Inform Yourself

Our goal isn't to make you a finance expert, teach you how to day trade, or set you up for a career in finance. We aim to get your finance acumen off the ground so you can understand the options you have in making decisions on what to do with your money without paying for an expensive advisor.

Below you will find a variety of topics explained at a 30,000 foot level to give you the base knowledge necessary for the most popular financial topics. We are continuing to expand this page with the popular topics you help choose! If you have a particular topic you would like explained, or anything you would like explained better, please visit the Contact section and you can email our experts.

Table of Contents:

I. Time Value of Money

II. Investment Vehicles

III. Investment & Retirement Accounts

IV. Tips & Tricks

Dollars

I. Time Value of Money

"Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it" - Albert Einstein

Have you ever heard the phrase, "A dollar today is worth more than a dollar tomorrow"? This concept captures the concept of inflation and money left on the sideline. For instance, in 1975, a burger from McDonald's cost about 25 cents, a gallon of gas cost 57 cents, and the median price for a home in the United States was just $38k. Now imagine if you had kept your money in an account bearing no appreciation for the past 5 decades. The money you earned in the 70's wouldn't take you very far, especially now in 2022 with the highest inflation in 40 years. Let's break the surface on the key fundamentals of this concept:

Inflation: The basic concept is simple, prices rise and purchasing power, ie. the value of your dollar, becomes weaker. There are a variety of ways to measure

inflation, but the most popular is CPI.

  • CPI (Consumer Price Index) is the average change in price of a collective group of consumer goods and services. This group consists of items such as groceries, dining, travel, furniture, internet, cars etc. and also consists of fees such as landscaping, house cleaning, and car repair. The weighted average change in prices of all goods and services in this bucket become is taken to calculate CPI.

Real Rate of Return or Real Interest Rate: You may have heard this term before, it goes hand-in-hand with the time value of money concept. The real rate of return or real interest rate is a calculation that determines the true value you are receiving or paying when inflation is taken into account. You must discount your expected return on an investment for inflation. For example, if you expect an investment to generate 10% over the next year (your 'Nominal' rate of return), but inflation is expected to be 2%, then your real rate of return would be closer to 8%. 

Invest to Combat Inflation: The only way to conquer time value of money is to make sure your money is appreciating or earning more interest than the inflation rate. There are several popular investment tactics summarized below that will help to do just that.

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II. Investment Vehicles

Stocks (See Perspective Picks in our Blog for stocks that we like)

The most well-known investment vehicle, yet many people don’t fully understand what a stock is. A stock, specified by a unique symbol such as ‘AAPL’ for Apple, represents a public company. A public company is one that has issued shares to the public for purchase and ownership. Shares are small units of equity, or ownership, in a company. To wrap it up, a Stock represents a company that is at least partially owned by the public. Below are a few common questions that should help you learn the basis of stocks:

  • How do I buy and sell stocks?

    • You can purchase a certain stock through various exchanges, such as the NYSE and the NASDAQ. Brokers such as CharlesSchwab, Fidelity, and Vanguard make it easy and free to buy and sell stocks or other investment vehicles on these exchanges.

  • What does it mean to short sell a stock?

    • Short selling a stock is betting on the price to go down. You essentially use borrowed shares to sell the stock at the current price and hope to buy the stock back at a lower price for a large profit. Since this tactic uses leverage, or borrowed funds or debt, it is very risky. Also, since a stock price has no limit on how high it can go, there is no limit on how much money you can lose.

  • How does a stock price move?

    • A stock price moves purely through supply and demand. If the company is performing well and investors believe that their sales or profit margins will increase, they will be willing to buy or pay a higher price for one share, or ownership unit. On the contrary, if a scandal comes out or investors believe the financials will decline in some way, they will sell for the current price as they feel the company is overvalued.

  • How does a stock price represent the value of a company?

    • A high stock price doesn’t necessarily mean a more expensive or valuable company. It all comes down to the number of outstanding shares or the number of shares the company issued to the public for sale. If 2 companies each have a share price of 100$, but one has 1 million outstanding shares and one has 1 billion outstanding shares, their value would differ immensely. The first company would have a market capitalization, or the total value of a company’s shares of stock or equity stake, of 100 million dollars. The second company would have a market capitalization of 100 BILLION dollars.

  • Below are a few terms that you may have heard regarding the value or risk level of a particular stock:

    • P/E Ratio: This is the most common valuation metric that analysts use to measure if a stock is over or undervalued. The concept is simple, how much money does the company bring in relative to its value. To calculate this, you can take the company’s market capitalization, or equity value, and divide it by the net profit by the company in a given period.

