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

Tax Deductions

I get this request all the time. “Hey Mike, I need to find more tax deductions so I don’t have to pay as much.” Depending on the person (and my mood), my  response is usually a sarcastic, “You can give half of your income to charity.” Obviously, people generally don’t want to give away half their income just to save on taxes. They are looking for deductions that allow them to reduce their taxes AND keep their money. I am going to simplify the tax code for now and just look at two different types of deductions. The first group are deductions that give you a benefit in the current year and allow you to keep your money. The second group of deductions give you a tax benefit, but you lose the money.

Keep your money and save on taxes - Traditional Individual Retirement Account (IRA), Employee Retirement Plan (401k, 403b, etc.), and Health Savings Accounts.

These are your first choices when looking to save more on taxes. Retirement plan contributions will grow in your account and you will pay tax on them in the future, but hopefully at a lower tax rate. Money that you put into a health savings account can be used for medical expenses in the future and you never pay tax on it.

Spend money to save on taxes – Mortgage interest, property taxes, charitable contributions, business expenses, etc.

This group essentially covers all other tax deductions. The amount you save from these is equal to the expense times your tax rate. These deductions are items that you need to make sure you include on your tax return if you incur them, but don’t create them for the sole purpose of reducing your taxes.

Here's why...

Example: You pay $5,000 in mortgage interest this year and your family makes $100,000 which puts you in the 25% tax bracket. You will receive a tax benefit of 25% of the $5,000 which is $1,250.

Would you trade me $5,000 for $1,250? Probably not. That’s why you shouldn’t do things just to get a tax deduction. It doesn’t mean that you are better off financially. However, some people would rather give $10,000 to a charity of their choice than $2,500 to the federal government. To each his own.

Remember to always think about the true savings when it comes to taxes. Don’t let a deduction tempt you into spending more money than you need to. And next time you hear Joe Cool in the break room talking about how he doesn’t want to pay off his mortgage early because of the tax benefits, you can explain the true financial cost of that decision.

-Mike Zeiter, CPA/PFS

P.S. – I have overly simplified this to discuss the general calculations. The tax rules are much more complicated so please consult with a professional about your specific options around tax planning.

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

 

Finding Your Slight Edge

I just finished reading a magnificent book called The Slight Edge by Jeff Olson. I highly recommend it. The idea of the book is simple. Do something small every day that will make you better off in the long run. For instance, if you decide to go to the gym today, you probably won’t have a six pack afterwards. At the same time, you most likely won’t have a heart attack today if you don’t go. But if you start working out, even if it is just 15 minutes a day, eventually you will be a lot stronger and healthier than you are today. Let’s take that concept and apply it to our finances.

You have all heard the example, “Just cut out that $5 daily latte and you will be set financially.” Is that true? Well…kind of. Let’s say you are one of those Starbucks addicts that stops by on the way to work every day and spends $5. You would save almost $2,000 over the course of a year by cutting out Starbucks. Of course, if you are anything like me, you would probably be arrested for assault before too long… but you get the point. Look at your lifestyle and find something little that you could cut out to save $20 or $30 a week. Start adding that to your savings instead.

Let’s try another example that would be even easier. Log onto your 401k at work and increase your contribution by 1%. If you don’t have a 401k, open an IRA and set up direct deposit of 1% to come out of your paycheck. I don’t want to hear the excuse that you can’t afford to contribute an extra 1%. If you make $40,000 a year, 1% is only $400 spread out over a year. You can handle it. Each year, increase your percentage by another percent. I promise that you will retire with dignity if you stick to this plan throughout your career.

These are just a couple examples but I challenge you to find your own financial “slight edge” for 2017. Do it now! Make it the one New Year’s Resolution that you won’t break by January 31st. Think of one small change that you can make in your life that won’t affect you right now, but it will set you up for long term success. You can do it! There is nothing stopping you from starting your path to financial freedom.

Happy New Year!

