How Stock Market Games Can Teach Investing

How Stock Market Games Can Teach Investing

“Tell me and I forget. Teach me and I remember. Involve me and I learn.”     

Benjamin Franklin

 

Want to learn how to invest in the stock market without losing money? Stock market games are a great way to practice whether you are a beginning investor or investing for awhile. These games are an example of learning by doing, also known as experiential learning and practical learning tools.

I am passionate about teaching people, especially young students how to invest in the stock market. Playing the stock market game can speed your learning and allow you to make painless mistakes. Investing is one of the best ways of creating and building wealth for your future. It can be your ticket to financial security and can be mastered as a lifelong skill. 

Investing can be daunting for experienced investors, let alone for those who are just starting. On the other hand, virtual games that can ease your entry are free, fun, readily available, and user-friendly. They offer participants a faster learning curve to build investment skills and better financial habits.

A Generational Opportunity?

During the pandemic, we have seen a significant rise in stock volumes in 2020, with year-to-year volumes up nearly 100% in early  2021. Much of the higher volume seems to be coming from retail trading. As a result of rising interest, young people have been opening up a record number of accounts at Robinhood and Webull. Webull has a virtual trading platform for those not ready to invest real money yet.

This trend may signify a generational opportunity of young individual investors participating in the market as a path to building wealth. These new investors can build their future wealth by first learning how to handle risks, market volatility, ensure portfolio diversification, and financial concepts. Engaging in stock market games can help you build your confidence, skills, and knowledge.

Why Investing Early Matters?

You should start investing early in life to have a long time horizon as possible for these reasons:

  • Leverage the power of compound interest  (interest on interest) earned on your initial investment for significant returns in your retirement and investment accounts.
  • Take on more significant risks when you are young and able to absorb the bumps and bruises of downturns.
  • Motivate yourself to save more, spend less so that you can grow wealth.

Investing is a viable means to accumulate wealth and enjoy financial comforts. The earlier you start to save money for investing purposes, the better.  Parents should begin talking to their kids about money when feasible, exposing them to investing basics and developing good financial habits.

Simulated Games Are Suitable For Virtually Everyone

Young people can get a big jump on investing by playing virtual stock market games with parents, friends, investment clubs, classes, or even on their own. Stock market simulated games are an excellent way to practice and gain experience in investing before you commit your own money.

I have used these virtual games for years to teach my college students about stock investing, critical financial concepts, and terminology. The games are fun to learn virtual trading and investment strategies in a realistic setting without risking a dime.

Digital Natives

Generation Zers come from an environment enriched with simulations and games. They are perfect candidates to learn how to invest from virtual stock market games as interactive tools.

As digital natives, they are on always-connected with cloud-based digital technology from birth. They often prefer video and simulated games to traditional modes of learning. However, virtual games are user-friendly and can appeal to anyone, even digital immigrants like me. As a result,  I use Market Watch Virtual Stock Exchange by Dow Jones for my college students and my kids at home.

How The Games Work

At the start, I customize settings. Each player gets $1,000,000 to invest in many US stocks, foreign stocks, mutual funds, and Exchange Traded Funds or ETFs. Some games allow the trading of foreign currencies, cryptocurrencies, options, and other securities. 

 My college students build their $1 million investment portfolio to buy at least $800,000 of stocks and keep $200,000 or less in cash. They can actively trade daily on the game or purchase and hold on to stocks in their portfolio as a long-term strategy. 

Investing Versus Trading

Most games allow for margin trading, short selling, and options trading for more advanced players. From my perspective, I favor the games as a lesson in investments rather than for trading purposes. Returns tend to be better for the long term in retirement and investment accounts.

As much as I applaud young investors in the market, I grew concerned about the market frenzy that pushed GameStop shares to ridiculous levels. So I wrote this letter to young investors concerning the dangers of short-selling and margin trading you can read about here.

They use the stock market game for a wealth of resources about the markets and the economy, but they research all publicly available information.

Why Use A Simulated Game For Investing?

 

1. Active Learning Of Investing Basics

Games are a fun and educational way to learn to invest, a pivotal way to accumulate wealth. There is a greater level of engagement and motivation when you are learning a skill through simulation. Players can quickly fill and modify their portfolios by buying and selling stocks with ease.

Many people avoid investing, believing it is too complicated, and fear losing money. Those are valid concerns. That’s a prime reason why getting your feet wet with the game allows you to get more comfortable. Trying out trading and investment strategies is less intimidating.

There are many articles and videos on the sites to understand differences in risk/reward trade-offs better and measure your tolerance to make more risky purchases. Feeling gains and losses are real enough and allow you to pivot in different ways.

2. Diversifying Portfolios Reduces Risk And Growth

When creating a virtual basket of stocks, players should diversify their portfolios in different industries. For example, in reality, you would not want to hold all fast-growing technology stocks or all safer utility stocks, but rather a blend of different kinds of companies. When building a portfolio, you may favor a mix of growth stocks, value stocks, stocks with above-average dividend yields in different industries. Virtual investors can become attuned to market information that may affect one stock or particular group more than others.

Avoid Concentration Risk

My son Tyler was playing a simulated game in a stock market club and put all of his money in one stock–Amazon–when it was rising significantly. He was so excited that he was doing the best in the club until one day Amazon reported quarterly results that missed analyst expectations.

Apparently, the company announced a rise in capital spending for their data business. Amazon shares crashed and became “dead money,” a term investors use to mean that the stock’s performance will drag for a while.

For Tyler, it was a learning experience about why diversification was important in your portfolio. Concentrating all your money in one stock is a dangerous strategy. It is not good to put all your eggs in one basket.

3. Macro Factors Investors Need To Know

Beginning investors need to understand external or macroeconomic factors that may impact the market. Players should be reading relevant financial news to learn about important events that can sway the market significantly. Learn what makes the market tick. How does the market react when the Federal Reserve takes action on interest rates, economic changes, inflation, and international events (eg. China)? Just understanding what is relevant to your stocks is a big lesson.

4. How To Deal With Market Volatility

From the relative safety of playing a virtual stock market game, players can better understand that market volatility happens regularly. The most experienced investors are often surprised about dramatic changes usually caused by headline risk or recession worries.

By virtual investing, you become more aware of rhythms in the market and prepare for a volatile market. As such, you can explore strategies to deal with turbulence without the loss of real money. Ask yourself: are you better off trading actively in a weak market or sticking to a buy-hold plan? Games allow you to experiment with cash without the fear of losing it. 

Market Volatility During The Pandemic

Many investors quickly baled when the pandemic’s effects hurt our economy, causing a dramatic market downturn in March 2020. However, the market proved its resilience by resurging and reaching record levels later in the year. Those investors who sold their holdings learned a lesson about riding out storms.

5. Competition With Your Peers Is (Almost) Realistic

Never let a chance to compete with your peers go to waste! Students love to compare their rankings. Most games rank players daily and allow you to see each other’s stock purchases, performance, and ranking.

My students tell me that they check their rankings daily, if not more often. If they lose a top-ranking, they often get upset. I need to remind them that it is virtual money. We discuss strategies in class. They can research what stock (or stocks) pulled their performance down and decide if they should buy more with available virtual cash to reduce their cost basis.

