Addington Financial Group - Frequently Asked Questions

Ernie

Ask Ernie

What should I watch out for when investing?

Prior to making an investment, you should consider your risk tolerance, time constraints, and objectives. Here are a few more things to be watch out for:

1) Throwing money after last year's winners. While historical performance is an important factor in weighing fund choices, it is not a guarantee that a fund will perform the same way in the future. Investment styles or categories cycle in and out of favor just like individual stocks, sectors, and industries.

2) Comparing apples to oranges. For example, a long-term growth mutual fund with a 28% return last year might seem pretty good. Not necessarily. Compare its performance with the performance of other mutual funds in the same category. If the returns of the top decile (20%), of long-term growth funds ranged from 39-55% last year, that 28% return was less than spectacular.

3) Taking mutual fund ads at face value. A lot of mutual fund ads brag: "We're Number 1." But how can they all be in first place? Only by taking liberties with their measurement criteria can so many (falsely) claim so much.

4) Not knowing a mutual fund's goals. Don't go by the mutual fund's name, such as 'income fund' or 'growth fund'- that may no longer be its actual goal. Read the fund's prospectus to see what the fund manager is really trying to accomplish, and what kind of investments the fund manager is making.

5) Thinking you're diversified when you really aren't. If you are investing in several different fund companies but their objectives are all the same, such as blue chip or tech funds, then you probably aren't diversified. Also, a number of fund companies use the same research for several of their funds and may have similar top ten holdings for them. This may be great when their picks are on the up swing but can be devastating on the down side.

Mutual funds involve market risk, including fluctuating returns and possible loss of principal.

What is the difference between growth and value investing?

"Everything that was a growth company 3 years ago is now a value company……but they're the same companies, and they have the same business." - John Carr VP of research H.C. Wainwright & Co. Economics

Is style going out of style? Traditionally, value investments are stocks with low price/book ratios, and growth stocks are---well, it depends whom you ask.

For disciplined growth investors, a good growth stock prospect might have a high P/E but an even higher growth rate. Since the telecom industry's nuclear winter and other growth stock valuations returned from the late 90's stratosphere, however, that distinction has come to mean less and less.

Investing is all about buying something for less than you think it's worth; fund managers philosophies don't change even though their style categories might. Chris Davis, fund manager at Davis Funds recently wrote that growth/value distinction is an "unnecessary categorization" and that they are always trying to buy dollar bills for 50 cents.

Of course, it is unlikely that the growth/value labels will go away. Investors like the distinction for many reasons, as well as the simple fact that different philosophies appeal to different temperaments: Some people like the speed of Porsches, others like reliable Hondas.

Managers who transcend growth or value are categorized anyway, then accused of "'style drift" when they don't fit neatly in a box. In 1992, Warren Buffet wrote to Berkshire Hathaway shareholders, "Many investment professionals see any mixing (of value and growth) as a form of intellectual cross-dressing. We view this as fuzzy thinking….In our opinion, the two approaches are joined at the hip."

Carr believes that the terms "growth" and "value" shouldn't be tossed altogether, but instead redefined. He believes it would be more useful to describe stocks in terms of "cyclical" versus "defensive".

"Cyclical stocks go up and down because of sensitivity to interest rates and monetary policy, and cyclical stocks are generally associated with value," Carr says. "If a company's earnings are independent of the economy, that makes a stock more valuable." And more associated with growth, he adds. "True growth stocks shouldn't depend on interest rates."

AMT
I keep hearing about the Alternative Minimum Tax. What is it and how do I know if it effects me?

Although by the name it sounds like you have a choice, the AMT is to make sure that taxpayers with substantial income are not able to avoid paying tax, the law limits the benefit a person can receive from favorable treatment of certain items. The "Alternative Minimum Tax" uses a separate accounting method with its own unique rules that govern the recognition and timing of income and expenses.

If the alternative minimum tax calculation results in a higher tax than regular income tax, the difference is added to regular income tax on Form 1040. In effect, the taxpayer must pay whichever is higher. In other words, if you take advantage of too many legal tax avoidance measures, the IRS imposes an "alternative tax" calculation.

AMT affects more taxpayers than ever before due to the fact that as incomes rise, the exemption amounts have not changed since 1993. Many taxpayers with moderate incomes will fall under AMT rules for the first time. Employees exercising stock options, often find that the AMT rules will apply to them.

We informally refer to the AMT as the CPA employment act!

What happens if the date-of-death value of stock or other assets inherited from a spouse in a community property state is much less than its original cost?

If the stock has appreciated, the entire basis is stepped up to the date-of-death value. Unfortunately, the same rule applies here: The basis will be stepped down to the date of death value.

Just as the tax bill on gains is eliminated by death, so is the tax benefit of losses. If the spouse is seriously ill, it would be wise, from a tax standpoint, to sell a ravaged asset to lock in the capital loss.

Also, for non-spouses it would be beneficial from a tax standpoint to gift the asset prior to death rather than inherit. This way the beneficiary would be gifted the asset along with the original cost basis versus inheriting the asset with the stepped down basis.

Last year I had a short-term capital gain on a piece of real estate. Can I use my carryover of long-term capital loss on stock sales to offset my real estate gains?

Yes. You must first match each type of carryover loss to offset the same type of gain: long-term losses against long term gains, short-term losses against short-term gains.

After that you can use any leftover losses first to offset current long-term gains then to offset short-term gains. Any remaining losses can be used to offset $3,000 of this year's ordinary income. It is important to remember to continue this process every year until you write off all of the loss.