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Wachovia

Question: We have inherited a substantial amount of stock's from Wachovia, (value around $50,000). Our question is should we keep these stocks knowing how unstable the market is, or, should we liquidate the stocks and pay off our credit card debt. Our current balance is approximately $25,000. So far we have spent around $35,000 of this inheritance from other sources. Thanks, Bev & Mike, Augusta, KS

Answer: I can't say if it makes more sense for you to hold or sell the stock. There are a lot of factors that go into a decision like that, from how patient you can be with the stock to how pressing is the financial needs you currently face. However, in the current environment (actually in any economic scenario) getting rid of credit card debt and staying out of credit card debt is a good thing.

That said, I want to highlight a critical aspect of the answer: Do you want to be a shareholder in Wells Fargo over the long haul? That's what you shortly will be since on Dec. 23rd the shareholders of Wells and Wachovia gave the thumbs up to a previously negotiated merger agreement.

The merger creates one of the country's largest banks with over $1.42 trillion in assets and some $800 million in deposits. The merger is part of a wave of consolidation sweeping the banking industry in response to the ongoing financial crisis. Vulnerable and weak institutions (like Wachovia) are seeking shelter by hooking up with sound and strong banks (such as Wells Fargo). San Francisco-based Wells struck the government brokered deal for Charlotte-based Wachovia back in October after a brief but bitter battle for control with Citigroup.

It's not surprising that the value of the merger has fallen since last October. It was originally estimated as a $15-plus billion deal, or around $7 a share. (Wachovia shareholders will receive 0.1991 shares of Wells Fargo common stock for each share of Wachovia they hold. ) But as I am writing this, Wachovia's stock is down to $5.43 a share, putting the value of the merger at a bit under $12 billion.

Again, if you hold on to the stock your making a bet on the long-term future of Wells Fargo, and that it will succeed over the next several years in integrating the operations of the two companies. The other factor is that you're betting you will earn a higher return on the equity than the "return" you would get on your money by paying off the credit card debt.

12/29/08 by Chris Farrell

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Long term stock market returns

Question: I have just read several books on investing in mutual funds for retirement. I am 35 and would be investing about $300 a month. I want to invest in a Vanguard mutual fund and am having a hard time deciding on one. Part of the problem is that I am suspicious of the yearly return figures that are always used as examples in these books and that are posted on the "performance" window of a mutual fund's overview (like on the Vanguard website). So many authors say things like, "your investment should be able to average an 8% return per year". The historical return charts on a typical mutual fund seem to support this statement, but when I played a few examples out on paper it didn't add up!.... My question is...Are proponents of mutual fund investing misleading me with their claims of 8% yearly returns?? Does the 5 or 10 year return percentage (found in the performance section of mutual found websites) actually give me any valuable info in selecting a fund? Natalie, Sedro Woolley, WA

Answer: You're right to be suspicious. There are a number of different series that capture long-term stock market returns. My favorite is the series put together by Professor Jeremy Siegel of the Wharton School. Since 1802, he figures, the compound average annual return on stocks adjusted for inflation has been about 7%. The same average return figure holds for the post World War 11 era. However, on average Lake Eerie never freezes. For instance, the bull market of the 1990s lasted for much of the decade and the stock market rose by some 300%. But the stock market is currently down 45% from its October 2007 high. Yet it's up 27% from its March, 2009 low. Even a cursory glance at history shows that stocks fluctuate wildly.

The return figures you're seeing at the mutual fund websites do tell you how the fund has done over time. It's useful information. I also like to send time studying even more detailed return figures published by mutual fund rating services Morningstar. A number of factors account for the difference between an equity mutual fund performance and the stock market. Among the most important are fees and the composition of the portfolio.

Congratulations on setting up an automatic savings plan. For the stock market portion of your portfolio I am an advocate of investing in a broad-based equity index mutual fund. The fund will mirror the results of the underlying index, such as the total stock market index or the Standard & Poor's 500. It's also important to diversify among a number of different assets. A good, short primer on the investing basics is The Random Walk Guide to Investing: Ten Rules for Financial Success by Burton Malkiel.

