Socially Responsible Investing Comes of Age

By MICHAEL IACHINI

APRIL 19, 2018

There’s never been a more opportune time to sync your personal values with your investments. Socially responsible investing (SRI)—which seeks to effect positive social change while also generating competitive financial returns—has emerged as a significant, grass-roots trend. According to a 2016 study by US SIF: The Forum for Sustainable and Responsible Investment, 80% of fund managers who have incorporated such strategies into their portfolios did so in response to requests from individual and institutional investors.1

There also has never been more choice. From 2012 to 2014, the number of U.S. investment funds that incorporated environmental, governmental or social criteria increased by 28%, and their assets quadrupled to more than $4.3 trillion over the same period.2 What’s more, great strides in data collection and a slew of new online tools have made identifying such funds a matter of a few clicks and keystrokes. For example, Schwab’s exchange-traded fund (ETF) screener and mutual fund screener both have a “socially conscious” filter that allows clients to search for and compare SRI funds.

But let’s get down to brass tacks: When it comes to returns, can such funds really hold their own against their less socially responsible competition? Let’s take a look.

The SRI advantage

Far from compromising on returns, SRI funds may offer a competitive advantage. The MSCI KLD 400 Social Index, for example, averaged an annual rate of return of 10.44% from 1990 through January 2017, compared with 9.95% for the S&P 500® Index over the same period.3

And according to data from Morningstar, SRI mutual funds have consistently kept pace with their non-SRI counterparts in the short, medium and long terms (see “Doing good does well,” below).

Doing good does well

Socially conscious funds delivered competitive returns over both the short and long terms.

Source: Charles Schwab Investment Advisory, Inc., with data from Morningstar, as of 3/31/2018. Returns represent the average annualized performance of U.S. equity open-end socially responsible and non–socially responsible mutual funds. Past performance is no guarantee of future results.

And although SRI funds were once criticized for their relatively high fees, they’ve become more competitive over time. Out of the 225 Morningstar-listed mutual funds that self-identify as socially conscious, nearly half had lower expense ratios than their category’s average.4

Building a values-based portfolio

One challenge to creating a values-based portfolio is achieving adequate diversification, particularly when it comes to socially conscious bonds. That’s because the lion’s share of the U.S. bond market is made up of Treasuries and mortgage-linked bonds—investments whose impact is difficult to measure, making it challenging to apply SRI standards.

That said, there are SRI funds for corporate bonds, international stocks, and U.S. large- and small-cap stocks. There are even balanced funds that blend socially responsible bonds and stocks within a single investment vehicle.

However, while it’s easy enough to find a like-minded ETF if you’re interested in, say, sustainable energy, what if you have multiple goals—pinpointing sustainable-energy companies with boards that reflect gender and racial diversity, for example? To fulfill this level of specificity, you may need to do a bit of digging. Fortunately, most socially conscious funds are eager to advertise their bona fides on their websites.

The future of investing?

As the once-niche market of SRI investing continues to gain steam and demonstrate solid long-term returns, we’re likely to see more widespread adoption of these strategies in the future. For example, in 2015 the Department of Labor responded to popular demand and cleared the way for managers of 401(k) accounts and pension funds—whose combined assets total roughly $6.7 trillion5—to consider socially conscious factors in their investment decisions.

Millennials, too, are fueling the SRI trend. One study found that two-thirds of those age 22 to 34 are likely to invest in a company well-known for its social responsibility, compared with less than half of those over age 34.6 And as Millennials continue to grow and mature as investors, the SRI market will likely grow with them.

12016 Report on US Sustainable, Responsible and Impact Investing Trends.
2Ibid.
3Morningstar, as of 01/31/2017.
4Ibid.
52016 Investment Company Fact Book, Investment Company Institute.
6Aflac Corporate Social Responsibility Survey, 10/2015.

Important Disclosures

Investors should carefully consider information contained in the prospectus, or if available, the summary prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Past performance is no guarantee of future results.

Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV).

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Charles Schwab Investment Advisory, Inc., is an affiliate of Charles Schwab & Co., Inc.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry-group representation.

The MSCI KLD 400 Social Index is a capitalization weighted index of 400 US securities that provides exposure to companies with outstanding Environmental, Social and Governance (ESG) ratings and excludes companies whose products have negative social or environmental impacts.

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Not Always Tax Free: 7 Municipal Bond Tax Traps

By COOPER J HOWARD

MARCH 09, 2018

Key Points
  • Although municipal bonds pay interest that is generally exempt from federal and state income taxes, it’s not always free from all taxes.
  • We identify some of the taxes that could apply if you buy municipal bonds and next steps you may want to consider.

Investors often think of municipal bonds, which are sold by local and state governments to fund public projects like building new schools and repairing city sewer systems, as being totally tax free—but that’s not always the case.

While the interest payments on munis are usually exempt from federal income taxes, other taxes may apply. It’s important to know the rules, because municipal bonds are one of the few investments available to income-oriented investors looking to reduce their income tax bills. Here are seven types of taxes that could apply if you buy muni bonds.

1. De minimis tax. If you acquire a muni at a market discount, you may have to pay taxes on the difference between the par value and the acquisition price. The de minimis rule says that for bonds purchased at a discount of less than 0.25% for each full year from the time of purchase to maturity, gains resulting from the discount are taxed as capital gains rather than ordinary income.

For example, take a bond that matures in 10 years with a face value of 100. The de minimis “breakpoint” on this bond is 97.5 (100 – [0.25 × 10 years]). If you bought this bond for less than 97.5, you would be required to pay ordinary income tax on the discount. The tax rate on ordinary income is generally higher than that on capital gains.

What you can do: To avoid the de minimis tax rule, consider purchasing bonds priced at par or a premium to their face value. Paying a premium may mean having to make adjustments to your tax filing, but the associated tax benefits more than offset the added complication, in our view. In addition, if a bond is selling at a premium, it’s likely because it is offering a high coupon rate.

2. Alternative minimum tax. There are two parallel income tax systems in the United States: ordinary income tax and alternative minimum tax (AMT), which disallows a number of deductions that are allowed in the ordinary income tax code. Taxpayers must calculate their tax under each system, then pay whichever is higher—ordinary or AMT.

Income from some municipal bonds—for example, those that fund stadiums, airports or more business-like enterprises—might be subject to AMT. If you have to pay AMT and hold such a bond, your interest income would generally be taxed at the applicable AMT rate—which could be 26% or more, if you’re in the AMT exemption phase-out range. Effectively, that means the yield on a municipal bond paying 2.50% would drop to 1.85%. The recently passed tax legislation increased the phase-out thresholds for AMT to $1 million for joint filers, up from $160,900—meaning fewer filers will be subject to AMT under the new tax laws.

What you can do: For bonds held at Schwab, you can find out if a municipal bond is subject to AMT by accessing the “Research” page after logging into schwab.com, searching for a municipal bond and viewing its “Security Description” page. You can also contact a Schwab Fixed Income Specialist at 877-566-7982.

3. Increase in taxation of Social Security benefits. Although municipal bonds generally aren’t subject to federal taxes, the IRS does include income from such bonds in your modified adjusted gross income (MAGI) when determining how much of your Social Security benefit is taxable. If half of your Social Security benefit plus other income, including tax-exempt municipal bond interest, amounts to more than $44,000 for a joint return ($34,000 for individual), up to 85% of your Social Security benefits may be taxable.

What you can do: If you are receiving Social Security benefits, we suggest reviewing IRS Publication 915, “Social Security and Equivalent Railroad Retirement Benefits,” which discusses the taxation of retirement benefits, to determine how this might apply to your individual situation.

4. Increase in Medicare premiums. If you’re covered by Medicare, the federally tax-exempt interest from municipal bonds may increase the amount you pay for Medicare Part B or Medicare prescription drug coverage. If you’re married and filing jointly and your MAGI is more than $170,000 ($85,000 for single filers), you will be required to pay an additional amount for Medicare Part B and Medicare prescription drug coverage.

To determine your Medicare premiums, the Social Security Administration generally uses your most recent federal tax return. For example, to determine 2018 monthly adjustment amounts, the Social Security Administration would use your tax return filed in 2017 for tax year 2016. You can learn more about Medicare premiums in the Social Security Administration publication “Medicare Premiums: Rules For Higher-Income Beneficiaries.

What you can do: We don’t believe paying an additional Medicare premium justifies not investing in municipal bonds. Given that your MAGI will also include income from other sources, such as dividend income and interest income from taxable bonds, avoiding municipal bonds will not necessarily allow you to avoid the increase in Medicare premiums. Also, investing in zero-coupon bonds likely won’t allow you to avoid paying higher premiums, because the part of the increase in the zero-coupon bonds’ value may be included in the calculation to determine your Medicare premiums.

5. Capital gains tax. We generally suggest individual investors hold a bond until maturity. However, if you need to sell earlier and you receive a price greater than your cost basis—your acquisition price after adjusting for any premiums paid or discounts received—the gain will be subject to capital gains tax.

What you can do: Determining cost basis for an individual bond can get complicated, as there are special reporting rules that govern the adjustments to a bond’s acquisition price. For bonds held at Schwab, you can find your adjusted cost basis on the “Positions” page after you log into schwab.com.

6. State income tax. If you purchase a bond from your home state, generally the interest payments you receive will be exempt from state income taxes. However, interest paid on bonds from outside of your home state typically will be subject to state income tax.

What you can do: If you live in a state with low tax rates or one that issues a minimal amount of municipal bonds, we would suggest looking outside your home state. The added benefits of diversification and higher yields might make up for the hit you would take by paying state income taxes.

7. Taxable municipal bonds. A small minority of munis are taxable. For example, interest paid on bonds issued to help fund an underfunded pension plan or bonds issued under the Build America Bonds (BABs) program is federally taxable. Taxable muni bonds generally yield more than tax-free bonds to make up for the difference.

What you can do: For investors in lower tax brackets and investing in taxable accounts, or those investing in either Roth or traditional IRA accounts, we believe taxable municipal bonds can make sense compared to other taxable bonds because, historically, munis have exhibited stronger credit characteristics than corporate bonds of comparable ratings.

The bottom line is that municipal bonds offer significant tax advantages and could make sense in the portfolios of many income-focused investors. However, the details matter. If you are highly tax-sensitive and would like to invest in these securities, you will want to make sure you understand how the tax traps mentioned above might affect your portfolio.

If you have questions about your portfolio, you could consult IRS Publication 550, “Investment Income and Expenses,” or check in with your tax advisor.

Important Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security’s tax-exempt status (federal and in-state) is obtained from third-parties and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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Why Market Returns May Be Lower and Global Diversification May Be More Important in the Future

By VEERAPAN PERIANAN

MARCH 06, 2018

Key Points
  • Market returns on stocks and bonds over the next decade are expected to fall short of historical averages.
  • The main factors behind the lower expectations for asset returns are low inflation, historically low interest rates and elevated equity valuations.
  • International stocks appear more attractive than U.S. stocks based on valuations, underscoring the importance of investing in a diversified portfolio.

Market returns on stocks and bonds over the next decade are expected to fall short of historical averages, while global stocks are likely to outperform U.S. stocks, according to our 2018 estimates.¹

This article provides a broad overview of the methodology used for calculating our capital market return estimates and highlights the importance of global diversification and maintaining long-term financial objectives that are based on reasonable expectations.

The main factors behind the lower expectations for market returns are below-average inflation (despite a recent rise in expected inflation), historically low interest rates and elevated equity valuations.

The reduced outlook follows an extended period of double-digit returns for some asset classes, as shown in the chart below. As such, now may be a good time for investors to review, and consider resetting, long-term financial goals to ensure that they are based on projections grounded in disciplined methodology and not historical averages.

Our estimates show that, over the next 10 years, stocks and bonds will likely fall short of their historical annualized returns from 1970 to 2017. The estimated annual expected return for U.S. large-cap stocks from 2018 to 2027 is 6.5%, for example, compared with an annualized return of 10.5% during the historical period. Small-cap stocks, international large-cap stocks, core bonds and cash investments also are projected to post lower returns through 2027. However, the expected annual return for international large-cap stocks is 7.2% over the next 10 years, which is higher than the expectations for U.S. large-cap stocks.

Here are answers to frequently asked questions about these market estimates:

Why are long-term estimates of returns important?

How do you calculate your long-term forecasts?

Why do you expect long-term returns to be lower than historical averages?

What could lead to higher returns?

Why do you expect international stocks to outperform U.S. stocks?

What can investors do now?

Why are long-term estimates of returns important?

A sound financial plan serves as a road map to help investors reach long-term financial goals. To get there, investors need reasonable expectations for long-term market returns.

Return expectations that are too optimistic, for example, could lead to a delayed retirement or make it difficult to pay for a big expense such as a college education.  If return expectations are overly pessimistic, too much may be saved in the nest egg at the expense of everyday living.

How do you calculate your long-term forecasts?

The long-term estimates cover a 10-year time horizon. We take a forward-looking approach to forecasting returns, rather than basing our estimates on historical averages.

For U.S. and international large-cap stocks, we use analyst earnings estimates and macroeconomic forecast data to estimate two key cash-flow drivers of investment returns: recurring investment income (earnings) and capital gains generated by selling the investment at the end of the forecast horizon of 10 years. To arrive at a return estimate, we answer the question: What returns would investors make if they bought these assets at the current price level to obtain these forecasted future cash flows?

For U.S. small-capitalization stocks, we forecast the returns by analyzing and including the so-called “size risk premium.” This is the amount of money that investors typically expect to earn over and above the returns on U.S. large-capitalization stocks.

For the U.S. investment grade bonds asset class, which includes Treasuries, investment-grade corporate bonds and securitized bonds, our forecast takes into account both the yield-to-maturity (YTM) of the 10-year U.S. Treasury note and a corporate credit risk premium.² We believe the future level of returns an investor will receive, even if interest rates rise, is reflected with YTM. YTM is the return an investor can expect to receive if the bond is held till maturity. Although cash yields are currently negligible, we believe cash will keep up with the rate of inflation over the long run. Our inflation rate forecast is the consensus forecast of economists

Why do you expect long-term returns to be lower than historical averages?

Three primary factors are behind the forecast for reduced returns: lower inflation, low interest rates and elevated equity valuations.

