fbpx

Category Archives for "Investments"

Savvy End-Of-The-Year Tax Moves

Savvy End-Of-The-Year Tax Moves

If you are like the vast majority of people, the thought of paying more taxes than legally necessary is troubling.  Unfortunately with our busy lives pulling us in all directions, it is easy to get distracted and not have the time to focus on potential sources of tax savings throughout the year.

However, the end of the year is a good time to take a few hours and focus on potential tax savings opportunities that you might be able to lock-in before the new year arrives.

Doing that every year-end could help you to save thousands on your tax bill due the following April.

Let’s take a look at a few of the most common year-end tax-savings opportunities:

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
Give To Charity

The period from Thanksgiving to the end of the calendar year is the time when Americans tend to give the most to charity. In many cases, this is done for two reasons: to give back to worthwhile causes and to save a bit on your taxes by generating a charitable deduction.

In order to have your donations qualify for a tax break, you must itemize them on Form 1040. You do not qualify for the tax break if you don't itemize and instead claim the standard deduction. In the Tax Cuts and Jobs Act of 2017, Congress made the threshold for itemizing higher than it had been in previous years, but many givers, particularly generous ones, still qualify.

Note that in order to make a charitable contribution, you must have charitable intent.  For most people, the tax savings represents only 35 or 40% of the value of the charitable deduction, so it makes sense to do it if you both want to help and donate as well as save on taxes.

Another area to remember is that donating appreciated assets such as stocks that have increased in value and or art for example can be even more attractive because you save on the potential capital gains that you would have owed had you sold that asset as well as getting a tax deduction equal to the current full market value of the donated asset.

Charitable gifts can also involve more advanced approaches for somewhat larger donations, such as setting up a donor advised fund account or donating an assets over time while it continues to generate income for the donor.  These are more advanced charitable donation strategies that would be beyond the scope of this article.

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster
Tax-Loss Harvesting

End of year is a good time to review your investment holdings. In particular, review your unrealized and realized capital gains and losses for the year.

Capital gains are taxable at the prevailing rate in the year they are realized. Capital losses, however, can be used to offset gains.

Here’s how it works: If you have more capital losses than you have gains for a given year, then you can claim up to $3,000 of those losses and deduct them against your ordinary income.

Fortunately, if you have more than $3000 in capital losses, then you're allowed to carry the excess forward for use in future years. You calculate and claim the capital loss deduction by using Schedule D of your Form 1040 tax return as part of your required reporting of sales of investments throughout the year.

Depending on your investment holdings, year-end can be a good time for you to look at your holdings and sell the ones that could allow you to generate a capital loss in the current year.  This can be especially valuable if, as per the above, you have gains that can be offset with these year end losses. 

This process of looking at your holdings for unrealized losses in your taxable investment accounts is called tax loss harvesting and your cpa or investment advisor can help you with this process.

Tax loss harvesting is subject to some specialized rules, such as the wash sale rule.  This rule states that you can only realize the loss upon the sale of a holding if you do not buy it back within 30 days (before or after) the sale. 

If the position is one that you expect to appreciate over time, you may not want to tax loss harvest it (as you will miss out on the gains for the next 30 days) or alternatively, you may want to identify some other correlated position to own during the time when you are subject to the 30 day wash sale rule.  Of course, on the 31st day you are free if you so desire to buy back you original position and still take the tax loss from selling the position.

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
Defer Taking Capital Gains Until Next Year

In addition to tax-loss harvesting, you may wish to defer any unrealized capital gains until next year. Remember, you will pay capital gains tax on gains realized during the tax year. You could elect to simply keep your paper profits going forward without realizing the gain. This may also make sense as part of a long-term investment plan focused on high-quality securities that you really want to hold for the long term anyway.

Some mutual funds distribute capital gains distributions at year end.  On the other hand, by owning individual securities and exchange traded funds, you can defer you gains (and continue to compound them) for potentially a long period of time.

Even if you are sure you want to liquidate a position, once you start getting towards the end of the year, you may be better off waiting until the early part of the following year to actually sell the position for two reasons.

First, by deferring the gain on the sale into the new year, you defer the tax due by around a year.  Second, many securities tend to decline at year end and bounce back in January (potentially due to tax loss selling by many investors) so you might get better execution by waiting for the new year as well (at least on average).

Qualified Retirement Plans

If you are eligible for qualified retirement plans such as IRAs and 401-Ks, make sure that you maximize the tax-deductible contributions before year-end. In many cases, folks make regular bi-weekly contributions deducted from their payroll compensation. Also check to see if your situation qualifies for other types of deferred retirement plans?

For example, self-employed folks can set up a solo 401(k), or Simplified Employee Pension (SEP) IRA.  Depending upon your situation, the amounts that you can contribute may be substantially higher than in a Traditional or Roth IRA.

The deadline for establishing and contributing to a SEP IRA is the tax-filing deadline, including extensions.

A more advanced type of qualified retirement plan is called a Defined Benefit or Cash Balance Plan.  This type of retirement plan is more complicated and generally needs an actuary and a third party administrator.  It typically costs a bit more to set up and maintain as well.  However, for small but highly profitable businesses it can provide very large tax deductions as well as allow accumulation of substantial retirement plan assets.

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster
Review Your Medical Bills

Fortunately, the tax code provides for tax deductibility for qualified medical expenses. For 2019, you can deduct the total qualified and unreimbursed medical care expenses that exceed 10% of your adjusted gross income.

Qualifying expenses include things like:

  • Costs incurred for medical services from physicians, surgeons, dentists, and other medical professionals.
  • Purchases of medications prescribed by a medical professional.
  • Costs of medical devices, equipment, and supplies prescribed by a medical professional, including, among other commonly needed items, eyeglasses.
  • Premiums paid by you for health and dental insurance.
  • Long-term care costs and insurance.
  • Transportation and lodging costs for traveling to a health care facility including mileage

If you have a high deductible qualified health insurance plan, you may also be eligible to set up and fund a Health Savings Account or HSA prior to year end.

Since health care costs in retirement as a significant concern and expense for most individuals, the HSA is an excellent strategy with significant tax benefits to those who qualify and set it up properly.

Ridgewood Investments is experienced in setting up HSA’s and can assist you to do so.

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
Look for Tax Incentives

Tax incentives are benefits, legally defined in federal and state tax codes, designed to attract business or encourage a specific economic or social activity. They are often used to help create affordable housing, catalyze job growth, set up enterprise zones, assist with historic preservation, and to encourage environmental responsibility.

Examples of these that you may qualify for include tax credits for installing energy-efficient residential appliances, tax breaks for using biodiesel fuel, and tax incentives for a wide variety of improvements for Americans with disabilities, to name a few. Consulting with your accountant may uncover a few that you can use prior to year end.

Make An Extra Mortgage Payment

Making an extra mortgage payment is something you might consider doing, especially if your monthly interest on the mortgage is relatively high. This simple trick may give you an extra amount of interest to deduct at the end of the year if you itemize. It may also reduce your principal more quickly as well.

This strategy can make sense if you want to payoff your mortgage more quickly or if you have a high interest mortgage (relatively rare these days). 

However, if your interest rate is lower than you average investment return, it may not make sense to accelerate your mortgage payments at year end despite the tax deduction.  This is especially true these days when the deductibility of mortgage interest was curtailed in the Tax Cuts and Jobs Act of 2017.

Avoid Future Estate Taxes

If you are a high-net-worth individual, looking at your estate tax situation may be highly beneficial. In 2019, the estate tax applied to folks with over $11.4 million in assets. You can reduce your potential estate, and its future tax burden, by making gifts. You can give up to $15,000 per person completely gift tax-free this tax year.

For example, each of you and your spouse can gift the above amount to each of your children (and even grandchildren).  Interestingly, the gift tax exemption is not limited to relatives.  Any amounts that you give as gifts reduced the future size of your estate and if the gifts are invested properly by or on behalf of the recipient the benefit in terms of future estate tax savings can be quite meaningful.

As an experienced investment and financial advisor based in New Jersey, Ridgewood Investments has comprehensive knowledge on a wide variety of savvy investing strategies and year-end tax-saving and planning ideas.

Take an opportunity to take advantage of a few of the above year-end tax saving moves to make your tax burden less taxing.

About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.

What You Need to Know About Annuities (Secret Pitfalls You’ll Never Figure Out Until It Is Too Late)

What You Need to Know About Annuities (Secret Pitfalls You Never Figure Out Until It Is Too Late)

Perhaps you’ve been contacted by an insurance sales representative urging you to consider buying an annuity. You’re not quite up to speed on these annuities, but the pitch sounds good: You get regular monthly payments for the rest of your life.  All you have to do is sign on the proverbial dotted line.

What you may not know unless you know where to look and how to read and understand the fine print is that annuities can have hidden costs and other confusing provisions that most annuity sales reps never tell you about (in some cases, they may not even be aware! the insurance companies train their salespeople to emphasize those points most favorable to their own goals and rarely train them on the drawbacks) 

In most cases, unfortunately, the person trying to sell you an annuity product is not a disinterested observer - their livelihood and income depend on selling!  Given these skewed incentives related to commission payouts that can vary widely depending on which annuity product and contract riders you decide to buy, you need to be aware that some annuity distributors may have a conflict of interest that could impair their ability to advise you on what you should do. 

