401(k) Retirement Savings Plan
You participate in a 401(k) retirement savings plan by deferring part of your salary into an account set up in your name. Any earnings in the account are federal income tax deferred.
If you change jobs, 401(k) plans are portable, which means that you can move your accumulated assets to a new employer's plan, if the plan allows transfers, or to a rollover IRA.
With a traditional 401(k), you defer pretax income, which reduces the income tax you owe in the year you make the contribution. You pay tax on all withdrawals at your regular rate, determined by your filing status and tax bracket.
403(b) retirement savings plan
A 403(b) plan, sometimes known as a tax-sheltered annuity (TSA) or a tax-deferred annuity (TDA), is an employer sponsored retirement savings plan for employees of not-for-profit organizations, such as public school districts, colleges, hospitals, foundations, and cultural institutions. (Despite the names by which 403(b)s are known, participants are not required to invest in annuities and usually can choose from mutual funds and other qualified investments.)
Some employers offer 403(b) plans as a supplement to -- rather than a replacement for -- defined benefit pensions. Others offer them as the organization's only retirement plan.
Your contributions to a traditional 403(b) are tax deductible, and any earnings are tax deferred. Contributions to a Roth 403(b), which some but not all employers offer, are made with after-tax dollars, but the withdrawals are tax free if the account has been open at least five years and you're 59½ or older.
457 retirement savings plan
The tax-deferred retirement savings plans known as 457 plans are available to state and municipal employees.
Like traditional 401(k) and 403(b) plans, the money you contribute and any earnings that accumulate in your name are not taxed until you withdraw the money, usually after retirement. The contribution levels are set each year at the same level that applies to 401(k)s and 403(b)s, though 457s may allow larger catch-up contributions.
You also have the right to roll your plan assets over into another employer's plan, including a 401(k) or 403(b), or an individual retirement account (IRA) when you leave your job.
An accredited investor is a person or institution that the Securities and Exchange Commission (SEC) defines as being qualified to invest in unregistered securities, such as privately held corporations, private equity investments, and hedge funds.
To be an accredited investor you must have a net worth of more than $1 million excluding the value of your primary residence, or a current annual income of at least $200,000 with the anticipation you'll earn at least that much next year. If you're married, that amount is increased to $300,000.
Asset allocation means dividing your assets on a percentage basis among different broad categories of investments, called asset classes. Stock, bonds, and cash are examples of asset classes, as are real estate and derivatives such as options and futures contracts.
Most financial services firms suggest particular asset allocations for certain categories or groups of clients and fine-tune those allocations for individual clients.
The asset allocation model -- specifically the percentages of your investment principal allocated to each investment category you're using -- that's appropriate for you at any given time depends on many factors, such as the goals you're investing to achieve, how much time you have to invest, your tolerance for risk, the direction of interest rates, and the market outlook.
A broker acts as an agent or intermediary for a buyer or a seller, or, less commonly, for both. The buyer, seller, and broker may all be individuals, or one or more may be a business or other institution. For example, a stockbroker works for a brokerage firm, and handles client orders to buy or sell stocks, bonds, commodities, and options in return for a commission.
A broker-dealer (B/D) is a brokerage firm that holds a license granted by the Securities and Exchange Commission (SEC) to act as a broker, or agent, to buy and sell securities for its clients' accounts. The firm may also act as principal, or dealer, and trade securities for its own inventory.
Some broker-dealers act in both capacities, depending on the circumstances of the trade or the type of security being traded. For example, your order to purchase a particular security might be filled from the firm's inventory provided you are notified that this has happened.
A broker-dealer must evaluate whether or not an investment is suitable for a particular client and may advise clients on investment choices. Most charge clients a commission to execute a trade.
A capital gain is the difference between the purchase price and the sale price of a capital asset when the sale price is higher than the purchase price.
For example, if you buy 100 shares of stock for $20 a share and sell them for $30 a share, you realize a capital gain of $10 a share, or $1,000 in total.
If you have owned the stock for more than a year before selling it, you have a long-term capital gain. If you hold the stock for less than a year, you have a short-term capital gain, which incurs greater taxes than a long-term capital gain.
Certificates of Deposit (CD)
Certificates of deposit (CDs) are time deposits with fixed terms, typically ranging from three months to five years. On traditional bank CDs, you earn compound interest at a fixed rate, which is determined by the current interest rate and the CD's term. Adjustable-rate and market-rate CDs may also be available, though specific terms and conditions apply. When you purchase a CD from a bank, your account is insured by the Federal Deposit Insurance Corporation (FDIC) up to the per depositor limit.