  • Low inflation. Inflation averaged 4% annually from 1970-2017. Our forecast is for inflation to average 2.2% from 2018-2027. This is a slight increase from last year. It is still, however, much lower than the historical average. When the rate of inflation is low, bond yields also have been low. That is because bond investors generally do not require as much yield premium to compensate for the erosion in buying power that inflation can inflict on a portfolio. For stocks, low inflation historically has meant low nominal (before inflation) returns.
  • Low rates.  Lower inflation generally means low nominal (before inflation) interest rates. This affects yields on everything from cash to 30-year Treasury bonds. By historical standards, we are also in an era of low real rates (i.e., rates after adjusting for inflation) and this is likely to continue because the consensus forecast for global economic growth is much lower. Low yields mean investors earn less from the fixed-income portion of their portfolios. Stock returns tend to be higher than bond yields due to the relatively greater risk in holding stocks. When bond yields are lower, stock returns tend to be lower.
  • Elevated equity valuations. Most equity markets appear to have moved considerably higher during 2017 than justified by their earnings growth expectations, resulting in high valuations. We acknowledge that current expectations for earnings growth are improving relative to previous years, in part due to the recent corporate tax rate changes in the U.S. and better economic growth prospects for many countries. However, we would like to see further evidence of earnings growth to justify higher returns on stocks going forward.

Curb Your Expectations and Consider Going Global

What could lead to higher returns?

Returns could exceed our expectations if the U.S. economy grows more than economists anticipate. According to consensus forecasts, economists expect 2.1% annual gross domestic product (GDP) growth over the next 10 years, even after accounting for the recent corporate tax rate changes.  Higher-than-expected economic growth would likely lead to higher earnings growth, driving stock and bond returns higher. An example of the economy growing faster than expected occurred from 1990-1999. During that period, economists expected annual GDP growth of 2.4%, while the U.S. economy actually grew at a much higher rate of 3.2% annually on average. Corresponding returns from U.S. large-capitalization stocks were 18.2% on average and core bonds averaged 7.7% despite severe market turbulence in 1998.

Also, it is important to note that tax policy changes alone cannot support earnings growth. Corporations leveraging tax savings for long-term capital investments would be important to helping boost earnings on a sustainable basis, which would, in turn, lead to better return expectations.

Why do you expect international stocks to outperform U.S. stocks?

As shown in the chart above, U.S. large-cap stocks are expected to return 6.5% annually over the next 10 years, compared to a higher return expectation of 7.2% for international large-cap stocks. This is mainly due to the current elevated valuations for U.S. stocks compared to international stocks.

What can investors do now?

Thanks to the power of compound returns, what investors do (or don’t do) today can have big implications on their ability to meet their long-term goals.

Here are a few things to consider doing. First, if you don’t have a long-term financial plan, now is a good time to put one together. Second, try to minimize fees and taxes, particularly in a lower-return environment. And last but not least: Build a well-diversified portfolio.

¹ Charles Schwab Investment Advisory, Inc., a separately registered investment advisor and an affiliate of Charles Schwab & Co. Inc., annually updates the capital market return estimates.

² Treasury notes generate what is considered a “risk-free” rate, or yield, because of the negligible chance of the U.S. government defaulting on its debt obligations. A corporate credit “risk premium” is the amount of money that investors expect to earn above and beyond the yield because of the chance of a default by the corporation that issued the bond.

Important Disclosures

Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

All forward looking statements contained in this article, including any forecasts and estimates, are based on Charles Schwab Investment Advisory’s outlook only as of the date of this material.  Charles Schwab Investment Advisory, Inc. (“CSIA”) is an affiliate of Charles Schwab & Co., Inc. (“Schwab”).

Investing involves risk including loss of principal.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.  Data here are obtained from what are considered reliable sources; its accuracy, completeness or reliability, however, cannot be guaranteed.

Past performance is no guarantee of future results.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

International investments are subject to additional risks such as currency fluctuation, geopolitical risk and the potential for illiquid markets.

Small cap funds are subject to greater volatility than those in other asset categories.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed‐income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

U.S. Large Cap total returns 

Standard & Poor’s market-capitalization weighted index focuses on the large-cap segment of the U.S. equities market.  It consists of 500 widely traded stocks that are chosen for market size, liquidity, and industry group representation.  S&P 500 is a registered trademark of, and proprietary to, S&P Dow Jones LLC.

U.S. Small Cap total returns

Russell indices are market-capitalization weighted and subsets of the Russell 3000® Index, which contains the largest 3,000 companies incorporated in the United States and represents approximately 98% of the investable U.S. equity market.  The Russell 2000® Index is composed of the 2000 smallest companies in the Russell 3000 Index.  The Russell 2000® Growth Index contains those Russell 2000 securities with a greater-than-average growth orientation.  The Russell 2000® Value Index contains those Russell 2000 securities with a less-than-average growth orientation.  The Russell 1000® Growth Index contains those Russell 1000 securities with a greater-than-average growth orientation.  The Russell 1000® Value Index contains those Russell 1000 securities with a less-than-average growth orientation.

International Large Cap total returns

MSCI EAFE® Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI EAFE Index consists of the following 22 country indices: Australia, Austria, Belgium, Denmark, France, Finland, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

U.S. Investment Grade Bonds

The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS. The U.S. Aggregate rolls up into other Bloomberg Barclays flagship indices, such as the multi-currency Global Aggregate Index and the U.S. Universal Index, which includes high yield and emerging markets debt. The U.S. Aggregate Index was created in 1986, with index history backfilled to January 1, 1976.

Barclays Global Aggregate Bond Index provides a broad-based measure of the global investment-grade fixed-rate debt markets. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices. The Global Aggregate Bond Index ex US excludes the U.S. Aggregate component.

Cash Investments

This index measures the total return equivalent of 3-month U.S. Treasury securities.  The index consists of the last three 3-month Treasury bill issues, based on the month-end rate.  Returns for the index are calculated on a monthly basis only. The index is published by Citigroup Index LLC.

Indexes are unmanaged, do not incur management fees, costs, or expenses and cannot be invested in directly.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Charles Schwab Investment Advisory, Inc. (“CSIA”) is an affiliate of Charles Schwab & Co., Inc. (“Schwab”, Member SIPC).

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What’s in Your “Total” Bond Fund?

By KATHY A JONES

FEBRUARY 16, 2018

Achieving diversity in a bond portfolio used to be as simple as investing in an aggregate bond-index fund. However, recent changes to the bond market have made that strategy less effective. Government-related bonds with longer durations now comprise a larger share of the market,and the overall credit quality of corporate bonds has declined, leaving the bond market with more credit risk and interest-rate risk than in the past.

The Bloomberg Barclays U.S. Aggregate Bond Index, for example, the benchmark for many bond funds, is not what it was before the Great Recession—for three reasons.

1. Overexposure to Treasuries

The Bloomberg Barclays U.S. Aggregate Bond Index has a significantly higher allocation to Treasuries than it did a decade ago, largely because of the flood of federal bonds in the wake of the financial crisis (see “Treasuries take over,” below).

Treasuries take over

In 2007, U.S. Treasuries represented less than one-quarter of the Bloomberg Barclays U.S. Aggregate Bond Index; by 2017, their share had jumped to more than one-third.

Source: Bloomberg Barclays U.S. Aggregate Bond Index. Data as of 12/14/2007 and 12/15/2017.

All things being equal, Treasuries tend to offer lower yields than other investment-grade bonds; consequently, the index’s yield prospects fall as its allocation of such bonds increases.

Further complicating matters is the fact that many of those Treasuries were issued during the recent period of historically low interest rates, meaning they—and, by extension, the bond funds that track them—will decrease in value as rates rise. That’s especially true of the longer-term bonds in the index, which will be locked into those rock-bottom rates for many years to come.

2. Increased sensitivity to rising interest rates

The U.S. Treasury isn’t the only entity that issued a raft of long-term bonds during the past decade. Many companies and governments did the same to lock in low rates for an extended period—and the Bloomberg Barclays U.S. Aggregate Bond Index has become more sensitive to rising interest rates as a result. The index’s average duration, a measure of such sensitivity, rose to 6 years in June 2017, versus 4.7 during the preceding two decades.2

3. Heightened credit risk

Over the past decade, the credit quality of the corporate bonds in the Bloomberg Barclays U.S. Aggregate Bond Index has deteriorated markedly: In 2007, 63.9% were rated A or higher; by 2017, that number had fallen to 50.6% (see “Slipping grades,” below).

Of course, lower-rated bonds tend to have higher coupons, which may help counteract the overexposure to Treasuries. However, such bonds also carry a higher degree of risk.

Are Stock Splits a Thing of the Past?

FEBRUARY 16, 2018

Not long ago, public companies with high-flying stock prices would sometimes split their shares as a means of attracting new investors. The typical split was two for one, in which companies doubled the number of outstanding shares but cut the price per share in half, believing the lower price would rouse investors’ interest.

But stock splits are a lot less common these days. In 1997, 102 companies in the S&P 500® Index split their stocks;1 in 2016, only seven companies did so2—a decline of more than 93%.

What gives? Perhaps most important, investors are increasingly turning to mutual funds and exchange-traded funds (ETFs) instead of buying discrete stocks, so companies have less incentive to court individual investors with low prices.

Investors’ perception of such stratospheric stocks has also changed, says Randy Frederick, vice president of trading and derivatives at the Schwab Center for Financial Research. “Many of today’s leading technology companies, in particular, boast share prices well into the triple digits—a trait some investors have come to equate with successful business models and attractive growth opportunities,” he says.

If cost prohibits you from buying a certain stock, “many mutual funds and ETFs offer large allocations for a fraction of the price,” Randy says, “while also providing exposure to other companies and industries you otherwise might not have considered.”

The bottom line: Splits aren’t the only way to gain access to high-priced stocks.

1Lu Wang, “Stock Split Is All but Dead and a New Study Says Save Your Tears,” Bloomberg Markets, 08/23/2017.

2Reinhardt Krause, “Comcast Joins Apple, Netflix as Stock Splits Rarer,” Investors.com, 01/27/2017.

Important Disclosures

Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

Investing involves risks, including loss of principal.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness and reliability cannot be guaranteed.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry-group representation.

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How to Prioritize Multiple Savings Goals

FEBRUARY 16, 2018

Despite our best intentions, we’re too often tempted to pull back on our long-term savings goals in order to satisfy more pressing financial matters—be it a surprise repair bill, an emergency medical procedure or some other unexpected expense.

Beyond immediate needs is the challenge of prioritizing competing medium- and long-term goals, like eliminating credit card debt versus the desire for a new car, or capturing the company match on a 401(k) versus adequately funding a 529 college savings plan.

“There’s no doubt about it: Our brains often focus on what’s right in front of us,” says Rob Williams, managing director of financial planning at the Schwab Center for Financial Research. “So sometimes we need to remind ourselves to focus on the short and long terms.”

The good news, Rob says, is that investors needn’t starve one investment objective in order to fully fund another. Here are his top tips for heading down several savings paths at once.

1. Prioritize your goals

Start by not only articulating your goals but also listing them in order of importance. That said, everyone should make retirement of paramount concern. “You can borrow for or do without a lot of things,” Rob says, “but retirement isn’t one of them.”

Here’s what a sound hierarchy of some of the most common financial goals might look like:

  • Capture 401(k) match: If your employer offers a 401(k) plan with a matching contribution, this should probably be your No. 1 priority. “Failing to contribute enough to capture your company’s maximum match means leaving free funds on the table,” Rob says.
  • Create a rainy-day fund: Having cash on hand in case of an emergency can help you avoid having to borrow at unattractive rates—or, worse, dip into long-term investments. Aim to save enough to cover three to six months’ worth of essential expenses.
  • Sock away even more for retirement: In 2018, you can contribute up to $18,500 ($24,500 if you’re 50 or older) to a 401(k) plan and up to $5,500 ($6,500 if you’re 50 or older) to an Individual Retirement Account. “Even if you can’t afford to max out one or both accounts, every little bit helps,” Rob says.
  • Save for a down payment: Rob says that, depending on your situation, most people should plan to pony up at least 20% of the purchase price—and possibly more if the home will be a rental or vacation property. Even if the lender will accept a smaller down payment, saving more can help reduce private mortgage insurance premiums.
  • Contribute to college savings: Given the ever-escalating cost of higher education, the sooner you start saving, the better. This is the one priority for which there’s an established loan program, though, so don’t let it trump your other to-dos.

Other goals, such as saving for a big trip, a new car or a wedding, might need to take a back seat to more pressing objectives—which is where a financial planner fits in. “Defining and prioritizing your goals can be the toughest part of the financial-planning process,” Rob says, “and the right advisor can help you make smart choices within the realm of what’s possible.”

2. Invest by time frame

Once you’ve made a list, it’s time to sort your goals by time horizon and then invest the funds accordingly:

  • Goals for the next two years: Given the tight time horizon, these objectives would benefit from relatively liquid cash investments, such as certificates of deposit, money market funds or short-term Treasury bills.
  • Goals for the next three to 10 years: With an investment horizon that is neither short nor long, these objectives would benefit from assets that focus on not just growth but also capital preservation, such as a relatively conservative mix of bonds and stocks.
  • Goals more than 10 years out: With enough time to ride out the inevitable market vagaries, these objectives can benefit from a more aggressive allocation to stocks, which can rise and fall more dramatically in value in any single year but offer the greatest potential return over the long haul.

3. Consider the type of account required for each goal

For example, you could put your emergency funds in a standard savings account, your college savings in a 529 plan, and your nest egg in a 401(k) or other qualified retirement account. This approach can also reduce the temptation to use money earmarked for one goal to satisfy another—particularly because tapping a 529 plan for noneducational expenses or taking premature withdrawals from a retirement account can result in stiff penalties.

4. Put savings first

If you tend to save only what’s left over after paying your monthly expenses—rather than committing a specific amount or percentage to each objective in advance—your long-term goals are likely to suffer. Instead, pay yourself first (that is, put yourself ahead of other creditors) whenever possible, Rob says.

If you don’t already know how much you’ll need to set aside each month to reach your investment objectives, a savings calculator can help. Here, too, a financial planner will weigh your ongoing costs against your investment objectives. “It’s all a balancing act,” Rob says. “You want to find a solution that allows you to live comfortably today while making meaningful progress toward tomorrow.”