Read on below as we reveal some of the most common hidden issues and pitfalls related to annuities - secrets that many never figure out until it is too late!

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
Annuities 101

An annuity is a contractual arrangement between an insurance company and a private individual or purchaser, often an investor thinking about retirement, where an upfront lump sum is paid by the individual to the insurer in order to receive future or immediate payments at regular intervals. Consequently, the subject of annuities often comes up in retirement planning. 

There are four main types of annuities: Immediate Annuities, Deferred Income Annuities, Fixed Annuities, and Variable Annuities. Let’s look at each type (though a comprehensive discussion of these is beyond the scope of our topic today):

  • Immediate Annuity. This is the easiest type to understand. You make an upfront, lump-sum payment to an insurance company. You then immediately become eligible to receive regular payments from the insurer. The length of payment can be over a fixed period or the rest of your life.
  • Deferred Income Annuity. These are similar to an immediate annuity except that your payments don't begin right away. Instead, you will begin to receive them sometime in the future. Some people use deferred income annuities to hedge against the possibility that they’ll live too long and run out of other retirement funds.  Typically a deferred income annuity will give you a stream of payments a bit higher than an equivalent sized immediate annuity would provide (because of the waiting period).
  • Fixed Annuities. This is an insurance contract that enables you to accumulate capital on a tax-deferred basis. The capital accumulates at a regular fixed rate, determined by prevailing interest rates at the time the contract is established. Additionally, in most cases there is a provision in the contract guaranteeing that your principal will not decrease.  Fixed annuities often appeal to conservative minded investors.  Since interest rates are so low today, the returns of fixed income annuities are naturally muted at the present time.
  • Variable or Index Annuity. These are similar to fixed annuities in that gains within the annuity grow on a tax-deferred basis. The returns that can be achieved are tied to a specific market, often the U.S. stock market, whose returns vary from year to year. Variable annuities often come with some protections, such as minimum amounts of income once payments begin, withdrawable cash options, and death benefits.   Variable annuities can have riders that provide downside protection against stock market declines, however, this protection can be expensive and has to be paid for from the upside that an investor would enjoy overtime from an equivalent sized direct investment portfolio held outside the annuity wrapper (more on annuity taxation later in this article).

Of course these categories are not mutually exclusive.  So for example, you can have a fixed immediate or deferred annuity.  Another popular hybrid combination is the index annuity or the fixed index annuity (more on this later).

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster
What’s in it for the Insurance Providers?

At first glance, annuities with their “guarantees” sound like a good deal for the buyer.  In many cases the pitch seems to imply that annuities give you the best of both worlds for the intrepid investor - good upside with little or no exposure to the downside.  This sounds like nirvana to many investors.

But, why do insurance companies offer them in the first place if they are such a good deal for the purchasers? As we all know, insurance companies are sophisticated entities with teams of actuaries and are generally far more sophisticated than the customers who they sell to.

First of all, the seller of the annuity, the insurance company, gets a hefty upfront premium. This is money they can immediately invest and some of the gains (and sometimes some of the principal) can be used to pay for sales commissions and other costs as well as generate profits for the insurance company over time. 

Money paid upfront to insurance companies in exchange for future payments generates “float” - money that the company gets to use and invest in the meantime.

Insurers price their products so that they can make a bigger overall profit on this investable money than they will pay out. This “spread” between their anticipated investment profits and the lesser amount they believe they will have to pay out is how they make their money.

But what if they’re wrong and their investment doesn’t pan out? They also generate a solid ongoing income stream from high costs that they are often built into annuities to charge for insurance “coverage” and riders.

These fees will be spelled out in the contract in some detail, but most purchasers of annuities lack the patience, time, or expertise to thoroughly review and digest the annuity disclosure documents (called a prospectus) that sellers are required by regulators to prepare and distribute.

One very important point to keep in mind is that annuities are highly complex instruments - no two forms are exactly alike.  Moreover, as contracts they are only as good or as bad as the language and the promises and the credit backing them up. As such it is critically important to read and be well aware of the “fine print.” 

In fact, an annuity is an intangible based on a promise to provide contractual financial payments in the future.  As with any contract, if you don’t have the time, interest, or expertise to thoroughly review the terms and conditions in the disclosure documents, it may be a good idea to consult an expert who knows what to look for and is watching out for your interests as a prospective purchaser.

Of course, for an investor who truly needs or desires the guarantees and or is unwilling or unable to make investments that could create greater income by cutting out the middle-man, annuities can definitely be worth considering as one of many options suitable for conservative investors.

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
Beware of High Fees, Expenses and Costs

High annuity fees can be quite a drag on the investor’s overall bottom line. Let’s look at this more carefully.

Fees associated with annuities can include investment management fees, rider charges, insurance charges, surrender charges, and perhaps a few more.

  • Management Fees. Especially important in a variable annuity, a management fee is often applied periodically when the annuity is invested in a stock or fund portfolio managed and monitored by the insurance company or their outside subadvisors. This fee can range anywhere from about .25% to well over 1%.  This fee is often “built-in” to the individual funds and so can’t be seen on your periodic statement in many cases.
  • Rider Charges. You can add a rider to the annuity for specific features that you deem important. For example, you might wish to have a cost-of-living adjustment made annually on your payouts. Riders will generally cost you extra money. Typically, rider charges can cost 1% or more annually.
  • Insurance charges. These fees are designed to cover the expense of providing and promoting the annuity coverage plus covering the cost of the guarantees provided in many annuities. Moreover, these charges can be quite high, often 1% or more.
  • Surrender Charges. Some, but not all, insurance companies make you pay a surrender charge if you want to get out of your annuity contract. Surrender charges can be steep, up to 7% in some cases.  A surrender charge is like paying a large fee just to get your own money back.  It is there for a very good reason: when the salesperson sells you the annuity, they need to be paid their commission check mostly upfront.  The insurance company however, needs time to use your money to recoup this sales cost which they expect to do over time as long as you leave your money with them.  If however, you want to pull out your money early, they need to recoup this cost so they often charge you a penalty - called a “surrender charge”.  Surrender charges generally decline over time (it is not uncommon for the level of surrender charge to decline each year and go to zero between 5 to 10 years depending on the annuity contract).

As you can see, when added up, the fees associated with many annuities can be steep indeed - sometimes in excess of 3% per year.  This is the reason that on after-fees basis and especially in a low interest rate world, fixed annuities often incorporate relatively modest income returns within their assumed projections.

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster
Return on Investment vs Return of Investment

So if most fixed annuities are incorporating relatively low returns, especially after fees and expenses, why do the payments sound so attractive in the insurance company projections and the sales pitch?

This leads us to a critical point that relates to what portion of your annuity payments consist of returns on your investment in the annuity versus a return of your investment.  The important point to understand is that a significant portion of your payments may actually be return of your capital rather than return on your capital.

Let's illustrate this point with a simple example.  Let's say that someone age 70 purchases a $100,000 fixed annuity and in exchange is promised a stream of income of $800 per month for as long as they are alive.  In this example, $800 is just for illustration purposes and the actual number could be higher or lower depending on a variety of factors.  A simple calculation shows that the annuity purchaser will be getting $9600 of payments from this annuity, which sounds like a great deal and may even feel like a 9.6% return on the original investment.

However, remember that even with a 0% interest return, it would take more than 10.4 years to simply deplete the original principal amount of $100,000 that was invested.  Since in our example, we are illustrating a life annuity, our purported annuity purchaser would never even get their original money back unless they lived past 80.  Assuming some modest return rate - like 3 or 4%, the breakeven point just on the original principal plus interest would be pushed out by an additional 4 or 5 years.  Of course, those who live much longer than average  benefit as the lucky “winners” of the annuity lottery - getting back more than they put in by virtue of beating the odds and outliving everyone else.

It is important to realize that since annuity payments often end upon the occurrence of some event that is certain to happen but uncertain as to timing (such as death of one or more annuitants), it is critically important when evaluating an annuity contract to separate that portion of the annuitized payment that is likely to come from return of investment versus return on investment.

Only then can you truly make an apples-to-apples evaluation of the annuity option against other options such as investing the principal yourself or with the help of an experienced advisor and taking your own withdrawals from your money instead of doing it through an insurance company structure with its corresponding fees and expenses.

When are Annuities a Suitable Proposition?

Annuities can be a good financial product if you are buying them for the right reasons or for the right person.

An annuity can make sense if it has been thoroughly evaluated and is an integral component of a well-thought-out, long-term financial plan; you understand how it works; your fees and charges are relatively low or at least provide you significant value in exchange for the costs, and you know why you are buying it and doing so with a full understanding of what you are getting.

Another situation in which annuities can be a good fit is if the buyer is spendthrift, and has difficulty saving their income and/or really needs the safety of handing a significant sum over to an insurance company (hopefully a well run and conservatively managed one) whose promise in exchange for the lump sum can provide some security against what they would be likely to do with the money in the alternative.

Yet another situation in which an annuity can be interesting for some people is if they have reason to believe (or simply want to gamble) that they will be one of the longevity “winners” in the annuity pool.  If they live well in excess of the average life-span in the annuity pool they could receive more payments in their later years than they would have gotten otherwise.