You can form teams within the game structure simulating portfolio managers who consult with each other. Young people can engage in collaboration, collegiality, and problem-solving within their group. These are excellent soft skills to build for your careers that employers love to see. 

6. Building Confidence And Self-Esteem

The reality of picking stocks and learning some investing basics is a big confidence booster. Students playing a stock market game say:

  •  It was fun learning how to invest.
  • They plan to open an investment account (eg. Robinhood or Webull).
  • Virtual investing has helped them to become more confident in their abilities.

Investors tend to value savings to deploy for investment purposes. If so, and it provides you with an incentive to save more, that is a worthwhile accomplishment.

Popular Simulated Stock Market Games

There are at least 5 games to choose from that allow for competition, awards, alternative securities, and provide resources for players. Here are some of my favorites.

1. Marketwatch Virtual Stock Exchange

MarketWatch is a top financial and news website owned by Dow Jones. The Virtual Stock Exchange game can be customized by an administrator such as a parent or teacher providing $100,000 or $1,000,000 in private or public mode. The game provides rankings for each player. Administrators like me can customize trading parameters. Participants can trade stocks, global stocks, mutual funds, and ETFs.

Players can find and trade stocks in real-time and build their own portfolios They can create, watchlists and have access to articles, videos, and charts. There are advanced trading options with specific orders such as at the limit price or less or stop order,  meaning an order to buy or sell a stock once the price reaches a specified price. There are nearly 40,000 games currently in play.

Integrating The Game 

For the past 10 years, I have administered several games a year with my finance students, integrating the game with my finance curriculum. As a result, I have an easier time teaching how the Fed influences the financial markets. They update excel spreadsheets for prices, yields, and valuation, learning relevant financial concepts.

  In recent years, the game has become more user-friendly with more resources. Student feedback has been overwhelmingly positive. They have fun watching their rankings relative to their peers, finding out why their stock performance has outperformed or underperformed. They find the game quite realistic and are eager to set up their own investment accounts.

2. The Stock Market Game

Although geared for teachers and students, anyone can participate in The Stock Market Game individually or as a team, including a family. Participants can trade their own $100,000 investment portfolio. The portfolios can be a mix of stocks, bonds, mutual funds, and cash. Players can participate in a competition or in a non-ranked session. This game is created by the educational nonprofit organization, the Securities Industry, and Financial Markets Association, or SIFMA.

SIFMA touts a 2009 FINRA study of The Stock Market Game providing positive results on students in grades  4-10 who played the game, scoring higher on investor knowledge tests.

3. Wall Street Survivor

Partnering with AOL, Seeking Alpha, and The Motley Fool, Wall Street Survivor is among the most popular simulated games available. You can start with anywhere from $10,000 to $10 million in virtual money. There is the option to join a public or private league or create your own league. This site is resource-rich and provides courses, videos, newsletters, starter guides, and articles. I particularly like that they have resources to analyze a business and its financial statements. As a former analyst, the resources make my heart sing.

You can earn badges and vie for real cash prizes of $2,000 monthly. You practice trading and take quizzes to reinforce your knowledge. According to their site, they have over 1 million users. Wall Street Survivor has a cryptocurrency game as well.

4. How The Market Works

This site has been around since 2004 and is good for classes, groups, and individuals. While tailored toward beginning investors, there are advanced resources that participants can use including Wall Street Analyst Ratings, financial news, company financial statements, and technical charts. You can buy global stocks, mutual funds, ETFs, options, and even commodity futures. Customization of games, competitions, and flexibility in cash balances are all available.

5. Investopedia Stock Simulator

The respected financial site Investopedia has its own comprehensive stock simulator. You can start with $100,000 in virtual cash. Participants can join an existing game or create a customized game of their own, trading stocks, options, margin trading, and adjustable commission rates. Players are ranked, can research their investments, and earn rewards for completing various activities. You can connect with over 700,000 traders and investors globally.

 Final Thoughts

If you are new to investing, stock market games are a great way to gain experience in a simulated setting without the risk of losing your own money. These free games are fun on sites rich in resources to learn at your own pace or as part of a team.

You can create portfolios, learn concepts and build confidence along the way. The games have enhanced the investing capabilities of my college students, many of whom are now active investors on their own. It is my passion to teach students how to invest. 

Have you ever participated in a simulated stock market game? If so, what was your experience? I encourage you to try one of the games with your friends or family as a first step to investing for real. Thank you for reading! Please subscribe to The Cents of Money and join our growing community!

 

 

Webull Review: What You Need To Know

Webull Review: What You Need To Know

Everyone should have an opportunity to build wealth. Learning the basics of investing and understanding the risks is an excellent way to pave your way to a successful financial future. It wasn’t easy to invest or trade stocks until recently without paying commissions to eat away at your profits.

The plethora of zero-commission brokers has leveled the playing field for more affordable investing. Webull can be a good choice for many and an alternative to Robinhood.

I should confess upfront that I tend to prefer investing rather than trading as the way to go in building wealth. That doesn’t mean holding onto long positions through thick and thin. No, leaving positions on autopilot can be risky. You should also know I am scornful of the practice of margin trading. I’ve watched friends go up in smoke from paying exorbitant interest that put them out of business.

 

What Is Webull?

As a relative newcomer, Webull is joining the competitive field of online trading that appeals to young traders. I applaud the rise in young retail investors participating in the markets. Webull offers commission-free online trading as a mobile-oriented broker. Like other mobile apps, Webull’s trading platform appeals to traders who have some financial markets’ experience and seek advanced features, including in-depth and real-time market data.

They are a legitimate player in online trading by constant improvement in the tools they offer to their subscribers,

Webull Background

Founded in 2017, Webull has about 15 million registered users in early 2021, gaining greater customer acceptance despite its lower profile than Robinhood. Comparisons to Robinhood are inevitable. When Robinhood halted trading temporarily in the GameStop frenzy, their users jumped ship to Webull, which had resumed trading more quickly.

Webull is growing its customer base quickly, which may account for the rocky beginning that I share with you below.

How To Get Started Opening A Webull Account

Setting up a Webull account is straightforward. You can sign up with your email address or your mobile number, and you will receive a verification code. Make sure you select your preferred brokerage account. You can choose a cash account or a margin account. Next, add your personal information, your profile, and answer regulatory and security questions. You will need to upload your proof of identity using a passport or a state-issued ID card. Both sides of a driver’s license suffice for identification.

Webull promotes free stocks (from $5-$250), which require a $100 deposit. I received two free stocks. You will need to link to a bank to fund your WeBull account with an ACH bank transfer. Technically, there is no minimum amount required unless you set up a margin trading account that requires at least a $2,000 deposit.

Before they transfer money from your bank to your Webull account, they will deposit two tiny amounts (like $0.09 and $0.33) into your bank account. You confirm the deposit amounts to Webull. There is a 24-hour delay in the posting. The next day, I found the deposits and attempted many times to let Webull know.

