What Is An Interest-Bearing Account?

What Is An Interest-Bearing Account?

When you save money, you want to put it in a safe place, have readily available access, and earn some interest. You don’t want to stash your cash in pillowcases, under your bed, or in a shoebox.

Managing your savings in your interest-bearing accounts is crucial for maximizing interest-earning while minimizing fees on all your funds.

What is an interest-bearing account?

To accomplish these needs, you want to deposit this money into an interest-bearing account at your bank. They will pay interest as a percentage of your bank balance. These accounts are the safest and most liquid assets to manage and free from financial risk. They are part of your net worth, and more importantly, your liquid net worth.

Who provides monetary asset management? Depository institutions are financial institutions that can legally offer checking and savings accounts, credit cards and make loans. These banks that provide FDIC insurance up to $250,000 per person per account on deposit funds are regulated banks. They include commercial banks, community banks, savings banks, and online banks. Similarly, credit unions give their customers similar services but are NCUA-insured by the National Credit Union Administration.

Whether your bank is a traditional brick and mortar institution, or an online bank, they hold and use this funding source to make investments or loans to consumers. Loans and fees are a significant income source for depository financial institutions. Online banks may be a better choice to stash your money as they have favorable features like mobile apps and offer higher interest rates given their lower overhead costs.

Your Money Is Safe

When they use our money, it never disappears from our accounts. No worries. Our banks’ interest-bearing accounts are FDIC-insured up to $250,000 per account and are safe. The annual percentage yield (APY) reflects the interest rate you will earn. This is the return on total interest on a $100 deposit for 365 days, given the financial institution’s simple annual interest rate and the compounding frequency.

Compound Interest

Typically, banks use compound interest, which is earning of interest on interest. The compounding effect helps your money to grow faster. Interest gained incrementally gets added to the principal balance, and over time your money grows more quickly. The compound frequency can range from daily, monthly, quarterly, or annually. The more frequent the compounding, the more money you will earn. Many banks compound daily or monthly but that won’t make a massive difference at current low rates.

Generally, when you earn more interest on specific accounts, there may be tradeoffs. You will encounter more limitations-less frequent withdrawals or transactions-in return for higher APY. Be aware of initial minimum deposits and ongoing balance minimums you may need to maintain.  Should you exceed these restrictions, you may be paying more fees which can be costly.

 Consider These Factors Before Opening An Account

What are the applicable interest rates you will earn, fixed or variable, and compounding frequency?

Are there required deposits and ongoing minimum balances to maintain and fees to pay?

Can you link to a checking account at the respective bank?

How convenient are the deposit options such as using a mobile app, ATM, or mail?

Can you access your money, and what potential limitations are there?

What fees or penalties does the bank assess on my banking accounts? Are they avoidable?

Types of Interest-Bearing Accounts

 

Traditional Savings Account

The plain vanilla savings account is a good starting place to make your deposits. The FDIC’s latest national interest rate for these savings accounts is not very exciting at 0.06% to earn interest.

Finding income in a low yield environment has been challenging since the Fed brought down its fed funds rate to 0.0%-0.25%. Although rates are currently low, the improving economy may unleash higher inflation and may cause the Fed to reverse its policy, raising its interest rates. That will push up bank interest-bearing account rates.

You can link your savings account to your checking account to transfer funds, pay bills, and have a place for liquidity purposes. Some consumers may prefer to have their savings and checking accounts at different locations to slow down their spending habits.

Think of your savings accounts for your short-term money needs because they provide the lowest interest rates compared to other bank products.

High Yield Savings Account

Typically, the high-yield savings accounts earn higher interest rates than the traditional savings rate. NerdWallet pegs the latest national APY for the high yield savings account at 0.40, close to seven times the rate for conventional saving accounts.

Keep in mind, all interest rates are affected by the Fed’s monetary policy and are likely to stay low in 2021. Inflation is rising, and it’s anyone’s guess if it is transitory or likely to go higher and remain awhile. Should the latter happen, the Fed may need to raise interest rates, making these bank products more profitable.

Although traditional brick and mortar banks and online banks offer high-yield savings accounts, the online banks may be more generous for your deposits given their lower overhead costs.

Emergency Funds

These accounts are excellent for establishing an emergency fund for unexpected expenses. They are readily accessible, liquid but you will want to be sure, so check the details. Besides an emergency account, these accounts help save a down payment for a home, car, or vacation planning.

When surfing around for higher yields, you are bound to find higher rates but with requirements. Higher minimum deposits or an ongoing amount in your account are common when you get higher yields. You may not want to tie up your money. If you don’t maintain some level, you may incur additional fees or other charges. 

 Money Market Account ( MMA)

You can open a money market account (also called a money market deposit account)  at a financial institution insured by FDIC with 0.10% for the national rate. MMAs will offer slightly higher rates than savings accounts, typically require minimum deposits ranging from $500 to $2,500, and some offer check-writing privileges.

These accounts should not be confused with money market mutual funds, which are not insured. Instead, a money market fund is a mutual fund sponsored by an investment company rather than a bank that invests in money market securities.

Online banks have higher rates above the national average, but you need to review the details of their offer.

Certificates of Deposit (CDs)

A certificate of deposit, or CD, is an interest-earning savings instrument purchased for a fixed period, such as three or six months, or one year, two years, or even five years. Some banks offer variable-rate CDs that pay interest that may adjust up or down periodically.

Like all money market securities, CDs are low risk but are subject to interest rate risk. For example, if you locked in a lower rate for a five-year CD, and interest rates are rising, you can’t move your money to another five-year CD with higher rates unless you have a CD that can be inflation-adjusted.

The latest FDIC national rates range from one month CDs at 0.03% to 0.27% for 60 month CDs. These are not exciting investment returns at this time. The longer the timeframe to maturity, the higher the rate. Deposits can range from $100 to $100,000.

Historically High CD Rates

According to the Federal Reserve Bank of St. Louis, the historically highest CDs were 18.65% in December 1980! Before you drool over those returns, be aware that the Fed was battling very high inflation of 12.5% and a 20% fed funds rate. The high-interest rates lasted for years and were not a picnic unless you had idle cash to buy CDs. CD rates, like other interest-bearing accounts, follow the rates set by the Fed. 

One issue to be cautious about with CDs is that there may be some penalties or fees to access the money you invest into these securities. These accounts may not be as accessible. You will be notified by the bank when the CDs are maturing but if you aren’t prompt, they roll into the next period. You can withdraw money from a CD before the end of the specified timeframe but you will subject to interest penalties.