You usually face a penalty if you withdraw funds before your CD matures. With a bank CD, you often forfeit some or all of the interest that has accrued up to the time you make the withdrawal.
Cold calling is a sales method in which brokers telephone clients they do not know and offer to sell stocks or other types of investments.
Compounding occurs when your investment earnings or savings account interest is added to your principal, forming a larger base on which future earnings may accumulate.
As your investment base gets larger, it has the potential to grow faster. And the longer your money is invested, the more you stand to gain from compounding.
For example, if you invested $10,000 earning 8% annually and reinvested all your earnings, you'd have $21,589 in your account after 10 years.
If instead of reinvesting you withdrew the earnings each year, you would have collected $800 a year, or $8,000 over the 10 years. The $3,589 difference is the benefit of 10 years of compound growth.
Consumer Price Index (CPI)
The consumer price index (CPI) is compiled monthly by the US Bureau of Labor Statistics and is a gauge of inflation that measures changes in the prices of basic goods and services.
Some of the things it tracks are housing, food, clothing, transportation, medical care, and education.
The CPI is used as a benchmark for making adjustments in Social Security payments, wages, pensions, and tax brackets to keep them in tune with the buying power of the dollar. It's often incorrectly referred to as the cost-of-living index.
Disposable personal income (DPI)
Disposable personal income (DPI) is the amount that’s left after income taxes, FICA taxes, and other required amounts are withheld from gross income.
DPI is the money you have available to spend on your essential and discretionary household expenses, to save, and to invest.
Diversification is an investment strategy. When you diversify, you spread your investment dollars among different sectors, industries, and securities within a number of asset classes.
A well-diversified stock portfolio, for example, might include small-, medium-, and large-capitalization domestic stocks, stocks in six or more sectors or industries, and international stocks. The goal is to protect the value of your overall portfolio in case a single security or market sector takes a serious downturn.
Finding the diversification mix that's right for your portfolio depends on your age, your assets, your tolerance for risk, and your investment goals.
Diversification may help protect your portfolio against certain market and management risks without significantly reducing the level of return you realize. But it does not guarantee you will realize a profit or insure you against losses in a market downturn.
A dividend is a portion of a corporation's earnings that the board of directors may choose to pay out to shareholders as a return on investment.
These dividends, which are often declared quarterly, are usually in the form of cash, but may be paid as additional shares.
You may be able to reinvest cash dividends automatically to buy additional shares if the corporation offers a dividend reinvestment program (DRIP) or direct purchase plan (DPP).
Dividends are taxable income unless you own the investment through a tax-deferred account, such as an employer-sponsored retirement plan or individual retirement account. This rule applies whether you reinvest the dividends or take the money.
Exchange Traded Fund (ETF)
Exchange traded funds (ETFs) resemble open-ended mutual funds but are listed on a stock exchange and trade like stock through a brokerage account.
You buy shares of the fund, which in turn owns a portfolio of stocks, bonds, commodities, or other investment products. You can use traditional stock trading techniques, such as buying long, selling short, and using stop orders, limit orders, and margin purchases.
The ETF doesn't redeem shares you wish to sell, as a mutual fund does. Rather, you sell in the secondary market at a price set by supply and demand. ETF prices change throughout the trading day rather than being set at the end of the trading day, as open-end mutual fund prices are.
Each ETF has a net asset value (NAV), which is determined by the total market capitalization of the securities or other products in the portfolio, plus dividends but minus expenses, divided by the number of outstanding shares issued by the fund.
An expense ratio is the percentage of a mutual fund's or variable annuity's total assets deducted to cover operating and management expenses.
Those expenses include employee salaries, custodial and transfer fees, distribution, marketing, and other costs of offering the fund or contract. However, they don't cover trading costs or commissions.
For example, if you own shares in a fund with a 1.25% expense ratio, your annual share is $1.25 for every $100 in your account, or $12.50 on an account valued at $1,000.
Expense ratios vary widely from one fund company to another and among different types of funds. Typically, international equity funds have among the highest expense ratios, and index funds among the lowest.
A fiduciary is an individual or organization legally responsible for managing assets on behalf of someone else, usually called the beneficiary. The assets must be managed in the best interests of the beneficiary, not for the personal gain of the fiduciary.