04/14/09 by Chris Farrell

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Investing with the Wizard of Omaha

Question: I'd like to buy Warrren Buffet's Berkshire Hathaway shares. I understand that there 2 kinds brk-a and brk-b. The b-share costs about 1/30 of an a-share but it isn't not convertible to a-shares. My friend advises me to buy a-share but cannot give me a reason. Is b-share really inferior to a-share other than the cost? Please help me. Chris, St. Paul MN

Answer: Billionaire Warren Buffett, the Wizard of Omaha, is perhaps the greatest stock picker of all time. He runs Berkshire Hathaway, a holding company with more than 70 businesses. The price difference between the two kinds of stock is astounding when translated into dollars and cents. As I am writing this an A-shares is worth $92,000 and a B-share $3001.50.

I can't say whether you should prefer Class A to Class B, but the key difference between the two classes of stock has to do with ownership rights.Class A shareholders have the full voting rights of stock ownership. A Class B shareholder gets 1/200th the voting rights of a Class A share. In essence, Class B shareholders have a stake in how well Buffett does as stock picker and chief executive, but they're largely disenfranchised as owners. For instance, if someone made a takeover offer for Berkshire the Class A shareholders get to decide whether the deal goes through or not. The Class B shareholders are along for the ride. Question is, does that matter to you?

The Wizard of Omaha describes the difference between the two shares here.

07/22/09 by Chris Farrell

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Buying a few shares

Question: I am 20 years old and am working and going to school part time. My question is, I want to invest a little money, somewhere between 100 and 200 dollars. The purpose would be to buy into some of these historically low stocks in company's that are still pretty solid. It would be for the personal fun of watching what will happen over the upcoming years since I don't plan on doing and serious monetary investments for several years. Now to get to the question. Is there an easy way for me to do that myself online? And what sites would that be? And can I even by shares with such a little investment? Thank you for your advice. I really enjoy your program. TJ, Finlayson, MN

Answer: I like your idea and your approach. Investing a small amount of money is a good way to learn about the markets and to have some fun. However, if you could up the amount you can invest a bit it would help. The cost of an online trade will run you about $10 or so. But I don't want to discourage you. It's the kind of curiosity and educational opportunity I'd love more young adults to pursue. Its money well spent. I also agree that there are intriguing values in the market.

You can do what you want to do online. One low cost provider is sharebuilder.com. It's owned by the ING Direct, a U.S. subsidiary of the giant Dutch financial conglomerate.

Another option if you're going the buy-and-hold route is to purchase stock directly from a company rather than through a broker. "Direct Purchase Plans" are mostly offered by large, blue chip companies. The typical plan allows you to buy stock for small amounts of money, usually the value of a share. You can get more information about companies that offer a DPP option at enrolldirect.com.

There are a number of good options for researching stocks. The major business newspapers and magazines like the Wall Street Journal and Businessweek offer a wealth of detailed information, as do online sites like morningstar.com, finance.yahoo.com, and google.com/finance. Have fun.

I'm curious. Does anyone have a different suggestion or alternative for a novice investor who wants to learn about the markets with a small amount of money?

08/03/09 by Chris Farrell

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Stocks for the long haul

Question: First of all, I really like your steady and reliable counsel. You have a great style too. Here's my question: I believe someone released a study this summer saying that bonds have generally outperformed stocks in the U.S. for decades -- most notably from 1968 through the present. Is this report flawed? If not, why aren't more people talking about it? (It seems to turn the conventional wisdom on its head?)

This link may not be the primary source, but it seems to be citing the information I heard. Dave, Queenstown, MD

Answer: One of the wrong investing mantras in recent history was that stocks weren't really risky. Sure, stocks were more volatile than bonds with an investment horizon of a couple of years. But with time stocks always outperformed bonds, turning into the investment equivalent of diamonds while bonds were cubic zirconium. The height of this thinking came with the book Dow 36,000 by James K. Glassman and Kevin A. Hassert. It was published in 1999. "The Dow Jones industrial average was at 9000 when we began writing this book," they noted in their introduction. By their calculations "in order for stocks to be correctly priced, the Dow should rise by a factor of four--to 36,000... The Dow should rise to 36,000 immediately, but to be realistic, we believe the rise will take some time, perhaps three to five years."

