. 

Alternatively, while the Nasdaq Composite index is down 29% from all-time highs, the Dow Jones index is trading 14.5% below record levels.

In a nutshell, blue chip stocks are a top bet for investors with a low-risk appetite looking to gain exposure to the equity market. Some investors see blue chips as boring stocks, but for others, boring might be exactly what they’re looking for.

The Final Takeaway

Blue chip stocks are considered the crown jewel of investing and are the all-time favorites of value investors, including the legendary Warren Buffet. As seen above, these stocks typically have minimal risks associated but can generate generous returns over time. 

The ongoing market crash has also increased the dividend yields of several companies higher. Dividend yields and stock prices have an inverse relationship, so the stock market sell-off allows investors to lock in high dividend yields at a cyclical low, given the prospects of a market recovery are uncertain. 

Blue chip stocks can be a buffer during periods of heightened market sluggishness, thanks to their strong cash flows and solid financials. Investors are currently deterred by the increasing market risks and bearish sentiment, so investing in the best blue chip stocks can substantially hedge their portfolios. 

Moreover, given the sky-high inflation rates, blue chip dividend stocks can be used to mitigate inflation risks as well.  

The post What are Blue Chip Stocks, and Should You Invest In Them? appeared first on FinMasters.