Tag Archives: Cash Flow

Long Term Investing is about Future Cash Flow

Posted on by

Ultimately, in long term investing, fundamentals and cash flow are paramount for an investor (an investor is a business owner).

Years ago, a hockey game between the Boston Bruins and Edmonton Oilers had been paused for some technical issues with the stadium lights. To kill some time, the announcers started interviewing people including the Edmonton Oilers, Wayne Gretzky, undoubtedly the world’s greatest hockey player at the time. The announcer stated that Gretzky wasn’t the biggest guy in the league, or the strongest, or the fastest or the toughest, yet he was regarded as the greatest hockey player in the world.  So, how then did Gretzky explain his own genius?  Gretzky simply replied:

“I don’t go where the puck is; I go where the puck is going to be!”

In a simple one liner, Gretzky confirmed that his success did not come from chasing the puck. Instead it came from staying one step ahead and by anticipating  where the puck would  likely go next.

Thus, it is important to look at the future potential of a stock or investment instead of focusing solely on past performance. Long term investing is about looking from the perspective of a business owner at a company’s fundamentals and cash flow.

Cash Flow

In finance, cash flow (CF) is the term used to describe the amount of cash (currency) that is generated or consumed in a given time period by a business. It has many uses in both operating a business and in performing financial analysis. In fact, it’s one of the most important metrics in all of finance and accounting.

Every investment is the present value of all future cash flow.

Many investors are lured by short term performance.  They are interested in finding the latest, hottest, top performing stocks and investments driven by the financial entertainment media.  However, investors who buy those top performing investments today may not necessarily enjoy the same returns in the future. In investing, it’s essential you approach buying stocks like a business owner.

Cash flow is not the same as net income (or profit).

While cash flow describes the movement of money into and out of your business, profit is the surplus of money your business has after you’ve subtracted the revenue from your expenses.

The inflow and outflow of cash into and out of a company reflects the health of that company’s operations. That’s why it’s important as an investor (business owner) to be able to understand a company’s fundamentals and cash flow.

Cash flow is more dynamic in concept then profit – as it measures the movement of money – then profit, which simply demonstrates how much money you have left over after your expenses have been deducted. Even a profitable business can fail if a business doesn’t have a healthy cash flow.

Without a healthy cash flow, profit is meaningless.

Many successful companies (like Amazon, Twitter, Uber and Yelp) actually existed a long time without profits, but no company can survive without a healthy cash flow. For small to mid-cap companies, profit is still important, but cash flow is vital.

If you don’t have cash on hand, you can’t pay for your company’s basic needs like rent, employee salaries, electricity or equipment. If you don’t have enough cash on hand to replenish inventory or pay operating expenses, you will become unable to generate new sales. If you can’t afford operating expenses, your company will eventually fail. That’s why cash flow is such an accurate predictor of an investment or company’s success.

Cash Flow From Operating Activities

The operating activities reflects how much cash is generated from a company’s products or services. Positive (and increasing) cash flow from operating activities indicates that the core business activities of the company are thriving.

Cash Flow From Investing Activities

Investing activities include any purchase or sale of an asset, loans made to vendors or received from customers or any payments related to a merger or acquisition is included in this category. In short, changes in equipment, assets, or investments relate to cash from investing.

Cash Flow From Financing Activities

Cash flow from financing activities shows the net flows of cash that are used to fund the company. Financing activities include transactions involving debt, equity, and dividends. Some examples are: issuance of equity (shares), payment of dividends, issuance of debt (e.g. bonds) and repayment of debt.

Free Cash Flow

One of the most important financial number is free cash flow (FCF). It is the cash flow available to all the creditors and investors in a company, including common stockholders, preferred shareholders, and lenders.

You can calculate FCF, if not provided, quickly. FCF = Operating cash flow – capital expenditures (aka. CAPEX). Simply, capital expenditures on the CFS is the line item “Purchase of Property, Plant and Equipment” (PPE). the PPE expenditure is the “maintenance amount” of running a business. Though it says “purchase”, this includes repairing, renewal and/or maintenance of the companies assets.

No company can survive without a healthy cash flow.

Generally, you want to see a steady increase in cash flow from operations. If this number is growing (while debt being in control) at a rate of 10% or more annually.

However, past performance cannot guarantee future results. In other words: don’t assume that an investment is going to continue to perform well in the future simply because it’s done well during a specific time period in the past. 

Two of the key ingredients for success in investing is understanding that cash flow is king and your a business owner when you purchase a company’s stock.

References:

  1. https://ignorethestreet.com/cash-flow-statement-fundamentals/
  2. http://www.momentumcapitalfunding.com/cash-flow-fundamentals-business-owners/
  3. https://corporatefinanceinstitute.com/resources/knowledge/finance/cash-flow/
  4. https://www.powerofpositivity.com/make-you-rich-quotes/

Discounted Cash Flow

Posted on by

Investments are the discounted present value of all future free cash flow.

Discounted cash flow (DCF) is a method of investment valuation in which future cash flows are discounted back to a present value using the time-value of money.

Present value (PV) is a financial calculation that measures the worth of a future amount of money or an investment’s future cash flow in today’s dollars adjusted for interest and inflation. In other words, it compares the buying power of one future dollar to purchasing power of one today.

PV is an indication of whether the money an investor receives today can earn a return in the future. Investors calculate the present value of a firm’s expected cash flows to decide if the stock is worth investing in today.

An investment’s worth is equal to the present value of all projected discounted future cash flows.

