financial

Do Reverse Mortgage Loans Require Mortgage Insurance?

January 12, 2025 Ogghy Filed Under: BUSINESS, Investopedia

It depends on the type of loan that you get

Fact checked by Suzanne Kvilhaug
Reviewed by Doretha Clemon

A reverse mortgage could provide much-needed cash to cover costs such as basic living expenses, medical care, and home repairs. Still, numerous fees can make reverse mortgages prohibitively expensive for some homeowners.

One particularly onerous expense is the lender-required mortgage insurance premium (MIP). If you have a home equity conversion mortgage (HECM)—which is backed by the federal government—then you’ll pay an initial MIP at closing plus annual MIPs for the length of the loan.

Key Takeaways

Reverse mortgages can provide much-needed funds during retirement, but high costs make these loans a poor choice for many homeowners.
The most common reverse mortgage is the home equity conversion mortgage (HECM), insured by the Federal Housing Administration (FHA) and offered by FHA-approved lenders.
HECM borrowers owe a 2% initial mortgage insurance premium (MIP) at closing plus an annual MIP equal to 0.5% of the outstanding mortgage balance.
HECM MIPs are expensive, but they provide borrowers with several important protections.
As reverse mortgages are open-ended, the interest and fees can accrue long before you or your estate repays the loan.

What Is a Reverse Mortgage?

A reverse mortgage lets you convert some of your home equity into cash without selling the home. You don’t make monthly payments to a lender; instead, the lender gives you an advance on part of your home equity as a lump sum, a monthly amount, or a line of credit. Interest and fees accrue over the life of the loan, which becomes due when you sell the home, move out, or die.

To qualify for a reverse mortgage, you must be age 62 or older, have substantial equity in the home, and live in the home as your principal residence. If you get an HECM, the most common type of reverse mortgage, you must also attend a counseling session approved by the U.S. Department of Housing and Urban Development (HUD). Once approved, you can use the cash to pay for things like basic living expenses, healthcare costs, home renovations, or even a new house if you have an HECM for Purchase loan.

What Is Mortgage Insurance?

With traditional mortgages (sometimes called forward mortgages), it is the lender—not you—who is protected by mortgage insurance when you default on your mortgage payments, die, or are otherwise unable to meet the mortgage terms.

Private mortgage insurance (PMI) and MIPs are not the same thing. PMI is generally required on a traditional mortgage if your down payment is less than 20% of the home’s purchase price and you finance with a conventional mortgage loan. However, if the Federal Housing Administration (FHA) backs your mortgage, you’re required to pay MIPs. These include an up-front MIP equal to 1.75% of the base loan amount, plus annual MIPs for at least 11 years, regardless of the size of your down payment.

Important

MIPs apply to all HECM reverse mortgages. Most proprietary reverse mortgages don’t require up-front or annual MIPs but often have higher interest rates.

Mortgage Insurance for Reverse Mortgages

Mortgage insurance works a bit differently for reverse mortgages. Instead of just protecting the lender, MIPs provide several important assurances to reverse mortgage borrowers.

A borrower receives the loan payments as set out by the terms of the loan, even if the lender goes out of business.
You or your estate can’t owe more than the home’s value when the loan becomes due and the home is sold.
If you or your heirs want to pay off the loan and keep the home (instead of selling it), you won’t owe more than the home’s appraised value.

Warning

Mortgage lending discrimination is illegal. You can’t be discriminated against based on race, color, national origin, religion, sex (including gender identity and sexual orientation), familial status, or disability. If you think you have experienced such discrimination, file a complaint with the Consumer Financial Protection Bureau (CFPB) or with HUD.

At closing, you pay an up-front 2% MIP based on the FHA’s maximum lending limit of $1,149,825 or the home’s appraised value, whichever is less. For example, if your home is valued at $250,000, the up-front MIP would be $5,000 ($250,000 × 0.02). You can pay it in cash or use the money from your loan.

After that, your lender charges annual MIPs equal to 0.5% of the loan’s outstanding balance. These premiums generally accrue over time, and you (or your estate) pay the amount once the loan is due.

How Much Does Mortgage Insurance Cost?

If you have the most common type of reverse mortgage, a home equity conversion mortgage (HECM), your lender will charge you a 2% up-front mortgage insurance premium (MIP) based on your home’s appraised value, up to the $1,149,825 maximum lending limit set by the Federal Housing Administration (FHA). After that, an annual MIP kicks in, equal to 0.5% of your loan’s outstanding balance.

Can I Avoid Mortgage Insurance on a Reverse Mortgage?

You can avoid paying MIPs by getting a proprietary reverse mortgage, but the loan may cost more in the long run due to higher interest rates. On the other hand, you will owe up-front and annual MIPs if you have an HECM.

However, you get several important protections in exchange for paying those premiums. Specifically, the loan proceeds are guaranteed (even if the lender goes out of business), and you or your estate will not owe more than the value of the home once the loan becomes due and the house is sold.

Do Reverse Mortgages Have Closing Costs?

Like traditional mortgages, reverse mortgages involve closing costs. For example, if you get an HECM loan, you’ll generally pay the following expenses:

MIPs—a 2% initial MIP due at closing, plus an annual MIP that’s 0.5% of the outstanding mortgage balance
Third-party charges—including for the appraisal, title search, title insurance, surveys, inspections, recording fees, mortgage taxes, and credit checks
Origination fee—the greater of $2,500 or 2% of the first $200,000 of your home’s value plus 1% of anything over $200,000, capped at $6,000
Servicing fee—up to $30 per month with an annually adjusting or fixed interest rate loan, and up to $35 per month if the interest rate adjusts monthly
Interest—usually variable interest rates, which can increase over time

The Bottom Line

HECMs require you to pay up-front and annual MIPs. However, reverse mortgage insurance benefits the borrower, unlike traditional private mortgage insurance, which protects the lender.

If you decide a reverse mortgage is right for you, you could save money by shopping around and comparing loan costs. While lenders charge the same MIPs, the other loan costs—including origination fees, closing costs, servicing fees, and interest rates—vary by lender.

A Checklist for Medical Technology Investments

January 12, 2025 Ogghy Filed Under: BUSINESS, Investopedia

Reviewed by Thomas Brock

What Is the Medical Technology Industry?

The medical technology industry, commonly known as medtech, is made up of companies that develop, design, produce, and sell medical technologies, equipment, and health care information systems.

Its impact on the care and well-being of patients and the efficiency and effectiveness of providers has been, and continues to be, substantial.

Medtech offers investors substantial growth potential, strong returns on capital, government-enforced restrictions on competition, and products that can be essential to maintaining people’s quality of life.

At the same time, it has its challenges. Companies face major upfront development expenses, a high failure rate, a constant stream of would-be rivals and a federal regulatory body that enforces strict, and sometimes arbitrary, standards.

As of 2024, medtech was a $587 billion industry. Compound annual growth of revenue from late 2019 to the end of 2023 was 8.3%.

As with any investment, you should be sure to conduct your due diligence before investing. With that, here is a checklist of five pointers that may help your investment decision-making in the dynamic medical technology industry.

Key Takeaways

The medtech industry offers impressive profit potential but faces major, ongoing challenges.
Industry advantages include strong returns on capital, government-enforced restrictions on competition, and the public’s desire for products that can maintain or enhance quality of life.
As of 2024, medtech was a $587 billion industry.
Research and development, new products in the pipeline, and FDA approval are keys to a medical technology company’s success.
Generally, medtech stocks have outperformed the S&P 500 over time.

1. Look for an Innovator, Not a Follower

When considering a potential medical technology investment, it’s generally better to look for a company dedicated to new technologies and innovation.

Take Note of R&D and New Products

New products typically offer better performance (better outcomes for the patient, easier for the doctor to use and so on). Such improvements typically command a premium price and drive market-share shifts to the new product.

The best way to assess whether a given company is focused on innovation is to look at the company’s product pipeline and research and development (R&D) efforts.

Small companies are generally upfront about their projects currently underway (often it’s the only thing management has to talk about with investors).

However, large companies don’t often disclose much information of this type. In those cases, try this rule of thumb: If a company is spending less than 10% of its revenue on R&D, be suspicious.

2. Don’t Sweat the Details

Expert medical knowledge isn’t required for medtech investing. In fact, even the smartest medical minds have a mixed record when it comes to seeing the future of medical technologies.

So investors should never feel intimidated by a medical expert’s potentially complicated or obscure take on a given stock or therapy.

It is certainly worthwhile to read up on the conditions that a company’s products are intended to treat. Go online to find a wealth of information on almost every medical condition that constitutes a viable market opportunity.

