SEP IRA Rules and Contributions: What you need to know

What is a SEP IRA?

A SEP IRA is short for a Simplified Employee Pension Individual Retirement Account. It is basically an IRA account which employers have the ability to contribute to. Employers benefit from having an SEP IRA because it is easier to set up than a 401(k) and also costs less to administer.

Who is eligible?

All employees are eligible are long as the meet these three requirements:

  1. At least 21 years old
  2. They have worked for the employer at least three of the past five years
  3. They have received compensation of $500 or more for the tax year

As a result, any employee who meets these three requirements must participate in an SEP, even if they are only part-time, seasonal, were laid off, fired, etc., during the year.

Why would you want to choose a SEP IRA?

SEP IRAs are must easier to set up than a 401(k). It is basically the same as setting up a regular old investment account. Start up and maintenance costs are also very low when compared to 401(k) plans. Contributions are discretionary, so the employer can decide if they want to contribute to the retirement plan that year. SEP contributions and Traditional IRA contributions are completely separate. That means the employer and employee can contribute to the same IRA account, and the limits applied to the two accounts do not affect one another. A SEP is a very attractive option to a small business owner that wants to provide a retirement account to employees at a low cost.

What are the contribution limits to a SEP IRA?

Employers are allowed to contribute the lesser of 25% of an employee’s compensation for the year or up to $52,000 for the 2014 taxable year. The limit that employers can contribute for themselves is a little more complicated, but it is basically 18.6% of net profit.

What other rules are applicable to a SEP IRA?

The employer must provide the same amount to every employee. For example, if the owner contributes 10% to Sally’s retirement account, they must contribute 10% to every single eligible employee’s retirement account. The last day you can make contributions to a SEP is either April 15th or the extension due date. A SEP IRA is very similar to a Traditional IRA in that:

  1. You can begin to make withdrawals at 59 ½ years old
  2. You must take required minimum distributions at 70 ½ years old.
  3. Funds are invested in the same way as a traditional IRA

Final Word

SEP IRAs are great options for small business owners who are looking to create an employer contributed retirement account for either themselves or their employees.

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Day Trading = Financial Suicide?

One method of making money in the stock market is day trading. Day trading rose in popularity in the late 1990s when investors could double or even triple their gains within a matter of hours. With returns like this, it was hard to resist the temptation of becoming a day trader yourself.

In this day and age, you do not get the returns that you could have gotten in the 90s, but the temptation to day trade is still there. Markets have been booming ever since the Great Recession. Since the market bottomed out in 2009, the S&P 500 has returned 172% and the Dow Jones Industrial Average has returned 131%. Due to the increase in markets at such a rapid rate, investors today have been able to day trade and achieve solid results.

As a matter of fact, I just recently read an article on a 16 year old who began day trading and had thus far achieved decent results. In 2012 her stocks returned over 34% vs the S&P 500 which only returned 12%. While it is not impossible to achieve those results, it is hard to maintain such rapid rate over a long sustainable time period.

Jason Zweig discussed the topic of day trading in his commentary to The Intelligent Investor. He discussed that while some trades make money and some trades lose money, your broker will always make money. In addition, he goes into detail about the true cost of trading over such short time periods.

The Costs of Day Trading

  1. Your own eagerness to buy and sell stock will lower your return. Zweig call this cost “market impact.” While this cost doesn’t show up on any of your statements, it can cause you great losses. Let’s say you are eager to buy a stock, and you end up paying an extra 10 cents per share to get it. If you buy 500 shares of that stock, you just cost yourself $50. On the flipside, if you sell the stock too soon, you can also lose out on significant gains.
  2. Brokerage fees eat into gains. Many brokers will charge you anywhere from $4 to $9 to make a trade, no matter how many stocks you purchase. Assuming you pay $7 per trade, you will pay a total of $14 to buy and subsequently sell a stock. If you purchase $1000 worth of stock, this will eat into 1.4% of any gains you make.
  3. Taxes, taxes, taxes. When you buy and sell your stocks frequently, taxes can eat into your gains significantly. Any gains you make on stocks you sold within a year are taxed at your ordinary income rate, which could be up to 39.6%. Compare that to the maximum rate of 20% you pay for gains for stocks held on to for over a year, and you could be paying significantly more in taxes.

Research Study

Zweig also cites a study done by professors of Finance Brad Barber and Terrance Oden at the University of California. In this study, the professors studied 66,465 households with accounts at large discount brokers from 1991 to 1996. What they found was those that traded the most (portfolio turnover of 21.5% a month) had an average return of 11.4% vs a return of 18.7% for those who had the lowest turnover (portfolio turnover of 0.19% a month). In addition, those who had the lowest turnover actually had a slightly better return than the market average. The chart below shows a visual representation of this study.