5. Stay on track

Finally, consider automatic deductions from your checking account or paycheck to ensure you’re consistently saving toward each of your established goals. These deductions can take the form of either a lump sum or, better yet, a percentage of pay that increases as your income does.

And be sure to track how your investments are performing relative to your goals—though not so often that you’re responding in real time to normal market fluctuations.

Rob also suggests periodic check-ins with a financial planner, particularly if you’re tempted to make any sudden moves that could upend your long-term plans. “Their role isn’t just to put you on a path toward your financial future,” he says, “it’s also to help you stay on that path—every step of the way.”

Important Disclosures

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

Investing involves risk, including loss of principal.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness and reliability cannot be guaranteed.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed‐income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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Why Invest in Actively Managed Mutual Funds?

FEBRUARY 16, 2018

During the past decade, investors in U.S. equities piled $1.4 trillion into index mutual funds and exchange-traded funds (ETFs)—while pulling $1.1 trillion out of their actively managed counterparts.1 To conclude from those numbers that actively managed funds may soon go the way of the dinosaur, however, would be a mistake, says Jim Peterson, chief investment officer of Charles Schwab Investment Advisory.

Although index funds represent almost a third of the U.S. equities market, up from a fifth just a decade ago,2 Jim believes that active management still has an important role to play—in three key areas.

1. Downside risk

Aiming to protect your downside is perhaps the single biggest reason to invest at least a portion of your portfolio in an actively managed fund. “Many active managers select stocks based on fundamentals—such as earnings per share—that at least theoretically reflect a company’s intrinsic value, whatever the market may be doing,” Jim says. Most index funds, on the other hand, are designed to mimic the performance of market-capitalization-weighted indexes like the S&P 500®, whose momentum is often dictated by just a few big stocks (see Can the Advance-Decline Line Predict a Market Top?).

This focus on fundamentals can hurt active managers in a bull market, when rapidly appreciating stocks rack up exponentially greater gains. However, it can help when the tide turns and stocks that once lifted the market now drag it down. Indeed, a majority of actively managed U.S. large-cap mutual funds outperformed the S&P 500 in 2007, when the stock market began to slide amid the first signs of the financial crisis, and again in 2009, in the midst of the Great Recession (see “When the going gets tough …” below).

When the going gets tough …

… active managers may shine. In the beginning and ending years of the Great Recession, for example, a majority of actively managed U.S. large-cap mutual funds outperformed the S&P 500.

Source: SPIVA® U.S. Scorecard, S&P Dow Jones Indices. Data from 2007 through 2016.
Past performance is no guarantee of future results.

2. Bonds

Perhaps the strongest statistical case for active management comes from the world of fixed income, where a majority of actively managed short- and intermediate-term investment-grade bond funds and global-income funds have beaten their indexes over the past five years.3 The reason for this outperformance lies in active managers’ ability to maneuver in an environment of rising rates.

Index funds must mirror their benchmarks’ holdings, regardless of what interest rates are doing. Funds that track the Bloomberg Barclays U.S. Aggregate Bond Index, for instance, have roughly 60% of their holdings in bonds with maturities of five years or longer4—a recipe for underperformance should interest rates continue to rise (see What’s in Your “Total” Bond Fund?). Active managers, on the other hand, “can swap out longer-duration bonds with shorter-duration ones in order to take advantage of higher rates sooner,” Jim says.

3. International

Nowadays, there’s almost no corner of the globe that international investors can’t access; however, knowing which corners hold the most promise and which the most peril is not for the uninitiated.

“Assessing potential investments across the planet is a lot to ask of an individual investor,” Jim says. What’s more, when it comes to investing overseas, complicating factors like currency fluctuations can test the limits of even the most talented individual.

In other words, there are more areas in which the average investor might want a professional’s opinion. And that’s precisely what active management has to offer.

1Investment Company Institute. Data from 01/2007 through 12/2016.

2Morningstar, as of 01/31/2017.

3S&P Global. Data from 01/01/2012 through 12/31/2016.

4Bloomberg L.P., as of 12/20/2017.

How to pick a stock picker

Past performance alone won’t help you identify the right fund manager.

Active management is only as good as its managers. So how do you separate the winners from the also-rans? “If you can identify managers who are likely to perform in the top quartile of their category, there’s a pretty good chance you’re going to beat the benchmark,” says Jim Peterson, chief investment officer of Charles Schwab Investment Advisory (CSIA).

Doing so is far easier said than done, however. While most investors rely on a fund manager’s recent track record, “the reality is more complex than just anchoring your expectations to past performance,” Jim says.

Rather, in screening funds for its Schwab Mutual Fund OneSource Select List®, for example, CSIA tries to weed out active managers unwilling to meaningfully deviate from their benchmark indexes. These “closet indexers” have little to offer over actual index funds, Jim says.

What’s more, CSIA also keeps a careful eye on modestly sized funds experiencing significant inflows, even if they’re tied to recent gains. “In our experience,” Jim says, “the managers of such funds can find it difficult to replicate their success on a substantially larger scale.”

Important Disclosures

Investors should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling 800-435-4000. Please read the prospectus carefully before investing.

Past performance is no guarantee of future results.

Investing involves risks, including loss of principal.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness and reliability cannot be guaranteed.

Charles Schwab Investment Advisory, Inc., is a registered investment advisor and an affiliate of Charles Schwab & Co., Inc.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

International investments involve additional risks, including differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry-group representation.

The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market.

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The Unexpected Ways Europe Can Diversify Your Portfolio

FEBRUARY 16, 2018

European equities are often essential to a diversified portfolio—but which Europe are we talking about? The Europe of France, Germany, the U.K. and a dozen other industrialized nations that together constitute one-fifth of the world economy? The Europe of emerging markets such as Czechia and Hungary? Or the Europe of former Eastern bloc countries such as Estonia and Romania, now dubbed frontier markets because of their heightened risk to investors? (See “A tale of three Europes,” below.)

“The region can definitely diversify your portfolio,” says Jeff Kleintop, Schwab’s chief global investment strategist, “but in ways you might not expect.”

A tale of three Europes

Far from monolithic, Europe is made up of developed, emerging and frontier markets.

Source: MSCI Inc.

Surprising diversification

Rather than looking at Europe as a collection of macro economies, consider the continent’s countries through the lens of sector diversification.

“Germany, for example, has an export-oriented economy driven by the auto industry—so much so that the country’s main stock index, the DAX, tracks the MSCI World Automobiles Index almost perfectly,” Jeff says. And what’s true of Europe proves to be true of the U.S. as well—which is one reason international diversification by sector is so compatible with a broad portfolio of U.S. stocks. “Although we have a lot of sectors in the U.S., the S&P 500® Index moves pretty much in lockstep with the technology sector,” Jeff explains. “That’s worked out well in recent years but nevertheless needs offsetting. In the aftermath of 2000’s dot-com crash, for example, outperforming European stocks helped counter the domestic contagion of the tech sector.”

By the same token, investors should resist second guessing a specific stock based on the outlook for the country’s overall economy. “Individual economies don’t matter nearly as much as the sectors that drive their markets,” Jeff says.

How to invest

Investing in Europe gets you more diversification today than at any time in the past 20 years. Indeed, Jeff’s most recent analysis reveals that the degree to which the world’s biggest stock markets are moving in sync has fallen to its lowest levels since 1997 (see “Less in lockstep,” below).

Less in lockstep

The so-called G20 nations—which along with Spain make up 80% of the world’s gross domestic product—have seen their stock-market correlations fall precipitously since peaking in 2009.

*Daily one-year rolling correlation of one-month percent change in MSCI indexes for G20 and Spain.

Source: Charles Schwab, with data from FactSet as of 07/11/2017.

For investors with a long-term focus, Jeff suggests starting with a broad-based, European developed-markets index fund—with one important caveat: “Not all funds are created equal, so make sure you know what you’re getting,” he says.

Specifically, some European developed-market indexes, such as the MSCI Europe Index, include U.K. stocks, while others, such as the MSCI EMU Index, do not. The distinction matters because of Britain’s vote to exit the European Union (EU). Will distributors and manufacturers continue to enjoy unfettered access to approximately half a billion consumers on the continent? Will Brexit affect investment flows, the labor supply and perhaps even property values?

Although U.K. stocks have suffered little thus far, there are signs that business spending is softening, Jeff says. And as the government races to finalize the details of its EU divorce by March 2019, the path ahead remains uncertain.

While broad exposure to European markets can be achieved without U.K. stocks, Jeff believes it’s too early to count out Britain just yet. “The key isn’t to abandon the country altogether,” he counsels, “but to adjust your allocation as the impact of Brexit gradually comes into focus.”

If you’re interested in European emerging markets, on the other hand, Jeff says it’s probably better to avoid Europe-only funds and instead consider a global emerging-markets index fund. Such funds are often geared toward Asia but usually contain some Czech, Polish and Hungarian equities as well. “This exposure to Asian companies can help balance out the more limited diversification provided by Europe’s emerging-market stocks,” he says.

Meanwhile, frontier markets are best left to institutional investors. “Because their exchanges are so miniscule, frontier markets often become the functional equivalent of investing in just one or two stocks,” Jeff says. “You end up with less diversification, which defeats your reason for turning to Europe in the first place.”

Important Disclosures

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Investing involves risk, including loss of principal.

International investments involve additional risks, including differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness and reliability cannot be guaranteed.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The Deutscher Aktienindex (DAX) Index consists of the 30 major German companies trading on the Frankfurt Stock Exchange.

The MSCI World Automobiles Index is composed of large- and mid-cap stocks across 23 developed-market countries. All securities in the index are classified in the Automobiles industry (within the Consumer Discretionary sector) according to the Global Industry Classification Standard (GICS®).

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The MSCI Europe Index captures large- and mid-cap representation across 15 developed-market countries in Europe. With 444 constituents, the index covers approximately 85% of the free-float-adjusted market capitalization across the European developed markets equity universe.

The MSCI European Economic and Monetary Union (EMU) Index captures large- and mid-cap representation across the 10 developed-market countries in the EMU. With 241 constituents, the index covers approximately 85% of the free-float-adjusted market capitalization of the EMU.

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Tips for Maximizing Your Next Bonus

FEBRUARY 16, 2016

According to human resources association WorldatWork, 85% of U.S. companies plan to offer their employees bonuses or similar compensation awards this year.1 Here are four ways to make the most of your next windfall—before you splurge on something special.

  1. Have a plan: Prioritize your goals by assigning a percentage of your bonus to each. For example, you might decide to put 50% toward savings, 30% toward debt reduction and 20% toward your next vacation. Make sure to factor in taxes, too, since your regular withholding may not be sufficient.
  2. Pay down credit card debt: The average U.S. household carries nearly $16,000 in revolving credit card debt and pays roughly $900 in interest each year.2 That money is better put to use elsewhere, so pay off any balances as soon as possible, starting with the card that charges the highest interest rate.
  3. Save for emergencies: Even the healthiest and most financially secure among us need to plan for the unexpected. Set aside enough cash to cover three to six months’ worth of essential expenses. Put it somewhere relatively liquid—but not so accessible that you’ll be tempted to spend it.
  4. Boost your retirement savings: If you participate in a workplace retirement plan, your employer might automatically deduct from your bonus whatever percentage you regularly contribute. If you don’t have an employer-sponsored retirement plan or are looking to save even more, you can contribute up to $5,500 ($6,500 if you’re age 50 or older) to an Individual Retirement Account this year.
  5. Splurge: After meeting the above goals, reward all that responsible behavior with something just for you.

The bottom line: With a little planning, you can bolster your finances—and celebrate your achievements.

12017–2018 Salary Budget Survey.

22017 American Household Credit Card Debt Study, NerdWallet.

Important Disclosures

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness and reliability cannot be guaranteed.

(0218-7GTF)

Margin: How Does It Work?

By RANDY FREDRICK

FEBRUARY 08, 2018

In the same way that a bank can lend you money if you have equity in your house, your brokerage firm can lend you money against the value of certain stocks, bonds and mutual funds in your portfolio. That borrowed money is called a margin loan, and can be used to purchase additional securities or to meet short-term financial needs.

Each brokerage firm can define, within certain guidelines, which stocks, bonds and mutual funds are marginable. The list usually includes securities traded on the major U.S. stock exchanges that sell for at least $5 per share. Also, keep in mind that you can’t  borrow funds in retirement accounts or custodial accounts.

How does margin work?

Generally speaking, brokerage customers who sign a margin agreement can borrow up to 50% of the purchase price of marginable investments (the exact amount varies depending on the investment). Said another way, investors can use margin to purchase potentially double the amount of marginable stocks than they could using cash.

Few investors borrow to that extreme—the more you borrow, the more risk you take on—but using the 50% figure as an example makes it easier to see how margin works.

For instance, if you have $5,000 cash in a margin-approved brokerage account, you could buy up to $10,000 worth of marginable stock—you would pay 50% of the purchase price and your brokerage firm would loan you the other 50%. Another way of saying this is that you have $10,000 in buying power. (Schwab clients may check their buying power by referring to the “Margin Details” module on the right side of Trade pages and selecting the “Marginable Securities” option in the drop-down menu

Similarly, you can often borrow against the marginable stocks, bonds and mutual funds already in your account. For example, if you have $5,000 worth of marginable stocks in your account and you haven’t yet borrowed against them, you can purchase another $5,000—the stock you already own provides the collateral for the first $2,500, and the newly purchased marginable stock provides the collateral for the second $2,500. You now have $10,000 worth of stock in your account at a 50% loan value, with no additional cash outlay.

Because margin uses the value of your marginable securities as collateral, the amount you can borrow fluctuates day to day along with the value of the marginable securities in your portfolio. If your portfolio goes up, your buying power increases. If your portfolio falls in value, your buying power decreases.

Margin interest

As with any loan, when you buy securities on margin you have to pay back the money you borrow plus interest, which varies by brokerage firm and the amount of the loan.

Margin interest rates are typically lower than credit cards and unsecured personal loans. And there’s no set repayment schedule with a margin loan—monthly interest charges accrue to your account, and you can repay the principal at your convenience. Also, margin interest may be tax deductible if you use the margin to purchase taxable investments (subject to certain limitations, consult a tax professional about your individual situation).

