What Is A SPAC? Their Investment Considerations

What Is A SPAC? Their Investment Considerations

SPACs became very visible in 2020, with 219 SPACs raising $73 billion, outpacing traditional IPOs, which raised $67 billion. There is a mystique about investing in SPACs. We’ll try to demystify SPACs by explaining their structure, their investment considerations, and identify benefits and drawbacks. 

SPACs are speculative investments with high risks with returns that often favor the founder, however, new structures are emerging that may enhance returns. 

Continued Growth In 2021

Growth continues in 2021, with SPACs acting as an alternative way to take a private company to the public market. Its IPO process is different. The SPAC raises capital through its IPO to acquire an operating company which, more than likely, is not known. Subsequently, the SPAC acquires the target company, and after the shareholder approves the deal, the company becomes a listed stock. 

From an investor’s perspective, you can invest in the SPAC once it goes to the public market after the merger combination is publicly listed or any time in between those events. As with any speculative investment, there is skepticism about investing in SPACs. Therefore, we believe a deeper understanding of its structure can help us decide one way or the other if this kind of investment belongs in our portfolio.

Third Generation of SPACs

SPACs are not new, having been around since the early 1990s. The first generation helped smaller companies who could not go the traditional IPO route of going public. However, sponsors received favorable terms, hurting investor returns and inflicting reputational damage. The SPAC structure reemerged in the early 2000s but faced competition from venture capital firms while the traditional IPO means to go public remained a preference.

The returns for SPACs still tend to favor the sponsors who play a dual role in organizing the structure. The pandemic, the economic downturn, and the volatile market in early 2020 spurred substantial growth in the SPAC industry. The high quality of sponsors, target companies, and increased SEC regulatory scrutiny on insider pay structures stimulate investor interest and provide better returns. Some SPAC experts see a positive difference in the SPACs today.

What Is A SPAC?

A SPAC is a special purpose acquisition company, sometimes referred to as a “blank check company.” Blank check companies are an appropriate term at the development stage. Initially, the SPAC doesn’t have a specific business plan or purpose and is highly speculative.

Creating a SPAC begins with a sponsor forming a corporation to go public in an initial public offering (IPO), working with an underwriter. A SPAC IPO shares few characteristics with a traditional IPO, and we will contrast how they are different.

You may be thinking, why would I buy shares in a company without a business plan or purpose? Asking this question is valid. The quality of the sponsor is the first clue as to the quality of the SPAC. Sponsors have come from large private funds (e.g., hedge funds), former S&P 500 CEOs, senior executives, and individual or group of investors.

SPACs have organized around a specific, often “hot” industry in the latest round of announcements such as emerging energy, electric vehicles, and health technology. The sampling of winners are DraftKings, Virgin Galactic, Repay Holdings, QuantumScape, and Vivint Holdings. Nikola was a success initially, but its CEO had to step down. Notable SPAC sponsors with substantial experience are legitimizing the SPAC market.

A Select Group Of Sponsors:

Chamath Palihapitiya, Social Capital Hedosophia series*

Bill Foley, Trasimene Acquisition Corp.

Bill Ackman, Pershing Square Tontine holdings

Michael Klein, Churchill Capital

Omar Ishrak, SPAC Compute Health Acquisition

*See below our discussion of Chamath Palihapitiya and the Hedosophia series

Stages of A SPAC

Before the IPO, the sponsor invests capital, paying a nominal price for the shares and warrants. Post-IPO, the sponsor will have about a 20% interest in the SPAC. These shares are called “founder shares.” As the sponsor, they receive a lower price as their compensation for the SPAC’s work.

Sponsors tend to get more favorable returns for SPACs than some investors as they play a dual role in organizing the structure and finding the right target.

At the time of the IPO, the sponsor can buy more shares and warrants but at the fair market value. The SPAC IPO sells units to public investors who will receive with each unit consisting of a share and a warrant. Potential investors should scrutinize the information in 10K and 8K reports filed with the SEC; and learn about the sponsor, company, risk factors, and management team.

In a SPAC IPO, the price is typically set at $10 per share and has no relationship to its value. It will trade with a temporary stock symbol until the merger combination reflects the company.  The IPO proceeds go into a trust invested in safe Treasury securities until the SPAC, and its sponsor identifies a  private company for its merger combination.

The Time Between IPO And Merger Combination

Most SPACs have a two-year window in which to find a private company for its combination. Once the SPAC identifies the initial business combination opportunity, there will be negotiation with the target company, and shareholders get to redeem its shares or vote on approving the merger.

If the SPAC does not complete the merger because it did not find a target company, the SPAC liquidates, and the shareholders receive the IPO proceeds. Shareholders can redeem their SPAC common shares for cash at a shareholder meeting to approve a combination. They have to elect redemption two days ahead of the meeting.

A Few Findings

Research by Michael Klausner found that over two-thirds of SPAC stockholders tender their shares for redemption. They analyzed 47 SPACs through its stages from issuance at $10 per share to post-merger. A few findings:

  • The $10 share value drops to $6.67 per share due to dilutive costs.
  • Underwriting fees for a SPAC IPO is typically 5%-5.5%, less than that of the traditional IPO.
  • When factoring in other costs, median dilution for investors could be as high as 50.4%.
  • Shareholders who redeem shares pre-merger earn higher median returns of 11.6%, though below  31.3% returns for sponsors.
  • The longer investors hold on to their post-merger equity, the lower their returns.

 

De-SPACing

Post-merger combination occurs after the announcement of the target company. The SPAC is still trading but on its pre-merger stock symbol.  There is a transition period to prepare the company to communicate with existing and new investors, developing investor presentations as they complete the transaction. This period is readying a private company for the public limelight, which can be overwhelming and demanding.

In the traditional IPO process, the company and bankers allocate shares mainly to institutional investors. The IPO stock is not yet trading in the public market until pricing. Once priced, it will begin trading in the secondary market. In a SPAC IPO, the stock is first trading as a blank check company and then transitions to a company post-merger.

Investing In SPACS

I want to share my experience in investing in SPACs, specifically Chamath Palihapitiya and his Social Capital Hedosophia series. Palihapitiya has been a sponsor of six different SPAC IPOs, ranging from IPOA through IPOF. His plans are for 26 SPACs through IPOZ. That may prove ambitious even for him.

Why did I pick these over other SPACs?

Chamath Palihapitiya has an impressive background, from being an early executive of Facebook to a successful venture capitalist with a $1 billion net worth.

It is not solely his wealth but his ability to articulate where disruptive technologies are going. He is thoughtful about people on Main Street, may consider politics in the future. He has significant relationships with Silicon Valley. Thus far, I invested in all of the IPO letter stocks, except IPOA, the shell company that became Virgin Galactic.  His SPACs have raised a lot of capital and are at different stages.

How Have They Done?

Three of the SPACs (IPOA, IPOB, and IPOC) have found their target companies, transitioning to companies.

By far, IPOA’s conversion to Virgin Galactic  (SPCE)  has been quite a star, rising over 140%.

IPOB is now Open Door (OPEN), an online home-selling business. Its shares are down 14.9% since it began trading post-merger as OPEN.

IPOC is now Clover Health Investment, a Medicare insurer. Its stock is down 18.7% as CLOV. It hit a speed bump last week when short-seller Hindenburg Research reported that it is under an active Justice Department investigation. Clover Health responded to Hindenburg’s report here.

IPOE has more than doubled from its initial IPO price. This SPAC will merge with Social Finance, better known as SoFi, an online lender and Robinhood competitor. It has a high capitalization of near $9 billion, well over the median amount for SPACs of $500 million in 2020.

Neither IPOD and IPOF have found their merger target but are trading above their $10 initial price. IPOD is up 65%, while IPOF is up about 50%.

Understand The Risks

Like newly issued shares in a traditional IPO, it is too early to judge the investment merits in the short-term. I have faith in this sponsor, and his ability to seek quality merger candidates in growth areas. However, it is up to the investor to learn what the risks are and if you can tolerate them.

You can consider how to minimize their risks by diversifying with a SPAC ETF. In the interest of full disclosure, my SPAC investments are relatively small, less than 1% of my portfolio. Young investors who have shown interest in investing in SPACs and other areas should read our letter.

 SPAC Benefits 

1. Buy At The Ground Level. There is a chance for smaller investors to join institutional investors to participate in an exciting industry and company at an earlier time at the ground level. It depends on the SPAC and its sponsor. This opportunity typically doesn’t exist for the retail investors to get the stock at the IPO price who potentially pay a much higher price.

2. Low Price Point. At the initial stage, the shares are the same at $10 per share, a desirable price point for retail customers.

