What is a “Stock”?

 

A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings.

 
  • There are two main types of stock: common and preferred. 
  •      Common stock usually entitles the owner to vote at shareholders' meetings and to receive dividends.
  •          Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares.

 

For example, owners of preferred stock receive dividends before common shareholders and have priority in the event that a company goes bankrupt and is liquidated. 

 
Also known as "shares" or "equity".
 
A holder of stock (a shareholder) has a claim to a part of the corporation's assets and earnings. In other words, a shareholder is an owner of a company. Ownership is determined by the number of shares a person owns relative to the number of outstanding shares. For example, if a company has 1,000 shares of stock outstanding and one person owns 100 shares, that person would own and have claim to 10% of the company's assets.
 
Stocks are the foundation of nearly every portfolio. Historically, they have outperformed most other investments over the long run.
 
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What is an “Option”?

 

A financial derivative that represents a contract sold by one party (option writer) to another party (option holder).

The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).

 
  •          Call options give the option to buy at certain price, so the buyer would want the stock to go up.
  •          Put options give the option to sell at a certain price, so the buyer would want the stock to go down.

Options are extremely versatile securities that can be used in many different ways. Traders use options to speculate, which is a relatively risky practice, while hedgers use options to reduce the risk of holding an asset.

 
In terms of speculation, option buyers and writers have conflicting views regarding the outlook on the performance of an underlying security.
 
For example, because the option writer will need to provide the underlying shares in the event that the stock's market price will exceed the strike, an option writer that sells a call option believes that the underlying stock's price will drop relative to the option's strike price during the life of the option, as that is how he or she will reap maximum profit.
 
This is exactly the opposite outlook of the option buyer. The buyer believes that the underlying stock will rise, because if this happens, the buyer will be able to acquire the stock for a lower price and then sell it for a profit.
 
 
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What is a “Bond”?

 

A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate.

 

Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities.

 

Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents

The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will be paid and when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds is usually paid every six months (semi-annually). The main categories of bonds are corporate bonds, municipal bonds, and U.S. Treasury bonds, notes and bills, which are collectively referred to as simply "Treasuries".

Two features of a bond - credit quality and duration - are the principal determinants of a bond's interest rate. Bond maturities range from a 90-day Treasury bill to a 30-year government bond. Corporate and municipals are typically in the three to 10-year range.


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What is an “ETF”?

A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. 

ETFs experience price changes throughout the day as they are bought and sold. 

Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated every day like a mutual fund does.

By owning an ETF, you get the diversification of an index fund as well as the ability to sell short, buy on margin and purchase as little as one share. Another advantage is that the expense ratios for most ETFs are lower than those of the average mutual fund. When buying and selling ETFs, you have to pay the same commission to your broker that you'd pay on any regular order.

One of the most widely known ETFs is called the Spider (SPDR), which tracks the S&P 500 index and trades under the symbol SPY.

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An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital. Each shareholder participates proportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and can typically be purchased or redeemed as needed at the fund's current net asset value (NAV) per share, which is sometimes expressed as NAVPS.


Exchange Traded Notes - An Alternative To ETFs

ETN - short for exchange traded note - is the investment industry's latest acronym. ETNs are similar to exchange traded funds (ETFs), but differ in structure. ETNs are issued by Barclays Bank - the ETF industry's largest provider. Three ETNs are currently available: two representing the primary commodities indexes; Goldman Sachs Commodities Index (GSCI) and the Dow Jones-AIG Commodity Index, and the other, oil.

SEE: Commodities: The Portfolio Hedge.

In this article, we'll explain this innovative approach to index investing and compare it to its cousin, the ETF. (For more insight, see Introduction to Exchange Traded Funds and An Inside Look At ETF Construction.)

How Is an ETN Different Than an ETF?ETNs are structured products that are issued as senior debt notes by Barclays, while ETFs represent a stake in an underlying commodity. Barclays is a 300-year-old bank with $1.5 trillion in assets and an 'AA' credit rating from Standard & Poor's.

This provides ETNs with a fairly dependable backing, but even with this kind of credibility, ETNs are not free of credit risk - after all, Barclays Bank will never be as safe as a central bank, such as the Bank of England. In the 1990s, for example, Barings Bank (which was as reputable as Barclays, at the time) collapsed as a result of the large losses incurred by a speculative trader employed at the bank.

Tax TreatmentETNs track their underlying indexes minus an annual expense of 75 basis points per year. Unlike ETFs, there are no tracking errors with ETNs. Based on Barclays' recommendation, investors should treat ETNs as prepaid contracts. This means that any difference between the sale and purchase will be classified as capital gains. There are no other distributions with ETNs. In comparison, the return from commodity-based ETFs will come from the interest on treasury bills, short-term capital gains realized on the rolling of futures contracts, and long-term capital gains.

Since long-term capital gains are treated more favorably than short-term capital gains and interest, the tax treatment of ETNs should be more favorable than that of ETFs. However, as of November 2006, the IRS had not made a definitive ruling on their tax treatment. For international investors, the differences are compounded as treatment for these capital gains and will be treated differently in their home countries. (For related reading, see Capital Gains Tax 101.)

RiskOutside of the tax treatment, the difference between ETNs and ETFs comes down to credit risk vs. tracking risk. ETNs possess credit risk, so if Barclays goes bankrupt, the investor may not receive the return he or she was promised. An ETF, on the other hand, has virtually no credit risk, but there is tracking risk involved with holding an ETF. In other words, there is a possibility that the ETF's returns will differ from its underlying index.