The benefits of margin

A margin loan can be used to meet short-term lending needs not related to investing.  Margin can also be used for investing purposes to magnify your profits as well as your losses. Here’s a hypothetical example that demonstrates the upside; for simplicity, we’ll ignore trading fees and taxes.

Assume you spend $5,000 cash to buy 100 shares of a $50 stock. A year passes, and that stock rises to $70. Your shares are now worth $7,000. You sell and realize a profit of $2,000.

What happens when you add margin into the mix? This time you use your buying power of $10,000 to buy 200 shares of that $50 stock—you use your $5,000 in cash and borrow the other $5,000 on margin from your brokerage firm.

A year later, when the stock hits $70, your shares are worth $14,000. You sell and pay back $5,000 plus $400 interest1 which leaves you with $8,600. Of that, $3,600 is profit.

So, in the first case you profited $2,000 on an investment of $5,000 for a gain of 40%. In the second case, using margin, you profited $3,600 on that same $5,000 for a gain of 72%.

The risks of margin

Margin can be profitable when your stocks are going up. However, the magnifying effect works the other way as well.

Jumping back into our example, what if you use your $5,000 cash to buy 100 shares of a $50 stock, and it goes down to $30 a year later? Your shares are now worth $3,000, and you’ve lost $2,000.

But what if you had borrowed an additional $5,000 on margin and purchased 200 shares of that $50 stock for $10,000? A year later when it hit $30, your shares would be worth $6,000.

In this example, if you sell your shares for $6,000, you still have to pay back the $5,000 loan along with $400 interest1, which leaves you with only $600 of your original $5,000—a total loss of $4,400. If the stock had fallen even further, trading on margin could result in a scenario where you lose all of your initial investment and still owe the money you borrowed plus interest.

Margin call

Remember, the marginable investments in your portfolio provide the collateral for your margin loan. Remember, too, that while the value of that collateral fluctuates according to the market, the amount you borrowed stays the same. If your stocks decline to the point where they no longer meet the minimum equity requirements for your margin loan—usually 30% to 35% depending on the particular securities you own and the brokerage firm2—you will receive a margin call (also known as a maintenance call). When this happens, your brokerage firm will ask that you immediately deposit more cash or marginable securities into your account to meet the minimum equity requirement.

An example: Assume you own $5,000 in stock and buy an additional $5,000 on margin, resulting in 50% margin equity ($10,000 in stock less $5,000 margin debt). If your stock falls to $6,000, your equity would drop to $1,000 ($6,000 in stock less $5,000 margin debt).

If your brokerage firm’s maintenance requirement is 30% (30% of $6,000 = $1,800) you would receive a margin call for $800 in cash or $1,143 of fully paid marginable securities ($800 divided by (1-.30) = $1143)—or some combination of the two—to make up the difference between your equity of $1,000 and the required equity of $1,800.

Important details about margin loans

  • Margin loans increase your level of market risk.
  • Your downside is not limited to the collateral value in your margin account.
  • Your brokerage firm may initiate the sale of any securities in your account without contacting you to meet the margin call.
  • Your brokerage firm may increase its “house” maintenance margin requirements at any time and is not required to provide you with advance written notice.
  • You are not entitled to an extension of time on a margin call.

Triggering a margin call

What happens if you don’t meet a margin call? Your brokerage firm may sell assets in your portfolio and isn’t required to consult you first. In fact, in a worst-case scenario it’s possible that your brokerage firm will sell all of your shares, leaving you with no shares yet still owing money.

Again, most investors choose not to purchase as much as 50% on margin as presented in the examples above—the lower your level of margin debt, the less risk you take on, and the lower your chances of receiving a margin call. A well-diversified portfolio may help reduce the likelihood of a margin call.

If you decide to use margin, here are some additional ideas to help you manage your account:

  • Pay margin loan interest regularly.
  • Carefully monitor your investments and margin loan.
  • Set up your own “trigger point” somewhere above the official margin maintenance requirement.
  • Be prepared for the possibility of a margin call—have other financial resources in place or predetermine which portion of your portfolio you would sell.
  • NEVER ignore a margin call.

The bottom line

Buying stock on margin is only profitable if your stocks go up enough to pay back the loan with interest—and you could lose your principal and then some if your stocks go down too much. However, used wisely and prudently, a margin loan can be a valuable tool in the right circumstances.

If you decide margin is right for your investing strategy, consider starting slow and learning by experience. Be sure to consult your investment advisor and tax professional about your particular situation.

¹ Example uses a hypothetical, simple interest rate calculation at a rate of 8%. Actual interest charge would be higher due to compounding. Contact Schwab for the latest margin interest rates.

² At Schwab, margin accounts generally receive a maintenance call when equity falls below the minimum “house” maintenance requirement. For more details, see Schwab’s Margin Overview and Disclosure Statement.

Important Disclosures

Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

When considering a margin loan, you should determine how the use of margin fits your own investment philosophy. Because of the risks involved, it is important that you fully understand the rules and requirements involved in trading securities on margin.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, Financial Planner or Investment Manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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The Importance of Tax-Efficient Investing

By HAYDEN ADAMS

JANUARY 12, 2018

Benjamin Franklin’s old line about death and taxes rings as true today as it did more than 200 years ago. Taxes are such a normal part of life that people may overlook them until it’s time to file their returns. Unfortunately, by that point it’s usually too late to implement a strategy for minimizing their tax bill.

Returns lost to taxes

When it comes to investing, it’s not just how much you make that matters—it’s how much you keep after taxes.

The Schwab Center for Financial Research examined the long-term impact of taxes and other expenses on investment returns and concluded that while investment selection and asset allocation are still the most important factors affecting your returns, minimizing taxes and other costs isn’t very far behind.

The good news is you can exercise a good deal of control here. With a bit of planning, you can maximize the tax efficiency of your portfolio and help reduce the effect of taxes on your investments.

Think of it this way: You can exercise far more control over your portfolio’s tax situation than you can over its exposure to the short-term gyrations in the market.

How do I maximize tax efficiency?

Investment accounts can be divided into two main categories, taxable accounts (like a brokerage account) and tax-advantaged accounts (such as an IRA, 401(k), or Roth IRA). As a general rule, investments that tend to lose less of their return to taxes are good candidates for taxable accounts. Likewise, investments that lose more of their return to taxes may be better suited for tax-advantaged accounts. Here’s where you might consider placing your investments:

Of course, this presumes that you hold investments in both types of accounts. If all your investment money is in your 401(k) or IRA, then just focus on asset allocation and investment selection.

Diversifying by tax treatment

Holding your investments in different accounts based on tax treatment (i.e. taxable and tax-advantaged accounts) adds value during the accumulation phase of your financial life by allowing you to defer taxes (or, in the case of a Roth, eliminate entirely the taxes on investment returns1). It also adds an additional layer of diversification to your portfolio during the distribution phase in retirement. Call it “tax diversification.”

Diversifying by tax treatment can be especially important if you’re uncertain about the tax bracket you’ll end up in down the road. For example, if you’re on the fence, instead of choosing between a traditional IRA or 401(k) and a Roth account, why not split your contributions between the two? When you start withdrawing money in retirement, you’ll be able to manage your income tax bracket with more flexibility because you’ll be able to choose which accounts you take your cash from based on the tax implications.

For example, to minimize your tax burden, you could focus on taking tax-free municipal bond income, qualified dividends and long-term capital gains from your taxable accounts and tax-free income from your Roth accounts. That would free you up to take only enough money from your taxable IRAs to keep you from moving into the next highest tax bracket (or to satisfy required minimum distributions, if applicable).

Making strategic use of your different accounts according to their tax treatment can also help you plan your charitable giving and estate planning goals—different accounts receive different types of gift and estate tax treatment. For example, you might want to give appreciated securities from your taxable accounts to charity for a full fair market value deduction and no capital gain tax. You can also leave such shares to your heirs who will receive a step-up in cost basis after you’re gone. Roth IRAs also make a great bequest, as distributions are free from income tax for your beneficiaries.

However you decide to split up your portfolio between account types, remember that for asset allocation purposes, you should still think of all your investments as being part of a single portfolio. By way of an oversimplified illustration, if you kept all your stocks in your taxable account and an equal amount of money in bonds in your tax-advantaged account, you wouldn’t have two portfolios consisting of 100% stocks and 100% bonds. You would have one portfolio consisting of 50% stocks and 50% bonds. The different assets just happen to be in different accounts.

Other considerations

In general, holding tax-efficient investments in taxable accounts and less tax-efficient investments in tax-advantaged accounts should add value over time. However, there are other factors to consider, including:

  • Periodically rebalancing your portfolio to maintain your target asset allocation. Because rebalancing involves selling and buying assets that have either grown beyond or fallen below your original allocation—essentially, you take profits from your winners and buy assets that have underperformed—it could cause an additional tax drag on returns in your taxable accounts. In taking profits from assets that have grown, you may incur either long- or short-term capital gains. You may want to focus your rebalancing efforts on your tax-advantaged accounts and include your taxable accounts only when necessary. Adding new money to underweighted asset classes is also a tax-efficient way to help keep your portfolio allocation in balance.
  • Active trading by individuals or by mutual funds, when successful, tends to be less tax-efficient and better suited for tax-advantaged accounts. A caveat: Realized losses in your tax-advantaged accounts can’t be used to offset realized gains on your tax return.
  • A preference for liquidity might prompt you to hold bonds in taxable accounts, even if it makes more sense from a tax perspective to hold them in tax-advantaged accounts. In other situations, it may be impractical to implement all of your portfolio’s fixed income allocation using taxable bonds in tax-advantaged accounts. If so, compare the after-tax return on taxable bonds to the tax-exempt return on municipal bonds to see which makes the most sense on an after-tax basis.
  • Estate planning issues and philanthropic intent might play a role in your portfolio planning. If you’re thinking about leaving stocks to your heirs, stocks in taxable accounts are generally preferable. That’s because the cost basis is calculated based on the market value of the stocks at the time of death (rather than at the time they were originally acquired, when they may have been worth substantially less). In contrast, stocks in tax-deferred accounts don’t receive this treatment, since distributions are taxed as ordinary income anyway. Additionally, highly appreciated stocks held in taxable accounts for more than a year might be well-suited for charitable giving because you’ll get a bigger deduction. The charity also gets a bigger donation, than if you liquidate the stock and pay long-term capital gains tax before donating the proceeds.
  • The Roth IRA might be an exception to the general rules of thumb discussed above. Because qualified distributions are tax free, assets you believe will have the greatest potential for higher return are best placed inside a Roth IRA, when possible.

The bottom line

If you want to keep more of your income, managing your investments with tax efficiency in mind is a must. What’s more, tax efficient investing techniques are accessible to almost everyone—it just takes some planning to reap the benefits. If you have a tax or financial advisor, be sure to talk with them about tax efficient strategies that could be implemented within your investment portfolios or call a Schwab Financial Consultant to learn more.

If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and penalties.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone.

Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed‐income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

Tax‐exempt bonds are not necessarily a suitable investment for all persons. Information related to a security’s tax‐exempt status (federal and in‐state) is obtained from third‐parties and Schwab does not guarantee its accuracy. Tax‐exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes.

Capital gains are not exempt from federal income tax.

Risks of the REITs are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and credit worthiness of the issuer.

Diversification and asset allocation strategies do not ensure a profit and cannot protect against losses in a declining market.

Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events can be created that may affect your tax liability.

Investing involves risk including loss of principal.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(0118-8RY6)

Be a Smarter Money Manager in 2018

NOVEMBER 21, 2017

You’ve probably heard that most New Year’s resolutions end up in the bin of regret, with few people who make them actually following through.

To have a successful year, resolutions alone aren’t enough, especially when it comes to making a personal financial plan. Unlike a resolution, which tends to be a (short-lived) test of willpower, a plan has specific goals and tangible strategies to turn your aspirations into reality. Consider a detailed quarterly strategy for your money – on that highlights key dates, important tasks and handy reminders.These tips can help you manage your money wisely in 2018.

Remix: As you’re planning 2018, be sure to examine your portfolio’s asset allocation mix. If it needs to be rebalanced, take care of it now.

Tax time: If you’re self-employed, your final estimated tax payment for 2017 is due January 16. While you’re at it, note the dates that quarterly payments are due for 2018 on your calendar and set alerts.

Use it or…If there’s money left in your 2017 health care flexible spending account (FSA), you may have until March 15 to spend it—or forfeit it. Check with your employer for details. Not that an FSA is different from a health savings account (HSA). In an HSA, your money carries over, so you don’t have to spend it in any particular year.

Pay yourself: If you have a traditional IRA, turned 70½ at any point in 2017, and haven’t taken your first required minimum distribution (RMD), do so before April 1 to avoid a hairy 50% penalty. (You’ll have to take another one by December 31.) And if you have a 401(k)—unless you’re still working with the same 401(k) account employer—the same rules apply to it.

File it: Tax returns are due on April 17. Even if you’re requesting the six-month extension, pay what you owe today—otherwise you could face penalties and interest later.

More deductions: Remember that April 17 is also the last day to make a contribution to an IRA for the 2017 year.

Policy check: Review your home, auto and life insurance policies. Life events such as divorce, remarriage or illness could require you to adjust your coverage. Talk to an agent before you get distracted by summer travel to make sure you’re getting the proper policy at the best price.

Social Security check: Review your Social Security benefits statement and check for errors. Social Security bases your payout on the 35 years when you earned the most. If your earnings aren’t reported correctly, you won’t receive all the benefits you’re entitled to.

To your health: Each fall, employees can tweak their contributions to health savings accounts (HSAs) and flexible savings accounts (FSAs). Confirm your employer’s open-enrollment period (it varies from company to company) so you can get the most from these pretax plans.

Savings reminder: If you’re self-employed and paying estimated quarterly taxes on September 15, make sure that you’re also on track to contribute the maximum to your retirement accounts. Calculating the allowable amount for your SEP-IRA can be complicated, however, so you may want to consult a tax professional.

Take credit: Get free copies of your credit reports from the official site authorized by federal law. A little credit housekeeping now can set the stage for better rates on a home, car, business loan and more later.

Time’s up: If you requested an extension on your taxes, October 16 is the last day to file returns.

Your legacy: Before the end of the year, organize your estate planning documents. A living will (also called a health care directive) gives instructions for your care in case you’re unable to make those decisions yourself.