Oops. A closer look at the data suggests that the notion of stocks as a riskless security over the long haul is wrong. Bonds have often outperformed stocks for 10 year periods of time. Stocks did not always do better than bonds even with a 30-year time horizon before 1871, notes Robert Shiller, economist at Yale University. You don't even have to reach into the history books. From 1983 to 2008, the annual total return on stocks was 9.8% a year versus an 11% average annual return on Treasury bonds. The study you mention cuts the data a different way, but the point remains the same: There have been long periods of time when bonds have outperformed stocks.

That said, the fundamental notion informing modern finance is the proposition that returns are only earned as compensation for taking on risk. Stocks are riskier than bonds since equities represent the uncertain rewards for entrepreneurship, while bonds are long-term contracts that spell out when borrowers must make principal and interest payments. "There is no predestined rate of return, only an expected one that may not be realized," says Laurence Siegel, director of investment policy research at the Ford Foundation. "The risk of holding stocks, then, is the possibility that in the long run, returns will be terrible."

I like stocks. Stocks should do better than bonds over a very long time period. But it's the return from taking on greater financial risk. And the risk is that stocks may do poorly for a considerable period of time. I think it's a risk worth taking.

But all the uncertainty is the reason behind my bottom line: Diversify.

09/16/09 by Chris Farrell

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A stock market winner

Question: My wife and I are in our mid 30s and we decided to take a gamble back in Jan 09 when everyone said the world was coming to an end. We took $20,000 out of our savings and plunged it into an established travel company we used to work for that was trading below its all time low (lower than after 9-11). Well the world did not end, and 9 months later we're sitting on a handsome sum of money thanks to a 4x growth in stock price. My question is what should we do with the money? Popular ideas are to slowly work the money into a Roth IRA or other investments, or to pay off our $120,000 7.2% 30 year mortgage (25 years remaining), which would free up $1200 in expense monthly.

I appreciate your help and love the program. Jonathan, Miami, FL

Answer: I love your story. We all know that being a contrarian investor is smart, but it isn't easy. As John Maynard Keynes famously wrote eight decades ago, "Worldly wisdom teaches it is better for reputation to fail conventionally than to succeed unconventionally."

What would I suggest doing with the money? You could always refinance your 7.2% mortgage with fixed rates to 5% these days. And then you could use the money to build up a broadly diversified portfolio. But, assuming you like your home and neighborhood, I'd lean toward taking advantage of your windfall to live debt free. Imagine, you're both in your mid-30s and from here on out you could live well off your income from work, add to your savings, and avoid borrowing. Being debt free at your age will give you a lot of financial flexibility and personal freedom down the road.

09/24/09 by Chris Farrell

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Stock options

Question: My husband is a mid level executive and he receives stock options yearly as part of his compensation. Since the stock prices have been continually declining at his company, we now have five year's worth of options we are unable to exercise. Aside from the stock price increasing, is there any way we will be able to recoup this money? Mary, Milwaukee, WI

Answer: Your husband's situation isn't uncommon among publicly-traded companies. Many executives now hold stock options that are worthless because the "exercise" price is greater than the market value of the underlying stock. In other words, you'd lose money if you exercised the options. The Wall Street metaphor for this experience is that the options are "underwater". Descriptive, isn't it?

There's nothing your husband or you can do. It's really up to management and the board. They can decide to leave the current option awards program unchanged. In that case, everyone will have to wait and see if the stock price improves before the option grant expires. The employee optionholders remain in the same financial boat as shareholders. However, some companies have decided to take a different tact. They are rewarding employees by substituting their old underwater options for newer ones with a lower exercise price, retiring the options and issuing restricted stock, or by exchanging cash for the options.