3. Different Stages To Invest. Investors can buy SPAC shares at the IPO price, participate before the merger deal is announced, and after the deal’s completion of the deal when the merged company is listed. Shareholders can opt to redeem their shares before the approval vote for a merger.

4. There Are Many SPAC Choices. SPACs vary by sponsor, industry, and company. With many SPACs in the market, there are choices with better terms or structures for investors. Bill Ackman’s Pershing Square Tontine Holdings is the largest SPAC in 2020, has positive attributes that may serve as a better model for future SPACs.

Different Structure, New Model?

Pershing Square SPAC’s structure deviates from other SPACs by eliminating the sponsor’s 20% “promote” at lower prices for the founder, special warrant incentives to keep shareholders from redeeming shares, and buying smaller interests in private companies, rather than one operating company for its SPAC. This may reduce risk or improve returns.

5. Investment returns vary for SPACs with potentially higher returns at certain stages.  According to Tim Jenkinson and Miguel Sousa’s research, they found a 7.6% median return when investors buy shares shortly after the IPO and sell it soon after announcing the potential merger.

6. Diversification. To minimize risk, you may consider buying a SPAC ETF, with a diversified pool of SPACs. There are a few new ETFs to investigate.

SPAC Drawbacks

1. These Are Speculative Investments. Investors need to be more cautious given more significant risks.  At the blank check company stage, you are investing blindly. Your reliance is on the sponsor, so you need to understand the founder who may not have a lot of experience in the field. Before investing, you should learn about their track record, previous successes as investors or senior management, and access to target companies.

2. Underperformance For Many SPACs. Like most traditional IPOs, long term stock performance is usually low or negative returns. That is true for SPACs. Not every stock becomes a Virgin Galactic, whose shares appreciated 146% in the year after going public. On average, SPAC transactions underperform the equity market. Klausner’s research on tracking 46 SPACs, found median negative returns of 14.5% after three months, 23.8% after six months, and a detrimental 65.3% after 12 months.

3. Few Quality Target Companies? Many SPACs are looking for quality target companies in a handful of hot industries. At some point, SPACs may have challenges finding outstanding companies for their combination and may settle for lower quality.

Final Thoughts

Investing in SPACs has been an exciting area in the financial markets. We hope we helped you better understand SPACs and their investment considerations. It is a speculative investment with high risks and returns that often vary depending on its stage, the sponsor, the target company, and the industry.

Thank you for reading! We would appreciate your comments and feedback. If you enjoyed this article, please share and consider subscribing to The Cents of Money for our weekly newsletter.

 

 

 

 

 

 

 

 

 

Saving For Retirement In Your 20s

Saving For Retirement In Your 20s

Saving For Retirement Yet?

Savings, investing, and retirement are very related, yet the topic of retirement planning gets pushed off to the side.

We fear dealing with the unknown, or we are neglectful.

Instead, planning early and often for retirement will empower you to control for a stage of life that could quite exciting if done right.

It is always an excellent time to start thinking about saving some tax dollars long term.

Start As Early As Possible

You can start planning for retirement at any age, but the earlier, the better. Start in your 20s to take advantage of tax benefits, compounding interest, and peace of mind when you are older.

According to a 2017 study, 12% of Generation Zers are already saving for retirement. Another 35% of the participants plan to start saving when they are in their 20s. Gen Zers, also called iGen and Post-Millennials, seemed to have gotten the strong message that controlling your destiny, including retirement planning, should be in your hands.

A Mini Case Study 

As a college professor, I teach Gen Zers, but I learn so much from them. Recently, I opened up a discussion on marketing, lifestyle, and status with a question about how millionaires live.

Not surprisingly, many students volunteered with images of luxury cars, mansions, yachts, but one student yelled out, “They have lots of savings and invest more.”  Suddenly, the class took a turn, and others shared how they had “put some money away” while another had opened a retirement account.

One of my quieter students hesitated and then forcefully shouted out, “Professor, I am 18 years. There is no *#!^$ way I am saving now for retirement !” A hush came over the room, some students giggled, and suddenly several students started sharing their thoughts about saving, investing, and starting early on retirement.

My students said that their parents hadn’t saved much “for anything.” The students wanted to do better for themselves by planning for retirement early. They intend to put money into their retirement accounts. They don’t think Social Security will be there for them.

I always recommend books to my students and offer points toward their grade if they write a short essay. They seemed eager for points, so I suggested: The Millionaire Next Door: The Surprising Secrets of America’s Wealthy: Thomas J. Stanley, William D. Danko. If you haven’t yet read this book, it identifies the key traits of those who accumulate wealth by emphasizing that putting away money for your future is paramount.

By the way, a surprising number of my students have taken up the offer, read the book, and submitted an essay for their extra points.

 Why You Need Retirement Planning Early

  1. Life expectancy has increased significantly since 1960. Recent forecasts point to further increases to 83-86 years for men and 89-94 years for women in 2050. Assuming you retire at 65-66 years, you will need 20 years of savings at a minimum.
  2. There could be challenges for Social Security retirement income benefits. About 65 million, or nine out of ten Americans, aged 65 or older received $1 trillion in social security benefits in 2020.  These income benefits represent 33% of the income of the elderly.
  1. Defined pension benefits have a long history but were a 20th-century cornerstone for retirees. A defined benefit pension plan promises a specified pension payment or a lump sum payment from your employer when you retire. It is a particularly desirable compensation perk but declining in use like rotary phones (a now antiquated way to dial a telephone). Today,  only 4% of private-sector workers only participate in pensions, a significant decline from 60% in 1980.

 Retirement Goals You Should Consider

  • Start saving early in a retirement account even if they are initially small amounts. 
  • Raise your contributions accounts as you receive salary boosts and bonuses.
  • Put up enough dollars to earn your employer’s match.
  • Aim to contribute up to the limit allowed for your 401K employer-sponsored 401K and your Roth IRA plans. 
  • Borrow from retirement accounts only as a last resort. 

 

Retirement Accounts are Really Investment, Not Savings Accounts 

By saving early in your retirement, you are investing for the long term. Through the benefit and magic of compounding, you can have substantial funds by contributions, even if you begin with a relatively small amount in your 20s. 

 For example, Emily is 35 years old and puts 6% or $4,200 of her annual salary into the plan. Her account balance would be $279,044 with a 5% yearly return and 30 years until she retires at age 65. That amount would jump to $397,000 if she opted for a more aggressive fund at a 7% return along with higher risk. These amounts do not reflect an employer’s potential matching contribution.

Have Tax Advantages 

There are different retirement accounts, but they have a few things in common: they have tax advantages with varying growth scenarios depending on your preference. They have contribution limits set by the IRS that have increased over the years.

The best known of all retirement plans is the traditional 401K.  They have primarily replaced the defined pension benefit plans.

Most, but not all, employers provide the 401K plans for recruitment and retention purposes.

Small companies, which typically have resisted offering these plans because of cost concerns, often have many part-time or contract employees. They have been slower to adopt these plans and can choose to provide SIMPLE 401 K (see below).

Varying 401K  Plans

If you consider employment between two companies, examine the competing offers based on their sponsored plans for employer matching of your contribution.

Typically, a company will match 50% of every dollar you annually up to a percentage of your gross income, usually around 6%. Some companies match on a dollar to dollar basis but at a low rate of your salary.

Your contributions are on pretax dollars up to $19,500 in 2021, with an additional $6,500 contribution allowed if you are over 50 years as a catch-up measure.

Using pre-tax dollars, defer your federal and state taxes paid upon withdrawal, beginning age 59.5 years. Withdraws before that time will usually result in a 10% penalty. If you are retired, you must begin withdrawing required minimum amounts (RMDs)  by age 70.5 years. 

Greater Participation In Retirement Plans Can Happen

About 70% of all US workers have access to employer-sponsored plans, including 401K, 403b, 457, and the federal government’s Thrift Savings; 55% are participants. As more companies offer automation of contributions directly from paychecks, more employees will likely participate. 

If your company offers a 401K plan and will give you some kind of employer match contribution to add to your own, you are robbing yourself of that gift, and the compounding benefits for the many years you have until retirement. You are just leaving money on the table! 

Surveys have indicated that some employees say they don’t participate in their employers’ 401 K plans because they get overwhelmed by the possible choices they have and then postpone signing up for the program. Employers have encouraged employee participation by providing more information about investment choices and transitioning to opt-out offerings, rather than opt-in.

You can make changes in your selections if you think you picked a too aggressive or too conservative investing approach. Pick one and read your statements, familiarize yourself with the other choices if you want to make a change. Just make sure you start your plan and put in enough to qualify for and trigger your employer’s contribution. 

Roth 401K is similar to the traditional 401K but uses already taxed dollars, so your withdrawals are tax-free.  Roth 401K’s began in the retirement lexicon in 2006 after the introduction of Roth IRA.

