How Brokerage Fees Work

There are two different types of brokerage firms: full service and discount. The differences between the two and the fees they charge are significant. So how much does a broker cost? Here’s a brief guide to how brokerage fees work with both types of firms.

What Are Brokerage Fees?

In general, brokerage fees are fees the broker charges you to hold and manage your investments. These fees might include annual fees, fees for researching investment data, and inactivity fees if you aren’t trading regularly. It’s important you are aware of the different types of brokerage fees, as well as the types of brokers available to manage your investments.

Full-Service Broker

In contrast, full-service brokers are paid commissions based on transactions. The average fee per transaction at a full-service broker is $150. This is much lower than in the past, but still much higher than discount brokers where on average a transaction costs approximately $10.

At a full-service broker, you are paying a premium for research, education, and advice. But it’s important to remember that full-service brokers are also salespeople.

There are also full-service brokers who charge an annual fee between 1% and 1.5% of total assets managed for a client and will eschew per-trade charges. If you don’t feel comfortable researching and making your own trades, this is a good option to consider. These brokers will also have an incentive to perform well because if your portfolio’s assets under management increase, this means that they make more for managing them.

Discount Broker

Discount brokers generally do not offer investment advice. Trading fees for online discount brokers range anywhere from $4.95 to $20, but most are between $7 and $10. This rate is subject to change since discount brokers are consistently lowering their fees in order to attract more customers and gain market share. Some even offer free trades. If you do, your homework discount brokers can save you a lot of money when it comes to transaction costs.

Doing Your Own Research

Most investors don’t bother reading Securities and Exchange Commission (SEC) filings, but SEC filings are available to the public, and the information within them is like taking an open book test. The answers are provided for you. Unlike press releases, a public company must state the facts in its SEC filings. This makes it relatively easy to research stocks.

Also, pay close attention to industry trends. If fast-casual food chains that offer natural and organic food are in, go with the trend, not against it. Do your research to determine the best of the breed. And you don’t even need to dive that deep. As a general rule, if the broader market is hot, revenue growth will be the key factor driving stock price appreciation. Investors and traders love revenue growth in bull market environments. If the broader market is cold, net income growth and a strong balance sheet will be the keys to success. Investors and traders like to run to safety for dividends and share buybacks in these environments.

The Bottom Line

If you’re impulsive and/or not willing to do your homework, then you should consider a full-service broker. Otherwise, a discount broker, which allows you to execute trades but does not offer investment advice, is a better option.

By Dan Moskowitz in Investopedia

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Types Of Investments: Ownership, Lending, And Cash

The word investment has become muddled with overuse. A stock or a bond is an investment. People are now encouraged to make investments in their educations, their cars, and even their flat-screen TVs. All of these things may make sound financial sense, but they are not, strictly speaking, investments.

No matter what the commercials say, there are only three basic categories of investment. They are products that are purchased with the expectation that they will produce income or profit, or both.

1. Ownership Investments

Ownership is what comes to mind for most people when the word investment is batted around. These are the most volatile and profitable class of investment. The following are examples.

Stocks

Owning stock means owning a portion of a company. It may be a miniscule stake, but it’s ownership.

More broadly speaking, all traded securities, from futures to currency swaps, are ownership investments. Investors purchase them in order to share in the profits, or because they will increase in value, or both.

Some of these investments, such as stocks, come with the right to a portion of the company’s value. Others, such as futures contracts, come with the right to carry out a certain action that will benefit their owners.

Key Takeaways

  • Stocks, real estate, and precious metals are all ownership investments. The buyer hopes that they will increase in value over time.
  • Lending money is an investment. Bonds and even savings accounts are loans that earn interest over time for the investor.
  • Cash equivalents like money market accounts are easy to liquidate when needed and repay investors with a modest amount of interest.

Your expectation of profit is realized (or not) by how the market values the asset you own the rights to. If you own shares in Apple (AAPL) and the company posts a record profit, other investors are going to want Apple shares too. Their demand for shares drives up the price, increasing your profit if you choose to sell the shares.

Business

The money put into starting and running a business is an investment.

Entrepreneurship is one of the toughest investments to make because it requires more than just money. Consequently, it is an ownership investment with extremely large potential returns.

By creating a product or service and selling it to people who want it, entrepreneurs can make huge personal fortunes. Bill Gates, founder of Microsoft and one of the world’s richest men, is a prime example.

Real Estate

Houses and apartments that are purchased to rent out or to resell are investments.

