Page 265 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 6. Employee Benefits and Perquisites 251

0.08333 $4,167; $4,167 0.60 $2,500). However, if the individual were in a 50 percent
tax bracket and was still seeking a 5 percent after-tax return on investment, a 10 percent
taxable return would be required.
Personal Investing. Investors are always interested in yields, or returns on their investment.
In the fixed-income market, investments are usually short term (typically six months) or long
term (such as 30-year bonds). Normally, long-term rates are higher than short term to reflect
a greater degree of risk—mainly inflation. An increasing spread typically signals rapid
growth, whereas an inverted spread (short-term return is higher than long term) suggests a
recession. Little or no gap between the two would signal a slowdown in the economy.
Increasing interest rates slow down investment, whereas decreasing interest rates encourage
investment.
Another definition of yield is the annual dividend paid on a share of stock divided by the
stock price. The yield, therefore, increases only when dividends increase faster than stock
price or decrease more slowly than declines in stock price. A yield rally (an increasing rate of
return) may be simply the result of a falling stock price.
Those preferring the stock market over safer investments such as U.S. Treasury bonds
expect to achieve a reasonable equity premium (historically about 6 percent) over safer invest-
ments. The premium is the sum of dividends and stock price appreciation in excess of the
fixed income interest rate.
The investor in the stock market can make individual selections, put money with a stock
picker, invest in a managed fund, or put money in an index fund that tracks the S&P 500,
the Wilshire 5000, Russell 2000, or some other index. Mutual fund investors have the choice
of going with a load or no-load fund. A load fund is typically sold through a bank, broker, or
investment adviser. In exchange for advice and service, a commission is charged on the
investment. This commission can be paid up-front (A Funds) or on an ongoing basis. B
Funds have an exit fee for the first five years. C Funds charge an ongoing brokerage fee. No-
load funds have no such charge, but they also provide no advice or service. Both charge
management and administrative fees on the account while it is active. No-load funds
typically do not charge exit fees. Some high-yield bond funds charge fees to avoid money
managers moving cash in and out of funds. Another investment place for high net-worth
executives to manage their wealth is private banking, typically a separate unit of a bank. For
years, private banking appeared to be restricted to those with large inherited wealth who
were more interested in service than in investment return (as long as it was better than
cash management). Regardless of the choice, it is useful to track the equity premium and
determine if charges are appropriate.
Some personal investors purchase puts and calls on stock owned to hedge losses and
increase gains. A put allows the holder to sell stock at a stated price to the holder of the put.
For example, if the stock is currently at $100, the put might be at $90. If the stock drops
below $90, the put is exercised and the loss held to $10. Conversely, a call is the right to buy
at a stated price. Let’s assume $100 as in the example above. Any gain in stock price above
$100 can be realized by exercising the call. Puts and calls are for short periods of time and do
not have to be exercised. If not, the investor is out only the cost of the put or call. Puts and
calls were reviewed in more detail in Chapter 4 (“The Stakeholders”).
A financial planner should be helpful in determining the appropriate allocation of assets
among stock (own company and others), fixed income, real estate, and cash equivalents as
well as appropriate tax-avoidance vehicles.