Other 400 Plans For Different Organizations

403(b) plans are for employees of non-profit organizations.

The 457 plans are for state, local government employees, nonchurch, and other tax-exempt organizations. No employer contributions are allowed for this plan.

Employers with 100 or fewer employees offer Savings Incentive Match Plan for Employees or SIMPLE 401 K. Employers must choose between making matching contributions up to 3% of each employee’s pay or nonelective contributions of 2% of employee’s pay.

Traditional IRA

If you don’t have access to a 401K plan, or even if you do, you can personally set up your retirement account with a traditional IRA or a Roth IRA.

Your contribution to a traditional IRA is in pretax dollars. You defer tax payments until you make withdrawals at age 59.5. If you take out money from your IRA before age 59.5, you will pay taxes and may trigger a 10% penalty plus tax. You may contribute $6,000 in 2021, or $7,000 if you age 50 or older.

IRA withdrawals begin at age 70.5 as required minimum distributions or RMD.

The logic behind paying taxes at an older age is that you may be in a lower tax bracket. However, the reason may be in reverse, and that’s why Roth IRA’s have increased in popularity. Of course, your tax brackets will reflect how well you do in your career, and it is not likely you know that in your 20s.

Roth IRAs

With Roth IRAs, you contribute after-tax dollars, and your money grows tax-free. Your withdrawals are tax-free after 59.5 years. 

Roth IRAs have no required minimum distributions like their older IRA counterpart. You may be able to withdraw your contributions, not your earnings, before age 59.5 years without penalty if your Roth IRA has existed for five years or more.

In many ways, Roth IRA has been the preferred vehicle for personal retirement accounts and are more tax-friendly longer term.

Arming yourself with both 401K and IRA retirement accounts is the minimum planning you can do when you are in your 20s and 30s.

Borrowing Money From Your Retirement Savings Is The Last Resort

There are times when you face financial hardship and consider borrowing from your retirement plan.  Your 401K plan (not your IRA plan) allows you to borrow from your retirement assets and repay the amount with interest to your account rather than to a financial institution.

One of the most significant drawbacks of using your retirement assets is the loss of tax-deferred compound growth for the loan duration. Taking assets out of a retirement account should be a last resort. We discussed withdrawals, and if you do so too early, you pay taxes and penalties.

Final Thoughts

You have long years in front of you. Starting early in your planning, even with small amounts, allows you to benefit from compounding growth through the years. Earning interest on interest adds significantly to your retirement fund. 

Do it early so you can avoid the real angst of not planning. Procrastination is not an answer for anything! You’ll be glad you are getting a headstart!

Thank you for reading! 

 

 

 

10 Best Brokerage Accounts To Consider When Investing

10 Best Brokerage Accounts To Consider When Investing

When you are ready to start investing your money, choosing the right brokerage account is the key to reaching your financial goals and building the right foundation.

Fortunately, you have plenty of options to consider when you are looking for your online broker.

This is great news because you can be more selective and ensure you are using a broker that fits your investment needs. However, there is also a downside.

Since there are so many options, it can be daunting as a beginner or investing noob to know where to start and which platform is best for you.

But don’t worry! Below I’ll cover the best brokerage accounts to consider, which will hopefully help you make a more informed choice!

What is a Brokerage Account?

A brokerage account is an investment account that will allow you to buy and sell various investments like stocks, bonds, mutual funds, index funds, or ETFs. It’s also an account that can hold cash, so you have money ready to go to work for you when you are ready to invest.

Types of brokerage accounts

When you look at opening a traditional brokerage account, you will typically have two choices when you pick your broker: an individual brokerage account or a joint brokerage account.

Individual brokerage account: This is the standard account that most people use, where you open a brokerage account in one name and are the only account owner attached to that account.

Joint brokerage account: If you open a joint brokerage account, this means you will be opening a shared account with two or more individuals. Typically, you’d open a joint brokerage account with your spouse, but one can be opened with your child, other family members, and even business partners. There is more info as well as pros and cons with this account type – learn more here.

What can you do with a brokerage account?

Utilizing a brokerage account is a great way to help you accumulate wealth, save for a large purchase in the future, and invest for retirement outside of your 401k or IRA.

When you open a brokerage account, you have more financial options for your money than, say, a savings account at your bank.

You can buy and sell stocks, mutual funds, ETFs, and other securities.
Get access to investing tools, research, and experts to help you.
It helps you reach bigger financial goals than letting your money sit in a bank.

When should you open a brokerage account?

You should open a brokerage account when you have savings goals five years or more away but might not be for retirement. This account can be a great companion to your emergency fund, which can elevate your overall financial health.

And since a traditional brokerage account is a taxable account, make sure you first have your emergency fund built and max out your retirement accounts first. That way, you are financially prepared and are ensuring you are investing for your future retirement.

Opening a traditional brokerage account can also be a great way to put more of your money to work, especially as you earn more or have leftover money to invest. It’s how you can ensure to become wealthy and live a more comfortable life.

So Which Brokerage Account is Best?

The challenge with choosing the right brokerage account is that many offer similar features, services, and price points for trades and accounts.

In the last few years, the financial industry had some disruptors shake up the market, forcing some of the original players to match. This is great news for you, the investor. But like I said earlier, this can make it difficult to choose the right broker or confuse you.

Below is a list of the best brokerage accounts:

  • Charles Schwab
  • Vanguard
  • Fidelity
  • Webull
  • Robinhood

Charles Schwab

Charles Schwab is one of the best online brokers out there. They offer a wide range of low-cost index funds and ETFs, and this year dropped their trade commission fee to better compete with some new fintech companies (like Robinhood).

Their platform is relatively easy to use. But like with anything, it takes some time to get up to speed. Once you’re familiar, though, it’s easy to set up a sound index investing strategy with Schwab.

Fee Snapshot:

  • 0.02% lowest fee for an ETF or index fund
  • $0 commission per trade

Noteworthy Funds:

  • SWTSX – Schwab Total Stock Market Index Fund (0.03% expense ratio)
  • SWISX – Schwab International Index Fund (0.06% expense ratio)
  • SWAGX – Schwab U.S. Aggregate Bond Index Fund (0.04% expense ratio)

Vanguard

Vanguard is a personal favorite of mine and is also a pioneer in index fund investing. Also founded in the 1970s, it was developed by John C. Bogle, who is also touted as the father of index funds.

Vanguard is the original and arguably the best place to buy index funds. It was founded by John Bogle, the man who created index funds himself.

While they don’t have the absolute lowest fees or sexiest online platform, they have a long history of being a trusted broker for index investors. Plus, their costs are still pretty dang low.

Fee Snapshot:

  • 0.04% lowest fee for an ETF or index fund
  • $0 commission per trade (with Vanguard funds)

Noteworthy Funds:

  • VTSAX – Vanguard Total Stock Market Index Fund (0.04% expense ratio)
  • VTIAX – Vanguard Total International Stock Index Fund (0.11% expense ratio)
  • VBTLX – Vanguard Total Bond Market Fund (0.05% expense ratio)

Fidelity

Fidelity has slightly fewer index fund options compared to Vanguard and Schwab, it seems, but that’s not always a huge deal. Especially if you are building a simple three-fund portfolio.

They do offer funds with 0% expense ratios. That’s right, 0%!

That is something that neither Schwab nor Vanguard offers at this point. It could be something that changes in the future, with prices becoming more focused on these online brokers.

Fee Snapshot:

  • 0.00% lowest fee for an ETF or index fund
  • $0 commission per trade (with Fidelity funds)

Noteworthy Funds:

  • FNILX – Fidelity ZERO Large Cap Index Fund (0.00% expense ratio)
  • FZROX – Fidelity ZERO Total Market Index Fund (0.00% expense ratio)
  • FZILX – Fidelity ZERO International Index Fund (0.00% expense ratio)

Webull

One of the newer brokerages on the block is Webull, which has quickly started establishing itself as a top contender in the investing space. The company was founded in 2017, so it has a short track record and offers some great things for investors.

Webull was built as a mobile-first platform, and they offer commission-free trading of stocks, ETFs, and options. You can open individual brokerage accounts or an IRA, plus you can even trade cryptos. The one downside is that they do not offer index funds at this time, but they do have a great selection of ETFs.

Also, they have a robust trading research platform to help you make better investment choices.

Learn more about Webull

Robinhood

Robinhood gets a slight edge over Schwab because of the simple and intuitive platform. That, combined with free trading, is hard to beat!

Though, it does offer a bare-bones platform. Which helps keep it easy to navigate, but if you’re looking to do robust stock research, you’ll likely need to do that outside of the Robinhood app.