Changing names: Review the beneficiaries on your retirement accounts and make any necessary changes that might be triggered by a divorce or remarriage.

Do good: Make tax-deductible contributions to your favorite charities before the holidays distract you. Also, be sure to take advantage of the annual gift tax exclusion for personal gifts to loved ones.

As you map out your plan for the year, make sure it’s customized to suit your needs and goals. This calendar, just like your finances, can’t live in a “set it and forget it” space. Stay on top of deadlines with phone or email reminders, and adjust your plan as curveballs (say, planning a child’s wedding) inevitably come your way.

Important Disclosures

Investment and insurance products are not deposits, are not FDIC insured, are not insured by any federal government agency, are not guaranteed by a bank or any affiliate of a bank, and may lose value.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

This information is general in nature and not intended as specific, individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, please consult with a qualified tax advisor, CPA, financial planner or investment manager.

The Schwab Center for Financial Research (SCFR) is a division of Charles Schwab & Co., Inc.

(1117-7522)

A Primer on Wash Sales

By HAYDEN ADAMS

NOVEMBER 17, 2017

Key Points

  • The wash-sale rule was designed to discourage people from selling securities at a loss simply to claim a tax benefit.
  • A wash sale occurs when you sell a security at a loss and then purchase that same security or “substantially identical” securities within 30 days (before or after the sale date).
  • If you end up being affected by the wash-sale rule, your loss will be disallowed and added to the cost basis of the securities you repurchased.

The wash-sale rule was designed to prevent investors from selling a security at a loss so they can claim tax benefits, only to turn around and immediately buy the same security again. Even investors who have no intention of breaking this rule can get tripped up by it if they use an automatic investment strategy, such as reinvesting dividends, potentially costing themselves some tax benefits in the process.

Here we’ll take a closer look at the wash-sale rule and answer some common questions about it.

Q: I want to sell a stock to take a tax loss, but I plan to buy it again because I want it in my portfolio. What are the tax implications?

If you want to sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, the wash-sale rule will kick in.

In such cases you won’t be able to take a loss for that security on your current-year tax return. Instead, you will have to add the loss to the cost basis of the replacement security. In addition, the holding period of the original security gets tacked onto to the holding period of the replacement security.

Here’s an example of how this might work:

Let’s say you buy 100 shares of XYZ stock for $10 per share ($1,000 of stock). One year later, the stock starts dropping, so you sell your 100 shares for $8 per share—a $200 loss. Three weeks later, XYZ is trading at $6 per share and you decide that price is too good to pass up, so you repurchase the 100 shares for $600. This triggers a wash sale.

As a result, the $200 loss is disallowed as a deduction on your current-year tax return and added to the cost basis of the repurchased stock. That bumps the cost basis of your $600 of replacement stock up to $800, so if you later sell that stock for $1,000, your taxable gains will be $200 instead of $400. And because you previously held XYZ for a year, it will automatically be treated as a long-term capital gain, even if you sell it after just a few months.

A few other things to note: A higher cost basis decreases the size of any future gains realized from the sale of the replacement security, thereby lowering your future tax obligation. If you sell the investment at a loss, the higher cost basis would actually increase the size of the loss for which you could claim a deduction.

And one of the potential upsides of an extended holding period is that it would lower your tax obligation if you sold the replacement security after less than a year. (Normally, short-term capital gains from investments held for less than a year are taxed at the higher regular income tax rate, while longer-term capital gains are taxed at the lower capital gains rate).

Q: What was Congress trying to accomplish with the wash-sale rule?

Basically, the goal is to prevent people from selling securities for no other reason than to generate losses that could be used to reduce their taxable income. Before the law was in place, investors could sell a losing stock and then buy it again a minute later, effectively locking in a loss to reduce their taxes.

Q: What if I wanted to sell a security to take a loss, but didn’t want to be out of the market for an entire month just to avoid the wash sales rule? What could I do?

You could sell the security at a loss and the use the proceeds from that sale to purchase a similar —but not substantially identical—security that suits your asset allocation and long-term investment plan.

Unfortunately, the government has not provided a straightforward definition of what it considers “substantially identical.” Investors will have to use their best judgment to avoid the wash-sale rules.

Here’s an example of how the process would work. Let’s say you own an exchange-traded fund (ETF) that is closely correlated to the S&P 500® Index and you end up selling that ETF at a loss. You could then use the proceeds from that sale to purchase a different ETF (or multiple ETFs) with similar but not identical assets, such as an ETF that tracks the Russell 1000® Index. By doing this you are able to take a loss on your current year tax return and still remain in the market with about the same asset allocation in your portfolio.

The process of taking losses and finding other investments that meet your needs isn’t always easy. To successfully harvest a tax loss, you have to monitor your asset allocations, watch out for wash sales, and make sure that the replacement assets you buy aren’t substantially identical.

Q: If I purchased and sold shares of a stock at a loss in one of my Schwab accounts and then repurchased them in another Schwab account, would I still trigger the wash-sale rule?

Yes, wash-sale rules apply across all of your accounts, including those outside Schwab. In addition, wash-sale rules also apply to transactions in your spouse’s accounts. IRS regulations require only that Schwab track and report wash sales on the same CUSIP number (a unique nine-character identifier for a security) within the same account. Ultimately, each individual is responsible for tracking sales in their accounts (and their spouse’s accounts) to ensure they don’t have a wash sale.

Q: Do the wash sale rules apply to ETFs, mutual funds and options?

Yes, if the security has a CUSIP number, then it’s subject to wash-sale rules. In addition, selling a stock at a loss and then buying an option on that same stock will trigger the wash-sale rule.

ETFs and mutual funds present investors a different set of challenges. Switching from one ETF to an identical ETF offered by another company could trigger a wash-sale. There are ways around this problem. For instance, an investor holding an ETF indexed to the S&P 500 at a loss might consider switching to an ETF or mutual fund that is indexed to a different set of securities, such as the Russell 1000 or Dow Jones Industrial Average.

Q: What would happen if I sold a security at a loss in a taxable account and then immediately repurchased it in a retirement account, such as an IRA?

The IRS has ruled (Rev. Rul. 2008-5) that when an individual sells a security at a loss and then repurchases that security in their (or their spouses’) IRA within 30 days before or after the sale, that loss will be subject to the wash-sale rules.

Q: Can I sell a security at a loss on Dec. 15, in order to squeeze it into the current tax year, and then repurchase the security on Jan. 4 without triggering a wash sale?

No, the wash-sale rules are not confined to the calendar year. In this situation and your loss would be disallowed if you reacquired the security within 30 days.

For more information on the wash sale take a look at the following resources on the IRS website:

Important Disclosures

Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

The information provided is for general informational purposes only. Nothing in this article should be considered as an individualized recommendation or personalized investment or tax advice. The investment and tax strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment or tax strategy for his or her own particular situation before making any decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

Examples provided are for illustrative (or informational) purposes only and not intended to be reflective of results you can expect to achieve.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership.

The Dow Jones Industrial Average (DJIA) includes the stocks of 30 of the largest and most influential companies in United States.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(1117-730V)

Tips for Finding Financial Advice

By CARRIE SCHWAB-POMERANTZ

NOVEMBER 15, 2017

Key Points
  • Financial advice isn’t all or nothing. You’re in control and can choose the type and amount you want.
  • Whether you’re looking for online advice, a one-time consultation, on-going management or a complete financial plan, take your time finding the best advisor or service to help you achieve your goals.
  • Never hesitate to ask questions about fees, background, compensation and possible conflicts of interest—and always remain involved.

Dear Carrie,

While I’ve always managed my own money, it’s getting harder for me to stay on top of everything. I’m considering a financial advisor, but I feel wary. Any tips on what/who to look for?

—A Reader

Dear Reader,

Financial advice can come in a lot of forms and be delivered by a variety of professionals. Just wading through what has been referred to as the ‘alphabet soup’ of financial certifications—CFA, CPA, CFP® to name just a few—is enough to confuse anyone. Add to that the news you may have read about the new, partially implemented Department of Labor Fiduciary Rule, and it’s no wonder you’re unsure.

The positive side is that you have a choice—and the opportunity to find the best advice to help you achieve your financial goals. But finding appropriate and reliable advice at a reasonable cost takes careful thinking and research.

Start by deciding how much and the type of advice you need

Financial advice isn’t all or nothing. You’re in control and can choose the type and amount you want, ranging from high-tech automated portfolio advice to a comprehensive and in-depth, personalized relationship with an advisor or team of professionals.

  • Automated investment advice—Brand new investors may want to start here. Harnessing the power of technology, a number of online services will build a well-diversified portfolio based on your stated goals. This type of service may rebalance your portfolio automatically, and for a small additional fee may also provide access to a financial advisor.
  • One-time or periodic consultation—If you feel you only need periodic guidance to keep your portfolio on track, another approach can be to simply check in with an advisor now and then. A consultation would give you the opportunity to discuss big-picture strategy as well as particular investments. For a little more help, you could arrange to meet with an advisor on a regular basis. Either way, the advisor might make recommendations but you’d make the decisions and might even handle the transactions.
  • Ongoing portfolio management—This is a bigger proposition and is generally best suited for people with at least $250,000-500,000 in assets to manage. In this arrangement, you’d work with an advisor to come up with a long-term investment strategy. With your approval, your advisor would manage your accounts for you, making your life simpler by handling the transactions. However, you’d still be very much involved in the decisions.
  • Complete financial plan—This typically includes all aspects of your financial picture—investments, retirement planning, estate planning, taxes and insurance—and makes sure that all the parts are working together to support your goals. It will take a fair amount of time and effort to gather all the necessary information and communicate your long- and short-term goals, but in my mind, almost everyone can benefit from having this type of holistic perspective and ongoing relationship that will evolve over time.

Understand what the credentials mean

There are a wide variety of financial credentials, representing an equally wide variety of education, experience and regulatory oversight. Perhaps the most important distinctions (and most often confused) are those between a broker, an investment advisor and a financial planner.

A broker typically is employed by a broker-dealer and is registered with the Financial Industry Regulatory Authority to buy and sell securities on your behalf. A broker can help you evaluate your portfolio, make buy and sell recommendations, and execute trades.

In contrast, an investment advisor, also known as a registered investment advisor or RIA, is registered with either the Securities and Exchange Commission or a state securities regulator specifically to provide financial advice and/or investment management, which can include buying and selling securities. A distinction is that RIAs are held to a fiduciary standard, which means they’re required to act in your best interest at all times, while brokers (excluding those providing guidance on retirement accounts under the new DOL Fiduciary Rule) are held to a different and less stringent suitability standard, meaning recommendations must simply be appropriate to your needs.

Another option is to work with a Certified Financial Planner™ (CFP®) professional who is required to complete extensive training and continuing education. This type of advisor can help you with big picture planning as well as with portfolio management and is also held to a fiduciary standard. A good resource for finding a CFP® professional is the Financial Planning Association’s website, plannersearch.org.

The DOL Fiduciary Rule I mentioned earlier is designed to expand the fiduciary standard to include retirement accounts and extends the fiduciary responsibility to brokers as well advisors who are already held to this standard. While this new rule is still being debated, it really is important for individual investors to make certain they question any potential broker or advisor about whether or not they are held to that fiduciary standard.

Know what you’re paying for and how

Another important issue is compensation. A one-time consultation might be free or have an hourly fee. For ongoing management, it’s common to be charged a percentage of assets managed, typically about 1 percent. A comprehensive financial plan may be included in your investment management service, or it may entail a separate fee.

It’s also critical to look out for potential conflicts of interest. You should understand whether your advisor stands to benefit by selling you an investment. Bottom line, your goal is to make certain an advisor’s counsel is based on what’s best for you, not what’s best for his or her own paycheck. In fact, if someone is compensated by commissions or incentives, I’d proceed with an extra amount of caution—if at all.

Ask the right questions

Finding the right advisor is about asking the right questions. Arrange for an initial consultation (it’s usually complimentary) and ask about education, time in the business, number of clients, types of services and amount of money under management. Find out about their investing philosophy and preferred types of investments. And get very specific about how you will be charged and why.

Plus, don’t overlook the importance of a good rapport. If you expect to have a long-term relationship, you want to be comfortable personally as well as professionally.

Stay involved

Lastly—even with an advisor—stay on top of things. Make sure you understand the thinking behind any recommendations and advice. And remember, it’s your money; the final decisions are ultimately yours.

Important Disclosures

(1117-7WBW)

The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.

Investment Expenses: What’s Tax Deductible?

By HAYDEN ADAMS

NOVEMBER 10, 2017

Key Points
  • If you itemize your deductions, you may be able to deduct a number of investment-related expenses on your tax return.
  • If you borrowed money to purchase taxable investments you might be able to use the interest expenses from the loans to reduce your taxable investment income.
  • Up to $3,000 of capital losses can be used to offset ordinary taxable income.

If you itemize deductions on your annual tax returns, make sure you’re not missing out on deductions for investment expenses you paid. The IRS allows taxpayers various tax deductions for the investment-related expenses if that expense is related to producing taxable investment income.

Maximizing your tax deductions has the potential to reduce your tax burden, so let’s look at some of the most common deductible investment expenses and how they can reduce your taxable income.

Miscellaneous investment-related itemized deductions

You can deduct certain miscellaneous investment-related expenses from your taxable income once those expenses cross a certain threshold based on your income, which we’ll explain below. First, a list of those expenses, as well as some expenses that aren’t included.

Investment-related expenses that you may be able to deduct:

  • Fees for investment counsel and advice, including subscriptions to financial publications and research used to guide your investment decisions.
  • Software or online services used to manage your investments.
  • Charges for automatic investment services and dividend reinvestment plans.
  • Transportation to your broker’s or investment advisor’s office.
  • Safe deposit box rent (if the box is used to store certificates or investment-related documents).
  • IRA or Keogh custodial fees, if paid by cash outside the account.
  • Attorney, accounting or clerical costs necessary to produce or collect taxable income.
  • Costs to replace lost security certificates.