The following chart represents a comparison of the GSCI's ETF and ETN.

Features

ETN

ETF

Issuer

Barclay's Bank

Barclay's Global Investor

Liquidity

Daily, On Exchange

Daily, On Exchange

Registration

Securities Act of 1933

Investment Company Act of 1940

Recourse

Issuer Credit

Portfolio of Securities

Principal Risk

Market and Issuer Risk

Market Risk

Institutional Size Redemption

Weekly, To the Issuer

Daily Via Custodian

Short Sales

Yes, On an Uptick or Downtick

Yes, On an Uptick or Downtick

Tracking Error

No

Yes

Expense Ratio

75 bps

75 bps

Source: iShares

And the Winner Is...
Now that you have a better understanding of the differences between ETN and ETF, which one should prevail? To some degree that will be determined by your tax bracket and your investment time horizon. While the biggest benefit of an ETN is that the entire gain is treated as a capital gain, this gain is also deferred until the security is either sold or matures - something that should not be taken lightly by tax-conscious, long-term investors. With an ETF, capital gains and losses are realized as each futures contract is rolled into another one.

A ruling by the IRS would help remove the tax uncertainty of ETNs. As it stands now, the view that ETNs are classified as prepaid contracts is one that has been made by Barclays and not as an official ruling by the IRS. However, giving taxes higher priority over the quality of an investment can be perilous - the tax code and tax rates are always subject to change.

The absence of tracking risk is also of some value for ETN investors, but it should not be overrated because this has not been a big problem with ETFs. Furthermore, the question of liquidity for ETNs has not yet been answered.

The Bottom LineThe big difference between ETNs and ETFs is credit risk and tax treatment. While much can be made about the counterparty risk of ETNs, is it really any different from the counterparty risk that exists in the structured product and derivatives markets today?

At this point, Barclays has only introduced three ETNs, but their unique structure means that they could be applied to any tradable index. This opens the door for the potential development of many more ETNs in the future, as asset classes like timber, foreign currency bonds, foreign commercial real estate and equity volatility in the U.S still lack an index security.

While the benefit of active management is arguable, there is no disputing the value that financial engineering has brought to the financial markets since deregulation took hold in the early 1970s. Financial engineering has made our markets more liquid and more efficient. The advent of ETN is no different. However, as with any new product, there are unanswered questions.

Read more: http://www.investopedia.com/articles/06/ETNvsETF.asp#ixzz1ygATZVW2

Mutual Funds: Different Types Of Funds


No matter what type of investor you are, there is bound to be a mutual fund that fits your style. According to the last count there are more than 10,000 mutual funds in North America! That means there are more mutual funds than stocks.

It's important to understand that each mutual fund has different risks and rewards. In general, the higher the potential return, the higher the risk of loss. Although some funds are less risky than others, all funds have some level of risk - it's never possible to diversify away all risk. This is a fact for all investments.

Each fund has a predetermined investment objective that tailors the fund's assets, regions of investments and investment strategies. At the fundamental level, there are three varieties of mutual funds:

1) Equity funds (stocks)
2) Fixed-income funds (bonds)
3) Money market funds

All mutual funds are variations of these three asset classes. For example, while equity funds that invest in fast-growing companies are known as growth funds, equity funds that invest only in companies of the same sector or region are known as specialty funds.

Let's go over the many different flavors of funds. We'll start with the safest and then work through to the more risky.

Money Market Funds
The money market consists of short-term debt instruments, mostly Treasury bills. This is a safe place to park your money. You won't get great returns, but you won't have to worry about losing your principal. A typical return is twice the amount you would earn in a regular checking/savings account and a little less than the average certificate of deposit (CD).

Bond/Income Funds
Income funds are named appropriately: their purpose is to provide current income on a steady basis. When referring to mutual funds, the terms "fixed-income," "bond," and "income" are synonymous. These terms denote funds that invest primarily in government and corporate debt. While fund holdings may appreciate in value, the primary objective of these funds is to provide a steady cashflow to investors. As such, the audience for these funds consists of conservative investors and retirees.

Bond funds are likely to pay higher returns than certificates of deposit and money market investments, but bond funds aren't without risk. Because there are many different types of bonds, bond funds can vary dramatically depending on where they invest. For example, a fund specializing in high-yield junk bonds is much more risky than a fund that invests in government securities. Furthermore, nearly all bond funds are subject to interest rate risk, which means that if rates go up the value of the fund goes down.

Balanced Funds
The objective of these funds is to provide a balanced mixture of safety, income and capital appreciation. The strategy of balanced funds is to invest in a combination of fixed income and equities. A typical balanced fund might have a weighting of 60% equity and 40% fixed income. The weighting might also be restricted to a specified maximum or minimum for each asset class.

A similar type of fund is known as an asset allocation fund. Objectives are similar to those of a balanced fund, but these kinds of funds typically do not have to hold a specified percentage of any asset class. The portfolio manager is therefore given freedom to switch the ratio of asset classes as the economy moves through the business cycle.

Equity Funds
Funds that invest in stocks represent the largest category of mutual funds. Generally, the investment objective of this class of funds is long-term capital growth with some income. There are, however, many different types of equity funds because there are many different types of equities. A great way to understand the universe of equity funds is to use a style box, an example of which is below.