However, the concept of acting responsibly can be broadly interpreted, and may mean preserving principal to some fiduciaries and producing reasonable growth to others.
Executors, trustees, guardians, and agents with powers of attorney are examples of individuals with fiduciary responsibility. Firms known as registered investment advisers (RIAs) are also fiduciaries.
Glide path is the approach a target date fund takes in reallocating its portfolio as time passses.
Each fund company’s glide path varies somewhat from those of its competitors, based on the company’s investment strategy and risk profile.
What is similar is that all target date funds have a specific time horizon. They invest to achieve growth in the early phases of their life span, gradually reallocating to produce income and protect principal as their target dates approach. What differs is the rate and timing of the reallocation, in particular how much of the fund remains invested for growth at the target date.
Target date funds are often retirement investments, using target dates such as 2025 or 2040. Or they may be used in 529 college savings plans, where they are described as age-based tracks.
Individual Retirement Account (IRA)
Individual retirement accounts are one of two types of individual retirement arrangements (IRAs) that provide tax advantages as you save for retirement.
Everyone with earned income may contribute to a tax-deferred IRA. Those whose modified adjusted gross income is less than the annual cap for his or her filing status qualifies to contribute to a Roth IRA.
There are annual contribution limits, catch-up provisions if you're 50 or older, and restrictions on withdrawals before you turn 59 1/2. Tax-deferred IRAs have required minimum distributions (RMDs) after you turn 70 1/2.
Earnings withdrawn from a traditional IRA are taxed at the same rate as your ordinary income. So are the contributions if you qualified to deduct them for the year they were added to your account.
A load is the sales charge, or commission, you may pay if you buy mutual fund shares through a broker or other financial professional.
If the sales charge is levied when you purchase the shares, it's called a front-end load. If you pay when you sell shares, it's called a back-end load or contingent deferred sales charge. With a level load, you pay a percentage of your investment amount each year you own the fund as on ongoing sales charge.
Long term capital gains tax rate
A long-term capital gain is the profit you realize when you sell a capital asset that you have owned for more than a year at a higher price than you paid to buy it.
Unlike short-term gains, which are taxed as ordinary income, most long-term gains on most securities are taxed at rates lower than the rate that applies to ordinary income.
You can subtract any long-term capital losses you realized in the same tax year from your long-term capital gains to reduce the amount on which potential tax may be due.
Modified Adjusted Gross Income (MAGI)
Your modified adjusted gross income (MAGI) is your adjusted gross income (AGI) plus exclusions or deductions you may have taken for housing expenses or income earned outside the United States or for income received as a resident of American Samoa or Puerto Rico.
If your MAGI is less than the annual minimum and maximum levels set by Congress for your filing status, you qualify for various tax adjustments, deductions, and credits. Some of these include the right to subtract student loan interest, take a deduction for your contributions to a tax-deferred IRA, make contributions to a Roth IRA, and take the American Opportunity, Lifetime Learning, and adoption tax credits.
Money market mutual fund
Money market mutual funds invest in stable, short-term debt securities, such as commercial paper, Treasury bills, and certificates of deposit (CDs), and other short-term instruments.
The fund's management tries to maintain the value of each share in the fund at $1.
Unlike bank money market accounts, money market mutual funds are not insured by the Federal Deposit Insurance Corporation (FDIC).
However, since they're considered securities at most brokerage firms, they may be insured by the Securities Investor Protection Corporation (SIPC) against the bankruptcy of the firm. In addition, some funds offer private insurance comparable to FDIC coverage.
A mutual fund is a professionally managed investment product that sells shares to investors and pools the capital it raises to purchase investments.
A fund typically buys a diversified portfolio of stock, bonds, or money market securities, or a combination of stock and bonds, depending on the investment objectives of the fund. Mutual funds may also hold other investments, such as derivatives and cash.
A fund that makes a continuous offering of its shares to the public and will buy any shares an investor wishes to redeem, or sell back, is known as an open-end fund. An open-end fund trades at its net asset value (NAV).
The NAV is the value of the fund's portfolio plus money waiting to be invested, minus operating expenses, divided by the number of outstanding shares.
Net asset value
Net asset value (NAV) is the dollar value of one share of a mutual fund or exchange traded fund (ETF).
NAV is calculated by totaling the value of the fund's holdings plus money awaiting investment, subtracting operating expenses, and dividing by the number of outstanding shares.