Checking Account

A checking account is a deposit account held at a financial institution that performs transactions that allow for withdrawals and deposits by the account holder. You can write checks against deposits in this account.

Some checking accounts may pay interest, and if so, they are negotiable orders of withdrawal or a NOW account. Checking accounts called demand-deposit accounts typically do not pay interest on deposits. Typically, banks pay relatively low interest on checking compared to savings accounts.

Be Wary of “Free Checking Accounts”

When searching for a “free checking account,” make sure you know what the bank considers a free checking account.  It probably means a non-interest-bearing account without maintenance fees or minimum requirement.

Fees We Pay

Banks charge a ton of fees. Fintech company Stilt reports that Americans paid $11.6 billion in bank fees in the first three months of the pandemic when people were most hurting and losing jobs. A Go Banking Rates survey found the average American pays $7 in banking fees per month. The survey revealed that 88% of the respondents were not planning to switch banks in 2019 even if they were charged unnecessary fees. 

The most common bank fees and estimated costs are:

  • Monthly maintenance fees (savings) of $1-10.
  • Monthly service fees (checking),  $3-20.
  • Non-sufficient funds, $25-27.
  • Overdraft protection, $34-36.
  • Transfer from savings, $10-$12.50

 There are other fees people may incur such as when keeping a low balance, stop-payment orders, excessive withdrawals, loss of your debit card, foreign transactions, paper statements, and inactivity on an account.

These charges can add up for the banks as income but painful for consumers. You can always try to get these fees waived if it is the first occurrence. Instead, try to do your part to manage your account well.

According to a Bankrate 2020 study, the average minimum balance needed to open a non-interest-bearing account is $156. However, the average minimum balance for an interest-earning account goes up significantly to $7,550.

High Yielding Checking Account

FDIC-insured banks or NCUA-insured credit unions offer higher-yielding checking accounts. However, expect significantly higher minimums for opening and maintaining such accounts and learn what fees you may have to pay to earn the high interest.

 Final Thoughts

Interest-bearing accounts play a significant role in managing our monetary assets. They provide us with liquidity, safety to store our cash, and accessibility for emergencies while being able to earn some interest. There may be fees that offset these convenient benefits, so make sure understand the details.

Thank you for reading! If you found some value in this article, please find others that may be of interest to you by visiting The Cents of Money.

 

 

How Long To Keep Tax Returns: 7 Questions To Consider

How Long To Keep Tax Returns: 7 Questions To Consider

How long to keep tax returns is one of the most asked questions in personal finance.

Did you know the average American spends 13 hours every year preparing federal tax returns? For small business owners, that figure almost doubles to 24 hours!

It’s always a relief once taxes are filed for the year. But what do you do with all the paperwork afterward? How long should you keep your tax returns and records?

For most people, three years is a good time frame, but it could be much longer in many situations. Plus, it can often be a good idea to hold onto records longer than the required time for other non-tax reasons.

Keep reading to find out exactly how long you should keep your tax records in your situation. The answer may surprise you!

What is the Period of Limitations?

First, let’s start with some definitions. As always, the IRS has some slightly confusing terminology around how to measure the amount of time you should keep tax returns.

According to the IRS, the period of limitations is the “period of time in which you can amend your tax return to claim a credit or refund, or the IRS can assess additional tax.”

You would obviously want to keep all of your tax records for the period of limitations that applies to your specific situation, which we’ll get to in more detail below.

To measure the period of limitations, it starts at the time when the tax return was filed. Returns filed early are treated as filed on the due date. So if your taxes were due on April 15th, but you filed in February, the clock still starts on April 15th. However, if you got an extension and filed on September 15th, the period of limitations would start on that date.

How Long to Keep Tax Returns (according to the IRS)

For the actual tax return itself, the IRS advises keeping them forever. I would 100% agree with that. Especially in the digital age, where everything can be saved on a hard drive or backed up in the cloud, there’s no reason to toss your actual tax returns.

Past tax returns can help prepare future returns and in calculating amended tax returns if necessary. For example, if you own rental property as I do, you would depreciate it over 27.5 years. Having past tax returns as a backup for my calculations makes it much easier to enter the depreciation when I sit down to do my taxes the following year.

However, many other records help support your tax return, such as W-2 forms, 1099s, charitable donation receipts, mileage logs, and many more. How long should you keep all of those documents?

Here are the rules for the period of limitations and how they apply, straight from the IRS website.

Period of Limitations That Apply to Income Tax Returns

  1. Keep records for 3 years if situations (4), (5), and (6) below do not apply to you.
  2. Keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later if you file a claim for credit or refund after filing your return.
  3. Keep records for 7 years if you file a claim for a loss from worthless securities or bad debt deduction.
  4. Keep records for 6 years if you do not report income that you should report, and it is more than 25% of the gross income shown on your return.
  5. Keep records indefinitely if you do not file a return.
  6. Keep records indefinitely if you file a fraudulent return.
  7. Keep employment tax records for at least 4 years after the tax becomes due or is paid, whichever is later.

In plain English, most people should keep their tax records anywhere from three to seven years. (Remember this is measured by the period of limitations and starts either on the due date of the tax return or when you actually filed, whichever is later). If you want to play it safe without having to think through the fine print and how it applies to you, you can plan to keep your tax records for seven years.

However, if you want to dig a little deeper, the next section will cover some specific scenarios.

One interesting thing to point out is the recommendation to keep records indefinitely if you do not file a return or file a fraudulent return. I hope the readers of this article do not fall into this camp, but to emphasize the point, there is no statute of limitations on when the IRS can come after you if you file a fraudulent income tax return. So please don’t do it!

Unique Requirements for Property Owners

One of the first possible exceptions to the rules is for keeping tax records related to property (such as your personal home, cars, or rental property).

According to the IRS, you should keep records relating to property “until the period of limitations expires for the year in which you dispose of the property.” So if the three-year period of limitations applies to your situation, you would need to keep all property records for at least three years. These documents would include anything that supports your calculations for depreciation, amortization, or depletion deductions.

For example, if you bought a house 20 years ago and sold it this year, you would need to keep any records related to that property that supports the deductions claimed on your tax return for an additional three years. This would include loan documents or closing statements from when you purchased the property 20 years ago.

Another thing to consider, especially if you invest in real estate, is the 1031 exchange. If you utilize a 1031 exchange to defer taxes by selling one investment property and buying another, you will need to keep property records for three (or more) years after you sell the new property.

This is because the cost basis from the old property helps determine the cost basis of the new one, and you need a paper trail going all the way back to support the final gain or loss on the sale of the new property.

