Tax Law Advisors - Investing - The Basics & Beyond: Articles, Tools & Resources You Can't Afford To Miss!

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If you're completely new to investing, you might be wondering what, exactly, is a "stock"? Simply put, a share of common stock represents a tiny piece of ownership in a public company. If there are one million shares outstanding of Company X, and you own one share, you in effect own one-millionth of that company - its assets and the profits it is able to produce over time. The more shares you own, the more you benefit from a company's growth.

Why Do Companies Issue Stock?

Businesses need money, or "capital," to grow and thrive. A company will typically issue stock to raise money for financing operations, acquiring new equipment or other companies, fund research and development, and other such uses.

Another term for raising money through stock issuance is "equity financing," and the capital produced through this method is referred to as equity capital. Companies might also issue bonds to finance various activities; this is referred to as "debt issuance."

What Categories of Stock Exist?

Also called "equities," stock can be categorized several ways. The first is by size, or "market capitalization": A company's net market capitalization is measured by its share price multiplied by the number of shares on the market. To use the example above, if Company X's share price is $10, its market capitalization (or "cap" for short) would be $10,000,000 - one million shares outstanding multiplied by $10 per share. Generally, companies with $1 to $1.5 billion in market capitalization are considered "small cap" stocks, those with between $1-1.5 billion and $5 billion are considered "mid cap" stocks, and those with market caps above $5 billion are considered "large cap" stocks.

Another way to categorize stocks is by style. "Growth" stocks are those considered to have the potential to expand their sales, revenue, and profitability quickly. "Value" stocks are those believed to be undervalued by investors and thus selling for less than their intrinsic value.

A third way to divide stocks is by geography. Stocks of U.S. companies are considered "domestic" stocks, while those of companies outside the U.S. are considered "international" stocks. Typically, international equities are further divided into "developed" (such as Europe or Japan) or "emerging" (China, Southeast Asia, Latin America) markets. Foreign investing involves additional risks, such as currency fluctuations and political uncertainty. Investment return and principal uncertainty. Investment return and principal value will fluctuate so shares, when redeemed, may be worth more or less than their original costs.

Finally, stocks can be categorized by sector and industry. Common categories include technology, communication, healthcare, energy, financial services, consumer goods and basic materials, which may respond differently to economic changes.

How Can I Buy Stocks?

Typically, investors purchase stocks through entities known as exchanges. These marketplaces include the New York Stock Exchange, the American Stock Exchange, and the NASDAQ Stock Market. The exchanges are merely a way to connect those who want to buy shares with those willing to sell them. How do you know what a stock is selling for? Stock prices, or "quotes," can be located in newspapers, on certain television programs, and through the Internet.

Another way to own stocks is through mutual funds.

Why Should Individuals Own Stocks?

Over time, stocks have proven themselves to be the most powerful way to accumulate wealth, outpacing bonds, government securities, and inflation. Stocks provide individuals with the opportunity to benefit from growth in the U.S. economy as companies expand their sales and profits.

Stockholders can benefit from owning stocks in two ways: First, through price appreciation, as the price of their shares goes up; and second, through dividends, which many companies pay on a regular basis. Together, these factors make up your stock's total return.

What About the Risk?

Many people have heard of or experienced events such as "Black Tuesday," in October 1929, when the Dow Jones Industrial Average nosedived 12.8%, and, more recently, "Black Monday" in October 1987, when the Dow lost 22.6% of its value (still the worst single trading day on record). More recently, we saw stomach-churning drops in 1997 and 1998, and endured a long bear market from 2000 through 2002.

And it is true that, in the short term, investing in the stock market can be risky. Markets tend to be volatile, responding quickly and forcefully to events and news such as the 9/11 terrorist attacks, rumors of economic changes, presidential elections, and geopolitical happenings. Individual stocks face risks as well. A company, because of poor business conditions or poor management, could become unable to make dividend payments. Or it could fail completely, leaving your stock essentially worthless.

Over the long term, however, stocks have earned higher and more positive returns than any other financial investment. These higher returns help offset the risks of investing in stocks.

Diversification Can Reduce Risk

Among the risks you face in the stock market is the risk that you will have to sell an investment for less than you paid for it. If you buy stock in many different companies, in many different sectors of the market, you can minimize your risk. After all, it is highly unlikely that every company in which you have invested will suffer at the same time. However diversification does not protect against loss.

You can also minimize your risk by investing some money in international stocks. Historically, when the U.S. stock market has dropped, markets in Europe and Asia have dropped less, or even risen in value. Although we live in an increasingly global economy where economic events have an impact everywhere, global diversification should still be a part of your plan.

What Role Should Stocks Play In Your Portfolio?

In general, your stock market investments should represent money you won't need for at least 10 years. That time frame allows enough time for your investments to ride out the inevitable growth/recession economic cycles and bull/bear market cycles. Certainly younger people investing for their retirement should consider putting a substantial portion of their funds in stocks. One very general rule of thumb is that the percentage of your invested assets should be at least 100 minus your age - 70% for a 30-year-old.

Investing in stocks may also be appropriate for retirees who don't need all of their money and are trying to maximize what they will pass onto their heirs. Your best bet is to work with a financial advisor to determine the optimal amount you should allocate to stocks.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Source: Financial Visions, Inc.

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~Tax Law Advisors provides customized pre-tax planning today, so Corporations and their Owners can enjoy a better tomorrow.~

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A bonds is essentially a loan from the bond buyer (an individual or institutional investor) to the bond issuer (a corporation, municipality, or other government entity). Bonds are often referred to as "income securities" because, in return for the use of your money, the bond's issuer agrees to pay a certain rate of interest at regular intervals for a set period until the bond matures or the principal is otherwise repaid.