Discounted cash flow is a way of evaluating a potential investment by estimating future income streams and determining the present worth of all of those cash flows in order to compare the cost of the investment to its return.

When an investor is trying to determine how to spend capital, it is important to determine whether or not investments will result in a positive return. The DCF method allows an investor to determine the value of the future projected cash flow in today’s dollars. An investor can subtract the amount spent on the investment from the present value of future cash flows to calculate the net present value of the investment.

In other words, they can calculate how much money the investment will make in today’s dollars and compare it with the cost of the investment. NPV and Internal Rate of Return are the methods used in Discounted Cash Flow.

The Net Present Value (NPV) represents the present value of cash flow. The NPV can also be called as the difference between the present values of cash inflow and cash outflow. To calculate the net present value of an investment using the discounted cash flows method:

Example – an investor is considering investing in property that would cost his LLC $1,000,000 and he hold it for 5 years. What is the net present value of this investment using the discounted cash flows method?

The investor determined the discount rate to be 10%. With this information, he calculated the following future discounted cash flows:

  • Year 1 = $130,000
  • Year 2 = $150,000
  • Year 3 = $200,000
  • Year 4 = $210,000
  • Year 5 = $200,000

The total projected cash flows is $890,000.

The net present value of this investment is $890,000-$1,000,000 which is equal to -$110,000.

In this example, an investor should not make this investment because the original cost (cost basis) is greater than the value of the future discounted cash flow creating a negative return over the time period.

As in this example, the DCF is compared with the initial investment. If the DCF is greater than the original cost, the investment is profitable. The higher the DCF, the greater return the investment generates. If the DCF is lower than the present cost, investors should rather hold the cash.

An investor’s expected cash flows are at a discount rate that is actually the expected return. The discount rate is inversely correlated to the future cash flows. The higher the discount rate, the lower the present value of the expected cash flows.

The NPV represents the present value of cash flow and is generally used for comparing both the internal and the external investments of a company. DCF is a method to calculate the value of an investment based on the present value of its future cash flow.

References:

  1. https://www.myaccountingcourse.com/accounting-dictionary/discounted-cash-flow
  2. https://corporatefinanceinstitute.com/resources/knowledge/valuation/discounted-cash-flow-dcf/
  3. https://www.myaccountingcourse.com/accounting-dictionary/present-value

A Stock’s Price vs. a Company’s Intrinsic Value

Posted on by

“Stock prices fluctuate unpredictably.  But company values stay relatively steady.” Kenneth Jeffrey Marshall,

Value investing is one of the most popular ways to find great stocks in any market environment. Value investing represents an approach to investing, where investors evaluate the fundamentals or intrinsic values of companies rather than estimating the future market prices of stocks. The definition of a value stock, for our purposes, is a stock that is underpriced by the market or due to volatility relative to its worth or fundamentals.

Value investing is about finding stocks that are either flying under the radar and are compelling buys, or offer up tantalizing discounts when compared to fair value (or intrinsic value). According to Investopia, intrinsic value is a measure of what an asset is worth. In short, it’s the underlying value of a company and its cash flow.

The idea of value investing involves purchasing great stocks of companies priced by the market well below their intrinsic values, which can give investors a margin of safety. The margin of safety comes from buying good companies at cheap prices. It comes from buying good companies that you understand, and to do so at a discount to companies estimated intrinsic value. That discount is where the margin of safety comes from.

Great stocks shouldn’t get cheap. But sometimes they are.

Value investing also allows traders to detach from their emotions of fear and greed when stock prices fluctuate. It enables them to hold the stocks for long-term rather than buying and selling if they’re feeling wildly optimistic or pessimistic because of stock price and market volatility.

Price and value differ:

  • Price is what something can be purchased or sold for at a given time. Price fluctuates.
  • Value is what something is worth, it fluctuates less.
  • Identify the right price at which to buy stock
  • Hold quality stocks fearlessly during market swings

Value investors understand that over time, the market price of a stock will converge with its actual fundamental worth or intrinsic value. But at a single point in time, it may not. And those single points are enough to purchase good companies cheap or below its intrinsic value.

Value investors also understand that there always comes a time when glamorous businesses stop getting priced like rock stars, and start getting priced like businesses.

Over time, the average price of an asset does converge to the average worth of that asset. But in the short term they can be wildly different, since stock prices fluctuate unpredictably.  But company values stay relatively steady.  This insight is the basis of value investing, according to Kenneth Jeffrey Marshall, author of the investing book, “Good Stocks Cheap: Value Investing with Confidence for a Lifetime of Stock Market”.

The occasions when a stock price is far away from a company’s intrinsic value is when a patient value investor acts.

Value investing is buying companies for less than they’re worth…their intrinsic value. According to the Kenneth Jeffery Marshall, professor, value investor, and the author of “Good Stocks Cheap”, best value investing procedures to utilize include:

  • Do you understand the company
  • Is it a good company:
    • Has it been historically good
    • Will it be good in the future
    • Is it shareholder friendly
  • Is the stock price cheap or at what price will the company’s stock become cheap (margin of safety)

The secret of successful investing: Staying invested and patience. Stock prices can be volatile and can fluctuate unpredictably in the short term.  But the intrinsic values of companies stay relatively steady. Thus, you should chose to invest in companies selling for less than they are worth (intrinsic value) and not over pay for a company.