The idea is to classify funds based on both the size of the companies invested in and the investment style of the manager. The term value refers to a style of investing that looks for high quality companies that are out of favor with the market. These companies are characterized by low P/E and price-to-book ratios and high dividend yields. The opposite of value is growth, which refers to companies that have had (and are expected to continue to have) strong growth in earnings, sales and cash flow. A compromise between value and growth is blend, which simply refers to companies that are neither value nor growth stocks and are classified as being somewhere in the middle.

For example, a mutual fund that invests in large-cap companies that are in strong financial shape but have recently seen their share prices fall would be placed in the upper left quadrant of the style box (large and value). The opposite of this would be a fund that invests in startup technology companies with excellent growth prospects. Such a mutual fund would reside in the bottom right quadrant (small and growth).

Global/International Funds
An international fund (or foreign fund) invests only outside your home country. Global funds invest anywhere around the world, including your home country.

It's tough to classify these funds as either riskier or safer than domestic investments. They do tend to be more volatile and have unique country and/or political risks. But, on the flip side, they can, as part of a well-balanced portfolio, actually reduce risk by increasing diversification. Although the world's economies are becoming more inter-related, it is likely that another economy somewhere is outperforming the economy of your home country.

Specialty Funds
This classification of mutual funds is more of an all-encompassing category that consists of funds that have proved to be popular but don't necessarily belong to the categories we've described so far. This type of mutual fund forgoes broad diversification to concentrate on a certain segment of the economy.

Sector funds are targeted at specific sectors of the economy such as financial, technology, health, etc. Sector funds are extremely volatile. There is a greater possibility of big gains, but you have to accept that your sector may tank.

Regional funds make it easier to focus on a specific area of the world. This may mean focusing on a region (say Latin America) or an individual country (for example, only Brazil). An advantage of these funds is that they make it easier to buy stock in foreign countries, which is otherwise difficult and expensive. Just like for sector funds, you have to accept the high risk of loss, which occurs if the region goes into a bad recession.
Socially-responsible funds (or ethical funds) invest only in companies that meet the criteria of certain guidelines or beliefs. Most socially responsible funds don't invest in industries such as tobacco, alcoholic beverages, weapons or nuclear power. The idea is to get a competitive performance while still maintaining a healthy conscience.

Index Funds
The last but certainly not the least important are index funds. This type of mutual fund replicates the performance of a broad market index such as the S&P 500 or Dow Jones Industrial Average (DJIA). An investor in an index fund figures that most managers can't beat the market. An index fund merely replicates the market return and benefits investors in the form of low fees.

Mutual Funds: The Costs


Costs are the biggest problem with mutual funds. These costs eat into your return, and they are the main reason why the majority of funds end up with sub-par performance.

What's even more disturbing is the way the fund industry hides costs through a layer of financial complexity and jargon. Some critics of the industry say that mutual fund companies get away with the fees they charge only because the average investor does not understand what he/she is paying for.

Fees can be broken down into two categories:
1. Ongoing yearly fees to keep you invested in the fund.
2. Transaction fees paid when you buy or sell shares in a fund (loads).

The Expense Ratio
The ongoing expenses of a mutual fund is represented by the expense ratio. This is sometimes also referred to as the management expense ratio (MER). The expense ratio is composed of the following:

• The cost of hiring the fund manager(s) - Also known as the management fee, this cost is between 0.5% and 1% of assets on average. While it sounds small, this fee ensures that mutual fund managers remain in the country's top echelon of earners. Think about it for a second: 1% of 250 million (a small mutual fund) is $2.5 million - fund managers are definitely not going hungry! It's true that paying managers is a necessary fee, but don't think that a high fee assures superior performance.

• Administrative costs - These include necessities such as postage, record keeping, customer service, cappuccino machines, etc. Some funds are excellent at minimizing these costs while others (the ones with the cappuccino machines in the office) are not.

• The last part of the ongoing fee (in the United States anyway) is known as the 12B-1 fee. This expense goes toward paying brokerage commissions and toward advertising and promoting the fund. That's right, if you invest in a fund with a 12B-1 fee, you are paying for the fund to run commercials and sell itself!

On the whole, expense ratios range from as low as 0.2% (usually for index funds) to as high as 2%. The average equity mutual fund charges around 1.3%-1.5%. You'll generally pay more for specialty or international funds, which require more expertise from managers.

Are high fees worth it? You get what you pay for, right?

Wrong.

Just about every study ever done has shown no correlation between high expense ratios and high returns. This is a fact. If you want more evidence, consider this quote from the Securities and Exchange Commission's website:

"Higher expense funds do not, on average, perform better than lower expense funds."

Loads, A.K.A. "Fee for Salesperson"

Loads are just fees that a fund uses to compensate brokers or other salespeople for selling you the mutual fund. All you really need to know about loads is this: don't buy funds with loads.

In case you are still curious, here is how certain loads work:

• Front-end loads - These are the most simple type of load: you pay the fee when you purchase the fund. If you invest $1,000 in a mutual fund with a 5% front-end load, $50 will pay for the sales charge, and $950 will be invested in the fund.

• Back-end loads (also known as deferred sales charges) - These are a bit more complicated. In such a fund you pay the a back-end load if you sell a fund within a certain time frame. A typical example is a 6% back-end load that decreases to 0% in the seventh year. The load is 6% if you sell in the first year, 5% in the second year, etc. If you don't sell the mutual fund until the seventh year, you don't have to pay the back-end load at all.

