Truths about the Stock Market

The United States has dozens of brokerage firms but there are 4 major firms that stand out due to number of clients and amount in assets: Charles Schwab, Fidelity Investments, E*TRADE, and TD Ameritrade. Between these 4 companies is tens of trillions in assets, meaning your money, held in tens of millions of different accounts. The following will dive into some of the details of these four, and other, brokerage firms.

When you hear that the average historical stock market return over time is 10%, that is true. However, that percentage is very deceiving because it does not account for several factors and will not be the return you actually realize. The 10% number comes from the historical average of the S&P 500, which is an index that measures the 500 largest American publicly traded companies. These are companies that are large, established, and stable companies whose stock is a “safe” investment. Riskier stocks may or may not yield the same return.

This 10% is the return before adjusting for inflation. Average inflation rate from 1920 through June 2020 is 2.59% with the most recent 30 years average inflation rate reaching 3.22%. To be on the conservative side, which is always wise when planning money and the future, use a 3% inflation rate when considering your returns. The 10% average return, when adjusted for inflation, becomes 7%.

By many peoples standards, 7% is not a bad return. But, we have not yet reached the return you will actually realize. From that 7% return, fees will be deducted and taxes will be paid before you pocket the profits of your investment. Both of these topics are covered in more depth below. Once fees and taxes are subtracted from the return percentage, stock returns tend to fall below 4%. A $1,000 investment will produce a $40 annual return. That is in a good, rising stock market year. Will gains like that get you the retirement you desire?

Multifamily syndication investments are usually structured with an annual preferred return and a remaining equity split. The preferred return means that the investors get paid a percentage, often 8%, of the profits first. The general partners, the individuals who put the deal together, do not receive any profit until the investors are paid their preferred return amount. Any profit that remains after the preferred return is distributed to the investors is split between the investors and the general partners. This split is usually in favor of the investors as 60/40 or 70/30. Annual double digit returns, that you get to pocket, from multifamily syndication investments are commonplace.

Brokerage firms can be divided into three categories; full-service, discount, and online. Full-service brokerage firms often include products and services ranging from estate planning, tax consultation and preparation, and in-person or phone consultations to many other financial services. All this comes with large fees. The commissions, recurring, and annual maintenance fees alone at these firms can reach over 4% (Ganti).

Other fees commonly charged by brokerage firms are subscriptions to premium research and investing data, trading platform access fees, inactivity fees, fees when you buy or sell a mutual fund, expense ratios, transaction fee, sales loads, management and advisory fees, and 401(K) fees. Often you have to dig deep in the fine print to locate information about and numbers for these fees.

The fee percentages charged get smaller as the amount you invest gets larger. Unless you are opening accounts with $250,000 minimums, you will be charged the higher fees. When the numbers are in the trillions, billions, and millions, as the four main brokerage firms handle, the percentages of fees can be very small and still equal billions and millions in profits for the company.

Even if the fees are small, they can still add up over time and greatly reduce the value of your portfolio. The following is an example of the impact fees can have, taken from the article, “Understanding Investment Fees: From Brokerage Fees to Sales Loads.” The link for this article can be found below in the Further Your Education section.

An investor puts $500 a month into a brokerage account for 30 years, depositing a total of $180,000 over that time and earning an average annual 7% return.

As you can see, even a 2% fee has a significant impact on the value of the portfolio after 30 years. When you add all the fees charged by most brokerage firms to get the total in fees you are actually paying, they often far exceed 2%.

With multifamily syndication, there are two common fees charged; a one time acquisition fee, 1-5% of the purchase price, and an asset management fee, 1-3% of the monthly revenue collected. Two other fees that you may see, but aren’t very common, are a refinancing fee of 0-1% of the loan amount and a disposition/sale fee that is 0-1% of the sale price. Even more rare is a guarantor fee, a small percentage of the purchase price. Any fees beyond those are very rare and I would question why they exist.

Wave Impact Capital Group only charges the two most common fees. A 1.5% one time acquisition fee that is paid to the general partners at the time of purchase closing. This amount is part of the money raised during the capital raise from investors to close the deal. This is paid as a reimbursement to the general partners at closing for the time, energy and capital required to acquire the investment opportunity. A 1% monthly asset management fee is part of the expenses of the property and paid to the general partners for maintaining the quality and function of the asset. There are no fees taken out of the preferred return distributed to investors or taken from the remaining profit split.