    • EPS: Earnings per share is another common term. This is used to calculate the above P/E Ratio on a per-share basis. All it does is divide the net profit of the company in a given period by the number of outstanding shares. Then the stock price, or price per share, can be divided by the EPS, earnings per share, to find the same P/E ratio

    • Beta: This measure is the riskiness of a given stock or another asset. This is compared to the riskiness, or volatility, of the entire stock market. The entire market, generally captured by the S&P 500 index, has a beta of 1. Any stock or asset that is riskier than the market at large will have a beta greater than 1. Anything less risky than the overall market will have a beta of less than 1.

  • What are the different indexes such as the S&P 500 all about?

    • The major indexes outlined below aim to gauge market performance at an overall level, industry wide level, or by different classes of size:

      • S&P 500: This is the most popular index. It tracks the performance of 500 large public companies. This is a free-weighted index, so the performance of larger companies will have an equal impact as the performance of smaller companies. The companies in this index can consist of virtually any industry and a variety of sizes/growth rates.

      • Dow Jones Industrial Average: This is probably the next most popular index. It is a weighted index that tracks a selected 30 large publicly owned, blue-chip companies trading on large exchanges. Blue chip stocks are typically large and established companies that have strong cash flows/earnings, pay dividends, but do not have room to grow much more.

      • NASDAQ 100: This tracks the 100 largest non-financial companies on the Nasdaq exchange. The Nasdaq exchange consists of over 2500 companies that can range from high growth tech companies to low growth blue chip stocks. This is popularly known as the tech-heavy index because it is weighted based off of company size and the largest companies in the world in 2021 are all technology companies.

      • Russel 2000, or 3000: This is a simple index that tracks the smallest, ie. Small caps, public companies. These 2 different indexes track the 3000 smallest public companies which is then broken down to the 2000 smallest public companies in the world.

      • Russel 1000: Contrary to the Russel 2000 and 3000, the Russel 1000 tracks the performance of the LARGEST 1000 public companies.

 

ETF's

Exchange Traded Funds have become exponentially popular in the 21st century. This goes together with the term, “Never put all your eggs in one basket”. Essentially, they are a bundle of stocks or bonds that provide diversified exposure to the market vs. investing in one individual stock or asset. You can buy these on an exchange the same way you would buy a stock. These ETFs come in a variety of flavors:

  • Track the performance of a particular index

    • The most popular index to track would the S&P 500. Most investment companies have developed their own ETF to precisely return the performance of the S&P 500 index. One example is Vanguard who offers SPY.

    • ETFs have been created to essentially track any index of your choice such as the Dow Jones, the Nasdaq, the Russel 1000,2000,3000 etc.

  • Track the performance of a particular industry

    • There are ETFs available to trade for a diversified investment in the Energy industry, aerospace & defense industry, high growth tech industry, consumables industry, even crypto currency ETFs are starting to arise. In short, you name the sector, and there is probably an ETF for it. One example is QQQ, which tracks the Nasdaq 100/technology oriented companies.

  • Dividend generating ETFs

    • Combine the top dividend paying stocks that do not have huge variations in share price but will pay you a consistent dividend each month or quarter

      • Dividends are excess earnings that companies pay to their shareholders vs reinvesting in their business. This is common for blue chip stocks that have already come close to their ceiling as far as growth and the best investment would be to give the shareholders, the owners, a portion of the profits

  • Bond Funds

    • Collectively purchase a variety of bonds, which can be short term/long term government debt, corporate debt etc. We touch a little more on bonds in section link to bond page

Note that ETFs can either be actively managed or passively managed. Actively managed ETFs have managers buying and selling the components, or portfolio holdings, within the fund. They do this to try and enhance returns and beat benchmark indexes. The active funds have much larger fees to compensate for the active management. Passive funds have much less buying and selling within the fund and only try to match a specific index. The fees, or ‘expense ratios’ as you may see are much lower with these funds.

 

Mutual Funds

Mutual-Funds: Mutual Funds are very similar to ETFs in that they group a variety of securities, investments, into one pool to give you diversified exposure to the broad stock market, a certain industry, or a specific goal such as dividend income. They also can be actively or passively managed just like ETFs. There are a few key differences investors should know about before selecting a Mutual-Fund or an ETF:

  • Many times Mutual-Funds have a minimum initial investment to get started.