A fund's NAV changes regularly, though day-to-day variations are usually small. With a mutual fund, the NAV is reset at the end of each trading day, while with an ETF, the NAV changes throughout the day.
The NAV is the price per share an open-end mutual fund pays when you redeem, or sell back, your shares. With no-load mutual funds, the NAV and the offering price, or what you pay to buy a share, are the same. With front-load funds, the offering price is the sum of the NAV and the sales charge per share and is sometimes known as the maximum offering price (MOP).
To figure your own net worth, you add the value of the assets you own, including but not limited to cash, securities, personal property, real estate, and retirement accounts, and subtract your liabilities, or what you owe in loans and other obligations.
If your assets are larger than your liabilities, you have a positive net worth. But if your liabilities are more than your assets, you have a negative net worth. When you apply for a loan, potential lenders are likely to ask for a statement of your net worth.
A pension is an employer plan that's designed to provide retirement income to employees who have vested -- or worked enough years to qualify for the income.
Defined benefit plans promise a fixed income, usually paid for the employee's lifetime or the combined lifetimes of the employee and his or her spouse.
The employer contributes to the plan, invests the assets, and pays out the benefit, which is typically based on a formula that includes final salary and years on the job.
You pay federal income tax on your pension at your regular rate, so a percentage is withheld from each check. If the state where you live taxes retirement income, those taxes are withheld too. However, you're not subject to Social Security or Medicare withholding on pension income.
A prospectus is a formal written offer to sell stock to the public. It is created by an investment bank that agrees to underwrite the stock offering.
The prospectus sets forth the business strategies, financial background, products, services, and management of the issuing company, and information about how the proceeds from the sale of the securities will be used.
The prospectus must be filed with the Securities and Exchange Commission (SEC) and is designed to help investors make informed investment decisions.
Each mutual fund and variable annuity provides a prospectus to potential investors, explaining its objectives, management team and policies, investment strategy, and performance. The prospectus also summarizes the fees and analyzes the risks you take in investing.
A qualified dividend is a dividend that is taxed at a taxpayer’s long-term capital gains tax rate rather than at the rate that applies to his or her ordinary income.
A dividend is generally qualified if two conditions are met. First, it must have been paid on stock issued by a US corporation or eligible non-US corporation. However, certain dividends are never qualified including those paid by real estate investment trusts (REITs) and regulated investment companies.
Second, the person who owns the stock on which the dividend has been paid must have owned it for at least the minimum holding period. The holding period in most cases is at least 61 days during the 121-day period that began 60 days before the ex-dividend date.
Real Estate Investment Trust (REIT)
A real estate investment trust (REIT) pools investors' capital to invest in a variety of real estate ventures.
There are three types of REIT: Equity REITs buy properties that produce income. Mortgage REITs invest in real estate loans. Hybrid REITs usually make both types of investments.
REITs may be publicly traded corporations. In that case, after the REIT has raised its investment capital, it trades on a stock market just as a closed-end mutual fund does. Other REITs are private, nonlisted investments available to qualified investors who wish to be limited partners.
All REITs are designed to be income-producing investments, and by law 90% of a REIT's taxable income must be distributed to investors. This means the yields on REITs may be higher than on other equity investments although the income is not guaranteed. REIT income distributions are taxed as ordinary income
Reallocate, in the context of an asset allocation strategy, means to change the percentage of investment assets assigned to specific asset classes.
The purpose of reallocation is to reposition a portfolio to improve the potential for meeting a particular objective. For example, you might reallocate in response to a major change in the economy or if you married, divorced, or had a child.
You might reallocate, for example, as you get closer to retirement and wish to put greater emphasis on producing income and less on seeking growth. In that case, you might increase your allocation to fixed-income investments and income-producing stock and decrease your allocation to small-company stock, stock mutual funds, and stock ETFs.
Real return adjusts the percentage return on an investment or investment portfolio to account for the impact of inflation.
For example, if the return on a stock investment is 6% in a year that the rate of inflation is 2%, the real return is a positive 4%. But if the return on an investment is 3% in a year the rate of inflation is 4%, the real return is a negative 1%.
Real return is useful in evaluating whether or not your investments are providing returns that increase your purchasing power or at least keep it stable. Flat or negative real returns are a major argument against investing too conservatively for the long term. Any investment can produce negative real returns in a flat or falling market.
Rebalance, in the context of an asset allocation strategy, means to bring an investment portfolio’s current asset allocation back into line with the portfolio’s intended allocation.