A no-load fund sells its shares without a commission or sales charge. Some in the mutual fund industry will tell you that the load is the fee that pays for the service of a broker choosing the correct fund for you. According to this argument, your returns will be higher because the professional advice put you into a better fund. There is little to no evidence that shows a correlation between load funds and superior performance. In fact, when you take the fees into account, the average load fund performs worse than a no-load fund.

Mutual Funds: Picking A Mutual Fund

Buying
You can buy some mutual funds (no-load) by contacting fund companies directly. Other funds are sold through brokers, banks, financial planners, or insurance agents. If you buy through a third party, you may pay a sales charge (load).

That said, funds can be purchased through no-transaction fee programs that offer funds from many companies. Sometimes referred to as "fund supermarkets," these programs let you buy funds from many different companies. They also provide consolidated recording that includes all purchases made through the supermarket, even if they are from different fund families. Popular examples are Schwab's OneSource, Vanguard's FundAccess, and Fidelity's FundsNetwork. Many large brokerages have similar offerings.

What to Know Before You Shop
Net asset value (NAV), which is a fund's assets minus liabilities, is the value of a mutual fund. NAV per share is the value of one share in the mutual fund, and it is the number that is quoted in newspapers. You can basically just think of NAV per share as the price of a mutual fund. It fluctuates everyday as fund holdings and shares outstanding change.

When you buy shares, you pay the current NAV per share plus any sales front-end load. When you sell your shares, the fund will pay you NAV less any back-end load.

Finding Funds
Nearly every fund company in the country also has its own website. Simply type the name of the fund or fund company that you wish to learn more about into a search engine and hit “search.” If you don’t have a specific fund company already in mind, you can run a search for terms like “no-load small cap fund” or large-cap value fund.”

For a more organized search, there are a variety of other resources available online. Two notable ones include:

The Mutual Fund Education Alliance is the not-for-profit trade association of the no-load mutual fund industry. They have a tool for searching for no-load funds.

Morningstar is an investment research firm that is particularly well known for its fund information.

Identifying Goals and Risk ToleranceBefore acquiring shares in any fund, you need to think about why you are investing. What is your goal? Are long-term capital gains desired, or is a current income preferred? Will the money be used to pay for college expenses, or to supplement a retirement that is decades away? Identifying a goal is important because it will help you hone in on the right fund for the task.

For really short-term goals, money market funds may be the right choice, For goals that are few years in the future, bond funds may be appropriate. For long-term goals, stocks funds may be the way to go.

Of course, you must also consider the issue of risk tolerance. Can you afford and accept dramatic swings in portfolio value? If so, you may prefer stock funds over bond funds. Or is a more conservative investment warranted? In that case, bond funds may be the way to go.

The next question to consider include “are you more concerned about trying to outperform your fund’s benchmark index or are you more concerned about the cost of your investments?” If the answer is “cost,” index funds are likely the right choice for you.

Additional questions, to consider include how much money you have to invest, whether you should invest in a lump sum or a little bit over time and whether taxes are a concern for you.

Mutual Funds: Evaluating Performance


Perhaps you've noticed all those mutual fund ads that quote their amazingly high one-year rates of return. Your first thought is "wow, that mutual fund did great!" Well, yes it did great last year, but then you look at the three-year performance, which is lower, and the five year, which is yet even lower. What's the underlying story here? Let's look at a real example from a large mutual fund's performance:

1 year 3 year 5 year
53% 20% 11%

Last year, the fund had excellent performance at 53%. But, in the past three years, the average annual return was 20%. What did it do in years 1 and 2 to bring the average return down to 20%? Some simple math shows us that the fund made an average return of 3.5% over those first two years: 20% = (53% + 3.5% + 3.5%)/3. Because that is only an average, it is very possible that the fund lost money in one of those years.

It gets worse when we look at the five-year performance. We know that in the last year the fund returned 53% and in years 2 and 3 we are guessing it returned around 3.5%. So what happened in years 4 and 5 to bring the average return down to 11%? Again, by doing some simple calculations we find that the fund must have lost money, an average of -2.5% each year of those two years: 11% = (53% + 3.5% + 3.5% - 2.5% - 2.5%)/5. Now the fund's performance doesn't look so good!

It should be mentioned that, for the sake of simplicity, this example, besides making some big assumptions, doesn't include calculating compound interest. Still, the point wasn't to be technically accurate but to demonstrate the importance of taking a closer look at performance numbers. A fund that loses money for a few years can bump the average up significantly with one or two strong years.

It's All Relative
Of course, knowing how a fund performed is only one third of the battle. Performance is a relative issue, literally. If the fund we looked at above is judged against its appropriate benchmark index, a whole new layer of information is added to the evaluation. If the index returned 75% for the 1 year time period, that 53% from the fund doesn't look quite so good. On the other hand, if the index delivered results of 25%, 5%, and -5% for the respective one, three, and five-year periods, then the fund’s results look rather fine indeed.

To add another layer of information to the evaluation, one can consider a fund’s performance against its peer group as well as against its index. If other funds that invest with a similar mandate had similar performance, this data point tells us that the fund is in line with its peers. If the fund bested its peers and its benchmark, its results would be quite impressive indeed.