The house you live in is a different matter because it is filling a basic need. It fills a need for shelter. It may appreciate in value over time, but it shouldn’t be purchased with the expectation of profit. The mortgage meltdown of 2008 and the underwater mortgages it produced are a good illustration of the danger of considering a primary residence as an investment.

Many people made the error of purchasing homes that they could not afford on the assumption that those houses could soon be sold for much more.

Precious Objects and Collectibles

Gold and precious gemstones, Impressionist paintings and signed LeBron James jerseys, all can all be considered ownership investments, provided that these objects were bought with the intention of reselling them for a profit.

Like any investments, they may rise or fall in value over time. Tastes in art and collectibles change. Gold and gems have market values that fluctuate.

From the cold-eyed view of the investor, they also have costs. They must be insured and kept in pristine condition in order to retain their value.

2. Lending Investments

Lending money is a category of investing. The risks generally are lower than for many investments and, consequently, the rewards are relatively modest.

A bond issued by a company or a government will pay a set amount of interest over a set period of time. The only real risk is that the company or government will go bankrupt, in which case the bondholder may get little or none of the investment back.

Saving Accounts

A regular savings account is an investment. The investor is essentially lending money to the bank. The bank will pay interest to the account holder and will earn its profit by loaning out the rest of the money to businesses at a higher rate of interest.

The return on savings accounts is currently quite low, but the risk is essentially zero. In the U.S., savings accounts are fully insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC).

Bonds

Bond is a catch-all category for a wide variety of investments from U.S. Treasuries and international debt issues to corporate junk bonds and credit default swaps (CDS).

The risks and returns vary widely between the different types of bonds. Overall, these types of lending investments pose a lower risk and provide a lower return than ownership investments.

3. Cash Equivalents

These are investments are “as good as cash,” which means that they can be converted back to cash easily and quickly.

Money Market Funds

Money market funds are similar to savings accounts and can be purchased at any bank. The difference is that the investor commits to leaving the money alone for a period of time in return for a slightly higher rate of interest. The time period is as little as three months and no longer than a year.

Money market funds are more liquid than other investments, meaning you can write checks out of money market accounts just as you would with a checking account. Although, once you start writing checks on it you’ve erased much of its value as an investment.

These Are Not Investments

Education

Education is often called an investment and certainly, it can have lifelong rewards that include a higher income. It could be argued that we sell our education as if it was a small business service in exchange for a steady income.

By this logic, we’re investing when we buy a stress ball or a cup of coffee. These are goods that offer benefits but they are not investments.

Consumer Purchaces

Beds, cars, mobile phones, TVs, and anything else that depreciates in value with use and time, are not investments. You may spend more to acquire something of higher intrinsic value but once you’ve used it it’s still used goods.

By Andrew Beattie in Investopedia

Please contact Albert A. van Daalen for advice and support in Investment Services.

How To Get The Job You Love And Live Your Best Life

The pandemic has made many people reevaluate their life and work. Seeing so many people succumb to the Covid-19 disease was an eye-opening, sobering experience. It hit home that life is precious and too short. We’re always one step away from disaster. In an instant, our time here is over.

After this revelation sinks in, it’s natural to rethink everything about your job and career. You start considering if you really want to continue the same-old thing for another 10 or 20 years. 

You contemplate, “Is this all there is? Am I wasting my talent and is it possible to find a job that offers meaning and a sense of purpose? Is there something that inspires me to wake up and get out of the bed in the morning, feeling excited about the upcoming day?”

If you are having these feelings, I’d like to introduce you to the Japanese-inspired concept of  “Ikigai.” This loosely translates to having a reason for being—similar to the French expression, “Raison d’être” (a reason to be).  

Achieving the Ikigai state of mind starts with a little soul searching. It’s not too hard. You just need to think about what would offer you career satisfaction and some meaning to your life. The word itself is derived from the combination of the Japanese words “iki,” meaning life and “gai,” value. Ikigai is the art of finding your purpose in life. It’s the reason for being—getting out from under the covers in the morning and making it through difficult times.

Here’s how you could simply start. Draw on a piece of paper a Venn diagram with three concentric circles. In each circle, write “things that I like to do,” then “things that I’m good at”  and add a dash of reality by including “I can earn a living doing this.” The intersection of the circles will show your purpose.  