My Experience – An Unnecessary Delay

At this point, I reached out to customer support with emails and calls. Each time I called, I was on hold for 45-60 minutes. Come on, guys! My customer support person was always the same, Doug, and I wondered if there was only one person. Doug was super friendly, apologetic, and similarly stumped as to why my deposit verification wasn’t working, which held up my trading account’s funding.

This setup didn’t take hours; it took days! Finally, tech support intervened, and they fixed my account. Signing up via an email account rather than a mobile version was the culprit, but that should not make a difference. I get that they are mobile-oriented, but some of us still prefer bigger screens.

The delay in customer support occurred as Webull was signing up many customers. During the GameStop frenzy, volumes soared, and some customers left Robinhood when trading halted in some stocks. I have since learned that Doug will have company as they are adding people to customer support now.

Payment For Order Flow And Retail Trading

The SEC requires that Webull disclose it engages in the practice of “payment for order flow.” Webull, Robinhood, and many small brokers receive compensation for directing orders to market makers for executing the equity and options trades. These brokers realize cost savings and enhance their ability to handle high order volumes to offer zero-commission trading.

Trading volumes for stocks and options have been exploding as more individuals open trading accounts. This activity overwhelmed many small brokers. The average daily volume in equities has grown from 7 billion in 2019 to 14.7 billion in early 2021. The higher proportion of routing to these market makers (i.e., specialists on both the buy and sell of a trade) indicates that retail trading accounts for tremendous volume growth.

2021 Pros of Using Webull

No Fees Or Minimum Deposit

Webull offers commission-free trading with no required minimum amount, except for $100 to receive your free stocks. Zero commissions extend to unlimited day trades and options trades (no charge per trade or contract) and other tradeable securities they offer. There are no annual fees or charges for inactivity.

They do charge $75 for either closing an account or if you want to transfer your Webull elsewhere.

Free Stocks

Webull runs continuous promotions offering free stocks valued from $5-$250 per share once you drop $100 in your account. It is improbable that you will receive a free high-priced stock. I received two stocks: an AMC share valued at $8 and a Southwestern Energy (SWN) share valued at $4.38.

Tradeable Securities

The company has expanded its offerings, but there are some limitations. You can choose among hundreds of ETFs for diversification purposes. Webull allows trading during extended hours during pre-market hours (4:00 am – 9:30 am) and after-hours (4:00 pm – 8:00 pm). That you can is not a reason that you should as markets have less liquidity and more volatility.

Webull’s Offerings

  • Stocks
  • Options
  • ETFs
  • Gold
  • Cryptocurrency
  • ADRs (i.e., American Depository Receipts)

You can open a traditional IRA, a Roth IRA, or Rollover IRAs on Webull, and “more IRAs are in the works,” according to their website. Currently, they do not offer mutual funds, money markets, or bonds, which are big holes for those who may want diversification.

Easy-To-Use Customizable Dashboard

Forty-five or more widgets populate the dashboard to satisfy simple to more complex needs. The company has continuously improved its dashboard to allow traders to analyze trends and market information for a better experience with faster load times. Clients can configure their trading panel to fit their investment strategy.

Stock Charts

There is a rich assortment of high-quality stock charts with technical indicators from the most simple to advanced trading. You can display prices using Moving Averages, line, bar, Candlesticks, Hollow Candle, Heiken Ashi, or Colored Bar. You can draw, manipulate, compare two charts. I focus on fundamentals more than charts, but I plan to work on this skill.

Stock Screens

Webull’s stock screens are the typical ones such as top gainers, most active, stock earnings actual and estimates, dividends, splits, and Advances/Declines. Clients can look at markets by location: US, Hong Kong, London, Toronto, and all major global markets. I found these screens easy to find and use and all on one page with some toggling.

You can screen by market, sector, and market capitalization. There is a nifty IPO center showing activity in the primary market. The dashboard doesn’t display a SPAC center, but I bet that may come soon if there is interest in such a display.

Fundamental Analysis Tools Could Better

Investors can use fundamental analysis tools that may seem rudimentary to many. I am dating myself, but my first view of the markets was on a Quotron. I recall a librarian snipping news off a teleprompter giving us earnings results, dividend hikes, management changes, and other information.

The current fundamental analysis tools available to Webull customers indicate financial statement highlights, cash from operations, earnings estimates per stock, analyst ratings, short interest, institutional holdings and by ETF, and order flows. I use this information when making purchase decisions, looking for market sentiment changes, and it is easy to find.

Fundamental investors need more tools, such as downloading SEC documents and research reports from Ned Davis and Thomson Reuters.

Technical Indicators

The site has several technical tools to satisfy more advanced traders. Webull offers capital flow analytics to show the inflow and outflow positions in the market. These indicators show money coming into a specific stock or sector. Among the technical indicators is Simple Moving Average, Exponential Moving Average, Bollinger Bands, MACD, Volume, and Relative Strength Index (RSI).

Level I And Level II Trading

Level I and Level II are two different trading screens used in stock trading. Traders use these screens for direct access to real-time market data, such as the last trading price, the current bid and ask price, daily high and low, and trading volumes. Webull provides Level 1 trading data that gives traders all buys and sellers with actual “bid and ask” orders currently in the market.

Level II trading is market data powered by NASDAQ’s TotalView and is essentially NASDAQ’s order book. It adds a substantial dimension by showing the number of buyers and sellers at different price levels. Webull offers Level II trading for free for three months and is $1.99 per month after the trial period when you sign up for a new account. Robinhood provides this service free only to its gold members who pay $5 per month for this and other extras.

Webull offers other paid plans for premium data from regional markets like Hong Kong Stock Exchange, Toronto Stock Exchange, and London Stock Exchange.

Trading Platform

Webull gets a lot of respect and credit for its trading platform, available on mobile and desktop formats. A browser-based and downloadable desktop platform is accessible with advanced or customizable charts, screeners, and many technical indicators.

The platform is attractive for traders who want advanced features. You can set up watch lists, price alerts, and voice commands.

Margin Trading Available

I am not a fan of margin trading, especially if young traders are inexperienced with the practice. For those who are more mature and capable of handling its risks, margin trading is available without requiring an additional subscription or membership fees. To qualify for margin trading, you need at least $2,000 in your account.

The stated margin rates on Webull’s site appear to be in line with other providers. Rates vary by the margin loan size. The highest level of 6.99% is for a small loan up to $25,000, declining to 3.99% for a $3+ million loan. Margin interest is calculated daily and paid monthly. Be aware that these are stated margin rates, and brokers often raise rates or change requirements when markets get volatile.

Short Selling

When investors or traders sell short, they take a short position instead of a long position when purchasing a stock. For a short position, you need to borrow the shares, paying margin interest for the loan. The cost associated with a short sale is the fee for borrowing that stock. Webull’s fee changes every day for every available stock and is charged daily.

I cannot stress the risks of short-selling and margin trading. When markets get volatile, brokers can raise their requirements regarding how much money traders have to put down using leverage or margin.

Security and Safety

Being secure and safe investing your money on an online trading site is a primary concern. Webull is regulated by the SEC and FINRA. As a member, SIPC covers up to $500,000 per account per brokerage firm, and up to $250,000 may be in cash. Two-factor verification and encryption of your personal information and passwords are worthy safety features. They also require you to set up two different passwords for different functions.