From peer-reviewed journal papers to individual patient blogs, any investor can get a sense of the driving factors in the treatment of any medical condition.

Note

Ongoing medtech innovation has improved health care with technologies and products that have resulted in better informed patients, earlier and more accurate diagnoses, greater choices of treatments, less invasive surgeries, and cost reductions.

3. Understand the Life Cycle

There are several key points in a medtech company’s life cycle, and each stage has certain ramifications for an investor.

1. Startup companies often face years of losses and cash outflows as management tries to lead new products through clinical trials and regulators, and onto the market.

The amount of cash on the balance sheet, the efficacy of the product, and the candor of the management team are crucial. Assuming that the clinical data is positive, the company will eventually face the FDA and the thumbs-up/thumbs-down decision that follows.

2. If a company secures FDA approval, the next stage is the marketing launch and sales ramp. At this stage, it is critical for the company to have a solid marketing team in place. Look for strong initial sales growth, but don’t expect profits just yet.

3. Once a company achieves profitability, the game changes. Simply put, very few medtech companies ever mature into large, independent players.

For the most part, companies are acquired or turn to buying companies themselves. That means investors should keep an eye on deals and take note of companies that overpay in their attempts to grow through acquisitions.

4. For those companies that do establish themselves as large, independent players, this stage is a continuous process of managing the existing business, introducing new products, and shepherding the growth of shareholder value.

Important

In 2024, greater medtech industry growth was seen as highly possible, especially in certain niches, such as cardiovascular therapeutics.

4. Watch for Government Actions

If there is a risk factor to medical technology that’s not common to other companies, it is the significant potential impact of the U.S. government on businesses in this industry.

FDA Approval

The Food and Drug Administration (FDA) effectively determines whether a company can do business in the U.S. Before a device can be sold legally, the FDA has to approve its sale.

While not all product approvals require expensive clinical trials, most of the products that drive significant revenue growth for the industry do require substantial data on efficacy and safety before the FDA permits their sale.

FDA Monitoring

In addition, the FDA requires ongoing monitoring and reporting and can order devices off the market if hidden dangers reveal themselves in subsequent years.

The FDA has a mandate to protect the safety of the general public, but the proper tradeoff between the risk and reward of a new device or therapy is subjective.

Complicating matters, the attitude of the FDA regarding that tradeoff seems to ebb and flow over time.

Investors can minimize the risks to their portfolio by choosing companies that either have a suite of approved products already on the market or that have very strong data for products under development.

Influencing Payment

The government also plays a role in determining if medical technology companies get paid for their devices and therapies.

Medicare is a major factor when it comes to how Americans pay for their health care. If the government pulls back on how much it’s willing to pay for various therapies or devices, that can affect the sector.

In fact, private insurers will often take a cue from Medicare when they form their own coverage policies.

5. Accept a Different Valuation Standard

The valuation standards in medical technology are a little different from those in other industries. If you look at many of the bellwether medical technology stocks, such as Alcon (ACL), Stryker (SYK), Boston Scientific (BSX) and Medtronic (MDT), you will see historical ratios above (and sometimes well above) the prevailing S&P 500 Index levels. These ratios include:

Over time, medtech stocks have generally outperformed the S&P 500 and held up relatively well in periods of difficult broader-market performance.

There are arguments in favor of more-robust valuations; this industry sports above-average margins and return on invested capital, doesn’t fear generic competitors, and offers products with pretty inelastic demand. After all, a person may be able to delay buying a new car or TV until the economy gets better, but they can’t delay treating a heart attack or broken hip.

Investors new to medical technology should also realize that, for better or worse, the price-to-sales ratio is a commonly used metric for these stocks (particularly at the small-cap and mid-cap levels).

In fact, emerging medtech stocks trading below a price-to-sales ratio of 4 may be regarded as a buy, and those trading above 8 or so may be regarded as overpriced or at least overheated.

Who Are Big Players in Medtech in 2025?

Major medtech companies include Abbott Laboratories (ABT), Becton Dickinson (BDX), Boston Scientific Corp. (BSX), and Stryker (SYK).

What Is the Focus of Medtech in 2025?

In 2025, it’s expected that the larger companies will focus on artificial intelligence, R&D, product differentiation, and medical device portability.

How Do I Invest in Medtech?

You can research and invest in individual medical technology companies. Or, you might consider medtech exchange-traded funds that may simplify your efforts and offer you instant diversification in the industry.

The Bottom Line

Medical technology is a dynamic industry, with new technologies and products emerging virtually every year. Some investors avoid it because they believe that it’s too complicated to understand.

It may take some time and effort to get up to speed on medical technology companies and their stocks. But if an investor methodically researches and assesses the overall industry and individual medtech stocks, they can then decide with confidence whether medtech is a good fit for their portfolios.

How Many People Work in the Coal Industry?

January 11, 2025 Ogghy Filed Under: BUSINESS, Investopedia

Reviewed by Andy Smith

According to the U.S. Bureau of Labor Statistics (BLS), 42,800 individuals were employed in the coal industry in January 2024. The BLS estimates that by December of 2024, that figure had dropped to 42,600.

The number of U.S. coal mining industry jobs have been declining for many years. In January of 1986, 169,700 people worked in coal mining. In January of 2014, the coal industry employed around 76,000. By December of that year, the number was 69,700.

Key Takeaways

The coal mining industry in the U.S. has been on the decline for years.
The entire coal mining industry is relatively small in the U.S. and concentrated in just a few states.
The BLS estimates that 42,600 people worked in the coal mining industry in December of 2024.
Coal jobs have been lost due to a variety of factors including a push for greener energy and more efficient technology used in coal mining.
By the end of 2024, U.S. coal jobs were 60% of what they were a decade earlier.

Energy Policy and Jobs

President Obama’s Green Power Plan is often cited as one reason for the decline of coal, but the regulations and incentives would not have gone into effect until 2022.

After he took office, President Trump ordered the Environmental Protection Agency (EPA) to review and eliminate the measures.

Competition from natural gas—in part due to fracking—also damaged the coal industry, as has a broad reduction in the amount of energy required to generate economic growth. Furthermore, automation has reduced some need for human labor. This means employees can fare badly even as the companies they work for thrive.

With the Biden administration, renewable energy such as solar power returned to the policy priority list. According to an annual solar jobs census, 279,447 people in the U.S. worked in the solar power industry in 2023.

Note

West Virginia is home to the greatest number of coal miners in the country—14,014 as of 2023—which is roughly one-third of all U.S. coal miners.

Coal Jobs

The aforementioned 42,600 coal mining jobs made up only around 0.02% of the more than 168 million-strong civilian labor force in the U.S in December 2024.

Many individual companies, such as Amazon and Walmart, employ more people than the entire group of coal mining employees.

The relatively small number of employees can’t be tied completely to the number of job openings shrinking. In 2021 and 2022, coal industry employers could not find enough workers to fill their positions.

It may be that people simply do not find coal mining as attractive an employment proposition as they did in the past.

Mining is dirty, dangerous, requires physical effort over long days, and pays relatively low wages. It may be that even when coal industry companies offer higher wages, people simply may not want to return to the coal mines.

How Many Coal Mining Jobs Are There in the U.S.?

As of December 2024, there were approximately 42,600 coal mining jobs in the U.S.

Will U.S. Coal Mining Jobs Rebound in 2025?

It doesn’t look like it. In fact, the Institute for Energy Economics and Financial Analysis (IEEFA) reports that the U.S. will close down half of all coal generation capacity by 2026.

How Many Coal Jobs Are There in the World?

According to the International Energy Agency (IEA), the global coal industry in totality employs 8.4 million people worldwide, mostly concentrated in countries like China, India, Indonesia, and South Africa. Of that figure, 6.3 million work in mining, processing, and transportation. That total industry figure is expected to decline to 6.1 million in 2030.

The Bottom Line

As of December 2024, an estimated 42,600 people worked in the U.S. coal mining industry. That’s a far cry from the 169,700 employees in 1986. But the nation’s focus on climate plans and cleaner energy has made a lasting impact on the industry that most likely will continue to reduce the number of jobs.

403(b) vs. 401(k) Plans: What’s the Difference?

January 11, 2025 Ogghy Filed Under: BUSINESS, Investopedia

Fact checked by Hans Daniel Jasperson
Reviewed by Marguerita Cheng

*Kameleon007 Managing your retirement money will be easier if you consolidate your accounts.*

403(b) Vs. 401(k) Plan: An Overview

403(b) and 401(k) plans are both tax-advantaged retirement savings plans sponsored by employers for their employees. The biggest difference in the 403(b) vs. 401(k) is that the 403(b) is strictly for government and non-profit employees while the 401(k) is for employees of companies in the private sector.

