Bonds can be taxable or tax-free – here’s your guide to the different types and calculating what’s due on them

bonds
Bonds are divided into two classes: taxable and tax-exempt. While their capital gains are always taxable, the interest they earn may not be.

All investments generate income in one way or another – sometimes as you hold them, sometimes only when you sell them for a profit. And that investment income tends to be taxable.

Bonds are no exception. But as an asset class, they’re a particularly diverse group. And so is the way they’re taxed. Some bonds are fully taxable, some partially taxable, and some not at all. 

And because they generate income in a few different ways, their tax rates vary too. 

Let’s examine bonds and taxes in more detail.

How are bonds taxed?

Bonds and bond funds generate two different types of income: interest and capital gains

Interest

Bonds are a type of debt instrument. When you buy a bond, you’re loaning money to the government or company that issued it; in return, that entity pays you interest. Most bonds pay a fixed, predetermined rate of interest over their lifespan. 

That interest income may be taxable or tax-free (more on the types of bonds that generate tax-free income later). For the most part, if the interest is taxable, you pay income taxes on that interest in the year it’s received. 

The rate you’ll pay on bond interest is the same rate you pay on your ordinary income, such as wages or income from self-employment. There are seven tax brackets, ranging from 10% to 37%. So if you’re in the 37% tax bracket, you’ll pay a 37% federal income tax rate on your bond interest.

Capital gains

If you buy a bond when it’s first issued and hold it until maturity – the full length of its lifespan – you generally won’t recognize a capital gain or loss. The money you get back is considered a return of your principal – what you originally invested in it.

However, after they’re issued, bonds often trade on financial exchanges, just like stocks. If you sell them before their maturity date on the secondary market, the bonds can generate capital gains and losses, depending on how its current price compares to your original cost. Bond funds can also generate capital gains and losses as the fund manager buys and sells securities within the fund.

So, the profit you make from selling a bond is considered a capital gain. Capital gains are taxed at different rates depending on whether they’re short-term or long-term.

Short-term capital gains apply if you hold the bond for one year (365 days) or less. Then the gain is taxed at your ordinary income tax rates.

Long-term capital gains apply if you hold the bond for more than one year. Then you can benefit from reduced tax rates, ranging from 0% to 20%, depending on your filing status and total taxable income for the year.

capital gains

Are all bonds taxed?

Bonds are divided into two classes: taxable and tax-exempt. 

A bond’s tax-exempt status applies only to the bond’s interest income. Any capital gains generated from selling a bond or bond fund before its maturity date is taxable, regardless of the type of bond. 

Taxable bonds

The interest income from taxable bonds is subject to federal, state (and local, if applicable) income taxes.

Taxable bonds include:

  • Corporate bonds
  • Mortgage-backed securities
  • Global bond funds
  • Diversified bond funds

Tax-exempt bonds

Municipal bonds, aka munis, are the main type of tax-exempt bonds. 

Munis are issued by states, counties, cities, and other government agencies to fund major capital projects, such as building schools, hospitals, highways, and other public buildings.

Interest income from muni bonds is generally not subject to federal income taxes. It can also be exempt from state or local income taxes if your home state or city issues the bond. Interest income from muni bonds issued by another state or city is taxable on your state or local income tax return. 

Fast fact: Muni bonds exempt from federal, state, and local taxes are known as “triple tax exempt.”

US Treasuries, bonds issued by the US Dept. of the Treasury, and savings bonds are also tax-exempt – to a degree. If you own them, you owe federal income tax on them. However, they are generally free from state and local income taxes. 

How can I avoid paying taxes on bonds?

Here are a few strategies for avoiding – or at least reducing – the taxes you pay on bonds.

  • Hold the bond in a tax-advantaged account. When you invest in bonds within a Roth IRA or Roth 401(k), the returns are tax-free, as long as you follow the withdrawal rules. Bond income and profits from sales earned within a traditional IRA or 401(k) are tax-deferred, meaning you don’t pay taxes until you withdraw the money in retirement.
  • Use savings bonds for educational purposes. Consider using Series EE or Series I savings bonds to save for education. When you redeem the bond, the interest paid is tax-exempt as long as you use the money to pay for qualified higher education expenses and meet other qualifications
  • Hold bonds until maturity. Holding a bond until maturity, instead of selling it early on the secondary market can help you avoid paying taxes on capital gains. However, you still owe tax on any taxable interest generated by the bond while you owned it.

The financial takeaway

Minimizing the tax consequences of bonds comes down to investing in tax-exempt bonds, such as muni bonds and US Treasuries, and using tax-advantaged accounts where your money can grow on a tax-free or tax-deferred basis.