That said, users should do their part in protecting their accounts to the greatest extent possible.

Virtual Trading and Competitions

When you initially have your account, you can do virtual or paper trading for free without depositing any money, using some or all of their tools. For the beginner, this feature is desirable for those who want to practice and feel comfortable with their website.

As far as I know, Robinhood does not have simulated trading. I use simulated stock market games to allow students to invest and trade stocks in my classroom, so I liked seeing this feature.

And there’s more. Webull has Paper Trading Competitions, encouraging participants with prizes up to $300 going to everyone who has a positive return at the end of each week.

There is a private Twitter feed where users can comment on individual stocks, creating a community vibe for those new to trading, starting with the simulation.

2021 Cons Of Using Webull

Investment Limitations

There are some gaps in Webull’s offerings, notably mutual funds, OTC stocks, and bonds. They have been steadily building their products since 2019, offering options and cryptocurrency trading currently. As of yet, they do not offer fractional shares or pink sheet stocks, and on the latter, I hope they never do.

The ability to have an IRA account on Webull is terrific. However, they will need to have mutual funds for such accounts for diversification.

Cash Management

Webull doesn’t pay interest on uninvested cash or have a partner bank to handle this option. Robinhood pays interest on idle money, and Reddit’s comments indicated that some users stay with them for that reason. Although interest rates are super low now and perhaps not as urgent, it will be a product Webull will need to have soon as interest rates rise.

Prefer Better Educational Support

With the influx of young individual investors who joined firms like WeBull to trade for the first time since the March lockdown, it is essential to have educational support. I find WeBull’s educational material sorely lacking for their clientele, especially in advanced trading. When it comes to academic support, more is better in the financial world.

When you are trading and investing, you may run across many financial concepts and jargon you need to know.

Needs Better Customer Support

It may be just my personal experience that I had so much trouble reaching customer support, but I doubt it. When I called customer support, the minimum wait was 45 minutes to as long as 109 minutes. (Yes, I was counting!) That is unacceptable, especially when I tried to move the money into my account that had left my bank. I was persistent, but other potential users may give up.

On one of the long waits, I perused Webull’s name on the web and found they have an “F” rating on Better Business Bureau (BBB), with numerous complaints. So I looked at several brokers’ ratings on BBB and was not surprised that many have F’s, including Robinhood or low grades (C minus) for Fidelity and Ally Invest. TD Ameritrade appears to be an outlier with an A-minus.

I will say that when you do get a live person on WeBull’s customer service, they are patient and helpful. They need to add more live customer support.

What Can Webull Do Better

Webull seems to continue to broaden their products to their credit, and they should add mutual funds, bonds, and fractional shares.

They should partner with a bank to offer interest on idle cash.

Webull needs to strengthen customer support for kinks that are inexplicable, like my experience and educational materials.

Who Is Webull Best For

Webull’s paper trading option can benefit beginners who aren’t quite ready to pay for their trades. Their platform is best suitable for those in the intermediate level who want simplicity or desire more advanced trading. I use my Webull as an alternative broker to do some trading and investing separate from my financial advisor and other accounts.

Full-time day traders who require far more advanced systems would probably find WeBull’s platform lacking in some areas.

Final Thoughts

Webull is emerging as a legitimate competitor and alternative to Robinhood, growing its customer base to a potential number two spot among online brokers serving retail traders. This relative newcomer in the zero-commission online trading world continuously broadens its products to satisfy its customers and leverage its trading platform.

This article originally appeared on Your Money Geek and has been republished with permission.

Being Frugal When Saving Time And Money

Being Frugal When Saving Time And Money

“Price is what you pay; value is what you get.”

Warren Buffett

I bristled when they called me a cheapskate when I was a young kid. It cast a dark shadow over me. We lived in a modest neighborhood in the Bronx, so it wasn’t like some of us were from the upper class. Still, our lifestyle was far more humble than others. I was laughed at for getting an ice cream without sprinkles or wearing ratty clothes. My parents were more frugal for a good reason. They struggled with their small business and needed to save money for our basic needs. For many people, frugality is a necessity. For others, it may be a choice.

Cheap Vs. Frugal

Nowadays, calling someone frugal is more of a virtue, like giving a badge of honor to that person. Being frugal or cheap is sometimes used interchangeably, but the terms have different meanings. According to Merriam-Webster, frugal is characterized by or reflecting economy in the use of resources. On the other hand, cheap has a range of definitions. Cheap has two or more meanings: charging or obtainable at a low price and inferior quality or worth.

While both terms are about saving money, being cheap is usually motivated by price and paying less. On the other hand, being frugal considers price along with quality and value in evaluating the purchase. There is a gray area but considering if a person is cheap or frugal, you’ll know the difference by their actions or words. Cheap people are penny-pinchers who will mostly pick the lowest price option even if the quality is suspect, regift presents, and are poor tippers. Many will engage in D-I-Y projects like plumbing and electrician work just for the sake of not spending the money.

When Frugality Can Go Too Far

Being overly cheap or extreme frugality without reason and lack of generosity is a symptom of obsessive-compulsive personality disorder (OCPD) by the International OCD Foundation. The American Psychiatric Association has pointed to this symptom as when “a person adopts a miserly spending style toward both self and others.” Growing up, my Uncle Harry lived with us for many years. He was a Holocaust survivor of the death camp Auschwitz. As a teen, he suffered from the camp’s traumatic effects. He lost his family, except for my mom, and married late in life. Unfortunately, he divorced soon after.

It was extreme frugality that killed his marriage. His wife, Doris would come home with a dozen eggs or too many groceries and he would have a breakdown over the potential for wasted food. His psychiatrist noted his anxiety about saving money or extreme frugality was a tragic symptom of his experience.

In contrast to being cheap, frugality is a strategy that saves money and considers the whole picture: quality, durability, value, and price of what you are buying. Those who are frugal are savvy about saving money for themselves and others. They will consider other variables like whether that purchase is good for the environment and other causes.

The Frugal Warren Buffett

Warren Buffett is as legendary for his frugality as he is for his investing acumen. He lives in the same Omaha home since 1958. Buffett frequents McDonald’s and his company’s cafeteria. He is a value-seeker when investing or in his lifestyle. Yet, for all of his frugalness, Warren Buffett has generously donated $37 billion since 2006.  One of my favorite Buffett quotes: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

6 Benefits To Being Frugal  

 

1. Having A Purposeful Mindset

Adopting a frugal mindset means being more thoughtful about your purchase decisions. It is not about having it all but about choosing your purchases carefully for you and your family.  Having a frugal attitude favors good money habits like saving money and better financial management overall. It is not about choosing the lowest price option basing your decision on price alone. Other factors are part of the value proposition.

Frugality is a lifestyle that people adopt for the simple pleasures of life. It is not new. Plato and Henry David Thoreau in Walden advocated modest or minimalist living. It contrasts with societal desires for materialistic possessions which often leads to overspending just to keep up with your peers. Being thrifty has its merits and can lead to sound well-being.

