There are many types of Investments. There are safe ones, risky ones, in-between ones. The most common types of investments are these.
Source: investopedia
From highest to lowest risk (and consequently highest return to lowest return):
Stocks are individual shares in company (such as 50 shares of Google). You buy a a part of the company. You make money if the stock increases in value (if the company does well). These can earn you lots of money if you choose the right company. You can also lose your shirt. Key word: Diversify!
Invest in stocks for the long-term: retirement, or for at least 10 years. This is not a place to store your down-payment cash.
Mutual funds: A collection of stocks and bonds. A mutual fund can have hundreds of different companies' stocks in a variety of industries (health care, technology, manufacturing). Can be high- or low-risk, depending on its balance of stocks vs bonds. Good for diversification. A 10% average annual return is respectable. More on mutual funds here .
Money Markets: A type of mutual fund that is low-risk. You can often write checks using money from these accounts. Good for short-term investments (2-3 years), since you can be pretty sure your money will be safe and get a decent return (5% or so -- shop around).
Bonds: An investment based on debt. "When you purchase a bond, you are lending out your money to a company or government." Low-risk. Good if you need steady income and cannot tolerate risk. Folks in retirement tend to have these types of investments.
CDs (Certificates of Deposit): An investment that is set for a fixed time period at a fixed rate, say $500 for 6 months at 4.6%. Local banks sell CDs. Low-risk, because you know how much money you will make from the start. There is usually a penalty for early withdrawal.
Savings accounts: Your garden-variety savings account you have at the bank. Barely beats inflation, if at all.
Friday, January 4, 2008
Asset allocation
Asset allocation is a way to divvy up the types of investments you have -- some a very high-risk, others less so. It's all about having a balanced portfolio. Time is your best friend when it comes to investing. Typically, younger people (in their 20s and 30s) have time on their side, so their portfolios have more high-risk (and high-return) investments. The older you get, the lower risk you can take.
Types of assets (from highest to lowest risk) are:
* Stocks
* Bonds
* Money Markets
* CDs (Certificates of Deposit)
* Savings accounts
Picture a round plate with different types of pies. Your high-fat, high-sugar (but very very tasty) banana cream pies are your stocks. Your sugar-free, fat-free fruit pies are your bonds. Your sensible chicken pot pies are your money markets and CDs. The younger you are, the more banana cream pies you can have. The older you get, you lean more toward the sugar-free and chicken pot pies.
A younger person might have this type of asset allocation:
Suze Ormanwould even recommend against any bonds at all.
A person in or near retirement might have one that looks like this:
Vanguard has cookie-cutter funds it calls "Target Retirement" funds. The asset allocation becomes more conservative the closer you get to retirement. Here's a sampling of the asset allocations. The year indicates the investor's date of retirement:
Target Retirement 2035: 89.9% stock, 9.95% bonds, 0.15% short-term reserves*
Target Retirement 2025: 79.12% stocks, 20.82% bonds, 0.06% short-term reserves*
*(Money markets, bonds, savings accounts fall under "short-term reserves.")
Types of assets (from highest to lowest risk) are:
* Stocks
* Bonds
* Money Markets
* CDs (Certificates of Deposit)
* Savings accounts
Picture a round plate with different types of pies. Your high-fat, high-sugar (but very very tasty) banana cream pies are your stocks. Your sugar-free, fat-free fruit pies are your bonds. Your sensible chicken pot pies are your money markets and CDs. The younger you are, the more banana cream pies you can have. The older you get, you lean more toward the sugar-free and chicken pot pies.
A younger person might have this type of asset allocation:
Suze Ormanwould even recommend against any bonds at all.
A person in or near retirement might have one that looks like this:
Vanguard has cookie-cutter funds it calls "Target Retirement" funds. The asset allocation becomes more conservative the closer you get to retirement. Here's a sampling of the asset allocations. The year indicates the investor's date of retirement:
Target Retirement 2035: 89.9% stock, 9.95% bonds, 0.15% short-term reserves*
Target Retirement 2025: 79.12% stocks, 20.82% bonds, 0.06% short-term reserves*
*(Money markets, bonds, savings accounts fall under "short-term reserves.")
Suze Says
Suze Orman has concise and practical information on investing. From her book "The Money Book for the Young Fabulous & Broke":
• Fund 401(k) to contributing max of employer
• Fund Roth IRA to annual max ($5,000 for 2008; annual income must be less than $100,000)
• Build 8-month emergency fund ($18,000)
• Pay off credit cards (especially over 8%, as their interest “beats” investments)
• Make a 20% deposit on a home to avoid PMI
Related links:
Suze's Site
Wikipedia entry on Roth IRA
• Fund 401(k) to contributing max of employer
• Fund Roth IRA to annual max ($5,000 for 2008; annual income must be less than $100,000)
• Build 8-month emergency fund ($18,000)
• Pay off credit cards (especially over 8%, as their interest “beats” investments)
• Make a 20% deposit on a home to avoid PMI
Related links:
Suze's Site
Wikipedia entry on Roth IRA
Wednesday, January 2, 2008
Tax-efficient or not?
