Blog | InvesTrust

When investing, particularly for long-term goals, there is one concept you will likely hear about over and over again — diversification. Why is diversification so important? The simple reason is that it helps ensure that your risk of loss is spread among a number of different investments. The theory is that if some of the investments in your portfolio decline in value, others may rise or hold steady, helping to offset the losses.

Diversifying within asset classes

For example, say you wanted to invest in stocks. Rather than investing in just domestic stocks, you could diversify your portfolio by investing in foreign stocks as well. Or you could choose to include the stocks of different size companies (small-cap, mid-cap, and/or large-cap stocks).

If your primary objective is to invest in bonds for income, you could choose both government and corporate bonds to potentially take advantage of their different risk/return profiles. You might also choose bonds of different maturities, because long-term bonds tend to react more dramatically to changes in interest rates than short-term bonds. As interest rates rise, bond prices typically fall.

Investing in mutual funds

Because mutual funds invest in a mix of securities chosen by a fund manager to pursue the fund’s stated objective, they can offer a certain level of “built-in” diversification. For this reason, mutual funds may be an appropriate choice for novice investors or those wishing to take more of a hands-off approach to their portfolios. Including a variety of mutual funds with different objectives and securities in your portfolio will help diversify your holdings that much more.

Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Diversifying among asset classes

You might also consider including a mix of different types of asset classes — stocks, bonds, and cash — in your portfolio. Asset allocation is a strategic approach to diversifying your portfolio. After carefully considering your investment goals, time horizon, and risk tolerance, you would then invest different percentages of your portfolio in targeted asset classes to pursue your goal.

Winning asset classes over time

The following table, which shows how many times during the past 30 years each asset class has come out on top in terms of performance, helps illustrate why diversifying among asset classes can be important.

	Number of winning years, 1987-2016
Cash	3
Bonds	5
Stocks	10
Foreign stocks	12

Performance is from December 31, 1986, to December 31, 2016. Cash is represented by Citigroup 3-month Treasury Bill Index. Bonds are represented by the Citigroup Corporate Bond Index, an unmanaged index. Stocks are represented by the S&P 500 Composite Price Index, an unmanaged index. Foreign stocks are represented by the MSCI EAFE Price Index, an unmanaged index. Investors cannot invest directly in any index. However, these indexes are accurate reflections of the performance of the individual asset classes shown. Returns reflect past performance and should not be considered indicative of future results. The returns do not reflect taxes, fees, brokerage commissions, or other expenses typically associated with investing.

The principal value of cash alternatives may fluctuate with market conditions. Cash alternatives are subject to liquidity and credit risks. It is possible to lose money with this type of investment.

The return and principal value of stocks may fluctuate with market conditions. Shares, when sold, may be worth more or less than their original cost.

U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest, whereas corporate bonds are not. The principal value of bonds may fluctuate with market conditions. Bonds are subject to inflation, interest rate, and credit risks. Bonds redeemed prior to maturity may be worth more or less than their original cost.

The risks associated with investing on a worldwide basis include differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country.

Investments offering the potential for higher rates of return also involve higher risk.

In general, when you sell your home, any amount you receive over your cost basis (what you paid for the home, plus capital improvements, plus the costs of selling the home) is subject to capital gains taxes. However, if you owned and used the home as your principal residence for a total of two out of the five years before the sale (the two years do not have to be consecutive), you may be able to exclude from federal income tax up to $250,000 (up to $500,000 if you’re married and file a joint return) of the capital gain when you sell your home. You can use this exclusion only once every two years, and the exclusion does not apply to vacation homes and pure investment properties.

For example, Mr. and Mrs. Jones bought a home 20 years ago for $80,000. They’ve used it as their principal residence ever since. This year, they sell the house for $765,000, realizing a capital gain of $613,000 ($765,000 selling price minus a $42,000 broker’s fee, minus the original $80,000 purchase price, minus $30,000 worth of capital improvements they’ve made over the years). The Joneses, who file jointly and are in the 28% marginal tax bracket, can exclude $500,000 of capital gain realized on the sale of their home. Thus, their tax on the sale is only $16,950 ($613,000 gain minus the $500,000 exemption, multiplied by the 15% long-term capital gains tax rate).

What if you don’t meet the two-out-of-five-years requirement? Or you used the capital gain exclusion within the past two years for a different principal residence? You may still qualify for a partial exemption, assuming that your home sale was due to a change in place of employment, health reasons, or certain other unforeseen circumstances.

Special rules may apply in the following cases:

You sell vacant land adjacent to your residence
Your residence is owned by a trust
Your residence contained a home office or was otherwise used for business purposes
You rented part of your residence to tenants
You owned your residence jointly with an unmarried taxpayer
You sell your residence within two years of your spouse’s death
You’re a member of the uniformed services

Socially responsible investing (SRI) has come to represent various investment strategies that favor companies with business practices generally viewed as socially responsible, ethical, and/or sustainable.

Overall, investor interest in SRI has been gaining momentum. In fact, the number of investment funds incorporating ESG (environmental, social, and governance) factors has increased 12% in the last two years alone, from 894 in 2014 to 1,002 in 2016. These 1,002 funds represent $2.6 trillion in net assets.¹

What is SRI?