Over time, some of the distinctions between the two have narrowed. For example, 403(b) plans used to be restricted to investing in tax-sheltered annuities, whereas 401(k) plans had a broader selection of investment options. However, this restriction on 403(b) plans was loosened in 1974, allowing participants to invest in mutual funds as well.

Both plans are named after the sections of the Internal Revenue Code that govern them.

Key Takeaways

Both 401(k) and 403(b) plans offer tax advantages to both employees and employers.
401(k) plans are offered by private-sector employers, while 403(b) plans are for non-profit and government employees.
Contributions to either type of plan can be made pre-tax or post-tax (via Roth options), and employers may also make contributions.
The main differences between the two plans are related to who offers them and certain legal requirements.

401(k) Plans

A 401(k) plan allows employees to contribute a portion of their salary to a retirement account through automatic payroll deductions, up to an annual maximum dollar amount. The contributions are made on a pre-tax basis, meaning they are deducted before income tax is applied. The taxes are deferred until the money is withdrawn, usually in retirement.

The employee who chooses a traditional 401(k) plan gets an immediate tax break with every contribution, up to the maximum. The money invested in the fund will not be taxed until it is withdrawn, presumably after retirement. This is called a “pre-tax” plan.

Some employers also offer a Roth 401(k) plan. In this case, the income tax is paid immediately but no taxes will be owed when it is eventually withdrawn properly. The Roth is a “post-tax” plan.

The employer offering a 401(k) plan may make matching contributions on behalf of employees, up to a limit, and may also add a profit-sharing feature to the plan. These plans are often vested. That is, the employee must stay with the company for a set time, usually a few years, to have the full right of ownership over the money in the fund.

403(b) Plans

A 403(b) plan operates in much the same way as a 401(k), but it is designed for employees of public schools, non-profit organizations, and certain religious institutions. Participants include teachers, school administrators, professors, government employees, nurses, doctors, and librarians.

While 403(b) plans offer the same basic retirement savings options, there are some distinctions:

Vesting: Some 403(b) plans offer quicker vesting periods or allow immediate vesting of employer contributions.
Investment Options: In the past, 403(b) plans were limited to tax-sheltered annuities, but mutual funds are now allowed.

Legal Differences Between 401(k) and 403(b) Plans

Unlike a 401(k) plan, 403(b) plans may not have to comply with all of the regulations in the Employee Retirement Income Security Act (ERISA). Notably, governmental employers, non-electing churches, and certain other organizations are exempt from following ERISA requirements.

For example, 403(b)s are typically exempt from nondiscrimination testing. Done annually, this testing is designed to prevent management-level or “highly compensated” employees from receiving a disproportionate amount of benefits from a given plan.

The reason for this and other exemptions is a long-standing Department of Labor regulation, under which 403(b) plans are not technically labeled as employer-sponsored as long as the employer does not fund contributions. However, if an employer does make contributions to employee 403(b) accounts, they are subject to the same ERISA guidelines and reporting requirements as those who offer 401(k) plans.

Additionally, investment funds are required to qualify as a registered investment company under the 1940 Securities and Exchange Act to be included in a 403(b) plan. This is not the case for 401(k) investment options.

Practical Differences Between 401(k) and 403(b) Plans

While both plans allow for employer contributions and pre-tax savings, there are practical differences:

Employer Matching: Although 403(b) plans can offer employer matches, many employers do not offer them, preferring to maintain their ERISA exemption. However, if an employee has more than 15 years of service with certain nonprofits or government agencies, they may be able to make additional catch-up contributions to their 403(b) plans.
Expense Ratios: Because of fewer regulatory requirements, 403(b) plans may have lower expense ratios than 401(k) plans. This can be an advantage for employees who are concerned about investment fees.
Plan Administration: 401(k) plans are often administered by mutual fund companies, whereas 403(b) plans are frequently managed by insurance companies. This difference often leads to 403(b) plans offering fewer investment options, particularly annuities.

The SECURE Act and Annuities in 401(k) Plans

Employees with 401(k) plans may see more annuity options in their plans since the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. This law eliminates many of the barriers that had discouraged employers from offering annuities as 401(k) options.

By implementing certain guidelines and procedures, ERISA fiduciaries are now protected from being held liable should an annuity carrier have financial problems that prevent it from meeting its obligations to its 401(k) participants.

Additionally, under Section 109 of the SECURE Act, annuity plans offered in a 401(k) are now portable. This means that if the annuity plan is discontinued as an investment option, participants can transfer their annuity to another employer-sponsored retirement plan or IRA, thereby eliminating the need to liquidate the annuity and pay surrender charges and other fees.

What Are the Contribution Limits for 401(k) and 403(b) Plans?

The plans have the same yearly contribution limits set by the IRS at $23,000 for the 2024 tax year and $23,500 for 2025. People over age 50 can contribute an additional $7,500 in both years. A higher catch-up contribution limit applies for employees who are 60, 61, 62 and 63. In 2025, this catch-up contribution limit is $11,250.

Can I Contribute to Both a 401(k) and 403(b) Plan?

If you have two jobs, you might be offered both, assuming that one employer is a private company and the other is a government agency or a non-profit. In that case, you are allowed to contribute to both. You will still be subject to the overall limit on your combined contributions.

How Do Catch-Up Contributions Work With a 401(k) vs. 403(b) Plan?

With a 401(k) or 403(b), plan participants age 50 and older can make additional catch-up contributions above the standard contribution maximum. The catch-up contribution limit is $7,500 for both the 2024 and 2025 tax years. Employees who are 60, 61, 62 and 63 can contribute up to $11,250 in catch-up contributions In 2025.

In a 403(b) plan, employees with at least 15 years of service with the same employer can also make additional annual contributions that are the lesser of:

$3,000,
$15,000, reduced by the amount of additional elective deferrals made in prior years because of this rule, or,
$5,000 times the number of the employee’s years of service for the organization, minus the total elective deferrals made for earlier years.

401(k) vs. 403(b): Which Is Better?

Both types of defined-contribution retirement accounts are solid retirement accounts that offer tax advantages and investment options for retirement. The major difference is in what type of employer is offering the plan,

The Bottom Line

Both 401(k) and 403(b) plans offer tax advantages and a way to save for retirement, but they differ in terms of employer type and regulatory requirements. If you’re offered both, it’s worth considering your employer’s contributions, investment options, and any catch-up contribution opportunities to maximize your retirement savings.

Does Net Neutrality Stifle Investment and Innovation?

January 11, 2025 Ogghy Filed Under: BUSINESS, Investopedia

Reviewed by Robert C. Kelly

The Federal Communications Commission (FCC) under the Obama administration instated a policy called net neutrality, which prevented internet service providers (ISPs) from blocking content or throttling (slowing down connection speeds) based on the cost of the service. With net neutrality, users could access the internet equally. Under the Trump administration, however, FCC chair Ajit Pai rolled back the net neutrality rule, arguing that the policy has led to lower investment in broadband. Industry consultants, think tanks and trade associations supported this view, adding that the policy stifles innovation. But is that true?

What You Need to Know

Net neutrality is a policy that prohibits internet service providers (ISPs) from throttling or blocking content based on a user’s ability to pay.
The Federal Communications Commission (FCC) under the Obama administration introduced the policy, which was later gutted under the Trump administration. The FCC under the Biden administration reinstated it. However, it was paused after an ISP trade group filed an appeal. In January 2025, a court sided with the trade group, saying the FCC cannot regulate ISPs in this way.
Ajit Pai, who was the head of the FCC during the Trump administration, said net neutrality limits ISPs’ ability to do business, as the potential for regulation makes them “unsure of whether the government will let them compete in the free market.”
Supporters of net neutrality argued that the policy allows for a free and open internet.

History

On July 12, 2017, internet companies took part in a protest that was meant to highlight how the FCC chief Ajit Pai’s proposal to remove net neutrality regulations would hurt consumers. The organizers of the “Day of Action” called net neutrality the basic principle that protects free speech on the internet. Eventually, though, Pai announced that the FCC would be holding a vote to roll back net neutrality—and the agency decided to do just that. Under the Biden administration, the FCC did the opposite, and net neutrality was back. But then a trade group representing ISPs convinced a court to pause the policy while it weighed the group’s appeal. Finally, in January 2025, the court decided in the trade group’s favor, stating that regulating ISPs in this way is beyond the FCC’s purview.