In other cases, an annuity may not be the best choice for your money. Beware when someone is trying to persuade you to buy one without looking at your total financial picture. Typically it is not a great idea to buy one unless you have a well-crafted financial plan and buying an annuity really fits into it. Accordingly, don’t be coerced into buying one if an effective salesperson tells you that this particular annuity will be going away soon or if you feel pressured in any other way. 

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
Fixed Index Annuities and Annuity Taxation

Two other issues with annuities of certain types is that the complexity can obscure some meaningful drawbacks of certain annuity structures.  For example, Index Annuities or Fixed Index Annuities which are probably the most popular annuity by premium volume currently can feature interest crediting methods that are difficult to understand and perhaps even opaque. 

Specifically,  many of these annuities may be crediting based on a proprietary index or calculation formula that is designed to seem more advantageous than it is under a detailed financial analysis.  Some of the crediting formulas have “caps”, for example, that limit the upside that you will receive when the underlying index does particularly well - this can be an issue because capping returns can be quite expensive over time in the form of a much lower overall rate of return for a given index.

One of the reasons so many index annuities are sold is that they are regularly pitched at seminars or sold aggressively to buyers who are mostly unable to perform a thorough analysis of the products themselves.

Taxation of annuities is another potential drawback that many annuity buyers do not fully appreciate when buying them.  This is understandable, since many annuities are sold with the idea that they are tax advantageous to the buyer since the annuity structure creates a measure of tax deferral in that investment income generated inside the annuity contract is not immediately taxable. 

However, from a tax point of view, most non-qualified annuities do not get a step-up in tax basis to the date of death.   Assuming that the annuity was purchased with after-tax dollars, this means that the annuity beneficiary will have to pay taxes on the entire amount attributable to gain on the original investment.

Also, it will be taxed as ordinary income and not at the much lower capital gains rate that a normal non-annuity investment would have enjoyed along with the step up in basis at death.  This leakage from potentially unfavorable tax treatment at the back end offsets the tax deferral benefit at least in part and should be considering whether an annuity is the right solution for a given person.

Finally, there are some alternatives to annuities that might be worth considering.  In some cases, taking the lump sum you would have given over to an insurance company and investing it in a well balanced and diversified portfolio of stocks, bonds, funds, etfs and income real estate can be done at a lower cost and potentially generate higher total payments to the annuitant over time than an equivalent sized annuity might have done.

In some cases the difference can be tens of thousands or even millions in extra payments through the combination of dividends, interest and compounding based appreciation of an overall portfolio.

What If You Already Own An Annuity And Want to Evaluate Alternatives?

Armed with the information above, you now have a far greater grasp of the pros and cons of annuities than most and so are armed to make a far more informed decision in the future.

Some reading this may already have purchased one or more annuities that they already own.  In some cases, you may have realized that the fees and/or surrender charges or investment options in your existing contract(s) may not be giving you the best alternatives for your needs today.

Even if this is your current situation, do not worry or despair.  Even with existing annuities already in place, a good advisor can help you evaluate exactly what you have and identify opportunities for you to restructure your assets and even start doing better going forward.

Among the tools to consider in this case is 1035 tax free exchange from your existing annuity into a better or lower cost annuity option.  Another alternative may be to simply free your capital from a bad contract (as efficiently as possible) and start deploying that capital into a better place to start improving your investment portfolio one step at a time.

Ridgewood Investments: Keeping Your Financial Welfare in Mind

As you can see, there are multiple types of annuities and each type has complexities that you need to understand before purchasing one.

Ridgewood Investments is a fee-only investment advisor, as such we do not accept commissions or sales incentives related to annuities, insurance, or any other such financial products from any insurance or annuity company.

At Ridgewood Investments, we believe that annuities can play sometimes play a role in a good financial plan when used judiciously and properly and for the right client needs.  Unfortunately they are often misused or sold too aggressively. 

If you could use some sophisticated impartial advice or merely a second opinion on something you have purchased already or are considering to purchase, reach out to Ridgewood Investments for an objective review of your own unique situation or needs. 

We have a sophisticated understanding of complex instruments like annuities and insurance contracts and take pride in watching out for our clients and educating them to position themselves for long-term success.

About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.

True Wealth Is Far More Than Just Financial Success

True Wealth Is Far More Than Just Financial Success

As an investment advisor, my firm Ridgewood Investments helps our clients grow the value of their investments with customized guidance and education on making better investing and financial decisions.  A good portion of our work centers on helping others accumulate a significant amount of financial wealth.

Typically, I write articles and give talks like those published on our website at www.ridgewoodinvestments.com/insights that discuss one or more aspects of growing, preserving, or accumulating financial wealth.  Just in the last few weeks these topics have included articles on The Power of Roth IRAs to Grow a Large Nest Egg and How to Improve Returns on Your Cash in A Low Interest Rate World.

We love the work we do and believe that financial wealth and success is achievable and important, because it gives us options to buy goods, services, or experiences that can help us to be healthier, happier, more productive, and free or to provide these benefits for others.  The measured pursuit of financial wealth also rewards disciplined risk taking and can make the incentives in our overall system work better to produce value for everyone.

However, this week is Thanksgiving in the United States - a time when families and friends gather and on at least this one day a year, express gratitude and thanks for our many blessings: among which (for most of us) are the time we have left on this beautiful planet, the presence of loved ones in our lives, the greatness of this country and its principles of tolerance and freedom, among many others.

So this week, I want to reflect on a topic that is especially appropriate at this special time of the year i.e. my belief that true wealth is far more than just financial wealth.  While I didn’t always understand this idea, I have come to appreciate it more and more as I have grown and matured (I just celebrated my 50th birthday earlier this year).

When I was a child, at the age of 5, I moved to the United States from my native country of India.  We initially came to Jersey City, New Jersey located across the Hudson River from Manhattan, New York and our first residence was a modest 1 bedroom apartment in a brick tenement building where my sister and I shared a pullout couch in the living room. 

Our eat-in-kitchen was smaller than my current master closet.  I am told that my initial reactions to my adopted country (it was winter when we arrived) was to repeatedly ask my parents when we were going to go back home.

Fortunately, we didn’t go back “home” though my 5 year old self would have wanted to do so if it had been up to me, at least initially.  We were immigrants who left India, like many others, with the hope of more opportunities and a better life in the United States. 

Having just arrived from a relatively poor and more bureaucratic (some might even say corrupt) system, my parents and family had very little in terms of transferable financial wealth that we could bring with us.  Fortunately, my parents had some education, but they were essentially starting from scratch in their mid 30s, with two young children.

As I think back to those times and the years since, I realize that I have been incredibly (almost unbelievably) fortunate.  Besides the opportunity to move to and live in the United States, I also had parents and other role models who were intelligent/thoughtful as well as loving/supportive (thanks Mom and Dad!).

Growing up, I mostly took this for granted.  I subconsciously assumed that all parents and families were as close and supportive as my own (it just didn’t occur to me otherwise).

However, as I graduated and started working, I came to realize that everyone didn’t have such close and supportive families.  Over the years, I have met people who were estranged from their families and they had to be far more self reliant than I could have been.  I was always impressed by their achievements and their strength. 

As a sensitive kid, I benefited immeasurably from my supportive environment.  In fact, without it, I think my path in life could have turned out far differently.  “There but by the grace of God go I”  is one of my favorite sayings as a result.

The above example is only one of many I could cite.  Others in this category include generally good health, access to a great education, high level job opportunities, caring teachers and mentors who took an interest, my many clients and their families who have allowed us to do the work we do now, and my own loving family and children just to name a few.

A few years after my first child was first born, I was at a group event and it was my turn to present.  As part of an exercise, we had each made posters using magazine image clippings and text encapsulating future dreams and things we were grateful for. 

One of the pictures I clipped that day was of a happy and healthy baby.  To me it represented my young son.  While it was during my early years as an entrepreneur and founder of Ridgewood Investments, I had by then already accumulated some financial resources through working, saving and investing at least enough to be moderately comfortable. 

When I spoke to the group that day as I presented my vision board, I expressed being grateful for having my son for whom I would have gladly traded in all my financial capital and gone into debt and even given my own life to protect.  Parents reading this know what I am talking about.

Fortunately, like many of the most valuable things in our lives, my son came to me for free.  But in that sense, I was already wealthier than the wealthiest man on earth because I had the benefit of something (or in this case a little someone) in my life whose value to me was far in excess of any amount of financial wealth. By this yardstick, I was already infinitely wealthy.  Later I had a second child so my wealth increased to at least twice infinity!

For many of us, our loved ones all fall into this category of the priceless in our lives.  But the other instances of our true (non-financial) wealth go far beyond this.  All of us have a certain amount of time which cannot be bought or even known with certainty - it was also given to us for free.  To the extent we have our health - it is yet another priceless gift. 

Just ask anyone with little time left or someone challenged with failing health what they would give to get more of either.  Unfortunately, both are things that financial wealth cannot be a substitute for when absent, though in limited ways financial wealth can sometimes and in some circumstances help to free-up or prolong.

Going beyond the priceless and irreplaceable things in our lives, we also have the benefit of many others that are of very high if not irreplaceable value.  Our relationships and friendships to those who offer us their caring and assistance might fall into this category. 

In this respect, our mothers and wives and sisters and daughters do far more than their fair share and we, especially those of us who are men (myself included) could more often be more aware and thankful and be emulating their example.