Related Post: 10 Ways To Better Manage Your Spending

2. Motivate Yourself By Knowing Your Goals

It is easier to save or manage money when you have a plan for your future. Determine your short and long-term goals. Those who plan to retire early,  work hard to set aside money for savings, retirement, and investments. Their plan will motivate them to be financially independent and retire early (FIRE). It is not for everyone, but it does give you a chance to develop good money habits for future financial flexibility. By adopting frugal ways to save more, spend less now so you can retire early in life. Spending within your means allows you to choose what you want to do later on at a still young age.

I left my job on Wall Street in 2001, before the FIRE movement became popular in the 2010s. My choice was to go to law school and practice for a few years, have kids, and teach at a college. For me, it has worked out fortunately though it was a big adjustment that could have been smoother. To be honest, I didn’t have a well-developed plan though I did want to return to school because I enjoyed learning new things. Goal setting is essential even if you finetune through the years.

The Frugal Millionaire

In The Millionaire Next Door, a favorite read of mine, millionaires were profiled in two groups. The Under Accumulators of Wealth (UAWs) were the more typical white-collar professional millionaire, devoting more of their high income to luxury goods to maintain their status. As a result, they had lower net wealth compared to their income by neglecting savings and investments.

The Prodigious Accumulator of Wealth (PAWs) were more frugal millionaires. They avoided a showy lifestyle, bought used cars, often living in blue-collar areas. Goal-oriented, they made intelligent buying decisions, using savings to invest more of their money in securities or in businesses for good returns. PAWs spent less on luxury, accumulating higher net wealth relative to income from less.

3. Prioritize Spending To Improve Your Financial Health

Although you don’t want to penny-pinch, prioritize your spending. Frugal spenders tend not to be compulsive shoppers, accumulating lots of material possessions to regret. That doesn’t mean you can’t travel, buy good things, or enjoy your life. Quite the contrary. It is about spending thoughtfully and moderately and not on a whim. Know the difference between your wants and needs or living essentials. Your needs–food, rent, clothes, medical, education– should be a priority. Yes, you can have that latte if it gives you a particular pleasure.

Being frugal means spending below your means so that you can save money to improve your financial health. Those who are frugal tend to:

  • Save money rather than spend;
  • Avoid debt rather than purchase on credit;
  • Pay their credit card balances in full;
  • Have an ample emergency fund invested in a money market deposit account;
  • Contribute at least the minimum amount into your employer-sponsored 401K plan to earn their match; and,
  • Set aside money to build up an investment account.

Related Post: 10 Commandments of Saving Money

4. Price Vs. Value

Buying solely on a price basis without regard to quality is a hallmark of cheapskates. Those who are frugal make economic rather than impulsive decisions. Price is important, but there are other factors to consider. When making purchases, economic people will evaluate the quality, usefulness, reliability, durability, style, convenience, experience, and trustworthiness of the company or the brand. In other words, they will look at the whole picture.

Of course, the price versus value equation depends on the product itself. Frugal shoppers are not going to evaluate many factors for convenience products bought frequently. Price plays a bigger role when buying toothpaste or laundry detergent. For these products and many others, you can save money by buying generic brands at a discount to name brands. The price will be lower for generic brands, as much 35% reductions compared to name brands but the quality is often the same.

Don’t Shop On Price Alone

On the other hand, shopping for appliances, furniture, clothing, and other items less frequently bought quality and other considerations matter. Buying furniture chiefly because it is inexpensive is a recipe for disaster. That is being penny-wise pound foolish. Robert Burton is credited with that British saying in 1621 and is in The Anatomy of Melancholy. I am not sure Burton had our cheap bookcases in mind. However, that is what Craig and I remember saying after we bought cheap bookcases at a “bargain price.” We regretted that purchase made in our early years together almost immediately. The bookcase crashed in the middle of the night. Cheaply made, it didn’t hold up our books for too long.

5. Frugalness Is Good For The Environment

Practicing frugality has become part of the minimalism cult and more acceptable in recent years.  Mindless consumption is being frugal and less wasteful, which is good for the environment. Even if you are not saving money, reusing bags at the grocery store, or not taxing our utilities makes economic and environmental sense. Turn over your lights when leaving your room or home. Wash your clothes on the cold setting and lower or raise your thermostat. You may have personal savings, but you are also helping a cause.

6. Be Frugal About Wasting Time

Time is money. Both are valuable resources, but time is more precious because it is finite. We cannot replenish time. Saving money is necessary, but not when it causes you to waste time. Time is an element that many of us use poorly. Examples of how we splurge on time when trying to save money are:

  • Driving around to get the best gas price;
  • DIY projects when you aren’t handy or don’t even like doing them; and,
  • Grocery shopping at different places to get the best price at each store

Being frugal with our time means being more focused on how we are spending it. To save money, I sometimes over-research things for the best product. Make a “to-do” list to organize your time more meaningfully. Don’t go shopping without a list.

When your time is short, consider spending money on time-saving services. Studies say it can promote happiness when time constraints are stressing you out. On the other hand, Some people work more efficiently under a tight timeframe. I find that I often accomplish more with time constraints which help me to be more focused. Balance your needs of saving money and saving time according to your abilities and preferences.

Related Post: The Relationship Between Time, Money, And Productivity

Final Thoughts

No one wants to be a cheapskate. On the other hand, being frugal is often a virtue that may lead to a happier lifestyle. Just be sure you are not becoming obsessive like my Uncle Harry. Saving time and money are valuable goals that can help to eliminate stress while strengthening your financial health. Maintain a balance to live a life you enjoy. You don’t need to stop pleasures just for the sake of being frugal. Instead, prioritize what is essential for you.

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Blue Chip Stocks: 9 Reasons Why You Need Them In Your Portfolio

Blue Chip Stocks: 9 Reasons Why You Need Them In Your Portfolio

Blue-chip stocks are the ivy league of investment stocks. They are shares of companies known for steady cash flow, solid balance sheets, reliable business structure, and excellent performance history. And like Coca-Cola or Nestle, these underlying companies are household names that have stood the test of time.

Their excellent performance and track records over time make blue-chip stocks some of the most secured investments. They should form a part of your diversified portfolio to help balance the possible losses in market downturns.

Your portfolio would be incomplete without blue-chip stocks.

It’s vital to have blue-chip stocks in your portfolio. But before we dive into that, let’s have a quick overview of blue-chip stocks.

What are Blue-chip Stocks?

Blue-chip stocks are shares of long-standing companies that are well established, big, financially stable, leaders in their sector, and well-known. Like blue-chips in poker games, from which the name is derived, blue-chip companies are highly valued.

They are known for strong financials, steady dividends, and cash flow – characteristics that long-term investors are looking for.

The benefits of having blue-chip stocks as part of your portfolio include steady dividend payout, dividend growth, lower volatility, and predictable growth trend.

Seasoned investors consider them to be relatively safer than other stocks. Hence, they will make a valuable addition to your portfolio, especially in times of market uncertainties.

