Teen Traders, Good or Bad?

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Recently, Fidelity announced that it is launching a Fidelity Youth Account for 13 to 17 years old.  The no-fee account allows teenagers to buy and sell stocks, exchange traded funds and Fidelity mutual funds. Fidelity pitches this new business as an education opportunity for teens to learn how to manage their money. So, should we cheer for the news that the brokerage house now allows teens to trade stocks? Not so fast.

First, since the start of pandemic last year, many of the new retail investors who entered the stock market are younger investors. Of the 4.1 million new accounts that Fidelity added in the first quarter of 2021, 1.6 million were opened by retail investors 35 and younger, an increase of more than 222% from a year prior, according to CNBC. Now, by allowing teens to trade stocks, is this another tactic for brokerage houses to attract money of even younger demographics?

Second, the name no-fee account is misleading. This could give teens the impression that trading is free. It could also encourage some investors to trade more. Numerous studies in the past have shown that frequent trading by timing the markets are detrimental to average investors’ long-term investment success.

Third, I am all for educating teens on sensible personal finance, but I think this time, it does the opposite of fostering good financial habit. According to a recent industry report that most of the Generation Z investors, people who were born between 1997 and 2015, get their investment advice from social media such as TikTok. Want to know what this means for investment world? Look no further than GameStop stock bubble earlier this year. This kind of investing habits are not unique to Gen Z investors. Think about how many of us who make investment decisions based on the “advice” or “tips” gotten from friends, coworkers, and/or online social media groups.

All in all, what I see from Fidelity’s latest venture is not a boon for teens and their families. If we really want to educate our teens on personal finance, teaching them the good habits of saving and budgeting, and understanding the impacts of personal debt are much more important than knowing how to trade stocks at this age.

Bitcoin, an Investment Asset Class?

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Almost every great product or commercial idea has a great story behind it. Take the famous perfume, Chanel No.5, for example. The story goes like this: During the late summer of 1920 Coco Chanel commissioned perfumer Ernest Beaux to make a perfume for modern women. It is said that Beaux’s assistant accidentally added a dose of aldehyde in a quantity never used before to the concoction for the perfume sample they named No.5. And among all the 10 samples Ernest Beaux came up with for Chanel, She picked No. 5. The perfume is a huge success.

So, what does the story of a legendary perfume have to do with Bitcoin? It’s because Bitcoin, too, has a fascinating story behind its origin. But, let’s first look at what this thing called Bitcoin is.

A Basic Primer on Bitcoin

What is Bitcoin? In short, Bitcoin is a digital currency. Unlike government issued currencies, there is no one central administrator such as the Fed to regulate it. It is decentralized. It can be sent from user to user on the peer-to-peer online network without the need for traditional financial intermediaries such as banks. A distributed, public ledger called block is used to record and store every Bitcoin transaction. Similar to ledgers used by accountants for bookkeeping, each electronic ledger-block contains a set of transaction history of Bitcoins in a certain time period. Each block has certain storage capacities. Once filled, these blocks are “linked” or “chained” to each other because each new block also stores the hash of the previous block’s header, thus chaining the blocks together. Hence, this linked chain of blocks gives the name “blockchain”. Anybody can look up Bitcoin transactions and download a copy of the blockchain into their computers. But, the real identities of the parties to each Bitcoin transaction are not necessarily linked to that transaction. In this sense, Bitcoin is considered anonymous.

What does it mean by “owning Bitcoins?” Owning Bitcoins is very different from traditional ways of having money bills in your wallets or putting money in your bank accounts. In the world of Bitcoin, you do not physically hold the currency or have an account with Bitcoin balance. Nor can you store Bitcoins in your computer like a file such as MP3. According to Coinbase, an online platform for buying, selling, transferring, and storing digital currency, “owning bitcoins” actually means owning an online Bitcoin address, which has a balance recorded on the blockchain. Owning this bitcoin address gives you the control of the associated Private Key, a secret number that allows Bitcoin to be unlocked and sent, and therefore allows the signing of transactions. Put it simply, to make a Bitcoin transaction, the sender just asks for the receiver’s Bitcoin address, and then generates some locking scripts using the receiver’s Bitcoin address so that only the receiver can create unlocking scripts using his or her private key associated with that address.

