 Definition
A call is a type of option contract that gives the owner the right to buy a stock at a certain fixed price within a specified timeframe. Why It's Important As I discussed in last week's word, Options, they are a good way to hedge against a downturn in the market if used correctly. Let's take an example: Let's say a stock trades at $100 per share, and I think it's going to go up pretty soon. I could potentially buy 100 shares of stock, paying $10,000 OR I could buy a call option that would give you the right to pay $110 per share for stock any time in the next two months. My buy in for the option is typically $1-$2 per share. So, I would pay $200 for that right at the high end. This is a sunk cost (I'm not getting it back regardless of what happens). If I'm right and the stock goes up to $130 per share by the time the option expires, then I can excercise my option and purchase the stock at $110 therefore making a profit of $20 per share even if I sold them right after purchase. The weakness of the call option is that if the stock only goes up a little, the option's value can go down. For instance, if the stock goes up to $105 per share, I wouldn't excerise my option and take the loss of my $175 buy in (sunk cost, remember). On the flip side, this could work out great if I am completely wrong! Let's say the same stock now trades at $90 per share. Instead of taking a loss of $2,000 (110 - 90 x 100), I can just take my $175 loss and be on my way. There are pros and cons to trading options. As always, do your research!
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 Definition
An option is a contract that gives the buyer the right, not the obligation, to buy or sell an asset at a certain price in the future. Why It's Important Options play an important part in some portfolios as a way to hedge (arbitrage) against loss. Although you can purchase options on bonds, stocks, and futures, stocks are typically the go-to. So, how does it work? Let's use a simplified example. Let's say I think Apple is going to go up. I pay a fee (or premium) to purchase a call (buy) option for the current price. This means as Apple climbs in value I can exercise my call option to get the stock for a lower price. But, let's say the stock goes down, I can opt to not exercise my option and just let it expire. If that's the case, I only lose the premium that I paid for it. On the other side of the table, if I were the person selling the contract, I would lose money as the price went up and gain money if the buyer decided not to exercise it. Beware! If you are the person selling the contracts, you have to make sure you have enough shares to cover the order in case it gets exercised otherwise it could spell trouble. Options are pretty risky and I don't recommend trading them unless you have a full understanding of what's going on. This topic will be discussed at my Investing: DIY - Advanced Topics event this weekend.  Definition
Adjusted Gross Income or AGI is gross income minus adjustments to income for tax purposes Why It's Important AGI is the portion of your income that you are taxed on. I think the best way to explain this term is to provide an example. Let's say your salary is $50,000 a year. Because you are awesome, you contribute 5% of your salary to a 401k. To keep is simple, we will leave the salary deductions there (in real life, you will probably also deduct medical, dental, and vision benefits as well). 5% of $50,000 = $2,500 so instead of being taxed on your full (gross) salary of $50,000, you would only be taxed on $47,500 of it. $47,500 is your Adjusted Gross Income. This is why participating in company sponsored benefits plans (like medical, 401k, HSAs, etc.) are so important. It effectively lowers your tax bill. It is important to note that in order for your gross income to get adjusted, the benefit has to come out PRE-TAX. Otherwise, it will not have an effect. Once you arrive at your AGI, you multiply by the tax rates to get your tax liability. We will discuss that next week!  Definition
A broker-dealer is any person or firm engaged in the business of buying and selling securities for the accounts of others or its own account. Why It's Important You may be thinking that is an expansive definition. Well, it is and for a good reason! A brokerage acts as a broker when it buys and sells for its customers and as a dealer when it buys and sells for itself. Broker-dealers can range from small, independent, boutique firms to subsidiaries of big banks and investment companies. There are over 3,700 broker-dealers in the US to choose from! The big three (as of October 2018) are:
One role of a broker-dealer is to underwrite (distribute) new securities for issuers. Broker-dealers are powerful entities and essential for the flow of the market! A lot of financial advisors work under a broker-dealer, which is why you may see a company you don't recognize on your investing statements. A broker-dealer could either be a wirehouse (which sells its own products to the market) or an independent broker-dealer (which sells products from other sources). If you have investment accounts, your homework this week is to find out who the broker-dealer is. *Hint: Check your latest statement*  Definition
The FIRE movement is a school of thought where you aim to become debt-free (financially independent) and retire as early as possible, typically before age 35. Why It's Important The FIRE movement is a trendy movement in the financial blog and influencer circles because who doesn't want to become debt-free and not HAVE to work?! I capitalized HAVE because the movement is not saying to sit around and wait to die. It just makes it so you don't have to rely on worrying about money and can do more fulfilling work. The motivation behind the movement came from Americans being able to live longer than before, the inaccessibility of pensions from jobs, and the shorter job tenure. Last year, I read "Your Money or Your Life" by Vicki Robin, one of the pioneers of the modern FIRE movement. She makes the argument that every moment in your life is worth money, and jobs are more expensive than what meets the eye. She urges people to track every expense even down to the clothes you have to wear to work to the food you have to eat to get your real wage. The book made me look at things a little differently. If you are interested in further exploring the FIRE movement, a documentary just came out to select theatres called "Playing with FIRE." I recommend checking it out to see the type of lengths people go to make that dream a reality.  Definition