Fundamentally, SRI is an investment strategy in which companies’ social and environmental records and objectives are factored in when building a portfolio.

Money managers who use SRI strategies often integrate ESG factors with traditional financial analysis to choose securities for their funds. The heightened focus on corporate sustainability issues allows investors to compare how businesses in the same industry have adapted to meet social and environmental challenges, and provides some insight into which companies may be exposed to risks or have a competitive advantage. For example, in some instances, poor decisions and lack of planning could cause negative financial results for a company, whereas good corporate citizenship may boost a company’s public image and help create value.

Why is SRI attractive to investors?

Individual investors may have different opinions about which policies and practices have a positive or negative impact on society. Fortunately, there are a number of SRI options to choose from. This gives investors the ability to build a portfolio that aligns with their personal values and offers the potential for earning positive returns.

In addition, investors may have difficulty measuring the intangible value associated with socially responsible companies, which means these companies may be undervalued and represent a potential buying opportunity.

What might investors find unappealing?

SRI opponents claim that investing should be about making money first; therefore, social and environmental issues are viewed as noble impediments to that goal. Focusing on SRI strategies limits the total universe of available investments and could make it more challenging to diversify and maintain your desired asset allocation. Diversification and asset allocation are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss.

Moreover, although data is available, it can be difficult to thoroughly assess the ethics of a given company. For example, beyond the value chains of a company itself, investors might also need to look at the different social standards among the contractors and subcontractors associated with the company.

Remember that different SRI funds may focus on very different ESG criteria, and there is no guarantee that an SRI fund will achieve its objectives.

All investing involves risk, including the possible loss of principal, and there can be no assurance that any investment strategy will be successful. The return and principal value of SRI stocks and mutual funds fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.

¹ The Forum for Sustainable and Responsible Investment, 2016

If you transfer money or property to anyone in any year without receiving something of at least equal value in return, you may need to file a federal gift tax return (Form 709) by the April tax filing deadline. If you live in one of the few states that also impose a gift tax, you may need to file a separate gift tax return with your state as well.

Not all gifts, however, are treated the same. Some gifts aren’t taxable and generally don’t require a gift tax return. These exceptions include:

Gifts to your spouse that qualify for the marital deduction
Gifts to charities that qualify for the charitable deduction (Filing is not required as long as you transfer your entire interest in the property to qualifying charities. However, if you are required to file a return to report gifts to noncharitable beneficiaries, all charitable gifts must be reported as well.)
Qualified amounts paid on someone else’s behalf directly to an educational institution for tuition or to a provider for medical care
Annual exclusion gifts totaling $14,000 or less for the year to any one individual (However, you must file a return to split gifts with your spouse if you want all gifts made by either spouse during the year treated as made one-half by each spouse — enabling you and your spouse to effectively use each other’s annual exclusion.)

If your gift isn’t exempt from taxation, you’ll need to file a gift tax return. But that doesn’t mean you have to pay gift tax. Generally, each taxpayer is allowed to make taxable gifts totaling $5,490,000 (in 2017, up from $5,450,000 in 2016) over his or her lifetime before paying any gift tax. Filing the gift tax return helps the IRS keep a running tab on the taxable gifts you have made and the amount of the lifetime exclusion you have used.

If you made a gift of property that’s hard to value (e.g., real estate), you may want to report the gift, even if you’re not required to do so, in order to establish the gift’s taxable value. If you do, the IRS generally has only three years to challenge the gift’s value. If you don’t report the gift, the IRS can dispute the value of your gift at any time in the future.

If you die without a will, your property will generally pass according to state law (under the rules for intestate succession). When this happens, the state essentially makes a will for you. State laws specify how your property will pass, typically in certain proportions to various persons related to you. The specifics, however, vary from state to state.

Most state laws favor spouses and children first. For example, a typical state law might specify that your property pass one-half or one-third to your surviving spouse, with the remainder passing equally to all your children. If you don’t have children, in many states your spouse might inherit all of your property; in other states, your spouse might have to share the property with your brothers and sisters or parents.

But not all property is transferred by will or intestate succession. Regardless of whether you have a will, some property passes automatically to a joint owner or to a designated beneficiary. For example, you can transfer property such as IRAs, retirement plan benefits, and life insurance by naming a beneficiary. Property that you own jointly with right of survivorship will pass automatically to the surviving owners at your death. Property held in trust will pass to your beneficiaries according to the terms you set out in the trust.

Only property that is not transferred by beneficiary designation, joint ownership, will, or trust passes according to intestate succession. You should generally use beneficiary designations, joint ownership, wills, and trusts to control the disposition of your property so that you, rather than the state, determine who receives the benefit of your property.

Even if it seems that all your property will be transferred by beneficiary designation, joint ownership, or trust, you should still generally have a will. You can designate in the will who will receive any property that slips through the cracks.

And, of course, you can do other things in a will as well, such as name the executor of your estate to carry out your wishes as specified in the will, or name a guardian for your minor children.