Then, where did Bitcoins come from? Or, who issues Bitcoins, you may wonder. The closest example to how Bitcoins come from is probably gold mining. The gold miners dug the gold out of the ground for circulation. Nobody issues gold. Similarly, there is no such central authority like Federal Reserve to issue Bitcoins. Bitcoins are created by Bitcoin protocols, a rule of systems determining how many of and who can create them. Bitcoins are mined and brought to circulation by Bitcoin miners. Unlike the gold miners in the 19th century California gold rush, who used tools like pickaxe and pan, the Bitcoin miners use powerful and specialized computers to solve complex computational math problems on the Bitcoin network. By doing this, Bitcoin miners verify the authentication of each Bitcoin transaction. Once a miner has verified 1 MB (megabyte) worth of transactions, also known as a “block,” he or she is rewarded with a number of newly-created Bitcoins. Therefore, you can say that Bitcoins are created out of thin air. It is said that there is a total of twenty one millions of Bitcoins. So far, eighteen millions of them have been “mined.”

A Brief History of Bitcoin

It started with its enigmatic inventor, a Japanese called Satoshi Nakamoto who published a white paper called “Bitcoin: A Peer-to-Peer Electronic Cash System.” right after the 2008 financial crisis. In these papers Satoshi Nakamoto envisioned a kind of digital currency that can be sent from user to user on the peer-to-peer online network without the need for traditional financial intermediaries. On Jan. 3, 2009, the first block, called the genesis block, was mined; the first test transaction took place about one week later, and the first economic transaction involving Bitcoins took place when a Florida man negotiated to have two Papa John’s pizzas delivered for 10,000 Bitcoins on May 22, 2010, according to an article by Coryanne Hicks published on US News and World Report’s website.

The first exchange platform on which Bitcoins were traded is a now defunct website called bitcoinmarket.com, which went live on March 17, 2010 (source: bitcoin.com). Nowadays Bitcoins are traded in multiple exchanges such as Coinbase and Binance among others.

From its humble beginning of trading one Bitcoin for 5 cents to the high of $19497.40 in 2017, then tumbling down to a trough of $3232.76 and back to present day of roughly $55979.20 as I am writing this article, the price history of Bitcoin is a volatile one.

Bitcoin as an Investment Asset

From an obscure alternative financial concept to the mainstream investment world, Bitcoin has been generating buzzes as well as controversies among investment professionals along the way. There are two camps of opinions on whether Bitcoin is an investment asset or not. The first camp firmly believes that Bitcoin is a new asset class. This camp constitutes mostly of Bitcoin miners, traders and investors. In an article written for Forbes, journalist Laura Shin summarized four reasons why she thinks Bitcoin is a new asset class: investability of Bitcoin, its economic value, its correlation of returns from other investment assets, and its risk-return profile. The other camp who does not think Bitcoin is an asset class, or at least not yet, including Goldman Sachs. Goldman Sachs’ rationale includes Bitcoin’s high volatility, its inability of generating cash flow like bonds, and its inability of generating earnings through exposure to global economic growth. Recently, current Treasury Secretary Janet Yellen has joined the Bitcoin skeptics and warned that Bitcoin is “an extremely inefficient way” in conducting monetary transactions. 

No matter what your take on these two opposing views, first of all we have to understand how Bitcoin is valued. Is it worth whatever price you happen to see on the financial market on that day? Like many other goods the value of Bitcoin follows an economic principle called the “law of supply and demand”. Essentially, your Bitcoin could be worth $50,000 or 5 cents depending on the price people is willing to pay to have it. I caution anyone who is eager to jump onto the Bitcoin bandwagon. You need to thoroughly understand what investing in Bitcoin means, how this might fit in your investment portfolio and how it can benefit your individual situations. Otherwise, it could cost you dearly.