Investment related expenses that can’t be deducted:

  • Trading commissions: These expenses are added to the cost basis of your investment, also known as “capitalizing” the expense. When you eventually sell the investment these expenses will reduce your taxable gain on the sale.
  • Investment advisory fees related to tax-exempt income: The general rule is if the income is not taxable then the expenses related to that investment are not deductible. If you pay a single fee to your investment advisor it may be difficult to identify the fees related to your tax-exempt investments. In these situations it is generally best to deduct only the portion of the advisory fee related to your taxable investments.
  • Costs of traveling to attend a shareholder’s meetings.
  • Borrowing costs associated with life insurance.

You can’t claim a deduction for miscellaneous investment-related expenses unless they amount to 2% or more of your adjusted gross income (AGI). Put another way: Imagine putting all your investment expenses into a bucket. Once the bucket is full (this is the 2% limitation), the expenses that overflow from the bucket are what you are allowed to deduct on your return.

Let’s consider an example. Mary has $100,000 of AGI and $5,000 in investment related expenses. The table below shows how she would calculate her deduction.

Example #1
Calculation of Deductible Investment Expenses

Again, the first $2,000 isn’t deductible. However, Mary does get to deduct the remaining $3,000 as an itemized deduction on Schedule-A of her Form 1040, thereby reducing her taxable income from $100,000 to $97,000.

Investment interest expense

Investment interest expense is the interest paid on money borrowed to purchase taxable investments. This would cover margin loans you use to buy stock in your brokerage account. In such cases, you can deduct the interest on the margin loan. (This wouldn’t apply if you used the loan to buy tax-advantaged investments such as municipal bonds.)

The amount that can be deducted in a given year is capped at your net taxable investment income for the year. Any leftover interest expense gets carried forward to the next year and potentially can be used to reduce taxes in the future.

To calculate your deductible investment interest expense, you need to know the following:

  • Your total investment income for investments taxed at your ordinary income rate. This normally includes ordinary dividends and interest income, but does not include investment income taxed at the lower capital gains tax rates, like qualified dividends or municipal bond interest which is not taxed.
  • Your deductible investment expenses (the amount we calculated in Example #1)
  • Your total investment interest expenses (for loans used to purchase taxable investments).

To calculate your deductible investment interest expense, you first need to determine net investment income by subtracting your deductible investment expenses from your total investment income. Then compare your net investment income to your investment interest expenses. If your expenses are less than your net investment income, the entire investment interest expense is deductible. If the interest expenses are more than the net investment income, you can deduct the expenses up the net investment income amount. The rest of the expenses are carried forward to next year.

Let’s say Mary has $11,000 of investment income (from ordinary dividends and interest income), $3,000 of deductible investment expenses and $10,500 of investment interest expenses from a margin loan.

Example #2
Calculation of Deductible Investment Interest Expenses

Because of the investment interest expense deduction, Mary’s taxable income has been reduced even further, from $97,000 to $89,000.

How do qualified dividends affect investment interest expense deduction calculations?

Qualified dividends that receive preferential tax treatment aren’t considered investment income for purposes of the investment interest expense deduction. However, you can opt to have your qualified dividends treated as ordinary income.

In the right circumstances, electing to treat qualified dividends as ordinary dividends can increases your investment interest expenses deduction, which allows you to pay 0% tax on the dividends instead of the 15% or 20% tax qualified dividends normally receive.

Here’s an example of how it might work.

Mary has $2,000 of qualified dividends in 2017, on which she would normally pay $300 in tax ($2,000 x 15% tax rate). If Mary elected to treat the qualified dividends as ordinary income she could boost her net investment income from $8,000 to $10,000. As a result, she would be able to deduct more of her investment interest expense in the current year—and pay no tax on the qualified dividends.

Example #3
Calculation of Deductible Investment Interest Expenses if Qualified Dividends are Treated as Ordinary Income

Because Mary is a tax-savvy investor, she was able to reduce her taxable income from the original $100,000 to $87,000. That’s a $13,000 reduction in taxable income, which could result in $3,250 of tax savings if her marginal tax rate is 25%.

Note: The election to treat qualified dividends as ordinary dividends should not be taken lightly. Once made, the election can only be revoked with IRS consent. Consult with your tax professional before implementing this tax strategy.

Capital losses

Losing money is never fun, but luckily there is a silver lining. Capital losses can be used to offset your capital gains. If your capital losses exceed your capital gains, up to $3,000 of those losses (or $1,500 each for married filing separately) can be used to offset ordinary income and lower your tax bill. Net losses of more than $3,000 can be carried forward to offset gains in future tax years.

For more information about maximizing the tax benefit of capital losses and tax strategies like tax loss harvesting, see “Reap the Benefits of Tax-Loss Harvesting to Lower Your Tax Bill.”

Don’t forget about the cost basis of your investment

To make the most effective use of capital losses, keep track of your investments cost basis. The cost basis is generally equal to an investment’s purchase price plus any expenses necessary to acquire that asset, such as commissions and transaction fees. Later, when you sell your investment the cost basis is used to reduce the taxable gain. For more on cost basis, see “Save on Taxes: Know Your Cost Basis.”

What to do now

The IRS also has some resources that provide examples and detailed explanations of the topics included in this article, including: Publication 550, Publication 529, and the instructions for Form 1040, Schedule A, Schedule D, and Form 4952.

In addition, be sure to consult your tax professional (CPA, lawyer, or enrolled agent) about your situation, preferably well before the end of the year.  No matter the time of year, it’s also a good idea to check with your tax advisor before you enter into any transaction that might have significant tax consequences.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The type of securities and accounts mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(1117-730A)

5 Investing Risks Worth Worrying About

NOVEMBER 10, 2017

If you’ve ever lost sleep worrying that a dramatic event might derail your finances—your brokerage failing à la Lehman Brothers, for example, or the stock market tumbling as a result of a technical glitch—you might be focused on the wrong risks.

For one, there are robust protections for individual investors in the unlikely event a bank or brokerage goes under, and many so-called black swan events caused only minor market disruptions.

More important, it’s the subtler pitfalls—the ones that can creep up on you over time—that are really worth guarding against, says Mark Riepe, senior vice president at the Schwab Center for Financial Research. “It’s one thing to take a calculated risk,” he says. “It’s another to get blindsided by the sorts of day-to-day risks to which we’re all susceptible.”

With that in mind, here are five hazards investors too often neglect.

1. Procrastination

When it comes to retirement, doing nothing may be the biggest risk of all. The longer you delay establishing goals and putting a savings plan in motion, the less time you have to benefit from compounding, or earning returns on your returns. “And if you wait too long,” Mark says, “it can become almost impossible to catch up.”

Suppose a hypothetical 25-year-old invested just $250 a month until retiring at age 65. At the end of four decades, assuming an annualized return of 6%, this early and consistent saver would have accumulated nearly half a million dollars—more than three-quarters of it attributable to compounding (see “The snowball effect,” below).

If that person had delayed saving until age 35, by comparison, he or she would have had to save nearly twice as much a month to achieve the same net savings.

The snowball effect

Investing just $250/month for 40 years would earn you nearly $375,000 in compound returns.

Source: Schwab Center for Financial Research. This hypothetical example is for illustrative purposes only and is not intended to represent a specific investment product. It assumes an annualized return of 6% and that dividends and interest were reinvested, and does not reflect the effects of fees or taxes.

2. Unrealistic expectations

Even after you’ve set goals and established healthy savings habits, you still risk coming up short in retirement if your expectations for returns are unreasonably high. Although it’s impossible to say for certain how your investments will fare over time, there’s broad consensus about what to expect in the coming decade.

Charles Schwab Investment Advisory, for example, expects U.S. large-cap stocks to return an average of 6.7% annually from 2017 through 2026, counting dividends and share-price appreciation, and investment-grade bonds to return just 3.1%. That’s one-third and one-half lower, respectively, than the averages experienced during the past half century.

For proof of why this matters, look no further than the headlines about states facing funding shortfalls in their public-employee pensions. In almost every instance, politicians were overly optimistic about the returns fund managers could achieve.

“With almost all of these underfunded pension plans, we see a dramatic example of what happens when you don’t save enough—and fool yourself into thinking that the market will bail you out with an unrealistic rate of return,” Mark says.

3. Neglected portfolio

A lot of risks needlessly pile up if you don’t update your plan and portfolio from time to time. An approach that made sense for a married couple with no kids may be all wrong once the family expands, for example, and an aggressive investment strategy when you’re 50 might be downright detrimental a decade later. Even the most forward-looking portfolio can drift from its goals as some asset classes stagnate while others surge.

“There’s no such thing as one and done,” Mark says. “Your situation changes, the world changes—and your portfolio may need to change with it. You should review absolutely everything at least once a year.”

4. Inflation

Inflation in the United States has been at historically low levels for the better part of a decade. Indeed, “there’s now an entire generation that has little or no experience dealing with the risks associated with inflation,” Mark says. That said, you shouldn’t ignore the possibility that the purchasing power of your long-term investments might be badly eroded by a rising cost of living, particularly as it compounds over time.

Inflation is a risk for retirees, in particular, because an outsize percentage of their spending goes to health care, which has seen much steeper price increases relative to the other goods and services that make up the Consumer Price Index (CPI).

One way to combat this risk is to set a higher retirement-savings goal to prepare for this eventuality. Another is to recalibrate your investing approach—by shortening the duration of your bonds so their prices aren’t as vulnerable to the rising interest rates that often accompany inflation, for example.

5. Lack of learning

Research has shown that those with even a basic level of financial literacy—including an understanding of compounding, diversification and inflation—are more likely to achieve their retirement goals than those without.1 “There’s a risk in not taking the time to understand key financial concepts,” Mark says. “Conversely, there’s an opportunity for those who do make the effort.” (See “Back to school,” below.)

The risk is especially acute for young adults, who often enter the workforce with a limited understanding of financial fundamentals. “Time is a young person’s greatest advantage,” Mark says, “but they need to know why and how to leverage it.”

Mark suggests we all take the time to educate those just starting out. “Teach them the basics and introduce them to your go-to resources,” he says. “Often, it’s just a matter of pointing them in the right direction.”

1Annamaria Lusardi and Olivia S. Mitchell, Financial Literacy and Planning: Implications for Retirement WellbeingNational Bureau of Economic Research, 05/2011.

Important Disclosures

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

Investing involves risk, including loss of principal.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness and reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

(1117-7G67)

Financial Tips for Millennials

By CARRIE SCHWAB-POMERANTZ

NOVEMBER 10, 2017

Dear Carrie,


My son just graduated from college and soon will be starting his first job. I don’t want to overwhelm him with information, but I do want to make sure he starts off on the right foot with his finances. What would you suggest?

Dear Reader,


At 80 million strong, millennials outnumber every other generation in America.1 As a group they tend to be socially responsible, committed to their values, and less likely than previous generations to follow traditional family or career paths.

But here’s the rub: According to Deloitte, many millennials also have an innate distrust of financial institutions and money managers. On top of that, they tend to be risk averse, with less than 30% of their wealth invested in the stock market.2

This concerns me not only as a financial planner but also as a parent. As a proud mother of three millennials, I want to do my best to help them—and their peers—become fulfilled, independent and productive adults. And I believe a big part of that is introducing them to prudent money management and investing.

If you have millennials in your life who could use some help getting started, consider passing along these three tips I always give to young investors—including my own.

1. Make saving a habit

Building a secure financial future starts with saving. That might sound simple, but knowing how much to set aside and where to put it can get confusing, especially when you’re working toward multiple goals. That’s why the Schwab Center for Financial Research developed our Savings Fundamentals, listed here in order of priority:

  • Capture your match: If your employer offers to match a percentage of your contribution to the company 401(k) or other retirement plan, contribute at least enough to capture the maximum. Otherwise, you’re walking away from “free money”.
  • Cut back on credit card debt: Yes, credit cards are convenient, but they also can lure you into spending more than you can afford, leaving less for savings. Personally, I can think of no bigger waste of money than paying interest on credit card debt. If you’re in over your head, make a plan to pay off persistent balances as soon as possible, then redirect that money to savings.
  • Build a rainy-day fund: Even if you’re young and healthy, expensive and unexpected events can occur. Aim to save enough to cover three to six months’ worth of necessary expenses, such as food, insurance, rent and utilities.
  • Prioritize retirement: Finally, revisit your retirement savings. When you’re in your 20s, a good goal is to put away 10% to 15% of your gross income. If you wait until your 30s or later to start, you’ll need to set aside a much bigger chunk of your paycheck.

Once you’re on board with these four steps, you can expand your horizons. This can be a good time to save toward the down payment on a home or a major vacation, or to accelerate payments on long-term debt such as student loans. Calculate how much you’ll need and start socking away any disposable income.

2. Start investing

With your savings in place, the next step is to start accumulating long-term wealth by investing. Before you begin, make sure you understand the basics:

  • Go slow but steady: Sometimes, the hardest part of investing is getting started, and that’s where dollar-cost averaging comes in. With this strategy, you invest a set amount of money at regular intervals—say, once a month. When the market is down, your allotment buys more shares; when it’s up, your allotment buys fewer shares. Over time, this approach allows you to build a sizeable portfolio without having to venture too much, too quickly.
  • Put your eggs in many baskets: Diversification means spreading out your investments across and within asset classes by distributing your money across different sectors, industries and companies, for instance.
  • Take advantage of your age: Sustained time in the market is perhaps a young person’s greatest investing asset, thanks to the miracle of compounding and the cumulative growth potential of stocks. Dipping in and out of the market, on the other hand, is a good way to derail your plan.
  • Understand your assets: Markets go up and down, but over the long run, stocks (as measured by a broad market index like the S&P 500®) have grown in value—and quite a bit more so than bonds or cash investments.

I also urge young investors to take advantage of technology such as robo advisors, which use algorithms to construct and manage a cost-effective portfolio based on your goals, time horizon and risk tolerance.

3. Seek advice

My final suggestion for every young investor is to ask lots of questions along the way. Talk with your parents, take advantage of online resources and in-person workshops, and ask for help if you hit a roadblock. The world of investing is large and complex, but turning to a knowledgeable and trustworthy expert can help you become a confident and informed investor.

Carrie Schwab-Pomerantz (@carrieschwab), CFP®, is president of Charles Schwab Foundation and senior vice president of Schwab Community Services at Charles Schwab & Co., Inc.

1Anthony Cilluffo and D’Vera Cohn, “10 Demographic Trends Shaping the U.S. and the World in 2017,” Pew Research Center, 04/27/2017.
2Daniel Kobler, Felix Hauber and Benjamin Ernst, “Millennials and Wealth Management: Trends and Challenges of the New Clientele,” 06/2015.