Looking at any one piece of information in isolation only tells a small portion of the story. Consider the comparison of a fund against its peers. If the fund sits in the top slot over each of the comparison periods, it is likely to be a solid performer. If it sits at the bottom, it may be even worse than perceived, as peer group comparisons only capture the results from existing funds. Many fund companies are in the habit of closing their worst performers. When the "losers" are purged from their respective categories, their statistical records are no longer included in the category performance data. This makes the category averages creep higher than they would have if the losers were still in the mix. This is better known as survivorship bias.

To develop the best possible picture of fund's performance results, consider as many data points as you can. Long-term investors should focus on long-term results, keeping in mind that even the best performing funds have bad years from time to time.


Read more: http://www.investopedia.com/university/mutualfunds/mutualfunds3.asp#ixzz1wWHXgW9s


'529 Plan'

The prepayment may be in the form of a contribution to an account established specifically for paying higher educational expenses. There is no income restriction for individuals who want to contribute to a 529 plan; however, because contributions cannot exceed the amount that sufficiently covers the expenses of the beneficiary's qualified higher education, individuals should take care not to over-fund the 529 plan.

529 plans (also known as a "qualified tuition program") were created under the Small Business Job Protection Act of 1996 (SBA '96) as a means of allowing taxpayers to save for higher education expenses for a designated beneficiary. A 529 plan may be provided by a state, an agency of the state or by an educational institution.

Like the education savings account (ESA), the 529 plan is an excellent way to save for education expenses. Earnings accumulate on a tax-deferred basis and distributions that are used for qualified education expenses are tax- and penalty-free. Unlike the ESA, the 529 plan may be set up in a way that allows individuals to prepay a student's qualified higher-education expenses at an eligible educational institution. Also, the contribution limits for a 529 plan are considerably higher than those for an ESA. Here we take a look at 529 plans, how they work and how you can use them to save for a child or grand-child's college education.



529 Plans: Types Of Plans

There are two types of 529 plans:

  • Prepaid tuition programs, which may be offered by the state of an eligible educational institution. Prepaid tuition programs allow for the advance purchase of credits for the designated beneficiary. These are usually established during enrollment periods established by the state of the eligible educational institution.
  • College savings plans allow contributions to be made to the account on behalf of the designated beneficiary. These can usually be established at any time, including immediately after the designated beneficiary is born.
Individuals would review the feature and benefits of both types of 529 plans to determine which is more suitable for the designated beneficiary.

The designated beneficiaryunder a 529 plan is the student the plan is established for. The designated beneficiary can be changed to an eligible person. Typically, the designated beneficiary is changed if the current designated beneficiary will not need the funds in the 529 plan for eligible education expenses. If a state or local government or certain tax-exempt organizations purchase an interest in a 529 plan as part of a scholarship program, the designated beneficiary is the person who receives the interest as a scholarship.

For purposes of a 529 plan, an eligible educational institution is any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the Department of Education. This includes virtually all accredited public, nonprofit and proprietary (privately owned profit-making) post-secondary institutions.

Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs.

Individuals should check with the educational institution to determine if it is an eligible education institution for 529 plan purposes.

529 Plans: Eligibility

Who Can Establish and Contribute to the 529 Plan?
Anyone can establish and contribute to a 529 plan on behalf of a designated beneficiary. This means that relatives, family, friends and even the designated beneficiary can establish the 529 plan for him- or herself. But the rules do vary. For instance, some 529 plans limit participation to residents of the state while others allow anyone to participate, regardless of the individual's state of residence. Individuals should check with the financial institution or the education institution providing the plan to determine the eligibility requirements for establishing an account under the plan.

Some 529 plans may have established enrollment periods before which new accounts must be opened.

Age and Income Requirements
Unlike the ESA, 529 plans do not have income restrictions. Some 529 plans - although there are very few - place age restrictions on designated beneficiaries. Individuals must check with the plan provider and the plan documents to determine whether there are any restrictions that apply to the 529 plan they want to establish for the designated beneficiary.

The investment options available under the plan may be determined by the age of the beneficiary, and are often automatically adjusted as the beneficiary's age moves from one range to another. For prepaid tuition programs, the cost per credit may be determined by the number of years that the designated beneficiary has left before he or she reaches a certain age- usually the age that students typically begin attending college.

Change in the Designated Beneficiary
Like the ESA, the 529 plan allows the designated beneficiary to be changed to a qualified family member who meets any age requirements as determined by the plan.
For the purpose of determining who can become a designated beneficiary of a 529 plan, a qualified family member includes the following:

  • The designated beneficiary's spouse
  • The designated beneficiary's son or daughter or descendant of the beneficiary's son or daughter
  • The designated beneficiary's stepson or stepdaughter
  • The designated beneficiary's brother, sister, stepbrother or stepsister
  • The designated beneficiary's father or mother, or ancestor of either parent
  • The designated beneficiary's stepfather or stepmother
  • The designated beneficiary's niece or nephew
  • The designated beneficiary's aunt or uncle
  • The spouse of any individual listed above, including the beneficiary's son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
  • Any individual for whom the home of the designated beneficiary is his or her primary home for the entire tax year
  • The designated beneficiary's first cousin
Amounts that are rolled over to a new designated beneficiary must be rolled over within 60 days of being distributed. Alternatively, the change can be made by changing the name and tax identification number on the 529 account to that of the new designated beneficiary. (For related reading, see How And When To Switch Your 529 Plan.)
Who Can Establish and Contribute to the 529 Plan?
Anyone can establish and contribute to a 529 plan on behalf of a designated beneficiary. This means that relatives, family, friends and even the designated beneficiary can establish the 529 plan for him- or herself. But the rules do vary. For instance, some 529 plans limit participation to residents of the state while others allow anyone to participate, regardless of the individual's state of residence. Individuals should check with the financial institution or the education institution providing the plan to determine the eligibility requirements for establishing an account under the plan.

