Archive for the ‘Investing’ Category:
Investing 101: Bonds
Although stocks seem to get all the attention on the news, another type of investment, called a bond, is important too.
So What is a Bond?
A bond is like a loan between two parties. Typically, this loan is between a person (you or me) and a company or government. When you buy a bond, you’re loaning money to a company who will pay you back what you loaned plus interest. Bonds typically last 3-30 years, depending on who issues them.
What’s So Great About Bonds?
Bonds are known to be much safer than stock. Bonds are all but guaranteed to be paid back, especially if you own one from a stable government or company.
How Do I Buy One?
Bonds are sold through the same brokerages listed in the previous post. For United States bonds, you can purchase them through TreasuryDirect. There, everything is handled electronically and you don’t have to receive an actual piece of paper representing the bond.
How Do Bonds Make Me Money?
Bonds make you money in the same way a bank or credit card company makes money: through interest. Most bonds pay out interest twice a year. How much you receive will depend on the bond’s interest rate and the value of the bond.
Also, once the bond matures (meaning it’s full value is reached), you can cash it in, getting the original amount of money you paid back.
What’s Not So Great About Bonds
Bonds don’t return as much money as stocks typically do. There’s also always the chance that a company will go bankrupt and won’t be able to pay back the bond. Although bond holders get payment before stockholders if this were to happen. I don’t worry about U.S. government bonds not being repaid since if the United States is ever in the situation of not being able to pay me back, I think we’ll have much bigger problems to worry about.
Overall
While bonds are considered “safe” investments and provide a predictable return, you pay a price for this decreased risk: less money. Holding bonds is fine at any age of course, but it’s definitely wise for those middle aged or nearing retirement to transition from stocks to bonds.
Investing 101: Stock
Arguably the most common thing people think of when the word “investing” comes into their minds is stock.
So What is Stock?
Stock is like your own little piece of a company. You buy stock in units called shares. When you buy a share, you give money to the company which can then use it to finance new products or services. When companies sell stock for the first time, it’s called “going public”. This event is a called an IPO or Initial Public Offering. Companies typically only do this once they reach a certain size.
Two Different Types
There are 2 major types of stock: common and preferred.
Common stock allows the shareholder to vote at company meetings, meaning they get a say in how the corporation is run. Common stock holders may also receive payments called dividends. (More on these later)
Preferred stock also allows shareholders to receive dividends, but they do not receive voting rights. The advantage of preferred stock is that they have priority in the event a company goes bankrupt. Common stock holders won’t receive dividends or other payments until after all the preferred stock holders have.
What’s So Great About Stock?
Stock often has one of the best returns of any investment. It’s one of the best places to invest money over long periods of time. Besides the financial benefits, stock allows you to choose which companies to support. You might purchase stock in a company that makes solar panels, but not in one that sells oil, if you believe strongly in green technology.
Where is It Bought and Sold?
Stock wouldn’t make much sense if it was hard to purchase. To solve this problem, something called a stock exchange was created. These organizations bring buyers and sellers together, somewhat like eBay, to create a marketplace. The largest one in the world is called the New York Stock Exchange, commonly abbreviated to NYSE. Others exist such as the NASDAQ, London Stock Exchange, Tokyo Stock Exchange, and many more.
How Do I Buy and Sell Stock?
Although stock is traded in places like New York, (On Wall Street to be specific.) that doesn’t mean you actually have to travel to buy a few shares. That would be really inconvenient, especially back in the day before cars and airplanes.
Instead, stock can be bought and sold through a broker. A broker is a person or company that represents you on the exchange floor. These days, your broker is often just a computer who buys and sells as you click.
Popular Brokers:
How Does Stock Make Me Money?
Stock can make you money in the simple form of buying and selling shares. For example, you could buy a share of Apple for $100 and then sell it at a later date when the price goes up, for say $110. Boom, you just made ten dollars!
Note: This is a vastly simplified explanation of what buying and selling shares is like. Constantly buying and selling shares is a tricky business, one best left to the pros. And even they can lose money!
Dividends- when a company makes a profit, they have the option of putting the money back into the business or making payments to shareholders called dividends. A business might say that they’ll pay a dividend of 25 cents per share. If you owned 100 shares, you’d receive $25.00.
These payments are usually made 4 times a year, once every quarter.
What’s Not So Great About Stock
Stock can be very risky. There’s absolutely no guarantee that you’ll make money. There’s actually a chance you’ll lose everything. Stock is something you buy and hold onto for a long time. Over the long term (10 years or more), the stock market usually returns 8%-10%, but over the short term, the return can be much much less.