One way to find companies is by looking at several key metrics and financial ratios, many of which are crucial in the value stock selection process. There are several key metrics that value investors look at, which include:

  • Price to Earnings Ratio (PE). PE shows you how much investors are willing to pay for each dollar of earnings in a given stock. The best use of the PE ratio is to compare the stock’s current PE ratio with: a) where this ratio has been in the past; b) how it compares to the average for the industry/sector; and c) how it compares to the market as a whole.
  • Price/Sales ratio. P/Sales compares a given stock’s price to its total sales, where a lower value is generally considered better. This metric is preferred more than other value-focused ones because it looks at sales, something that is far harder to manipulate with accounting tricks than earnings. The best use of P/S ratio to compare it to the S&P 500 average. Also, you can evaluate the trend of the stock’s P/Sales over the past few years.
  • Price/Earnings to Growth ratio (PEG). PEG ratio is another great indicator of value. PEG ratio is a stock’s price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period. The PEG ratio is used to determine a stock’s value while also factoring in the company’s expected earnings growth, and it is thought to provide a more complete picture than the more standard P/E ratio. A lower PEG may indicate that a stock is undervalued.

The reality is that some of your selected stocks will lose money. That’s why it is important to diversify your investments, so that losses in a stock may be outweighed by gains in other stocks.

Strength of value investing

Deep value factors, such as book-to-price or tangible book-to-price, usually rally first, when actual levels of rates are still low, says Boris Lerner, Global Head of Quantitative Equity Research. Other value factors, such as earnings yield or free-cash-flow yield, tend to pick up later, as rates rise above trend.

Rising interest rates are the primary reason value investing has staying power. When inflation and rising interest rates are trending higher, it can clip the wings of pricey growth stocks, whose valuations are predicated on future returns, which make pricier growth stocks less appealing. When rates go up, it instantly raises the bar on far-out profits needed to justify today’s stock prices.

Because value names are typically mature companies with valuations based on current cash flow, rising rates don’t have the same impact. At the same time, many traditional value sectors, such as financials, directly benefit from rising rates.

Put the strength of value investing to work for you. In a nutshell, the basic tenet of value investing is paying less for a company than its worth.

  • References:
  1. https://growthwithvalue.com/wp-content/uploads/2020/12/Good-Stocks-Cheap-Book-Summary.pdf
  2. https://finance.yahoo.com/news/10-cheap-value-stocks-buy-140144393.html
  3. https://www.entrepreneur.com/article/397977
  4. https://www.morganstanley.com/ideas/value-stocks-forecast-2021
  5. https://www.gurufocus.com/news/949267/interview-holding-stocks-forever-with-professor-kenneth-jeffrey-marshall

Kenneth Jeffrey Marshall teaches value investing in the Masters in Finance program at the Stockholm School of Economics in Sweden, and at Stanford University. He also teaches asset management in the MBA program at the Haas School of Business at the University of California, Berkeley. Marshall is a past member of the Stanford Institute for Economic Policy Research; he taught Stanford’s first-ever online value investing course in 2015. He earned his MBA at Harvard Business School.

Beat Inflation with Dividend Stocks | Fidelity Viewpoints

Posted on by

“Stocks that can boost dividends during periods of high inflation may outperform.” Fidelity Viewpoints

Key takeaways according to Fidelity Viewpoints

  • Dividends aren’t just nice to have, they’re essential to the stock market’s return—accounting for approximately 40% of overall stock market returns since 1930.
  • During periods of high inflation, stocks that increased their dividends the most considerably outperformed the broad market, on average, according to Fidelity’s sector strategist, Denise Chisholm.
  • Dividend-paying stocks’ regular, scheduled payments also may help to reduce the volatility of a stock’s total return.

The economy is gradually recovering from its pandemic-related slowdown and shutdowns, and inflation has hit its highest rate in 39 years. People are emerging from the pandemic and are spending money they saved or money they’re getting from the government. Thus, a combination of soaring pent-up consumer demand and persistent supply chain disruptions has tarnished an otherwise robust economic recovery.

The Bureau of Labor Statistics said the Consumer Price Index of food, energy, goods and services rose by 0.8 percent in November, pushing annual inflation above 6.8 percent. The level is the highest since 1982 and it also marked the sixth consecutive month in which annual inflation rates have exceeded 5 percent.

Currently, approximately 70 percent of Americans rate the economy negatively, with nearly half of Americans blaming Biden for inflation, according to a recent Washington Post-ABC poll.

This combination of economic challenges and consumer worries may make this an especially good time to consider investing in stocks that pay consistent dividends.

A few important things for investors to know about dividend stocks:

  • Dividend payouts typically happen quarterly, although there are a few companies that payout monthly.
  • Many high-quality companies routinely raise their dividend payouts, helping hedge against inflation.
  • A stock’s dividend yield moves in the opposite direction of its stock price, all else being equal, so a high yielding stock may be reason for caution.

Fidelity research finds that dividend payments have accounted for approximately 40% of the overall stock market’s return since 1930. What’s more, dividends have propped up returns when stock prices struggle.

Dividends account for about 40% of total stock market return over time

US stock returns by decade (1930–2020). Over various decades, dividends have remained a fairly steady component of stocks’ total returns amid more highly volatile stock prices. Past performance is no guarantee of future results. Source: Fidelity Investments and Morningstar, as of 12/31/2020.

To invest successfully in dividend stocks, one of the keys is finding companies with strong balance sheets and with secure payouts that can grow consistently over the long haul. Moreover, it’s important to understand the concept of dividend yield, which investors use to gauge how much dividend income their investment will produce.