Mike Zeiter, CPA/PFS

$1,000 Decision

Congratulations! You have an extra $1,000 in your account at the end of the month. Maybe you got some Christmas money, maybe it’s an inheritance from an uncle, or maybe you worked hard and saved it up. The question that many people face at this moment is, “What do I do with this money?”

So how do you decide what to do with that money? Assuming you haven’t decided to spend it already, there are many places to put the money. I am going to break down the three most common options. You could 1) Keep it in the bank, 2) Pay off debt, or 3) Put it towards retirement. The good news is, there is no right answer. The bad news is, there is no right answer. Some financial experts will swear by one choice and call you an IDIOT for doing anything else. However, unless you decide to take that money and go to the mall for that new wardrobe, you are not an idiot. I am going to make the case for each of these options based on some example situations.

Save it – You live paycheck to paycheck. Every month is a struggle as to whether you will be able to make that next rent/mortgage payment. Put this money in a savings account and pretend it isn’t there. It’s always nice to have some money to fall back on if something goes wrong. Another argument for saving it is if you want to save money for a big purchase coming up; a new car, a vacation, or a home. If it is a home, I would suggest taking the time to build up enough savings for a 20% down payment.

Pay off debt – Let’s say you are an average person with credit card debt, an auto loan, student debt, and a mortgage. You should pay off your credit cards. Credit cards normally have outrageous interest rates and you will be better off getting them out of your life. If you don’t have credit cards, maybe your student loans or auto loan has an interest rate over 5%. Debt can be a major burden on your life, so take the opportunity to pay off extra when you can.

Save for Retirement – You are debt free or very little debt with low interest rates. You are saving a little each month, but don’t have any major expenses planned soon. This is a great opportunity to add to your retirement. Use this money to open up or contribute to an IRA. The money you save early will grow over time to earn much more than if you wait 5 or 10 years. In the words of Albert Einstein, “Compound Interest is the 8th wonder of the world. He who understands it, earns it ... he who doesn't ... pays it”.

The important thing is to make the decision that your are comfortable with. Any one of these decisions could be best for you. Maybe you want to split the money between two options. That's fine! It’s similar to hitting a traffic jam and deciding to stay or take a different route. When you arrive at your destination, do you actually know if you chose the fastest route? No, but you made it to your destination and you were comfortable with your decision. The important thing now is to think about it so you have a plan when this happens to you in the future.

If you have questions or need help, feel free to reach out.

Thanks,

Mike Zeiter, CPA/PFS

Welcome!

Welcome to my Personal Finance blog! For those of you who don’t know me, my name is Mike Zeiter. I am a Certified Public Accountant living in Missouri who specializes in personal taxes and financial coaching.

I know what you’re probably thinking, “What in the world would make me want to read a blog written by a CPA? It’s already boring enough to listen to them talk!” Trust me, I get it. Finances are dull. Taxes are a headache. Budgeting can seem less exciting than getting a cavity filled. My goal is to make this blog informative, but also entertaining for my readers. I want to help you understand important financial topics so that you can make the best decision for your money.

I’m starting this blog to hopefully empower people to take control of their financial lives. Everyone is different. There is no one right answer for how you should handle your money. I wish I could write a book that says, “How to be RICH.” Everyone could just start at page 1 and be wealthy by the end. Personal finance doesn’t work like that, unfortunately.  I want you to understand the options and make the best decision for you and your family.

I invite you all to take this journey with me. My hope is that I can use this blog to help people from all walks of life, all backgrounds, all income points, with every piece of financial baggage or none of it. I hope to help readers with their finances that I may not be able to reach on a personal level. This blog is about you, not me. So, if you don’t like posts, email me and tell me how I can make it better. Your opinion is more important than mine.

Again, welcome to the blog! I’m excited to have you here and can’t wait to hear from you. If you would, comment below with finance/tax topics you would like to learn about!

Thanks,

Mike Zeiter, CPA