You might rebalance, for example, after a period of strong stock market performance that has increased the percentage of your portfolio invested in stock and decreased the percentage invested in bonds.
When the actual allocation of your portfolio deviates too much from your intended allocation, you may be exposed to more risk than you are comfortable with or assume less risk than may be required to produce the return you seek. Those are the situations in which rebalancing may be required.
Registered investment advisers
A registered investment adviser (RIA) is a firm that is paid for providing investment advice, registers with the Securities and Exchange Commission (SEC), and is generally subject to regulated by states or the SEC, depending on how much money the firm manages.
Firms registered with the SEC have more than $100 million under management. Firms with assets up $100 million register with the state securities agency in the state or states where they operate.
An RIA's employees, called investment adviser representatives (IARs), are bound by a fiduciary standard in recommending securities to their clients. They may manage clients’ investment portfolios and earn a fee, or sometimes a fee plus commission, for their advice.
An RIA must file a two-part Form ADV. Part 1 provides basic information about the firm. Part 2 is a detailed narrative explanation, in Plain English, about how the firm operates, how it does its analysis, what it charges, and any material disciplinary actions.
Registered representatives are licensed to act on investors' orders to buy and sell securities and to provide advice relevant to portfolio transactions.
They may be paid a salary, a commission -- usually a percentage of the market price of the investments their clients buy and sell -- or in some cases by fees figured as a percentage of the value of a client's account.
Registered reps, more commonly known as stockbrokers, work for a broker-dealer that belongs to the exchange or operates in the market where the trades are handled. The reps must pass a series of exams administered by FINRA to qualify for their licenses and are subject to FINRA oversight. FINRA is the acronym for the Financial Industry Regulatory Authority, a self-regulatory organization for the securities industry.
Your return is the profit or loss you have on your investments, including income and change in value.
Return can be expressed as a percentage and is calculated by adding the income and the change in value and then dividing by the initial principal or investment amount. You can find the average annual return by dividing the percentage return by the number of years you have held the investment.
For example, if you bought a stock that paid no dividends at $25 a share and sold it for $30 a share, your return would be $5. If you bought on January 3, and sold it the following January 4, that would be a 20% annual percentage return, or the $5 return divided by your $25 investment. But if you held the stock for five years before selling for $30 a share, your average annual return would be 4%, because the 20% gain is divided by five years rather than one year.
Target date funds
A target date fund is a fund of funds that allows you to invest in a portfolio with a particular time horizon, typically your expected retirement date.
In fact, each target date fund characteristically has a date in its name, such as Fund 2015, Fund 2020, Fund 2025, or Fund 20030, and so on. You choose one whose date is closest to the date you plan to retire.
A target date fund aiming at a date in the somewhat distant future tends to have a fairly aggressive asset allocation, with a focus on equity funds. As the target date approaches, the fund is reallocated to become more conservative to preserve the assets that have accumulated and provide income. The pace of that reallocation is known as the fund's glide path.
Tax-deferred retirement account
Tax deferred means that any tax that may be due is postponed until a later date.
For example, a tax-deferred retirement savings account, such as a traditional 401(k) or 403(b), allows you to postpone income tax that would otherwise be due on employment income you contribute to the account and any earnings on those contributions until some point in the future.
Then tax is due on amounts you withdraw, at the same rate you pay on your regular income. The balance remaining in the account continues to be tax deferred.
A big advantage of tax deferral is that earnings may compound more quickly, since no money is being taken out of the account to pay taxes. But in return for postponing taxes, you agree to limited access to your money before you reach 59 1/2.
US Treasury bills
US Treasury bills are the shortest-term government debt securities. They are issued with a maturity date of 4, 13, 26, or 52 weeks. The par value is $100, which is also the minimum purchase.
The interest a T-bill pays is the difference between the purchase price and par value, which is repaid at maturity.
The bills are sold weekly by competitive auction to institutional investors, and to noncompetitive bidders through TreasuryDirect for the same price paid by the competitive bidders. Noncompetitive bidders can purchase up to $5 million in bills in a single auction.
T-bills are described as risk-free investments. Because they are backed by the full faith and credit of the US government, they pose virtually no credit risk. And, because their terms are so short, they pose little or no inflation risk.
US Treasury Bonds
US Treasury bonds are long-term government debt securities with 30-year terms.
These bonds are considered among the world’s most secure investments since they backed by the full faith and credit of the US government.