On Freedom

Both supporters and critics of net neutrality argue that their side (to uphold the policy or eliminate it) promotes internet freedom.

For example, Comcast Corp. (CMCSA) filed comments with the FCC detailing its support for the agency’s commitment to “restoring, protecting, and maintaining a free and open internet.”

Arguments Against Net Neutrality

Net neutrality opponents argued that the classification of ISPs as public utilities creates regulatory uncertainty, which stifles investment and innovation in the telecom industry.

Pai said that just the possibility of rate regulation prevents companies from investing in advanced networks because they are “unsure of whether the government will let them compete in the free market.”

Before the FCC under the Trump administration cut the policy, Comcast called net neutrality an “outdated regulatory regime” that harms investment and innovation. Verizon Communications Inc. (VZ) worried about the scope of the government’s authority, and it asked policymakers to “catalyze innovation” and “encourage investment.” AT&T Inc. (T) painted a bleak picture for an America under net neutrality: “Less broadband investment in turn means fewer jobs, lower productivity and lost opportunity, particularly in rural America where broadband investment is needed the most.”

On Innovation

In its filing with the FCC, Comcast said that paid prioritization would have uses in telemedicine and self-driving vehicles that may need to communicate with each other. The Verge pointed out that automated cars don’t use broadband at all. They rely on the exchange of data wirelessly over an unlicensed spectrum called the Dedicated Short Range Communications (DSRC) band. Moreover, paid prioritization in telemedicine would mean low-income groups would lose its benefits.

Since it is hard to quantify whether innovation has been depressed, the Internet Association, which counts giants like Amazon (AMZN) and Google (GOOGL) as members, has taken to using patent application statistics. The organization used government data from 2010 and 2012 to show a 58.4% increase in telecom patent applications at a time when federal regulators were looking to use the 2010 policy to protect net neutrality.

Patents granted under code H04W or “wireless communication networks” increased 10.66%, and patents granted under H04L or “transmission of digital information” increased 5.25% in 2016 from the year before, according to IFI CLAIMS Patent Services. AT&T was among the top 50 companies that received the most patents that year and also saw its patents increase from 2015.

The Studies

When he argued that net neutrality has led to less broadband capital spending, Pai cited studies by the USTelecom Association and economist Hal Singer. “The key to realize our 5G future is to set rules that maximize investment in broadband,” he said at the Mobile World Congress in February 2017. Singer has previously prepared white papers and written testimony for AT&T and Verizon in the past, according to his bio on the Department of Justice website.

But the Internet Association cites studies that show spending by publicly traded telecom companies increased following net neutrality.

Why is there this discrepancy?

For starters, in their respective calculations, USTelecom Association and Singer did not include Sprint’s leased-equipment capital investments—approximately $2 billion.

Public interest group Free Press, whose study IA cited, said, “That’s nonsense. Sprint purchasing and leasing smartphones is no different from cable companies purchasing and leasing set-top boxes, which USTA does count as investment.” The USTelecom Association and Singer also subtracted $2 billion from AT&T’s reported capital spending to account for the company’s acquisition of DirecTV and Mexican wireless operations.

Note

Free Press also notes that while AT&T and a few other publicly traded ISPs may have reduced spending after net neutrality, twice as many increased their investment levels.

Pai also cited a study by Free State Foundation, a conservative think tank backed by the telecom industry, which said Title II net neutrality rules cost the U.S. $5.1 billion in broadband capital investment. A look at the methodology reveals it used USTelecom data, which includes the adjustments mentioned before, and established a trend line from 2003 to 2016 to calculate what broadband investment should have been.

This is similar to a paper from George Ford, an economist at a D.C. think tank with anonymous donors that was cited by Comcast on its website. Ford wrote, “the threat of reclassification reduced telecommunications investment by about 20% to 30%, or about $30 to $40 billion annually.” Ford’s analysis is counterfactual: the period he looks at is from 2010, when the threat of net neutrality rules first emerged and then estimates what would have been the annual investment had there been no such threat.

What Is Net Neutrality?

Net neutrality is a policy that prevents internet service providers (ISPs) from blocking content or throttling (slowing down connection speeds).

What Happened to Net Neutrality?

In the U.S., net neutrality was delivered a final blow in January 2025 when a federal appeals court sided with a trade group that represented internet service providers (ISPs).

Is There Net Neutrality Around the World?

Yes. For example, the EU and India have net neutrality policies.

The Bottom Line

While it’s possible ISPs may invest in more advanced networks because net neutrality has been repealed, it’s difficult to find evidence for this, and the companies even reportedly told investors they haven’t affected investment. But as of January 2025, the issue has been settled: net neutrality is no longer in effect in the U.S. Still, elsewhere around the world—such as the EU and India—it’s going strong.

16 Tax Deductions and Benefits for the Self-Employed

January 11, 2025 Ogghy Filed Under: BUSINESS, Investopedia

Expenses like a home office, car, insurance, and even your education bills could get you a big tax break

Reviewed by Lea D. Uradu
Fact checked by Suzanne Kvilhaug

Self-employed people have extra costs that they have to bear as they do business. But there are numerous deductions that can soften the blow when tax season comes around.

The Tax Cuts and Jobs Act (TCJA introduced new deductions, like the qualified business income (QBI) deduction (see number 16, below), but it also eliminated or changed others, including the entertainment and fringe benefit deduction, the local lobbying expenses deduction, and the domestic production activities deduction. However, key provisions of the TCJA are set to expire at the end of 2025: the standard deduction and income tax rates are set to return to pre-TCJA levels, and the cap on the state and local tax (SALT) deduction will be lifted.

Here are 16 current tax deductions for self-employed individuals.

Key Takeaways

Reviewing what you can deduct each year is important to make your business as profitable as possible if you’re self-employed.
You can calculate a deduction for a home office and a vehicle used for business purposes.
Meals with clients and business travel are deductible, but meals included with entertainment may not be.
Premiums for insurance that you pay for to protect your business and health insurance are legitimate deductions. And don’t forget startup, advertising, and retirement plan costs.

1. Retirement Plan Contributions Deduction

The deduction for self-employed retirement plan contributions is an incredibly worthwhile tax break. Contributions to simplified employee pension individual retirement accounts (SEP-IRAs), savings incentive match plans for employees (SIMPLE) IRAs, and solo 401(k)s reduce your tax bill now and help you rack up tax-deferred investment gains for later.

Potential Savings

You could feasibly contribute as much as $23,500 in deferred salary to a solo 401(k) for the 2025 tax year. (In 2024, it was $23,000.) You can make catch-up contributions of $7,500 for a total of $31,000 if you’re age 50 or older. (In 2024, it was $30,500.)

Your total maximum contributions to a self-employed 401(k) can’t exceed $70,000 for 2025 (it was $69,000 for 2024), not counting catch-up contributions of $7,500 for both employee and employer contribution categories. (The catch-up contribution for 2025 is also $7,500.)

Is It Hard to Claim?

You can establish a SEP plan with a simple, one-page form, according to the IRS. Fidelity and Charles Schwab offer a free solo 401(k), which also can be a good plan choice. Plan contributions are deducted on Form 1040, Schedule 1, on the line for self-employed SEP, SIMPLE, and qualified plans. It can be helpful having a tax preparer advise you on claiming this deduction on your taxes.

What Else to Know

Contribution limits vary by plan type, and the IRS adjusts the maximums annually. Of course, you can’t contribute more than you earn, and this benefit will only help you if your business leaves you enough profits to take advantage of it.

2. Self-Employment Tax Deduction

The self-employment tax refers to the Social Security and Medicare taxes that self-employed people like freelancers, independent contractors, sole proprietors, and small business owners must pay. These taxes help fund Social Security and Medicare. The self-employment tax rate is 15.3% on net earnings (12.4% for Social Security and 2.9% for Medicare). Employers and employees share these taxes, each paying 7.65%. People who are fully self-employed and therefore subject to self-employment tax have to pay for both parts themselves.

Where does the deduction come in? The Internal Revenue Service (IRS) treats the employer portion of the self-employment tax as a business expense and allows you to deduct it accordingly.

Investopedia’s Tax Savings Guide can help you maximize your tax credits, deductions, and savings.

Potential Savings

You can deduct half of your self-employment tax from your net income when you’re calculating your income tax. So, if your self-employment tax amounts to $3,500 for the year, for instance, at tax time $1,750 would be deductible on your Form 1040. Keep in mind that this doesn’t reduce the net earnings from self-employment or the self-employment tax itself.

Is It Hard to Claim?

