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Think of investing as if you were building a house, with each investment vehicle as a type of tool. The four most common types of investment vehicles include: individual stocks and bonds, mutual funds, and exchange traded funds (ETFs). Just as it is important to know how each tool works and what job each tool is best suited for in building a house, it is important to know how each kind of investment works best in building your portfolio.

Stocks & Bonds

Stocks and bonds are the two basic building blocks of investing. A stock is a direct ownership in a business, and a bond is a loan. The financial industry has taken stocks and bonds and created a variety of products ranging from mutual funds to credit default swaps. Having this many investment options is great, but along with these expanded options comes the responsibility to understand which of these options can be best used to help you meet your financial goals.

Purchasing stock means that you take ownership in an entity. One of the main benefits of direct ownership is that it is easy and clean. There are no management fees and no other organizations or people involved. The cost of purchasing an individual stock can be easily affordable—many times $10 or less per stock. The downside of direct ownership is that you must stay on top of your investments. At the very least, you should read company reports and filings and have a good understanding of basic accounting principles. Obviously this is a large amount of work and even if you do excellent diligence there is still a chance that your investment will fail.

Purchasing a bond means that you loan money to an entity, such as a business, individual, or government. Buying a bond is like buying a car: you have to be ready to negotiate with the dealer. Owning a bond also requires you to know what type of claim you have to company assets in the event of bankruptcy.

Mutual Funds

Mutual funds are a way for investors to pool their money together in order to increase purchasing power and to lower execution costs. One of the downsides to mutual funds is the various fees that can be associated with them. All mutual funds charge a management fee, and some charge sales fees in addition to the management fee. Should you decide to invest in a mutual fund, read the prospectus each year to understand the fees you are paying and the investment mandates of the fund. It is important to note that mutual funds can only be traded once a day at the close of the market.

Exchange Traded Fund

The Exchange Traded Fund (ETF) is a more recent financial innovation. The ETF combines the principals of mutual funds into a vehicle that trades like a stock. The ETF works because of the law of one price. The law of one price states that if two investments track the same thing, then the return from holding either of the investments is exactly the same. For example, if one investment becomes over valued you would sell the overvalued investment and use the proceeds to buy more of the correctly priced investment. While in theory the law of one price always holds, in reality this is not always true. Should you choose to purchase an ETF, pay close attention to what the underlying group of investments being tracked is, and how many shares of the ETF are bought and sold each day. Check on who sponsors the ETF and that the sponsor ensures that the ETF functions properly.

Individual stocks and bonds, mutual funds, and ETFs are all good investment tools. Each has a place in a well-diversified investment plan. Research and find out what investment tool is best suited for your investment strategy, and monitor those investments carefully.

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This article originally appeared in the January, 2013 issue of Columbia Sun News.

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Charles B. Flowers

Trying to make sense of the new tax reporting laws for your investments can seem daunting. According to Deanna Flores, Principal at KMPG, LLC, recent changes to the year-end tax statements investors receive is “one of the largest changes in tax reporting for investors in over 20 years.” The purpose of these changes in reporting requirements is to help taxpayers report accurate and timely information on their tax returns.

Prior to 2011, if a security was sold in a taxable account, the broker would send an annual 1099 report which contained a section titled “1099-B.” The 1099-B would include a description of the security, the symbol, the quantity sold, the date of sale, and the gross proceeds of the transaction. It was the responsibility of the investor to provide the cost basis or amount paid for each security sold on Schedule D-1 of the investor’s tax return. The broker was not required to send the IRS any information related to the cost of the securities that were sold.

The annual tax report investors now receive will show the cost basis of the securities sold and whether the gain or loss is short or long term. Starting in 2011, the Emergency Economic Stabilization Act caused a few changes in the 1099-B. One of the key provisions of the law is that brokers like Charles Schwab, Fidelity, Vanguard, etc. must now report cost basis information on securities sold in taxable accounts to both investors and to the IRS. Since this is an enormous change for the brokers, the IRS is phasing in the reporting requirements. Individual stocks purchased on (or after) 1/1/2011 will be considered “covered securities,” meaning they will fall under the new reporting requirements. Mutual funds and most Exchange Traded Funds purchased this year (2012) will become “covered,” and Fixed Income and Options will be covered in 2014. This law only applies to taxable accounts and will have no impact on IRAs, Roth IRAs, 401ks, or 403b accounts.

What should investors be doing to make sure everything goes smoothly when it comes to tax reporting?

A much larger number of taxpayers will be impacted by the new law because mutual funds will be covered in 2012. It is important that you are prepared. Be sure to review the cost basis your broker has for your investments to make sure there are no unnecessary surprises when it comes time to file your taxes.