Overall
Stock is a vital piece of almost any investor’s portfolio (all of the different investments one holds). This is even more true for young people, since we have the most time to gain from good years and plenty of time to make back what we lose in the bad years.
How to Open a Roth IRA (Do It Today!)
Now that we’ve talked about what a Roth IRA is, it’s time to set one up. To start an account, you have to first pick a broker (someone who buys and sells investments on your behalf). Luckily, it’s not hard decide if you’re young or broke or both.
Of the following companies that I researched, only one would allow me to open a Roth IRA with no minimum deposit or fees.
- T.Rowe Price
- Fidelity
- Scottrade
- Vanguard
- Zecco
- Charles Schwab
- TD Ameritrade
- E*Trade
The decision was pretty much made for me. While I liked Vanguard’s investment strategy (the company is built on index funds, which have low expenses with good returns), I didn’t want to wait to save up $1000 to go with Vanguard. (Other companies wanted at least $500)
Another plus was E*Trade has cool commercials like this one.
So, to setup the account, all you have to do is download this form. (If you’re over 18, you can open it online here.) It asks for the standard information that you’d give any bank when you open up a new account. Address, Social security number, blah blah blah.
There is one section where it asks what your “investment objective” is. I chose Growth, since I’m willing to take some risks (I have 40-50 years until retirement) but not complete chance like Speculation. For trading, I chose 0-3 per month, although I honestly have no idea how often I’ll trade.
In section 9, “Select Your Account Options”, I chose the E*Trade Financial Extended Insurance Retirement Sweep Deposit Account. This is basically just a saving account where your money hangs out until you invest it. Beside this section, you’ll notice you can choose to receive certain account information through the mail. DO NOT select any of these unless you want to pay a fee to E*Trade. (Hint: You don’t)
Once the form is filled out, put it in an envelope along with a check made out to E*Trade Clearing LLC for any amount. The address is listed on the 1st page, in the upper left hand corner. Mail it.
Seriously, that’s it.
Once E*Trade sets up the account, you’ll be ready to invest.
Start Saving for Retirement with a Roth IRA
Have you earned any income in 2009? It could be from the local pizza place, the American Eagle in your mall, or even the cash you received for walking the neighborhood dogs. If you do, there’s a great place to put part of it.
The place is called a Roth IRA. IRA stands for Individual Retirement Account. It’s named after William Roth. What’s so great about it?
What’s awesome is that they allow your money to grow to enormous sums. If you put $2000 a year in a Roth IRA from age 15 until 60 and the market returns 9%, (entirely possible over a period of 45 years by the way) you would have over a million dollars. That’s sick isn’t it? I may be geeky, but that seems really exciting. Even better, you can take this money out when you retire without paying a cent in taxes.
Another bonus for teens: You don’t have to pay income taxes unless you make over $8,950 a year. Since most teens never come close to this, it means that any money you contribute to a Roth IRA will never ever be taxed by the government.
But I don’t have two thousand dollars! What am I going to do?
It doesn’t matter. Open one up anyway. You don’t have to contribute two grand if you can’t or just don’t want to. What’s important is that you open it and put something in. In the future, when you get a “real” job you can start contributing a lot more. But there’s no time like the present and every year you wait, will cost you money. Not just a little money, but a lot of money, as in thousands of dollars.
What’s the Catch?
There aren’t too many disadvantages to a Roth IRA, but keep in mind:
The money you contribute has to be earned. This means you can’t just put in money you got as an allowance. If your parents are really generous though, they can contribute whatever amount you’ve earned and then let you “keep” your money in a savings account or even in cash. You might try to see if they’ll match your contributions. Example: “Mom and Dad, I’ve earned $1000 from mowing lawns this summer. I’d like to keep part of that money to use during the year, but I was wondering if you would contribute $500 if I put in $500.”
Also, you can’t access your earnings until you’re 59-1/2. This shouldn’t be a problem though because the point of this account is to save for retirement. This is not the account you use to save for a car.
You need to have proof you earned your income. This typically means filing a tax return. I know this sounds scary at first, but don’t worry, it’s really easy. I’m planning to write an article on how to file your taxes by the end of February.
If you aren’t 18 yet, you’ll need one of your parents to be the custodian on the account. This is because minors can’t legally enter into financial or contractual agreements by themselves.
Even with these requirements, the Roth IRA is a great way to prepare for your future. You’re young. You have a huge advantage over older people who never opened one. Use it.
Tomorrow, check back for: Where and How Do I Open a Roth IRA?