Some 529 plans may have established enrollment periods before which new accounts must be opened.

Age and Income Requirements
Unlike the ESA, 529 plans do not have income restrictions. Some 529 plans - although there are very few - place age restrictions on designated beneficiaries. Individuals must check with the plan provider and the plan documents to determine whether there are any restrictions that apply to the 529 plan they want to establish for the designated beneficiary.

The investment options available under the plan may be determined by the age of the beneficiary, and are often automatically adjusted as the beneficiary's age moves from one range to another. For prepaid tuition programs, the cost per credit may be determined by the number of years that the designated beneficiary has left before he or she reaches a certain age- usually the age that students typically begin attending college.

Change in the Designated Beneficiary
Like the ESA, the 529 plan allows the designated beneficiary to be changed to a qualified family member who meets any age requirements as determined by the plan.
For the purpose of determining who can become a designated beneficiary of a 529 plan, a qualified family member includes the following:

  • The designated beneficiary's spouse
  • The designated beneficiary's son or daughter or descendant of the beneficiary's son or daughter
  • The designated beneficiary's stepson or stepdaughter
  • The designated beneficiary's brother, sister, stepbrother or stepsister
  • The designated beneficiary's father or mother, or ancestor of either parent
  • The designated beneficiary's stepfather or stepmother
  • The designated beneficiary's niece or nephew
  • The designated beneficiary's aunt or uncle
  • The spouse of any individual listed above, including the beneficiary's son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
  • Any individual for whom the home of the designated beneficiary is his or her primary home for the entire tax year
  • The designated beneficiary's first cousin
Amounts that are rolled over to a new designated beneficiary must be rolled over within 60 days of being distributed. Alternatively, the change can be made by changing the name and tax identification number on the 529 account to that of the new designated beneficiary.

529 Plans: Contributions

Regular contributions to 529 plans must be made in cash (which includes checks). In-kind contributions, such as stocks, bonds, mutual funds or other non-cash items cannot be used to make regular contributions to and cannot be made in the form of securities.

Contribution LimitThe maximum amount that may be contributed on behalf of each designated beneficiary varies among states. Typically, contributions to each plan are limited to amounts that are necessary to finance the designated beneficiary's eligible education expenses. Where limits are established, they are usually applied on a lifetime basis. For instance, a plan may limit total contributions to $200,000, which is the maximum total that can be contributed to the designated beneficiary's 529 account over time.

Amounts contributed to a designated beneficiary's 529 account are treated as a gift. However, contributions of up to $13,000 can be made for each designated beneficiary without incurring federal gift tax in accordance with the annual exclusion applies to gifts to each done. Alternatively, an individual may be able to contribute a lump sum that covers five years, giving a total of $65,000 ($130,000 for married couples), provided the individual makes no additional gifts to that designated beneficiary for the five-year period.

Care must be taken to ensure contributions do not exceed amounts necessary to cover eligible expenses, as the earnings portion of distributions not used to cover such expenses may be subject to income tax and early distribution penalties.

Rollovers, Transfers, Changing Designated Beneficiaries
If a designated beneficiary no longer wants or needs the balance in his or her 529 plan, the amount can be given to an eligible family member. For this purpose, eligible family members include the following:

  • The designated beneficiary's spouse
  • The designated beneficiary's son or daughter or descendant of the beneficiary's son or daughter
  • The designated beneficiary's stepson or stepdaughter
  • The designated beneficiary's brother, sister, stepbrother or stepsister
  • The designated beneficiary's father or mother, or ancestor of either parent
  • The designated beneficiary's stepfather or stepmother
  • The designated beneficiary's niece or nephew
  • The designated beneficiary's aunt or uncle
  • The spouse of any individual listed above, including the beneficiary's son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
  • Any individual for whom the home of the designated beneficiary is his or her primary home for the entire tax year
  • The designated beneficiary's first cousin
The amount can be moved to an eligible family member as a rollover, transfer or by changing the name and tax identification number on the account to that of the new designated beneficiary. If the rollover method is used, the rollover must be completed within 60 days of the amount being distributed from the plan.

Tax Deduction AllowanceSome states' 529 plan rules allow taxpayers to receive a tax deduction for contributions, but there may be certain requirements. For instance, while a state's 529 plan may allow anyone (regardless of his or her state of residence) to participant in its 529 plan, only residents of the state may be allowed a tax deduction for the contributions. Individuals must check with the particular plan to determine its features and benefits.

Permissible Investments in 529 Plans
The investment choices for 529 plans are usually limited to mutual funds or annuities. For some plans, the investment choices are based on the age of the beneficiary, allowing more aggressive investments for younger beneficiaries.

Read more: http://www.investopedia.com/university/retirementplans/529plan/529plan3.asp#ixzz1yg97seKT

529 Plans: Distributions


Distributions from 529 plans used for qualified education expenses are tax- and penalty-free if the amount is equal to or less than the designated beneficiary's qualified education expenses. For distributions that are more than the individual's qualified education expenses, the earnings may be subject to tax and an additional 10% early-distribution penalty. Some states allow qualified individuals, as defined by the state, to claim tax deductions for contributions they make to 529 plans. If a tax deduction is allowed, state taxes may also apply to a distribution of amounts other than earnings.