You’ll need to fill out Schedule SE to calculate your self-employment tax, which includes a calculation for the deduction. Once you have the amount to deduct, you enter it on line 15 of Schedule 1 (Form 1040).

What Else to Know

If your income is above a certain threshold, there’s an additional 0.9% Medicare tax that you have to pay. The income thresholds for 2024 are:

Married filing jointly – $250,000
Married filing separately – $125,000
Single – $200,000
Head of household (with qualifying dependent) – $200,000
Qualifying widow(er) with dependent child – $200,000

The income thresholds for the additional Medicare tax apply to your combined wages, compensation, and self-employment income. So, for example, you’d have to pay the additional Medicare tax of 0.9% on the $10,000 by which your joint income exceeds the $250,000 threshold if you have $100,000 in self-employment income and your spouse has $160,000 in employee wages.

3. Home Office Deduction

The home office deduction is one of the more complex tax breaks. The cost of any workspace that is part of your home and that you use regularly and exclusively for your business, whether you rent or own it, can be deducted as a home office expense.

Potential Savings

The expenses you can deduct for your home office include the business percentage of rent, deductible mortgage interest, utilities, homeowners insurance, and repairs you pay for during the year. Fifteen percent of your annual electricity bill becomes tax deductible if your home office occupies 15% of your home.

You have two choices for calculating your home office deduction: the regular method or the simplified option. You don’t have to use the same method every year.

Using the standard mileage rate is easier than calculating your deduction because it requires minimal record-keeping and calculation. Just write down the business miles and the dates when you drive them, then multiply your total annual business miles by the standard mileage rate. Then enter this amount, along with any parking fees and tolls you paid, on Schedule C, Line 9.

What Else to Know

To use the actual expense method for this tax break, you must calculate the percentage of driving you did for business all year and the total cost of operating your car, including depreciation, gas, oil changes, registration fees, repairs, and car insurance. For example, your deduction would be $300 if you spent $3,000 on car operating expenses and used your car for business purposes 10% of the time.

You must use the standard mileage rate method on a car you own in the first year when the vehicle is available for use in your business. After that, you can use either the standard mileage rate or actual expenses in later years.

9. Interest Deduction

Interest on a business loan from a bank is a tax-deductible business expense. Credit card interest isn’t deductible when you incur it for personal purchases, but it’s deductible when the interest applies to business purchases.

Potential Savings

The business portion of the loan’s interest expense is allocated based on the allocation of the loan’s proceeds if the loan is used for both business and personal purposes. Track the disbursement of funds for various uses if the entire loan isn’t used for business-related activities. Separate out business-related credit card purchases that carry interest.

If you have a business credit card and carry charges from month to month, the interest can add up over a year’s time.

Is It Hard to Claim?

The answer depends on whether you’re deducting interest from a loan (and what type of loan) or a credit card. Interest to be deducted is entered on Schedule C, Line 16b.

What Else to Know

Even if you don’t have a business credit card, you generally can still deduct qualifying interest charges on business expenses paid for with a personal credit card.

10. Dues and Publications Deduction

The cost of specialized magazines, journals, and books directly related to your business is tax deductible as supplies and materials, as are dues or fees for certain professional membership organizations.

Potential Savings

A daily newspaper wouldn’t be specific enough to be considered a business expense for most businesses, but a subscription to Nation’s Restaurant News would be deductible if you’re a restaurant owner. Nathan Myhrvold’s $625 “Modernist Cuisine” boxed set would be a legitimate book purchase for a self-employed, high-end personal chef.

As for membership dues or fees, you can’t deduct them for belonging to clubs “organized for business, pleasure, recreation, or any other social purpose.” Examples include “country clubs, golf and athletic clubs, hotel clubs, sporting clubs, airline clubs, and clubs operated to provide meals under circumstances generally considered to be conducive to business discussions.” Still, the IRS does make exceptions for groups that it considers to not exist for entertainment purposes, such as:

Boards of trade
Business leagues
Chambers of commerce
Civic or public service organizations
Professional organizations, such as bar associations and medical associations
Real estate boards
Trade associations

Potential Savings

Mundane items such as copy paper, postage, paper clips, printer ink, and pens can all be deducted. The IRS also allows deductions for books, professional instruments, and equipment, as long as they’re used within the year. If an item’s use extends beyond one year, you must generally recover its cost through depreciation.

Is It Hard to Claim?

No. Office supplies and postage should be claimed on Line 18, “Office expense,” of Schedule C.

What Else to Know

You may still deduct the cost of certain supplies that you keep on hand on a regular basis from year to year if:

You don’t keep a record of when they are used.
You don’t take an inventory of the amount on hand at the beginning and end of the tax year.
This method doesn’t distort your income.

16. Qualified Business Income (QBI) Deduction

The qualified business income (QBI) deduction, introduced in the Tax Cuts and Jobs Act, allows eligible self-employed people and small businesses to deduct a portion of their income from their taxes. The deduction is for “pass-through” income, which is business income that you report on your personal tax return. QBI is the net amount of qualified items of income, gain, deduction, and loss from a qualified trade or business.

Potential Savings

Eligible owners of sole proprietorships, partnerships, S corporations, and certain limited liability companies (LLCs) can deduct up to 20% of their QBI from their taxes. If your total taxable income (which is your adjusted gross income (AGI) minus allowable itemized or standard deductions) in 2024 is at or below $191,950 for single filers and $383,900 for joint filers, you may qualify for the full 20% deduction on your taxable business income. If your income is above the limit, you may still be able to claim the pass-through deduction, depending on the specific nature of your business.

Is It Hard to Claim?

As noted, at higher income levels, limitations on the QBI deduction come into play. Depending on the nature of your business and number of employees, consulting a tax accountant can help you get the full benefit of the QBI deduction.

What Else to Know

The qualified business income deduction is available whether you itemize deductions on Schedule A or take the standard deduction. However, it is set to expire on Dec. 31, 2025.

What Deduction Can I Claim Without Receipts?

The standard deduction is a fixed amount that can be claimed by individuals and married couples, is deducted from their taxable income, and doesn’t require any receipts. But if you are itemizing deductions, one deduction you can claim without receipts is for home office expenses. You simply multiply the IRS-determined rate of $5 by your home office’s square footage up to 300 square feet, so the maximum amount you can deduct is $1,500.

Similarly, if you itemize and you use a vehicle for business, you can calculate your deduction using the standard mileage rate determined annually by the IRS ($0.70 per mile for 2025). Simply keep track of your business miles and the dates when you drove them, and at the end of the year, total them up and multiply the result by the standard mileage rate to determine your deduction.

I Rent My Home. Do I Qualify for the Home Office Deduction?

Yes, you can qualify for the home office expense deduction if you meet all business use requirements. A renter can use the simplified or actual expense method based on the percentage of the home that’s dedicated to business use.

Is a C Corporation Eligible for the Qualified Business Income Deduction?

No. According to the IRS: “income earned through a C corporation or by providing services as an employee is not eligible for the deduction.” A C corporation files Form 1120, U.S. Corporation Income Tax Return and is not eligible for the deduction.

You also can’t deduct any portion of wages paid to you by an employer that is reported on a Form W-2, Wage and Tax Statement. Independent contractors and pass-through businesses are eligible for the deduction. They report their percentage of business income on a Schedule C, Profit or Loss From Business that accompanies Form 1040, U.S. Individual Tax Return.

Which Method Is Better for My Business Vehicle: Standard Mileage or Actual Expense?

It depends on the vehicle-related expenses that you’ve incurred during the year. It may be more beneficial to use the actual expense method if you’ve spent significant money on maintenance (oil changes, brake pad replacements, new tires), car inspections, and registration.

What Is the 20% Self-Employment Deduction?

With this deduction, you can deduct up to 20% of your Qualified Business Income (QBI). C corporation income is not eligible. You can also deduct up to 20% of qualified real estate investment trust (REIT) dividends and qualified publicly-traded partnership (PTP) income. Note: This deduction only applies to tax years that will end on or before December 31, 2025.

The Bottom Line

There are more deductions available than those that are listed here, but these are some of the biggest ones. Credit card processing fees, tax preparation fees, and repairs and maintenance for business property and equipment are also deductible. Other business expenses can be depreciated or amortized. You can deduct a small amount of the cost each year over several years.

Ask yourself, “Is this an ordinary and necessary expense in my line of work?” if you’re ever unsure whether a cost is a legitimate business expense. This is the same question the IRS will ask when examining your deductions if you’re audited. Don’t take the deduction if the answer is no. Seek professional help with your business tax return from a certified public accountant (CPA) or other credentialed tax preparer if you’re unsure.