However, it’s vital that you pick the right blue-chip stocks as not all of them will meet the required expectations. The idea is to focus on the real valuation of the company and steer clear of overvalued stocks.

Don’t be discouraged by the fact that blue-chip stocks aren’t fast-growing. Be more concerned with the consistent gains over the long term plus the greater stability. Blue-chip stocks belong in any successful investment portfolio.

Although there are no set standard criteria as to which stocks are considered blue-chip, they possess some identifying characteristics that set them apart.

Blue-chip companies have the following in common:

  • Stability: Blue-chips are typically decades old and have shown considerable earning consistency over that period.
  • Consistency: Blue-chips that are also dividend stocks show consistent dividend payments over time. They also tend to grow dividends paid per share at a steady rate. Returns on capital as well as returns on equity are also consistent.
  • Competitive advantage: Their reputation and cost efficiency due to size give them an edge. These companies can borrow money at a much lower cost than competitors because of their solid balance sheet and assets. Their products and services are high-quality and diversified across multiple geographic locations, which gives them resiliency.
  • Benchmark Indices’ Components: Blue chip companies are usually part of benchmark indices like The Dow Jones Industrial Average, the S&P 500, Nifty 50, Sensex, etc. Benchmark indices are a group of securities or stocks used in measuring how well or poorly other stocks or securities performed in the market.

Real-life examples of blue-chip stocks include Nestle, Coca-Cola, Proctor and Gamble, Shell, Mc Donald’s, and Amazon. These companies are also on the Fortune 500 list.

Now that you have a firm grasp of what a blue-chip stock is, let’s proceed with why it makes sense to have shares of profitable and well-recognized companies in your portfolio.

Why You Should Have Blue-chip Stocks in Your Portfolio

Blue-chip stocks should be a part of your well-diversified portfolio. Naturally, they are more expensive but are totally worth it in the long run. Here are some reasons why.

1. Safe Dividends

Your primary concern as a dividend investor is the safety of your dividends. That is, you continue to steadily receive your share of the company’s earnings. Because if the company stops paying dividends, then you cease to be a dividend investor. Dividends are part of a company’s profit distributed to shareholders as quarterly payments.

Smaller companies and startups typically keep all their earnings for investing in further growth and will not pay dividends yet. However, they may start to pay dividends once they grow to a reasonable size and have fewer internal investment opportunities.

In contrast, blue-chip stocks have witnessed steadily growing and consistent dividend payouts over time. As an investor, you benefit from portfolio income no matter the daily fluctuations in the share price.

Another beauty of dividends is that they hedge against inflation since they represent income that is likely to increase as the general cost of living climbs.

Blue-chip companies have strong financial foundations, which makes your dividends safe. They earn the trust of investors by consistently paying and growing dividends. This is the primary goal of any investment and a great way to build wealth long term.

2. High Returns on Investment

Historically, blue-chip stocks have performed better than the general stock market, which averages 8% to 10% return. Blue-chip stocks can return up to 12% when you ideally reinvest your dividends. It’s best you automatically reinvest your dividend and returns. Meaning that you’ll earn interest on your interest, making your stock portfolio grow even faster.

3. Safe Harbor Stocks

Blue-chip stocks tend to be safe harbor stocks. They are less volatile than penny stocks and smaller companies’ stocks and are also likely to rebound faster after a market downturn. Although they are not immune to losses when the broader market takes a hit, they won’t disappoint you in the long run.

Blue-chip stocks are best suited to buy-and-hold. And if you hold on to them long enough, say decades, they always bring in high returns no matter the market fluctuations. These stocks are safe and hardly do they go bankrupt. They offer an added measure of safety in a volatile market for your portfolio.

4. Brand Recognition

Blue-chip stocks are popular, recognizable brand names. This means you can get regular updates on the companies’ progress through mainstream media. You’ll be on top of your stock investments without putting in the extra effort to monitor the markets.

As an investor, you may get a kick from supporting your investment by, say-buying gas at a shell gas station or drinking Nestle bottled water.

5. Liquidity and Ease of Access

Because they are popular, blue-chip stocks are easy to buy and sell. You will appreciate this benefit more when you try to sell unpopular stocks. It can be frustrating trying to offload less-popular investment when their value starts to drop or when you want to release some of your equity.

Blue-chip stocks are some of the most liquid investments in the world. You can trade them at a moment’s notice and through various brokers, fund managers, or online platforms.

6. Diversification

Blue-chip companies are typically diversified along product lines, demographics and location. Take British Petroleum, for instance. It’s an Oil and Gas company, but it also owns convenience stores in the US and gas stations. It also owns the Wild Bean Coffee company headquartered in the UK. Therefore, the company straddles the consumer and retail markets as well as the commodities market.

This shows that a blue-chip investment can offer as much diversification as investing in 3 or more small growth and value stocks. And it will only cost you one transaction fee. Diversification ensures the company is resilient and won’t go out of business when one of its product lines or target market goes down.

7. Diversified Portfolio

When you invest in blue-chip companies, you secure a part of your portfolio against volatility. These companies will allow you to hedge against losses due to their excellent cost efficiencies. Even when the market witnesses a downturn, they will help you mitigate the losses due to their resilience. And historically, they are known to bounce back faster when the market recovers.

8. Availability of Investment Options

Investors can access blue-chip stocks in a variety of ways. You can buy the stocks directly, or you can get them through ETFs or investment funds. You can choose from a bouquet of investment options, including UK-based companies of the FTSE 100, the American S&P 500, or the Korean Exchange. The ETFs have the advantages of minimal transaction fees, allowing you to easily diversify your portfolio while keeping your cost down.

9. Strong Financial Fundamentals

Blue-chip companies ride on the wings of strong financial indices. Such companies have ideal debt-equity ratios, an efficient operating cycle, and excellent financials.

This gives you greater confidence knowing your investment portfolio has less volatility, lower downside risk, and the robustness to respond to unprecedented market events in a better way. These are some of the factors that make blue-chips preferred over other stocks in the general market.

Investors with a low-risk appetite are better off investing in blue-chip stocks. You want to earn decent gain without putting all your money at risk.

A blue-chip stock growth may not be exponential, but they offer more peace of mind for your investment than the regular stock.

How To Identify Blue-chip Stocks That Are Best Fit For Your Investment Portfolio:

So you are convinced that blue-chip stocks are the way to go for a sturdier investment portfolio. You understand that mutual funds and experienced investors prefer them due to their dominance in the financial markets and impressive track record.

While most large-cap companies’ stocks are considered blue-chip, not all of them are. A company’s size doesn’t necessarily mean they are blue-chip. With the thousands of blue-chip stocks in the market, how do you go about selecting the right one that will suit your investment needs?

  • Size: Its value indicates a company’s size by the stock market- or market capitalization. Market capitalization is the value of a publicly-traded company’s outstanding shares. It is the value you get by multiplying its total number of shares by the current market price.

Blue Chip stocks are typically huge, with a market capitalization in the ranges of $5 billion, $10 billion, or more. They also have large and steady revenue streams.

To select the best blue-chip stock to buy, start by considering large-cap companies that are dominant in their industries. With your investment preferences and the ideal composition of your portfolio in mind, first, identify the sectors you’d like to invest in and determine the best company stocks based on their market capitalization.