10/29/09 by Chris Farrell

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Reward companies not Wall Street

Question: I will retire this year at age 65. My husband and I are both conservative financially. We own outright our farm and two rental properties. I moved all the assets in my 401K to a cash account two years ago, so I have not suffered loses there (a good thing since I work for AIG!). I realize I must move some money into equities to keep up with inflation over time, but I don't trust any financial advisor (I have some experience) and I certainly don't want to invest in a way that will pour money into the coffers of Wall Street analysts and traders. Here is my question: when one invests in stocks (funds or individual) on the NYSE or Nasdaq, does Wall Street automatically profit? I want to 'Invest in America,' but I don't want to reward unethical financiers. I bet there are a lot of small investors who feel the same way I do. Thank you for any words of advice. Melinda, Burns, TN

Answer: Many people agree with you. And I imagine you have some stories to tell about living through all the turmoil at AIG.

Wall Street profits in most cases when it comes to buying stocks. But there are ways to limit the amount that goes into the pockets of financiers.

Now, you already know this, but to reiterate: When you buy publically traded stocks the money usually doesn't go to the company. The investor who sells the stock gets the gain or the loss. Companies get investor money during an initial public offering (IPO) and with any subsequent additional sales of shares. However, it's easier for a company to get access to capital--such as borrowing--when investor show their enthusiasm for its business by bidding up its stock price.

With funds, one way to limit Wall Street's gain is to buy a major stock index, either through a mutual fund or an exchange traded fund. The annual fees on both types of fund are razor thin. You can take another step in this direction by purchasing socially responsible index funds. This kind of investment combines low fees along with putting your money into companies you like and managements you'd like to reward.

With an index fund you aren't paying for the services of a professional money manager or advisor. You're your own money manager.

With individual shares, I wonder if it would work for you to buy stock directly from a company? There are a number of large companies, typically major national and multinational corporations, that offer shareholders direct purchase plans--you can buy company stock without going through a broker.

You can learn more about companies offering this kind of plan by going to betterinvesting.org. It offers a long list of companies with direct purchase plans, starting with 3M and ending with Zion Bancorporation. (Betterinvesting is the website for the National Association of Investors Corporation, the umbrella organization for many investor clubs).

I do believe that there are many ethical financial firms in the country, from many credit unions to a number of mutual fund companies. I'd do business with financial companies with a strong track record of good service and low fees, along with a proven willingness by management to steer clear of fads that eventually harm customers.

One last point: Do you need to invest in stocks to stay ahead of inflation? Don't get me wrong. I am a big fan of equities. But would purchasing Treasury Inflation Protected Securities--a hedge against inflation--be a better bet for you? It's worth exploring.

11/16/09 by Chris Farrell

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Gift stock to Mom

Question: What are the tax implications of giving a gift of appreciated stock to parents? I have some stock which has appreciated over the last couple of years and would like to gift some of it to my mother. Does her cost basis become zero when she sells it? Would it be better for me to sell it, pay the capital gains taxes, and have her rebuy it with the proceeds? Jim, Cincinnati, OH

Answer: When it comes to taxes there are always two phrases I have to write. The first is, "it all depends." The second is "check with a tax professional." I'm certainly not a CPA.

That said, gifting appreciated stock to your parents could be a savvy move depending on several moving parts.

Here's an example with several assumptions: You say you bought the stock several years ago and it appreciated in value. Let's assume you bought the stock for $10 a share and when you gift it the value is $20 a share. The total value of your gift is below the current $13,000 gift tax exclusion. Your Mom is in a lower tax bracket than you're in.

Okay, you gift her stock at $20 a share. She turns the stock into cash by selling it immediately at $20. Now, her cost basis for figuring out her tax liability is $10 a share--the price you bought it at. However, she also gets to take advantage of the low capital gains tax rate since you owned the stock for more than a year. Better yet, if she's in a low tax bracket her capital gains tax rate could be below yours. For instance, the long-term capital gains tax rate for folks in the 10% and 15% tax brackets is zero. That's right, 0%. The long-term capital gains rate for everyone else is 15%. (These rates only hold through 2010. They change in 2011.)

As you can see the devil is in the details. Change one assumption and the tax implications shift. Still, the idea is worth pursuing. It could be a very cost effective way to get money to your Mom. And that's always a nice thing to do.

11/19/09 by Chris Farrell

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