Investing 101 Continued...

Hello Everyone! It has been a while since my last post... things have been crazy! Anyway, as I promised I am going to continue my discussion on investing. Tonight we are going to talk about mutual funds an ETFs.

3. Mutual Funds: Mutual funds became popular because of the power that they gave small individual investors in the market place, for a relatively low cost. Essentially a mutual fund company is headed by a fund manager that actively manages a portfolio by investing in a diversified mix of assets. They create pre-packaged “portfolios” within a specific asset class, sector, or risk measure that an individual can buy into. Individual funds have the buying power to create diversification within whatever sector they are aiming to own. In addition mutual funds are also considered to be incredibly efficient because they are only priced once daily at the end of the trading day, therefore they are said to trade at their true net asset value (NAV). Individuals can then buy into these mutual funds per share, achieving both diversification and professional management for a fee. Mutual funds really opened the world of investing to small individual investors. Mutual funds are now the most dominant investment tool in the U.S. They account for 90% of all investment companies, with more than $10 trillion under management in 2007.

4. ETFs: Exchange Traded Funds (ETFs) have been said to be “The new face of investing, changing the way that people will invest from now on.” ETFs are an investment vehicle that evolved out of the structure of mutual funds, although they differ in many ways. ETFs are investment portfolios that are comprised of stocks and other securities that are designed to closely mimic the structure of a particular index such as the S&P 500 or the Dow Jones Industrial Average. The most common types of ETFs are: Indexed ETFs that track different indexes such as the S&P 500, Commodity ETFs that track different commodities such as oil, Currency ETFs that track different currencies such as the dollar, Actively Managed ETFs that track different asset classes creating diversity, Hedge Fund ETFs that track the assets of different hedge funds, and leveraged ETFs. Unlike mutual funds, ETFs do not have fees and trade more like equities, meaning that there is a usually a ticket charge associated with each buy and sell, and are priced immediate when they are bought and sold. Just like equities you can place limits and stops on ETFs. ETFs are amazing because they give you access and cost efficiency of mutual funds and the transparency and flexibility of a stock.

Next time I will talk more about compounding interest and the rule of 72 due to popular demand. I guess that you are interested in knowing how investing will grow your money!! 

Until next time...

Bre

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Investing 101

Hello Everyone! I have finished talking about different savings options for now. I will revisit this topic later. Now I am going to talk about the basics of investing. There are a lot of different types of invests and I can't tell you how often I see people so confused that they think when they are invested in mutual funds they think they are invested in cash! Tonight I am going to start with some definitions.

1. Stocks: Often referred to as equities, stocks are ownership shares in a corporation. When you invest in equities you are investing in the unlimited gain and loss potential of the company. There are many types of stocks that can be characterized by many different "buzz" words. Some of the buzz words you may have heard are small-cap, mid-cap and large-cap. Cap stands for capitalization and this is referring to the size of the company by the market capitalization of it's shares outstanding. Small-cap companies are those with between $300m and $2b in market cap. Mid-cap companies are those with between $2b and $10b in market cap. Large-cap are companies are those with more than $10b in market cap. Other buzz words you may have heard are growth and value. Growth companies are smaller companies that have potential for a lot of growth, and investors will try to invest in these companies and ride the wave of return that is produced from the company's growth. Value companies are those whose stock price is considered to be under priced, therefore investors will invest in them because they think that the stock is "cheap". Investors have different philosophies about how investing in different types of stocks will make them the most money.

2. Bonds: Often referred to as fixed income or debt. When you invest in a bond you are actually loaning your money to the company or government that is issuing the bond. In return for the loan the issuing company gives you an interest payment. At the maturity date of the bond the investor receives the par value of the bond usually $1,000. You can buy bonds at a discount or at a premium. A discount means that you purchase the bond for less than par and a premium means you purchase it for more than par. Let's use an example, say you buy a bond that is priced at a discount at 90 (which really means $900 but  when pricing bonds the last zero is not shown). The maturity date of the bond is four years from now and the annual coupon (interest) payment is 8%. Usually bonds pay a coupon every six months, therefore you will receive a coupon payment twice a year at 4% for the next four years (8 payments total). At the end of the four years on the maturity date you will receive par for your bond, $1,000. Therefore, by the end of the maturity date you will have received 8 payments of $40 plus an additional $100 for the par payment (your paid $900 and then you received $1,000). You can sell your bond before the maturity date on a secondary market, however once you sell it you forgo any future coupon payments and the price that you sell it for is subject to the market and therefore may be below par. In general bonds are considered to be less risky than equity because you are guaranteed the income stream from the coupon payments and the par at maturity. However, if the company that you are loaning your money to goes into bankruptcy then you have the potential to lose the money that you loaned. This is called default risk. There is another form of risk associated with bonds called interest rate risk. If you were to invest in a bond today that is paying 4% per year, and then in two years interest rates are much higher and you could invest in a bond at the same price at 6% per year, but you cannot get this higher interest rate because your money is tied up in the lower interest rate bond then you are losing out in a potentially higher interest rate. This is what is called interest rate risk.