As a general rule, I plan to keep all property records forever. It’s easy to digitize them, and it comes in handy for reasons other than preparing taxes, such as applying for a loan or cash-out refinance. One of the things I’ve learned along the way as a real estate investor is to keep good rental property accounting and bookkeeping records throughout the year. It makes tax time so much easier, and I’m not scrambling to find months’ worth of receipts and expense records.

How Long Should I Keep Tax Returns as a Small Business Owner?

If you own a small business, have a part-time side hustle or freelance gig, or get a lot of your income from 1099s or under-the-table jobs, there are some special considerations for you.

While it’s not intentional (or at least it shouldn’t be), if you receive a lot of various 1099s, it can be easy to miss reporting some of that income. According to the IRS guidelines above, they have up to six years to audit you if you forgot or neglected to report at least 25% of your income.

For that reason, a business owner probably should plan to keep at least six years worth of 1099s and other records of business income and expenses to be safe.

This also applies to those with a W-2 job but who receive a significant amount of income from side hustles or other sources. If you’re using a few apps to make an extra $20 here or there, this probably doesn’t apply to you. But if you started a bookkeeping business on the side of your day job as a financial analyst, and it generates a decent amount of revenue, I would strongly consider following the guidelines in this section for business owners.

What if I Have Claimed Investment Losses or Bad Debt Write-Offs?

Sometimes your financial investments don’t go as planned, and you take a significant loss on a stock, business investment, or loan to your deadbeat uncle that never gets paid back.

The silver lining is you get to claim this loss to offset your income (in most cases) on your tax return. However, per the IRS, filing a claim of loss for bad debt or a worthless investment triggers a seven-year period of limitations. In this situation, you’ll want to make sure to keep your tax records for at least seven years in case of an IRS audit.

How Long to Keep State Tax Returns

In most cases, following the IRS guidelines for how long to keep federal tax returns will keep you in the clear for state tax records as well.

However, be sure to check your individual state requirements. Some states may have longer to audit your state tax return than the IRS has to audit your federal return. For example, there is a period of limitation of up to four years to audit your state income tax return in California. If you live in California, you would want to be sure to keep your records for at least that long.

How Long to Keep Tax Returns: Summary

It’s never fun to prepare and file taxes, and it’s even less fun to worry about how long you need to keep all of your tax returns and records. However, a few rules of thumb and guidelines from the IRS help you sort it all out.

In the end, there’s no one-size-fits-all solution. If you want to play it safe, keeping all tax-related documents for seven years is a good idea. If you have a corporate job with a W-2 salary and no property investments or significant losses, then three years is probably long enough.

Final Thoughts

Here is a quick summary to wrap things up:

  • In most situations, keep tax records for a minimum of three years from the filing date
  • If you own a small business or have multiple streams of income, it’s safer to keep tax records for at least six years
  • If you claim a loss from an investment or bad debt, keep your tax records for at least seven years
  • If you own property, keep all purchase and tax records for that property until at least three years after it is sold

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

Thank you for reading! If you found this article valuable, come visit us at The Cents of Money and consider subscribing to get our free weekly newsletter and more.

How To Start Investing For Beginners

How To Start Investing For Beginners

Do you want to start investing in stocks but were afraid to ask? No worries, we’re glad to help you take the first steps toward investing for beginners. Investing is the most reliable way to create wealth over the long term. Before you start putting hard-earned money into the market, there are some things you need to know.  Let’s begin now.

Success in investing doesn’t happen overnight. Your investment portfolio is a lot like a garden. A nice garden takes time, energy, and attention to grow its appeal. You may do some research when adding a variety of plants, flowers, and shrubs to your garden to give it its value and appeal. Some plants may grow more successfully than others that may not work out in your garden.

Like a garden, an investment portfolio takes time and attention to establish. You will want diversification to balance risks and returns. Over time, you will add different components like bonds to stocks to balance risks and returns in your portfolio.

 

What Is Investing?

Investing is a way to put your savings to work to earn even more money and a higher return on the respective asset. Investors make investments in the hopes of earning a positive total return.

The total return is the income an investment generates over a period of time divided by the price you paid for the asset (like a stock). Total income from a stock investment may include dividends, distributions, and capital gains.

The capital gains (or losses) are the profit earned (or loss) from owning this asset compared to its cost basis. This price appreciation occurs when your selling price is higher than the price you paid for the asset. 

Maximize Returns While Minimizing Risks

Essentially, you want to maximize returns, minimize risks and returns, manage fees and costs for the best results. Investors can leverage the compounding growth to achieve wealth and financial security for the long term in their retirement and taxable investment accounts.

Optimally, this is the scenario you should integrate with your financial plan. Compounding is the closest thing to magic in finance which works for good in investing and bad when growing your debt levels.

When you have reasons to invest, your incentives to save money push you to prioritize investments as a high priority. As such, you will more likely budget for this category. You would be surprised how your motivation to invest may reduce your spending.

Have A Financial Plan

Have a financial plan that organizes the things you want to save and invest for in life. Think about what you want your life to be like and jot down a range of short-term and long-term goals. This list may include taking vacations, emergency funds,  buying a home, a car, financing your children’s college education, starting a business, caring for older loved ones, or a comfortable retirement.

Making investments can help you to:

  • Fulfill your financial goals.
  • Increase your income.
  • Meet your retirement needs.
  • Maximize your enjoyment of life.

Don’t wait too long to save and begin investing. The sooner you start, the better to opportunity for you to build wealth.

Why Stocks?

Buying stock gives you partial ownership in a company, allowing you to participate in gains, losses, and potential dividends during the year. Historically, stocks tend to generate higher returns which correlate with higher risks than fixed-income investments.

Unlike bonds, which have a priority claim as creditors, stock investors could lose their entire investment should the company go out of business. Diversification, a strategy we talk about, later on, is the best way to reduce that risk.

Stock investments have higher returns correlating with higher risks than other asset classes and can better keep pace with inflation.

 The Dos Before Investing

 

1. Get Your Finances In Order

Before you start investing, understand your needs so that you are financially ready. When you commit money for investing, you should only invest funds you can afford to lose after you pay your bills and fulfill your basic living needs.

Investing is not risk-free and is without guarantees. You don’t want to take the money saved for a home or your retirement.

Ways To Prepare Your Finances:

Are you able to balance your budget monthly? You live within your means and can pay your bills, including the payoff of your credit card balances. By automating payments, you are managing your student loans well.

