Spencer Cheung

Econ Internship Class

Waddell & Reed

Internship Paper

During any economics circumstances, as a Waddell & Reed financial advisor, we give them some

insights to how their cash flow should look like for a typical household. We first recommend a

debt free environment, student loans, mortgage, financing a car are exempt. Any debt, credit

card, consumer, or anything that you are financing that doesn’t meet the above requirements are

consider in debt. Most household incomes are not going anywhere since most American are not

savers, they look at the short term who are the classical view citizen. As any financial advisors

would do, we always recommend any individual to have a minimum of 6 months of expense of

cash savings in case of any economy downturn. Market volatility is unpredictable, when the

economy is doing well, when people are confident about the market, we still believe having

excessive cash reserve is ideal.

Here is some basic information in regards to Cash Flow of an individual.

Protection planning are a form of insurance. We look at life insurance, long term disability, and

long term care insurance because they are the most common. In any economic situation, having

insurance is key because most people don’t understand what the consequences are when they

don’t have insurance. What will happen when your spouse pass away? What happens when you

could no longer work due to disability? What will happen if you need long term medical care

when your other half cannot work? We are not saying this is going to happen but we are trying to

say what if it happens. Most people believe insurance is useless, that’s why at Waddell & Reed,

we believe in having the right coverage with the lost amount of money paid.

When the economy is booming, people will have some extra money to spend on insurance,

during this time, we would not recommend term insurance because they are cheap, and they

don’t provide any benefits when you need them. This is where Variable Life Insurance comes into

play. Economy bust, we would assume most household would lose their total income in months

to come, life insurance policy terms play a major role in this situation. During this time, term

policy might be the ideal choice because it’s a contract ranging from a year to thirty, it’s very

cheap considering all other packages and it goes away for you to change your policy in the future

when the client seem fit. Even when the economy is booming, most clients believe a term policy

is the ideal choice due to the price difference where they could spend that extra premium

elsewhere.

I used some quick numbers to give an example about the difference you get from the different

options of life insurance. Term policy is the cheapest, we estimate that the coverage is only 10

years for the sake of this example. You are paying a term policy just because it’s cheap, you have

no cash value in the future, and most company that does a term policy wouldn’t pay a death

benefit when your spouse dies. Only 3% of all insurance company will pay a death benefit. When

we look at the other policies, all of them have cash value in the future though their prices are

higher. It’s a better investment than term just because you have a cash value and death benefits

guarantee. Most financial company that sell insurance would ask for clients to pay a high

premium. Here are some information. I have a chart on the bottom for easier understanding of

the benefits of term and different universal life insurance.

All insurance firm will only sell the high premium due to commission based and this isn’t

necessarily good in any economics situation in terms of boom or a bust. When an economy

boom, most people don’t mind spending the extra money to buy a higher premium in order to

have a better retirement but when an economy burst, most household would rather save that

money to do other things than to invest in their retirement.

At Waddell & Reed, we recommend a tax triangle for clients to take full advantage of how much

they have to pay taxes. No matter how the economy is doing, all households would have to pay

taxes no how much money you make. When an economy booms, most people who have a higher

capital gain must pay more taxes. Whereas an economy bust, when you lost capital gain, you pay

lower taxes but both cases you have to pay an advisor fee.

The above graph represents the tax triangle from Waddell & Reed. What we learn so far is most

typical house hold would do the following.

Bucket 1CDChecking and SavingsHousing

Bucket 3Roth IRACash Value Life InsuranceMunicipal

Bucket 2IRA401KSep

After tax

Tax on Growth1099 TaxProperty

No TaxTax as 100% Income

After Tax

0% Tax Growth Deferred

Either they will only do the first, they see their pretax income, their Government takes their

income tax, and what’s after is consider after tax income where they will put in their check or

savings, they will do a CD, or pay their mortgage. After that, any gains after all individuals’

after tax income will be tax again with 1099 capital gains, and property tax.