Investing in dividend stocks

When selecting dividend stocks, it’s important to keep dividend quality in mind. A quality dividend payout can grow over time and potentially be sustained during economic downturns. It’s the primary reason investors must not focus solely on yield.

Steve Goddard, founder and chief investment officer of Barclay, prefers companies with high returns on capital and strong balance sheets. “High return-on-capital companies usually by definition will generate a lot more free cash flow than the average company would,” he says. And cash flow is what pays the dividend.

Although overall dividend health has improved markedly since 2020 and looks good heading into 2022, it’s equally important to check a company’s dividend policy statement so you know how much to expect in payment and when to expect it. Dividend yield is a stock’s annual dividend expressed as a percentage of its price.

It’s crucial to recognize that a stock’s price and its dividend yield move in opposite directions, as long as the dollar amount of the dividend doesn’t change. Investing in the highest-yielding shares can lead to trouble, notably dividend cuts or suspensions and big capital losses

This means a high dividend yield may be a red flag of a problem with the underlying company. For example, a stock’s yield may be high because business problems are weighing down the company’s share price. In that case, the company’s challenges may even cause it to stop or reduce its dividend payments. And before that happens, investors are likely to sell off the stock.

Fidelity Investments’ research has found that stocks that reduce or eliminate their dividends historically have underperformed the market by 20% to 25% during the year leading up to the cut.

Also consider the company’s payout ratio—the percent of its net income or free cash flow it pays in dividends. Low is usually good: A low ratio suggests the company may be able to sustain and possibly boost its payments in the future.

“As a rule of thumb, no matter what the payout ratio is, it is always important to stress test a company’s payout ratio at all points in the business cycle in order to carefully judge whether it will be able to maintain or increase its dividend,” says Adam Kramer, portfolio manager for the Fidelity Multi-Asset Income Fund.

“It all depends on the stability of the cash flows of a company, so it’s more about that than the level of payout. You want to test the company’s ability to pay and increase the dividend under different scenarios. In general, when the payout ratio is more than 50%, it’s a good reminder to always stress test that ratio,” Kramer explains.

Be sure to diversify as you build a portfolio of dividend-paying stocks. To help manage risk, invest across sectors rather than concentrating on those with relatively high dividends, such as consumer staples and energy.

References:

  1. https://www.fidelity.com/learning-center/trading-investing/inflation-and-dividend-stocks
  2. https://www.barrons.com/articles/quality-dividend-stocks-51639134001
  3. https://news.yahoo.com/inflation-pinch-challenges-biden-agenda-200620196.html

Past performance and dividend rates are historical and do not guarantee future results. Diversification and asset allocation do not ensure a profit or guarantee against loss. Investing in stock involves risks, including the loss of principal.

Intrinsic Value of a Company

Posted on by

“Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.”  Warren Buffett

Intrinsic value is an important concept to evaluate the relative attractiveness of investments and businesses.

Intrinsic value can be defined as the discounted value of the cash that can be taken out of a business during its remaining life, explains investing guru Warren Buffett, Chairman and CEO, Berkshire Hathaway. It measures the value of an investment based on its current and future cash flows. Where market value tells you the current price per share other investors are willing to pay for an asset, intrinsic value shows you the asset’s value based on an analysis of its future cash flows and its actual financial performance.

Essentially, valuing a company intrinsically allows you to look analytically at a business and determine how much cash that business will generate over time, and then you discount the cash flows back to the present day.

Book value vs intrinsic value

In most cases, a company’s book value tends to understate its intrinsic value because many businesses are worth much more than their ‘carrying value’. The ‘carrying value’ is the original cost of an asset as reflected in a company’s books or balance sheet, minus the accumulated depreciation of the asset.

As a result, a company’s intrinsic value often exceed its book value, a result that proves capital was wisely deployed. In many cases, book value is not a reliable indicator of intrinsic value or a true representation of an asset’s fair value or market value. Thus, a company’s book value alone is somewhat meaningless as an indicator of its intrinsic value.

However, intrinsic value tend to be only effective on stocks that are stable and less volatile so that you can reliably valuate. If you see the book value growth and dividends all over the place, your estimates would be very uncertain.

You need 3 factors to determine a company’s intrinsic value:

  • Current free cash flow or owner’s earnings
  • Free cash flow growth rate over an eight to ten year period. Determine free cash flow growth rates by looking at past 5 year and 10 year growth rate.
  • Discount rate to discount future free cash flow to present day.

Discounted future cash flows

Cash taken out of a business in the future is not worth the same as it is today. If you had the money today you could invest it today. Money in the future is partly eaten up by inflation, but more importantly more uncertain if it is there at all.

The calculation of intrinsic value is not so simple. Intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised.

To calculate owner earnings, or another way to look and to calculate free cash flow, one adds things back in such as depreciation, changes in working capital and such. Buffett feels that “owner’s earnings” more accurately reflects the actual cash flow that an owner receives.

Net present value for the ten years and your discounted terminal value for the 10th year we can calculate the intrinsic value.

When investing in a company, you first must determine the value of the company according to your estimates of discounted cash flow. You want the biggest difference between its intrinsic value (high as possible) and its market price which is the current price of the stock that is traded on the exchange (low as possible). Over time, you should expect the market value to intersect its intrinsic value.