Important to note here as well is that simple is not always better when it comes to investing. Robinhood makes stock trading very easy, almost like a game. Which it certainly is not! All trades should be made carefully and only after doing diligent research.

Fee Snapshot:

  • $0 commission per trade

The Best Automated Options (Robo-Advisors) for Beginners?

If you are just getting started with investing or might be looking for more automated options, there are some other brokerage accounts you might want to consider as a beginner.

Below is a list of the best brokerage accounts for beginners:

  • M1 Finance
  • Betterment
  • Stash
  • Ally Invest
  • Blooom

M1 Finance

Many people would like to invest but aren’t interested in always learning or tinkering with their portfolios. One option is to choose M1 Finance, which makes investing easy with their automated account management and portfolio options.

You can choose over 80 custom profiles to invest in, own fraction shares of stocks or ETFs, and create investing and rebalances schedules, so you don’t have to log in constantly. There are a few account options, too, like an individual brokerage account, joint brokerage account, an IRA, or a Trust.

With M1 Finance, you aren’t charged commissions or markups on any trades, no platform usage fee, and no fees to deposit or withdraw from your bank. However, there are some miscellaneous fees to pay attention to for certain actions.

Learn more about M1 Finance

Betterment

Robo-advisors, in general, win out on ease of use, plain and simple. Especially with Betterment, which offers a clean and easy to navigate interface. Plus, once you answer their upfront questions, they manage your investments for you. It doesn’t get much easier than that!

Though, Betterment does come with a cost – a 0.25% management fee. That fee adds a high cost to your investments, so you need to be sure that the simplicity that Betterment brings to your life is worth the extra cost!

Fee Snapshot:

  • 0.25% management fee
  • 0.03%-0.25% range of fees for ETFs

Noteworthy Funds:

  • SCHB – Dow Jones U.S. Broad Stock Market (0.03% expense ratio)
  • VOE – CRSP US Mid Cap Value (0.07% expense ratio)
  • SCHF – FTSE Developed ex-US (0.06% expense ratio)

Stash

Stash Invest, or just Stash, has quickly risen the ranks as one of the best investing platforms for beginners and beyond. You can invest in fractional shares of funds and stocks with as little as $1. The company will also help you balance and provide portfolio recommendations tailored to your needs.

Stash offers three account plans for investors that will cost $1 to $9 per month (pending your selection). Each plan offers features, even beyond your investments, so you have more control of your money.

You can also invest in a brokerage account, traditional IRA, or Roth IRA retirement account.

Learn more about Stash

Ally Invest

In the personal finance industry, many love and utilize Ally Bank for their online banking needs. But you might not have realized they also offer investment options and services too.

Ally Invest offers Self-Directed Trading and Managed Portfolios, which have some differences between them.

Self-Directed Trading: stocks, bonds, mutual funds, and ETFs, commission-free stocks, commission-free ETFs, commission-free options trading.

Managed Portfolios: Robo-advisor that you can start with just $100. No advisory fees, annual charges, or rebalancing fees, and 30% of your portfolio is set aside as an interest-earning cash buffer. Monitoring and automatic rebalancing of portfolio, ETFs, and various portfolio choices to pick from.

Learn more about Ally Invest

Blooom

Blooom is a unique robo-advisor in that they mainly focus on 401(k)s. They don’t offer a variety of funds themselves, but rather they connect to your existing 401(k) provider to offer optimization tips and potentially even manage your account.

Blooom offers two levels of service:

  1. A Free 401(k) Health Check-Up: Blooom can hook up to your 401(k) to review your account and provide recommendations on how to optimize your investments
  2. Paid Ongoing 401(k) Management: Blooom offers ongoing 401(k) management, so you can take a more hands-off approach and let them take the wheel

Fee Snapshot:

  • Free 401(k) analysis
  • $10/month flat fee for ongoing 401(k) management

What The Blooom Free Analysis Provides:

  • Diversification recommendation
  • Fee check-up – ensuring you are in the lowest fee funds possible
  • Obvious watch-outs, like being invested in company stock
  • Retirement tracking snapshot

Are brokerage Accounts Worth It?

Pending your current personal finances, opening a brokerage account can be a great option for you. These allow you to save money and invest in helping you reach a future goal (like saving six-figures).

Here is what makes brokerage accounts worth opening:

No withdrawal limitations or penalties like 401ks or IRAs
You can take money out anytime without paying fees.
You can invest as much as you want, with no account restrictions.
There can be more flexibility when you pay taxes, pending when you sell
Can earn a tax break from any loss on losing investments

Remember, the downside is that you will typically have to claim any capital gains as taxable income with a brokerage account. However, funds and ETFs are more tax-efficient that might be interesting for you to invest.

Is my money safe in a brokerage account?

When you invest in a brokerage account, your money is insured and protected by SIPC (Securities Investor Protection Corporation). This protects the customers up to $500,000 and up to $250,000 in cash. For any legit broker, this means you have protections in place to receive refunds if your cash and assets of the brokerage go bankrupt.

How do I Choose A Brokerage Account?

Since there are so many options today, it might be hard to know which brokerage account to choose. While many of the above brokerage accounts offer very identical features, there will still be some minor differences that might matter to you.

Here are some important tips to think about before opening any brokerage account.

Understand the fees

While fees have gotten lower over the years thanks to the Fintech disruption, many brokerage accounts may offer various fee amounts. Naturally, you want the lowest fees possible. But don’t get too caught up in chasing minor fraction percent savings, especially if one broker has everything you need.

Look for things like fund fees, account fees, if there are fees to buy or trade stocks, etc. Compare those numbers to all the brokers you are considering.

What types of investments do they offer?

As you consider opening and investing in a brokerage account, what kind of investments you need will matter. Pending the company you choose, you’ll want to ensure they have the type of investments you want.

Do they offer ETFs, index funds, bonds, stocks? Are their choices limited and selective? Do they offer custom portfolios, or do you need to pick your investments only?

Make sure the platform lets you do everything you need

The goal is to have a platform that allows you to manage investments all in one place. While you might be interested in just a traditional brokerage account, it’s nice to have other options like retirement accounts, 529 plans for future education costs, etc.

Brokerage Accounts FAQ

Can you use a brokerage account as a checking account?

A brokerage account does have similarities to a checking or savings account in that you can make as many contributions or withdrawals as needed at any time. However, a brokerage account gives you way more investment options and is not FDIC insured like a traditional bank.

Do you pay taxes on a brokerage account?

When you open a traditional brokerage account that is not a retirement account, you have opened a taxable account. This means if you make money when your investments go up or your investments pay dividends or interest, that income is going to be taxed.

Is there a penalty for withdrawing from a brokerage account?

With a traditional brokerage account, there are no penalty fees for withdrawing money from that account. However, any money you withdraw will be taxable. So any capital gains from the sale of your assets are subject to taxes, which is something to keep in mind.

This article originally appeared on Your Money Geek and has been republished with permission.

11 Best Robinhood Alternatives To Start Investing Your Money

11 Best Robinhood Alternatives To Start Investing Your Money

If you are using the Robinhood app for investing, you might be considering switching or just testing out something different.

After all, there are many Robinhood alternatives these days, thanks to new fintech companies looking to make it easier for anyone to invest.

Yet, with all the investing platforms and apps out there, which are some of the best ones to choose?

Below you’ll learn a bit about the Robinhood app, alternatives to Robinhood, and which might be right for you.

What is Robinhood?

If you are already using Robinhood, then you know exactly what this investing app and trading platform does, so feel free to skip to the next section.

However, if you are on this post considering Robinhood and its alternatives, then stick with me briefly. Robinhood provides free stock trading, options, ETF, and cryptocurrency trades, and to get started there is no account minimum.

The challenges are that Robinhood currently does not offer mutual funds or bonds and you can only invest in taxable accounts.

In the early days, Robinhood was the only platform to offer commission-free trades, which was revolutionary at the time. But many financial companies have now offered that too.

Is Robinhood really free?

Robinhood is the pioneer in commission-free trading, which means you retain more of your gains. However, the company makes money through their data and research subscription, SEC trading fees, and selling customer orders to trading firms.

Is Robinhood good for investing?

Robinhood can be a good investment option for those looking to get started in day trading, options trading, cryptocurrency, and ETFs. You can invest in fractional shares for as low as $1 and everything is commission-free.

Recent Robinhood Issues

While the Robinhood app had become a darling in the fintech world, valued currently over $7 Billion dollars, they have run into a few issues over the years. This has caused many people and investors to further seek out Robinhood alternatives.

In 2019, the company was fined $1.25 million by the Financial Industry Regulatory Authority (FINRA).

The reason was they did not ensure users received the best prices possible from October 2016 through November 2017. The company neither denied, nor confirmed the claims.