We aren’t static in our desires. The economy and job market tend to swiftly shift. As things change, you may need to change too. On a regular basis, you can have a daily mantra and continually ask yourself, “Am I living the life I want? Am I engaged in the work that I find worthy of devoting my time and energy to?” If you lose your drive and passion or the industry you’re in falls apart, you’ll need to adjust your Ikigai.

There is an amazing benefit that comes along with finding your Ikigai. When you labor at something you enjoy, it doesn’t feel like work. Think of a fantastic athlete like former basketball star Michael Jordan. When he was on the court, you could feel his intense love and passion for the sport. He was always locked in to what he was doing. 

This is called “being in the flow.” You get so caught up in what you’re doing that time flies by quickly. You’re so immersed in your job that everything else is a blur. All extraneous, outside stimuli are nonexistent to you, as you’re laser-like focused on what you’re doing. As you notice the tasks that automatically place you into a state of flow, try to gravitate toward those activities.

When you engage in work that you love, it has an exponential growth component. You work long and hard hours because you want to do it. Managers at work notice your drive and enthusiasm. They’ll offer you promotions and raises to keep you. This will add fuel to your fire. Colleagues will want to partner with you, recruiters call to entice you to move to a competing company and internal bosses will try to get you on their teams. The showering of appreciation and rewards will inspire you to keep going strong. This is one of the reasons why you see people who are rich getting richer. It’s a self-fulfilling prophecy. 

Although this pandemic has been dark and dreadful, there is always a little sunlight, if you look hard enough. One of the unintended—yet positive—consequences of the disease is that it is forcing people to reevaluate their jobs, careers and lives. Use this time wisely, find your personal Ikigai and live your best life.

By Jack Kelly in Forbes

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Common Methods Of Measurement For Investment Risk Management

Risk management is a crucial process used to make investment decisions. The process involves identifying and analyzing the amount of risk involved in an investment, and either accepting that risk or mitigating it. Some common measures of risk include standard deviation, beta, value at risk (VaR), and conditional value at risk (CVaR).

Key Takeaways

  • One of the principles of investing is the risk-return trade-off, where a greater degree of risk is supposed to be compensated by a higher expected return.
  • Risk – or the probability of a loss – can be measured using statistical methods that are historical predictors of investment risk and volatility.
  • Here, we look at some commonly used metrics, including standard deviation, value-at-risk (VaR), Beta, and more.

Standard Deviation

Standard deviation measures the dispersion of data from its expected value. The standard deviation is used in making an investment decision to measure the amount of historical volatility associated with an investment relative to its annual rate of return. It indicates how much the current return is deviating from its expected historical normal returns. For example, a stock that has high standard deviation experiences higher volatility, and therefore, a higher level of risk is associated with the stock.

For those interested only in potential losses while ignoring possible gains, the semi-deviation essentially only looks at the standard deviations to the downside.

Sharpe Ratio

The Sharpe ratio measures performance as adjusted by the associated risks. This is done by removing the rate of return on a risk-free investment, such as a U.S. Treasury Bond, from the experienced rate of return.

This is then divided by the associated investment’s standard deviation and serves as an indicator of whether an investment’s return is due to wise investing or due to the assumption of excess risk.

A variation of the Sharpe ratio is the Sortino ratio, which removes the effects of upward price movements on standard deviation to focus on the distribution of returns that are below the target or required return. The Sortino ratio also replaces the risk-free rate with the required return in the numerator of the formula, making the formula the return of the portfolio less the required return, divided by the distribution of returns below the target or required return.

Another variation of the Sharpe ratio is the Treynor Ratio that uses a portfolio’s beta or correlation the portfolio has with the rest of the market. Beta is a measure of an investment’s volatility and risk as compared to the overall market. The goal of the Treynor ratio is to determine whether an investor is being compensated for taking additional risk above the inherent risk of the market. The Treynor ratio formula is the return of the portfolio less the risk-free rate, divided by the portfolio’s beta.

Beta

Beta is another common measure of risk. Beta measures the amount of systematic risk an individual security or an industrial sector has relative to the whole stock market. The market has a beta of 1, and it can be used to gauge the risk of a security. If a security’s beta is equal to 1, the security’s price moves in time step with the market. A security with a beta greater than 1 indicates that it is more volatile than the market.

Conversely, if a security’s beta is less than 1, it indicates that the security is less volatile than the market. For example, suppose a security’s beta is 1.5. In theory, the security is 50 percent more volatile than the market.