When you arrive at an intrinsic value it will not necessarily match the current market value or price of the stock. In most cases you will find that there is a vast difference. You have potentially found a great company at a bargain and with a margin of safety. If the market price is much higher than the intrinsic value, it is also great. You can avoid the common mistake made by many retail investors of overpaying for a stock.

Knowing the value of a stock is perhaps the most desired skill. And in summary, intrinsic value is simply the discounted value of the cash that can be taken out of a business during its remaining life, according to Warren Buffett.

References:

  1. https://einvestingforbeginners.com/intrinsic-value-warren-buffett-aher/
  2. https://acquirersmultiple.com/2017/02/warren-buffett-how-to-calculate-intrinsic-value/
  3. https://corporatefinanceinstitute.com/resources/knowledge/accounting/carrying-amount/
  4. https://www.buffettsbooks.com/how-to-invest-in-stocks/intermediate-course/lesson-21/

Billionaire’s Income Tax

Posted on by

“Some liberal lawmakers hope the “billionaire tax” will eventually be extended to millionaires.”

A ‘Billionaires Income Tax’ would be a fundamental change in how the tax system operates in the United States, and open up a new revenue stream for the Treasury. The wealth tax plan would “get at the wealth of the richest Americans that currently goes untaxed until assets are sold”, according to Roll Call.

The Senate has proposed a special new tax on the uber wealthy, think billionaires, that Democrats will use to help pay for their next big multi-trillion dollar ‘Build Back Better’ fiscal spending package. The proposed tax on the net worth of billionaires’ stock holdings, real estate and other assets could help Democrats accomplish goals of raising taxes on the wealthy and funding their pet social safety net and climate programs.

The Senate Finance Committee Chair wants to “begin requiring people with more than $1 billion in assets, or who earn more than $100 million in three consecutive years, to begin paying capital gains taxes each year on the appreciation in value of their assets, regardless of whether they are sold”, Politico reported.

The ‘billionaire tax’ plan would reportedly hit around 700 Americans and generate several hundred billion dollars in tax receipts. “We have a historic opportunity with the Billionaires Income Tax to restore fairness in our tax code, and fund critical investments in American families,” said Senate Finance Chair Ron Wyden (D-Ore.). “The Billionaires Income Tax would ensure billionaires pay tax each year, just like working Americans.”

The proposal, should it pass Congress and be signed into law by the President, would almost certainly be challenged in federal court on its constitutionality. The Constitution restricts so-called direct taxes, ‘a term referring to levies imposed directly on someone that can’t be shifted onto someone else’. There’s a big exception for income taxes, as a result of the 16th Amendment, which allows Congress to tax income and earnings. (All current taxes are either forms of income tax or levies on transactions).

The proposed plan would tax people on the appreciation of their publicly traded marketable securities. Effectively, the plan would tax billionaires’ assets on any gains or appreciation in value of those assets. For example, if that asset became worth $110, they’d only owe on the $10 gain. And, the proposal would begin by imposing a one-time tax on all the gains that had accrued before the tax had been created.

Stocks, bonds and other publicly traded assets, marketable securities, would be assessed the levy each year. Harder-to-value assets like real estate or ownership stakes in privately held businesses would not be taxed until they are sold, but would then face an interest charge designed to approximate the tax people would have faced if they had been publicly traded assets.

Capital losses

Under the proposal, a billionaire subject to the tax whose asset values take a dive during the year would have two options. They could choose to:

  • Carry those losses forward to offset potential future mark-to-market gains, or
  • Carry them back to a year within the previous three to generate refunds for taxes paid on unrealized gains.
  • Carrybacks could only offset prior mark-to-market tax, not taxes paid on other income.

    • Nevertheless, the plan would incentivize the wealthy to move into non-publicly traded assets in order to avoid having to pay the IRS. And if the billionaire wealth tax survives the certain court challenges under the current conservative Supreme Court, you can safely bet that many liberal leaning states will follow suit and implement their own version of a billionaire or millionaire wealth tax.

    This new billionaire tax on wealth, instead on income, is a tax that some liberals lawmakers hope will eventually be extended to include every millionaire in assets, regardless of actual net worth. However, Congress always seem able to devise work arounds to exclude their own financial assets and the assets of their big re-election campaign donors from these extremely regressive tax policies.

    Additionally, this proposal, if enacted into law, would dramatically impact compound growth of assets and, would have the unintended consequences of slowing job creation and capital investments in the U.S.

    Senator Mitt Romney (R-Utah) said that the billionaire tax will leave the rich thinking: “I don’t want to invest in the stock market, because as that goes up, I gotta get taxed. So maybe I will instead invest in a ranch or in paintings or things that don’t build jobs and create a stronger economy.”

    References:

    1. https://www.rollcall.com/2021/10/27/wyden-details-proposed-tax-on-billionaires-unrealized-gains/
    2. https://www.politico.com/news/2021/10/27/billionaires-income-tax-details-wyden-517318
    3. https://www.marketwatch.com/story/mitt-romney-says-a-billionaire-tax-will-push-the-rich-to-buy-paintings-or-ranches-instead-of-stocks-11635269305

    Planning and Achieving Financial Freedom

    Posted on by

    Financial freedom can be an elusive—and hard-to-define—goal.

    Financial freedom is often said to be in the eye of the beholder. To some it may mean freedom of debt and being able to fund your lifestyle with your cash flow; to others it may mean early retirement on a Caribbean island. Whatever your financial goals or definition of financial freedom, there are ways and things you can learn to help you get your financial house in order.

