Friday, April 18, 2014

Morgan Stanley Profits Surge 56%

As an investor, I look for consumer discretionary companies that do one thing really well (Krispy Kreme, Starbucks, McDonald's) or financial companies that make money from many different lines of business (TD Ameritrade, Wells Fargo). My investment in TD Ameritrade (AMTD) has been outstanding--up around 90% in about a year--and, fortunately, it happened right after I decided to take much larger stakes in a few companies' stocks as opposed to spreading a little bit of money among several dozen. I mean, if you're not comfortable investing $10,000 into a stock, why "play around" with $400? If it drops, it drops the same % for everybody, and if you happen to hit a double or triple, where are you on a $400 investment compared to an investment of $10,000? Reading the WSJ online article announcing Morgan Stanley's recent surge in income and profits, I noticed that broker-dealers can make money in many different ways. They can underwrite securities. They can open an affiliated wealth management firm. They can trade securities for big profits. And, of course, they earn commissions whenever their customers want to trade, which is often. All along the way, they earn bazillions on unused customer cash, which is largely why I bought so many shares of TD Ameritrade when interest rates were low--as rates rise, AMTD will make more money. Unless they don't. In any case, here are some highlights from the WSJ Online article: Morgan Stanley's net income rose to $1.51 billion from $962 million. On a per-share basis, which reflects the payment of preferred dividends, the firm earned 74 cents, or 68 cents excluding accounting adjustments. Analysts polled by Thomson Reuters had expected adjusted earnings of 59 cents a share. Revenue rose 10% to $8.93 billion. Excluding accounting-related adjustments tied to the firm's own debt prices, revenue increased 4% to $8.8 billion, exceeding analysts' average estimate of $8.52 billion. Not too bad, huh?

Thursday, April 10, 2014

Series 7 Sample Question: Taxation

Series 7 exam candidates scour the web for Series 7 exam sample questions. Let's take a look at the kind of question you might see on your Series 7 exam: Which of the following statements accurately explains an investor's "marginal tax rate"? A. It is the rate applied to qualified dividends and long-term capital gains B. It is the rate of tax paid on the last dollar of income earned C. It is the rate applied to all of the investor's ordinary income for the year D. It is the average rate of taxes paid, calculated by dividing taxes paid by taxable income EXPLANATION: as always, take whatever you are given in the question and use it to eliminate answer choices. Choice A is trying to confuse you--investors might pay 15% or 20% (or even 0%) on qualified dividends and long-term capital gains, but they don't pay their marginal rate. A is eliminated. B looks good, but let's make sure. Choice C doesn't have it right, either--if somebody makes enough money to be pushed into the 33% bracket, that rate only applies to some of his income. C is eliminated. And, Choice D is defining the investor's effective tax rate. Choice B is the answer. An investor who tops out in the 33% bracket also pays 10, 15, 25, and 28% on various swaths of his income. He pays 33% on the "last dollar of income earned."

Wednesday, April 9, 2014

Can My Broker-Dealer Stop My Customers From Following Me to My New Employing Member Firm?

Can your employing broker-dealer prevent you from bringing your customers with you to your new employing member firm when you leave for a better opportunity? Yes. Can your employing broker-dealer stop your customers from transferring their account to your your new employing member firm? Absolutely not. See the difference? As FINRA explains perfectly in a Notice to Members, "As a condition of employment, certain members require their registered representatives to sign employment contracts in which each registered representative agrees that when he or she leaves the firm, he or she will not take, copy, or share with others any firm records. In addition, the registered representative may agree that, for a certain period of time following his or her departure from the firm, he or she will not solicit the firm's customers for business. Nonetheless, when a registered representative leaves his or her firm for a position at a different firm, clients serviced by the registered representative may decide to continue their relationship with the registered representative by transferring their accounts to the registered representative's new firm." The specific rule that prohibits interference with a customer's decision to transfer the account in such cases is FINRA 2140. Since you wouldn't otherwise be able to sleep tonight, I'll go ahead and reproduce that rule for you here: No member or person associated with a member shall interfere with a customer's request to transfer his or her account in connection with the change in employment of the customer's registered representative where the account is not subject to any lien for monies owed by the customer or other bona fide claim. Prohibited interference includes, but is not limited to, seeking a judicial order or decree that would bar or restrict the submission, delivery or acceptance of a written request from a customer to transfer his or her account." So, if you leave your firm for greener pastures, please do not violate your employment contract by poaching customers or--probably worse--walking out with their account information on a little thumb drive. But, if your customers decide to move their account when you make your move, your firm cannot play hardball with them and try to interfere with an ACAT transfer.

Thursday, March 20, 2014

How Are Dividends Taxed?