Value at Risk (VaR)

Value at Risk (VaR) is a statistical measure used to assess the level of risk associated with a portfolio or company. The VaR measures the maximum potential loss with a degree of confidence for a specified period. For example, suppose a portfolio of investments has a one-year 10 percent VaR of $5 million. Therefore, the portfolio has a 10 percent chance of losing more than $5 million over a one-year period.

Conditional Value at Risk (CVaR)

Conditional value at risk (CVaR) is another risk measure used to assess the tail risk of an investment. Used as an extension to the VaR, the CVaR assesses the likelihood, with a certain degree of confidence, that there will be a break in the VaR; it seeks to assess what happens to investment beyond its maximum loss threshold. This measure is more sensitive to events that happen in the tail end of a distribution—the tail risk. For example, suppose a risk manager believes the average loss on an investment is $10 million for the worst one percent of possible outcomes for a portfolio. Therefore, the CVaR, or expected shortfall, is $10 million for the one percent tail.

R-squared

R-squared is a statistical measure that represents the percentage of a fund portfolio or a security’s movements that can be explained by movements in a benchmark index. For fixed-income securities and bond funds, the benchmark is the U.S. Treasury Bill. The S&P 500 Index is the benchmark for equities and equity funds.

R-squared values range from 0 to 100. According to Morningstar, a mutual fund with an R-squared value between 85 and 100 has a performance record that is closely correlated to the index. A fund rated 70 or less typically does not perform like the index.

Mutual fund investors should avoid actively managed funds with high R-squared ratios, which are generally criticized by analysts as being “closet” index funds. In such cases, it makes little sense to pay higher fees for professional management when you can get the same or better results from an index fund.

Categorie of Risks

Beyond the particular measures, risk management is divided into two broad categories: systematic and unsystematic risk.

Systematic Risks

Systematic risk is associated with the market. This risk affects the overall market of the security. It is unpredictable and undiversifiable; however, the risk can be mitigated through hedging. For example, political upheaval is a systematic risk that can affect multiple financial markets, such as the bond, stock, and currency markets. An investor can hedge against this sort of risk by buying put options in the market itself.

Unsystematic Risks

The second category of risk, unsystematic risk, is associated with a company or sector. It is also known as diversifiable risk and can be mitigated through asset diversification. This risk is only inherent to a specific stock or industry. If an investor buys an oil stock, he assumes the risk associated with both the oil industry and the company itself.

For example, suppose an investor is invested in an oil company, and he believes the falling price of oil affects the company. The investor may look to take the opposite side of, or hedge, his position by buying a put option on crude oil or on the company, or he may look to mitigate the risk through diversification by buying stock in retail or airline companies. He mitigates some of the risk if he takes these routes to protect his exposure to the oil industry. If he is not concerned with risk management, the company’s stock and oil price could drop significantly, and he could lose his entire investment, severely impacting his portfolio.

The Bottom Line

Many investors tend to focus exclusively on investment returns with little concern for investment risk. The risk measures we have discussed can provide some balance to the risk-return equation. The good news for investors is that these indicators are calculated for them and are available on a number of financial websites: they are also incorporated into many investment research reports.

As useful as these measurements are when considering a stock, bond, or mutual fund investment, volatility risk is just one of the factors you should be considering that can affect the quality of an investment.

By Troy Segal in Investopedia

Please contact Albert A. van Daalen for advice and support in Investment Services.

Convertible Debenture

What Is a Convertible Debenture?

A convertible debenture is a type of long-term debt issued by a company that can be converted into shares of equity stock after a specified period. Convertible debentures are usually unsecured bonds or loans, often with no underlying collateral backing up the debt.

These long-term debt securities pay interest returns to the bondholder like any other bond. The unique feature of convertible debentures is that they are exchangeable for stock at specified times. This feature gives the bondholder some security that may offset some of the risks involved with investing in unsecured debt.

A convertible debenture differs from convertible notes or convertible bonds, generally in that debentures have longer maturities.

Key Takeaways

  • A convertible debenture is a type of unsecured long-term convertible debt issued by a company, meaning that it contains a stock conversion option.
  • Convertible debentures are hybrid financial products that have some features of both debt and equity investments.
  • Investors earn fixed interest payments while the bond is active, and also having the option to convert it into equity if the stock price rises over time.

Convertible Debentures Explained

Typically, companies raise capital by issuing debt, in the form of bonds, or equity, in the form of shares of stock. Some companies may use more debt than equity to raise capital to fund operations or vice versa.

