stock market

Bonds FAQ

▼ What is a Bond?

A bond is simply a certificate which the borrower promises to repay within a certain time period. Bonds FAQ for retirement from Scarsdale accountantFor the privilege of using the money, the government entity, municipality or company will agree to pay a certain amount of interest per year, usually an exact percentage of the amount loaned.

Bondholders do not own any part of the companies they lend to – they do not receive the benefits of dividends or the privilege to vote on company matters as stockholders would, and the success of the investment isn’t related to that company’s record in the market either. A bondholder is entitled to receive the amount that was agreed upon, as well as the principal of the bond.

Corporate bonds are generally issued in the denominations of $1000. This price is referred to as the face value of the bond – this is the amount that is agreed to be paid by the company at the time that it matures. Bond prices can differ from their face values, because the prices of the bonds are correlated to the current market rates. When these rates change, the value of the bond will as well. If one were to sell the bond before the time that it matures, the bond may be worth less than was initially paid. A callable bond is one that the issuer may choose to buy back at full face value before the maturity date.

There are three major features of bonds:

  • Issuing Organization
  • Maturity
  • Quality

Short Term Bonds mature in two years or less and long term bonds mature in ten or more. Intermediate is between two and ten years.

▼ What is Bond Quality?

Bond quality is the rating of the creditworthiness of an issuing organization. There are organizations that specialize in judging bond quality. The higher the rating, the lower the risk of the investment. The rating system uses letters A through D. The only bond considered to be risk free is the U.S. Treasury Bond.

▼ How Does the Bond Rating System Work?

Highest Quality Moody’s Standard & Poor’s
High Quality Aaa AAA
Good Quality Aa AA
Medium Quality Baa BBB
Speculative Elements Ba BB
Speculative B B
More Speculative Caa CCC
Highly Speculative Ca CC
In Default - D
Not Rated N N

▼ How do Interest Rates Affect Bond Prices?

Generally bond prices and interest rates have an inverse relationship – as interest rates drop, bond prices rise and vice versa.

▼ How does Maturity Affect Bond Prices?

Bond prices are heavily influenced by maturity – the longer the maturity, the greater the change in price for a change in interest rates. If interest rates rise, it would make a larger difference in the 20 year bond, as opposed to a 10 year bond. Because of this, bond fund managers will attempt to change the fund’s average maturity to anticipate changes in interest rates.

▼ What is a Bond Call Provision?

A “call” is when the issuer of the bonds has an opportunity to redeem the bonds after a certain specified amount of time has passed. This doesn’t guarantee a continuation of a high yield after the call date – it limits the appreciation of the bonds, and it makes the investment more risky. These call provisions can be complex, so it is best for investors that don’t have strong knowledge to avoid bonds with a call feature.

▼ Should I Buy Bond Funds Directly or go Through a Mutual Fund?

A bond mutual fund has within it multiple bonds, and for that reason it is impossible to lock in the payment rate or the principal, which you would be able to do if you were directly buying a fund.

A bond mutual fund is an investment company which manages a portfolio of individual bonds. The investors buy ownership in the company, and each share represents ownership in all of the company’s holdings. Managers will use these investments to buy and sell bonds that align with the objective of the fund.

Because a bond fund manager has more resources to deal with, they can invest in a vast array of bonds – many more than could any individual investor. There are also certain investments that cost tens of thousands of dollars a share – a bond fund costs far less.

Liquidity plays a major role in bond buying. If you purchase a bond individually and wish to sell it, you must find a buyer for your bond, but if you are invested in a bond fund, that fund has to buy your shares back at any time you wish.

▼ What are the Different Issuing Organizations?

  • Municipal bonds are offered by local governments, states and cities. The interest of these bonds is not subject to federal income tax, and if the bondholder lives in the jurisdiction of the governing authority, the interest is exempt from state and local tax. Because of all of these tax advantages, the interest rates paid on these bonds is usually lower than others.
  • Like municipal bonds, the U.S. government also issues these securities. Since they are issued by the U.S. Government, they are considered to have the best safety of all bonds.
  • Treasury bills can be bought through a broker or directly from the Federal Reserve.

Scarsdale tax preparers at Herman & Company CPA’s are here to help you with all your personal finance needs. Please contact us for all inquiries and to receive your free personal finance consultation!

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Mutual Funds and Stock FAQs

Scarsdale tax preparers at Herman & Company CPA’s have all the answers to your personal finance questions! Mutual funds and stocks faqs from scarsdale cpa paul hermanThe following are our most popular FAQs regarding mutual funds and stocks:

Mutual Funds FAQ

▼ How are mutual funds taxed?

