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‘Taxes!” he barked. “Capital gains!” groaned. Both of my clients lamented
P'ofits from their investments. They had lnvested in high-grade common stocks, ar>d each had realized after-tax profits in a*cess of $50,000! But neither remem- ered his original goal—long-term
Last month I discussed some invest- ITlent vehicles that provide liquidity and assitre preservation of principal. These Vestments form the base of the invest- 'llerit triangle. This month I will begin to .Qver some common investments that
considerable tax liability owing to
the potential to provide long-term
growth or income, but at a greater risk. . gh-grade common stocks fall into ls category. The definition of “high- I ade” is subjective, but most stock ana- ysts look at the same elements of a cor: rate balance sheet to arrive at an opin- n of the financial soundness of a |0rnPany. Earnings and dividend growth, r°n8-term debt, debt-to-equity ratio, and 'ained earnings are some of these ele- „,e,)ts.1,2 Other factors to consider in- e the price-to-eamings ratio and a
, easure of the stock’s relative volatility nown as the Beta Coefficient. ”*gh-grade common and preferred °cks should comprise a majority of your
portfolio. This is especially impor-
may be unable to follow the stock arket on a day-to-day basis, as these °£ks tend to be less volatile. n5s°me high-grade common stocks do j yield high dividends. If you are will- § to sacrifice some growth potential, u..j1. should consider income-oriented 1 'ties or preferred stocks. These two ^.Pes of stocks are subject to interest rate ho ancL therefore, react similarly to fends to changes in interest rates. Pre- ^d stocks are safer than their common
to the naval or maritime professional.
tterparts because preferred stock div
idends have “preference” over the common. However, unlike dividends on common stocks, which can be raised, preferred stock dividends most often are fixed. A variation on the preferred stock is the convertible preferred, which combines the higher income of the preferred with the growth (or loss) potential of the underlying common stock. Because shares of the convertible preferred can be converted (at a fixed ratio) into shares of the underlying common, convertible preferreds tend to imitate the market performance of the common.
Other primary sources of income in any conservative investment portfolio are investment-grade corporate and municipal bonds. Standard and Poor’s and Moody’s are the primary bond rating services. They rate most bonds according to the ability of the issuer to pay interest and repay the principal.3 Standard and Poor’s rates investment grade bonds as (in descending order) AAA, AA, A, and BBB; Moody’s comparable ratings are Aaa, Aa, A, and Baa. Generally, a bond with a lower rating will offer a higher yield. As a rule, you should not invest in any bond of less than investment grade.
In most cases, corporate and municipal bonds have a finite life (maturity date). Their yield is based on the face amount of the bond; often this is referred to as the “coupon yield.” Interest is paid semiannually. Corporate bonds usually are sold in increments of $1,000, while municipal bonds are sold in increments of $5,000. The most important difference between corporate and municipal bonds, however, is the tax status of interest income. Interest on corporate bonds is taxable, whereas interest on municipal bonds is exempt from federal taxes (and often from state and local taxes, too).
Each bond issue may have special features or tax status; you should understand these before investing. For example,
many bonds have a “call” feature, which allows the issuer to redeem the bond at a predetermined price (usually par or higher) before the maturity date.
Municipal hous ing bonds have an “extraordinary redemption pro-
vision, which allows the issuer to redeem the bond at
Income and/or Long-term Growth
Liquidity and Safety
at any time specific legal conditions exist. Like preferred stock, some corporate bonds can be converted into common stock at a fixed ratio. Their price movement tends to reflect the market action of the underlying common stock.
I will continue my discussion of investments for income and long-term growth in next month’s “Money Matters” column.
'Large brokerage firms have in-house analysts who provide their clients with fundamental analyses of many companies. Two of the most widely read references for stock ratings are Value Line and Standard and Poor's Stock Guide.
2If you want help understanding a corporate financial report, please write me in care of Proceedings.
’The term "non-rated” refers to securities that have not been rated by a rating service.
ngs / July 1988