Next time I will talk about mutual funds and exchange traded funds.


Cheers,
Bre


*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

IRAs and Return

Hello Everyone! After my last post I got a great question about IRAs and returns. The question was that there seems to be a lot of IRA CDs that are returning less than 4.5%, and have maturity dates, which makes them fairly illiquid. Where can you find IRAs that will give higher returns? The first thing that I want to clarify is that an IRA is a type of account, not a type of investment. An IRA account can be invested in many different types of investments. You can by investments with levels of downside protection and maturity dates such as a CD or an annuity. However, due to the current low interest rate environment these types of investments are lucky to return 4% per year and are very illiquid. But you can buy many other types of investments in your IRA such as stocks, bonds, mutual funds, ETFs and  options. As I previously mentioned, the stock market returned about 13% in 2010. Therefore there are definitely places where you can find higher returns in your IRA. You can even buy real estate with IRA money, however there are some limitations to this, so I recommend consulting an expert before purchasing real estate with IRA money.  Therefore, if you are looking for higher returns in your IRA you will need to move away from the "risk less" investment such as CDs and fixed annuities and invest in riskier investments such as stock, bonds and mutual funds... Be aware that there is a potential for great losses in these types of investments, therefore if you are not sure what you are investing in make sure that you hire a professional. I will continue to talk about different investment types in later blogs. 

I hope that this helps to clarify investing and IRAs.

Cheers,

Bre


*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Roths

Hello Everyone! Tonight I am going to finish our discussion on retirement savings. Last time we talked about IRAs and 401(k)s. Now we are going to talk about another type of IRA and 401(k) called a Roth. A Roth IRA has many similar characteristics to a traditional IRA except that it is funded with after-tax earned income. You may remember that one of the main benefits of an IRA is the tax-deferment (your money grows tax-deferred, no taxes are paid until it is withdrawn), so then why a Roth? The first benefit of a Roth is that the interest is tax-free. Therefore when you take a withdrawal you will owe no taxes because the principal was already taxed as income and the interest is tax-free! The second major benefit of a Roth is that it has more liquidity than a traditional IRA. You can withdraw the principal (the money that is contributed to the account, not the interest) at any time penalty free. This can be a big factor for young professionals, if you do not already have a lot of savings you may not want to tie of your money in an illiquid account in case of an emergency. There is a 10% penalty on early withdrawals of interest before the age of 59.5. You can also use Roth funds for some education, buying a home and health care. Therefore a Roth can be a great way to save for children's education. Another fact that you want to consider when you contribute to a Roth is your current tax bracket. If you are currently in a low tax bracket it may be a good time to contribute to a Roth instead of a traditional IRA, because hopefully when you retire you will have more income (and therefore a higher tax bracket) than you currently have! If you are currently in a high tax bracket, the tax-deferment of a traditional IRA may be better. However you never know what taxes are going to look like in 30 to 40 years from now when you retire. Therefore a good idea may be to have both a Roth and a traditional IRA so that you can diversify your tax liability. The annual contribution limit for a Roth is the same as a traditional ($5,000), but remember that this is for all of your IRAs. Therefore if you have a Roth and a traditional your totally contribution will be $5,000 per year NOT $10,000.

There are also Roth 401(k)s. In the case of a Roth 401(k) there will be two "buckets" of funds.    There is the traditional 401(k) "bucket" that the employer contributes to, and there is the Roth "bucket" that the employee contributes to. I am not going to get too much into this because you should have all the pieces to understand how this works. The contributions and employer match will be the same in a traditional 401(k), and the tax-free interest and after-tax principal is the same as the Roth IRA.

I hope that this is enough information to help you decide how you want to start saving for retirement. Remember it is never too early to start saving for retirement. 