Qualified Education Expenses
Generally, qualified education expenses include the following:

  • Expenses required for the designated beneficiary's enrollment in and attendance at an eligible school. Eligible schools include colleges, universities, vocational schools and accredited post-secondary educational institutions that are eligible to participate in a student aid program administered by the Department of Education.
  • Tuition and fees
  • Books, supplies and equipment
  • Academic tutoring
  • Room and board
  • Uniforms
  • Transportation
  • Expenses of a special needs beneficiary that are necessary for that person's enrollment or attendance at an eligible educational institution.
Tax Treatment of DistributionsA distribution from a 529 plan that is not used for qualified educational expenses may be subject to income tax and an additional 10% early-distribution penalty. The penalty will be waived, however, if the distribution occurs for any of the following reasons:
  • The designated beneficiary dies, and the distribution goes to another beneficiary or to the estate of the designated beneficiary.
  • The designated beneficiary becomes disabled. A person is considered disabled if there is proof that he or she cannot do any substantial gainful activity because of a physical or mental condition. A physician must determine that the individual's condition can be expected to result in death or continue indefinitely.
  • The designated beneficiary receives any of the following:
    • a qualified scholarship excludable from gross income
    • veterans' educational assistance
    • employer-provided educational assistance
    • any other nontaxable payments (other than gifts, bequests or inheritances) received for education expenses
  • The distribution is included in income only because the qualified education expenses were taken into account in determining the Hope Credit or Lifetime Learning Credit, both of which are tax credits that reduce the amount of taxable income for an individual funding a student's education.
On a state level, the tax treatment for distributions varies. Individuals should consult with their tax professional to determine how distributions from their 529 plans will be treated for tax purposes.

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529 Plans: Conclusion

Similar to the education savings account (ESA), the 529 plan is an excellent way to save for education expenses.
Let's recap:

  • 529 plans allow for the prepayment of qualified higher-education expenses at eligible educational institutions.
  • There are no income restrictions for individuals who want to contribute to a 529 plan; however, because contributions cannot be more than the amount necessary to provide for the qualified higher-education expenses of the beneficiary, individuals should take care not to contribute too much to the 529 plan.
  • An individual may contribute up to $13,000 each year to a designated beneficiary’s 529 plan without incurring federal gift tax, provided that the individual makes no additional gifts to that designated beneficiary for the year.
  • The distribution from the 529 plan may be used for:
    • tuition and fees
    • books, supplies and equipment
    • academic tutoring
    • room and board
    • uniforms
    • transportation
Materials on each State's 529 plan are available from the College Savings Plans Network’s (CSPN) website at www.collegesavings.org.

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An Introduction To Structured Products


Once upon a time, the retail investment world was a quiet, rather pleasant place where a small, distinguished cadre of trustees and asset managers devised prudent portfolios for their well-heeled clients within a narrowly defined range of high-quality debt and equity instruments. Financial innovation and the rise of the investor class changed all that.

TUTORIAL: Index Investing

One innovation that has gained traction as an addition to retail and institutional portfolios is the class of investments broadly known as structured products. This article provides an introduction to structured products with a particular focus on their applicability in diversified retail portfolios.

What are structured products?
Structured products are designed to facilitate highly customized risk-return objectives. This is accomplished by taking a traditional security, such as a conventional investment-grade bond, and replacing the usual payment features (e.g. periodic coupons and final principal) with non-traditional payoffs derived not from the issuer's own cash flow, but from the performance of one or more underlying assets.

The payoffs from these performance outcomes are contingent in the sense that if the underlying assets return "x," then the structured product pays out "y." This means that structured products closely relate to traditional models of option pricing, though they may also contain other derivative types such as swaps, forwards and futures, as well as embedded features such as leveraged upside participation or downside buffers. (For related reading, see Understanding Option Pricing.)

Structured products originally became popular in Europe and have gained currency in the U.S., where they are frequently offered as SEC-registered products, which means they are accessible to retail investors in the same way that stocks, bonds, exchange-traded funds (ETFs) and mutual funds are. Their ability to offer customized exposure, including to otherwise hard-to-reach asset classes and subclasses, makes structured products useful as a complement to these other traditional components of diversified portfolios.

Looking Under the Hood
Consider the following simple example: a well-known bank issues structured products in the form of notes, each with a notional face value of $1,000. Each note is actually a package consisting of two components: a zero-coupon bond and a call option on an underlying equity instrument, such as a common stock or perhaps an exchange traded fund (ETF) mimicking a popular stock index like the S&P 500. Maturity is in three years. Figure 1 represents what happens between issue and maturity date.

Figure 1



Although the pricing behind this is complex, the principle is fairly simple. On the issue date you pay the face amount of $1,000. This note is fully principal-protected, meaning that you will get your $1,000 back at maturity no matter what happens to the underlying asset. This is accomplished via the zero-coupon bond accreting from its original issue discount to face value.

For the performance component, the underlying, priced as a European call option, will have intrinsic value at maturity if the underlying asset's value on that date is higher than its value when issued. You earn that return on a one-for-one basis. If not, the option expires worthless and you get nothing in excess of your $1,000 return of principal. (Learn more about some of these options in Exploring Euro Options.)

Custom Sizing
In the example above, one of the key features is principal protection. In another instance, an investor may be willing to trade off some or all of this protection in favor of more attractive performance features. Consider another case. Here, an investor trades the principal protection feature for a combination of performance features.