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Questions/Comments?

Have you ever day traded? What are your experience with day trading? Please leave a comment below. I’m interested to hear your opinion. 

What grocery shopping can teach you about picking stocks

Imagine your average trip to the grocery store. You go through the ads and various coupons and figure out what items are on sale. If there are products that you have a preference for, you will go ahead and buy them for a bargain. It makes sense. When you like a product and see it selling at a lower price than usual, you will buy it. That begs this question: why should the approach the stock market any different?

When buying stocks, the first thing you want to do is identify companies that you like. Good companies can be defined in any ways. This depends on personal preference, but for me, a good company is one with good management in place. In addition, it is a company that has had steady growth over the years. Companies that have historically paid dividends are also another plus in my book. Finally, invest in what you know. Peter Lynch advises this in his book “One Up on Wall Street” which provides great insight on how he made 29% a year over the span of 20 years.

I suggest that you make a list of good companies that you like based on the criteria above. It doesn’t have to be a long list, be it should be long enough so that it gives you options in investing. Track of these companies over time. When these companies become “cheap” buy as much stock as you are comfortable buying. Cheap can be defined in any number of ways. I personally view cheap companies as one that have a low PE ratio. A low PE ratio has historically been one that is under 15. I use this as a base for deciding the value of a company. I also compare their PE ratio to the historical PE ratio of the company as well as the average PE ratio for other companies in their industry. You can also use price-to-book ratio and price-to-sales ratio when valuing a company.

When you combine you knowledge of great companies with the valuation metrics, you will greatly increase your chance of succeeding in the stock market. As Warren Buffett once said: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” 

Lesson from a young Warren Buffett

At the tender age of 11, Warren Buffet invested in his first ever stock. Buffett bought six shares of Cities Service preferred stock for $38 per share. The stock fell to $27 a share shortly thereafter. The shares eventually bounced back to $40 a share. Buffett sold the stock at that point for a nice $3 per share profit. Not too shabby…right?

Not long after Buffet sold his shares in Cities Service, their stock price jumped to $200 per share! Buffet could have made 426% on his initial investment if he had stuck with it. This experience taught Buffett a valuable lesson which he would carry with him the rest of his life.

What lesson is to be learned here? Teach your children about personal finance and investing at a young age. What they learn about money when they are young will help set them up for great success for the future. It will be the best investment you ever make.

Build Your Own Million Dollar Portfolio

Imagine if I were to give you one million dollars to invest with right now. What would you invest in? As a beginning investor, it’s easy to believe that you have the ability to find the right stocks at the right price. One problem that people incur during their early investing lives is that they believe that they can beat the stock market. By utilizing stock market simulation games, you can track your investment performance over time before you decide to jump into the stock market.

Young investors can benefit the most from utilizing stock market simulation tools. One particular website that I used when I was still learning about stocks was smartstocks.com. They give you one million dollars in imaginary money to invest in whatever stock you want. This gives you the opportunity to learn about investing.

It is important to utilize stock market simulators like smartstocks.com because they allow you to track your true performance over time. Many people believe that they knew the winners in the stock market before they made it big. They fail to remember the companies that failed that they also believed would be big winners. By utilizing a simulator, you can buy and sell stocks virtually and keep track of your performance over time. This will allow you to learn how good you truly are at picking winners and losers.

Keep in mind that if you do well in the short term, it does not always mean you will perform well over the long run. If you only utilize a stock market simulator for a few weeks and do well, you will not get the full effect than if you were to do it over a longer period of time.

Personally, I utilized a smartstocks for a few years off and on while I was in college. Utilizing a simulator allowed me to get my feet wet in the stock market. I learned that predicting the markets are not quite as easy as I imagined. Despite picking many winners through the simulator, I picked a few losers as well. These losers essentially wiped out any gains (and then some) I made from my winners, making me realize how important it is to diversify.

If you want to begin learn about the stock market, but don’t want to risk any of your own money quite yet, find a stock market simulator game online and try your hand at it for at least three months. Track how you perform compared to the market as a whole and build confidence in your investing abilities. If you still enjoy picking individual stocks by the end those three months, then you are well on your way to picking your own stocks for your portfolio. Sign up today at smartstocks.com and get started today!