Cheers,

Bre

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Savings Accounts

Hello everyone! Tonight I am going to talk about what options you have for savings accounts. Depending on what your expectations for interest returns are, your risk tolerance, your need for liquidity and the reason that you are saving, there are many options for savings accounts. 

Let's start with retirement accounts. In the "good old days" people got their retirement through pensions. Pensions are a form of Defined Benefit plans where upon retirement the retiree gets a guaranteed annual cash flow. The benefit varies from company to company, however it can look something like 75% of your top three paying years. Even though pensions still exist in some industries such as education, government and the airlines, very few people can rely on the benefits that a pension provides. More common now are Defined Contribution plans such as a 401(k). A 401(k) is a retirement savings plan provided by an employer. Although the structures can vary greatly, in general, the employee contributes to the plan, and then the employer matches the contributions. The match will vary, but an example could be up to 4% of your annual salary, or 30% of every dollar contributed. There are limits on the contributions. The employee can contribute a maximum of $16,500 per year (2011) and the combined contribution between the employee and the employer cannot exceed the employees annual salary. The money in a 401(k) is pre-tax, and the interest grows tax deferred. You cannot access the funds in your retirement accounts until you are age 59.5 penalty free. When you do withdraw the funds at retirement, withdrawals are treated as ordinary income for tax purposes. These tax benefits allow you to earn interest on funds that would ordinarily be going to Uncle Sam. There are a lot of details involved with 401(k)s and this was a pretty basic explanation, however some of the highlights of 401(k)s include firstly, the employer match. This is basically free money, therefore if you are lucky enough to have a 401(k) you should always try to contribute at least as much as the employer will match. The second significant benefit is the tax deferment. There are a couple of things to be aware of when participating in a 401(k), the first being the illiquidity of a 401(k). This is money that you should not expect to need until retirement. The second thing to be aware of is the investment choices within a 401(k). They are often very limited therefore you want to make sure that your savings is properly diversified.

The second type of retirement account that I will talk about tonight is an IRA. If you are not fortunate enough to have a 401(k) there are options for you to save for retirement. An IRA is a retirement savings account that an individual can open outside of their employment, however if does have to be funded with earned income. The primary benefit of an IRA over an ordinary brokerage account are the tax savings. In a traditional IRA all contributions are pre-tax. Therefore, similar to a 401(k) you can be earning interest on the money that you would ordinarily pay to the government. The interest is also tax-deferred. The contribution limit on an IRA is $5,000 per year, therefore there is a lot more opportunity for savings in a 401(k) with a contribution limit of $16,500. Another benefit of an IRA is that it can be invested outside of the investment constraints of a 401(k).  Again, any withdrawals will be penalized at 10% plus the taxes you owe if withdrawn before the age of 59.5. All withdrawals are taxed as ordinary income, even after retirement age. 

I think that that is enough for tonight. There are still a lot of savings accounts to discuss! But I will continue tomorrow. If there is something that you do not understand let me know. I thought of an interesting tidbit about compounding interest that I thought you might like: If you invest your money at 10% per year and make no additional contributions, your money will double every 7 years!

Cheers,

Bre

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Clarification

Hello Everyone! So I have gotten some great feedback already from all of you and I love it! I realized that some of  the acronyms that I have been using are not clear to everyone. If you do not understand something don't be afraid to say something because I am sure that you are not the only one. Here are 2 points of clarification:

1. CD: CD stands for Certificate of Deposit. They are essentially "Risk-free" investments that earn slightly higher interest rates than a savings account because they are held for a specific time period. Therefore you can earn higher interest because there is less liquidity than a savings account.

2. S&P 500: S&P 500 stands for the Standards and Poors 500 Index. This is one of the most popular US stock markets indices. It is an index of 500 Large-Cap companies. It is a favored index to use when looking at the health of the stock market because of the large number of companies that it represents as opposed to the Dow Jones Industrial Average, which is an index of only 40 companies.

Hope this helps!

Cheers,

B

Interest and Liquidity

Hello everyone! So let's continue our conversation about saving... I realized that there are two basic concepts on interest that I forgot to discuss yesterday. The first being inflation. As you probably know the value of money changes, so a dollar today has a lot less value then it did 50 years ago. In a "normal" economy inflation grows at about 3% per year. We can get into inflation and how the Fed and the Government tries to control it in a later discussion. However it is important to consider this because if your money is sitting in cash or in a very low returning investment you may actually be losing value. If your money is only growing at 25bp (0.25%) and inflation is growing at 3% then you are losing 2.75% every year! 