First, verify that your broker has the correct cost basis for all of the holdings in your taxable accounts. Even if an uncovered security is sold and the basis is not reported to the IRS, it is a good idea for your broker to have accurate information. Cost basis information can be viewed online or in your monthly statements.

Second, be sure that your broker is using your desired cost basis matching method for your security sales or transfers, as there are many methods from which to choose. This is important because if the method is incorrect, you could end up paying taxes that could have been avoided; an example of which is a gift of appreciated shares of an investment to charity. When gifting shares, you would prefer to give the lowest cost shares, leaving the higher cost shares in your account. Unless you have specifically instructed your broker which tax lot of shares to transfer, the broker is more likely to use the default cost basis matching method which may be different than what you wanted for the gift.

What if you notice incorrect information has been reported on the 1099-B?

If you happened to notice there is an incorrect cost basis figure on your reported 1099-B, contact your broker or advisor immediately. The general rule is that you have until the settlement date of the security sale to adjust the cost basis (1 day for mutual funds; 3 days for equities) to provide your broker with the correct information. If the trade has already settled, you may not be able to change the basis reported to the IRS on the 1099-B. In this case, form 8949 is used to correct any reporting errors on the 1099-B.

Are there any other resources that may help investors understand the cost basis reporting changes?

The best place to start is with your broker’s website, which is likely to have a Cost Basis Frequently Asked Questions (FAQs) page about the new requirements.

Your financial advisor or CPA should also be able to answer any questions you have about the new regulations. By using all the resources available, you will be able to navigate the new tax reporting laws with ease.

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This article originally appeared in the December, 2012 issue of Columbia Sun News.

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Stephen “Scotty” J. Scott

A reverse mortgage is a non-recourse loan offered to homeowners which allows the owner to access money from the home’s equity. For many years reverse mortgages have been considered to be “loans of last resort” due to the high upfront costs, but with the standardization of loan terms, low interest rates, and the introduction of lower fees from the FHA “saver” option in 2010, both consumers and financial advisors are reconsidering the reverse mortgage. Reverse mortgages can provide retirees with tax-free monthly income, access to credit as needed, relief from mortgage payments, increase in portfolio longevity, and support of the desire to “age in place.” These benefits do come with a price, so, as with all financial decisions, it is important to understand the implications of a reverse mortgage to determine whether this type of loan is right for you.

How will you receive the money?

Should you decide to seek a reverse mortgage, you can receive payments from the lender in the form of a lump sum, monthly payments, or a line of credit. While a reverse mortgage has no ongoing payment requirements, the unpaid interest on the home accrues on the outstanding balance. The loan must be repaid if the borrower sells the home, moves out of the home, dies, or fails to take care of the property. If you choose to take a lump sum, know that after the money is gone the balance on the loan continues to grow, thereby decreasing the equity in the home. A lump sum option rather than a fixed income option could leave you years later without financial resources to stay in your home or to facilitate a move.

What do you need to know as a potential borrower?

As a borrower, be sure you have the necessary funds to pay these expenses now and in the future. You can face foreclosure if you fail to properly maintain the home or pay property taxes and homeowners’ insurance. Non-borrowing members may be displaced from the home if the borrower dies or moves. This may include a spouse who is not a co-borrower. If you are married, put both names on the loan to avoid having your spouse displaced. Be sure to think through whether a dependent or a child would be displaced in the event of your death or a move. If you are considering a reverse mortgage to “age in place,” the amount secured may be a fraction of the amount needed. You will typically need to have other income or financial resources to cover the expense of in-home care.

When can you apply for a reverse mortgage?

While reverse mortgages are offered to homeowners who are over age 62, it is usually best for borrowers to obtain a reverse mortgage in their 70s or later. Borrowing young can have significant impact on resources available later in life and lock you into an unwanted situation. You may be able to have more equity by waiting and borrowing at a later age, obtaining a traditional home equity loan, or by selling your home. The amount available to borrow is limited and the proceeds you actually receive can be considerably less than the loan amount due to the fees. Plan to remain in your home for a long time due to the costs of the mortgage loan.

While the reverse mortgage can be an effective tool for some, it is important for retirees to proceed with caution and understand how it works, look at all available options and then determine whether it’s appropriate for your specific situation.

Check with your financial planner to decide if a reverse mortgage is right for you. For more information, see the following websites:

• aarp.org – Information on Reverse Mortgages
• ftc.gov – Reverse Mortgages: Get the Facts Before Cashing in on Your Home’s Equity
• consumerfinance.gov – Consumer Financial Protection Bureau Report Finds Confusion in Reverse Mortgage Market
  

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  This article originally appeared in the September, 2012 issue of Columbia Sun News.

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X. Alexandra Chastain

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Cheryl R. Holland