Investing Basics – Stocks and Bonds

Have you ever had a conversation with someone who is an expert in a certain area? It could have been meeting with your CPA to go over your taxes or talking with your real estate agent during a house hunt. Experts tend to use a lot of professional jargon. Most of them don’t realize that you may not understand. They get caught up in the conversation and you keep nodding because you are afraid of them thinking you are dumb. Unfortunately, some professionals know this and they will use jargon to make themselves sound smart. Investment professionals are particularly bad when it comes to making sure clients understand. So, I am going to have a series of blog posts called Investing Basics designed to explain different investment options.

There are many different investments available, but I am going to start by covering the two most common forms. These are stocks and bonds. Many people in the US only invest in these two options. If you participate in an employee retirement plan, then you definitely own at least one of these. Now the question is, “What the heck are stocks and bonds?”.

Stocks (also referred to as “shares”) are partial ownership of a company. Most companies issue stock in order to raise money and grow business operations. The stocks can then be bought and sold by anyone in the world. People buy stocks because they expect a company to make money in the future which will cause the value of their stock to rise. Stocks can also pay dividends to their shareholders, something that I will explain in more detail in a later post. Example: If I purchase one share of Apple stock, I am about a 0.00000001% owner of the company.

Bonds represent debt of a company or government entity (Federal, states, and cities). They issue bonds and promise to pay buyers interest over the life of the bond. Corporations will prefer to issue bonds when they do not want to give away more ownership in their company. They receive the money now, but are required to pay it back over a set period of time. People invest in bonds because they receive a set interest rate that they will be paid over time. Example: The State of Missouri wants to raise money for a construction project. They issue 10 year bonds at a 3% interest rate. I buy a bond for $1,000 so I would get paid $30 each year for 10 years and then receive my $1,000 at the end of the 10th year.

Stocks and bonds will probably be the majority of your investments throughout your life, but most people own them through a mutual fund. A mutual fund is essentially a group of stocks and/or bonds that is managed by a professional company. I will explain more about those in the future as well.

Now you know! I don’t think this will change how you invest, but I do want you to understand what these investments represent. And next time you laugh at the People of Walmart blog, just remember that you are probably a tiny owner if you have an investment account. That shopper may not be wearing a shirt, but hopefully they spend a lot of money.

Mike Zeiter, CPA/PFS

A Beginner's Guide to Roth Accounts

Does anyone else remember the commercial where a younger woman and her grandfather are in the car talking about retirement? Am I the only retirement nerd? Guess so. Anyway, the grandfather is on the phone, gets frustrated and says, “ROTH?!?! Who’s Roth?” I won’t go into the details of the life and times of Senator Bill Roth, but he helped change the landscape of retirement savings for everyone. Roth retirement accounts can be extremely beneficial when planning for your future. 

First, let me explain how a Traditional IRA (Individual Retirement Account) works. A traditional account allows you to set aside money now without paying tax on it. You receive the benefit in the year you make the contribution, but it will be taxed when you take the money out of your account during retirement. The hope is that you are in a higher tax bracket now than during retirement, which may or may not be the case.

What makes a Roth IRA different is when you pay taxes. It allows you to pay tax now and never pay tax on that money or the gains again. These accounts allow your investments to grow tax free. For instance, let’s say you put away $5,500 a year in a Roth IRA starting at age 25 until you turn 65. You will set aside a total of $220,000 over the 40-year span and pay tax each year on the amount contributed. However, if you invest that money in the market over that time, your investments could grow to over $1.5 Million. You would never pay tax on that money when you withdraw it during retirement. Not too shabby!

Roth accounts are offered for IRAs and some employer 401k’s. Anyone can open a Roth IRA. There are income restrictions on whether you are allowed to make contributions. However, you can always convert money from a traditional IRA to a Roth IRA. You must pay tax that year on the amount you convert. Roth 401k’s are becoming more popular now. They are great because there is no income limit for annual contributions and you are allowed to put up to $18,000 in each year.

There are many other rules and differences to consider when choosing between Roth and traditional retirement accounts, but these are the basics. The most important factors are your age and tax bracket. If you are under 40 and/or below the 25% tax bracket, a Roth account will almost always be the better option. Tax rates can always change, but there is a sense of relief knowing that the money in your Roth accounts is all yours and will never be taxed again.

Don’t forget you can make contributions for the 2016 tax year until April 15, 2017!

Mike Zeiter, CPA/PFS