The second topic that I want to discuss is compounding interest. Einstein once said that positive compounding is the best invention. Let's use a really easy example: if you invest $100 for 1 yr at 10% then at the second year you will have $110 and then at the third year you will have $121... Now add a few zeros after those values and you can see the power of compounding. However, remember that if positive compounding is the greatest invention, then negative compounding is the worst. For example, you have $15,000 and you lose 50% in the stock market, and now you have $7,500. What return do you have to make to get back to $15,000? 100%! and it only gets worse the more you lose. So remember that when you are saving and investing, not losing is winning. 

Ok so now that I have talked about a lot of different scenarios for interest, the next thing that 

we need to consider is liquidity. Liquidity is the ability to access your funds immediately without a significant change in value. Clearly the most liquid type of account is a checking account. You can access your funds anytime you want with no fees (other than ATMs!). Then there are savings accounts, which may have some restrictions on how much you can withdraw but in general they are very liquid as well. Then there are brokerage accounts, which are savings accounts that are invested in stocks, bonds, mutual funds, ETFs, etc. While typically there are no restrictions on how much money you can take out you can be restricted by the what the money is invested in. There are often fees associated with trading and it usually can take a couple of days to actually get your money. Then there are retirement accounts such as IRAs and 401ks. Other than a few exceptions you will get penalized for taking money out of these types of accounts before the age of 59 1/2. Finally, there are investments such as CDs and annuities that will have significant penalties if you try to withdraw the funds before the maturity date. 

My next discussion will take all of these factors about interest and liquidity and discuss what options there are for savings and I will go into specifics about these different types of savings accounts.

Cheers,

B

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

New Years Resolutions

Hello Everyone! This week I am going to talk about saving. Some of my New Years resolutions for 2011 include personal savings goals. There are a lot of ways to save money and there is a lot to consider when choosing the right way to save. One of the big challenges for me is the mountain of student loans that I have as well as limited cash flow. Therefore I am stuck with the question of whether it is more important to aggressively pay down my loans or to save? While everyone's situation is different, here are some things to consider...

The first two things to consider are interest rates and liquidity. These two factors will help you get the right combinations debt reduction and savings. Today I am going to focus on interest rates.

Interest Rates: Make sure that you consider both the interest rates that you are paying on any debt, as well as the interest rates that you are making, or could be making on your savings. You probably know that interest rates are at extreme lows right now. This can be both good and bad. This is great if you are a home buyer and can secure a mortgage at less than 5%.

On a historical basis, mortgages are extremely cheap.. However if you want a "riskless" investment such as a CD or a savings account your money may only be making 25 basis points (there are 100 basis points in 1%, therefore 25 bp = 0.25%). The low interest rates that are being provided on CDs and savings accounts are definitely something to consider when choosing where you want to save. 

Unfortunately there are no magic answers to the low interest rates on your savings. While there are places that you can earn higher returns, for example the S&P 500 was up over 12% in 2010, there are significantly more risks associated in investments that give higher returns (and potentially large losses, we all remember 2008!). To make the situation even trickier, credit card rates are not nearly as forgiving as mortgage rates, currently averaging right around 15%, and student loan rates averaging around 6%.

Tomorrow I will consider liquidity and then later this week, we will discuss some options for savings solutions based on interest rate, liquidity and cash flow needs.

Cheers,

B

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.

Introduction

Hello everyone. My name is Bre and I am 20 something living in Denver, CO. I work in personal finance and I have a Masters of Science in Finance. Recently I have realized that my friends and family know so little about personal fiance that it could be dangerous. This is no fault of their own, if you were to ask me how to build a desk or how to draw blood that would be dangerous. The difference is that everyone has to deal with their personal finances, while I hope that I never have to draw someone's blood. Additionally, I really enjoy sharing the knowledge of personal finance that I have with people. It is important that young professionals learn about personal finance, you do not have to be rich to make good financial decisions. This is why I am starting this blog. I know about personal finance, I love personal finance, and there are a lot of people out there that need to know more about personal finance.

There are so many things that I can discuss: taxes, saving, retirement, retirement accounts, credit scores... I am going to choose a theme per week and try to come up with as many facets of that topic I can think of to discuss. However, I think that knowing what you want to know about personal finance will make this blog a lot more interesting. So PLEASE ask questions! 

*This blog is strictly informational. The views are my own, and you should contact a financial professional before making any decisions. I am not paid or in anyway endorsed for the content of this blog.