Do you have savings set aside for emergencies? By saving regularly, you can allocate this money to an emergency account so that it will eventually cover six months of your basic living needs. This fund is readily available for unforeseen events like losing a job, your pet needing a medical procedure, or fixing your car.

Have you paid off high-interest debt? If you only pay the monthly minimum amount required by issuers,  your credit card balances will grow faster than the rate of your investments. You need to reduce and ultimately eliminate high-interest rate debt. Commit to paying bills on time and paying off card balances in full.

Are you spending within your means? Manage your spending so that you can direct some savings for investing purposes. Understand how investing fits in with your long-term plans.

Are you saving for retirement? Take advantage of your employer-sponsored 401K plan if offered by contributing a portion of your paycheck. Your retirement savings plan is your first entry into investing. By automating small contributions of 1% of your annual earnings, you are setting aside retirement money that will provide tax and compound growth benefits for your financial future,

This plan is investing for your long-term financial future and provides tax advantages. Most workplace plans offer to match your contribution, which is free money added to your account. Automate your contributions from your paycheck, increasing the amount you can as you can get salary boosts. 

2. Decide How Much And Where To Get The Money To Invest

Yes, you can start with as little as $100 or $1,000. However, you will want to increase your investments on an ongoing basis as you have more financial resources.

Pay Yourself First. Make this your motto so that you can save a portion (10%-20) of your paycheck for savings. Saving by reduced spending so that you can invest more. As you accumulate more money in your investment accounts, you will want to expand beyond stocks to other assets like bonds, real estate, money market securities.

Later on, you can meet with a financial advisor or other financial professionals. But let’s not get ahead of ourselves.

 

3. Understand Your Risk Tolerance

Risk tolerance refers to the amount of loss that you can handle while making an investment decision. All investments carry risks. Some investors are willing to take higher risks in exchange for anticipated higher returns. They are risk-takers compared to risk-averse investors who seek lower risks.

Those who are risk-averse may prefer the increased certainty of keeping their money in a bank savings account. This is saving money rather than investing money. The interest rate of a savings account doesn’t amount to very much these days and typically, will not beat inflation as stock investments can.

Wealth Accumulation Or Wealth Preservation

Typically, the younger you are, the more likely you can better handle risk than those closer to their retirement years. Another way of thinking about this is whether you are in the wealth accumulation or are preserving your capital phase of life.

To accumulate wealth, accept more risk, especially when you are investing for your financial future. When preservation of capital is your primary goal, typically, this means you are investing more conservatively, risk-averse to losing money in the market.

Usually, when you invest in the long term, you are more willing to accept more risk, especially if you have some liquidity set aside for unforeseen expenses.

4. What Is Your Investing Approach When Buying Stocks?

When you initially begin to invest in stocks, several options depending on your anticipated level of involvement. How hands-on do you want to be, and do you have the time to spend to make decisions?

Active Investing

An active investor will want to manage her accounts. They are hands-on investors who make individual stock selections. This approach requires time and a certain amount of knowledge and monitoring of the economy, market trends, industry sectors,  and fundamental analysis. If you are building your portfolio with individual stocks, you need to consider diversification. On the other hand, you can achieve diversification through the purchases of mutual funds and exchange-traded funds (i.e., ETFs).

Passive Investing

A passive investor does not engage in trading or active stock picking. Instead, they are usually long-term Buy-Hold investors who rely on index funds that typically track one of the major indices like the S&P 500. They will buy other mutual funds or ETFs.

The passive investing approach is an ideal path for beginning investors. They can get a feel for the market, decide how much time they can devote to building their diversified portfolio, and better understand their investment philosophy. This investment strategy provides savings if you stick to buying index funds with low fees (i.e., low expense ratio) and lower taxes if you hold your securities long term.

You can open an online account at a traditional or discount broker and actively invest or passively invest in individual stocks, mutual funds, or exchange-traded funds. Alternatively, you want to try a Robo-advisor. The road you decide to take will have implications on your costs.

5. Open An Online Brokerage Account

There are plenty of online brokerage options to open an account. Most have low to zero commissions, but there may be other costs so review their website. As a new investor, you can choose to open an online account at a traditional brokerage firm, emerging disruptor brokers, or Robo-advisors.

Some traditional brokers, like Charles Schwab, offer Robo-advisors, or hybrid services, while some original Robo-advisors increasingly offer human advisory services. So don’t get too hung up on the company name.

Features Vary

When you make your decision, consider the respective firm’s offerings in terms of an easy-to-use platform, types of securities, access to educational resources, and potentially fundamental research or stock charts. Newer providers may have limited securities for you to purchase (i.e., index funds or mutual funds, ETFs). If you are a beginning investor, you will want to make sure you can buy low-cost index funds. More on that later.

Robo-advisors are automated options that provide investment management services.  They are desirable for beginning investors who do not want to make their selections. Most traditional management firms have high minimum investment requirements and charge more than Robo-advisors, which may be an excellent alternative to a traditional financial advisor. As such, Robo-advisors may fit your bill.

The Robo-advisors use computer algorithms to build an appropriate portfolio based on your profile you provide to them. They want to understand your goals, tolerance for risk, and investing preferences and use financial planning tools to rebalance your portfolio and tax optimization when needed.  They vary in how much human advisory interaction you will have, with some having little to no human interaction with you, while others have more human advisory services.

6. Individual Stocks or Index Funds

You can buy stocks individually or as stock funds. Individual stock investing can be very rewarding, but there is a learning curve. Stock funds range from actively managed funds to passively managed funds. Both will provide essential diversification right away, which you won’t get buying only a couple of individual stocks at first.

Portfolio managers run actively managed funds typically with expertise in their sector and hand-pick their investments. However, actively managed funds charge higher costs (e.g., expense ratios and transaction costs) and require an increased minimum investment than passively managed index funds. The manager of the index funds targets replication of the index they are tracking (e.g., S&P 500 index).

Studies show that actively managed funds do not perform any better than passively managed funds over the long term. High fees over a long time reduce your returns.

For these reasons, low-cost index mutual funds or Exchange-Traded Funds (ETFs) are an excellent way to start investing. You will save money on their costs (ETFs are similar to mutual funds but may have lower fees), and you can purchase these funds with low to no minimum investment.

You can find index funds with expense ratios as low as 0.015% and no minimum initial investment. As such, you will pay  $1.50 annually for every $10,000, less than a latte.

Buying Low-Cost Index Funds

When you buy an index fund, you are buying a low-cost index fund that tracks your chosen index. A popular index uses the S&P 500 as a market benchmark. It follows 500 of the largest US companies measured by market capitalization. Typically, the companies are leaders in their respective industries.