Note: I am not affiliated with smartstocks.com in any way

Invest Young: A Few Simple Tips Will Make You a Millionaire

In my last article I made the argument that fear was the leading cause of young people investing. I illustrated how not doing anything with you extra cash will make you lose money. In this article I will go more into detail about how implementing an investing plan at a young age will make a giant impact on your life. I will also present a few simple steps that will help you become a millionaire.

Long-Term Impact of Investing When You are Young

Compounding and time value of money is a powerful thing. In a prior article, I showed how small changes coupled with time value of money can add up to giant sums of money. Time value of money also plays a huge role for your retirement and is the reason you need to start saving today. To illustrate my point I will discuss two different people. These people are Sally the Saver and Sam the Spender.

Sam and Sally are very similar. They had the same major in college, graduated at the age of 22, and got a job at the same time. Both make pretty good money working. They don’t have too much student debt.

Sam the Spender likes to spend money. As soon as he makes money he spends it. He continues this way until he hits his 30s. It is then that he realizes he has nothing put away, and he needs to start taking his investments seriously. Sam saves $500 dollars a month from his paycheck. He puts this into a stock market fund that returns an average of 8% a year. He continues on this path for 35 years, until the age of 65 when he retires. By the time Sam is 65 he will have put away $1,033,900! He is a millionaire!

Sally the Saver likes to save money. As soon as she makes money she saves it. She “pays herself first” if you will. At the age of 22, Sally begins to save $500 a month. She also puts this into a stock market fund that returns an average of 8% a year. She continues on this path for 43 years, until the age of 65 when she retires. By the time Sally is 65 she will have put away $1,977,500! This is almost twice as much as Sam and all she did was start saving eight years sooner!

Investing at a young age is the best decision you could ever make. When you put away cash when you are young, you open yourself up to so many more options as you age. You could continue to save up as you work. Or, you could have enough money to give you financial independence which would allow for you to start your own business. You won’t be on the constant treadmill where you work for a paycheck only for it to be gone two weeks later. The key here is financial independence. Being free from the shackles of work will make you happy. It will enable you to take chances in life that you wouldn’t otherwise take.

How to Become a Millionaire?

Becoming a millionaire isn’t as difficult as it may seem as displayed above by Sally and Sam. To become a millionaire you must be willing to save money. It doesn’t necessarily have to be a lot, but it has to be enough that will accumulate over time.

Don’t spend money on things you don’t need. You need to create a budget for yourself and stick to it. How can you force yourself to stick to a budget? Pay your investment plan first. Whether it is a 401(k) or just a plain old brokerage account, force yourself to make a payment to that investment plan first. Whatever money you have left over will be used for all of your other expenses you budgeted out.

Big financial decisions can lead to big savings

When you are buying a home or a new car, keep the long-term financial impact in mind. Make sure you can get the best deal you can on a new home or car. Don’t buy something that is unnecessarily big. Live below your means and you will achieve financial freedom. It’s these big decisions that either make or break people financially.

Don’t make dumb investments

If you are new to investing, don’t try your hand at picking stocks. Chances are that you are not going to beat the market. It is hard enough for people who do it for a living to beat the market. My recommendation is to put your money into a total stock market exchange traded fund (ETF). One good ETF for this situation is the Vanguard Total Stock Market ETF (VTI). This ETF tracks the market as a whole, has extremely low expenses, and will help reduce your risk. As you begin to learn more and more about investing, then you can start picking individual stocks.

A call to young people.

Start investing as soon as you can. If you have money leftover at the end of the month, open a brokerage account and begin putting it into a total stock market ETF. The longer you wait, the more you have to lose.

Booming Markets and Bonds

As the markets climbed to record highs today, I enjoyed pretty nice gains on my portfolio as we head into the holidays. Since I began investing in August I have enjoyed some pretty significant growth in a short period of time. Overall my portfolio is up about 7% as I continue to put a portion of my paycheck each month into the market. My biggest gains have been on Apple (AAPL) and 3D Systems (DDD), which have been up 19.09% and 18.67% respectively. In addition I have made 6.7% on my Ebay (EBAY) position in only 10 days and another 9% on Silicom (SILC) in only 6 days! Everything is going great!

But wait a second, didn’t mom always tell you if something sounds too good to be true than it probably is? As the stock markets soar higher and higher, there is speculation that we are due for a downturn eventually. Whether that is in a few days or months or a year from now, nobody knows. Sure experts and analysts can pretend to predict when the economy is going to boom or bust, but ultimately no one ever really knows how the market is going to behave.

