Finance 101: July 2024
In July the financial advisors at Ruedi Wealth Management wrote four more columns for The News-Gazette’s Business Extra section. Make sure to look for them every Saturday in the weekend edition of the paper, but in case you missed any in July, all four are below.
Should You Focus on Dividends?
David Ruedi, CFP®
During our radio show this week, we received a question from a caller about investing entirely in dividend stocks. Buying stocks that pay you a dividend stream is intuitively attractive to people, especially retirees who want to use the dividend stream for spending. However, whether a company pays a dividend shouldn't make a material difference to investors, who end up essentially the same whether or not a dividend is paid. On top of that, there is a significant downside to investing entirely in dividend-paying stocks.
When a company has profits, it has two options. It can retain and reinvest the money in ways it believes will increase the value of the business, or it can pay those profits to investors as a dividend. Though investors may prefer to receive their returns as cash dividends, dividends are not a free lunch. After a dividend is paid, the company's stock price drops by the dividend amount, and investors end up with the same amount of money they had before the dividend was paid.
Dividends are an important component of a diversified stock investor's overall portfolio returns. But investors should not hyper-focus on dividends, and should be more concerned about the total return they receive as investors. Whether that return comes in the form of dividends or an increase in stock prices doesn't really matter. An investor could simply sell a portion of an appreciated portfolio and receive the same amount as the dividend.
There is a significant downside to only owning dividend-paying stocks: the lack of diversification. By limiting their investment options to just companies that pay dividends, investors exclude thousands of companies they could have otherwise invested in. This leads to a more concentrated, riskier investment portfolio.
Also, the return of the stock market has historically been driven by a small percentage of star performers. By excluding so many companies, a portfolio invested solely in dividend-paying stocks will likely miss out on some star performers that drive returns.
While stocks that pay dividends may seem appealing, investors who focus solely on them end up with less diversified portfolios that are riskier and more likely to miss out on stock market returns. It's crucial for investors to prioritize diversification by investing in as many different companies as possible. If you're unsure about how to build a truly diversified investment portfolio to fund your financial goals, seeking the guidance of a financial advisor can provide the reassurance and confidence you need.
David Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.
Required Minimum Distributions
Paul Ruedi
When savers invest in a Traditional IRA, SEP IRA, SIMPLE IRA, 401(k), 403(b), or 457(b) plans they receive a tax break now, but will ultimately need to pay taxes when the funds are withdrawn from those types of accounts. Eventually the government wants their tax revenue, and actually forces people to distribute a portion from these accounts each year, through what are called Required Minimum Distributions or “RMDs” for short.
The first category of people who have to take required minimum distributions are people age 73 or older. If you turn age 73 this year, your first required minimum distribution (for 2024) will need to be taken no later than April of 2025. After that, all RMDs will need to be taken before December 31st of each year.
Savers in workplace retirement plans like 401(k)s will need to follow similar rules, but can delay taking required minimum distributions until the year they retire, if they own less than 5% of their company’ stock. The second category of people who need to take RMDs are those who inherit IRAs – who must do so based on a schedule that would need its own column to be explained thoroughly.
RMDs are calculated based on account balances on December 31st of the previous year. The amount of the account balance that you will need to withdraw is determined by your age in one of three life expectancy tables produced by the IRS. Without diving too deep into the calculations, the older you are, the higher the percentage of the account you will need to withdraw.
If you have more than one retirement account, RMDs will need to be calculated for each account. You can aggregate the amounts and withdraw them from one account, as long you don’t mix different account types together. For example, RMDs from a 403(b), an IRA and Inherited IRA can’t be aggregated because they are three different account types. Many financial firms will calculate the RMDs for you, but you will be responsible for withdrawing them. It is also important to note that Roth accounts are not subject to RMDs.
The penalty for failing to withdraw a Required Minimum Distribution is quite steep: an excise tax of 25% of the amount that was not withdrawn. This amount can be lowered to 10% if the forgotten RMD is corrected quickly. If you need help keeping track of your RMDs to make sure you take them, you may want to work with a retirement planner.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
What is a Stock Split?
Paul R. Ruedi, CFP®
When companies want to attract investors, one of the ways they do so is by issuing stock. The companies do not control the exact price of the stock, and over time if the company does well the stock price could be bid up so high that even a single share of the company can become too expensive for a typical person to purchase. For this reason, companies often will do a “stock split” where they break up existing shares into multiple shares of a lower value. But why do they do this, and is it a good or a bad sign if a company does a stock split?
The primary reason companies split their stock is to make their company more available for investment from typical people. How many shares they choose to split existing shares into is completely up to the company, and they will likely choose a number that puts the new shares at a reasonable price that is not too low or too high. For example, if a company saw its stock price rise to $2,000 per share, they may consider doing a 20-for-1 split to get the share price down to an investor-friendly $100.
There have been a couple of high-profile examples of stock splits recently. After a strong burst of performance, Nvidia’s stock was close to $1,000 per share, making it difficult for typical investors to buy a single share, let alone multiple shares. For this reason, they decided to do a 10-for-1 split. Chipotle Mexican grill recently approved a 50-to-1 split. When high profile companies do stock splits, they attract attention, and often some new enthusiasm for investors. But is a stock split itself a sign of good future performance to come?
There isn’t really any reason to expect company performance to be different after a stock split than before. It is simply a pizza that is cut into smaller slices, but it is the same pizza. Though there may be some short-term price movements as investors respond to the news of the split, over the long-term returns will be driven by company financial performance, which has nothing to do with the stock split.
The good news is, you don’t need to pick stocks and outguess the market to have a good investment experience. Investors would be much better off simply buying and holding a diversified portfolio of stocks. If you need help building a diversified portfolio that is aligned with your most important financial goals, you may want to consider working with a financial advisor.
Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.
Why Does the Stock Market Keep Going Up?
Paul Ruedi
People are intuitively aware that information moves stock prices. When the market goes down in response to a crisis, it is often easy to point to a particular culprit that is spooking investors. But what about when the stock market rises? I was asked this question just recently, and felt myself have to take a pause to really think about it.
The stock market is incredibly good at incorporating all available information and expectations into market prices. When I see a market rising to new highs, I can’t help but think there must be some new information driving the increase in prices. But what exactly that information is can be very tough to pinpoint.
My first guess would be that the stock market continues to rise to all-time highs because company earnings continue to rise to all-time highs. But it could also be new macroeconomic information, that gives investors higher expectations for the growth of the economy and company earnings across the board.
On a smaller scale, it could be information about a specific company coming out with a new product or reporting strong financial performance. Any piece of information that would cause a person to buy or sell moves stock prices.
This is when I really have to throw my hands up and say the stock market is such an efficient information processing machine, I cannot possibly know all the information it is processing. In response to the question “why is the stock market rising” I cannot possibly give a single explanation based on current events.
But what I can explain is that when investors make buying and selling decisions, they “price in” a certain amount of return to compensate them for taking the risk of owning an investment. With investors constantly “pricing in” some sort of anticipated return into stock prices when they buy and sell, you would expect that the stock market would rise over time to provide that return. A stock market inexplicably rising to new highs and beyond is simply a symptom of an efficient stock market providing a return to investors.
Lifetime investors will experience many unpredictable and seemingly unexplainable rallies in the stock market. The key to investing is to ignore current events and stick with your investments so you can reap the long-term returns of the stock market, which often are provided by unexplainable rallies. If you need help with that, you may want to talk to a financial advisor.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.