ISO vs. NSO – Employee Stock Options Basics

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ISO and NSO, what do these terms mean? These terms stand for incentive stock options (ISOs) and non-qualified stock options (NSOs or NQSOs) respectively. They are mostly common among companies which use their company stocks as part of the employee’s compensation and/or retirement benefit packages.

NSO or NQSO are options to buy shares of company stock at a stated price and can be exercised over a specific period, i.e. over 10 years. The exercise price is normally 100% of fair market value on the date the option is granted, but it can be set lower.

ISO is an option to buy shares of company stock at a set price on the date of grant and can be exercised over a period of up to 10 years. Like NSO, the exercise price of ISO is normally set at the fair market value on the date the option is granted.

After reading the above definitions of ISO and NSO you are probably wondering: what are the differences of these two options? The differences mostly lie in the employer tax deductions and income tax treatment of exercising ISO and NSO options to the employees.

With most NSOs, if the employee opts to exercise the options to hold the shares of company stock, then the employee must recognize as ordinary income the amount of difference between the option grant (exercise) price and the fair market value of the underlying stock at the time of exercise. This income is subject to social security (FICA) and federal unemployment (FUTA) taxes. Subsequently, the employee will recognize either capital gains or losses on any appreciation or depreciation in the stock value from the day of exercise until the day the employee sells the stock. Alternatively, the employee can opt to exercise to sell, and then the employee will pay income and social security taxes on the amount realized on the sale of the stock minus the option price.

Unlike NSO, where the employee has to pay ordinary income taxes when he or she exercises the options to hold the stock, an employee who receives ISOs does not have to pay regular income tax at the time of exercise. If, after the exercise the shares are held for at least one year from the date of exercise and two years from the date of grant of the options (1year/2year holding period requirements), the sale of the shares will result in long-term capital gain from the date of the option grant to the date of sale of the stock. If, the 1year/2year holding periods are not met, then the sale becomes a disqualifying disposition and the ISO is treated like a NSO, where the difference between the option price and the fair market value at the time of exercise will be taxed as ordinary income.  

The difference between the taxation of a disqualifying disposition of an ISO and that of an NSO is that the recognized ordinary income from the disqualifying ISO is not subject to social security and federal unemployment taxes.

Here are two examples explaining how ISO and NSO work:

  • Adam received 100 shares of NSOs from his employer ABC Industry, Inc. on February 8, 2017. The option exercise price is $5 per share. On the date of grant, there is no taxation to Adam. On March 15, 2018, when the fair market value of the ABC’s stock is $10 per share, Adam exercised his options. Adam would recognize $500 ($10-$5=$5 times 100 shares) as ordinary income. On March 20, 2019 when the ABC’s stock price rises to $20, Adam sells all of his 100 shares of ABC stock. Adam would recognize $1,000 as long-term capital gain and would pay capital gain taxes because he has held the stocks for more than 12 months after he exercise his NSOs. If, instead of exercising the NSOs on March 15, 2018, Adam waited until March 20, 2019 to exercise the option and simultaneously sell the underlying stock, then, Adam would recognize all proceeds from the sale, $20 stock price/share – $5 option price times 100 shares = $1,500, as ordinary income and would pay regular income tax and social security taxes on this $1,500.

  • Eve received 100 ISOs from XYZ Industry Inc. on January 28, 2017. The option exercise price is $5 per share. If Eve exercised her ISOs on January 31, 2018 when the fair market value of the stock was $10 per share, she would recognize no income for regular tax purposes. If subsequently, Eve sells the stocks when its price rises to $20 on February 9, 2019, she would be able to recognize the entire gain of $ 1,500 as long-term capital gain because she has met the 1year(from exercise)/2 year(from grant) holding period requirements. If,  Eve sells the stocks on December 31, 2018, then she has not met the 1year/2year holding period requirements. In this case, the $500 from the exercise of the options on January 31, 2018 would be treated as ordinary income and the subsequent gain of $1,000 from sale of the stocks on December 31, 2018 would be recognized as short-term capital gains.