Past memories of sublime experiences or moments of true joy and/or beauty might also be on my list of “true wealth” that I have accumulated.  I know that from time to time, I have experienced moments (often involving travel) that I will cherish and perhaps think back upon with a smile when my time in nearly up.  I try from time to time to increase my reserves of this kind of true wealth by creating other opportunities for more such experiences.

Our ability to momentarily transcend our normal lives through appreciation of art, music, beauty or food has this type of value as well.  And what about our freedom and our knowledge and our ability to learn and grow?

Immigrants, such as myself, from all corners of the globe have come to the United States or other parts of the free world.  Despite very real obstacles and injustices that still exist for migrants and natives, many find more access to education and other opportunities to participate and improve the lot of their families at least as compared to their own homelands or other more repressive countries.  While much progress remains to be made, there is also much to celebrate and be thankful for even in our imperfect societies as well.

In my own personal case, I had the benefit of education at places that I never even knew about or dreamed of when I was young.  Today, I would value this education and knowledge and the relationships I made there even more than my accumulated financial wealth.

This idea also gives me peace, because I feel that given enough time and even starting from scratch, the values and experiences that I have accumulated along the way would likely allow me to reaccumulate financial capital starting again even from zero (I hope, however, never to have to test this theory :). 

In a very real sense, if I had to choose between my education, abilities, values, connections and knowledge or all my current income and accumulated wealth, it would be a very easy choice in favor of the former.

Finally, even within our challenges and mistakes we have the opportunity to find untold riches.  Ask any successful person what challenges they faced in their path to success and how these obstacles shaped and/or served them to become the person they later became. 

Many will tell you that in hindsight, they benefited more from their obstacles than they did their successes and that they probably would not have become nearly as “successful” without their failures and challenges.  This idea is worth keeping in mind whenever things aren’t going our way (it has helped me overcome difficulties on numerous occasions).

To quote Sherrilyn Kenyon, “The strongest steel is forged by the fires of hell. It is pounded and struck repeatedly before it's plunged back into the molten fire. The fire gives it power and flexibility, and the blows give it STRENGTH. Those two things make the metal pliable and able to withstand every battle it's called upon to fight.”

No doubt, we are all very busy working on our immediate goals and just trying to get to the next milestone and sometimes just doing our best to keep all our balls in the air.  Each of us has our own lives and challenges and circumstances that sometimes lead to a roller coaster of emotions just to cope at times.

Whatever your personal circumstances and level of financial abundance or scarcity as you read this right now, try to at least balance out your personal accounts by also taking stock of the many ways that you may already be abundantly and immeasurably wealthy (often infinitely and irreplaceably so).

If this is true for you, consider taking a moment to make a mental or even better yet written account of the many things that belong on your personal list.  Things that you can be truly grateful for.

Making a gratitude inventory of your many sources of “true wealth” has at least two other happy byproducts. 

First, it will likely make you instantly happier as you become more aware of and thankful for these many gifts. 

Secondly, in some mysterious, powerful and sublime way, expressing gratitude for our many blessings seems to have a way of multiplying them.  Focusing on and being thankful for abundance in our lives seems to compound it.

All of us have many priceless and infinitely valuable things we already “possess” including our friends and family, our health, our minds, our hearts, our memories and our ability to feel and appreciate music and beauty.  Alas, all things are impermanent, but we can celebrate them right now in the present moment.

My hope in writing this article was to serve as a small spark for your own personal inventory of blessings.  So, whats on your list?

On this Thanksgiving, let’s focus on and keep in mind these many blessings and make an effort to express gratitude (including in words when appropriate) to the people or things that have in the past and/or continue today to add this kind of incredible value in our lives. 

Lets appreciate that true wealth is truly far far more than financial wealth though there is a place for both in our lives.

Take it from a financial advisor when I say you are far more wealthy than you realize once you begin to focus on how much “true wealth” you already enjoy in your life.  This Thanksgiving let’s be grateful.  I know I will.

High Net Worth Financial Advisor New Jersey

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder

About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.

Is Cannabis a Good Investment Right Now?

Is Cannabis a Good Investment Right Now?

Today, many people are wondering if they should be investing in cannabis related companies. Although it is still illegal as of late 2019 to produce or use marijuana at the federal level, over half the states in the U.S. have approved medical marijuana, and eight states, including trendsetter California, have made recreational cannabis legal.

Given the wave of legalization in both the US and Canada, the national news media are full of stories about the growth of the cannabis, hemp, marijuana and CBD oil markets.  In both the US and Canada, there are numerous companies and entrepreneurs creating companies to position themselves to address these markets.

Should you invest in cannabis? Is it a good money making opportunity or a risk better worth avoiding? Let’s take a look.

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
A History of Investment Versus Speculation

Some people buy stocks because they believe they are good, long-term investments, and that they’ll make money as these companies generate profits and create value for their shareholders.

Others buy for more speculative purposes to make a trade in the short-term: a hot tip or market momentum coupled with the desire for a quick profit motivates them.

Benjamin Graham, known as the “Father of value investing” offered the following observation of the distinction:

“An investment operation is one which, on thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”

So is investing in Cannabis an investment or a speculation?

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster
Speculative Bubbles and The Great Dutch Tulip Mania

In some cases, extreme speculation takes over in certain markets. This can be particularly true in markets early in their development that are subject to many competitors, shifting dynamics and a high degree of experimentation needed to figure out which business models and products will survive and thrive.  Examples of early stage speculative markets include the British Railway Mania of the 1840s, the Internet bubble involving the so-called “dot.com” companies, in the late 1990s, and, most recently, the Bitcoin mini boom-and-bust of 2017-2018.

Sometimes, speculative bubbles occur even in assets that make little sense.  For example, in the early 1600s, one of the first recorded speculative bubbles occurred in Holland focusing on, of all things, tulips bulbs. It was one of the greatest asset bubbles of all time. By 1634 there was a literal mania for tulip bulbs. Peak prices topped out at a level high enough to buy a mansion in Amsterdam. People were buying using credit and leverage. By 1637, the bubble had burst. Prices crashed. Speculators were ruined.

The Developing Cannabis Market in the U.S and Canada

Years ago, when penalties were stiff for producing and using marijuana, the only markets for cannabis were illegal markets.

With the recent deregulation of cannabis availability, legal marijuana sales have skyrocketed, in part fuelled by the development of medical marijuana. In California, sales of legal marijuana are on track to exceed $3.1 billion in 2019. By some estimates, the cannabis market in the US may reach $35 billion by 2020.  By almost any measure, Cannabis is a rapidly growing market.

Not all cannabis is psychoactive. Hemp has been and still is commercially produced in the US. One of the main organic products derived from hemp is Cannabidiol, also known as CBD, which has seen skyrocketing sales fueled by great claims for its health benefits. The CBD market is on pace for over $800 million in sales in the US alone in 2019 and projected to grow to over $1.8 billion by 2022.

In 2018, Canada legalized marijuana nationwide for adult use.  A number of private and public-traded Cannabis-related firms are now based in Canada. By late 2017, close to 80 legal marijuana growing firms operated in Canada.

Today, many people may think that cannabis will soon be legal in all 50 U.S. states. What remains to be seen, however, is whether the growth in sales of this commodity will correspond with good returns for those investing today when so much excitement is already built into prices.

How Many Cannabis-Related Companies are Operating?

According to Investopedia, as of October 2019, 17 cannabis-related stocks already trade on the NASDAQ. Companies such as Cronos Group (CRON), Canopy (CGC), Aurora (ACB), New Age Beverage (NBEV) and Tilray (TLRY) are some of the more famous public listed names.

There are also seven cannabis-focused exchange traded funds (ETFs) available to investors. Many of these are comprised of Canadian-based companies.

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
Cannabis Boom and Bust?

Are marijuana-related stocks a good investment now? Or are they simply too speculative for long-term investors?

One might say they have already gone through a mini bubble-burst. Over the last few months, shares of TLRY, CGC, ACB and CRON are down massively between 38% and 45%. This has occurred after being high-flying media darlings over the last few years.  Tilray, for example, peaked at almost $150 per share in October 2018 and is currently valued at $22 per share - a decline of almost 85% so far.

Even so, typical market valuation metrics suggest that cannabis firms may still be expensive based on current levels of sales and profits. Company value versus earnings is one such market yardstick.  Companies such as TLRY, ACB, and CRON have negative earnings to date, giving their enterprise value (EV) over earnings (EBITDA) negative multiples. By contrast, other “sin” firms such as alcohol and tobacco companies, with their long histories of profitability and massive cash flows, have positive and much more reasonable valuations given their far lower risk profiles.

The cannabis market is young and no doubt is likely to grow, perhaps meaningfully in the years and decades to come.  However, competition is intensifying and it is far from clear who the ultimate winners will be.  Until recently, the excitement had already driven their prices up tremendously, long before these firms have any real and sustainable earnings to justify their valuations.

Using Ben Graham’s definition above, investors in cannabis today are more likely to be speculating, ie gambling on the future of cannabis, rather than investing in something that is likely to preserve their investment as well as offer a return on top.  Of course, not all speculations are bad, and some even work out very well in the end.  The important thing is to be aware of the distinction and size your investment appropriately, if at all.

