Stock Investment Strategy – Get More Leverage by Trading Options

Options trading is an advanced stock investment strategy, but if you learn how it works you can substantially increase the amount of leverage that you have with your money. Rich Dad, Poor Dad author Robert Kiyosaki refers to option trading as the investment strategy of the rich.

Why is this?

Option trading simply gives you more leverage.

An option is a contract to buy a stock at a predetermined price. Stocks that have options available will usually have option contracts which expire on a monthly basis. Option contracts always expire on the third Friday of the month in the contract. For example, a July contract expires at the end of the trading day on the third Friday of July.

How does this give you leverage?

Let’s take a theoretical example with a fictional company “Poodlez.” A recent close price for Poodlez (POODZ) was $438.77 per share. If you wanted to buy 100 shares of Poodle, you would need $43,877. If Poodle went to $440.77 per share your total earnings on your $44,077 investment would be a mere $200 or a 0.4% return on investment.

Now let’s look at the Poodlez July option contract for $440 per share. Just like the stock price, option prices go up and down as well. Let’s say the July contract was available for $19.70 per share. If you bought this contract today you would have the right to buy Poodlez at $440 per share, between now and the end of trading day on the third Friday of July.

For the sake of this example let’s say that Poodlez goes to $470 per share. What you could then do is execute the contract with your broker. They’re setup to do this and will buy your Poodlez stock at $440 a share and sell it at the market price of $470 per share. The great thing about this is that you don’t need the $44,000 to buy the stock. The broker buys and sells it at the same time and you collect the profit.

By trading options you gain leverage over a stock that you possibly could not have afforded to buy outright.

There is a downside option trading.

Options are like buying ice cubes.

The moment you buy them, they begin to melt. In the above example if Poodle doesn’t go high enough between now and the third Friday of July to make you a profit, the option contract will simply expire and your investment will disappear.

A good way to think of options, if you don’t like the ice cube analogy, is that you are buying time.

While options can appear confusing they follow the basic rules of buying any stock. You’re buying a contract which gives you leverage over a stock so you should expect most of the fundamentals to be the same. This means that the research you do on a stock and its company before a trade still applies.

Investment houses usually require that you achieve a special trading status before trading options. Check with your broker to learn what those requirements are and study stock option investing as a smart addition to your stock investment strategy.

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Tax-Smart Investing in Retirement

In retirement,managing taxes should be a key element in your personal financial plan. One of the biggest challenges you may face is achieving a higher level of tax savings in your taxable investment accounts, while making the most of your tax-advantaged retirement accounts. Your wealth manager can help you make tax-smart investment decisions in all of your accounts, while helping you plan for your future growth and income needs in retirement.

Here are some tips for managing taxes and keeping more of what your investments earn:

1. Look for high-quality, tax-advantaged investments.

The true return on your portfolio is how much you keep after taxes. For this reason, many investors in the highest income tax brackets are attracted to municipal bonds, which are free from federal income tax. Municipal bonds are also free from state income tax when you buy bonds issued in the state of your primary residence. Focusing on your after-tax performance through tax-advantaged investments like high-quality municipal bonds can help you enhance your long-term returns, while potentially reducing investment risk.

For example, let’s say you are in the 25% tax bracket. A municipal bond paying 5% interest produces the same after-tax return as a corporate bond paying 6.67%. By buying a municipal bond, you have the potential to get the same after-tax return as a corporate bond, but with much lower risk. Studies by leading bond rating agencies show that even average-rated municipal bonds have a much lower risk of default than the highest rated corporate bonds.

2. Choose the right account structure for your needs.

For first-time investors, mutual funds are an easy way to get started. They offer professional management, instant diversification and low investment minimums, making them a popular vehicle for retirement plans and IRAs. However, as your investments grow over time, mutual funds have a tendency to show their limitations. For example, fees and expenses can be high, you can’t control when securities are bought or sold in a fund’s portfolio and fund managers are required to keep cash on hand for redemptions, reducing a fund’s investable assets. As a result, mutual funds often aren’t very tax-efficient for investors in higher income tax brackets.

If you have investable assets of $500,000 or more, you may want to consider a separately managed account. As the name implies, with a separately managed account, your money is kept separate from other investors. Investment decisions can be tailored to your specific needs, including your tax and estate planning needs. Your investment manager can employ sophisticated financial planning techniques, such as tax loss harvesting, to help you optimize tax breaks and enhance your long-term performance. And finally, with a separately managed account, your money can remain fully invested at all times.