  • Company Revenue: When you have identified the biggest companies based on capitalization in your preferred sector, the next step is to check out their revenue or income. Ideally, the companies you would want to invest in will have a larger market share in the sector they operate in and hence, higher revenues. Compare the revenues of the biggest companies in that sector and invest in the ones with the largest.
  • Compare the Piotroski Score (F-Score): A company’s financial strength is a vital criterion for considering its stocks as blue-chip. The go-to-tool for determining a company’s financial strength is the Piotroski Score or f-score.

Created by accounting Professor Joseph Piotroski, the Piotroski Score combines 9 criteria to evaluate a firm’s financial strength. These criteria include liquidity, profitability, operating efficiency, leverage, and source of funds.

A business with a high Piotroski score – 8 to 9 is financially strong and desirable from his analysis. A company with a score lower than 6 is considered to be in relatively good shape financially. Companies with scores lower than 3 are economically weak and should be avoided.

  • Return on Equity (ROE) Return on Equity or ROE helps you identify companies with higher profitability as against shareholders’ equity. It is a financial ratio that measures how well a company uses shareholders’ funds to generate profit. A company with higher ROE means that they are more efficient when compared to their peers in the industry.

It helps to bear in mind that each industry or sector has its own acceptable ROE. While a high ROE is a good indicator of an ideal blue-chip stock, ensure you get ROE data from the past 5 years at least. A good ROE over that period means a solid blue-stock pick.

  • Return on Assets (ROA): In the same way, Return on Equity is a measure of how efficiently a company uses shareholders’ funds. Return on Assets or ROA identifies a company that uses its assets effectively to generate profit. It is the profitability of a business against its total assets less its debts.

The ability of a company to optimally utilize its resources while maintaining profitability is a good sign. It shows that the company is in capable hands and can survive any economic turbulence. This is the kind of blue-chip stock you’ll want in your portfolio.

  • Valuation of the Company (Intrinsic Value of a stock): A company’s valuation or intrinsic value is not the same as its market capitalization. The market capitalization is based on the price you pay for the stock. It’s utterly different from the value of the company.

Factors like demand and supply, social and political environment affect a company’s price, amongst other economic factors. Avoid the seven deadly sins of investing.

Therefore, it would be counterproductive to judge a company based solely on its market capitalization. The true worth of a company is its market value.

When you buy an underpriced stock, you stand to profit on your investment since you are buying it at a price less than its actual value.

So when looking for blue-chip stocks to buy, pay close attention to the stock’s intrinsic value rather than the current market price. Get a list of the top companies in the industries you wish to invest in and compare their inherent value to get a short-list of blue-chips stocks you want to buy.

Final Thoughts

Blue-chip stocks are a must-have in any investment portfolio. With solid balance sheets, a trusted business model, steady cash flows, and a history of increasing dividends, blue-chip stocks are some of the most secure stocks you can ever buy. Due to their historically strong performance and excellent track records, seasoned investors consider them a safe haven.

But blue-chip stocks can also go down when the broader market takes a hit. However, they are less volatile than smaller growth companies and usually recover first when the market bounces back.

You should consider blue-chip stocks as part of your buy and hold strategy. You are likely to earn stable returns over the long term. Blue-chip stocks can be added as part of a diversified portfolio together with lower-risk investments like bonds.

Investors with a low-risk appetite are better off investing in blue-chip stocks. You want to earn decent gain without putting all your money at risk. A blue-chip stock growth may not be exponential, but they offer more peace of mind for your investment than the regular stock.

And despite their much-touted safety and stability, it’s best if you carry out your due diligence before buying any blue-chip stock. Do not just invest in a company because someone recommended them. No matter how solid the investment looks, take their suggestion and do your own research before committing your hard-earned cash.

This article originally appeared on Your Money Geek and has been republished with permission.

Thank you for reading this piece. Please visit The Cents of Money for other articles of interest. Consider joining us by become a subscriber and get regular updates.

Getting Stimulus Money? Spend This Money Wisely

Getting Stimulus Money? Spend This Money Wisely

The third and possibly final stimulus check from the federal government is on its way. Most people will get their stimulus money via direct deposit to tens of millions of bank accounts. If you and your family qualify for the most extensive distribution, you likely have some immediate or future needs. Whatever you decide to do, strategize to spend this money wisely.

Stimulus Checks And Extended Unemployment Benefits

Did you get your stimulus check yet? The maximum tax-free amount is $1,400 per individual ($2,800 per married couple if jointly filing), and $1,400 per dependent, including those ages 17 and up. The federal government extended unemployment benefits with a $300 additional supplement to state benefits through September 6, 2021.

Typically, unemployment benefits are fully taxable. However, the IRS gave a tax break by allowing taxpayers to exclude up to $10,200 ($20,400 for married couples filing jointly) benefits on their 2020 taxes for those who made less than $150,000 in adjusted gross income (AGI). As stimulus checks were going out to households, the IRS announced tax returns are now due on May 17 this year instead of April 15.

How To Use Your Money Depends On Your Needs

Every household varies as to their need for this money. For instance, lower-income families are more likely to devote much of their spending to living necessities.

In a June 2020  US Census study,  adults in households with income between $75,000 and $99,999 were more likely to use their stimulus money to pay off debt or add to savings compared to households overall. In contrast, 87.6% of adults earning $25,000 or below planned to use their stimulus payments to meet their expenses.

The stimulus money is part of more considerable fiscal support targeted to boost consumer and business spending. As the economy grows, more people will work.

The Fed has accommodated our weak economy with low-interest rates and continued liquidity. These efforts will stimulate our economy and help our financial markets, but they may cause higher inflation. Fears of higher inflation have added volatility in the stock market.

Some believe higher economic growth and inflation may be transient, causing some stock market opportunities ahead. Chair Powell seems to be staying on course of a stimulative monetary policy and will tolerate higher inflation over the 2% target. 

Is This A Financial Windfall?

Merriam Webster  defines windfall as “an unexpected, unearned, or sudden gain or advantage.” A windfall can range from being a sum of $1,000 to something far more significant. This money may result from an inheritance, legal settlement win, salary bonus, or a winning lottery ticket.

A small windfall, newfound money, or stimulus money can serve a similar function by bringing you a step closer to your financial goals. That is a win for you whether you direct the money to help you with your day-to-day expenses or cushion your retirement nest egg.

Strategize What You Need Now And For Your Future

Strategize before spending your additional money by paying what is most urgently needed now.  The funds should improve your financial situation. Most people receiving checks have had a difficult time making ends meet. They may have lost their jobs, had their hours cut, or their job remains in jeopardy.

You may need to shore up your finances now. Are there holes in your budget that need mending that you can take care of first?   Pay your bills, reduce your debt to manageable levels, eliminating high-interest credit card debt. Should you have money left over, save for emergencies.

On the other hand, if you have little to no debt, devote your extra money to where you can catch up on retirement savings and investing.  Allocate where you can boost your financial future–replenish your emergency fund, retirement, investing– by adding to where the money can potentially grow.