Ridgewood: Your Long-Term, Risk-Mitigating Investment Partner

Given its growth potential, it may be reasonable to place a small percentage of a portfolio in a few well-selected “speculative” investments  in this area, but only after doing your homework.

Someone as wise as Warren Buffett quipped that he has three piles on his desk, YES, NO, and TOO HARD.  Fortunately, in investing it is not necessary to select investments from the TOO HARD pile in which many speculative opportunities often belong.

Ridgewood Investments focuses on sound, long-term investing in a wide variety of proven markets.  Whether or not opportunities in the Cannabis sector turn out to be a good idea in the fullness of time, having an advisor like Ridgewood Investments on your side can really help you to get the most out of your investment opportunities!

About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.

Why You Need a Roth IRA (Hint: It Could be Worth Millions)

Why You Need a Roth IRA
(Hint: It Could be Worth Millions)

Do you need a Roth Individual Retirement Account (IRA)?

The short answer is that, in almost every case, if you are eligible, you might be missing out if you don’t.

In fact, without knowledge of how you can maximize the power of this type of individual retirement account, you might be leaving a lot of money on the table. How much money? Believe it or not, in some cases, it could amount to thousands or even millions of dollars.

Do you think that a Roth IRA might be appealing to you? If so, read on. We’ll educate you about Roth IRAs and show you how easy it can be to set one up and take advantage of its many benefits.

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
What is a Roth IRA?

IRAs were created by the federal government to encourage people, especially those who don't have workplace retirement plans, to save for their own retirements rather than become a burden on society.   However, if you know and follow certain rules, you can contribute to an IRA even if you do have a workplace retirement plan!

Broadly speaking, IRAs come in two types: traditional IRAs and Roth IRAs. The traditional IRA is generally funded with pre-tax money, meaning that you save taxes when you make the contribution.  However, when you later begin withdrawals from a traditional IRA, you must pay taxes on your distributions including on all your gains. Additionally, you must begin taking money from the traditional IRA when you reach the age of 70 ½ because the government eventually wants to collect its share of the taxes you owe.  And if you need money from a Traditional IRA before you turn 59 ½ you have to pay an additional 10% penalty in addition to the taxes that would be due on your withdrawal.

In this article, however, we are going to focus on the Roth IRA, mainly because of its even more generous wealth-building provisions. With a Roth IRA, you contribute money you’ve already paid taxes on for the calendar year of your contribution, but when you withdraw, potentially many years later you pay no taxes on any of the gains. In addition to the tax-free withdrawals there is no requirement to begin withdrawals at a specific age. Indeed, the Roth IRA offers the ability to pass on the IRA value to heirs tax-free.

The combination of tax-free growth, no taxes due upon withdrawal, and no minimum age of distribution make the Roth IRA a powerful investing tool, especially for affluent and high income families. Used properly, and combined with great investments, the Roth IRA’s potential to save you taxes over an extended investment horizon can enable you to harness the power of investment compounding to potentially build the value of your account over time into millions of dollars in tax-free gains.

History of IRAs and Roth IRAs

Prior to 1974, IRAs did not exist. In that year, Congress passed the Employee Retirement Income Security Act (ERISA), and the original version of the IRA was established.

Over time, numerous congressional actions expanded the utility of IRAs. In particular, the Economic Recovery Tax Act that was passed in 1981, made the IRA more widely available and increased the maximum annual contribution.

Congress established the Roth IRA in 1997 after Republican Senator William Roth of Delaware proposed it as a way to encourage a culture of saving rather than spending.. Its generous provisions, described above, are so different from the original IRA that the older version became known as a Traditional IRA.  

Both types of IRAs have become very popular. Today, it is estimated that IRAs hold more than $9 trillion, representing almost one third of all US retirement plan assets.

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster
Benefits of Roth IRAs (You Will Like These!)

Keep in mind that a Roth has many benefits that are not part of the rule-structure governing traditional IRAs, especially when you withdraw money: Roth withdrawals are generally tax-free! This beautiful benefit means that, as mentioned, if you start early and put the power of compounding to work, you can amass and keep 100% of a hefty nest egg as you approach retirement age.

Another Roth IRA feature is that there are no required minimum distributions, as there are with a traditional IRA. We’ll cover some of the ramifications of these provisions in the upcoming “Roth Tips” section.

A comparison of the wealth-building advantage of a Roth IRA versus a traditional IRA can illustrate the power of the Roth IRA.  Let's assume someone saves $5000/year for 30 years and that the account grows at 8% per year.  This amount of growth would give you a sum of $625,123 (and save you $37,500 in taxes over the 30 years). With a Roth IRA, you can take that whole sum tax-free. Assuming a tax rate of 25%, the traditional IRA net benefit to the account owner after taxes would be significantly less, at $468,842.  Given higher contributions, higher investment returns, and more time, the difference can be millions!

Setting Up Your Roth IRA

It’s relatively easy to establish a Roth IRA. First, determine that you are eligible based on your income (AGI). After that, you’ll need to find a custodian for your IRA, fill out required paperwork, and fund the Roth. Of course, investment advisors like Ridgewood Investments can assist you with all of these steps and even more importantly advise you on what investments can be used to maximize the growth of your contributions over time.

Roth Tips
  • Tip #1: One of the best tradeoffs that a retirement investor can make is, under the right circumstances, to convert a traditional IRA to a Roth. The best circumstance to do this may be if you have negative earnings on your traditional IRA. You can make the conversion, pay taxes on the pre-tax principal contributions (best done from other personal sources rather than from the original IRA itself), then convert it to a Roth IRA and reap its generous benefits.
  • Tip #2: Use the Roth IRA as a generational wealth pass-through fund. If your retirement needs are sufficiently met by other sources of income, simply let the Roth keep growing in value. Indeed, there is no provision that you ever need to withdraw from your Roth IRA during your own lifetime. Upon your death, the whole sum can be passed on to your designated heirs income tax free
  • Tip#3: Since the greater the growth of the Roth IRA the greater the tax savings you will benefit from, make sure that you select investments for your Roth IRA that offer you the possibility of good long-term growth.  This can mean to favor stocks or other growth investments rather than lower-returning or conservative investments such as bonds and money market funds.  This type of analysis is called “asset location” and a good investment advisor can help you make sure that your investments are placed in the right type of account within your overall portfolio.

Gain Freedom and Grow Your Wealth Without Working Harder

A Video by Ridgewood's Founder
Roth Pitfalls

Of course, even with something as well designed as a Roth IRA, there are a few pitfalls to be aware of. One is the Roth 5-year rule. This rule states that in order to receive tax-free withdrawals, you must have your contributions in a Roth IRA for at least five years and be 59 1/2. Otherwise, you may be liable for taxes on your gains as well as a ten-percent penalty. Be sure that you will not need to withdraw gains from your Roth conversion for at least five years.

Some folks may balk that you must pay taxes up-front when you make your contributions. Once you recognize the myriad of benefits, most astute investors stop thinking of that as a pitfall.

One important limitation to be aware of is that only people with income under specific amounts can contribute directly to a Roth IRA. You cannot do so if your adjusted gross income (AGI) in 2019 is greater than $203,000 (married filing jointly). Also, if you do qualify to fund a Roth IRA, the maximum amount that you can contribute in 2019 is $6,000.

Fortunately, there is a workaround for bypassing this income limit by using are more advanced strategy known as a “Backdoor IRA”.  Especially useful for high-income workers, this technique basically involves contributing to a traditional IRA first and then rolling that contribution into a Roth IRA (and paying the relevant taxes due upon conversion). Once again, experienced Investment advisors such as Ridgewood Investments can guide you through every step of the “Backdoor IRA” process.

Ridgewood Can Help!

As you can see, a Roth IRA can be a fantastic wealth-building tool if you combine its tax benefits with great long-term investments.   Matching up the Roth IRA with a portfolio of securities that can deliver growth as well as provide risk mitigation is critical. You also need to be aware of all the rules and provisions governing the Roth and potentially other IRA types because any mistakes with the process can set you back or lead to substantial penalties.

Ridgewood Investments focuses on growing and preserving wealth by tried-and-true long-term diversified investment methods. If you could benefit from some expert advice on maximizing the benefits you get from powerful tools like the Roth IRA - Ridgewood can help!  Contact us or schedule an appointment to chat about your own unique situation.

About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.

Help! My Cash is Earning Almost Nothing: What Are My Options for Better Returns?

Help! My Cash is Earning Almost Nothing: What are My Options for Better Returns?

Several decades ago, many investors kept a significant part of their savings in cash - typically in FDIC guaranteed bank accounts. Why? It’s was a safe and easy choice. They might have been keeping their powder dry for other opportunities in the market or in real estate or just wanting to earn some interest without volatility. Back then, waiting didn't hurt because bank account interest and money-market rates were considerably higher.  Savers were getting paid well to wait.

Unfortunately, this is no longer the case and hasn't been true for quite some time. Money markets and CD's earn near zero, not only frustrating the patient investor, but also wreaking havoc on the retirement income of those who used to depend on higher interest rates to support their lifestyle. Right now, keeping money in the bank or in money market funds is almost like earning a negative return because prices of most living expenses are rising faster than the rates earned on cash.  Many are bothered by these low returns but are unsure how to do better.  Read on below as we cover alternatives to cash that savers can use to immediately start earning better returns.