    Once you’ve decided that financial freedom is one of your top goals, you can start taking steps to achieve it. Thus, the first step toward achieving financial freedom is to define exactly what it means for you. You can’t generally achieve something that you haven’t defined. So, once you’ve defined what financial freedom means to you, you can start taking steps toward your goals.

    “What then is freedom? The power to live as one wishes.” Marcus Tullius Cicero

    Just because you have money does not mean you have financial freedom. There have been numerous people, especially professional athletes and entertainers, who have earned millions of dollars and subsequently lost it all through reckless spending and debilitating debt. Thus, even if you have a lot of money, if you don’t know how to manage and make your money work for you, it will more than likely disappear.

    Financial freedom typically means having enough savings, financial assets, and cash on hand to afford the kind of life you desire for yourself and your families. It means growing savings and investments to a level that enables you to retire or pursue the career you want without being driven to earn a wage or salary each year. Financial freedom means your money and assets are working hard for you rather than the other way around…you’re working hard for your money.

    In other words, financial freedom is about much more than just having money. It’s the freedom to be who you really are and do what you really want in life. It’s about following your passion, making choices that aren’t influenced by your bank account, net worth or cash flow, and living life on your terms.

    Track your expenses

    It’s difficult to know how to save money if you don’t have a good idea of where your money is going. Carefully track your spending habits for a typical month. Doing this will help you to become more conscious of your discretionary expenditures. It will also reinforce what expenses are essential and remind you to plan for unexpected expenditures, like medical emergencies and car repairs. Therefore, it is vital to understand and to know where your money is going.

    Make a budget

    Once you’ve taken inventory of your expenses, next step is to create a budget. While budgeting can sound like a cumbersome task, you may want to start by using a budgeting calculator to get a feel for how you are currently spending your money and how you’d like to change your spending.

    One popular budgeting method is the 50/30/20 rule. The 50/30/20 rule is a way to divide your post-tax income based on your needs, wants and savings. The rule states that people should spend 50% of their income on their needs. This includes health insurance, housing, transportation, and groceries. Then, the guideline states that people should spend 30% of their income on wants or non-necessities such as entertainment, travel, and more. Finally, the last 20% of a person’s income should be saved or invested. This might include retirement savings and building a stock portfolio.

    Once you have created a budget, don’t put it in a drawer and forget about it. Instead, make it a working and living document that you check and refer to often. Spend a half-hour per month reviewing how your actual expenses match your budget and make adjustments as necessary.

    Automate your savings

    Automating your savings and investing is one of the easiest steps you can take to ensure that you are on the path to financial freedom. You can set automated contributions to your employer-sponsored investments, including your 401(k) contributions and employee stock options.

    When your savings and investing are automated, your money will continue to grow without you having to think about it. This will help you to reach your financial goals easily and quickly.

    Have some percentage (10% to 20%) of your paycheck automatically deposited into a separate account—whether it’s a savings account, a 401(k) or an IRA. Money that isn’t easily accessible is not easily spent.

    Unfortunately, many Americans are not saving enough to maintain their current standard of living during their retirement years. It was found that about 21% of Americans have nothing saved for retirement, according to the Northwestern Mutual’s 2018 Planning & Progress Study.

    Start investing early

    Follow the adage, the best time to start investing was twenty years ago; the second best time is today. You should start investing in a tax deferred account, preferably with your employer matching a portion or all of your contribution.

    Planning for retirement is a marathon and not a sprint. Even if you are starting small, the most important thing is to get started. Therefore, it will likely take decades to reach your goal. Therefore, it is important to remember why you want to achieve financial freedom. Keeping your purpose, goals and the bigger picture in mind will help you navigate the day-to-day financial decisions.

    Once you become financially free, you have more choices of how to live your life and spend your days.

    When you decide that you want to start working toward financial freedom, it is important to remember that you will not become financially free overnight. However, according to certified financial planner David Rae, in a 2018 article in Forbes magazine, there are eight hierarchies of financial freedom that you can work towards:

    1. Level 1: Not Living Paycheck to Paycheck – The first level of financial freedom is building up an emergency fund and paying off any credit card debt. Unfortunately, living paycheck to paycheck is the reality of millions of Americans. According to the Federal Reserve’s Report on the Economic Well-Being of U.S. Households in 2017, some 40% of households could not cover a $400 unexpected expense.
    2. Level 2: Enough Money to take a sabbatical from your work – Accumulating enough money to be able to take a break away from work can be rewarding. This does not mean you have to quit your job, but it sure is a good feeling to know you can.
    3. Level 3: Enough to be Financially Happy and still Save – it’s about enjoying your life and having the money to do it. There can be peace when you are earning enough to save, doing the things you enjoy and still having extra at the end of the month.
    4. Level 4: Freedom of Time – Many people desire more flexibility with their schedules. Freedom of time and financial independence go hand in hand. Together, they are about following your passion, or spending more time with family, and not going completely broke doing it.
    5. Level 5: Enough for a Basic Retirement – Think about what your bare minimum retirement would look like. By knowing your bare minimum retirement, and knowing that you have enough money saved to at least cover some standard of living in your retirement, will also influence other life choices you may make along the way.
    6. Level 6: Enough to Actually Retire Well – Knowing you are on track to accumulate a nest egg to support that lifestyle is a big win. Well done to those who have accumulated enough assets, or passive income streams, to be in a position to retire well.
    7. Level 7: Enough for Dream Retirement – It would feel great knowing that you are on track to have enough money to retire and be able to live your dream life. What is stopping you from getting there.
    8. Level 8: More Money Than You Could Ever Spend – Having more money than you expected to spend is great. Building enough wealth so that you could not possibly spend all of it is another.