With NSO, the employer can take a deduction in the amount of income that is taxed to the employee. With ISO, however, if the employee complies with the 1year/2year holding period requirements, the employer gets no tax deduction from it.

If an employee is given stock options, he or she needs to be clear what kind of options they are. There is an employment requirement for employees who receive ISOs. That is, the employee who receives ISOs must remain employed with the same employer from the time of the grant of the options until at least 3 months before the exercise.

Another difference between these two employee stock options is that ISOs are not transferable except at death, while NSOs are transferable during the employee’s lifetime.

The Recent GameStop Stock Phenomenon

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Even if you are not a stock investor or you don’t follow market performance like a religion, you have probably heard of the latest news on GameStop, the video game retailer.

GameStop’s stock spiked from roughly $65 a share just before this past Monday to an intraday high over $480 on Thursday before closing around $236. This stratospheric rise of the video game retailer alone is enough for an awe-inspiring financial news story. But who were buying that caused the stock to rise to such high? There is more to this story.

The rise is fueled by traders in the WallStreetBets Reddit group and caused a short squeeze for the hedge fund short sellers who have bet against GameStop and shorted its stocks. What is a short squeeze? A short squeeze occurs when a stock or other asset jumps sharply higher, forcing traders who had bet that its price would fall, to buy it in order to stop even greater losses, according to Investopedia. Their scramble to buy only adds to the upward pressure on the stock’s price. The Reddit group also pushed up prices of AMC and BlackBerry significantly. Trading restrictions on GameStop’s stock posed by brokerages and trading platforms angered traders and some lawmakers but also helped lowering the stocks’ prices.

The sudden surge of GameStop’s stock price created unintended consequences for funds containing GameStop. For example, two exchange traded funds, XRT and GAMR found that GameStop now accounts for 20% of their total assets. It also tests the SEC’s market manipulation rule and could have profound impact on the market in the future.

Coping with Coronavirus Crisis

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Since March 24, 2020 Collin County, Texas has officially implemented its seven-day shelter-in-place law. Even before this order, residents in North Texas have been coping with the crisis that has drastically changed their lives.

Historically significant news and data used to come in once in a while now have come in almost daily since the end of last February, causing global financial markets to swing up and down wildly. And the word “unprecedented” has been used many, many times to describe the simultaneous global health crisis and financial crisis.

The speed of interest rates dropping was unprecedented. “Unprecedented” is this time that investors flight to cash abandoning stocks and safe haven assets like US treasuries at the same time. The number of Americans filing for unemployment benefits skyrocketed to a record–breaking 3.283 million for the week ended March 21. Consensus expectations were for 1.64 million claims. The previous record was 695,000 claims filed the week ended October 2, 1982. We are indeed living in an unprecedented time.

Amid this historical backdrop the central banks, especially the Fed, had adopted extraordinary measures to fight the financial fallout caused by this health crisis. And the Congress had just passed an unprecedented 2.2 trillion rescue/stimulus bill to relive financial burdens off Americans’ shoulders.

Based on a report by the Wall Street Journal, the bill will provide one-time checks of $1,200 to Americans with adjusted gross income up to $75,000 for individuals and $150,000 for married couples. Individuals and couples are eligible for an additional $500 per child. The one-time payment will be reduced by $5 for each $100 of income over those thresholds, completely phasing out for individuals whose incomes exceed $99,000, $146,500 for head of households with one child, and $198,000 for joint filers who don’t have children.

If you have recently filed tax return and the IRS has your refund account information on file, you can expect the direct payment into your refund account as early as in three weeks. It will take much longer to receive the payments by checks. The income figures above are based on the adjusted gross income from the 2019 return, or if that return hasn’t been filed, the 2018 return, said Jeff Levine of Kitces.com and Buckingham Wealth.

According to the bill it expands unemployment insurance to cover freelance and gig workers. The current unemployment assistance will be increased by $600 a week for four months.