7 Devastating Mistakes Investors Make

and How You Can Avoid Them.
Interest Rates and Markets From the Early 1980’s to Present Day: A Synopsis

Before we turn to some potential options to earn higher returns, let’s review four decades of interest-rates and their trends over time.  This background will help to add context to the problem of low returns on savings that many investors are facing today.

Though it seems like a distant memory today, back in the early 1980’s, the effective Fed Funds Rate, to which money market and CD rates are typically tied, were unusually high, sustaining in the high teens and at one point spiking to around 20%. Since then, short-term interest rates have dropped steadily, staying below 10% since the mid 1980s and staying below, often well below 5%, since 2009. In fact, for the years 2010 to 2015, the rate hovered just above zero. Of late, the rate has turned a bit higher, but not by much, offering a paltry 2.04% as of October 2019.

The U.S. Federal Reserve manages short-term interest rates. These rates are highly sensitive to the Fed’s perception of what is happening in the U.S. and global economy. So what was going on since the early 1980’s that has driven rates for savers to such low levels today?

In 1973, the U.S. dollar was disengaged from the gold standard. This was the beginning of an inflationary period that lasted for the remainder of the 1970’s. In order to fight inflation, the FED resorted to raising short-term interest rates. The rate hikes eventually created a recession in 1980. Nevertheless, investors in cash proxies were handsomely rewarded with the very high yields of that time.

The ongoing interest-rate decline since 2009 was largely caused by the Financial Crisis of 2007-2009. This event was considered by many to be the worst financial collapse since the Great Depression of the 1930’s. It began as the subprime-mortgage market in the U.S. began to unravel. That was the catalyst that developed into a full-blown global financial meltdown. There was fear of an overall collapse in the global financial system. To combat that possibility, central banks around the globe took coordinated actions to lower interest rates and add liquidity to the global financial system in the hope of stimulating national economies to bounce back and start to mend the financial system. Sluggish global growth since then has kept rates abnormally low. In fact, in some countries, short-term interest rates are currently negative.  This means that in quite a few countries, bank accounts and bonds actually give you back less money than you deposited or invested at the start.

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up your time
  • Take less risk and reach goals faster
Back to the Current Investor’s Dilemma

That brief history may be informative as to how we got to today’s low-interest-rate environment, but what are retirees and other investors to do. The reward for parking large amounts of cash is now dismal and in many places actually negative. Furthermore, for many retirees, who used to depend on returns from money markets and CD’s for a significant portion of their spendable income, the last few years have been a disaster. 

Fortunately, there are a number of options available. Unfortunately, very few of these options are as risk-free as cash. In today’s environment, seeking higher income often means investing in securities that can fluctuate in value. In this environment, investors have to be more sophisticated and savvy.  They have to have the ability to compare complex alternatives, do careful research on each options pros and cons and then make calculated moves to capture more value on their savings.  Let’s investigate some of these options.

Return-boosting Options: The Good, the Bad and the Ugly

These days, many investors are reaching for higher-yielding investments in place of the safety of money market funds and bank CD’s, where their principal was protected. Instead, they are looking, among other things, to real estate investment trusts (REITS), high-yield and dividend paying stocks, intermediate- to long-term bonds or bond funds, master limited partnerships (MLP’s) and closed-end funds. Although these generally provide a higher yield, they also come with risks not associated with cash equivalents.

REITs are investment pools that collect rents from their real-estate holdings and are required by law to pass on at least 90% of their profits to their shareholders in the form or regular distributions. Many of these yield between 3% and 7% and generally pay their dividends quarterly, although some also pay monthly. They may be an important part of many investors’ total portfolio but are not without risk. Chief among these is that they can decline in value.  For higher net worth and accredited investors, the option to invest directly in private income producing buildings is also available.  The benefits of investing directly in commercial real estate include better tax advantages and higher distributions but with the downside of lower liquidity on the investment.  At Ridgewood Investments, we are quite active in both areas of real estate investing and we are still finding good opportunities in both areas for long-term investors.

Intermediate- and long-term bonds deliver yields that are higher than cash-equivalent income securities. These days, however, longer-term U.S. Treasury bonds do not pay much more than cash equivalents perhaps about 1% or so. They also come with a potential problem: Their value will decline if interest rates rise.  Of course there are many other types of bonds to consider, such as municipal bonds and corporate bonds.  All are subject to interest rate risk so understanding the underlying credit characteristics of the bonds you invest in is quite important.

Stocks in general and dividend paying stocks in particular are another great alternative for long-term investors seeking higher returns.  During the entire post financial crisis period characterized by very low interest rates, stocks and especially US stocks have actually generated excellent returns.  Unfortunately, many people were scared out of the market by the last financial crisis and many of them never really got back in so they missed out on this last decade or so of great returns.  In fact, US stock markets have been making new highs these past few years.  Investors still sitting with a lot of cash may be unsure of how to proceed.  They may feel that they have missed out and it is too late to do anything about it.  However, the stock market always offers some great opportunities to investors who can take a long-term view and have a sound strategy based on solid principles like value investing and doing their homework.

Within the stock market, one area of particular interest may be dividend paying stocks including high-yield stocks, such as many electric utilities and telecommunication firms. These firms can offer yields in the 3% to 6% range plus a little growth on top of that over time. Again, like REITs and bonds, they can decline in value so you have to be careful. Some high-yield stocks, such as tobacco companies, have some inherent legal risks that can also negatively affect their prices.  Within the area of dividend stocks, another way to identify good opportunities is to look for companies that have average or even below average current dividend yields, but that are expected to grow their dividends consistently for many years to come.  These "dividend growth" companies can be good for earning higher income and greater total returns - again for long-term investors.  At Ridgewood Investments, we have an entire team dedicated to finding great dividend growth investing opportunities.

One caveat in all of the above areas is to watch out for unsustainably high yields.  High yielding securities can be value traps offering "sucker yields" and may have additional idiosyncrasies that add further risks to their total return potential.  Chasing a high yield only to find it cut after you make the investment can be a recipe for disaster.  Before you make any investment commitment to improve your returns, make sure you do thorough research to consult or hire the expertise needed to make good investment decisions in these and other areas.

Other resources you may
be interested in:

Watch explainer videos on business, personal finance, personal growth, and investing on Investing with Ken Majmudar.

An Experienced Advisor Can Be Invaluable in this Low Interest Rate Environment 

As you can see, it’s not the early-1980’s interest-rate environment anymore with its lucrative alternatives for savers.  Many folks sitting on large amounts of cash today may feel they may have missed this current bull run or feel unsure about what to do.

In times like this, you may wish to partner with a trustworthy advisor, especially when you review the risks associated with reaching for higher yields. At Ridgewood Investments, we help long-term investors including those sitting on large amounts of cash earning low returns.

If you are wondering what to do, help is only a call or email away.  Let us help you navigate the choppy investment waters of the current low-interest-rate environment and steer the ship of your investment portfolio to a better returning port.

About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.

Is Your Portfolio Ready for the Next Economic Recession?

Is Your Portfolio Ready for the Next Economic Recession?

Economists define economic recessions as a period of temporary economic decline during which trade and economic activity are reduced - generally confirmed by a fall in GDP (Gross Domestic Product) in two successive quarters.  Recessions are inevitable so if you intend to invest and grow your money for long-term goals such as retirement or growth, you have to be able to have an investment approach that is anti-fragile enough to withstand recessionary periods.

While the likelihood of recessions is almost certain even for healthy and dynamic economies, their timing is notoriously difficult to predict.  As Paul Samuelson, winner of the 1970 Nobel Prize in Economics once quipped, “the stock market has predicted nine of the last five recessions.” His point was that market timing and forecasts are often wrong and unreliable.  Thinking that you will be able to cash out of your investments and get back in at exactly the right time is a fantasy pursued by many that turns out ultimately to be unrealistic and foolish.  So if timing isn’t the solution, how can thoughtful investors prepare their portfolios through these occasional downturns?  Read on below as we outline three specific strategies you can utilize to prepare yourself to survive and thrive during more difficult times.

7 Devastating Mistakes Investors Make

and How You Can Avoid Them.
Are we overdue for a correction?

The chart below summarizes the timing and duration of the four recessions that have occurred in the US since 1980.

Recession

Duration

Decrease in GDP

Peak Unemployment

Main Cause

Dec 2007 to June 2009

18 months

-5.1%

10.0%

Housing Bubble

Mar 2001 to Nov 2001

8 months

-0.3%

6.3%

Dot-Com Bubble and 9/11

July 1990 to Mar 1991

8 months

-1.4%

7.8%

Gulf War

July 1981 to Nov 1982

16 months

-2.7%

10.8%

Energy Crisis

The good news for long-term investors is that recessions are not usually that long (typically lasting from 8 to 18 months before economic activity begins to turn upward again).  In contrast, growth periods are far longer and also occur more frequently.  This explains the general upward trend of markets that long-term investors can harness to grow their investments over time.

However, while the duration of recessions is actually not that long, the impact on unemployment and stock market valuations can be far more severe than you might think by looking at the table above.  For example, during the 2007 to 2009 recession, GDP only declined 5.1%, in contrast, US Stocks as measured by the Dow Jones Average fell almost 10x or approximately 50% from a peak in October 2007 to its low in March 2009.  Of course, if you had the stomach and ability to have been prepared after this last recession ended, however, you would have enjoyed an increase of over 350% since then in the Dow Jones with dividends reinvested. 