A convertible debenture is a type of hybrid security with characteristics of both debt and equity instruments. Companies issue convertible debentures as fixed-rate loans, paying the bondholder fixed interest payments on a regular schedule. Bondholders have the option of holding the bond until maturity—at which point they receive the return of their principal—but, holders may also convert the debentures into stock. The debenture can typically only be converted into stock after a predetermined time, as specified in the bond’s offering.

A convertible debenture will usually return a lower interest rate since the debt holder has the option to convert the loan to stock, which is to the investors’ benefit. Investors are thus willing to accept a lower rate of interest in exchange for the embedded option to convert into common shares. Convertible debentures therefore allow investors to participate in share price appreciation.

Special Considerations

The number of shares a bondholder receives for each debenture is determined at the time of issue based on a conversion ratio. For example, the company might distribute 10 shares of stock for each debenture with a face value of $1,000, which is a 10:1 conversion ratio.

The convertible debt feature is factored into the calculation of the diluted per-share metrics of the stock. The conversion will increase the share count—number of shares available—and reduces metrics such as earnings per share (EPS).

Another consideration for investing in unsecured debentures is that in the case of bankruptcy and liquidation they receive payment only after other fixed-income holders.

Types of Debentures

Just as there are convertible debentures, there are also non-convertible debentures whereby the debt cannot be converted into equity. As a result, non-convertible debentures will offer higher interest rates than their convertible counterparts since investors do not have the option to convert to stock.

Partly-convertible debentures are also a version of this type of debt. These loans have a predetermined portion that can be converted to stock. The conversion ratio is determined at the onset of the debt issuance.

Fully-convertible debentures have the option to convert all of the debt into equity shares based on the terms outlined at the debt issuance. It’s important that investors research the type of debenture they’re considering for investment including if or when there is a conversion option, the conversion ratio, and the time frame for when a conversion to equity can occur.

Benefits of Convertible Debentures

As with any fixed-income instrument, whether it is a bond or loan the debt it represents ultimately needs to be repaid. Too much debt on a company’s balance sheet can lead to high debt-servicing costs that include interest payments. As a result, companies with debt can have volatile earnings.

Equity, unlike debentures, does not require repayment, nor does it require the payment of interest to holders. However, a company might pay dividends to shareholders, which although voluntary, could be seen as a cost of issuing equity since the firm’s retained earnings or accumulated profits would be reduced.

Convertible debentures are hybrid products that try to strike a balance between debt and equity. Investors gain the benefit of fixed interest payments while also having the option to convert the loan to equity if the company performs well, rising stock prices over time.

The risk to investors is that there is little insurance in case of default if they’re holding shares of common stock. However, during bankruptcy liquidation, if an investor is holding a convertible debenture, the debenture holder gets paid before common shareholders.

Pros

  • Investors are paid a fixed-rate while having the option to participate in a stock price increase.
  • If the issuer’s stock price declines, investors can hold the bond until maturity and collect interest income.
  • Convertible bondholders are paid before stockholders in the event of a company’s liquidation.

Cons

  • Investors receive a lower interest rate compared to traditional bonds in exchange for the option to convert to stock.
  • Investors could lose money if the stock price declines following the conversion from a bond to equity.
  • Bondholders are at risk of the company defaulting and be

Real-World Example of a Convertible Debenture

Assume Pear Inc. wants to expand internationally for the first time to sell its mobile products and services. Investors are unsure if the products will sell abroad and whether the company’s international business plan will work.

The company issues convertible debentures to attract enough investors to fund their international expansion. The conversion will be at a ratio of 20:1 after three years.

The fixed interest rate paid to investors on the convertible debenture is 2%, which is lower than the typical bond rate. However, the lower rate is the trade-off for the right to convert the debentures into stock.

Scenario 1:

After three years, the international expansion is a hit, and the company’s stock price takes off rising from $20 to $100 per share. Holders of the convertible debentures can convert their debt into stock at the 20:1 conversion ratio. Investors with one debenture can convert their debt into $2,000 worth of stock (20 x $100 per share).

Scenario 2:

The international expansion fails. Investors can hold on to their convertible debentures and continue to receive fixed interest payments at the rate of 2% per year until the debt matures and the company returns their principal.

In this example, Pear got the benefit of a low-interest-rate loan by issuing the convertible debenture. However, if the expansion does well, the company’s equity shares would get diluted as investors convert their debentures to stock. This increase in the number of shares would result in a diluted earnings-per-share.

By James Chen in Investopedia

Please contact Albert A. van Daalen for advice and support in Investment Services.