If the return on the underlying asset (Rasset) is positive - between zero and 7.5% - the investor will earn double the return (e.g. 15% if the asset returns 7.5%). If Rasset is greater than 7.5%, the investor's return will be capped at 15%. If the asset's return is negative, the investor participates one-for-one on the downside (i.e. no negative leverage). There is no principal protection. Figure 2 shows the option payoff chart for this scenario.
Figure 2



This strategy would be consistent with a mildly bullish investor's view - one who expects positive but generally weak performance and is looking for an enhanced return above what he or she thinks the market will produce.

Over the Rainbow
One of the principle attractions of structured products for retail investors is the ability to customize a variety of assumptions into one instrument. For example a rainbow note is one that offers exposure to more than one underlying asset. A lookback is another popular feature. In a lookback instrument, the value of the underlying asset is based not on its final value at expiration, but on an average of values taken over the note's term, for example monthly or quarterly. In the options world, this is also called an Asian option to distinguish it from the European or American option. Combining these types of features can provide attractive diversification properties.

A rainbow note could derive performance value from three relatively low-correlated assets, for example the Russell 3000 Index of U.S. stocks, the MSCI Pacific ex-Japan index and the Dow-AIG commodity futures index. Attaching a lookback feature to this could further lower volatility by "smoothing" returns over time rather than on just one date.

What about liquidity?
One common risk associated with structured products is a relative lack of liquidity due to the highly customized nature of the investment. Moreover, the full extent of returns from the complex performance features is often not realized until maturity. Because of this, structured products tend to be more of a buy-and-hold investment decision rather than a means of getting in and out of a position with speed and efficiency.

A significant innovation to improve liquidity in certain types of structured products comes in the form of exchange-traded notes (ETNs), a product originally introduced by Barclays Bank. These are structured to resemble ETFs, which are fungible instruments traded like regular common stock on a securities exchange. ETNs are different from ETFs, however, as they consist of a debt instrument with cash flows derived from the performance of an underlying asset - in other words, a structured product. ETNs can provide access to hard-to-reach exposures, such as commodity futures and the Indian stock market. (For more insight, read Exchange Traded Notes - An Alternative To ETFs.)

Other Risks and Considerations
In addition to liquidity, one risk associated with structured products is the credit quality of the issuer. Although the cash flows are derived from other sources, the products themselves are legally considered to be the issuing financial institution's liabilities. They are typically not, for example, issued through bankruptcy-remote third party vehicles in the way that asset-backed securities are. The vast majority of structured products are from high investment grade issuers only - mostly large global financial institutions such as Barclays, Deutsche Bank or JP Morgan Chase.

Another consideration is pricing transparency. There is no uniform standard for pricing, making it harder to compare the net-of-pricing attractiveness of alternative structured products offerings than it is, for instance, to compare the net expense ratios of different mutual funds or commissions among broker-dealers. Many structured products issuers work the pricing into their option models so that there no explicit fee or other expense to the investor. On the flip side, this means that the investor can't know for sure what the implicit costs are.

Conclusions
The complexity of derivative securities has long kept them out of meaningful representation in traditional retail (and many institutional) investment portfolios. Structured products can bring many of the benefits of derivatives to investors who otherwise would not have access to them. As a complement to more traditional investment vehicles, structured products have a useful role to play in modern portfolio management.

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Real Estate Investment Trust - REIT

Individuals can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate. An additional benefit to investing in REITs is the fact that many are accompanied by dividend reinvestment plans (DRIPs). Among other things, REITs invest in shopping malls, office buildings, apartments, warehouses and hotels. Some REITs will invest specifically in one area of real estate - shopping malls, for example - or in one specific region, state or country. Investing in REITs is a liquid, dividend-paying means of participating in the real estate market.
Equity REITs: Equity REITs invest in and own properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties' rents.

Mortgage REITs: Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans.

Hybrid REITs: Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.

Hedge Fund

For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of more than $1 million, along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds for the super rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies.   

It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk". In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.


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Long/Short Equity

This type of hedge fund basically has free reign to buy or sell what it likes. A long/short equity hedge fund is usually considered to be higher risk. A hedge fund strategy that involves buying certain stocks long and selling others short. There usually isn't a restriction on the country that the stocks trade in either.

Private Equity

Equity capital that is not quoted on a public exchange. Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from retail and institutional investors, and can be used to fund new technologies, expand working capital within an owned company, make acquisitions, or to strengthen a balance sheet.  

The majority of private equity consists of institutional investors and accredited investors who can commit large sums of money for long periods of time. Private equity investments often demand long holding periods to allow for a turnaround of a distressed company or a liquidity event such as an IPO or sale to a public company.


Leveraged Buyout - LBO

In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds usually are not investment grade and are referred to as junk bonds. Leveraged buyouts have had a notorious history, especially in the 1980s when several prominent buyouts led to the eventual bankruptcy of the acquired companies. This was mainly due to the fact that the leverage ratio was nearly 100% and the interest payments were so large that the company's operating cash flows were unable to meet the obligation.

One of the largest LBOs on record was the acquisition of HCA Inc. in 2006 by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill Lynch. The three companies paid around $33 billion for the acquisition.

It can be considered ironic that a company's success (in the form of assets on the balance sheet) can be used against it as collateral by a hostile company that acquires it. For this reason, some regard LBOs as an especially ruthless, predatory tactic.