And in March 2020 while the stock markets were plummeting, Robinhood’s platform suddenly went offline and no one could access their accounts.

While server issues can happen to any company, Robinhood struggled to get everything back up in a timely manner (over 24 hours) and communication about the downtime was a bit poor.

Many customers were obviously frustrated as the market decline caused many to not trade or be able to safeguard their investments in time. You can read more about it in the NY Times.

News: More recently, Robinhood has suspended trades on a few stocks, which you can read more about here. But if that’s the last straw for you, there are better Robinhood alternatives to consider.

Why You Might Want to Check Out Robinhood Alternatives

There are still many customers and good reasons to use Robinhood as an investor.
Like the intuitive app, no trading fees, fractional investing, no account minimum (except for margin accounts), and they even have high-yield savings now.

However, as you expand your investing, your needs and interests may grow. Additionally, you might be frustrated based on the issues above or it does not offer what you need anymore.

Personally, the downsides I see with the company beyond their past issues are they do not offer retirement accounts currently; you can’t invest in mutual funds or bonds, and minimal customer support.

If you are looking for low-cost trading and more features for investing, then some of the below Robinhood alternatives might be great options for you to consider.

The Best Alternatives to Robinhood

Each of these alternatives to Robinhood offers similar and different features compared to one another. Pending your investing and financial goals, one may suit you better than others.

1. Acorns

Acorns is a popular finance app that also lets you invest in multiple trading options at $0. On their investing side, you have some neat options.

They are a micro-investing account, which allows you to invest your spare change.

You can invest for retirement when they recommend an IRA and portfolio that is tailored for you specifically. Acorns then will update it and handle it to match your goals.

And they offer a checking account with a debit card that saves, invests, and earns for you. You get free bank-to-bank transfers, no overdraft or minimum balance fees, and unlimited free or fee-reimbursed ATMs nationwide.

Pending which tier you choose, Acorns costs either $1, $2, or $3 a month. Super affordable for access to numerous financial products.

2. M1 Finance

M1 Finance is a free brokerage and financial platform that offers “automated investing.” When you invest with them, you’ll be able to invest in fractional shares of stocks or even ETFs.

But what is unique to M1 Finance is their Pie-based investing interface, to help you build and manage your investment portfolio much easier.

Once you sign-up, the app will ask you for your details and goals. From there, M1 Finance creates a pie that features over 6,000 stocks and funds. You choose which pie best fits for you and then you are diversified.

This simplifies your investing as you don’t have to research or figure out what funds are best. Just rebalance a bit as needed and continue investing!

There is plenty more to get into, which you can read in my M1 Finance review.

3. Stash

Another investing app to consider is Stash, which you’ll have access to banking, investments, retirement, and saving all in one.

While not free to use, you can easily get started with their beginner level that costs just $1 a month. If you want to up the ante, you can go with their $3 or $9 a month option that provides other great benefits.

Like some of the other Robinhood alternatives, Stash lets you invest with any dollar amount because of their fractional sharing options.

There are more than 400 stocks and funds that you can choose from, which include stocks, bonds, and ETFs.

Stash also offers a traditional IRA or Roth IRA to invest for your retirement. And even custodial accounts, which you can open an investment account for your kids.

Of course, I’m merely scratching the surface of their investing platform, but you can learn more here and open an account with a $0 balance, but $5 is required to begin investing.

4. Webull

Many people love no commissions or no fees, which is why many investing apps offer that service. And Webull is no different. The investment company offers $0 Commissions and no deposit minimums.

Diversify your portfolio with a comprehensive suite of investment products such as stocks, options, ETFs, and ADRs.

And it’s good for any level of stock trading knowledge, so whether you are a beginner or a pro, Webull can be a great platform for you.

There are some fees, which are any of the SEC fees required by law and some wire transfer fees, but there are not any service or management fees! You can read more about fees and pricing info here.

What makes Webull a strong alternative to Robinhood, is the app offers a deep analysis of the investment options you have. This helps you make better investment choices and trades while trying to help you lower your risk.

Additionally, they have a practice trading app where you can test out investments without any real money. Helping you learn and perfect your investing.

Quickly, Webull is growing to become a major player in the investment and trading app space.

5. Ally Invest

Ally Invest may sound familiar because it’s another product off the widely popular Ally Bank. However, you do not need to be a banking customer to have access to their investing platform.
With Ally Invest you have two trading options, self-directed trading, and managed-portfolios.

Here is a quick breakdown:

Self-directed trading:

No commission fee on U.S. listed stocks and ETFs
No commissions on option trades and competitive contract fee of just 50¢ per contract
A wide variety of investment choices built with the do-it-yourself investor in mind
In-depth research and market analysis tools to support all types of investment strategies Investment choices
Commission-free stocks, Commission-free ETFs, Commission-free options
Bonds and Mutual funds
Margin account

Managed Portfolio (robo-advisor):

Get started with $100
No advisory fees, annual charges, or rebalancing fees, and 30% of your portfolio is set aside as an interest-earning cash buffer
We recommend and manage a professionally designed portfolio based on your personal goals, timeframe, and risk tolerance
We’ll monitor and automatically rebalance your portfolio to make sure your plan stays on track
Includes a mix of low cost, diversified exchange-traded funds (ETFs)

Ally Invest is a great Robinhood alternative because it has more investment options and trading tools to help you succeed.

6. Stockpile

While most of these alternatives to the Robinhood app offer free commission trades, Stockpile is different. The company charges $0.99 per trade, which is still a fairly solid price.
However, there are no monthly fees or minimums required! But Stockpile can be a good option for you and has some cool features.

First, is their fractional shares investing, where you can invest in over 1,000 stocks and ETFs with any amount.

If you download the Stockpile app, you can learn about stock trading via their mini-lessons

One unique aspect of Stockpile is they are the only brokerage where you can give an e-gift or physical gift card that is redeemable for stock. You can give the gift of stocks without even having an account with them!

Lastly, you can also open an account for kids or teens, which you have control to approve to ensure they do not go wild in trading.

7. eToro

While I personally am not investing in cryptocurrency just yet, many people are and want these options. And additionally, many are using Robinhood to buy and sell digital currencies like Bitcoin, Ethereum, Dogecoin, and many others.

But if you are looking for an alternative for crypto investing, then eToro might be an option worth considering.

This platform has quickly become one of the most popular crypto destinations that offer access to the best coins, with no hidden fees. The minimum deposit is $50 and that can get you started buying and trading on their platform.

Additionally, eToro offers what they call “Copy Trading,” where you can copy other top traders at no extra charge. Those top traders get paid directly as part of their Popular Investor Program.

8. TD Ameritrade

One of the older stock trading platforms on this list is TD Ameritrade, which is now owned by Charles Schwab. This is a great platform for new investors or day traders who are active in stock market trading.

But there is something here for those looking to buy and hold as an investing strategy for retirement.

In 2019, TD Ameritrade went commission-free. Pretty much all platforms have some sort of free commission structure as more fintech companies pushed for fewer fees in recent years.
Additionally, there is no account minimum to get started.

TD Ameritrade might be a good choice for you because It has more stock trading options than Robinhood. This includes investment choices like mutual funds, forex, bonds, and others.

One of the big wins is their tools and educational materials. I used these in the past when I was interested in more day trading.

But their thinkorswim platform and mobile trading will give you plenty of practice and knowledge about investing.

9. Firstrade

When I was doing the research for various alternatives to Robinhood, I came across Firstrade. I have not heard of them much before, but the online broker looked intriguing.

Firstrade offers investors the traditional brokerage account or retirement account with various assets to consider investing in. For example, mutual funds, ETFs, options, stocks, etc.

What I like about this company is the amount of educational material and tools to help investors grow and build wealth.

They have reports provided by Morningstar, Benzinga, and other known stock marketing investing websites.

And like many others on this list, they offer free trades and no hidden fees. This is key with any broker option you choose and ensure you are keeping as much money as possible.

10. E-Trade

One of the older investing platforms in the game is -Trade, which also recently had to match other investing platforms with $0 commission trades.

If you plan on trading stocks more often, E-Trade is a popular choice and more enticing with its better features and fee structure changes.

But you can open various accounts like traditional brokerage, IRAs, managed portfolios, they even have savings and checking accounts as well.

And with your trading accounts, you have access to stocks, bonds, futures, options, ETFs, mutual funds, and prebuilt portfolios to make your life easier.

The investing platform offers extensive collections of information, covering everything beginners and advanced investors need to know or may have questions about.

Since pricing is the most important based on looking for Robinhood alternatives, E-Trade has stepped up their game and offers $0 fees on stocks, options, and ETFs as well as minimal fees for other investing types

I’m not going to dive in too much here, because E-Trade covers a lot. So if you are intrigued or want to learn more, I highly recommend exploring their website further and watching some of their videos to understand all the benefits.