A Closer Look at Acadian Asset Management

January 11, 2025 Ogghy Filed Under: BUSINESS, Investopedia

Reviewed by Robert C. Kelly

Boston-based Acadian Asset Management is an international investment management firm founded in 1986. The firm has offices in Singapore, Sydney, Tokyo, and London in addition to its headquarters in Boston. The firm aims to be its clients’ most valued resource for investment insight and success.

Acadian uses fundamental insights to identify investment opportunities. These decisions are based on empirical evidence used with repeatable and transparent processes.

Key Takeaways

Acadian Asset Management is a Boston-based investment firm founded in 1986.
Acadian operates globally with offices in Singapore, London, Tokyo, and Sydney.
The fund uses both fundamental analysis and quantitative analysis for its investment strategies.
Acadian operates 44 investment strategies with a wide range of leverage, exposure, and risk.

Company Overview

Acadian Financial Research, the firm’s predecessor, was founded in 1977 by Gary Bergstrom. It designed and implemented the world’s first international index-matching strategy under the auspices of State Street Corporation (STT). Acadian Financial Research left State Street and began managing assets directly 10 years later.

Acadian Asset Management operates as a global equity investment firm, more boutique than all-encompassing. It focuses on heavy research, customized portfolio assistance, and long/short strategies. Acadian Asset Management uses both fundamental and quantitative analysis and manages its portfolios with top-down and bottom-up stock picking.

It is easy to spot the quantitative emphasis of Acadian Asset Management. The company openly boasts about its “scientific approach to innovation” and how responsible investing is embedded in its investment approach. An in-house research team creates internal research that works with the Acadian system.

Acadian Asset Management rejects the efficient market hypothesis and is positioned firmly in the active school of investment management. Its fundamental underpinnings are designed to exploit “mispricings” in the securities markets, especially globally, where markets are often much less developed than in the United States.

The unique aspect of Acadian’s system is its dedication to algorithms which cuts down on slippage and reduces transaction costs and other advisory fees on its investment holdings.

Executive Staff and Investment Team

Acadian is led by a personal investment team of more than 120 experts. The executive staff at Acadian Asset Management is well-entrenched. Several of its high-ranking officers have worked at the company for more than two decades.

John Chisholm was one of the co-founders of the firm and was co-chief executive officer (CEO) until he retired in July 2022. Chisholm developed the first versions of Acadian’s quantitative strategies as well as working as chief investment officer (CIO) for a time.

Ross Dowd teamed up with Chisholm as co-CEO. Dowd was previously the head of Acadian’s Global Client Group. He became sole CEO after Chisholm’s retirement until he retired in December 2023 and was replaced by Kelly Young. There are 10 other members of the executive committee.

Important

The staff at Acadian is extremely focused on environmental, social, and governance (ESG) investing which they’ve implemented into their investment concepts.

Brendan Bradley is the CIO and holds a Ph.D. in applied mathematics and a bachelor’s degree in physics. Mark Minichiello, the chief operating officer (COO), joined the firm in 2000.

The other critical member of the investment team is Malcolm P. Baker, a professor of finance at Harvard with a Ph.D. from Harvard, a master’s of philosophy from Cambridge, and a bachelor’s from Brown. Baker is responsible for formulating the investment research agenda for Acadian as the Director of Research for the firm.

Asset Classes, Investment Strategies, and Products

Acadian’s investment team likes to assess its “aggregate factors” which it describes as variables supported by specific observations from a range of disciplines including statistical analysis, fundamental equity insights, economic science, and behavioral finance. Each factor is classified into one of four key asset categories after it’s analyzed: value, quality, growth, and technical.

Acadian Asset Management and its affiliates managed more than $97 billion in assets under management (AUM) as of September 2023. Most of them were pension funds, endowments, foundations, and other large institutions.

The primary asset classes for Acadian funds are emerging markets equity, global non-US equity, regional equity, and small caps. The funds also offer so-called “concentrated” products for clients seeking higher levels of excess return and a focus on absolute risk and high risk-adjusted returns normally monitored through Sharpe ratios.

The fund has 44 investment strategies, providing a variety of options for investors to choose from depending on their desired exposure and risk tolerance. Strategies include:

All Country Managed Volatility Equity
China A-Shares
Australian Enhanced Equity
Emerging Markets Focused Alpha Equity
European Equity
Japanese Equity
Non-U.S. Micro Cap Equity

What Is Indexing?

Indexing is a strategy used to assemble a portfolio that mirrors the performance of a market index. This might be the S&P 500 or the Dow Jones Industrial Average. It’s considered a passive approach to trading.

What Is Arcadian’s Share Price?

Acadian Asset Management was trading at $23.93 a share on Jan. 10, 2025. This is down from $31.27 on Dec. 4, 2024.

What Is Arcadian’s Market Cap?

Arcadian’s intraday market cap was $893.017 million on Jan. 10, 2025.

The Bottom Line

Acadian Asset Management is a large investment fund that has decades of experience. The fund manages billions of dollars across the world for hundreds of clients using a variety of investment strategies suited to different investment needs.

Can Mutual Funds Use Leverage?

January 11, 2025 Ogghy Filed Under: BUSINESS, Investopedia

Reviewed by Charlene Rhinehart

Mutual funds can put a certain amount of leverage to work for better results even though, traditionally, they have not been considered leveraged financial products.

In fact, products have emerged that seek to reap the benefits of leveraged hedge funds in mutual fund packages.

However, liquidity requirements govern all mutual funds with strict rules regarding the degree of leverage a mutual fund may use.

Nevertheless, the promise of accelerated earnings made possible by the use of debt to increase a fund’s position has drawn many investors to leveraged mutual funds.

Key Takeaways

Mutual funds typically are long-only investment funds that do not use leverage to amplify their purchasing power.
While not a legal mandate, regulations that enforce minimum liquidity requirements include strict rules that curb the widespread use of leverage in mutual funds.
Mutual funds that use leverage typically do so only in modest amounts, and are categorized as ‘leveraged funds‘ to make that clear to investors.
Those looking for greater leverage can look to hedge funds or leveraged ETFs.

What Is Leverage?

In its simplest form, leverage is debt. When a company uses leverage, it means it takes on debt to achieve a goal faster than it is able to with equity capital alone.

In investing, to use leverage means to borrow funds to buy additional securities to reap a greater gain than is otherwise possible.

How It Works

Leveraged investments use debt to increase their gains in a short period. By increasing the amount of money invested, they increase their potential profits.

Conversely, they are liable to creditors if investments fail. For this reason leverage is inherently very risky. However, as investors know, risk and volatility provide the opportunity for huge gains (or crushing losses).

How Do Leveraged Mutual Funds Work?

Mutual funds are strictly limited by the U.S. Securities and Exchange Commission with regard to the percentage of their portfolios that can be funded by borrowed money.

This is because mutual funds are, by definition, highly liquid and the greater the proportion of debt to equity used in a fund’s portfolio, the less liquid the fund becomes.

Hedge funds are well known for using huge amounts of leverage to take advantage of highly illiquid investment opportunities that require large amounts of capital and patience. Mutual funds are meant to be bought and sold easily and remain affordable for a wide range of investors.

Leveraged mutual funds, therefore, seek to split the difference between these two asset classes by using a smaller amount of leverage while employing less traditional tactics, such as shorting and arbitrage strategies.

Allowed Percentage of Leverage

By law, the maximum amount of leverage that an open-end mutual fund can have is 33.33% of its portfolio value. If the portfolio is valued at $1 million, it may borrow up to $333,333 to increase its buying capacity.

However, if assets in its portfolio fair poorly and the fund loses value, then it must reduce its leverage to remain within the required limits.

Important

Leverage can work against investors because they’re responsible for more than the amount that they invest. If your portfolio isn’t leveraged and experiences losses, your own money is the only thing at stake. But if you borrow money to buy securities and the market turns against you, you’ll be responsible for paying back borrowed funds with money you may not have.

What Kinds of Mutual Funds Use Leverage?

Most leveraged mutual funds fall into the leveraged index fund category. This simply means that they attempt to return a certain multiple of the returns generated by an index. For example, a 2X S&P 500 fund is specifically managed to return twice the returns generated by the S&P 500.

Conversely, some leveraged funds, called inverse funds, attempt to return an inverse multiple of an index’s returns.

If a fund manager believes the S&P 500 will lose value in the coming year, for example, their fund may be aimed at generating a profit that is twice the amount of the index’s loss. A 10% drop for the S&P means a 20% profit for shareholders if everything goes to plan.