Why do I care?
If you want to eek out as much money as possible from your investments, you will choose tax-efficient funds to put into types of investments that you have to pay taxes on now: stocks, general money market and mutual funds. You can put tax-inefficient funds into investments you don't yet to have to pay taxes on, such as 401(k) and Roth and Traditional IRAs (this money grows tax-free).
How do I know if my fund is tax-efficient?
Source: USA Today
If a fund is tax-efficient, you the investor will not pay as much in taxes. A tax-efficient fund does less buying and selling from within (therefore not a lot of capital gains and not a lot of tax money due) and invests in companies with low dividend payouts.
* Look for low tax-cost ratios, found at Morningstar.
A ratio of 1 means that the fund gave up an average of 1 percentage point to taxes over time. So if a fund boasts a 13% return on money, you'd only get 12% return if the tax ratio was 1 %.
* Look for funds sold as "tax-managed" funds.
* Index funds, particularly large-company index funds, also tend to be tax-efficient. The funds simply track a stock index, such as the Standard & Poor's 500-stock index. These funds tend to trade infrequently.
Tax-inefficient funds
Source:Morningstar
Tax-inefficient funds are ones that cause your tax bill to rise.
* Ones that have high tax-cost ratios
* Funds that trade a lot, and thus generate heavy short-term gains
* Bond or REIT funds.
* High-turnover stock funds.
If you want to eek out as much money as possible from your investments, you will choose tax-efficient funds to put into types of investments that you have to pay taxes on now: stocks, general money market and mutual funds. You can put tax-inefficient funds into investments you don't yet to have to pay taxes on, such as 401(k) and Roth and Traditional IRAs (this money grows tax-free).
How do I know if my fund is tax-efficient?
Source: USA Today
If a fund is tax-efficient, you the investor will not pay as much in taxes. A tax-efficient fund does less buying and selling from within (therefore not a lot of capital gains and not a lot of tax money due) and invests in companies with low dividend payouts.
* Look for low tax-cost ratios, found at Morningstar.
A ratio of 1 means that the fund gave up an average of 1 percentage point to taxes over time. So if a fund boasts a 13% return on money, you'd only get 12% return if the tax ratio was 1 %.
* Look for funds sold as "tax-managed" funds.
* Index funds, particularly large-company index funds, also tend to be tax-efficient. The funds simply track a stock index, such as the Standard & Poor's 500-stock index. These funds tend to trade infrequently.
Tax-inefficient funds
Source:Morningstar
Tax-inefficient funds are ones that cause your tax bill to rise.
* Ones that have high tax-cost ratios
* Funds that trade a lot, and thus generate heavy short-term gains
* Bond or REIT funds.
* High-turnover stock funds.
Where do I invest first?
You've got your cash and the willingness to invest it for the future. Where do you start? First your 401(k), then a Roth IRA, next other taxable investments such as mutual funds or individual stocks.
Hierarchy of investment, according to Motley Fool
First, invest in your company's 401(k)
Take full advantage of the company match. (Beyond that, consider your other options.) What to invest: tax-inefficient investments such as corporate bonds and high-turnover stock funds. More on tax-efficient investments.
Next, invest in a Roth IRA
Use this account for relatively tax-inefficient investments that you'll hold for a long, long time. What to invest: High-turnover stock funds and high-yield bond funds are options, as are real estate investment trusts (REITs), which can be thought of as high-yielding small-cap stocks. This also could be the account where you do your short-term trading of individual stocks, if you're into that kind of thing.
Also: “Since contributions to a Roth IRA are after-tax contributions, a person should convert this contribution to a before-tax contribution.” How: These after-tax savings rates can be converted to before tax savings rates. This is done by dividing such after tax savings by 1 minus the marginal income tax rate. Source: tiaa-cref
Once you've maxed out the previous options, you still might want to contribute to your plan at work to get the tax deduction and tax-deferred growth. But, your investment options will be limited.
Third, invest in taxable investments (such as plain ole stocks or mutual funds).
What to invest: Stocks that you buy and hold for a very long time — especially stocks that pay little to no dividends. You don't pay taxes on these investments until you sell, and then at the relatively lower long-term capital gains rate. Also, any bonds that pay interest with special tax treatment — such as Treasuries and municipal bonds (which are usually free of both state and federal taxes).