11. Public.com

Out of all the Robinhood alternatives on this list, Public takes on investing slightly differently.

The commission-free trading platform focuses on companies that are added to different themes like companies in American Made, Fighting Disease, etc. You don’t have to invest in companies by theme, but it’s an interesting option.

Public offers thousands of stocks and ETFs that are currently available as fractional shares — this means you can invest in companies with less money.

Additionally, Public is built like a social media platform.

You can share your trades with friends and follow well-known investors to see how they are trading. And the platform also has a blue-check option to help ensure you are following the real verified public figures.

Is There a Better App Than Robinhood?

And there you have the best Robinhood alternatives that you might want to consider. As you can see, there are more options that offer commission-free stock trading and keep fees to a minimum.

However, which trading app you choose depends on your investing style and features that will best help you succeed.

Personally, I don’t think Robinhood is the worst option, but it’s important to understand what the platform offers and any of the issues the company has faced recently.

And while free or a $0 platform may sound great, choosing it just based on price could compromise your results because you wanted to save a few bucks a year.

While Robinhood is free and has some solid features, other apps like Acorns, Stash, Ally, and M1 offer more product features and services that can take your investing to the next level.

This article originally appeared on Invested Wallet and has been republished with permission.

A Letter To Young Investors On This Market Frenzy

A Letter To Young Investors On This Market Frenzy

Dear Young  Investors,

This stock market has been fascinating, exciting, and mesmerizing, but I fear a trainwreck is coming. When GameStop’s stock value rises to $34 billion from nearly $279 million a year ago, and its fundamentals are still weak, this move is not rational. I want you to understand why and I have tips to share to minimize risk. There appears to be no reason for this stock to climb as it had. None of the analysts or the company management are signaling a positive change.  

 Market frenzy is not new, but the Reddit forum, Wall StreetBets, and its influential power are a way of making recommendations. This new tactic may pose significant risks, not just to the hedge funds but to the marketplace itself. Already we have seen fallout such as Melvin Capital. This hedge fund lost 53% from its short-selling in January. They are a professional firm that should understand the perils of short selling.

My sympathy and concern lie with the young and inexperienced investors. They may lose their motivation to invest for lack of trust in the financial markets. I applaud the higher participation of young retail investors and hope for their investing success. We explain what is happening and provide helpful investing rules and tips to minimize risk later on in this letter.

Higher Retail Participation

 I have a gray hair or two, but in my experience, I have not run across the message board and retail traders recommending aggressive purchasing several out-of-favor stocks (GameStop, Koss, AMC, American Airlines) to the moon. Social media’s influence on the financial markets, specifically Reddit WallStreetBets, and now the more than six million members, powered several stocks–Bed Bath & Beyond, Koss, GameStop, AMC–to extraordinary heights as these companies’ fundamentals remain poor.

The Reddit forum peppers its board with new Wall Street lingo. Terms like “yoloed a stock” translates to  “you only live once.” It means that you should make a significant investment in that stock. For more on traditional Wall Street jargon, you can read our post here.

Who would have thought we would see such volatility in Gamestop and other stocks as retail traders rage against hedge funds in positions of the longs against the shorts, the traditional vs. new breed in this David vs. Goliath saga. I am sure some institutional investors are riding this horse alongside the retail traders. 

Is there stock manipulation in this activity? Stock manipulation occurs when there is artificial inflation or deflation of security prices for personal gain.  I don’t know that anyone would be surprised if that is happening. I am sure the SEC, and its eventual head, Gary Gensler, are watching closely. 

How Will This Market Frenzy End?

Who or what is responsible for the market frenzy, and how will it get back to normal, if ever? We have seen this story with different stock names before, and we will see it again. It will be a learning experience. There will be books to explain it with hindsight and at least one movie to entertain and educate us. “Wolf of Wall Street” will pale next to this new story.

I will try to explain what is happening and make sense of it, although it is a moving picture. I will always encourage you to understand the stock market, its risks, and how to reduce them. You need to invest responsibly. Investing remains the best path to wealth.

In recent years, the industry changes have seen new entrants like Robinhood enabling young and inexperienced retail investors to access the financial markets. Is Robinhood the villain or the victim? They have had to raise substantial capital to facilitate activity.

Increased retail participation is a good thing, but investors need to understand the market risks and use financial discipline. 

As an investor and an ex-Wall Streeter (I was an equity analyst at Drexel Burnham and UBS), I have seen my share of events (e.g., Long Term Capital, dotcoms, WorldCom, and subprime mortgages) that caused extreme market volatility. Financial markets are regularly subject to volatility, but the (GameStop) frenzy seems quite different and more extreme. People always get financially hurt, sometimes devastating so and this time will not be an exception.

GameStop

The astronomical rise to an irrational high of $483 (thus far) in GameStop (GME) in January 2020 was surprising given its rational $4.21 stock due to its poor fundamentals. Comparisons to Blockbuster in the then-emerging Netflix era are apt. GameStop, brick & mortar retail business selling video games and consoles during COVID, is not a recipe for success. My teen son downloads his games now. GameStop was once our favorite destination, but that was years ago.

A year ago, the shares traded at $4.21 per share with a $279 million market cap. With its fundamentals declining, GameStop has been a target for short-sellers, notably by hedge funds. Reddit forum has driven stocks to record levels initiating short squeezes (explained below) on institutional investors. Quotes from WallStreetBets are helpful to understand the movement to affect stock prices. 

This frenzy is more significant than the GameStop action, which has spread like a contagion to several other stocks, including AMC, Bed Bath & Beyond, American Airlines. Stock and options traders, many Robinhood customers, have collectively used their influence via WallStreetBets, a Reddit forum, to support GME’s price.

Since the start of 2021, GME has been hugely volatile, going up 600%. According to S3 Partners, short-sellers have lost $5.05 billion, resulting from short squeezes. Let me explain these terms, so you can better understand short-selling and short squeezes.

Short Selling And Short Squeezes

Traditionally, when you buy a stock, you hope the stock up above your purchase price, and you have a profit. Short-selling is a bet that the stock will decline, and you will buy the shares by borrowing the shares, speculating you can buy them at a lower price in the future. It is an advanced strategy and should be done only by experienced traders who will hedge with call options.

A short squeeze occurs when a stock, like GME, rises sharply, forcing short-sellers, who expected GME to fall, to have to buy shares to minimize their losses. If many traders are doing the same thing, it places upward pressure on the stock price.

Hedge funds heavily shorted GME. Its short interest was $5.51 billion, up from $276 million a year ago. The percentage of GameStop’s float (e.g., regular shares available to trade) sold short was 139.57%! That is an obscene number. The GME situation is ongoing, pinning the WallStreetBets traders against hedge fund companies or David against Goliath (the hedge fund companies). The facts are not fully known.

Even My Daughter Gave Me Advice

What was scary for me was a conversation I had with my daughter, Alex, this week. Alex is bright, a terrific student, but she doesn’t know much about the stock market or care. She surprised me when she asked if I owned any shares of GME or any of the pumped-up stocks. When I assured her that I didn’t, as she turned from me as if I were a loser, she said, “But, Mom, you could have made so much money!!!!” I love making money, but I do try to limit my risks.

So, this letter is also for my kids, Tyler and Alex, my college students, and of course, my readers!.

How Did We Get Here?

 

The Democratization of The Stock Market

More retail investor participation in the financial markets did not happen overnight. The household distribution of US stock ownership has been unequal for a long time. 

According to US Census, in 1952, only 4.2% of the US population owned common stock. A 2020 Gallup Poll reported that 55% of Americans hold stocks, but the ownership is mostly the wealthy. Based on net worth, the top 1% own the vast majority of stock market value at 88.1% as of 4Q2019.

In early 2020, with market downturn associated with coronavirus, many young first-time investors signed up for new accounts at online brokers, traditional and Robinhood. That trend of increased young investor participation will hopefully continue unless the GameStop phenomenon ends badly.

Reduced Barriers To Entry

There have been reduced barriers to entry driven by deregulation, technology, reduced cost, and increasing competition. Competition emerged first in the brokerage industry with discount brokers and online brokers.

Robo Advisors

The rise of smartphones drove investors to innovative and disruptive digital services. Robo-advisors such as Robinhood are investment management companies that use computer-generated algorithms and potentially human-based advisory services to develop a stock portfolio. Their products are stocks, funds, options, gold, cryptocurrencies, all available at zero commissions, lower management fees, and no-to-low minimum requirements.

They serve young and first-time investors with easier access to low-cost investing via trading apps on an equal playing field. These fintech companies have fully digital platforms with easy to use interfaces, sophisticated trading tools, and research resources.