The bill also includes $350 billion in loans to small businesses that can be used to cover payroll expenses, rent, and interest on mortgage obligations.

The IRS has also taken some steps to relieve Americans’ tax burden. It has officially postponed the deadline for filing income tax returns of year 2019 by 90 days. The new deadline will be July 15, 2020. “All taxpayers and businesses will have this additional time to file and make payments without interest or penalties,” said Treasury Secretary Steven Mnuchin in a recent tweet.

In an article written by Ben Werschkul for Yahoo! Finance, the IRS announced that it “will generally not start new field, office and correspondence examinations” during this period (April 1-July 15). The agency also announced that field collection activities will be suspended from April 1 to July 15. Liens and levies will be suspended during this period, too. However, the IRS underlined “field revenue officers will continue to pursue high-income non-filers”.

As this crisis rages on, there has already been some debate of whether the eventual recovery will be V shaped or U shaped. Given the unique nature of this economic crisis, whether the recovery will be V shaped or U shaped will largely depend on the progress of the medical research on effective treatment/vaccine against coronavirus. If the medical breakthrough comes earlier we may see a V shaped recovery. If not, we may see a U shaped recovery. Another interesting point made by Robert Rodriguez, former CEO of First Pacific Advisors in a latest interview by ThinkAdvisor pointing to a stock market rebound in the shape of a “lower-case “v”, not a rocket ship capital “V” — because of factors such as stock buybacks by companies benefiting from the fiscal stimulus will be banned.

Others like Jeremy Siegel, professor of finance at Wharton School of Business echoed a call by some financial professionals of rethinking the traditional “gold stand” of “60/40” portfolio strategy. Last Wednesday during a market update webcast sponsored by WisdomTree Asset Management he argued for the “need to pivot to a 75/25” portfolio strategy from the traditional 60/40 strategy “because interest rates are going to stay lower.” His point is based on historical real return index data from January 1802 through December 2019 showing that the real return from stocks was 6.8%, 3.5% for bonds, 2.6% for bills, 0.6% for gold and -1.4% for the dollar.

As with crisis in the past, there are opportunities for investors amid the market rout. For one, with the recent market sell-off, you may have a smaller tax bill if you convert your traditional IRA assets into Roth IRA. However, you need to consult your financial advisor before the conversion as the move is non-reversible and potentially complicated. For another, there are some solid companies priced attractively after the recent broad-market sell-off. But, I agree with what Peter Mallouk, president and CEO of Creative Planning said in another ThinkAdvisor interview that some of the worst things investors could do include getting into an industry that doesn’t recover, like energy, or betting on a company that can’t recover.

In the meantime, how do we as individuals go about our daily lives? I would like to share my personal experience of living through the coronavirus crisis.

I try as much as I can to keep my family’s pre-crisis routine . While staying at home, resist making too many trips to the pantry, though it is easier said than done. I make sure everybody in the family stay healthy by taking multivitamin supplements besides eating healthy meals, exercising at least 30 minutes daily and sunbathing for 15 minutes whenever the sun comes out. I sip water throughout my waking time almost daily. Since we do not need to commute to school or work, it is easier for us to get plenty of sleep everyday, another boost for our immune systems. To beat the feeling of isolation we get in touch with our friends as much as possible. We also spray letters and packages with disinfecting spray and wash our hands thoroughly after handling.

As a parent I would like to point out that now is an opportunity to teach our kids life lessons and build characters such as resilience and patience. It is also an opportunity to show solidarity among our neighbors and communities. If we are unable to volunteer, we can donate to local charities such as North Texas Food Banks. For those of us who have pets, we will have more time spent with them. Maybe, half an hour of dedicated play with our pets will strengthen our bonds. If your dog likes being touched, a little massage would be nice, too.   

Last, I want to say that generations of human beings have gone through and prevailed over wars, pandemics and financial crisis. Scientists worldwide are racing towards creating vaccines against coronavirus. If history can be of any indication I am confident that we will pull out of this twin crisis, too. Most importantly, we will have gained invaluable lessons and be better prepared for the future.