Among the cheapest S&P 500 index are the Schwab S&P 500 index (SWPPX), with an expense ratio of 0.02%, and the Fidelity 500 Index (FXAIX), with an expense ratio of 0.015%. Neither requires minimum initial investments. Fidelity has a series “ZERO” that has no-fee index funds.

There are index funds that track growth, value, income, and varying capitalization companies.  Index funds are available for various geography, industries, a mix of assets, and different development stages. With all these opportunities, you need to be mindful of fees and costs from employing a financial advisor or actively managed funds.

7. Have A Long-Term Perspective

When investing, focus on the long-term, avoiding selling your portfolio when the market becomes volatile. Markets have periodic downturns that provide savvy investors opportunities to buy dips in shares to start or expand a position. Stock investments can be rewarding for long-term investors with the chance to earn historical average equity returns of 10%.

8. Diversification Is Essential

A cardinal rule for beginning and experienced investors is diversifying your mix of stocks using ETFs and mutual funds. The benefit of having exposure to several market sectors is when a specific industry, like technology stocks, goes down in tandem or out of favor. Other sectors may take their place as leaders.

By buying low-cost index funds and ETFs, investors can best achieve diversification, whether initially or long-term. Concentration in any one stock or asset is hazardous. Besides investing in stocks, you should expand into bonds, real estate, commodities, and other areas to disperse the risk of overexposure in any one place.

Don’ts When Investing

1. Don’t Be Greedy

When you invest long enough, you know favorite stocks that go up often come down. You will want to replace greediness with financial discipline. Trim your winning positions is always a good way to lock in gains we sometimes lose when we are greedy. Give yourself a target to trim stocks when they rise 20%-25%. Greed is one of the seven deadly sins of investing

As the old Wall Street saying goes, “Bulls make money, bears make money, pigs get slaughtered.”

2. Don’t Concentrate Your Money In One Stock Or Asset

This factor is the risk you take on when you are not adequately diversified. Concentration in one stock, one industry, or longer-term in one asset class is risky. Sometimes one stock may have performed far better than other stocks and now is outsized in proportion to your holdings. Lock in your gains and raise some cash to buy more in a correction.

3. Don’t Fall In Love With A Stock

At times, you may feel some affection for a stock that trades beautifully, and you wish your entire portfolio will react like that name. The company management and fundamentals are above-average in a desirable part of the market. Don’t be blinded by what you may believe is the stock’s “never can do wrong” attitude. Save that for people you love, not stocks.

Good companies sometimes make bad stocks and vice-versa. I have some experience with being resistant to selling solid winners for a long time. However, things change. Maybe it was because there was a new competitor or a rare mistake on management’s part. Be aware that no stock or company is infallible, and don’t fall in love and find that you lost sight of some deterioration in its fundamentals.

4. Don’t Be Emotional When Investing 

The most experienced investors come upon times when their egos or other parts of their persona get in the way of their investment judgment. We carry our biases when we shop and invest and often are unaware to our detriment. Become more aware of these tendencies by being more conscious of our decisions.

Our biases cause us to spend more money when shopping, but we only realize it when we review our bills. When investing, we may not want to give up on a poorly performing stock because we don’t want to admit our mistake.

For example, you own shares of XYZ company which continue to go down as they report revenue and earnings below expectations. As the stock drops, you add to your position even though the company reports more bad news. You may be adding to the sunk costs you already have in this position. Sunk costs fallacy is a common investment bias, along with other biases we discuss in an article here.

5. Don’t Panic In A Market Downturn

There are times when the market plunges.  You panic and stress about your portfolio and decide to sell everything. Don’t do panic selling. This scenario is more common than you think. We have all had that sinking feeling where you stare at the screen and watch your stocks turn red. The operative word is “watch.” Unless you need to sell stocks for liquidity purposes, sit back and try to learn what the market is telling you.

During the first half of 2020, the pandemic caused the market to plunge in March as the economy deteriorated. The Fed stepped in quickly to adjust its policy to add liquidity to the financial markets. After entering the bear market territory, the market promptly proved its resilience by recovering its bullish stance.

Many people sold their shares, emptying their portfolios, while others used the downturn to buy opportunity. Staying put turned out to be the right move, as shares moved up quickly. Similarly, shares cratered to the bottom on March 6, 2009 (down over 50% from the 2007 high), due to the Great Recession. I sold some stocks in my portfolio, which left me with a lasting impression not to do panic selling so long as I can pay my bills. Focus on the long term, and for the most part, your stocks will come back.

6. Don’t Become A Short Term Trader

Many professionals are short-term or day traders. They are actively engaged with the market, have sophisticated trading tools, need sufficient capital, and work very long hours to learn about the market, economy, news, and respective events. It is very risky and not for the faint-hearted. I admire these traders who work hard, understand the short-term price movements, and make a living.

Day trading is not for the unsophisticated or beginning investor. As an investor,  sometimes you trade or sell stocks you intended to hold for the long term. The reason for getting rid of such a position could be that the catalyst you bought the stock for didn’t materialize, or you realize you were mistaken about the fundamentals. Things happen.

Generally, you should keep a long-term perspective. Traders will make a short-term trade to lock in a profit. However, you will be paying higher taxes for the short-term gain at the ordinary rather than the capital gains rate.

In recent months, we saw many individual investors take on significant risks trading meme stocks, like GameStop, fueled by social media attention rather than fundamentals. This trend is foolish and not real investing. Sure, stocks can go up until they don’t. Know what and why you are buying, and be purposeful by avoiding unnecessary risk.

7. Avoid Unnecessary Risks 

We have written about the risks associated with buying positions on margin, which is essentially an expensive loan. By doing so, you are adding significant risk, and especially if you get caught in a market correction.

Your broker has the right to make you pay your margin loan or sell stocks to satisfy the loan. Margin calls usually come at the worse time for you, the trader, or the investor.  Make sure you understand the financial consequences before engaging in this practice. Short selling is a complex practice best left to professionals and those comfortable with options trading. Read our post on the market frenzy to learn about these and other risks. 

 

7. Hard To Time The Market

The most experienced investors cannot time the market with accuracy. They understand the need to withstand market volatility causing large price swings and a long-term perspective. All of us would like to have the ability to buy stocks at the bottom and sell before a crash. We can take advantage by using some financial discipline by letting the market “settle down” before buying new shares or trimming when stock valuations become high.