Our Recommendations For Spending The Money Wisely  

 

1. Prioritize Your Everyday Bills

If you have outstanding household bills for your rent, mortgage, or utilities that need attention, consider negotiating with your providers. Ask if lower rates are possible or stretch out due dates. You want to avoid being late paying bills and affecting your credit score. It never hurts to try to do that at a time when people are most understanding.

Staying current on your bills can relieve the angst. And you don’t want to pile on late charges and add to your debt load.

2. Paying Off Your High-Cost Debt First

When you carry a lot of debt–credit cards, car, mortgage, student loans, or personal loans–can be overwhelming. Your stimulus money may not stretch that far. Interest rates are low for mortgages, car, and student loans, so your best bet is to reduce your credit card balances. Card issuers typically charge 15%-16% interest rates, and the compounding effect makes that balance grow faster.

It may be tempting to spread the cash proceeds around to all of your loans but target the most detrimental cost first.

3. Neglecting Any Car Repairs?

During COVID, you may be using your car less. If you are not following through with tune-ups, you can damage your vehicle in the long run. Do you have any car repairs you postponed but now can bring into the shop? Your repair guy will likely welcome you back.

4. Replenish Your Emergency Funds Or Start One

Many people have withdrawn money during the past year. They may have had to close businesses, leave jobs to take care of their family, or lost their jobs. It is time to reassess your emergency savings. Refill this fund so you can cover six months of your basic living needs should something unforeseen happen. A job loss, pet surgery, an unexpected illness, or car accident can mean higher costs beyond your budget.

Replenishing these savings can give you peace of mind. Those unexpected events do happen, as many of us learned the hard way last year.

Make sure to keep this money in liquid assets such as a higher-yielding savings account that is readily accessible. These days there is very little income to earn from low yields. But, economists are expecting higher interest rates as the economy strengthens. Therefore, use short-term securities like CDs so you can roll this money into higher yields when they are available.  

5. Add To Your Retirement Savings

Whenever you have extra money from a bonus, overtime, or raise, consider adding some of this money to your retirement savings. Notably, a 401K employer-sponsored plan or an IRA and Roth IRA makes sense. If you don’t have a retirement account, this is a good time to do so. 

Technically, your tax-free stimulus payment is unearned income. As such, it may be tricky to deposit money into your Roth IRA directly. Therefore, you may want to substitute earned money from other accounts, replacing those dollars with your stimulus money.

It is worth the effort to do so. Putting some money into a Roth IRA makes it a triple tax-free win. You aren’t paying taxes upfront. The contributed amount grows tax-free, and when you withdraw money after your turn 59.5 years.

Be Aware of Contribution Limits

You can have both a 401K and an IRA, but there are IRS contribution and income limits you need to be aware of so you can get the full deduction. Be mindful of those income limits for traditional IRA and Roth IRA for 2020 and 2021. They vary according to whether you are the single or head of the household, married, filing jointly, a retirement plan at work covers one or both spouses.

Contribute generously up to the maximum amount allowed:

The 2020 and 2021 limits are $19,500 for 401K and most 400 plans, and with a catch-up limit, $26,000 for employees aged 50 or over.

Total contributions for 2020 and 2021 are limited for all traditional IRAs and Roth IRAs to $6,000 or $7,000 if you’re age 50 or older.

6. 529 Savings For College

These accounts have federal tax benefits, like retirement accounts. Open a 529 savings account to set aside some money for your children’s college fund. Earnings on investments grow on a tax-deferred basis and tax-free when you withdraw money for educational costs. Generally, there are no contribution limits except for the $15,000 cap to qualify for the annual gift tax exclusion.

Each state has its own plan, and you don’t need to reside in the state to use their program. You may think that they are young and it is too early to think about their future, let alone college, if they are still at the crawling stage. The truth is that time goes by quickly, and before you know it, they are in high school. Don’t let this valuable time slip away without putting money into this fund. It will help your children to avoid borrowing heavily for college tuition.

7. Allocate Your  Savings To Investing

In a perfect world, all of your extra money should go toward investing. If you have a strong financial foundation with manageable debt, you should invest the money. Add to your investments or opening up an investment account for you or your kids.

Any savings you have from stimulus checks to a significant financial windfall should go to your investment accounts. That is if you have taken care of other needs. Invest early and have a plan in mind which considers your risk tolerance, timeframe, and diversification. 

When you are beginning to invest, you may not know where to start. Buying individual stocks can be very rewarding but can be risky. Consider low-cost index mutual funds or exchange-traded funds (ETFs) if you are uneasy purchasing individual stocks. Buying a pool of stocks is a popular way to own securities with diversification, avoiding concentration risk.

Professional portfolio managers actively manage mutual funds. They are constantly evaluating and choosing securities for the fund’s specific investment approach. Mutual funds are available for stocks, bonds, precious metals, other securities, varying risks,  and varying geographic markets. 

Active managers earn annual fees or expense ratios of your investment and are responsible for the fund’s performance. If you invest $1,000 in a mutual fund with a 1% expense ratio, you pay $10 per year towards the fund’s expenses.

Active Versus Passive Investing

Investors who buy actively managed funds pay higher expense ratios than passively managed index mutual funds that track a market-weighted portfolio. The latter index fund replicates the S&P 500 index via computers for a fraction of the fees, averaging 0.20%-0.50% expense ratios, below the typical 1%-2.5% costs of active managers.

You can buy a low-cost index mutual fund or an ETF consisting of a basket of securities, such as money markets, stocks, or bonds depending on your risk appetite. ETFs are similar to mutual funds but tend to be cheaper and more liquid. If both are available, I usually buy the ETF version. There are many funds with terrific choices, such as Vanguard, who pioneered indexed funds.

8. Give To Others

It is always a good time to give charitable donations to others. We always target giving 10% of our income to charitable contributions, but we have done more to offset the time we couldn’t do so. Everyone has their reasons for giving what they can and may stem from religious or ethical sources.

The minimum of one-tenth of one’s income belongs to God per measure handed down from the Patriarchs. As Jacob himself said to God, “Of all that You give, I will set aside a tenth to You” (Genesis 28:22). Giving 10% of your net income every year is a desirable goal—those who can do that.

Giving, like expressing gratitude, is among the most worthwhile healthy emotions to feel. Being grateful can even help us with our finances.

As part of 2021 $1.9 trillion American Rescue Plan, Biden extended the favorable tax deduction treatment in 2021 that was available last year. Taxpayers who take the standard deduction rather than itemize their tax deductions may set aside $300 (or $600 if you are married and filing jointly). The IRS suspended the typical limit of 60% of adjusted gross income for the amount of the charitable deduction made in a year.

The IRS has temporarily suspended limits on charitable contributions for those who itemize deductions on Schedule A. Check with your accountant whenever it relates to your taxes. 

 

Final Thoughts

Use your stimulus payment or windfall by spending the money wisely to improve your financial situation. It’s a personal decision based on your needs now or in your financial future. Strategize before spending this additional money so you can get the most of it. Hopefully, you are turning the corner to better times.

 

 

 

 

 

 

 

 

 

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