  • A Mutual-Fund is not as liquid as an ETF as it doesn’t trade intraday on an exchange like stocks and ETFs

    • The NAV, Net Asset Value, or price of a Mutual-Fund is calculated at the close of the trading day, 4pm EST. If you place an order at all throughout the day, you will receive the price that is calculated at the end of the day. If you wish to sell the Mutual-Fund, you will also get the price that is calculated at the close of the trading day.

  • Mutual funds offer automatic investing

    • With mutual funds, you buy a certain dollar amount of the fund versus a set number of shares like stocks and ETFs. With this, you are able to set up automatic investing and can set a predetermined amount that you would like to purchase on a weekly, monthly, or quarterly basis. This is a helpful tactic when you want to dollar cost average which you can learn more about below in Tips & Tricks.

Bonds

Bonds fall under the umbrella of ‘fixed income’, a term you may have hear before. A bond is essentially the right to receive interest payments from an entity you lend money to. This entity could be the government, such as a US Treasury bond, or a company in which you buy a corporate bond. Similar to how you would take out a loan from a bank and pay them interest, a bond acts the same except you, the buyer of the bond, lends the money and received the interest payments. Simply put, the more risky the repayment of the loan and interest payments are, the higher interest rate you will receive, and vice versa. Below are a few examples of popular bonds in the market:

  • US 10 Year Treasury Note

    • This is the typical benchmark analysts evaluate to determine the cost of debt in our current market. In essence, if you buy this bond you are lending the US government that amount and receiving fixed interest payments for 10 years until they repay the full amount at 10 years. The US government is the most reliable debtor in the world, so the interest rates are typically lower as the credit or default risk is almost zero.

    • Similarly, you can purchase a 20 year or 30 year bond from the US government as well. This will typically pay a slightly higher interest rate since your money will be tied up for a longer period

  • Corporate Bonds

    • Buying a corporate bond is essentially lending money to that company in exchange for interest payments. Different companies have different risk. For example, a startup with a negative profit margin and a lot of other debt on their balance sheet will have a higher default risk than a blue chip company with a long history of strong profits and cash flows. The higher the default risk, the higher the interest payment.

    • In order to determine a company’s default risk, credit rating companies such as Moody’s and Standard & Poor’s, will assign all companies with a rating from AAA all the way down to C or D. AAA is the lowest risk, highest quality of credit, and lowest interest payments while C or D is the highest risk, lowest quality of credit, and highest interest payments to compensate the borrower for that risk. The highest risk companies’ bonds are sometimes called ‘junk bonds’.

Moving on, there are a few different types of bonds you can purchase. Below are a few of the most popular types of bonds:

  • Fixed rate bonds: This type of bond has a set interest payment throughout the maturity of the bond. This is exposed to interest rate risk.

    • Interest rate risk is the risk inherited by the owner of a particular bond. If interest rates rise (ie. the Fed raises the benchmark interest rate), then the value/price of the bond falls. This goes back to supply and demand. If you own a bond that pays 2.0% interest payments each year, but interest rates rise and the new market rate is now 2.5%, people will pay less for your bond since they will receive a lower payment. If you own that same bond, but interest rates decrease and the new market rate is 1.5%, people will pay more for your bond since they can receive a greater payment.​

  • Floating Rate/Variable Bond: This type of bond provides the right to receive an interest rate that is linked to a benchmark rate such as the Federal Funds Rate or LIBOR. In essence, this type of bond is less exposed to interest rate risk as the rate/interest payment will always be close to what you can get in the market.

  • Zero-Coupon Bond: Unlike the fixed rate and floating rate bonds, a Zero-Coupon Bond doesn't make any interest payments (a 'coupon' is another term for an interest payment). In this case, you will pay a discount to par value for the bond up front, and receive a higher amount when the bond expires in the designated timeframe.

    • Par Value is the amount the bond issuer (the one borrowing the money/selling the bond) is obligated to pay back at the maturity/expiration date of the bond.​

 
Image by Carlos Muza

III. Investment Accounts

Not only are there a variety of investment decisions to make, but there is also a list of investment accounts that are built to reach different objectives. Taking advantage of the possible tax havens and other benefits associated with the different type of accounts is just as important as the actual investments you make within them. Below is a summary of the most popular accounts you should know a thing or two about:

  • Individual Taxable Brokerage Accounts: This is the most standard account that you set up through a licensed brokerage firm such as Charles Schwab, Vanguard, or some other institution. This account allows you to place orders with deposited funds to buy and sell the different types of investment vehicles discussed above. There are not special tax advantages to this account, you will have to pay capital gains tax on all investment gains in which you held the asset for more than one year, and regular income tax on any gains through assets you held for less than a year. The most basic form of a brokerage account is a ‘cash account’. This limits your ordering to mostly buying and selling. There are more advanced accounts you can set up to trade on margin (leverage or borrowed stock such as short selling) or trade options.