If you invest in bonds outside of tax-advantaged accounts, you’ll receive a Form 1099 from the bank or brokerage holding your investments around January 31 of each year. Hold on to these forms, as you’ll need them to report bond interest and capital gains on your tax return. The IRS also gets a copy of those 1099s.

 If you miss reporting any income, they’ll be sure to let you know.

Related Coverage in Investing:

A corporate bond provides companies with cash and investors with income – here’s how to evaluate the risks and rewards

Fixed-income investing is a strategy that focuses on low-risk investments paying a reliable return

Bonds vs. CDs: The key differences and how to decide which income-producing option is better for you

What are junk bonds? A risky yet high-yield investment that can bring rewards if you’re willing to take the chance

How to buy treasury bonds, one of the safest ways to invest for income

Read the original article on Business Insider

Investment income is taxed in a variety of ways – here’s how to estimate what you’ll owe and tips to minimize it

investment income
Your investment income may be taxed as ordinary income, at certain special rates, or not at all, depending on the type of investment it is and the sort of investment account it’s in.

  • Investment income can be taxed as ordinary income or at special rates, depending on the type it is. 
  • Capital gains and some dividends receive preferential tax rates. Interest and annuity payouts are taxed as ordinary income. 
  • All investments earn income tax-free while they remain in tax-advantaged accounts.
  • Visit Business Insider’s Investing Reference library for more stories.

You probably know that you have to pay taxes on just about all your income. But while the taxes on your work income is fairly straightforward – based on your tax bracket, and often automatically withheld from your paycheck – the tax on investment income can be more complex. 

Not all investment income is taxed equally.

In fact, your investments are taxed at different rates, depending on the type of investment you have. Some investments are tax-exempt, some are taxed at the same rates as your ordinary income, and some benefit from preferential tax rates.

When you owe the tax can also vary. Some taxes are due only when you sell the investment at a profit. Other taxes are due when your investment pays you a distribution. 

And finally, where you hold the investments matters. If the asset is in a tax-deferred account, such as an IRA, 401(k), or 529 plan, you won’t owe taxes on the earnings until you withdraw money from the account – or, depending on the type of account, ever.

See what we mean by complex? Never fear – here’s everything you need to know about the taxes on investment income, and the tax rates on different investments. 

What is investment income?

Investment income comes in four basic forms:

  • Interest income derives from the Interest earned on funds deposited in a savings or money market account, or invested in certificates of deposit, bonds or bond funds. It also applies to interest on loans you make to others.
  • Capital gains. Capital gains come from selling an investment at a profit. When you sell an investment for less than you paid for it, it creates a capital loss, which can offset capital gains.
  • Dividend income. If you own stocks, mutual funds, exchange-traded funds (ETFs), or money market funds, you may receive dividends when the board of directors of the company or fund managers decides to distribute the excess cash on hand to reward their investors.
  • Annuity payments. When you purchase an annuity, a contract with an insurance company, you pay over a lump sum. The insurance company invests your money, and converts it into a series of periodic payments. A portion of these payments can be taxable.

How is investment income taxed?

With so many variables, how can you estimate the tax bite on your investments? Here are the tax rates for different types of investment income.

Interest income

For the most part, interest income is taxed as your ordinary income tax rate – the same rate you pay on your wages or self-employment earnings. Those rates range from 10% to 37%, based on the current (2021) tax brackets. 

Some interest income is tax-exempt, though. Interest from municipal bonds is generally tax-free on your federal return; when you buy muni bonds issued by your own state, the interest is exempt from your state income tax as well.

Another exception is granted US Treasury bonds, bills, and notes, as well as US savings bonds. They are exempt from state and local taxes, though not federal taxes. 

Capital gains

The tax rate you’ll pay on capital gains depends on how long you owned the investment before selling it.

You have a short-term capital gain if you own the asset for one year (365 days) or less before selling it. Short-term capital gains are taxed at the same rate as your ordinary income.

You have a long-term capital gain if you hold on to the investment for more than one year before selling it. Long-term gains are taxed at preferential rates, ranging from 0% to 20%, depending on your total taxable income.

Capital gains are not taxable while the funds remain within a tax-advantaged IRA, 401(k), HSA, or 529 plan.

capital gains

Dividend income

The rate you pay on dividends from stock shares or stock funds depends on whether the dividend is qualified or unqualified. 

Qualified dividends are taxed at the same rates as long-term capital gains. Unqualified dividends are taxed at the same rates as ordinary income.

To count as qualified, you must have owned the dividend-producing investment for more than 60 days during the 121-day period that started 60 days before the security’s ex-dividend date. The ex-dividend date is the date after the dividend’s record date, which is the cut-off date the company uses to determine which shareholders are eligible to receive a declared dividend.