By a number of metrics, the current growth cycle which started in June 2009 is one of the longest continuous expansions in the last century.  Known as the Great Recession caused by the Financial Crisis, this last downturn prompted almost unpresented government and central bank interventions that many believe have caused structural issues that have yet to be fully addressed.  

As of the date of this article, the next recession may be long-overdue. On average, in recent times, we’ve had a recession every seven to eight years.  However, it has been more than 10 years since the last recession officially ended in June 2009.  In many countries, interest rates are actually negative and the recent trade frictions between the US and China may also have slowed economic activity between two of the most important global economies and their allies increasing risks of a recession going into 2020 which is an election year in the US.

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster
Will your investment strategy survive the next recession?

A strategy that can survive and thrive during a downturn is an essential aspect of portfolio planning. In a bull market, every portfolio looks good, or as Warren Buffet has put it, “Only when the tide goes out do you discover who’s been swimming naked.”  During the last crisis that ended about a decade ago, many investors found themselves unprepared and suffered devastating losses as a direct result of their inattention or inability to stick to the right portfolio strategies and investment approach.

Historically, there has been a correlation between asset class performance and phases of the business or trade cycle, for asset performance can be impacted by economic factors, such as corporate earnings, interest rates, and inflation. These forward indicators are helpful, sometimes, in identifying the current phase of the business cycle.

Summarized below are three strategies to prepare yourself and your portfolio for difficult times:

  • Strategy #1: Diversification and your mix between stocks and bonds
    Generally, stocks do better when the economy and their earnings are growing. Business confidence and investment is at its highest then and so too, unfortunately, is “irrational exuberance” so naturally valuations and stock prices go up. On the other hand, when a downturn threatens, business expectations fall and valuations and stock prices soon follow. By contrast, bonds and other debt exhibit an inverse pattern, typically yielding more modest returns during good times, but providing greater income and stability during downturns.  Having the right mix of these two asset classes as well as a well-planned diversification of investments within each category is an important aspect of being ready for economic downturns.
  • Strategy #2: Income and Dividend Investments
    Investments that pay interest and or growing dividends can be another way to protect yourself during recessionary times.  At Ridgewood Investments, one of our focus areas is to identify investments that pay good dividends with the prospect of growing those dividends for a long-time to come.  To some extent, bonds, preferred stocks, convertible stocks, and private investments such as income producing real estate or private debt or stable private businesses that generate income also share some of these stable income producing characteristics.  The common factor between and among all these investments is that you can own them for the long-term and live off the income stream or actually use the income to take advantage of the opportunities to “buy-low” that might be created during recessionary times.
  • Bonus Strategy: Options as Portfolio Insurance

    Options are a type of advanced financial instrument that can be used to hedge risk and contain short-term portfolio losses. Think of them as a type of insurance. If nothing bad happens, you won’t need them. However, if stock prices fall, they can cover some or all of your loss. Just like insurance, you have to pay a premium to own the option protection.  Most of the time, the cost of the premium is paid and lost without a corresponding payoff because the downturn doesn’t happen during that time period of coverage.  As a result, this approach can, over time, be a relatively expensive way to protect yourself and so should be used sparingly and in the right hands.  A detailed discussion of options is beyond the scope of this article, however, so we mention them just for completeness.

Summary and Next Steps

If you want to achieve your long-term goals, there any many options to consider.  As with most things in life, an ounce of prevention is worth a pound of cure.  If you wait until the next recession starts hoping you are prepared, it will probably be too late.

As experienced investment advisors, our team at Ridgewood Investments has the knowledge, tools, and expertise to assist our clients to be better prepared when others find out, only far too late, that they have been swimming naked. 

Contact us for a complimentary in-depth portfolio review and a further discussion of additional strategies that you can use to be prepared before the next recession arrives.

About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.

How to Invest and Grow Your Wealth in the Stock Market.

How to Invest and Grow Your Wealth in the Stock Market

If the idea of investing in the stock market makes you fearful or confused about how to make the right moves, you’re not alone.

Even though investing in the stock market can be more complex than other investment strategies, done correctly, it can produce meaningfully higher returns than savings accounts, cash or similar alternatives.

If you are able to save from your earnings and commit to sticking to a long-term horizon, the stock market and other long-term investments can be an excellent way to grow your nest-egg.

If you’re thinking of investing for the long-term, you’ll need to decide how you will choose and manage your investments and then set up an investment account.

Here are some of the fundamentals involved:

Doing it yourself or working with an advisor

Do you want to pick and manage your investments yourself or would you prefer to have an experienced advisor do it for you? The first option can be good for those who have an interest in, time for and existing knowledge of the stock market.  In addition to the above, you also need to have the right temperament and personality to be able to stay calm during the inevitable fluctuations that come with managing your investments on your own.

An experienced advisor who can do it for you (and at a level beyond the capabilities of most individuals) is usually a better option for those who might lack the time, personality, knowledge and/or interest to do it by themselves successfully.

After you research the alternatives, you can always start with one of the options that seems the best for you and switch if your experiences or your circumstances changes.

7 Devastating Mistakes Investors Make

and How You Can Avoid Them.
Choosing an investing account

Whether you do it yourself or work with an advisor, you will need an investment account at a reputable firm to hold your cash and investments.  Of course any experienced advisor will assist you to create your account if professional help is appropriate in your circumstances.

Most individuals set up one or more brokerage accounts to hold their savings and investments.  Brokerage accounts come in multiple types, whether individual or joint and whether taxable or tax-deferred.

One of the most popular types of tax-deferred brokerage accounts is the individual retirement account or, IRA for short.  Among other purposes, an IRA can help you move money from a prior employer 401k retirement plan without triggering any taxes.

Of course there are many brokerage firms and accounts to choose from.  Before selecting the firm to hold your accounts, it is important to analyse the brokerage account options for factors such as investment selection, costs, tools, and research support.

Discount brokerage firms such as Charles Schwab, Fidelity Investments, and TD Ameritrade provide a great deal of functionality while also offering low cost trading.  Other firms such as Interactive Brokers and Folio Institutional offer low cost trading but also powerful technology and tools for online trading. 

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster
Stocks or mutual funds?

If you've chosen to work with a good advisor, you can disregard the rest of this section and enjoy a cup of calming herbal tea. For the DIY'ers, it’s going to be particularly helpful to understand the difference between stocks and mutual funds.

  • Individual stocksHigher complexity – potentially higher return and risk. You simply choose a company you want to invest in and buy some shares.  This requires time and research and sometimes a strong stomach as well.  Done incorrectly, this option raises multiple challenges and risks so it should not be approached lightly.  You should make sure to have enough different stocks to give you diversification to withstand the risk of choosing some companies that don’t end up doing as well as you had hoped.

  • Mutual fundsMedium Complexity – lower control and flexibility.  These let you purchase a bundle of various stocks, bonds, real estate or other investments in one go. You will hold small amounts of shares in many different companies though your ownership in the pool of investments called a mutual fund.  Of course, the fund costs to create and maintain the pooled structure (also called the “expense ratio”) are passed on to you and the thousands or millions of other investors participating in any given fund.  Some funds are higher cost and some are lower cost – the value of each fund is based on a calculation called the Net Asset Value (or NAV for short) and this number is calculated once per day.

  • Exchange-traded fundsMedium complexity - This is a type of mutual fund that trades on a stock exchange, much like a stock.  However, unlike a stock it does not represent ownership in one company but rather like a mutual fund it is a pooled investment with holdings in potentially many different companies.  Like mutual funds, ETFs also have expense ratios but they trade whenever the stock market is open.

No matter which option or options is right for you, there are thousands of choices in each category in the United States markets alone and even more globally, so research and thought is required to select better options to meet your goals and objectives.

Done correctly investing for the long-term in any of the above categories of options can lead to life changing results for you and your loved ones.


About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.

Identifying Promising Opportunities in MicroCap Investments

Identifying Promising Opportunities in MicroCap Investments.

Investing in MicroCap companies has many similarities to investing in larger companies – though certain unique risk factors more applicable to MicroCaps require savvy investors to supplement their normal investment process.

Some of these considerations more applicable to smaller companies include the following:

  • They are underfollowed and less regulated 
  • Tend to have weaker reporting systems and controls
  • Have fewer resources in time and money than larger companies 

At Ridgewood Investments, we have been investing in MicroCap opportunities for many years and through our experience have come to develop our own five point investment process to help us focus on the most promising opportunities:

  1. Focus on quality companies 
  2. Perform extensive due diligence 
  3. Pay the right price 
  4. Monitoring results 
  5. Implement A Sell Discipline in advance 

Focusing on quality companies is an important initial step in MicroCap investing because in smaller and lower quality companies, the business model sometimes just doesn’t work and a checklist helps you eliminate these investment traps ab initio. For example, customers may not want to buy the company’s product or perhaps the product is one for which they can easily switch to a competitor or a new entrant into the market. Owning “quality” companies helps lower these risks. At Ridgewood we use a checklist of over 20 items to help us measure if a potential microcap investment candidate passes this initial quality test. These checklist items range from financial ratios to qualitative aspects of the business such as barriers to entry and competitive analysis. (email us to get a copy of our checklist – note that the idea of having a checklist is inspired, in part, by Atul Gawande’s book the Checklist Manifesto which we highly recommend)

7 Devastating Mistakes Investors Make

and How You Can Avoid Them.