All mutual funds distributions should be reported as income, whether you reinvest or not. Taxable distributions come in two forms, ordinary dividends and capital gains. The distributions of ordinary dividends represent the net earnings of the fund and are paid out periodically to the shareholders. Since these payments are considered to be dividends to you, they must be accounted for accordingly.

Capital Gain Distributions are the net gains of the sales of securities in the fund’s portfolio and will be taxed at a different rate than that of ordinary dividends. Yearly, your mutual form will send you a form, called the 1099-DIV, which will have a detailed breakdown of all of these.

▼ Can I avoid tax by reinvesting mutual fund dividends?

Funds will generally give you the opportunity to automatically reinvest in the fund. This does not prevent you from paying tax on your assets, but this reinvestment will prevent you from paying more “buy” fees to get into the fund, so it is advantageous.

▼ What taxes apply to my return-of-capital distributions?

Mutual funds sometimes will distribute back to shareholders monies that haven’t been attributed to the funds earnings. This is a non-taxable distribution.

Stock FAQ

▼ How does stock trading work?

Stocks are traded in quantities of 100 shares, called round lots. Any quantity of stock under 100 shares will be considered an odd lot.

▼ What is the difference between Preferred and Common Stock?

Most stocks are common stocks. However, there is another type (known as preferred) which gives certain advantages regarding dividends. Generally, preferred stock holders do not have the same voting rights that the holders of common shares do. Common stocks are based on company performance, while preferred stocks will usually have a stated dividend.

▼ How can I invest in foreign stocks?

It is fairly easy to invest in foreign corporations, because these corporations need to register these securities with the SEC. These companies are subjected to the same rules as U.S. companies.

Scarsdale CPA Paul Herman is here to help you with all your personal finance needs. Please contact us for all inquiries and to receive your free personal finance consultation!

Herman and Company CPA’s proudly serves Rye NY, Larchmont NY, Scarsdale NY, Katonah NY, Chappaqua NY, Bronxville NY, Dobbs Ferry NY and beyond.

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Tax Impact of Investment Strategies

Scarsdale tax preparers at Herman & Company CPA’s have all the answers to your personal finance questions! 

Higher 2013 income and capital gains rates and the new 3.8% net investment income tax (3.8% NIIT) may cause high-income investors to reexamine their investment strategy. Investment and taxes that accompany them from Scarsdale accountant

The type of account, taxable or tax deferred (e.g., qualified retirement plan), could affect the investment strategy in a number of ways. Qualified retirement plans, because of their tax-deferred nature, tend to favor the following strategies:

  • More frequent turnover (securities transactions within the portfolio) can be tolerated. Recognition of gains is not an issue in a qualified plan account; therefore, a strategy that allows frequent buying and selling (turnover) of the underlying investments would not have a detrimental effect because of associated tax liabilities.
  • More active management might be appropriate for a qualified plan, whereas passive investments such as index funds, might be held in taxable accounts.
  • Large-cap investments, which are more likely to be dividend-paying companies, may be better suited for qualified plan accounts because the income is not currently taxed.
  • Portfolio rebalancing (e.g., shifting funds from small cap to large cap stocks) is better accomplished using assets in a qualified plan to minimize the recognition of taxable income.

Taxable accounts tend to favor the following strategies:

 

  • Buy-and-hold strategies are appropriate to limit gain recognition and to limit gains to assets that qualify for preferential long-term gain treatment.
  • Passive investments, particularly index funds that have minimal taxable distributions, are more appropriate for taxable accounts.
  • International funds, which frequently have associated foreign tax payments, are more appropriate for taxable accounts so the foreign tax credit can be claimed.
  • Small-cap growth stocks are more appropriate because of the minimal dividend income generally associated with these types of investments.

A topic of continuing discussion among investment professionals is where to hold fixed-income investments and where to hold equity investments. Generally, sufficient fixed-income investments need to be in taxable accounts to provide liquidity. Those investments could be, for example, either tax-free or taxable bonds, depending on the after-tax yield as determined by your marginal tax rate. The need for current income will also affect whether additional fixed-income investments are held outside of qualified plans. Beyond the liquidity amount and provision for current income, the remainder of the fixed-income portfolio can be held in a qualified plan.

Similarly, for stocks, that part of the portfolio that is intended to be long-term, low-turnover, passively managed investments can be held in the taxable accounts. More aggressive parts of the portfolio that call for active management and potentially high turnover can be held in qualified plans.

Scarsdale accountant Paul Herman is here for all your financial needs. Please contact us for all inquiries and to receive your free personal finance consultation!

Herman and Company CPA’s proudly serves Purchase NY, Larchmont NY, White Plains NY, Harrison NY, Pound Ridge NY, Scarsdale NY and beyond.

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Any U.S. tax advice contained in the body of this website is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.