Robinhood

With at least 13 million customers, Robinhood is among the largest online investment platforms for stocks, options, and cryptocurrency trading. They don’t require their customers to have a minimum of money in their amount, so they cater to all people, not just the wealthy.

Robinhood attracts scrutiny from the SEC, Congress, and the public. They have increased their educational resources for beginning traders and investors. It is not clear how effective that will be in reducing risks associated with speculative trading.

Their average customer is in their mid-20s, with significant Millennial representation. Due to the madness occurring in the markets, Robinhood has restricted transactions in several stocks to closing positions only and raised their margin requirements as of this writing. CEOs Vlad Tenev and Baiju Bhatt asserted that many of their customers use Buy and Hold strategies with a long-term perspective.

Are Young Investors Taking On Too Much Risk?

Retail investor participation has grown in recent years. Many people began investing during the lockdown as sports, entertainment, and gambling establishments closed.

As a college professor, I encourage my students to begin investing in the market through the Stock Market Game. Some already have Robinhood accounts and are trading stocks, options, and cryptocurrencies. Investing in stocks, which typically generate higher returns than bonds, is the best path to achieving wealth. Higher returns come with higher risks that you need to understand to mitigate those risks.

8 Tips For Young Investors

 

1. Get Your Finances In Order First

Never invest money in the market you can’t afford to lose. Before investing, make sure you can keep your lights on by paying the utility bills. Your finances should be sufficient to cover your necessary living costs for a reasonable time. Don’t use your rent money to trade or invest. Instead, set some emergency money aside.  

2. Can You Explain Your Strategies?

Don’t take wanton or reckless risks by engaging in strategies you don’t understand. I know people have FOMO (fear of missing out) when they see their friends make a ton of money by adding many risks. Learn through YouTube Channels and resources available to you to understand the downsides in any stock trading or investing.

If you bought X stock, could you explain its fundamentals and why it is attractive at current valuations to a friend or colleague? I am talking about a 30-second pitch, but it is good practice to know why you are investing.

3. Don’t Use Leverage Through Margin Buying

Buying or trading stocks on margin is a significant risky move. When buying shares in a company, you may use some of your own money and borrow the rest from your broker.  People use margin buying to make higher profits through the added leverage. By paying only a small portion of the total amount, investors amplify their purchasing power. However, it doesn’t always work in your favor.

Essentially, you are borrowing money or using leverage to pay for your investment. Margin calls are an extension of credit, with your securities acting as collateral. Typically, you can borrow up to 50% of your intended investment, and your broker has a 30% margin requirement, although it can vary.

A Margin Requirement Example

Mary will borrow $25,000, buying  $50,000 of stock ABC. Under normal circumstances, If ABC drops 30% to $35,000=($50,000 x .30). Mary’s equity is now  $10,000 = (35,000-25,000 borrowed). Her broker’s margin maintenance requirement of 30% rears its head, meaning Mary needs to have $10,500 in her account= (35,000 x .30), requiring her to add $500= ($10,500-$10,000) for the margin call. 

The risks you may face are largely out of your control. When the market becomes volatile, brokers may raise margin requirements to as high as 100%.  A few brokers, including Robinhood and Interactive Brokers, raised margin requirements to 100% on specific volatile stocks like GameStop and Bed Bath & Beyond. You either can satisfy their requirement or sell the shares. If your stock has plummeted, and you don’t have the liquidity to meet the margin call, you must sell the shares.  

4. Short-Selling Is Complicated

For experienced traders and investors, short-selling has its merits, but there is no place for inexperienced traders or investors. A stock’s value may decrease for many reasons, including lower revenues and profits, product failures, or increased competition. Short-selling has been in the press, especially related to GameStop, which has a very high short interest and brought out a swarm of retail traders who have sent GameStop in the opposite of where the short-sellers want it to go. Watching the market volatility reminds me of the dangers of short-selling and margin buying strategies.

A short sale of a stock involves selling a stock you don’t own. Therefore, you have to borrow the shares to sell them on the market, speculating that the share price will decline. The short seller must replace the shares at a later date. As you borrow the stock for the short sale, this trade requires margin, but it requires a higher amount because there is no collateral, as we discussed.

The Fed requires all short sale accounts to have 150% of the implementation’s short sale value. This percentage is a minimum, but the broker can adjust the requirements upward.

An Example of A Short Sale

Let’s say you believe GM is overvalued at its current price of $35. You’ve done research (hopefully!) and found out the company will generate lower revenues than the consensus believes due to potential product recalls. You call your broker and arrange to borrow 100 shares of GM at $35, or $3,500 selling price, and the broker sells those shares.

A few months later, GM shares drop to $27, so you instruct your broker to purchase 100 shares at that lower price, or $2,700. These latter shares are given to the brokerage firm to repay the borrowed stock.  You pocket $800, or the difference between $3,500 and $2,700.

A Short Squeeze

This example is simple and straightforward. Imagine a transaction with GME and shorting 10,000 shares at $5 per share, or $50,000, expecting GME to go to $3 per share. Instead, GME shoots up to $300 per share, and days later, it is worth $3 million. There have been instances of short selling disasters. For example, when a company gets a higher buyout which lifts its shares. The GME situation is different for the messaging boards and how the traders collectively pushed up several companies’ stocks.

Use Call Options

Short selling is not for the faint of heart. You can limit your risks by using call options to hedge against a possible rise in the stock. Without an option, you are opening yourself up to unlimited losses. Targeted hedge funds (e.g., Melvin Capital) lost billions on GameStop, and they have experience. What makes young traders believe that they can handle these risks?

I have not engaged in short selling, which would mean I would want a stock to go down. However, some short-sellers provide valuable insights by uncovering stocks that may be overvalued or fraudulent. Short-seller Jim Chanos haunted the shares of Enron in 2001 by uncovering Enron’s accounting scandal.

Day Trade Is Challenging

The stresses of day trading are very high. Traders rapidly buy and sell stocks throughout the day, hoping to make more profits than losses. Unfortunately, many make more losses at first. They tend to borrow money, buy money on margins, and requires access to capital.

There is a low chance of success in earning an income as a day trader, yet it is a challenge to do this only on a part-time basis. It may sound exciting as you can do it from your home, but there are costly technology needs and a good stomach to handle the pressures. Swing trading is an alternative that has some similarities to day trading but is usually is done over a more extended period and not your full-time job.

When the market gets volatile, don’t bail by selling all your stocks. 2020 was an extraordinary year for many reasons. It was a year in which the stock market proved its resilience.

From its February peak to  March 23rd bottom, stocks dropped nearly 34%. However, the S&P 500 index resulted in a 16% gain for the year and a 44% gain for the NASDAQ. Imagine if you sold your shares on March 23rd?  Many people did sell, learning a lesson about holding on to stocks during market volatility.

5. Buy And Hold Strategy

I am not a short-seller and don’t use leverage or day trade for fear of taking on too much risk. I have made some poor choices through the years, such as selling stocks too early, being too greedy, not having enough patience, or buying a stock I didn’t understand. My investment strategy is more deliberate buying and holding onto fundamentally strong stocks for the long term.

This strategy has some advantages like compounding, lower capital gain tax rates, and waiting out the turbulence and dips, or buying more stock for dollar-cost averaging to reduce my basis. Compounding is an excellent tool to grow your wealth in retirement and taxable accounts exponentially. That said, you do need to use financial discipline. 

6. Take Some Money Off The Table – Don’t Be Greedy

It is a good idea to sell some stock to lock in a 20%-25% gain. I have learned the hard way, watching my stocks climb as if going up were inevitable, losing money in dotcoms and elsewhere. The old Wall Street saying remains close by with these words, ” Bulls make money, bears make money, pigs get slaughtered.” If you have some big gains from GameStop, you probably want to lock that in even if you will pay the higher tax rate.

On the other hand, if a stock is not working as you thought, it may be time to admit a mistake. Consider limiting your losses by selling the stock after it is down 8%. You want to revisit its fundamentals as something may have changed for the worse.  It hurts a lot when you see a bigger loss in a stock you still own. Often, cognitive biases, such as loss aversion, prevents us from giving up on one of our losers.

7. Diversification Minimizes Risk

Concentration in one stock is risky. What if you yoloed, and put a significant amount of your money in GameStop, and it suddenly dropped precipitously. It did that when Robinhood restricted GME and other stocks but removed the restriction when they received criticism. If not GameStop, it could be another stock name that becomes angel but then loses its wings.

Diversify your portfolio is a way to minimize risk. I buy stocks outright, but I remain diversified by buying index funds and ETFs. As you build your wealth, you should make sure you have diversified with other assets, including money markets, bonds, real estate, and gold. 