Some individual would join a 401K plan where it’s beneficial to some due to the fact that that

partial cut invested in 401K would be pretax. Your net income – the portion of your 401K

would become your new net income where the government would tax your new net income

not your pre 401K income. This is beneficial because this includes partial of your retirement

plan, and you could pay less taxes, but by the time you take that money, the government

would consider that as 100% income where you would be taxed then. Most importantly,

growth is deferred

Most American would only consider those two tax benefits. But there’s a third that

might be beneficial to some people that have extra income

This bracket is made of many things but just to list three commons, they are Roth IRA, CVLI,

and Muni. These unfortunately cannot be invested with pretax income. All these are invested

after you are taxed, but the difference between bucket 3 and bucket 1 is, your growth is

deferred over time, but most importantly, you pay 0% tax on all your growth asset within that

bucket unlike the other two where you have to pay taxes. You pay tax up front, but you don’t

ever have to worry about tax afterwards.

We believe that most clients should only pay taxes with due amount and find ways to pay the

right amount of taxes to the government and spend those money to invest because 401K is

volatile and it doesn’t guarantee you will have enough for retirement. By maximizing all three

buckets, clients would get the most benefits of taxes compare to only using the first two.

When we look at stocks in regards to boom and bust, we want to invest safely and intelligently

about which is the right choice. There are many criteria for choosing. At this moment, we are not

looking to set up a portfolio but rather pick two stocks and explain why these are good

recommendations. For my example, I consider the economy to be stable where it’s booming

while a bust would happen anytime in the future. When I consider my first choice, my first status

I look at is the beta. Beta when it’s at equilibrium is 1. I’m choosing stocks that are lower than 1

to minimize risk by looking at stocks that are less volatile. The second thing I look at is how their

dividend & yield is doing. I believe all stocks should be hold for a long period time ranging from

10 years to their entire lifetime. Utility stocks pay the highest dividend than any sector of the

market because they are less volatile, they don’t lose a great amount of value in their stock price

when the market burst. On the other hand, technological stocks are highly volatile, people invest

in those stocks are looking to buy/ sell to gain rather than looking at the dividends. Here is two

recommendations with some basic info from “Yahoo Finance”.

Recommendation one:

Trading at $89.86

Reason for choosing Exxon:

Beta is less than market 1, which means it’s less volatile than other stocks. Though 52 weeks

range, their market price is on the high side, but their P/E ratio is quite high compare to other

stocks within Dow Jones.

DIV & Yield not too bad, 3.35% compare to other markets.

This stock is good for long term holder, less volatile mean you don’t have to worry too much

when the market bust while their div per share is quite exceptional.

Gasoline though their price drops, but we still required a great amount of supply in order to

satisfy the needs. Though Middle Eastern is being corrupted by a group which changes the supply

of oil greatly. Even with their negative news in regards to their company about climate change,

those are small impacts that are not sufficient to cause a great harm to the company’s stock price

in the future.

With evidence, most household have cellular service rather than a landline service. I believe

telecom market has a bright future. Based on “Open Signal” we see an average Verizon

Communications Inc. is dominating its coverage in US. This reflects investors that they are still the

best provider of telecom service in their industry. Though there are some bad news about

workers going on strike but all unions would fight against the company for employers’ benefits.

Recommendation Two:

A U.S. dominant telecom company with the greatest coverage in the U.S. Their company first

sell cellular service until now with their FIOS internet. Telecom market is one of the safest

market in any markets in the world. Everyone uses them, they are replacing landlines, and

this is a great investment for the future. With his price semi high in its 52 weeks range. Their

trading volume is at 7.5m. Though their beta, P/E ratio or even dividend is not as good as its

rival, but it stands strong on its own. This stock is for individual that wants a safe investment

for the long term.

Portfolio management is based on the client’s interest including their goals, their retirement

planning, their life style, etc. We have to consider a couple facts before we could choose whether

it is the right investment portfolio for that individual. Things we have to consider about asset

relocation includes client’s risk tolerance, how long are they going to invest, what is the purpose

of their investment, and finally, liquidity, how important it is for this individual to change their

portfolio assets into cash.