Are You an “Affluent Worker?”

Forbes magazine recently had an article about some of our favorite clients. They call them the “High Net Worker.” These are people who are successful mid-level executives in major businesses. They range in age from 40 to the early 60s. They earn from $200,000 per year and often more than $500,000. They work long hours and are good at their jobs.

According to the Forbes article, many have no plans to retire. Our experience is different; retirement is definitely an objective. But many have valuable skills and plan to begin a second career or consult after retiring from their current company.

At this time in their lives they have accumulated a fair amount of wealth, own a nice home in a good neighborhood, and may be getting stock options or deferred bonuses. That means that at this critical time in their lives, when they are focused on career and have little time for anything else, they have not done much in the way of financial planning.

When it comes to investing, most view themselves as conservative. But because of their compensation their investments are actually much riskier than they think. It is not unusual for executives of large corporations to have well over 50% of their net worth tied to their company’s stock. Few people realize the risks they are taking until something bad happens. For example, the industrial giant General Electric’s stock lost over 90% of its value over a nine year period ending in 2009. The stock of financial giant UBS dropped nearly 90% between May 2007 and February 2009. These companies survived. There are many household names, like General Motors and K-Mart whose shareholders lost everything.

The affluent worker’s family usually includes one or more children who are expected to go to college. Many of these families have a 529 college savings plan for their children. Most have IRAs and contribute to their company’s 401k plan, but because many don’t have a financial planner they do not have a well thought out strategy for this part of their portfolio.

At a time when many less affluent families are downsizing, many families in this category are either looking to upgrade their homes, buy a bigger home, or buy a second – vacation – home. They may even help their adult children with down-payments.

If you are an Affluent Worker, give us a call and see what we can do for you. If you already have a financial advisor, it may be time to get a second opinion.

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Financial tips for corporate executives

The December 2014 issue of Financial Planning magazine had an article about “Strategies for Wealthy Execs.” It begins:

Just because your clients are successful executives doesn’t mean they understand their own finances.

And that’s true. Successful executives are good at running businesses or giant corporations. But that does not make them experts in personal finance.

One of the ways executives are compensated is with stock options. But options must be exercised or they will expire. Yet 11% of in-the-money stock options are allowed to expire each year. That’s usually because they don’t pay attention to their stock option statements.

Executives usually end up with concentrated positions in their company’s stock. Prudence requires that everyone, especially including corporate executives, have to be properly diversified. Their shares may be restricted and can only be sold under the SEC’s Rule 144. To prevent charges of insider trading, many executives sell their company stock under Rule 10b5-1.

An additional consideration for executives is charitable giving. Higher income and capital gains tax rates make it beneficial for richer executives to set up donor-advised funds, charitable lead trusts, charitable remainder trusts, or family foundations.

For more information on these strategies, consult a knowledgeable financial planner.

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EXECUTIVE STOCK OPTIONS

One of the biggest problems executives have is a lack of time to set their own houses in order, Even those that have financial expertise don’t tend to take care of their own personal business. . It’s like the classic plumber with a leaky sink. This is especially true with executive stock options.

 A big risk for executives is that they don’t think about how to exercise their options appropriately. Many exercise when they need the cash. Instead, they ought to be considering the stock’s possible growth or the amount of time until expiration.

 Often people doing either one of two things, they either need money for a major purchase so they exercise options, or they are going to wait to the last minute until the options are about to expire. The answer is to get executives to think more strategically about their options—consider tax ramifications with other income and avoid waiting until the last minute to exercise, which could mean being forced to exercise at the current price, however good or bad it is.

Diversification is also obviously a huge problem for corporate executives, whose portfolios are often concentrated with a single stock. But it’s a sensitive topic for them, since selling out of positions is often the prudent course financially, but not always good for public relations.

It’s especially a problem for the top executives at a company. They are often under the microscope if they sell a stock or exercise an option. It’s public knowledge and viewed negatively by the public who wonder if the CEO is selling because there’s a problem.

 Getting the advice of an unbiased financial advisor who integrates stock option exercise with an over-all investment plan is very often the best answer.

What is a covered call?

Definition of ‘Covered Call’

An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This is often employed when an investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium.

For example, let’s say that you own shares of the TSJ Sports Conglomerate and like its long-term prospects as well as its share price but feel in the shorter term the stock will likely trade relatively flat, perhaps within a few dollars of its current price of, say, $25. If you sell a call option on TSJ for $26, you earn the premium from the option sale but cap your upside. One of three scenarios is going to play out:

a) TSJ shares trade flat (below the $26 strike price) – the option will expire worthless and you keep the premium from the option. In this case, by using the buy-write strategy you have successfully outperformed the stock. 

b) TSJ shares fall – the option expires worthless, you keep the premium, and again you outperform the stock. 

c) TSJ shares rise above $26 – the option is exercised, and your upside is capped at $26, plus the option premium. In this case, if the stock price goes higher than $26, plus the premium, your buy-write strategy has underperformed the TSJ shares.

Via Investopedia.

What is an option?

An option is a contract to buy or sell a specific financial product officially known as the option’s underlying instrument or underlying interest. For equity options, the underlying instrument is a stock, exchange-traded fund (ETF), or similar product. The contract itself is very precise. It establishes a specific price, called the strike price, at which the contract may be exercised, or acted on. And it has an expiration date. When an option expires, it no longer has value and no longer exists.

Options come in two varieties, calls and puts, and you can buy or sell either type. You make those choices – whether to buy or sell and whether to choose a call or a put – based on what you want to achieve as an options investor.

Options can be used to generate added income from securities, like stocks that you already own. The most common of these are “covered call options.”   They can also be used as a temporary insurance policy against a decline in the price of a stock or the market as a whole.  The most common of these are known as “protective puts.”

Options are complex instruments that require a sophisticated understanding of securities, and while some options can be used to reduce risk, others can create large amounts of risk.