Important Disclosures

The Charles Schwab Foundation is a 501(c)(3) nonprofit, private foundation that is not part of Charles Schwab & Co., Inc., or its parent company, The Charles Schwab Corporation.

Dollar cost averaging does not ensure a profit and does not protect against loss in declining markets. It involves continuous investing regardless of fluctuating price levels. Investors should consider their ability to continue investing through periods of fluctuating market conditions.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry representation.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

(1117-7PRT)

The information provided here is for general information purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.

Are ETFs Dangerous?

By ANTHONY DAVIDOW

AUGUST 23, 2017

Exchange-traded funds (ETFs) are undoubtedly popular. Are they also dangerous?

These diversified baskets of stocks, bonds and other assets have been around for less than 25 years, but in that relatively short run they’ve managed to amass some $3 trillion of assets in the U.S. alone, according to the Investment Company Institute.1 In the last 10 years alone, the value of assets held by ETFs has nearly quintupled. ETFs accounted for nearly a third of the trades conducted on U.S. exchanges in 2016.2

Investors like them because they’re easy to trade—like stocks, you can buy and sell them on exchanges—and can provide broad or niche market exposure at a relatively low cost. As a result, investors use them in a lot of different ways—from trading individual ETFs on the market, to holding them in their 401(k)s and building portfolios with the cutting-edge automated services known as robo-advisors.

But ETFs’ seeming ubiquity is also making some market-watchers nervous. Some have said ETFs make markets less efficient and boost the valuations of otherwise unremarkable stocks. Some say ETFs have depressed volatility, while others see the opposite problem and suggest ETFs could cause extreme volatility during crises.

Are these concerns justified? In general, we don’t think so. Here we’ll address some of those concerns and offer some tips investors can use to trade ETFs.

Concern #1: ETFs make markets less efficient.

Many ETFs are designed to track particular indexes, typically by holding the same assets as an index (or at least a representative sample). For example, an ETF tracking the S&P 500® Index might hold a proportional amount of all 500 of the index’s constituent stocks. As a result, most ETFs are considered “passive” investments because decisions about whether to include a particular security in the basket come down to whether it is part of the target index. That structure is part of the appeal because it makes ETFs cheaper to operate than funds actively managed by an investment professional.

But some observers fear that because such ETFs passively buy assets without regard to prices, they don’t distinguish between good assets and bad. The concern is that such ETFs could lift all boats, whereas markets are normally supposed to elevate only worthy investments and shun the rest. A related concern is that because ETFs buy whole indexes, they could end up making all the assets on those indexes move in lockstep, thereby making markets less diverse.

Response #1

This might make sense if all ETFs followed the same strategy, but they don’t. Where a broad-market ETF might hold shares in proportion to their weightings on a market capitalization-weighted index such as the S&P 500, a “smart beta” ETF might focus on a particular slice of the market by tracking indexes that screen and weight stocks according to their dividend payments, volatility or recent stock-price momentum. (Note that smart beta strategies may be less diversified than a market cap strategy. You can read more about smart beta strategies here, here and here.)

Second, it’s worth noting that even with ETFs’ impressive growth, they still hold just shy of 6% of the U.S. stock market.3 In comparison, mutual funds hold around 23%. Households, pension funds, international investors, hedge funds, and other investors also own stocks. In other words, there are still plenty of parties in the market buying and selling shares for a variety of reasons.

In addition, the way ETFs are created and redeemed actually tends to make markets deeper and more efficient. Basically, the process involves ETF companies and entities called “authorized participants” (often broker-dealers) working together to buy and sell the assets needed to create new ETF units in response to changes in supply and demand. If there is sufficient demand for an ETF, an authorized participant can buy the underlying assets on the market and create a new ETF unit. Conversely, if investors selling ETFs start to put downward pressure on the ETF valuations, an authorized participant can reverse the process by redeeming shares. The creation and redemption process creates liquidity and is designed to help keep ETF valuations from straying too far from the value of their underlying assets.

Concern #2: Automated trading systems can cause ETFs to stray far from the value of their underlying holdings, causing markets to break down.

This is based on ETFs’ performance during the “flash crashes” that hit stock markets in May 2010 and August 2015. In both cases, irregularities in the market triggered orders by automated trading systems that caused ETFs to become disconnected from the value of their underlying holdings. Normally, authorized participants can step in and help bring prices back into alignment. In a flash crash, trading halts and the triggering of automated stop-loss orders can combine to make it extremely difficult to accurately price assets—thereby causing trading to break down altogether.

Response #2

Here, the first thing to note is that outside of a few extreme cases, ETFs trading has been very orderly and allowed investors to move in and out of markets with ease. As noted above, ETFs account for decent chunk of the trades conducted on U.S. exchanges. Investors who don’t trade during a flash crash aren’t affected by it.

And the authorities have taken steps to respond to the threat of flash crashes. Regulators, ETF sponsors and exchanges have been working together to make sure markets continue to function in moments of stress. The Securities and Exchange Commission has taken all this under consideration and introduced a system of trading halts to help rein in abnormally erratic markets.

Concern #3: ETFs may be easy to trade, but sometimes the underlying investments aren’t.

The idea is that ETFs’ stock-like liquidity could give investors the false impression that they can “safely” invest in otherwise illiquid or exotic parts of the market. However, price changes in narrow or thin parts of the market can cause ETF prices to swing sharply.

Response #3

ETF liquidity is dependent upon the liquidity of the underlying investment. For example, ETFs focused on large-cap stocks will likely be very liquid because the underlying stocks generally are. Conversely, ETFs focused on niche segments of the markets may not be liquid in periods of stress or extreme supply or demand imbalances.

While it’s true that such ETFs come with specific risks, they might also offer higher returns or exposure to otherwise desirable assets. But it’s worth handling them with care. They can make sense as part of a long-term strategy, but they’re probably not a good choice for short-term investing as it could be hard to sell at a desirable price during a downturn. (You can read more about portfolio liquidity here.)

Best practices

ETFs offer diversification at low cost, which helps explain their growing appeal. We don’t think they’re inherently dangerous. Nevertheless, it can make sense to follow a few rules of thumb when trading them.

  • Avoid trying to sell during a market crisis. Extreme volatility tends to be short-lived, and selling during a panic can lead to losses.
  • Use limit orders. These are orders to buy or sell at a set price (the limit) or better. Specifying the price at which you are willing to buy or sell an ETF does not guarantee execution, but it does protect you from executing a trade at a disagreeable price.
  • Avoid trading when markets open or just before they close. They tend to be more volatile then.

Finally, you can find more ETF-related content here and read more about our thoughts on indexing in our white paper, The Elegance of Indexing.

1Data as of 7/26/2017.

2Fourth Quarter 2016 NYSE ARCA ETF Report.

3Federal Reserve and World Bank data for 2016.

Important Disclosures

Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV).

Past performance is no guarantee of future returns.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

The S&P 500® Index is a market-capitalization weighted index that consists of 500 widely traded stocks chosen for market size, liquidity, and industry group representation.

Smart-beta strategies may be less diversified than other investment strategies. For instance, a smart-beta ETF might be more heavily weighted in a particular sector or geographical region, which would amplify an investor’s losses in the event of trouble in that sector or region.

Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

(0817-7944)

Quiz: How Much Do You Know About Index Funds?

MAY 11,2017

A decade ago, index funds represented less than one-fifth of the U.S. equities market. Today, they constitute nearly a third, with more than $5 trillion in assets under management.1

573% and counting

Total assets invested in index mutual funds grew from $327 billion in 2002 to $2.2 trillion in 2015.

Source: 2016 Investment Company Fact Book, Investment Company Institute. Data include total net assets of U.S. bond, equity and hybrid index mutual funds; data exclude ETFs and mutual funds that invest primarily in other mutual funds.

Despite their popularity, however, index funds remain relatively misunderstood. How much do you know? Take our true-or-false quiz to find out.

1. An index fund invests in the same securities as its underlying index, or benchmark.

A)   True
B)   False

2. Index mutual funds and exchange-traded funds (ETFs) are basically the same thing.

A)   True
B)   False

3. Not all index funds define developed and emerging-market countries the same way.

A)   True
B)   False

4. Index funds weight their underlying securities according to the value of their outstanding shares.

A)   True
B)   False

5. When picking an index fund, the single most important factor is cost.

A)   True
B)   False

6. Smart-beta funds cost more than market-capitalization-weighted funds.

A)   True
B)   False

7. You can achieve adequate diversification in your domestic stock portfolio by investing in an index fund that tracks the entire U.S. equities market.

A)   True
B)   False

8. Not all funds that track the same index perform equally.

A)   True
B)   False

1. Answer: A | Actually, make that mostly true. An index fund attempts to deliver the same returns as a specific index by owning most, if not all, of the same securities. However, some securities trade infrequently or are very expensive, which could cause fund managers to omit them, depending on their strategy. Also, many funds keep a percentage of their holdings in cash equivalents, which allows fund managers to meet day-to-day redemptions without selling securities. But too much cash can cause a fund to underperform its index. “Anything in excess of 3% should raise concerns,” says Michael Iachini, vice president and head of manager research at Charles Schwab Investment Advisory.

2. Answer: B | Although both are passive investments that mirror the performance of an underlying index, they trade differently. An ETF trades on a stock exchange throughout the day, when  its price is free to fluctuate—just like a stock. An index mutual fund trades only at the end of the trading session, during which time its share price is calculated by deducting the fund’s liabilities from the value of its outstanding shares, then dividing by the number of outstanding shares.

3. Answer: A | For example, Morgan Stanley Capital International (MSCI) classifies South Korea as an emerging market, while the Financial Times Stock Exchange (FTSE) considers it a developed market. Accordingly, South Korean stocks account for roughly 15% of the MSCI Emerging Markets Index and none of the FTSE Emerging Index. By the same token, FTSE has classified Pakistan as an emerging market for some time, while MSCI only recently updated the country’s status from frontier to emerging.

4. Answer: B | Market-capitalization-weighted indexes, such as the Russell 1000® and the S&P 500®, do indeed weight companies according to the value of their outstanding shares. However, other indexing strategies, known collectively as smart beta, emphasize factors other than market capitalization. Among the most popular are: equal weight, which weights every security equally, regardless of capitalization; fundamental, which screens and weights securities according to financial fundamentals such as book value, cash flow and sales; and low volatility, which overweights securities whose prices historically have fluctuated less than the market as a whole.

5. Answer: B | Other considerations include whether an index adheres to a market-capitalization-weighted or smart-beta methodology, how it has performed both relative to its benchmark and in absolute terms, and which asset class or lasses it represents.

6. Answer: A | Though substantially less expensive than most actively managed investments, smart-beta funds are nevertheless costlier than their more passively managed market-cap-weighted counterparts. Even so, “our research has shown that the potential outperformance of certain smart-beta strategies, such as fundamental, can offset their higher costs,” says Tony Davidow, asset allocation strategist at the Schwab Center for Financial Research. Investors can use Schwab’s ETF Select List® (schwab.com/etfselectlist) or Mutual Fund OneSource Select List® (schwab.com/selectlist) to compare the expense ratios of actively managed, market-capitalization-weighted and smart-beta funds.

7. Answer: B | Even an index fund that tracks, say, the Wilshire 5000®—which represents nearly all actively traded U.S. stocks—may not be adequate when it comes to diversification. That’s because, like other market-cap-weighted indexes, the Wilshire 5000 assigns the most weight to the biggest companies. Investors looking to diversify their domestic exposure should also consider smaller-cap funds.

8. Answer: A | A landmark 2002 study found that returns varied by as much as 2% a year among index mutual funds tracking the S&P 500—owing in part to the fees they charge.2 Mutual funds charge different expense ratios, and some charge “loads”—one-time fees to buy (front-end loads) or sell (back-end loads). What’s more, some mutual funds are more tax efficient than others in terms of dividends, interest and realized capital gains.

How to Save for Multiple Financial Goals

APRIL 12, 2017

A comfortable retirement. A new car. A down payment on a house. Paying for a child’s college education.

Coming up with a list of future financial goals is generally pretty easy. The bigger challenge is figuring out how you’re going to save for them all.

For most of us, socking a few extra dollars away in a savings account each month may be a good start, but it’s probably not enough, especially if we’re talking about multiple goals. The trick is to think strategically about your goals and come up with a saving and investment plan for each one. A little effort today can help make a big difference down the road.

Here are a few steps you can take as you work toward achieving your goals.

Set your goals

The first step is pretty easy: Write down your goals.

We suggest keeping the list short. If you have 15 different goals, you might struggle to keep track of them all. So think of this list in terms of what’s most important to you and your family—and prioritize. One way to do this is to group savings goals by needs, wants, and wishes, in order of priority. Saving for retirement will likely be high on the list, and we would also suggest setting up an emergency fund with enough money to cover at least three-to-six months of essential living expenses. Then you could add things like buying a home, paying for college, a dream vacation, a new car or a festive wedding.

Sorting and allocating

Once you’ve made a list, it’s time to sort them by time horizon. Here, you can take advantage of a technique known as “bucketing” that many people use to calculate their retirement income. In short, this involves dividing your money into a series of buckets that hold what you will need in a few months, in a few years or in 10 years or more.

Knowing when you’ll need the money can help you decide what sort of investments you should consider as part of your savings plan. In general, it makes sense to use less-volatile investments for short-term goals, as you’ll have less time to recover from a dip in the market, and more aggressive investments for longer-term goals, as potential returns can have more room to grow over time. Here’s how it generally works:

  • Bucket 1 is where you save for short-term goals, say in the next two years. This could include things like a wedding or nice vacation. Consider traditionally more-stable investments such as cash, money-market funds or short-term Treasury bonds or certificates of deposit. Putting money you plan to spend soon into liquid, readily marketable, generally low-risk investments can help you avoid having to sell other investments, such as stock, in a down market to raise cash.
  • Bucket 2 typically holds money that you expect to need over the next three to 10 years. This could include goals like a down payment on a home. Intermediate-term assets such as a mix of intermediate-term bonds or bond funds and stocks, with a focus on growth and capital preservation make sense for this bucket.
  • Bucket 3 typically holds money that you expect to need in 10 years or later, say for retirement or your kids’ college. This bucket should be invested for growth and income, with a larger allocation to stocks.