    • Capital Gains Tax: This is a tax that investors must pay on the sale of any investment held more than one year. As of 2022, for those that earn less than $459,750, the tax is a mere 15%. Above that level of income, it becomes 20%. Nonetheless, you take home more of your income earned through long-term (>1 year) investments than in your job. Again, you must hold the asset (stock, bond etc.) for at least 1 year, otherwise you will pay your regular income tax that you pay for your wages etc.

  • Individual Retirement Accounts (IRA): Outside of an employer-sponsored retirement account, you have the option to contribute to 2 different types of IRAs, a Roth, or Traditional IRA Account that both offer significant tax advantages that an investor must take ahold of if permissive:

    • Traditional IRA Account: This is also known as a pre-tax retirement account as you have the ability to deduct most if not all of you contributions from your tax bill. You can then invest in nearly all of the same options as in an Individual Taxable Brokerage Account, except these will grow tax free until you withdraw in retirement.

      • Limitations: No income restrictions, but you cannot contribute more than $6k/year IN AGGREGATE with your Roth IRA if you are under the age of 50 and $7k if you are 50 or older.

    • Roth IRA Account: The Roth IRA is an even more tax advantageous account as it is a post-tax account. That is, you cannot deduct your contributions on your current tax bill, but you invest and grow your money completely tax free and will have zero tax liability when you withdraw at retirement age.

      • Limitations: You cannot contribute to a Roth IRA is you make more than $142k as a single person of $214k if you’re married. Like the traditional account, you cannot contribute more than $6k/year IN AGGREGATE with your Traditional IRA if you are under the age of 50 or $7k if you are over 50 years old. It is recommended to contribute fully to your Roth IRA if you are young (<35) and under the income limit because you will have decades of tax-free investment growth.

  • Employer-Sponsored Retirement Accounts:

    • Traditional 401(k) – This is nearly identical to the Traditional IRA in which you defer tax payment until retirement. The only difference is that this account is employer-sponsored and the possibility of your employer matching/contributing a certain % of what you contribute. As of 2022, you can contribute up to $20,500 per year to your 401(k) and an additional $6,500 if you are over 50.

    • Roth 401(k) – This is also nearly identical to the Roth IRA above in which you pay tax on your wages but don’t pay any tax on the capital gains when you withdraw at retirement age. The main difference is that this account is employer sponsored and you may receive a matching contribution from your employer up to a certain % of your pay. As of 2022, you can contribute up to $20,500 per year to your Roth 401(k) and an additional $6,500 if you are over 50.

    • Simple IRA (Savings Incentive Match Plan for Employees Individual Retirement Account) – This is for small employers not sponsoring a retirement plan such as a 401k. This allows employees and employers to contribute to a Traditional IRA set up by the employer on behalf of the employee.

    • 403(b) – Similar to 401(k) plans, 403(b) plans are tax advantageous accounts sponsored by non-profit organizations and offer similar services.

  • Education Investment Accounts – These accounts exist to help you save for the towering costs of tuition for yourself or family.

    • 529 Savings Plan – This is the most popular plan for saving for college tuition. There are two possible options for this, and only one of them is an actual investment account

      • Prepaid Tuition – Essentially you can buy credits at today’s tuition rates for future use at an in-state university. If you feel that college tuition costs are going to rise dramatically by the time your child turns 18, this would be a good choice

      • Investment Account – You can contribute savings to an account where you can purchase stocks, bonds, etfs, mutual funds, etc. that will grow tax free as long as you withdraw and use the money for educational purposes. There are maximum lifetime contribution limits imposed by each specific state you must look into before choosing one of these options

  • Health Savings Accounts (HSA) – If you are enrolled in a high deductible health insurance plan, you may have the option to contribute towards an HSA.

    • An HSA is an investment account in which you can contribute money that is tax deductible on your current tax bill, and also grows tax free. This is the most tax-advantageous investment account, but you must use any withdrawals for medical expenses only. On top of that, at age 65, whatever is remaining essentially becomes a retirement account and you can withdraw any amount tax free as well.

      • Limitations: As of 2022, you are able to contribute $3,650 if single and $7,300 if married to your HSA each year. You have the option to invest in most stocks, bonds, mutual funds etc. as you would in any investment account.