3. Take advantage of lower tax rates on dividends and long-term capital gains.

Account earnings generated from stock dividends and long-term capital gains are currently taxed at a maximum rate of 15%. In contrast, earnings generated from short-term capital gains may be taxed at your ordinary income tax rate, which could be as high as 25% or more. For high net worth investors, this tax rule tends to make separate accounts much more tax efficient than mutual funds. In a separately managed account, your portfolio manager will decide when and how to sell securities based on your specific tax needs, as well as performance considerations.

4. Take a team approach to managing your wealth.

Successful wealth management integrates a broad range of disciplines, including tax planning, estate planning, insurance coverage, mortgage loans and daily banking solutions. The most successful investors today, such as Warren Buffett, have a large team of professionals working in concert to achieve their long-term goals. Fortunately, you don’t have to be Warren Buffett to create your own team of professionals. An independent wealth manager can serve as a central point of contact among your trusted advisors, such as your attorney, CPA, insurance agent and personal banker. By serving as the “quarterback” for your financial plan, your personal wealth manager can help you stay in the game longer and keep more of what you earn by implementing more tax-efficient investment strategies.

5. Review the tax efficiency of your portfolio once a year.

Tax laws are constantly evolving. For investors who are approaching or currently enjoying retirement, it’s especially important to keep up with recent developments in areas such as the alternative minimum tax and the estate tax. Talk to your wealth manager and tax professional about your current tax liabilities, while looking for opportunities to reduce taxes. It’s a good idea to review the tax efficiency of your portfolio once a year from a variety of angles, including your estate plan, your retirement plan, your current tax bill and your future financial goals.

Taking a few easy steps can often help you increase the tax efficiency of your overall portfolio. Remember, you don’t have to tackle your financial plan alone. Asking for guidance and advice along the way can help you spend less time on managing your finances and more time on the things that are most important to you.

Tax Smart Investing Strategy

Tax smart investing strategy means utilizing tax laws with stocks to obtain optimum
investment results.

Long term investors face a dilemma that short term investors do not in that long term
capital losses do not receive as favorable treatment as do short term losses.

All too often, investors buy stocks, put them away, and forget about them…until it’s too
late!

When they see their stocks down in value, they tell themselves, “Don’t worry, it’ll come
back.” My favorite definition of a long term investment is a short term trade that didn’t
work out!

The hallmark of the unsuccessful investor is the inability to take a loss. To them, taking
a loss is the same as admitting to being wrong…’losing face’. They’d rather lose money!
Unless they get by that barrier, they have no hope of being successful.

And the truth is, by using this tax smart investing strategy, they can enjoy the advantage
of receiving both short term capital loss tax treatment for their losses and continue to
hold their stocks for long term appreciation.

The maneuver you’re about to learn, tax smart investing strategy, is similar in theory to
how retail establishments treat their merchandise inventory at year end. It’s called an
inventory write-down.

Retailers, being a business, frequently adjust downward the value of unsold, or slow moving,
merchandise and charge off the write-down as a business expense.

The net result is lower taxes owed while still holding the inventory for future sale.

Investors, not being a business, can’t merely write-down the value of their stocks. They
actually have to sell to establish a loss. Then buy them back.

However, there is a tax rule called a ‘wash sale’ which comes into play whenever an
investor takes a loss and wants to buy back the stock to establish a lower basis.

The wash sale rule states that, in order to take a tax loss, replacement shares cannot be
purchased either 30 days before or 30 days after the date of the loss transaction.

If replacement shares are purchased within those 30 days the loss cannot be taken on that
years’ tax return but instead must be added to the cost of the replacement shares which
steps up the basis which defeats the purpose of the entire transaction.

This leaves the investor with a dilemma. What if, while the investor is sitting on the
sidelines sweating out the 30 day waiting period, the shares start to rise?

If you thought of buying a call option to keep the stock from getting away from you, that
won’t work either.

If you thought of buying shares of a company in the same industry, that is allowed. But
what if you aren’t interested in the other company? That would mean extra trades and
commissions. That’s not utilizing tax smart investing strategy to its best advantage.

The best solution, in my opinion, is to first buy the replacement shares at least 31 days
prior to the original shares going long term. Then, 31 days later, sell the original shares
establishing a short term capital loss for the current year and leaving the investor with
the same number of shares as before but with a lower cost basis.

Note that, although the investor is holding twice as much stock for 30 days, this is not
the same as averaging down where the investor intends to hold on to both positions.

This tax smart investing strategy not only allows investors to hold shares in favored
companies but also to maximize the significant tax advantages present.