Making Sense of the Latest Market Rout

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Oh boy, what a (market) roller coaster ride we have been on this week! This is not the planned topic for my February blog post. But in light of what has been happening in the market since this past Monday, I felt like pitching in with my own two cents and try to make sense of this stock market “carnage”. Even if you are someone who doesn’t pay attention to stock market daily, you probably have learned the recent market rout that has been going on for the past four days here in the States and beyond. To give you a sense of how bad the sell-off is, let’s look at it in a historical perspective. “S&P drops 10% in six days, fastest correction in history,” says one online financial news website. “US stocks slide into correction, on track for the biggest weekly loss since 2008” says another well-known financial newspaper. Sensational headlines abound.

As I am writing this article on Friday morning, Dow lost another 1000 points at one point. Though no one knows for certain how soon this sell-off will end, plenty of venerable news sources point to the coronavirus outbreak as the major culprit of this adrenaline rush market sell-off. The news reporting about the coronavirus outbreak in China has been going on for over a month, and the market participants are well aware of this and seemed to have shrugged it off. Then, why, all of a sudden, the market seems to be panicking about this coronavirus outbreak? Just last week we had market record highs. Is the coronavirus outbreak the only reason that has caused this stock market stampede? This advisor does not think so. There had been flashing warning signs throughout 2019 already: twice inverted treasury yield curve; continuing decline of US manufacturing activities; the credit crunch in the repo market at the end of 2019, and US stock market valuation that well exceeded its historical average.  Given the US stock market’s gravity-defying stellar performance in as late as of January 2020, this late stage bull market needs great fundamentals to sustain such high valuation. In my December 2019 article titled “A Look into Year 2020”, I mentioned that there could be two potential disruptions to the world economy and market in 2020: disruption of world supply chain and US presidential election. What a coincidence that during the weekend right before Monday, February 24 market first plunge, news broke out that Italy and South Korea were hit hard by the rapid spread of coronavirus, which means the world supply chain could be disrupted even further. At the same time, America learned that Senator Bernie Sanders won the Nevada caucus, thus unofficially put him as Democrat’s front-runner for the party’s presidential nominee. All of a sudden, the market realized that the narrative has changed from business as usual to this could go even worse. 

What is happening right now taught us several things. One, there is no such thing as this time is different for the market. Two, fundamentals do matter. Three, bubbles will pop. Sound familiar? But, when irrational exuberance is abundant, people tend to think this time IS different, from Dutch tulip mania all the way to dot.com bubble and up until this recent longest run bull market. Another thing learned from this episode is that as global economies become greatly interlinked the world markets seemed to have synchronized sell-offs in the same intensity, diminishing the effectiveness of geographic diversification. This is why people flocked to the usual safe haven assets such as US treasuries, rapidly depressing the 10 year treasury yields.

Who will save the market out of this misery? As always all eyes are on the Fed. There have already been some speculations that Fed will probably cut rates three times this year. Fed had never explicitly stated that it would cut rates this year. However, Fed did hint it would take any action it needs to stabilize the US economy. Granted, stock market is not equal to economy. Still, Fed is closely monitoring the situation. According to Wall Street Journal, Federal Reserve Chairman Jerome Powell signaled Friday that the central bank was prepared to cut interest rates if needed. Ah, talking about the market’s reliably dependable ally. But, don’t forget that the stock bull market was fueled by last year’s Fed’s rate cuts as well as corporate tax cut. Also, don’t forget that the coronavirus outbreak is a health issue not a financial issue. What is worse, given central banks of major developed countries have already cut their benchmark rates so low before this market sell-off that rate cutting may have limited effects on the market and/or world economy. What about fiscal policy? President Trump’s administration just released a $4 trillion spending budget. A further fiscal stimulus will further aggregate the problem of record US deficit. So, if the US economy slips into recession, it will be in a difficult situation this time.