Chess Game

IV. Tips & Tricks

"Someone’s sitting in the shade today because someone planted a tree a long time ago" - Warren Buffet

Now that you have some familiarity with the different types of investment vehicles and accounts accessible at your fingertips, it is time to understand the historically successful rules that all amateur investors should know:

1. The best time to start investing is yesterday: Time is literally money when it comes to investing and the more time your money has to grow, the more it will. The 'Rule of 72' implies that money invested in the S&P 500 doubles every 7 years. 

  • The 'Rule of 72' is a concept in which you take 72 divided by your expected annual growth rate of an investment to achieve the rate your investment will double. Since the S&P 500 has historically averaged a 10% return each year, that means your money would double every 7.2 years if invested in the S&P 500 since its inception.

2. A dollar saved is a dollar earned: This concept is simple, but important. Combining this with the rule of 72 helps put in Perspective how much that nice dinner, fancy clothes, new car, will cost you in the long run. The opportunity cost for every dollar you spend on unnecessary items is extremely high. For every dollar you save, you can invest and double it every 7.2 years. 

3. Rome wasn't built in a day: Don't fall for any get rich quick scams trying to convince you that a certain penny stock will go up 1000% in a week. It has been proven time and time again that long term investors are consistently the most successful, whether you invest in conservative funds or a company you believe in.

4. Do not try to time the market: Trying to load all of your money in when the market is falling is like catching a falling knife. You may get in at a price level that you regret months later if the market takes a severe turn as it did during the onset of the COVID 19 pandemic. The best method to avoid this is to dollar-cost average.

  • Dollar cost averaging is a method many long term investors use to limit the risk of getting in the market at the wrong time. For example, if you have $5,000 to invest, the idea is to invest about $1000 per month over the next 5 months or $500 per month over the next 10 months. This will allow you different entry points to avoid putting everything in at the peak of the market.

Use for Interactive Tool:

Young Investors (<35 years old):

Time is on your side, take advantage of it. This is the time to be aggressive with your investments as you have time to go through the peaks and valleys during different economic cycles. You should invest in mostly equities such as the S&P 500 as it has generated the best returns in modern history (10% per year on average) relative to more conservative investments such as bonds, CD's, etc. This doesn't mean you will automatically achieve 10% each year, the S&P 500 will experience swings of -20% some years and +25% other years, depending on the economic cycle. In the past 100 or so years, the average of all of those swings has been a positive 10% return, so certainly a great spot to put your money when you have time. The younger you are, the more aggressive you can be. Maybe you could explore some growth funds/ and stock such as Cathie Wood's ARKK or buying a few shares of Tesla. Again, you have time on your side to bear through the volatility the equities market will create and you will be thankful in the long run.

Middle Age Investors (35-55 years old):

These are the years in which retirement planning starts to enter your mind. You will most likely want to be exposed to some risk as you still have time before retirement, but you certainly can't handle the violent swings of your equity-heavy portfolio when you were younger. Depending on your life goals you may want to slowly expose yourself to some conservative investments such as bonds and bond funds. An economic downturn could create a losing equity market that takes up to 5-10 years to fully recover, especially with riskier equities such as high growth technology stocks. Considering a 80-20 or 70-30 split between equities and bonds in your portfolio may be a decent strategy at this stage of your life.

Retirement Age Investors (55+)

This stage in life will vary for most people. If you have plenty of saved up from a successful career or you were lucky enough to inherit a large sum of money at some point, you may be comfortable with just investing purely in bonds and money market funds as that will generate enough passive income to live happily. If you are trying to retire soon but not sure if you will have enough, you may need to expose yourself to a little more risk in the equity markets to get you over the finish line. The issue with this is it could delay your retirement substantially if the market takes a down turn. Regardless, you should have a fairly balanced portfolio between stocks and fixed income (bonds) at this stage in life. A 50-50 or 60-40 split will be successful for the average portfolio entering retirement. As you get older, you should continue to shift towards a risk averse strategy as you want to spend it while you have time and also leave money for your kin and legacy. The good news is you are able to leave stocks you still own at death to your family who will inherit these stocks with 0% capital gains, ie. essentially the price they paid for them becomes the price they inherit the stock at. In other words, if you bought a stock at $20 and died when it was at $200, instead of having a $180 gain, your children or those inheriting will have a $0 gain and no tax liability for capital gains. 

Please contact us if you have any questions on the topics above or if you would like anything added. We would love to hear from you!

Disclaimer: Perspective Personal Finance does not provide financial advice. This is for educational and interactive purposes only.