8. Avoid Extended Trading Hours

Traditional hours for the NYSE and the NASDAQ Stock Market are open from 9:30 AM to 4:00 PM unless opened for a half-day during certain times of the year. Outside these hours are the extended or “after-hours.”. Everyone, individual and institutional investors, have access to making trades during that time.

That doesn’t mean it is a good idea for individual investors to do so. The after-hours market tends to be very risky as liquidity is far more limited, trading and prices are more volatile. You may be trading more blindly, unaware of what you are paying or getting in return for your position with wider price spreads. You are trading against far more professional traders during this time.

Final Thoughts

The time to start investing is now. Once you get your finances in order so you have more flexibility, start investing for beginners. Follow our “Dos and Don’ts” as guidance as you grow more confident in your investing abilities. There is an exhilarating feeling when you can make your savings work for you, achieve your financial goals, and build your wealth in the long term. 

 Thank you for reading! If you found this of value, please visit The Cents of Money for more articles on investing and other personal finance topics. Consider subscribing and get our free weekly newsletter and our weekly posts.

 

 

 

 

51 Ways To Save Money In College

51 Ways To Save Money In College

“He (She) who will not economize will have to agonize.”

 Confucius

 

Saving money during college is a perfect way to develop good financial habits. Learning how to manage money on a tight budget, pay down debt, control spending, and make money may be among the best lessons they get in college.

Contrary to popular belief, college students are better budgeters than graduates starting their first job.

As a college professor, my students often share how they spend less on books, entertainment, and food. Many of the tips below come from those discussions. Being frugal is a badge of honor for my students and me who come from homes of modest means. 

Parents, I encourage you to share can share our list with your college-bound students. Likewise, if you are on your way to college, there are ways your parents may be able to help you as well.

51 Ways To Save Money In College:

 

Before College

  1. You should be working during the summer to have some spending money.
  2. Take Advanced Placement (AP) courses, if offered in high school. Make sure to do well on AP exams so that you can get full credit. Colleges are generally looking for a “4 or 5” score on the AP exam to reflect that you are “well or extremely qualified”. Some may grant credit for a score of 3. 
  3. The College Level Examination Program (CLEP) offers 34 exams that cover intro-level college course material. With a passing score on one CLEP exam, you could pick up three or more college credits at more than 2,900 colleges and universities. Your learning of these topics could have been through a high school course, independent study, or on-the-job training.
  4. Apply for work-study, grants, and scholarships.
  5. Attend a community college for the first two years at lower tuition rates. It is an excellent alternative for many students. You might even be able to live at home, saving dorm and food costs.

Be Resourceful At College

  1. Don’t buy new textbooks. Instead, look to rent your books from Chegg, Amazon, or Barnes & Nobles. They may also sell your textbooks in ebook form. Rental and ebook prices have come down quite a bit in recent years. Ask your fellow students who may have free pdf resources. Even traditional text publishers have digital book offerings.
  2. Reach out to your classmates and ask around for used books as early as possible. Ask your professors as they may have a list of previous students interested in selling books. There are flyers all over your campus with offers. Buy the paperback version, which is significantly more affordable.
  3. Find out about amenities offered on and around campus. See if there are discounts for school supplies and laptops. Often computer labs on campus may be selling refurbished computers with maintenance provided for some time.
  4. Use your college library and the public library for your books, ebooks, music, and videos.
  5. Students should learn about respective school resources. Take advantage of free help like tutoring, writing, computer IT, and printing. There are probably free or discounted entertainment and food offerings at certain times, such as club fairs or special events. As a faculty advisor for one of the largest clubs on campus, I purposely buy extra food for students who attend our presentations.
  6. Be aware of the application and enrollment dates. You need to know the deadlines for dropping courses and getting partial or complete reimbursement.

Budget Your Living Expenses

  1. Live at home if you are near campus. At the very least, you may be able to do your laundry and pick up snacks in a pinch.
  2. Review your alternatives between living in the dorm, house, or an apartment. Look at safety, walking distances, affordability, and complimentary transportation between campus and home. When renting a house or apartment, consider your potential roommates wisely.
  3. Monitor your costs for utilities, food, snacks, and such. Don’t waste energy. Make sure to pay your bills on time and credit card balances in full. Don’t ramp up unnecessary late charges. Do your roommates share your financial values, like shutting the lights when they leave?
  4. Review your on-campus dining plans for healthy, affordable choices. Consider potential alternatives in your college’s vicinity—Cook for yourself. Make salads or even ramen noodles in a bind. There are far more options today.
  5. Buy non-perishable items in bulk. Unless you are cooking for a pack of students, it usually doesn’t make sense to buy food in size if it is perishable.
  6. Limit eating out and avoid alcohol which is more expensive in restaurants. Look for special deals for college students.
  7. Use coupons and rebate apps to save on groceries and other personal care items.
  8. Avoid Starbucks and invest in a cheap coffee drip pot or a one-cup Keurig.

Transportation

  1. Having a car at school is expensive. Everyone will want you to drive them and will rarely pay you back for gas. Check out public transportation and look for student discounts. Walk, bike or carpool instead.
  2. Find the cheapest ride-share in your area if you need to go somewhere not covered by public transportation.
  3. Book trips early when you know you are heading home. Look for discounts or consider traveling on off-days.

Entertainment

  1. Make sure to use available Wifi on campus and at home to not go over budget on your data plan.
  2. Pick one streaming service like Netflix or Amazon Prime. Think of cable as a luxury you can have when you go back home. With more video streaming providers, competition may drive not prices. Look for lower prices.
  3. Look into Amazon for their deals called Prime Student. They have a free six-month trial that includes a ton of perks.
  4. Social events on and around campus or in nearby parks are usually free or cheap.
  5. Get free music from Pandora and Spotify. The ads are not that bad!
  6. Get discounts from businesses in your school’s neighborhood.

True Story

I gave my students a term project to go to every business within a 15-20 block radius of the campus and arrange student discounts. They filled out forms by the business, which pledged a discount (usually 5%-10%) for customers with a college ID. In return, the business name and address would be posted on the school website, generating some good traffic for them. The businesses included restaurants, a bakery, laundromats, groceries, a bowling alley, a movie theater, and a bagel place.

With a few exceptions, many owners wrote us letters of gratitude and kept their discounts in place for students. One of my former students who had already graduated called to thank my students and me for the project profusely. Her family was the owner of the nearby bagel place. She told me business was booming.

Money And Banking

  1. Look carefully at offers for credit cards with the lowest interest rates and cashback rewards. Review their terms for what they charge in fees and penalty rates.  Students are particularly vulnerable to these issuers. I believe a secured credit card is a great way to strengthen your credit score when you are under 21 years old. You can put down a security deposit of up to $500, which serves as collateral.