    Bottomline is that if you want to be financially free, if you want to be able to live the lifestyle of your choosing while responsibly managing your finances, you need to become a different person than you are today and let go of the financial mindset that has created your current financial predicament and has held you back in the past.

    Attaining financial freedom, which means having enough savings, investments and cash flow to live as you desire, both now and in your later years, requires a continuous process of growth, learning and emotional strength. In other words, whatever has held you back and provided you comfort in the past or kept you less than who you really are will have to be replaced. You will have to become comfortable for awhile being uncomfortable. And in return, the financially empowered, purposeful, and successful you will emerge — like a butterfly shedding its cocoon.

    References:

    1. https://www.richdad.com/what-is-financial-freedom
    2. https://smartasset.com/financial-advisor/financial-freedom
    3. https://www.forbes.com/sites/davidrae/2019/04/09/levels-of-financial-freedom

    Difficult Financial Conversations

    Posted on by

    The financial realities of being a woman — 4 out of 10 people—men and women alike—do not realize that women need to save more for retirement. Life expectancy, the pay gap, health care costs, and career interruptions due to caregiving are all contributing factors, according to Fidelity Investments Women Talk Money.

    Video: 5 Investing Conversations to Have Now with guest: Anna Sale, host of the podcast “Death, Sex and Money” and author of “How to Talk About Hard Things”
    Hosted by Lorna Kapusta, Head of Women Investors at Fidelity Investments

    “Money is like oxygen. It’s all around us. We can pretend it’s not but we need it to breathe. When you don’t have enough you really feel it.” Anna Sale, host of the podcast “Death, Sex and Money” and author of the book “How to Talk About Hard Things”

    “Money is at once a tool which is the choices we make around money, what we spend it on, how we save it”‘ says Anna Sale. “And money is also a symbol which brings up all these questions about am I enough, am I worthy enough, am I living up to all these expectations for myself. When we talk about money as a tool, sometimes the symbolic ways that money kind of makes us feel lots of big feelings can distort those conversations about money being a tool.”

    References:

    1. https://www.fidelity.com/learning-center/personal-finance/women-talk-money/investing

    Take Control of Your Finances

    Posted on by

    There are ways to feel more in control of your financial situation–and make the money you have go farther. The key is to take a close look at your current budget and to better manage your cash flow. You can best do this by finding expenses you may be able to pare back or eliminate, and by potentially finding new sources of income.

    Smart spending and saving strategies, according to FinTech company SoFi, to follow are:

    Create a Budget and Manage Your Cash Flow – Take a close look at your monthly spending to get a full picture of your spending, and start tracking your spending (every cash/debit/credit card transaction and every bill you pay) for a month or so.

    Once you understand your average monthly spending, compare it to what’s coming in. You can look at your bank statements for the past few months to get an idea of much after-tax income you are taking in on average per month.

    Comparing what is coming in vs. going out will help you know exactly where you stand financially.

    Uncovering Places to Save – Once you understand your monthly spending and group your expenses into categories, the next step is to list your expenses in order of priority, starting with the essentials and going down to the “nice to haves.”

    Once you’ve established which expenses are the most important, you can start looking for places to cut some of your unnecessary spending. For example, if you are spending a lot on restaurants and take-out, you might consider cooking at home a few more nights a week.

    Negotiating with Service Providers – You may be able to negotiate for a lower rate from many of your providers, especially if you’re dealing with a company that’s in a competitive market.

    Before you call or email a business or provider, it is important to know exactly how much you’re paying for a service, what you’re getting for your money, and how much the competition is charging for the same or similar service.

    It’s also a good idea to make sure you are communicating with someone who actually has the power to lower your rate and, if not, ask to speak with someone who does.

    You may also want to let providers know that if they can’t do better, you may decide to switch to another company.

    Cutting Back on Bigger Expenses – Look at the big items in your overall budget. For example, if your car payment too high, you could buy a less expensive to cut monthly payments.

    If rent is eating up too much of your income, you might want to look into finding a cheaper place to live that’s still nice, taking in a roommate, or moving in with friends.

    The lower you keep these costs, the easier it will be to live well within a tight budget.

    Knocking Down Debt – Having too much debt can hamper your chances of achieving financial security down the line.

    That’s because when you’re spending a lot of money on interest each month, it can be harder to pay all of your other expenses on time, not to mention grow your savings.

    Reducing debt may seem like a tall mountain to climb, but choosing the right debt reduction strategy may be able to help you chip away and slowly improve your financial situation.

    Since credit card debt typically costs the most in interest, you might consider tackling these debts first, and then move on to the debt with the next-highest interest rate, and so on.

    Starting an Emergency Fund – Start putting a little bit away into an emergency fund each month a priority: An unexpected expense—like your car breaking down or a visit to an urgent care clinic—could put you over the financial edge.

    If you start putting just a small amount aside each month into an emergency fund, it won’t be long before you have a decent financial cushion that could prevent you from having to run up high interest credit debt the next time something unexpected rolls around.

    Spending Only Cash for Everyday Expenses – Using plastic that can make it feel like you are not really spending money. Thus, switching to cash (and leaving the credit cards at home) for other expenses can be a great idea when money is tight.