Philanthropy is the desire to promote the welfare of others, typically in the form of monetary gifts and donations. Why It's Important Yesterday was Giving Tuesday! If you don't know what that is, it is a national holiday the Tuesday after Thanksgiving to promote giving back to the community. Thanksgiving is typically enjoyed with families and friends eating until your heart is content. Black Friday is usually spent spending (see what I did there) until your heart is content. Now, it is time to give until your heart is content! I want to stress the importance of making sure you give back to your community. But, giving doesn't always have to be monetary (money). You can give time, skills, ideas, etc. Even though I don't have a lot of money to spend, I consider myself very philanthropic. I donate a lot of time to causes and initiatives that I am passionate about. The exciting thing is what you give out comes back tenfold in many cases. Not having money is not an excuse! Get out there and be a philanthropist! The world is waiting for you!  Definition
A portfolio's turnover rate measures the level of buying and selling of investments. You will typically see a turnover ratio when analyzing mutual and index funds. They are the same thing. Why It's Important High turnover rates can lead to higher portfolio expenses. Not only that, but usually, if a portfolio has a high turnover rate or ratio, the more taxes you will potentially have to pay. Once a position is sold out of the portfolio, you will either have a capital gain or a capital loss. A good advisor will attempt to make sure your gains and losses offset so that you will not have additional tax implications. But this is not always possible. Paying attention to the turnover rate is super important to avoid a tax headache later. If you are investing in a taxable account, it is best to look for tax-advantaged funds or ones with low turnover. Tax-deferred or tax-free accounts (such as IRAs and 401ks) do not matter quite as much since you are not being taxed on the capital gains anyway.  Definition
A transaction fee is a fee charged by a brokerage firm for every trade that takes place. These fees can range from $0 to $9.95, depending on the firm. Why It's Important Transaction fees are significant because anytime you make a buy or sell trade in your account, you're charged that fee. So, let's say you need to sell out of investments and invest in something different. You will have to pay that fee not once but twice for each investment. Let's say the fee is $4.95 per transaction; you would have to pay $9.90 per investment to sell then subsequently buy a new security. Multiply that by how many investments you are trying to get rid of, and it could be quite expensive. I have seen situations where an investor paid hundreds of dollars just in fees to get out of bad investments! Transaction fees are becoming a little less important because most of the brokerage firms have moved to $0 fees this year. Among the firms that have made the change are Ally Invest, Charles Schwab, TD Ameritrade, and Fidelity. Of course, Robinhood has always been $0 fees since they started. With that said, there are plenty of options out there, and I don't think anyone needs to be charged a transaction fee unless you choose to go through an institution.  Definition
A mutual fund is a pool of managed investments. These funds are usually managed by a portfolio manager to keep them in line with their investment objectives. Why It's Important The best way to think of mutual funds is as a basket. When you purchase shares of mutual funds, you are purchasing a basket of different stocks or bonds. I love mutual funds, and that's typically all I invest in. Mutual fund benefits include professional management, diversification, liquidity, and brokerage commission savings. You are pretty much paying a mutual fund company to create a basket of stocks that meet your investing needs. For instance, you can find mutual funds of marijuana companies, international companies, and even companies that focus on sustainability. There were over 9,600 mutual funds available on the market as of 2018. So, there is plenty to choose from! You save on brokerage commissions because if you were buying individual stocks, it would be way more expensive. Some mutual funds have upwards of 3,000 stocks within them. If you were going to recreate that yourself, you would have to make at least 3,000 trades at whatever the commission rate is for the brokerage firm (currently ranging between free and $10) versus making one trade for the whole basket. The only downside to mutual funds is that they carry fees. Of course, you would have to pay the company/investment manager for their work, putting the mutual fund together and keeping it updated. My rule of thumb is never to purchase a mutual fund above 60 basis points. To me, anything above that is excessive with so many options available.  Definition
An accredited investor is a person or business that is authorized to buy and sell securities without being registered through the Security and Exchange Commission (SEC) Why It's Important An accredited investor can invest in a variety of unregistered investments such as hedge funds, venture capital, and private equity opportunities. But, of course, this status is not open to everyone. In order to gain the status of accredited investor, you have to meet two different criteria:
Now, as I said before, it doesn't have to be individuals. It could be a trust or any entity that meets the requirements. Eventually, I want to become an accredited investor! All in due time! |
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