The CARD Act

The Credit Card Accountability, Responsibility, and Disclosure Act, or the CARD Act, did not stop these vendors from marketing on college campuses to students. The issuers did make it more difficult for students under 21 to get a card without a co-signer. If you are between 18 and 21 years old, you can be an authorized user on your parent’s card, get a secured card, or a student credit card that is unsecured.

  1. Pay your credit card bills in full. Yes, I may have said it earlier. It’s that important. Do not carry any kind of balance or stop using your card, and use your cash more often.

32.You should set up a high-yield savings account with a local bank. You should be able to get free checking as a new account holder.

  1. Make sure to track your spending to avoid any unnecessary checking overdraft fees. There are a few good budget apps (Mint, PocketGuard, Wally) or a spreadsheet.
  2. Check your credit report periodically. Monitor for errors you need to correct. Watch out for potential fraud. If you suspect fraud, you should address it immediately. Several of my students have been victims of identity theft. The Federal Trade Commission website has instructions for you.

Shopping

  1. Avoid impulsive shopping, which induces overspending.  Do window shopping without money instead.
  2. Look for school discounts for a laptop. Consider what essentials you need in a computer and not necessarily what you want. There are a lot of choices, including refurbished computers, which may be suitable for college students. You don’t need a printer. Your school probably offers students a card every semester that provides free printing (e.g. 500 copies) at the school’s expense. Also, you can probably email your assignments to your professors.

37.You may even be able to get free anti-virus software to protect your computer and smartphone.

  1. Buy generic brands for over-the-counter drugs and groceries. You will be saving up to 35% over name brands without compromising on quality.

Health & Fitness

  1. See if your school provides free flu shots through their nursing department or medical school. There may be a local urgent care facility for basic medical needs that is affordable through your family’s insurance plan. In a post-Covid world, free vaccinations will be far more available.
  2. Rather than join an expensive gym, check out on-campus facilities and their track field. There may be discounts for a gym nearby. Our campus is known for massage therapy classes, and students always enjoy that free perk after classes. See if there is a pool on your campus. 

As A Student

  1. It is essential you must attend class, read your book, do the assignments, avoid absences and latenesses. Reach out to your professors for help. They want you to do well.
  2. Do not take an “Incomplete” in any class without knowing the consequences—nine of 10 students who have taken an “INC” never complete the work required. The grade turns into an “F,” and you may lose the credits and have to retake the course. Losing credits may delay their graduation, reduces their GPA, and adds cost.

A Saga About An Incomplete

  1. Talk to your professor and understand the time required for making up the assignment. One of my brightest students was on her way to an “A.” In early December, she let me know that she had a family trip coming up and would miss the term paper deadline.

We both agreed that an INC would be a placeholder for her final grade. She would complete the term paper in January when she was back. I gave her the new deadline, which was in the first quarter of the year. She even had a pretty good draft, and I was pretty sure she would do it on time.

To be sure she would stay on track and complete the class, I sent emails to remind her in January. I did not receive an answer. Worried, I phoned her at home, and she said I would have it soon. I never did get it. That Fall, she told me that her grade had turned into an “F,” but there was little I could do.

College students are huge procrastinators. Your professors know that and remind students in class and on school websites. Learn how to better avoid procrastination.

Work in College

  1. It is essential to do well in school. At the same time, it is crucial to work on or off-campus. The average full-time college student makes $195 per week. According to a 2016 Digest of Education Statistics, 43% of full-time students and 78% of part-time students worked. The majority of college students make between $7,200 – $42,000 per year.
  2. There are many types of jobs you can do part-time to add some money to your account. When you are busy, you often excel at time management. You can be a tutor, work in the learning or computer center. You can work at a restaurant or grocery. Many students consider working during January or during the summer to save more money.
  3. As a full-time student, you can become a resident advisor or assistant on campus. This position is desirable and looks excellent on your resume. The compensation varies, but you may earn free or reduced housing, a stipend, a meal plan, or dollars towards your tuition.

Pay Down Student Debt

  1. With all the money you may be saving and making, consider making small but regular payments to your student loans. Even $10-$20 per month helps to reduce the total amount. More importantly, it is a good financial habit. You may think it is early to think about student loan repayment, but it is good to be proactive with your student debt.

My Best Wishes On Getting A Good College Education

  1. Make the most of your college experience. Do it in four years.

Two more tips:

  1. Invest in Yourself. Become a sponge and learn everything you can. Develop soft skills such as critical thinking and problem-solving. Strengthen your communication skills. Get out of your comfort zone and take electives that you may not get a chance to do again. Join the Mock Trial Team, the Federal Reserve Challenge, or Debate Team. Join any worthwhile competition.
  2. Be ethical even if the world doesn’t always seem to value that trait. Your employers will.
  3. Before you know it, you will be meeting prospective employers for your first job out of college. Go to job fairs or any networking events so you can begin to speak to those who may become essential to your future. It is never too early to think about your next move. When looking for a job, consider the company’s benefit plan.

Final Thoughts

Saving money in college may be easier than you think. You need to make an effort to manage money on a tight budget, pay down debt earlier than required in small increments, control spending, surround yourself with like-minded friends, and make money when opportunities arise. Most of all, be a diligent student, so you don’t have to repeat courses unnecessarily.

 

And have some fun!

Thank you for reading. What kind of financial experience did you have when attending college? Any tips we left out you would like to add for our budding college-bound folks? Please share with us! We are happy to hear from you!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

How Risk Averse Are You? Here Are The Best Ways To Find Out?

How Risk Averse Are You? Here Are The Best Ways To Find Out?

All of the recent hype surrounding Gamestop, cryptocurrency, non-fungible tokens (NFTs), and meme stocks made me question – is anyone risk-averse anymore?

Does anyone value consistent returns over the 50/50 gamble to win big or lose it all?

Of course, I know the answer is “yes.” There are over $4 trillion in passive funds right now, which means there are a ton of people employing a long-term investment strategy.

But still, it feels like everyone is gambling with their hard-earned income like it’s their first time in Vegas. And it’s partially true.

While many people are investing in index funds and other traditional investments, Dogecoin (crypto that started as a meme… yes, a meme) has a market cap of nearly $50 billion!

Ford doesn’t even have a $50 billion market cap.

As I felt in a hint of FOMO surrounding all of these fast-growing investments, it felt like a good time to reexamine why I’m passing on these types of investments in the first place – because of the risk they carry.