    The reason is that using cash places a harder limit on your spending and helps you become more aware of your choices. When you can literally see your money going somewhere, you may find yourself becoming much more intentional in the way you spend it.

    Another benefit of cash is that it’s more difficult to get into debt since you can’t spend cash you don’t have.

    Starting a Side Gig – Once you’ve done some basic budgeting, it may be clear that additional income could help ease things while money is tight.

    Sometimes all it takes is some extra time and energy, but taking on a side hustle, or using your talents to pick up some freelance work can bring in additional income.

    Some ideas for generating extra income include:

    • Selling things on eBay or Craigslist
    • Hold a garage sale
    • Creating an Etsy store and selling homemade goods
    • Driving for a rideshare or food delivery service
    • Giving music lessons
    • Renting out a room on Airbnb
    • Walking dogs
    • Cleaning houses
    • Babysitting
    • Handling social media for small businesses
    • Selling writing, photography, or videography services to clients

    Start saving and investing, immediately – Your first financial goal should be to create an emergency fund and to establish the discipline for saving by “Paying yourself first”. To take advantage of compound interest, start investing early and regularly.

    Takeaways

    You can gain control of your finances by calmly sitting down, creating a budget, and determining your cash flow. This entails looking at your monthly income, as well as your average monthly spending, and seeing how it all lines up.

    To create a monthly budget, you must allot funds for expenses such as rent and other bills, then sets aside a small amount directly for savings and uses the rest to live off for the month

    Once you have a sense of your cash flow, you can take steps to reduce unnecessary spending, negotiate to lower monthly bills, chip away at expensive debt, and even start building a financial cushion.

    References:

    1. https://www.sofi.com/learn/content/what-to-do-when-money-is-tight/
    2. https://www.usatoday.com/story/college/2012/04/25/7-steps-to-take-control-of-your-financial-future/37391767/

    Sequence of Returns Risk in Retirement

    Posted on by

    A stock market pullback can pose a risk early in retirement.

    Retirees face many risks when investing for retirement. Markets crash, inflation can eat into your returns, you might even worry about outliving your savings. And, there’s another big retirement risk: Sequence of returns risk.

    Down markets can pose significant “sequence of returns” risk in the early years of retirement. Sequence risk is the danger that the timing of withdrawals from a retirement account will have a negative impact on the overall rate of return available to the investor, according to Investopedia.

    A “sequence of returns” risk is basically about how the order, or sequence, of stock returns over time — combined with your portfolio withdrawals — can impact your balance down the road.

    Once you start withdrawing income, you’re affected by the change in the sequence in which the returns occurred. During your retirement years, if a high proportion of negative returns occur in the beginning years of your retirement, it will have a lasting negative effect and reduce the amount of income you can withdraw over your lifetime.

    Timing is everything. Sequence risk is the danger that the timing of withdrawals from a retirement account will damage the investor’s overall return. Account withdrawals during a bear market are more costly than the same withdrawals in a bull market.

    “If there’s a big loss in the market and you’re taking withdrawals, you could be taking more from your portfolio than what it can make up for,” said certified financial planner Avani Ramnani, managing director at Francis Financial in New York. “If that happens early in retirement … the recovery may be very weak and put you in danger of not recovering at all or being lower than where you would have been and therefore jeopardizing your retirement lifestyle.”

    One of the basic rules of investing is that a long-term strategy is self-correcting. And, for long-term investors — those whose retirement is many years or decades away — such market drops matter less because there’s time for their portfolios to recover from this risk before they need to start relying on that money for cash flow in retirement.

    Retirement is a long game.

    Since running out of money in retirement is the primary concern for most retirees, fortunately, there are options for mitigating the risk:

    • Plan to spend more conservatively since the less you spend consistently, the less you have to withdraw overall.
    • Withdraw and spend less when your portfolio performance is suffering. 
    • Reduce the risk in your portfolio by creating a low stock allocation early in retirement but increase it over time, or use bonds for short-term expenses and stocks for long-term ones.
    • Set aside assets outside your investment portfolio that can support your spending needs when stocks are underperforming.

    You may simply be able to meet your goals without taking on the risk that comes with stocks.

    Key Takeaways

    Sequence of return risk is basically the risk that market declines in the early years of retirement, paired with ongoing withdrawals, could significantly reduce the longevity of your portfolio. Thus, timing is everything, and in retirement early market declines, particularly if they are paired with rising inflation, can have a huge effect on how long a nest egg can sustain you in retirement.

    The recommended way to mitigate sequence of returns risk when you can’t predict future market performance or future rates of inflation is by managing spending and/or keeping a portion of your portfolio in liquid assets, such as cash or bonds, to ride out the market downturn.

    When market returns are high and inflation is low, retirees can distribute more from their portfolios, according to Forbes Advisor Staff Editors Rob Berger and Benjamin Curry. When market returns are negative and inflation is higher than expected, retirees reduce the amount of their annual distributions.

    Remember, no one can forecast market performance or economic inflation. Yet, by managing your spending, you can adjust annual withdrawal amounts to reflect inflation and market returns.

    References:

    1. https://www.investopedia.com/terms/s/sequence-risk.asp
    2. https://www.thebalance.com/how-sequence-risk-affects-your-retirement-money-2388672
    3. https://www.cnbc.com/2021/09/21/stock-market-pullback-is-a-big-risk-early-in-retirement-what-to-know.html
    4. https://www.forbes.com/advisor/retirement/sequence-of-returns-risk/