Bonds can be for varying lengths of time (maturities) and of varying quality. Short-term bonds are defined as those that mature in three years or less. Intermediate bonds mature in three to 10 years, and long-term bonds have maturities of 10 years or more. The quality of a bond relates to its risk of default, or non-repayment by its issuer. Bonds issued by the U.S. government are of higher quality than those issued by many state and municipal governments, because U.S. government securities are backed by you, the taxpayer, and thus are far less likely to default. Company-issued bonds can vary even more dramatically in quality. As with any investment, the higher the risk associated with an investment, the higher the potential return you generally can expect from it. Of course, the taxability of a bond's interest also will have an impact on the return.

What Are the Risks of Investing in Bonds?

Just like other investments, bonds expose you to certain types of risks. Depending on the quality of the bond, you may face the risk that the issuer could experience economic problems and be unable to make its interest payments. You can minimize this risk by investing in higher-quality bonds, but they will have a lower return than high-yield debt securities, otherwise known as "junk bonds."

Bond investments are also sensitive to movements in market interest rates. Typically, if interest rates rise, the value of your bonds will likely decline. Or, if interest rates decline, your bonds may increase in value but provide less income as they mature and are replaced with new ones. If you have invested in the bonds because you need that income for living expenses, this can pose a problem. You can minimize this risk by diversifying your bond portfolio among investments with a variety of different maturities, and by keeping some of your portfolio invested in stocks, which react to interest rate changes differently than bonds do.

The Relationship Between Bonds and Interest Rates

People often get confused by the inverse relationship between interest rates and bond prices. Here's why bond prices RISE when interest rates fall, and vice versa.

Let's say you want your bond to earn $50 in interest by year's end. If interest rates are 5%, you need to have a bond with a face value of $1,000 to earn $50 in interest. If interest rates fell to 4%, however, you would have to increase that face amount to $1,250 to earn the same $50. On the other hand, if interest rates rose to 6%, you would only have to buy a bond worth $832,50 to earn $50.

Here's another example. Ike and Holly each purchased a newly issued $20,000, 10-year U.S. government bond with a 5.5%* coupon rate (the bond's interest rate). The bonds were issued "at par" and thus they each paid $20,000. In exchange for "loaning" the government $20,000, Ike and Holly will each receive $1,100 a year for 10 years. At the end of the 10 years, Ike and Holly will get their $20,000 back.

Five years after purchasing his bond, Ike needs to sell it. The interest rates have risen since Ike purchased the bond, and newly issued 10-year government bonds are paying 7%. To find a buyer for his 5.5% bond, Ike is forced to sell it for less than the $20,000 face value.

Two years later, Holly also decides to sell her bond. Interest rates have dropped since Ike sold his bond, and new 10-year bonds are paying only 5% interest. Because of this, Holly is able to sell her bond for more than $20,000.

Taxable or Tax Exempt?

Some bonds offer special tax treatment on the interest they pay. There is no state or local income tax on the interest from U.S. Treasury bonds, and no federal income tax on the interest from most municipal bonds, and often no state or local income tax either.

Which is better for you, taxable income or income that is tax-exempt? The answer depends on your income tax bracket - and the difference between what can be earned from taxable versus tax-exempt securities - not only now but also throughout the period until your bonds mature. An investment advisor can show you how much taxable income you would need at each income tax bracket to match the return from a tax-exempt security.

The bond market is far more complex than the stock market in many ways. There are significantly more bonds on the market, more types of bonds than stocks, and pricing is not as transparent. Many people own bonds through mutual funds. Contact us to learn more about how bonds can help you pursue all your financial goals,

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Source: Financial Visions, Inc.

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~Tax Law Advisors provides customized pre-tax planning today, so Corporations and their Owners can enjoy a better tomorrow.~

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Investing isn't limited solely to stocks, bonds, and cash (and mutual funds that hold stocks, bonds, and cash). For many Americans, real estate is their largest investment - usually their family home. But there are other ways to invest in real estate too.

Often, some of the best real estate investments may be those you make on your own, such as purchasing your own home, vacation properties, or investment properties ranging from vacant land to apartment buildings and office buildings. Real estate investments are also available through the financial markets. These include real estate investment trusts (REITs) and partnership investments ranging from small "private placements" to larger nationally syndicated and publicly traded partnerships. The era of the real estate tax shelter ended in the mid-1980s, but some of the current partnerships provide some tax-shelter elements. More important today, though, is an evaluation of a project's potential for financial success and its liquidity. If you invest in a partnership, be prepared for the additional delay and complication that a partnership Schedule K-1 may add to your own tax return.

Other Investments

Many other investment opportunities exist. These include complex and often very risky instruments such as futures and options; precious metals; and art, antiques, and collectibles of all kinds such as coins and jewelry. In general, these investments carry far greater risk than typical stock and bond portfolios, are less liquid, and may require larger transaction costs to buy and sell. Reliable information regarding these types of investments may also be more difficult to obtain. In some cases, you can acquire publicly traded stocks that will, to some extent, track the appreciation of such items - for instance, stock in a mining company.

At one time, conventional investment portfolio theory dictated that you maintain a small portion of your portfolio in gold or related investments. This is no longer common wisdom. Given these negative aspects, it is also important to point out that many individuals have enjoyed spectacular investment returns from these types of investments. This may often be particularly true for individuals who have more knowledge of certain asset types than the general public. And, of course, for some people these types of investment represent a hobby in which earning money is secondary to their enjoyment.

One way to think of your investment portfolio is as a pyramid. The base is made up of safe, secure holdings such as bank accounts and personal real estate, which each successive tier representing a smaller, more risky, and potentially higher-returning part of your investment mix. As always, we are available to help you make the asset allocation decisions for your individual situation.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Source: Financial Visions, Inc.

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