Hierarchy of investment, according to Motley Fool
First, invest in your company's 401(k)
Take full advantage of the company match. (Beyond that, consider your other options.) What to invest: tax-inefficient investments such as corporate bonds and high-turnover stock funds. More on tax-efficient investments.
Next, invest in a Roth IRA
Use this account for relatively tax-inefficient investments that you'll hold for a long, long time. What to invest: High-turnover stock funds and high-yield bond funds are options, as are real estate investment trusts (REITs), which can be thought of as high-yielding small-cap stocks. This also could be the account where you do your short-term trading of individual stocks, if you're into that kind of thing.
Also: “Since contributions to a Roth IRA are after-tax contributions, a person should convert this contribution to a before-tax contribution.” How: These after-tax savings rates can be converted to before tax savings rates. This is done by dividing such after tax savings by 1 minus the marginal income tax rate. Source: tiaa-cref
Once you've maxed out the previous options, you still might want to contribute to your plan at work to get the tax deduction and tax-deferred growth. But, your investment options will be limited.
Third, invest in taxable investments (such as plain ole stocks or mutual funds).
What to invest: Stocks that you buy and hold for a very long time — especially stocks that pay little to no dividends. You don't pay taxes on these investments until you sell, and then at the relatively lower long-term capital gains rate. Also, any bonds that pay interest with special tax treatment — such as Treasuries and municipal bonds (which are usually free of both state and federal taxes).
Tax Tips
If you are itemizing:
Rule 1: Save your receipts
Also save: Charitable receipts, property tax bills
Among items you can deduct: car expenses (if used for work), closing costs, student loan interest, certain dental and medical expenses (but not if already reimbursed by a flex spending account at work), gifts to charity, local income or sales tax, real estate taxes, personal property taxes, and mortgage interest (a biggie).
Should I itemize? Ask the IRS.
In general you would benefit if your itemized deductions are more than the amount shown below:
Single, under 65: $5,350
Married filing jointly (under 65): $10,700
Married filing separately (under 65) and if your spouse itemizes deductions: $0
Head of household: $7,850
Quaifying widow(er) with dependent child (under 65): $10,700
More at the IRS
Rule 1: Save your receipts
Also save: Charitable receipts, property tax bills
Among items you can deduct: car expenses (if used for work), closing costs, student loan interest, certain dental and medical expenses (but not if already reimbursed by a flex spending account at work), gifts to charity, local income or sales tax, real estate taxes, personal property taxes, and mortgage interest (a biggie).
Should I itemize? Ask the IRS.
In general you would benefit if your itemized deductions are more than the amount shown below:
Single, under 65: $5,350
Married filing jointly (under 65): $10,700
Married filing separately (under 65) and if your spouse itemizes deductions: $0
Head of household: $7,850
Quaifying widow(er) with dependent child (under 65): $10,700
More at the IRS
Capital Gains
Capital gains are basically the money you earn in interest on any investments (stocks, funds, bond, money markets, etc) you own.
You have to pay taxes on this money.
So if you are congratulating yourself for buying google at $100, you are also probably sad that you owe the government money.
The better your investments do, the more money you owe to the government in taxes. But, as you will see below, one way you can pay less in taxes is if you hold on to your investments for more than one year.
Capital gains are either short-term or long-term:
Short-term capital gains are the money you earned in interest on investments you owned for less than one year.
Long-term capital gains are the money you earned in interest on investments you owned for more than one year.
How much you have to pay the government:
Short-term capital gains: Taxed as ordinary income. (Whichever tax bracket you fall into.)
Long-term capital gains: 15% for all tax brackets except for 5% and 10% tax brackets. (If you are in either of these brackets, you pay a mere 5% long-term capital gains tax.)
What tax bracket are you in? Click here
You have to pay taxes on this money.
So if you are congratulating yourself for buying google at $100, you are also probably sad that you owe the government money.
The better your investments do, the more money you owe to the government in taxes. But, as you will see below, one way you can pay less in taxes is if you hold on to your investments for more than one year.
Capital gains are either short-term or long-term:
Short-term capital gains are the money you earned in interest on investments you owned for less than one year.
Long-term capital gains are the money you earned in interest on investments you owned for more than one year.
How much you have to pay the government:
Short-term capital gains: Taxed as ordinary income. (Whichever tax bracket you fall into.)
Long-term capital gains: 15% for all tax brackets except for 5% and 10% tax brackets. (If you are in either of these brackets, you pay a mere 5% long-term capital gains tax.)
What tax bracket are you in? Click here
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