Investing your money can seem intimidating because it’s so much different from working. When you work, you get paid for your time, your expertise, and your experience. You put in an hour of work; you get paid an hour of wages.
With investing, you simply put your money into an investment and wait for it to (hopefully) appreciate. Sometimes the value goes up, sometimes, it goes down, and it can sometimes seem like there’s no rhyme or reason to it. To some extent, at least in the short term, there isn’t.
However, investing is one of the best ways to grow your wealth because your money can grow while you are off doing other things. Let’s spend a little time today demystifying the various ways you can invest and make your money grow.
Stocks
When you buy stocks, you’re buying an ownership stake in the underlying company. If you own a share of Apple stock, it means you are an owner of Apple Incorporated. A very small owner but an owner nonetheless.
The key to investing in stocks is time. Stocks are traded all day, and the prices can vary greatly from minute to minute. That volatility can make your stomach churn, especially if your ownership stake is a big percentage of your portfolio.
One way to lower the volatility is to invest in a lot of different companies. The value of Apple stock is likely not closely correlated with many other companies because they are in different business categories. One of the ways to buy a lot of different companies is to invest in index funds.
Index funds give you diversification without the added cost. Instead of buying shares of 500 individual companies, you can just invest in an index fund that matches the S&P 500 index. You can often do this very cheaply as index funds have some of the lowest expense ratios.
Index funds are a type of mutual fund. A mutual fund is a managed investment fund. Investors give the mutual fund their money and the fund invests it on their behalf. Index funds are cheap because the management is easy – just follow an index. Other types of mutual funds exist to invest in specific categories or goals, such as investing in gold or real estate. Those funds are often more expensive because they require more people and expertise.
If you have the patience and fortitude to wait, investing in stocks can yield some of the biggest annual returns compared to other assets.
Come tax time, you will report capital gains or losses from your sale of stock on your tax return. Depending on how long you held the stock before selling it will determine if it is a short-term or a long-term capital rate. Short-term capital gains are for gains on investments you have held for one year or less. While long-term capital gains are for gains on investments you have held for longer than one year. The capital gains tax calculator can also help you with your tax planning to find out if you have a capital gain or loss and compare your tax outcome of a short term vs. long term capital gain — whether you already sold or are considering selling your stock.
Bonds
A bond is essentially a loan. When you buy a bond, whether it’s from an individual company, a municipality, or the United States Treasury, you are lending money to that entity.
Each bond has a face value, a term, and a coupon. The face value is the amount you get back after the term expires. The coupon is an interest payment you receive while you hold the bond. A 30-Year Treasury bond is issued by the United States Treasury that has a term of 30 years, an interest rate set at auction, and pays out that interest every six months. At maturity, you get paid the face value of the bond.
You can buy and sell bonds on the secondary market, much like stocks, and how much you pay for the bond is set by supply and demand. If you buy a bond and hold it until maturity, you know how much you’ll make on your investment as long as the entity avoids defaulting on the bond.
Depending on the type of bond you buy will determine your tax situation.
Generally, the interest you earn on Treasury bills, notes, and bonds are subject to federal income tax but not state or local income tax. Also, interest that your savings bonds earn is subject to any federal estate, gift, and excise taxes and any state estate or inheritance tax. However, if you use the savings bonds to pay for higher education you may be able to keep from paying federal income tax on your savings bond interest but there are some rules that apply.
Interest from municipal bonds are tax-free at the federal, state, and local levels as long as investors reside in the same place or municipality as the issuer. However, if the municipal bond is purchased in the secondary market and later sold, they may be taxed at ordinary long-term or short-term capital gains.
Certificates of Deposit
A certificate of deposit is a type of deposit account you open with a bank. A CD will have a term and an interest rate. The longer the term, the higher the interest rate. As long as you don’t close the CD, you’ll get paid that interest rate until the CD matures.
A CD is an extremely low risk because it’s backed by the bank itself. Your only fear is that the bank collapses, but even in that rare case, the FDIC should step in and make you whole up to $250,000.
If you need access to your funds and want to close the CD, you will have to pay an early withdrawal penalty. This penalty is often calculated in days of interest, depending on the bank’s fee structure and the term of your CD. Generally speaking, the IRS will tax the interest you earned on your CD as ordinary income.
These are just three simple ways for you to grow your money. The world of investing is much bigger than stocks, bonds, and CDs, but this is a good place to start.
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