Due to this uncertainty, I am going to diversify my portfolio more over the next few weeks in the event the market does eventually drop. Following Benjamin Grahams recommendations for investors, I will invest at least 25% of my portfolio in bonds. By investing in bonds I can help hedge some of the risk that comes with the stock market. If the markets drop, I won’t experience a big of losses as a result. If the markets continue to expand, I will miss out on some of those huge gains, but a least I can sleep a little easier at night knowing that not all of my investments rely on the stock market.

My plan is to research some Bond ETFs and figure out which ones I think are best for me. Many of the ETFs have dropped quite a bit in the past year, and I believe I can get some real bargains by investing now. I will chronicle my research on Bond ETFs and post about them here and hopefully I can help you diversify your portfolio as well!

Investing in Fortune’s “Best Companies to Work For”

Recently I read a post on http://creativelypaid.wordpress.com and the author mentioned something that peaked my interest. The author wrote a post about how investing in a company is similar to voting with your stock and how you should invest in companies that make a positive impact on the world. There have been sources that indicate that the World’s Most Ethical Companies from 2009 have grown at a rate nearly double that of the S&P 500.

Being the curious person that I am, I decided to dig a little deeper and do some research myself. My first task was to identify companies that treat their employees great. Companies that treat their employees right tend to have happier employees, and this rubs off on their customers. One such company that I can think of off the top of my head is Starbucks. Starbucks gives employees great benefits, such as stock options, a pound of any Starbucks coffee a week (or other goodies), health insurance, and 401(k) plans for their employees. While these perks do cost Starbucks a pretty penny, the benefits are completely worth it. Studies have shown that Starbucks employees are actually friendlier than local coffee shop employees as illustrated below:

“It was clear that the baristas were on a first-name basis with many of the customers, were familiar with their regular orders, and knew significant personal information about them,” the study says.

Read more: http://www.businessinsider.com/starbucks-friendlier-than-local-shops-2013-8#ixzz2nJyGUcr7

With that being said, I got a listing of Fotune’s 500 Best Companies to Work For from 2005 and took the publicly traded companies from that list and looked at their total returns since December 31, 2005 through December 12, 2013. One thing I will note is that some of the companies that were on the list that were public are no longer public (mainly because they were purchased by other companies). Without further ado, here is a chart I compiled of returns:

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Company % Return
Xilinx 67.73
JM Smucker 128.94
Starbucks 150.25
Adobe Systems 45.49
CDW 22.75
Qualcomm 63.84
S&P 500 39.95
Dow Jones Industrial Average 44.61
Average return of Best Companies to Work For 79.83

As you can see, companies with happier employees tend to have better returns than those of the market by almost double! Think about next time you make your investment decisions!

Are You an Investor or Speculator?

If you buy and sell stocks, you may automatically classify yourself as an investor. But it is very important to differentiate between someone who invests in stocks versus someone who speculates in stocks. This distinction is discussed in Benjamin Graham’s book “The Intelligent Investor.”

An investor in stocks is someone whom thoroughly analyzes and understands a business before they choose to invest in a company’s stock. By analyzing a company’s stock, you help protect your principal against serious losses that could arise in bear markets. In addition, investors aspire for “adequate” returns on their investments. Note that investors do not aspire for extraordinary performance, but rather “any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence” according to Graham.

Graham also differentiates investors from speculators by their use of stock market prices. He identifies that investors base the market by established standards of values whereas speculators base their standards of value off the market price. Graham is basically saying that investors do not use the market price of a stock to influence their decisions whether to buy or sell. Investors first look at the company’s underlying business and decide what price they would be willing to buy the stock for. If the company has a market price above this value, investors do not buy into the stock. Speculators, on the other hand, look to the market price of a stock when deciding whether or not they should buy or sell. Simply put, Graham suggests you invest in a stock you would be comfortable owning even if you didn’t have information about its daily market value.

Speculation is tempting. Believe me, I have been guilty of speculating in the past because I believed that I could do well and make money quickly from the stock market. The truth is, I was only making money for my stock broker. Every time I bought or sold a stock I had to pay a transaction fee to my broker. This is why Wall Street hypes up speculators. At the end of the day, they are the ones making away with all of your money. This is another reason why you must shift your thinking from a speculator to that of an investor.

In summary, if you want to experience steady growth of your portfolio and don’t want to face a ton of risks, you must change your mind set to that of an investor from that of a speculator. Remember these three principals of investors: 1) Thoroughly analyze a company and the soundness of their business. 2) Protect yourself against losses. Do this by determining what market price you would buy for a stock, then decide if it is a buy (not the other way around). 3) Aspire for adequate performance. You’re not going to get rich quick by investing.