The Definition of Risk

According to Merriam Webster, the definition of risk is the “possibility of loss or injury.”

In this case, when dealing with the world of personal finance, we will focus on the first three words – the possibility of loss. Specifically, financial loss.

A high-risk investment has a high probability of declining in value, resulting in you losing money. High-risk investments include things like equity, NFTs, and cryptocurrency.

Naturally, a low-risk investment has a low probability of declining in value. Low-risk investments include bonds and certificates of deposit (CDs).

And then you have everything in the middle, like real estate.

Though, the risk is not a binary measure… the other variable to consider when determining risk is time.

The longer you hold an asset, the less risky it gets (usually). For example, in any one year, the S&P 500 could go up or down by 30%. So that is a pretty risky option.

However, over a long period of time, it gets less risky. You can be relatively confident that the S&P 500 will average a return of +5-10% per year over most 20 year time spans.

That’s why when you are 20 or 30 and just start investing; it makes sense to invest in equity. You have a long time horizon over which you will be investing.

When you get close to retirement and need your money in the next few years, it likely makes sense to adjust your portfolio allocation to more conservative investments. Because your time horizon is shorter, investments, in general, get riskier.

Risk Averse Definition

Risk aversion is defined as avoiding risk. Pretty straightforward.

If you are a risk-averse investor, you will seek out investments with a low probability of declining in value. This is because you value preserving your money more than seeking out the best possible return.

And, of course, the tradeoff with being a risk-averse investor is that you will not get crazy high returns on your money. Instead, you will receive smaller but consistent and positive returns.

On the flip side, somebody who is not risk-averse prioritizes finding the best possible return over finding safe investments.

How to Know How Risk Averse You Are: Ask Yourself 5 Questions

I developed a quick 5 question quiz to help determine your level of risk aversion.

Some of these questions have subjective answers, and others are objective. Regardless, all of them will help you figure out what risk level you can accept, which is helpful to know when building your own investment portfolio.

Question 1: How Close to Retirement Are You?

  1. 0-5 years away
  2. 6-10 years away
  3. 10-20 years away
  4. 20+ years away

Question 2: How Big is Your Emergency Fund?

  1. I Don’t Have One
  2. 1 Month of Savings
  3. 2-3 Months of Savings
  4. 3+ Months of Savings

Question 3: Of the Following, Which Would You Choose for Your Investment Returns This Year?

  1. A guaranteed return of 3%
  2. A 95% chance of receiving a 7% return (5% chance of 0%)
  3. A 75% chance of receiving a 11% return (30% chance of 0%)
  4. A 50% chance of receiving a 25% return (50% chance of 0%).

Question 4: Do You Ever Buy a Lottery Ticket or Gamble?

  1. Never
  2. Maybe Once a Year
  3. Occasionally
  4. Every Chance I Get, I love lotteries and the casino

Question 5: In General, Would You Say You Are Good with Money?

  1. To be honest, not really
  2. I’m OK – I have a basic budget and a good income, but I don’t save or invest as much as I would like to
  3. For the most part, yes. I save and invest at least 10% of my income
  4. Yes, I’m a money expert and on track for my financial independence goal

What Your Results Mean

Now, add up your score based on your answers above. You should get a result somewhere between 5 and 20.

You can use the total to get an idea of how risk-averse you are or should be when investing:

5-10: High-Risk Aversion

You are a risk averse investor who is OK with lower returns and should seek out conservative investments.

You are likely close to retirement and value security over high potential returns. Bonds, certificates of deposit (CDs), and interest-bearing accounts appeal to you because of their stability and liquidity.

And while you don’t avoid stocks altogether, when you invest in them, it’s in low-cost and passive index funds. You might also seek out the help of a financial advisor or Robo-advisor.

Your money mantra is all about getting a consistent and predictable return over seeking out home-run investments. Uncertainty is not your friend.

Typical Investments:

  • Bonds (including government bonds, treasury bills, corporate bonds)
  • Certificates of Deposit (CDs)
  • High Yield Savings Account (with a good interest rate)
  • Money Market Funds
  • Equity Index Funds and Exchange-Traded Funds (ETFs)

11-15: Moderate Risk Aversion

You have an average and healthy amount of risk tolerance.

You likely have a good handle on your personal finances but are not the gambling type. While you invest the vast majority of your wealth in stocks, it’s either in index funds and mutual funds or in a portfolio of dividend-paying stocks that have the right level of diversification.

You also probably balance your equity-heavy portfolio by investing a small portion of your money into bond funds. Of course, that is in addition to having cash on hand in an emergency fund.

Typical Investments:

  • Equity Index Funds, Exchange-Traded Funds (ETFs), and Mutual Funds
  • Diversified Portfolio of Stock
  • Real Estate

16-20: Low-Risk Aversion

You are not very risk-averse and are not afraid to gamble if the expected return and potential payoff are high.

While you may still invest primarily in the stock market if you have a low-risk aversion, you also have a high probability of investing in cryptocurrency and even day trading stocks. This is because you are constantly seeking out the best investment opportunities to maximize the return on your money.

Though, this doesn’t mean you throw caution out the door and that you are risk-seeking. Aggressive investors can still be smart and pragmatic. When you do gamble and place bets, you do your research and pick wisely.

The phrase “higher risk, higher reward” likely resonates with you.

Typical Investments:

  • Equity Index Funds, Exchange-Traded Funds (ETFs), and Mutual Funds
  • Diversified Portfolio of Stock
  • Cryptocurrency
  • Speculative Stocks

Risk Aversion: Why it Matters in Personal Finance

Understanding your level of risk aversion is a valuable step in ensuring you build an investment portfolio that suits your needs. Be aware of the seven deadly sins of investing, and take steps to reduce risk.

After all, personal finance is… personal.

Just because your neighbor, friend, or work colleague invested in Gamestop back in March doesn’t mean that you should too!

Similarly, just because someone invests only in index funds doesn’t mean that it is the absolute best strategy for everyone (although I think it is a good one!). It would be best to make investment decisions based on your specific comfort level, situation, and long-term plans.

And remember, having a little bit of risk aversion is healthy. It’s what stops you from flying to Vegas to put all of your life savings on red for a ~48% chance to double your money and a ~52% chance of going home with nothing (this is a roulette reference for anyone who answered “never” to question 4!).

However, you have to keep in mind that all investing involves some amount of financial risk. Therefore, your goal should be to minimize that investment risk while still seeking the best possible outcomes on your investments.

Like many things in personal finance, it’s all about balance.

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

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