Other leveraged mutual funds employ a 130/30 strategy, where they borrow $30 for each $100 of portfolio value and use it to short some stocks while going long on others to beat a given benchmark. Other funds are less aggressive, employing a 120/20 strategy instead.

Are Leveraged Mutual Funds Riskier Than Typical Mutual Funds?

Yes, they carry more risk due to the added amount of exposure they gain with borrowed money. This can magnify not just their holdings and potential profits, but potential losses, as well.

Are Leveraged ETFs Safer Than Leveraged Mutual Funds?

Generally, no. In fact, they can be seen as riskier. That’s because such ETFs may have a greater amount of leverage than leveraged mutual funds. Plus, unlike mutual funds, they track market performance throughout the trading day and may encounter highly volatile price movements that can result in substantial losses.

How Do I Know if a Mutual Fund Is Leveraged?

You can check a fund’s prospectus to learn whether it uses debt. The fund name also may tip you off with terms that indicate amplification, such as “leveraged,” “2x,” or “ultra.”

The Bottom Line

Mutual funds, although designed to be a liquid investment, are allowed by the Investment Company Act of 1940 to use leverage (or borrowed funds) to potentially enhance their returns.

However, the amount that they may use is strictly limited due to the risk of leverage to amplify losses and the need mutual funds have to make redemptions.

Top 3 Pitfalls of Discounted Cash Flow Analysis

January 11, 2025 Ogghy Filed Under: BUSINESS, Investopedia

Reviewed by Thomas Brock
Fact checked by Timothy Li

Most finance courses espouse the gospel of discounted cash flow (DCF) analysis as the preferred valuation methodology for all cash flow-generating assets. In theory (and in college final examinations), this technique works great. In practice, however, DCF can be difficult to apply in evaluating equities.

Even if one believes the gospel of DCF, other approaches are useful to help generate a complete valuation picture of a stock.

Key Takeaways

The discounted cash flow (DCF) model is a way of estimating the present value of an asset based on its stream of future cash flows.
The model relies on the concept of the time value of money, whereby a dollar paid in the future is less valuable than a dollar today.
While good in theory, it is often difficult to accurately predict the correct inputs for the model.

Basics of DCF Analysis

DCF analysis seeks to establish, through projections of a company’s future earnings, the company’s real current value. DCF theory holds that the value of all cash flow–generating assets—from fixed-income bonds to stocks to an entire company—is the present value of the expected cash flow stream given some appropriate discount rate.

Basically, DCF is a calculation of a company’s current and future available cash, designated as free cash flow, determined as operating profit, depreciation, and amortization, minus capital and operational expenses and taxes. These year-by-year projected amounts are then discounted using the company’s weighted average cost of capital to finally obtain a current value estimate of the company’s future growth.

The formula for this is usually given as:

$begin{aligned} &PV = frac{CF_1}{(1+k)^1} + frac{CF_2}{(1+k)^2} + cdots + frac{CF_n}{(k-g)(1+k)^{n-1}}\ \ &textbf{where:}\ &PV = text{present value}\ &CF_i = text{cash flow in the } i^{th} text{ period}\ &CF_n = text{cash flow in the terminal period}\ &k = text{discount rate}\ &g = text{assumed growth rate in perpetuity beyond the terminal period}\ &n = text{the number of periods in the valuation model}\ end{aligned}$

For equity valuation, analysts most often use some form of free cash flow for the valuation model cash flows. Free cash flow (FCF) is usually calculated as operating cash flow less capital expenditures (CapEx).

Note that the PV has to be divided by the current number of shares outstanding to arrive at a per-share valuation. Sometimes analysts will use an adjusted unlevered free cash flow to calculate a present value of cash flows to all firm stakeholders. They will then subtract the current value of claims senior to equity to calculate the equity DCF value and arrive at an equity value.

The rule of thumb for investors is that a stock is considered to have good potential if the DCF analysis value is higher than the current value, or price, of the shares.

Important

DCF relies on future assumptions about growth and discount rates, which can vary greatly. It’s less useful for short-term and speculative investments.

Problems With DCF

DCF models are powerful, but they do have shortcomings. Moreover, they often work better for some sectors than others. Here, we took a look at some of the possible pitfalls.

Operating Cash Flow Projections

The first and most important factor in calculating the DCF value of a stock is estimating the series of operating cash flow projections. There are a number of inherent problems with earnings and cash flow forecasting that can generate problems with DCF analysis.

The most prevalent is that the uncertainty with cash flow projection increases for each year in the forecast—and DCF models often use five or even 10 years’ worth of estimates. The outer years of the model can be total shots in the dark.

Analysts may have a good idea of what operating cash flow will be for the current year and the following year, but beyond that, the ability to project earnings and cash flow diminishes rapidly.

To make matters worse, cash flow projections in any given year will most likely be based largely on results for the preceding years. Small, erroneous assumptions in the first couple of years of a model can amplify variances in operating cash flow projections in the later years of the model.

Capital Expenditure Projections

Free cash flow projection involves projecting capital expenditures for each model year. Again, the degree of uncertainty increases with each additional year in the model.

Capital expenditures can be largely discretionary; in a down year, a company’s management may rein in capital-expenditure plans (the inverse may also be true). Capital expenditure assumptions are thus usually quite risky.

While there are a number of techniques to calculate capital expenditures, such as using fixed asset turnover ratios or even a percentage of revenues method, small changes in model assumptions can widely affect the result of the DCF calculation.

Discount Rate and Growth Rate

Perhaps the most contentious assumptions in a DCF model are the discount rate and growth rate assumptions.

There are many ways to approach the discount rate in an equity DCF model. Analysts might use the Markowitzian R = R_f + β(R_m – R_f) or maybe the weighted average cost of capital of the firm as the discount rate in the DCF model.

Both approaches are quite theoretical and may not work well in real-world investing applications. Other investors may choose to use an arbitrary standard hurdle rate to evaluate all equity investments. In this way, all investments are evaluated against each other on the same footing.

When choosing a method to estimate the discount rate, there are typically no surefire (or easy) answers. Perhaps the biggest problem with growth rate assumptions is when they are used as a perpetual growth rate assumption. Assuming that anything will hold in perpetuity is highly theoretical.

Many analysts contend that all going concern companies mature in such a way that their sustainable growth rates will gravitate toward the long-term rate of economic growth in the long run. It is therefore common to see a long-term growth rate assumption of around 4%, based on the long-term track record of economic growth in the United States.

In addition, a company’s growth rate will change, sometimes dramatically, from year to year or even decade to decade. Seldom does a growth rate gravitate to a mature company growth rate and then sit there forever.

Due to the nature of DCF calculation, the method is extremely sensitive to small changes in the discount rate and the growth rate assumption. For example, assume that an analyst projects company X’s free cash flow as follows:

In this case, given standard DCF methodology, a 12% discount rate and a 4% terminal growth rate generates a per-share valuation of $12.73. Changing only the discount rate to 10% and leaving all other variables the same, the value is $16.21. That’s a 27% change based on a 200 basis point change in the discount rate.

*Image by Sabrina Jiang © Investopedia 2020*

Alternative Methodologies

Even if one believes that DCF is the be-all and end-all in assessing the value of an equity investment, it is very useful to supplement the approach with multiples-based target price approaches. If you are going to project income and cash flows, it is easy to use the supplementary approaches.

It is important to assess which trading multiples (P/E, price/cash flow, etc.) are applicable based on the company’s history and its sector. Choosing a target multiple range is where it gets tricky.

While this is analogous to arbitrary discount rate selection, using a trailing earnings number two years out and an appropriate P/E multiple to calculate a target price will entail far fewer assumptions to “value” the stock than under the DCF scenario.

This improves the reliability of the conclusion relative to the DCF approach. Because we know what a company’s P/E or price/cash flow multiple is after every trade, we have a lot of historical data from which to assess the future multiple possibilities. In contrast, the DCF model discount rate is always theoretical and we do not really have any historical data to draw from when calculating it.

What Is a Discounted Cash Flow?

Discounted cash flow is a valuation method used to estimate the value of an investment. It calculates the present value of the expected future cash flows of an investment. The future cash flows are adjusted for the time value of money using a discount rate, which reflects the risk and opportunity cost of the capital invested. The ultimate goal is to determine whether the investment is worth making based on its ability to generate profits in the future.

What Is the Difference Between NPV and DCF?

Net present value (NPV) is a method of determining the value of an investment by calculating the difference between the money you expect to receive in the future versus the money you spend today, adjusted for the time value of money. Discounted cash flow (DCF) estimates the value of an investment based on its expected future cash flows, which are discounted (reduced) to its present value using a discount rate. In essence, NPV is the result of applying DCF to determine if an investment is profitable.