As an individual investor, you are probably searching for answers and trying to make sense of those giddy headline news. You may hear noises such as “sell all”, “buy the dip”, or “do nothing”. These can all make sense depending on individual situations. I think now one of the silver linings for individual investors is the strong US jobs market. It is a big contrast between this time and the financial crisis of 2008-2009 where the unemployment rate once reached 10%. I also agree with what Fed Chair Mr. Powell said in a statement released Friday afternoon: “The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity.” So, how can an investor ride out this market volatility? If you have been working with an advisor, I am sure you and your advisor have already hashed out a plan precisely for times like this. If you don’t have a formal plan, don’t panic. The market goes up and down. Volatility is part of the market. If you are antsy and feel like doing something, instead of guessing where the market bottom is, take a deep breath and do the following things. After you go through these steps, you will probably have an idea of what you need to do next. Here is the list:

  • Check if you have stashed away 3-6 months of your living expenses in a safe investment vehicle such as a savings account or money market fund. This is your emergency fund. If you don’t have one, then start by saving $5-$10 per day or more if you can afford to do so.
  • Check if you have adequate insurance for you and your family. The reason why you need to do this especially now is that if you don’t have adequate insurance, say, a large medical bill in the near future that is not covered by your health insurance could force you to sell some or all of your investments in a downward spiraling market.
  • Talk to your loved ones and together write down your family’s financial goals. Sort them into three groups: near, inter medium and long term goals. Then, estimate to your best knowledge the amount of funds each goal needs. Near term goal means it is happening within 2-3 years. Inter medium term goal means anywhere between 5-9 years. A long term goal means anything in 10 or more years. After you finish this step, you will pretty much have a ball park idea of how much money you need for near, far future and in between.   

If you still feel queasy about the current situation, talk to your advisor and address your concerns together. Remember for all the advice out there the ones appropriate for your friends or coworkers are not necessarily suitable for your situation; it all depends on your individual circumstances.

Zero commissions for stock trade, is this good for investors?

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Tuesday, October 1 Charles Schwab rocked Wall Street by announcing that it’s cutting stock trading commissions to zero. TD Ameritrade fired back immediately by lowering its stock trading commissions to zero, too. Anytime a cut in investment cost is a boon for the average investors, as a general rule. So, should we cheer for the news that these brokerage houses are cutting investors’ trading costs? Not so fast.

First, look a little closer you will see that the new zero commissions apply only to trades done online or on mobile devices, and they do not apply to transactions in foreign stocks, large block transactions requiring special handling, restricted stock transactions, transaction-fee mutual funds, futures, or fixed income investments. Also trades placed by phone will continue to cost $5 each and through a broker at $25. So, the cut in commissions literally benefits only those investors who often do online trades of domestic stocks.

Second, this move could encourage some investors who don’t trade often in the past because of the concern of incurring large amount of trading costs to trade more. Numerous studies in the past have shown that frequent tradings by timing the markets are detrimental to average investors’ long-term investment success. Whether or not Charles Schwab or TD Ameritrade’s customers will trade more often after this move remains to be seen in the future.

Third, according to Charles Schwab’s Chief Financial Officer Peter Crawford the zero-commission policy will reduce company’s quarterly revenue by $90 million. Charles Schwab, or any other company, is not a charity. Companies need revenue to survive and compete in their respective industries. If Charles Schwab cuts its stock trading commissions to zero, how does it make up for the lost revenue? For that I suggest readers look no further than the recent example of Fidelity Investments. Last year, Fidelity touted its zero expense fees funds and marketed them to the general public. Not long after that news broke that Fidelity charges customers with hidden fees and has been probed by the government. Will Charles Schwab make up for the lost revenue by starting charging hidden fees and cut corners of their services? I will leave that to readers to draw their own conclusions.  

All in all, what I see from Charles Schwab’s move is a lose-lose scenario. Brokerage houses lose revenue, yet investors gain little because this may encourage frequent trading which is bad for investors’ long-term investment results.