Whenever a stock is sold for a profit, even if that profit is not removed from your brokerage account to use in daily life but remains in the account for more stocks to be purchased with it, then capital gains taxes are owed on that profit. You personally don’t realize a gain until you sell and withdraw the money from your account, but the government realizes a gain anytime you sell at a profit. Accounts held in a 401(K) are exempt from the taxes owed until you withdraw the money, which is why there are required withdrawals form these retirement accounts - the government wants to be paid.

The amount of tax owed depends on the length of time you held the stock for. If you sell the stock within a year of purchasing it, then the profit is taxed as a short-term capital gain at your usual tax rate. In other words, the profit from a stock held for one year or less is taxed as ordinary income. Holding the stock for over a year results in a long-term capital gain tax on any profit. This can be taxed at 0%, 15%, or 20% depending on your filing status and income level. In most cases, less tax will be owed if the stock was held for longer than one year.

The tax code encourages investment in real estate with large tax benefits. The profit from the sale of investment real estate is taxed as a capital gain, however, the tax code has a way to defer that tax owed by utilizing Section 1031. This tax code provision allows the profit from the sale of one property to be used to purchase another investment real estate property without owing taxes. There are time requirements, added legal cost, and paperwork but the final result is a tax savings that can reach into the hundreds of thousand of dollars. The 1031 Exchange method can be used repeatedly to continue deferring the tax liability on real estate investment properties. Then when the owner of the investment property dies, assuming trusts and other legal documents are properly in place, the heirs that inherit the property have the taxes forgiven. If done properly, there will never be capital gains tax owed on a multifamily syndication.

To learn how multifamily syndication investing can offset your annual income and reduce your tax liability, read the articles about Depreciation and Cost Segregation found on the Wave Impact website.

All types of investments come with different risks and levels of that risk. The risks found with stocks are market risk - the decline in value of the investment due to economic events, liquidity risk - being able to sell at a fair price and get your money back, inflation risk - the loss of purchasing power because the investment does not keep up with inflation, and horizon risk - having to sell in a down market due to an unforeseen event. While it can be tracked how the economy influences the stock market, it is harder to show that emotion plays a key role in stock valuation.

No one can control or predict the future of the economy, a single company, or someone, let alone masses of people's emotions. At best, we can use historical data and measure past behavior. If you view the lists put out by financial experts on ‘the top stocks to buy next year’ or ‘the mutual funds that will perform best next year,’ every list is different. One of the lists will end up mostly true but does that show knowledge of the expert that can be repeated year after year or does it represent statistical chance?

History has shown us that the best way to reduce risk in the stock market is to buy a diverse group of funds when the market is low, hold them long term for at least 10 years, and sell when the market is high. Is the current market at its low and should you buy now or will it go lower tomorrow, or next week? No one knows. The same questions arise when it comes time to sell. Will the market continue to rise next month or do I sell today? And diversify. Why? Because if you buy a little of it all, then when that fund goes down hopefully this one will go up and you will break even in the end. Quality financial advisors are paid millions and this is still the best advice they can give us.

The real estate market goes through 4 cycles, expansion - when most growth happens, equilibrium - a time of slowing and stabilization, decline - when values drop, and absorption - where values begin to increase and recovery begins, but this growth is slow. This is similar to the cycles of the stock market, with a large difference. While there is no knowledge of how long the real estate market will be in each phase, the transition from phase to phase happens very slowly with plenty of time to react in the best interest of your portfolio and investment plan. Transitions between the rise and fall of the stock market can happen in a matter of hours or even minutes, leaving little time for investment corrections.

On top of the lack of timing control in the stock market, there is no control over the individual investment in stock. You have no control over the company or the decisions that may have influence on the stock value. Before you even buy multifamily real estate, you know what the revenue and expenses are for that property and how they can be adjusted, within that market's limitations, to create the most profit. In real estate, risk is greatly reduced by knowing and understanding the financial numbers while maintaining a large contingency fund in case of an unforeseen disaster, such as a fire.

What is the number one goal of any business? To make a profit for its owners. As an account holder at a brokerage firm, you are a client of that business. Meaning you are one of the individuals helping that company generate its profit. 3 of the top 4 brokerage firms mentioned at the beginning of this article generate multi billions in annual profits with the remaining firm nearing the billion dollar profit mark. This profit does not decrease in a down market when your portfolio remains steady or even declines in value. You are still paying to be their client, therefore generating a profit for them.

With multifamily syndication, as an investor you become an equity partner in the LLC of the investment property. You are not a client contributing to the profit for the owner. You become a part owner in the investment and, as such, you get paid a portion of the profits.

Continue your education on your path to financial freedom, then take action on what you have learned so the dream becomes reality.