8. Don’t Gamble Or Speculate Without Some Knowledge

Investing in the markets is a way to use your earned money to make more money than you lose. Don’t gamble your hard-earned dollars on anonymous tips or speculate without trying to understand its risks and rewards.

As I wrap up this letter, I believe you can find success in investing and find ways to make it fun and rewarding. Don’t get sucked into strategies that won’t benefit your finances. As you make more money, you can use your generational influence to make societal changes through work and charity. You don’t have to make money to do good in the world. Don’t get discouraged when you lose money. Make that a learning experience.

Final Thoughts

The unusual market activity prompted by social media-driven calls to buy stocks to counter heavily shorted stocks borrowed by institutional investors is dangerous. It serves as a reminder that investing is never a sure bet. There is a generational opportunity for young people to participate in the financial markets.

I hope that they are rational investors that use common sense and discipline to stave off potential losses. It will be a shame if these investors are vulnerable to losses and are mistrustful of the financial markets as some of these traders engage in possible revenge strategies.

Thank you for reading! If you found value in this article, visit us at The Cents of Money for other such reads.

 

 

 

 

 

5 Best Performing Stocks And What To Do Now

5 Best Performing Stocks And What To Do Now

2020 was a weird year for the world economy. Even more surprising has been the impact of the economic fallout on the stock market. It was a year when expensive stocks grew even more costly. Given the high unemployment rate and the fall in GDP, everyone expected the stock market to crash. Yet, the markets bounced back and are higher than the pre-pandemic levels. Professionals and amateurs were equally surprised at the stock market performance and the list of best-performing stocks last year.

Why Did The Stock Market Perform Well

Before we dive into the best-performing stocks, let us understand what was so different about the last year. Although the unemployment rate skyrocketed to the highest levels since the great depression, most white-collar jobs were unaffected. The ability to work from home resulted in many jobs being saved. The usage of technology to solve the current crisis also resulted in earnings getting pulled forward several years.

The Federal Reserve, the Treasury, and Congress worked together to provide stimulus packages to various affected communities. While we can debate the speed and effectiveness of these measures, the data clearly showed that the vast majority of Americans could use the funds to augment their net worth. The Personal Saving Rate shot to an all-time high of 33%. As per the data released by N.Y. Fed, total household debt decreased in Q2 2020, marking the first decline since 2014

Personal-Saving-Rate

Best Performing Stocks in Nasdaq for 2020

The Nasdaq list of best-performing stocks encapsulates how everything changed in our lives during 2020.

Zoom became part of our everyday vocabulary as everyone started working from home, and all events were conducted virtually. Closure of gyms resulted in people working out at home using Peloton. Moderna using their mRNA technology took only six weeks to devise and manufacture initial lots of its vaccine.

Any list of best-performing stocks of 2020 would be incomplete without Tesla. The stock had a meteoric rise in 2020, capturing everyone’s imagination. The stock price increase propelled Elon Musk as the world’s wealthiest person, overtaking Jeff Bezos and Bill Gates.

COMPANY TICKER PRICE CHANGE
Tesla Inc. TSLA 743%
Moderna Inc. MRNA 434%
Peloton PTON 434%
Zoom Video ZM 396%
Pinduoduo Inc. PDD 370%
Best Performing Stocks in Nasdaq for 2020

Best Performing Stocks in S&P 500 for 2020

When we look at the best-performing stocks in the S&P 500, we have Tesla at the top of the list again. The inclusion of Tesla into the S&P 500 was not without controversy. By far, Tesla was the largest firm by market value ever to join the S&P 500.

Tesla’s inclusion in the S&P 500 forced all the index funds that track the S&P to purchase tens of billions of dollars of Tesla stock in a bid to track the index as closely as possible. As a result, the stock spiked higher in price to a self-fulfilling prophecy.

Tesla’s impact on index inclusion was a real outlier. Usually, stocks are added at a much lower market cap, and it would not impact the index to such an extent. As per the S&P 500 committee rules, a company must report an accumulated profit over four consecutive quarters. Tesla turned profitable only recently. However, the stock price had risen a lot higher even before it started making money.

COMPANY TICKER PRICE CHANGE
Tesla Inc. TSLA 743%
Etsy Inc. ETSY 302%
Nvidia Corp. NVDA 122%
PayPal Holdings Inc. PYPL 117%
L Brands Inc. LB 105%
Best Performing Stocks in S&P 500 for 2020

Best Performing Stocks Based On Lifetime Wealth Creation

According to the SSRN paper “Do Stocks Outperform Treasury Bills?” authored by Bessembinder, ExxonMobil (Ticker: XOM) created a staggering amount of $1 trillion in wealth between 1926 and 2016. It has been one of the best lifetime wealth creation machines. Undoubtedly, Exxon’s reliable dividend has paid out to shareholders since 1882 has contributed to its remarkable performance. ExxonMobil has been part of the Dow since 1928 and has rightfully earned its place with the wealth creation over generations.

Best Performing Stocks - Lifetime Wealth Creation
Lifetime wealth creation to shareholders in aggregate

Best Stocks To Buy Now

It might be tempting to look at the list of best-performing stocks to extrapolate that their performance would continue. However, past performance is not indicative of future performance. Picking individual stocks is hard, even if they have been the most successful stocks in the past.

Ironically, ExxonMobil was removed this year and replaced by Salesforce (Ticker: CRM). The WTI futures contract turning negative did not help ExxonMobil’s cause either.

If ExxonMobil’s fate did not convince you that stock picking is not a great idea, let us deep dive further into Bessembinder’s research. He found that most common stocks that have appeared in the Center for Research in Security Prices (CRSP) database since 1926 have lifetime buy-and-hold returns of less than one-month Treasuries.

Yes, you read that right. Holding the majority of individual stocks would be a losing proposition, and you would be in a much better position, just putting that money in safe and secure treasuries.

If you wonder how to reconcile this underperformance with the data that stocks outperform treasuries, the answer lies in a tiny subset of stocks. When stated in terms of lifetime dollar wealth creation, the best-performing 4% of listed companies explain the entire U.S. stock market’s net gain since 1926.

In simple terms, only a small subset of listed stocks is responsible for most of the wealth creation in the overall stock market. Those are the real A+ players. The other stocks were true laggards.

The outperformance of this tiny elite group of stocks is such that it compensates for most other stocks’ underperformance.

“The results reinforce the importance of diversification, and low-cost index funds are an excellent way to diversify broadly.” Hendrik Bessembinder, Arizona State University’s W. P. Carey School of Business

Advantage Of Index funds

Bessembinder’s study is an excellent example of why index funds are a better choice for everyone. It is fun to look at the best-performing stocks and dream of picking the next Tesla or Amazon. However, it is hard to pick the winners in advance.

A better alternative to looking for the needle in the haystack is to buy the entire haystack. No one would have anticipated the company would survive or even reach the current valuation levels looking back at Tesla.

I have a small allocation of fun portfolio used for moonshot investing to pick individual stocks. But my assignment to my moonshots is such that even if it goes to zero, I would be fine. Define your risk tolerance and stick with your investment plan without getting swayed by the best-performing stocks because the best performing stock of last year could drop in value tomorrow.

Most of my net worth is concentrated in low cost diversified index funds. Instead of trying to time the market and determine if it is an excellent time to buy or sell stocks, I just auto-invest. My asset allocation is defined, and my investment platform periodically invests my funds and auto rebalance as needed for free.

I understand why looking at the stock indices at an all-time high might make you nervous. However, sitting in cash is not a winning strategy. As 2020 has demonstrated, you can analyze all the economic indicators and conclude that we should be in a recession. Yet stocks could march higher and higher.

If the volatility of stock markets makes you nervous, the best course of action is to examine your asset allocation. Define your asset allocation between stock and fixed income. Run the numbers using the best retirement calculators to figure out when to retire and how much you need.

If you want to reduce your stock investments due to volatility and the bond portfolio does not provide returns, look into asset-backed securities that offer higher returns, like farmland investing. While you do not get the safety of U.S.> treasuries, you do get higher returns.

Final Thoughts On Best Performing Stocks

Analyzing the list of best-performing stocks to determine if they would continue their outperformance is hard. Although momentum and trends persist for a while, using those factors to base your investment doesn’t always work out.

We have seen how one of the highest wealth-creating stocks in history, such as ExxonMobil, also recently fell out of favor.

The prudent course of action is to allocate the bulk of your portfolio to boring low-cost index funds that track the market. Have a small, fun portfolio if you want to pick individual names but be prepared to lose all value. And if the volatility of investing in stock markets makes you nervous, then invest a portion of your portfolio in hard, tangible asset-backed securities.

This article originally appeared on Your Money Geek and has been republished with permission.

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