Note: These buckets aren’t one-size-fits-all. Each should be tailored to your risk tolerance for each goal as well as your time horizon. And be sure to diversify. You probably don’t want the fate of your goals to hang on the performance of a single asset.

Start Investing

Once you’ve identified your buckets, it’s time to start putting money in them. Even modest contributions, when made regularly, can pay off substantially over time. You could even consider using a strategy such as dollar-cost averaging, which is when you buy a fixed dollar amount of a particular investment on a regular schedule, regardless of how the price fluctuates. That generally means buying more shares when prices are low and fewer shares when prices rise.

And stick to your priorities. Fund the items at the top of your list first, such as your retirement savings, regardless of what bucket they are in.
Note: You will have to do some budgeting to figure out how much you should save for each goal. Use one of Schwab’s savings calculators if you need help.

Stay the course

Check on your investments at least quarterly (or more often if you have a more aggressive portfolio). In general, you should consider making your allocations more conservative as you approach your goals by shifting away from riskier investments, such as stocks, in favor of more-stable ones, such as bonds. Major life events, such as job changes, the birth of a child or a marriage, may also call for some adjustments.

Regular check-ins also make it easier to make adjustments. For example, if the price of a college education rises faster than you planned for, you might respond by cutting back your spending, increasing your regular contributions or (if your time horizon is long enough) shifting money into more aggressive assets that may generate higher returns.

Remember that you may need to “rebalance” your portfolio occasionally, which involves selling assets that have appreciated and buying more of those that haven’t done as well. For example, if your stocks appreciate to the point where your stock allocation accounts for a larger share of your portfolio than your target allocation allows, and your bond allocation shrinks, you could consider selling some of the stock and buying more bonds to bring your portfolio back in line with your target. By rebalancing on a regular basis, you can help ensure your portfolio doesn’t drift too far from your target mix of asset classes. Not rebalancing is akin to letting the market decide your asset allocation over time, which can significantly change your exposure to risk.

Finally, stick to your plan. Down markets can be unnerving. Successfully managing investments requires a long-term view and a commitment to staying on track.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Diversification and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events can be created that may affect your tax liability.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.
Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

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Health Savings Accounts: FAQs About HSAs

APRIL 10, 2017

What is a health savings account?

Health savings accounts (HSAs) are tax-advantaged savings and investment accounts available to people with high-deductible health plans. You can set aside money in an HSA, free of federal taxes, to pay for qualified medical expenses. Money saved or invested in an HSA also grows federal-tax-free.  And as long as you spend the money on qualified medical expenses—such as doctor visits, prescription medications, eye exams and dental care—withdrawals aren’t taxed, either.

Why do they exist?

HSAs were created in 2003 to give people with high-deductible health plans a tax break, as many employer-sponsored health plans have shifted more of the responsibility of paying for health care to individuals.

As many as 22 million people now participate in an HSA, and some 72% of employers with more than 500 employees look set to offer these accounts by 2019. That’s up from less than a quarter in 2010.¹

Who can open an HSA?

You are eligible to enroll in an HSA if:

  • you’re enrolled in a high-deductible health plan;
  • you aren’t covered by another health plan that’s not high-deductible (for instance, a spouse’s plan);
  • you aren’t enrolled in Medicare; and
  • you can’t be claimed as a dependent on someone else’s tax return.

As the name implies, high-deductible health plans have higher-than-average deductibles. For 2017, the IRS defines them as requiring annual out-of-pocket payments of $1,300 for an individual plan, and $2,600 for a family plan, among other requirements. You can find more details about HSA requirements in IRS Publication 969.

How do I contribute?

If your employer offers a high-deductible health plan, it may also direct you toward an HSA (some employers even make annual contributions to their employees’ HSA accounts). You can also open an account on your own through a qualified HSA provider, such as a bank or insurance company.

Both you and your employer can contribute to an HSA up to annual limits:

You can make your annual contribution right up to the federal tax filing deadline for that year—for instance, for the 2016 tax year, you have until April 18, 2017, to contribute to your HSA.

However, note that you can’t contribute to an HSA if you’re enrolled in Medicare. If you’re 65 or older and file for Social Security benefits, you’ll automatically be enrolled in Medicare Part A. You should stop making HSA contributions six months prior to filing for Social Security, if you are claiming benefits after age 65.

Can I invest HSA balances?

Funds in an HSA account can be invested, although the investment choices will vary depending on the HSA administrator. Some HSAs have limited options, such as a bank savings account. Others may offer a range of products, including mutual funds or exchange-traded funds. Note that many plans require a minimum balance—for instance, $1,000 or $2,000—before you can make investments.

As a practical matter, it’s a good idea to keep HSA funds needed to pay for two to three years of potential out-of-pocket healthcare expenses in cash or a cash investment, such as a bank deposit account—for instance, a checking or savings account—or a money market fund. Keeping a portion of your funds in a relatively stable, liquid investment can help you avoid being forced to sell riskier investments in a down market to fund an unexpected medical bill.

Also, you should never put off seeing a doctor because you don’t want to spend the funds in your HSA. Potential investment growth may be nice, but you won’t enjoy your earnings much if you’re sick.

What if I change jobs?

Your HSA is portable—if you change jobs, you can take it with you. Also, if you die with money still in your account, you can leave it to your spouse (who can use the money free of estate taxes, and tax-free for non-medical expenses) or other heirs (who would pay taxes on the money they inherit).

What is a qualified medical expense?

Doctor visits, diagnostic tests and laboratory fees, prescription medication, eye and dental exams, psychiatric care and many other types of expenses are considered qualified expenses. See IRS Publication 502 for a complete list of qualified expenses.

What is the “triple tax benefit” of an HSA?

As mentioned above, HSAs offer account holders a triple tax exemption:

  • no federal income taxes on contributions2
  • no federal taxes on investment earnings3
  • no taxes on withdrawals for qualified medical expenses

By comparison, 401(k) retirement plans offer just a double tax benefit—you pay no income taxes on contributions and no tax on investment earnings, but you do pay taxes on distributions in retirement. That triple exemption can make HSAs a uniquely powerful tool for building a nest egg for future health care expenses.

However, note that if you’re under 65 and you spend money from your HSA on non-qualified expenses, you’ll have to pay ordinary income tax on your withdrawals—plus a 20% penalty. After age 65, you’ll just have to pay income taxes.

HSA vs. FSA: What’s the difference?

Both an HSA and a health care flexible spending account (FSA) let you set aside pre-tax dollars to pay for future health care expenses. However, there are some key differences:

  • There are no special eligibility requirements for an FSA.
  • If you don’t use the total amount contributed to an FSA during a calendar year, you may lose it. Although your employer may allow you to carry over $500, or give you a grace period in which to spend unused funds, this isn’t required.
  • You can’t take an FSA with you if you change jobs, and any unused funds may have to be forfeited.

1 Paul Fronstin, “Health Savings Account Balances, Contributions, Distributions, and Other Vital Statistics, 2015: Estimates from the EBRI HSA Database,” Employee Benefit Research Institute, 11/29/2016.
2 HSA contributions are not deductible in several states, including California, Alabama and New Jersey. Check with your tax advisor for specific tax advice.
3 State taxes may vary.

Important Disclosures

Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.

Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

Charles Schwab & Co., Inc. does not sponsor or maintain Heath Saving Accounts.

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What Does Your Fund Yield?

Some investors buy mutual funds and exchange-traded funds (ETFs) to help generate income—which typically comes from either stock dividends or bond interest payments. But how do you measure income or “yield” on these investments?

Most funds display two measures of yield, which can help investors understand a fund’s yield story.

30-day SEC yield

In an effort to standardize yield reporting, the Securities and Exchange Commission (SEC) developed the 30-day yield metric, which must be displayed by any fund that reports its yield. To calculate it, a fund divides its net income per share (dividends plus interest) during the 30-day period by the best price per share on the last day of that same period. This metric doesn’t reflect what a fund distributed to fund shareholders over the prior year, so it’s most helpful when considering funds with monthly income payments, like bond funds.

Distribution yield

Also called the “trailing 12-month yield” or “TTM,” this metric is calculated by dividing a fund’s cumulative distributions over the previous 12 months by its net asset value (NAV) at the end of the period. Because this indicator is backward-looking, it doesn’t reflect recent portfolio adjustments or price changes that could affect the fund’s future yield. As a result the TTM yield is usually considered an estimate.

Both metrics help you measure a fund’s income—but both have limitations. Many investors consider the backward-looking TTM an estimate and the SEC yield more current and a stronger indicator of what to expect in the near future.

Important Disclosures

Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Some specialized exchange-traded funds can be subject to additional market risks. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Charles Schwab Investment Advisory, Inc., is an affiliate of Charles Schwab & Co., Inc.

Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

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ETF vs. Mutual Fund: It Depends on Your Strategy

By MICHAEL IACHINI

NOVEMBER 08, 2016

Investors looking to diversify their stock and bond holdings at relatively low cost often turn to the world of funds. Exchange-traded funds (ETFs), index mutual funds and actively managed mutual funds can provide broad, diversified exposure to an asset class or region or a specific market niche, without having to buy scores of individual securities.

The challenge, however, lies in narrowing down the type of investment best suited to help you achieve your goals. A classic ETF that tracks an index—or a low-cost index mutual fund that does the same? Or perhaps the newer breed of ETF called a fundamentally weighted index ETF that may improve a portfolio’s overall risk-adjusted performance? Or maybe an actively managed mutual fund?

There may not be a single answer: Chances are you may benefit from owning a mix of these funds. For example, if you want the flexibility to trade based on the latest market trends, ETFs make sense—prices change throughout the trading day to reflect current market values. Traditional mutual funds, on the other hand, are priced just once daily, at the close of the trading day.

But if you’re making frequent investments into a college fund or IRA account, a no-load mutual fund can be the way to go. It could help you avoid the trading commission you may be charged when buying and selling ETF shares.

And while ETFs and index funds are smart options for your core portfolio, fundamentally weighted index ETFs and actively managed funds can be valuable complements for certain segments of the market.

Before you decide on the mix that’s right for you, let’s look at the benefits of each type of investment.

ETFs

ETFs have been around for a little more than 20 years and have become extremely popular. As of mid-2016, assets have grown to more than $2.2 trillion, according to the Investment Company Institute (ICI), an industry association.

ETFs trade like stocks and are primarily passive investments that seek to replicate the performance of a particular index. This is the source of one of their key strengths: Passively managed funds tend to have lower costs than actively managed ones. ETFs generally have low annual operating expenses. Some charge as little as 0.03%. That’s a sizable advantage over actively managed funds that charge an average of 0.78%, according to Morningstar. ETFs are also generally more tax efficient because they tend not to distribute a lot of capital gains, as tracking an index usually doesn’t require frequent trading. ETFs may involve trading commissions, but some brokerages offer commission-free ETFs.

Consider investing in an ETF if:

  • You trade actively. Intraday trades, stop orders, limit orders, options and short selling are all possible with ETFs, but not with mutual funds.
  • You want niche exposure. ETFs focused on specific industries or commodities can give you exposure to particular market niches. Niche investing often isn’t possible with index mutual funds, though some actively managed niche funds might be available.
  • You’re tax sensitive. Both ETFs and index mutual funds are more tax efficient than actively managed funds. And, in general, ETFs can be even more tax efficient than index funds.

Mutual funds

Mutual funds are very popular among investors, with U.S. assets totaling nearly $16 trillion as of mid-2016, according to the ICI—in large part because most workplace retirement plans, such as 401(k)s, offer mutual funds and not ETFs. Mutual funds are generally bought directly from investment companies instead of from other investors on an exchange. Unlike ETFs, they don’t have trading commissions, but they do carry an expense ratio and potentially other sales fees (or “loads”).

Index funds

Like ETFs, index mutual funds are considered passive investments because they mirror an index. That means they can also be a low-cost way to invest—many have annual expenses of less than 0.10%.

A few scenarios where an index fund may be a better option than an ETF:

  • You invest on a frequent schedule. If you make monthly or quarterly IRA deposits or use dollar-cost averaging—a strategy in which you manage risk by investing fixed sums of money at regular intervals—a no-load fund can be more cost-effective. Using ETFs could cause you to incur a trading commission every time you make a periodic investment.
  • You can buy an index mutual fund that has lower annual operating expenses. Don’t assume ETFs are always going to be the lowest-cost option. You may be able to find an index fund with lower costs than a comparable ETF, and spare yourself the potential trading costs.
  • The ETF is thinly traded. When you purchase or sell ETF shares, the price you are given may be less than the underlying value of the ETF’s holdings (the net asset value, or NAV). This discrepancy—called the bid/ask spread—is often minuscule, but for ETFs that don’t get a lot of trading activity, the spread can be wide at times. Mutual funds, by contrast, always trade at NAV without any bid-ask spreads.

Actively managed mutual funds

The investments in an actively managed mutual fund are selected and managed by a portfolio manager (or multiple managers), who are often supported by a team of research analysts. Active managers build a portfolio that reflects their strategy and outlook. For example, in rough markets, active managers can play defense by selling more speculative or risky assets and adding more conservative investments. Actively managed funds are typically more expensive than ETFs or index funds—in large part, to compensate management.

Consider investing in an actively managed mutual fund if:

  • You want a fund that potentially could beat the market. The main reason people invest in actively managed funds is the potential that they might beat their benchmarks (though most aren’t able to do so consistently). Additionally, active management with a specific strategy may complement index funds in a portfolio. For example, some managers aim to reduce downside risk and volatility.
  • You are investing in a less efficient part of the market. Some markets are considered to be highly “efficient,” meaning the businesses or markets are so popular and information is so quickly and widely distributed that there isn’t much opportunity for active managers to add value. Large-cap U.S. stocks are an example of an efficient market segment. Emerging market stocks or high-yield bonds are less efficient markets where deep research and a proven strategy can pay off.

    Important Disclosures

Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Past performance is no guarantee of future results.

Some specialized or “niche” exchange-traded funds can be subject to additional market risks. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, shares of ETFs are not individually redeemable directly with the ETF. Shares are bought and sold at market price, which may be higher or lower than the net asset value.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Charles Schwab Investment Advisory, Inc., is an affiliate of Charles Schwab & Co., Inc.

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