Are DCF and IRR the Same?

No, discounted cash flow (DCF) and internal rate of return (IRR) are not the same. DCF is a method used to calculate the present value of expected future cash flows, which takes into account the time value of money. It helps determine if an investment will be profitable in the future. IRR, on the other hand, is the rate at which the present value of future cash flows equals the initial investment; the break-even rate which makes the net present value (NPV) zero. IRR helps compare different investment opportunities, with a higher IRR being the better investment choice.

The Bottom Line

DCF analysis has increased in popularity as more analysts focus on corporate cash flow as a key determinant in whether a company is able to do things to enhance share value.

It is one of the few equity valuation tools that can provide a real, intrinsic value against which to compare current stock price as opposed to a relative value comparing one stock to other stocks in the same sector or to the market’s overall performance. Market analysts observe that it is hard to fake cash flow.

While most investors probably agree that the value of a stock is related to the present value of the future stream of free cash flow, the DCF approach can be difficult to apply in real-world scenarios. Its potential weaknesses come from the fact that there are numerous variations analysts can select for the values of free cash flow and the discount rate for capital. With even slightly different inputs, widely varying value figures can result.

Thus, DCF analysis is perhaps best considered over a range of values arrived at by different analysts using varying inputs. Also, since the very focus of DCF analysis is long-term growth, it is not an appropriate tool for evaluating short-term profit potential.

Besides, as an investor, it’s wise to avoid being too reliant on one method over another when assessing the value of stocks. Supplementing the DCF approach with multiple-based target price approaches is useful in developing a full understanding of the value of a stock.

6 Asset Allocation Strategies That Work

January 11, 2025 Ogghy Filed Under: BUSINESS, Investopedia

Fact checked by Suzanne Kvilhaug
Reviewed by Thomas J. Catalano

Asset allocation is a very important part of creating and balancing your investment portfolio. After all, it is one of the main factors that leads to your overall returns—even more than choosing individual stocks. Establishing an appropriate asset mix of stocks, bonds, cash, and real estate in your portfolio is a dynamic process. As such, the asset mix should reflect your goals at any point in time.

Below, we’ve outlined several different strategies for establishing asset allocations, with a look at their basic management approaches.

Key Takeaways

Asset allocation is very important to create and balance a portfolio.
All strategies should use an asset mix that reflects your goals and should account for your risk tolerance and length of investment time.
A strategic asset allocation strategy sets targets and requires some rebalancing every now and then.
Insured asset allocation may be geared to investors who are risk-averse and who want active portfolio management.

1. Strategic Asset Allocation

This method establishes and adheres to a base policy mix—a proportional combination of assets based on expected rates of return for each asset class. You also need to take your risk tolerance and investment time frame into account. You can set your targets and then rebalance your portfolio every now and then.

A strategic asset allocation strategy may be akin to a buy-and-hold strategy and also heavily suggests diversification to cut back on risk and improve returns.

For example, if stocks have historically returned 10% per year and bonds have returned 5% per year, a mix of 50% stocks and 50% bonds would be expected to return 7.5% per year.

But before you start investing, you should first read if you can make money in stocks.

2. Constant-Weighting Asset Allocation

Strategic asset allocation generally implies a buy-and-hold strategy, even as the shift in values of assets causes a drift from the initially established policy mix. For this reason, you may prefer to adopt a constant-weighting approach to asset allocation.

With this approach, you continually rebalance your portfolio. For example, if one asset declines in value, you would purchase more of that asset. And if that asset value increases, you would sell it.

There are no hard-and-fast rules for timing portfolio rebalancing under strategic or constant-weighting asset allocation. However, a common rule of thumb is that the portfolio should be rebalanced to its original mix when any given asset class moves more than 5% from its original value.

3. Tactical Asset Allocation

Over the long run, a strategic asset allocation strategy may seem relatively rigid. Therefore, you may find it necessary to occasionally engage in short-term, tactical deviations from the mix to capitalize on unusual or exceptional investment opportunities.

This flexibility adds a market-timing component to the portfolio, allowing you to participate in economic conditions more favorable for one asset class than for others.

Tactical asset allocation can be described as a moderately active strategy since the overall strategic asset mix is returned to when desired short-term profits are achieved.

This strategy demands some discipline, as you must first be able to recognize when short-term opportunities have run their course and then rebalance the portfolio to the long-term asset position.

Important

The asset mix in your portfolio should reflect your goals at any point in time.

4. Dynamic Asset Allocation

Another active asset allocation strategy is dynamic asset allocation. With this strategy, you constantly adjust the mix of assets as markets rise and fall, and as the economy strengthens and weakens. With this strategy, you sell assets that decline and purchase assets that increase.

This makes dynamic asset allocation the polar opposite of a constant-weighting strategy. For example, if the stock market shows weakness, you sell stocks in anticipation of further decreases and if the market is strong, you purchase stocks in anticipation of continued market gains.

Note

Dynamic asset allocation relies on a portfolio manager’s judgment instead of a target mix of assets.

5. Insured Asset Allocation

With an insured asset allocation strategy, you establish a base portfolio value under which the portfolio should not be allowed to drop.

As long as the portfolio achieves a return above its base, you exercise active management, relying on analytical research, forecasts, judgment, and experience to decide which securities to buy, hold, and sell with the aim of increasing the portfolio value as much as possible.

If the portfolio should ever drop to the base value, you invest in risk-free assets, such as Treasuries (especially T-bills) so the base value becomes fixed. At this time, you would consult with your advisor to reallocate assets, perhaps even changing your investment strategy entirely.

Insured asset allocation may be suitable for risk-averse investors who desire a certain level of active portfolio management but appreciate the security of establishing a guaranteed floor below which the portfolio is not allowed to decline.

For example, an investor who wishes to establish a minimum standard of living during retirement may find an insured asset allocation strategy ideally suited to their management goals.

6. Integrated Asset Allocation

With integrated asset allocation, you consider both your economic expectations and your risk in establishing an asset mix. While all of the strategies mentioned above account for expectations of future market returns, not all of them account for the investor’s risk tolerance. That’s where integrated asset allocation comes into play.

This strategy includes aspects of all the previous ones, accounting not only for expectations but also for actual changes in capital markets and risk tolerance.

Integrated asset allocation is a broader asset allocation strategy. However, it cannot include both dynamic and constant-weighting allocation since an investor would not wish to implement two strategies that compete with one another.

What Is a Good Asset Allocation by Age?

What is considered a good asset allocation will vary for every individual, depending on their financial goals, risk tolerance, and financial profile. General financial advice states that the younger a person is, the more risk they can take to grow their wealth as they have the time to ride out any downturns in the economy. Such portfolios would lean more heavily toward stocks.

Those who are older, such as in retirement, should invest in more safe assets, like bonds, as they need to preserve capital. A common rule of thumb is 100 minus your age to determine your allocation to stocks. For example, if you are 30, then you’d allocate 70% to stocks and 30% to bonds (100 – 30 = 70). If you are 60, you’d allocate 40% to stocks and 60% to bonds (100 – 60 = 40).

What Is the Safest Place to Put Your Money in Retirement?

The safest place to put your money in retirement is low-risk investments, like high-yield savings accounts, certificates of deposit (CDs), Treasuries, and money market accounts. These investments offer capital preservation through stable assets that generate a return (albeit low returns). You should also keep cash on hand for emergencies.

How Do I Allocate My Investment Portfolio?

How you allocate your investment portfolio will depend on a variety of factors, such as age, financial profile, investment goals, and risk tolerance. Generally, your investment portfolio should have a diversified asset allocation to spread risk. This includes investing in stocks, bonds, real estate, and other investments. Within these investments, you should also diversify.

For example, in stocks, you can invest in blue-chip companies in the healthcare and manufacturing sectors as well as investing in small-cap companies in the oil and automobile sectors. Within bonds, you can choose Treasuries and corporate bonds. Remember to regularly rebalance your portfolio as market conditions and your investment profile change.

The Bottom Line

Asset allocation can be active to varying degrees or strictly passive in nature. Whether an investor chooses a precise asset allocation strategy or a combination of different strategies depends on that investor’s goals, age, market expectations, and risk tolerance.

Keep in mind, however, that these are only general guidelines on how investors may use asset allocation as a part of their core strategies.

Be aware that allocation approaches that involve reacting to market movements require a great deal of expertise and talent in using particular tools for timing these movements. Perfectly timing the market is next to impossible, so make sure your strategy isn’t too vulnerable to unforeseeable errors.

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