When I log into my taxable brokerage account, I look up the dividends paid so far this year, and I find the following: NATURAL RESOURCES ROYALTY (HGT) $8.28. QUALIFIED DIVIDEND (MCD) $12.15. Notice there are different types of dividend income payments. As with dividends from REITS, the natural resources royalty paid by Hugoton Royalty Trust does not receive the qualified dividend treatment that the dividend from McDonald's does. Qualified dividends paid by most public companies like McDonald's, Starbucks, General Electric, etc., receive a special tax treatment that is usually much lower than the investor's marginal rate. Most investors, like yours truly, get to pay just 15% tax on qualified dividends. On the other hand, if the investor's marginal bracket is 33%, he would keep only 67% of an ordinary dividend paid by a REIT or a natural resources royalty paid by a royalty trust. However, if the investor's marginal bracket is 39.6%, he also gets nailed with a 20% tax on qualified dividends--not 15%. So, while most investors pay 15% on qualified dividends, the wealthiest investors now pay 20%. And, investors whose marginal bracket is no higher than 15% pay a tax rate on qualified dividends of . . . zero percent. What does any of this mean to an investor? Well, if he's only getting $12.15 quarterly from Micky Dee's, not much. But, if he were receiving $120,150 quarterly on top of a decent salary, that would push him into the 39.6% bracket, and he'd be keeping 80%, not 85% of that income. How much difference would that 5% make? Enough to buy his daughter a new baby-blue Subaru. Real money. To Mitt Romney, it means no more 13.7% tax rate. He'll continue to live mostly on qualified dividends, but that will start him out at 20%, not the kinder, gentler, 15%. Again . . . real money. One thing is clear, when Democrats call the new tax code changes a "tax on millionaires and billionaires," we now see how dubious the claim is. First, the 39.6% marginal bracket and the associated 20% tax on dividends kicks in on the income above around $400,000 a year--is that anyone's definition of a "millionaire-and-billionaire"? Also, the true millionaires-and-billionaires out there can, like Mitt Romney and Warren Buffett, live mostly on qualified dividends, so that whole 39.6% marginal bracket is meaningless--you can bump it up 5 points, but they're still paying 20% or less on their dividend income. When the tax-hiking Democrats change the tax code like this, they end up hitting folks in the middle brackets much more. Folks living paycheck to paycheck don't receive a lot of dividend income, so when politicians push the "millionaires and billionaires" up to higher brackets, the folks below them get pushed up, too. Since they live paycheck-to-paycheck, bumping the rate they pay on that income hits them square in the face. Because of the 15% tax on my qualified dividends, I now fund my taxable account regularly, the way most people fund their IRA. In addition to my SIMPLE IRA contribution, I make sure to put more and more $ into my taxable account, where I try to buy mostly dividend-paying stocks. By the time I retire, I hope to collect a decent income stream on these dividends and keep 85% of it. And, if I sell any stocks for a long-term capital gain, I keep 85% of that, too. While it's nice to build up the SIMPLE IRA, all withdrawals from there will be taxed as ordinary income. So, as you can see, the changes to the tax code make the taxable brokerage account something worth considering in addition to true retirement accounts.

Friday, March 7, 2014

Suitability of Investment Recommendations - Free Online Class

Suitability of recommendations is an important part of your Series 7 exam. Use the link at the end of this brief post to sign up for a FREE class starting in just a few hours. We'll break down 10 practice questions similar to what will show up on your test, and we'll dig into key concepts including: time horizon, liquidity needs, investment objective, and risk tolerance as they relate to various investment vehicles. Sign up now!

Friday, February 28, 2014

How to Calculate Tax-Equivalent Yield for a Series 7 Question

When an investor has found two 10-year bonds, both rated A-, should she invest in the 6% tax-free municipal bond or the 8% taxable corporate bond?
The answer depends entirely on her marginal tax rate. A test question could go something like this . . .

When deciding between a 6% tax-free bond and an 8% taxable bond, at which marginal bracket does an investment in the tax-free bond become advantageous?
A. 20%
B. 25%
C. 30%
D. 33%

In order to figure out the tax rate that first makes the 6% bond more attractive, you''ll have to keep taking the .06 the bond pays and divide it by .80, then, .75, then .70, and maybe even .67 until the tax-equivalent yield ends up higher than 8%. What happens when we take .06 divided by .75? We get a tax-equivalent yield of .08, which is exactly the same as what the corporate bond offers. Not surprisingly, when we take .06 and divide it by .70 (30% marginal bracket), we find that the tax-equivalent yield is now 8.57%, making C our answer. Yes, at 33% the investor should also be buying the municipal bond, but the question asked at which bracket the yield begins to rise above 8%. As always, the Series 7 expects you to do more than memorize a few terms and try a few little tricks to fudge your way through it.Pass your Series 7

Monday, February 17, 2014

The Often Overlooked Unit Investment Trust

Most Exchange-Traded Funds (ETFs) are set up as unit investment trusts that are only redeemable into large "creation units" by the broker-dealers who sponsor them. Everyone else trades the shares, which seek to mimic the performance of a particular index. That's all well and good, but the UIT that intrigues me is the fixed portfolio of preferred stock or bonds that has no investment adviser and, therefore, no management fee. A portfolio of, say, 50 preferred stock issues is purchased and placed in trust overseen by the trustee, who pays out the income produced by the securities in the portfolio after trustee and administrative fees have been deducted. Your exam might refer to such a UIT as a "supervised, non-managed portfolio, typically of fixed-income securities." That's exactly what it is, and since I'm pretty sure that trading in and out of preferred stocks is both expensive and unnecessary, I see no reason to pay an investment adviser to manage/trade the portfolio.
So, what's stopping me? Interest rates. Yields are still so low at this point that I can't get excited over parting with a large chunk of change just to watch 2-3% yields dribble in. I've told myself that when I can get a 5% yield or higher, I will start buying in. As your test wants you to know, my risk is that interest rates will keep climbing after I buy in--the value of my units will drop if that happens. Then again, I would still be collecting a decent yield from preferred stock, and I can check the credit quality of the issues and let the trustee handle it from there.
A likely test question on a UIT would point out that these securities are primarily regulated under the Investment Company Act of 1940.Need Help with your Series 7?