Once a company passes the quality test, the next step is to perform intensive and thorough due diligence. We start off by comprehensively reading the company’s SEC Filings (including footnotes!), conference calls and press releases. This is the time to be looking for buried red-flags and hidden pitfalls. For example, is the amount of options and/or warrants a company has issued reasonable and reflect positively on management’s capital allocation abilities? We once identified a clean coal technology company that had a great product and seemed to have investment promise, but upon closer examination we noticed this company had a habit of regularly diluting the current shareholders by issuing an egregious amount of options and warrants. In this step we also scrutinize the totality of the company and management’s history of past decisions and communications to see if they have a strong track record of capital allocation and strategic decisions or the opposite.

After the above initial stage of diligence, if the company still looks interesting, we start to have more extensive conversations with management, competitors, customers, suppliers and anyone else that can help verify and give more insight on the business and industry. We often travel to visit the company as well as attend trade shows and read industry publications if applicable. Not many microcap investors do this much due diligence on their investments, and even fewer sell-side analysts that cover smaller companies do so – partly because they don’t typically have the budget to travel and invest in such deep diligence. As investors willing to go the extra mile, this step is one where we can develop “an edge” on the upside while also reducing the risk of investing in a poorly run or even fraudulent company on the downside. In the last three years, I’ve avoided two potential investments that ended up being frauds later – in both of these cases the companies refused my request to let me visit their operations.

Another key to reducing risk when investing in very small companies is maintaining valuation discipline. The cheaper that one can purchase a company’s shares, compared to what its intrinsic value is, the less risk is being taken. In other words, purchasing a dollar for 50 cents is less risky than purchasing a dollar for 90 cents or even worse 150 cents. Rather than having a trader’s mentality we focus on cultivating a business owner’s mentality. Once we identify a good company that we want to own, even if we own some shares already, we get excited not dejected, if the price of a company’s stock goes down and creates more compelling value for us to take advantage of. 

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster

Although it can be psychologically tough to buy more of a stock as it is dropping, by doing extensive primary research and developing strong conviction on the value of a company, it makes it easier to pull the trigger. Remember that there can be many reasons why someone wants, needs or is forced to sell a stock, however only one reason why someone would buy, which is that they think that it is worth more. 

After buying, we continue to monitor and perform ongoing periodic due diligence updates on the business and the industry. This update process is continuous and lasts as long as the stock is in the portfolio. We continue to read all the news, press releases, SEC filings as well as have meetings with the companies, competitors, suppliers, customers and so forth.

Finally, always make sure to maintain and update price targets for each investment upfront (though targets can be updated in light of information). Once the company has hit its fair value, be happy selling the position. Also, if things change and the target price falls to where the prospective return is no longer attractive, look at selling the position as well. It’s important to consistently revisit and re-check the original investment thesis to see if it still holds. This process has helped us reduce the risk of investing in microcaps. While no one can be right one hundred percent of the time (only liars), the hope is to have a good batting average for which one of the keys is to be selective based on a sound investment process and not swing at most pitches.

This article is informational in nature and should not be construed as providing individualized investment advice. Investors are advised to conduct their own research and due diligence or seek the advice of a registered investment professional. Both the Author and Ridgewood Investments disclaim any liability from the use or misuse of this information.

About the Author

Sam Namiri is a Portfolio Manager and Analyst at Ridgewood Investments, where he concentrates on managing the Ridgewood Select Value Fund, our fund focused on investing in small and micro-cap companies.  

Prior to Ridgewood, Sam was an associate at Grand Slam Asset Management, a Small Cap Hedge Fund and also the Founder and President of Shop Network, a jewelry company involved in television, media, manufacturing, distribution and e-commerce. He led the company in producing a reverse-auction television show selling jewelry which aired on DirectTV, started a plant overseas to manufacture semi-precious gemstone jewelry, and developed a global supply chain.

Mr. Namiri has a BS in Industrial Engineering and Operations Research from the University of California, Berkeley and an MBA from Columbia Business School.

Reading the Proxy Statement to Evaluate Management

Reading the Proxy Statement to Evaluate Management.

One of the main focuses in my microcap investment strategy is to find high quality companies. However, a high quality company needs a high quality management team and board members as well.

Thoroughly reviewing the Proxy Statement also known as the DEF 14A, as referred to by the SEC, gives valuable information that investors can use in their evaluation of the management of any company.

I believe that there are only a small minority of investors who read the Proxy Statement thoroughly. Even those that do, likely only glance at the management compensation section and ignore the rest. The Proxy Statement is meant to provide shareholders with valuable information that allows them to be informed as shareholders of the company when voting their shares.

From the company’s perspective, the Proxy is meant to disclose compensation guidelines and governance policies, showcase board members and their committee roles, explain what is being voted on at the annual meeting, and present materials that shareholders can use to understand what they are voting on.

However as an investor and shareholder, the Proxy Statement is helpful to understand the motivations and incentives of the people managing the company to make sure that they are aligned with shareholders. Warren Buffett stated on CNBC: “You want to figure out ... how well that they treat their owners,” he said. “Read the proxy statements, see what they think of —see how they treat themselves versus how they treat the shareholders … The poor managers also turn out to be the ones that really don’t think that much about the shareholders, too.”

7 Devastating Mistakes Investors Make

and How You Can Avoid Them.

So what are some of the key things that I look for? First I evaluate the board members and their backgrounds and prior experience. In addition to reading the Proxy to learn about their biographies and backgrounds, I run a simple web search and also look on social media to learn more about them. If I have any mutual connections, I talk to them as well to see what they think or know about the board member. My goal is to find out if the board member is an active contributor or if they are just golfing buddies with the CEO looking to cash an extra check. The easiest way to tell if a board member is truly aligned with the shareholders is to find out if he or she owns a meaningful position in the stock of the company.

The Board structure of a company is very important as well. One important consideration is whether the CEO is also the Chairman of the Board. The Chairman holds a lot of power and having both roles may vest too much authority in one person, which can potentially cause problems. Especially if the CEO is well paid yet doesn’t own many shares, his or her goal often becomes to do whatever they can to keep collecting paychecks for as long as possible. If the CEO is also Chairman then they are more likely to be able to stay in the CEO position longer regardless of performance.

Compensation is another extremely important section to analyze. Something to pay attention to is the percentage of executive compensation that is fixed versus variable. Look at the past and see the rate of increase in compensation and compare their compensation to other companies of similar size. Read about the short term metrics that the company looks at to evaluate management and what the targets are. Do these align with shareholder interests? If Earnings Per Share (EPS) is a metric that management is evaluated against for their annual bonuses, they may push for a stock buyback to lower the share count and boost EPS for their own benefit even though buying back the shares is not the best use of capital. I prefer companies that set targets and evaluate management on multi-year return on invested capital and free cash flow metrics instead of metrics that can be more easily manipulated such as EPS and adjusted EBITDA.

Equity compensation is another metric that I look at closely. I want to make sure that the company isn’t just giving out shares annually just for showing up, but truly values its shares and gives them for truly good performance. I also prefer that companies give restricted stock that vests over a few years instead of options, as this better aligns management with shareholders. When granted options, management is more likely to swing big and take more risk. 

Join our family of 200+ clients who trust Ridgewood.

One step can bring you a lifetime of benefits.

  • Increase your wealth without working harder
  • Protect those you love
  • Get your financial life organized
  • Free up yo​ur time
  • Take less risk and reach goals faster

Finally, in particular with microcap companies, it is important to look at the employee agreements and severance agreements of the key executives and learn about how they benefit from a potential change in control or acquisition. You ideally want a good balance where they are incentivized to accept a good deal from an acquirer, but also not be too expensive where their payout from an acquisition would be so expensive that it deters a potential acquirer.

A few other things that are important to notice and look for in the Proxy Statement are insider ownership and how much of the company management owns, who the major outside shareholders are, whether there are different classes of shares, who the peer companies are according to the compensation consultant, perks and related party transactions and also who the auditor is and whether the audit firm has changed frequently. All of this information helps provide more data points to paint either a pretty or ugly picture of the people leading the company that you might invest in.

As a shareholder in any size company, it is important to read the Proxy Statement, however, in the MicroCap space where companies are not as much in the spotlight and are more likely to suffer with poor management and corporate governance, the Proxy Statement can be an indispensable resource in helping investors to sniff out the good, the bad, and the downright ugly.

About the Author

Sam Namiri is a Portfolio Manager and Analyst at Ridgewood Investments, where he concentrates on managing the Ridgewood Select Value Fund, our fund focused on investing in small and micro-cap companies.  

Prior to Ridgewood, Sam was an associate at Grand Slam Asset Management, a Small Cap Hedge Fund and also the Founder and President of Shop Network, a jewelry company involved in television, media, manufacturing, distribution and e-commerce. He led the company in producing a reverse-auction television show selling jewelry which aired on DirectTV, started a plant overseas to manufacture semi-precious gemstone jewelry, and developed a global supply chain.

Mr. Namiri has a BS in Industrial Engineering and Operations Research from the University of California, Berkeley and an MBA from Columbia Business School.