Annuity payments

The taxation of annuity payments is a little more complex. While you may earn interest, dividends, and capital gains within your annuity, you don’t owe any taxes on this income until you actually start receiving your annuity payouts. You only have tax due on the sums you receive each year.

What you owe also depends on whether you purchased the annuity with pre-tax or after-tax dollars. If you purchase an annuity with pre-tax dollars (by rolling over money from your 401(k) or IRA), payments from the annuity are fully taxable.

But if you purchase an annuity with after-tax dollars – that is, you didn’t use retirement account money, you only pay taxes on the earnings portion of your withdrawal. The rest is considered a return of principal (the original lump sum you paid into the annuity). 

 When you receive your 1099-R from your insurance company showing your annuity payouts for the year, it will indicate the total taxable amount of your annuity income.

Whether you pay tax on 100% of the annuity payments or only the earnings portion of your withdrawal, all annuity payments are taxed at the ordinary-income rate.

How do I avoid taxes on investment income?

Most investment income is taxable, but there are a few strategies for avoiding – or at least minimizing – the taxes you pay on investment returns. 

  • Stay in a low tax bracket. Single taxpayers with taxable income of $40,400 or less in 2021 qualify for a 0% tax rate on qualified dividends and capital gains. That income limit doubles for married couples filing jointly. If you can take advantage of tax deductions that will keep your taxable income below that amount, you may be able to avoid paying taxes on a significant portion of your investment income.
  • Hold on to your investments. Hanging on to stocks and other investments can help ensure you take advantage of preferential rates for qualified dividends and long-term capital gains.
  • Invest in tax-advantaged accounts. Interest, dividends, capital gains – almost all forms of investment income are shielded from annual taxes while they remain in one of these accounts. With a traditional IRA or 401(k), the money is only taxable once you withdraw funds from the account. Money earned in a Roth IRA is never taxable, as long as you meet the withdrawal requirements. Interest income from a health savings account (HSA) or 529 plan is not taxable as long as you use the money to pay for qualified medical or educational expenses, respectively.
  • Harvest tax losses. Tax loss harvesting involves selling investments that are down in order to offset gains from other investments. If you have investments in your portfolio that have poor prospects for future growth, it could be worth it to sell them at a loss in order to lower your overall capital gains. Many robo-advisors and financial advisors will take care of harvesting for you, trying to net out the winners and the losers.

The financial takeaway

A few tax-exempt assets aside, investment income is taxable. And it’s taxed in two basic ways: at ordinary income rates or at a lower preferential rate, generally known as the capital gains rate.

All assets accrue income tax-free while they remain in tax-advantaged accounts.

While it’s never a good idea to make investment decisions based solely on the tax implications, it is wise to consider the tax consequences of any investment moves you make. Taxes might not be the only reason you choose one investment over another, but tax breaks can be a bonus on any well-thought-out investment strategy.

Related Coverage in Investing:

Dividends are taxed in different ways – here’s how to figure what you owe on your stocks’ payouts

Interest income from your investments is taxable – here’s how to calculate what you owe and ways to lower it

Bitcoin taxes: Understanding the rules and how to report cryptocurrency on your return

Capital gains are the profits you make from selling your investments, and they can be taxed at lower rates

A variable annuity can provide you with more retirement income since its payouts rise with the stock market

Read the original article on Business Insider

Long call options vs. long put options – what ‘going long’ in options trading means

long option1
In options trading, a long position means buying either a long call option or a long put option. The long call option reflects an optimistic feeling that a stock price will rise.

  • In options trading, going long means owning one of two types of options: a long call and a long put.
  • A long call option gives you the right to buy stock at a preset price in the future. A long put option lets you sell it.
  • Long positions hedge risk: If the stock doesn’t move as hoped, the option expires at little cost to you.
  • Visit Business Insider’s Investing Reference library for more stories.

A long position in investing basically means to buy or own a stock. Generally, you do so because you expect it to increase in value in the future – hence, you’re holding it for the long-term. 

But a long position also has a specialized meaning, having to do with options and options trading. It refers to buying a specific kind of option, based on your belief as to where the price of a stock (or another asset) is headed.

Let’s examine how a long position in options, or “going long” as the traders say, works.

What is a long position in options?

In the options-trading world, taking a long position, or going long, means you’re purchasing an option. An option is a contract that gives you the right to buy or to sell shares for a preset price (or “strike price”) on or before a future date, usually within the next nine months. It’s an opportunity to do this trade, but not a commitment – so, an option.

There are two types of long options, a long call and a long put. 

  • A long call option gives you the right to buy, or call, shares of a named stock for a preset price at a later date.
  • A long put option does the opposite: It gives you the right to sell, or put, shares of that stock in the future for a preset price.

How a long call option works

If you believe a certain stock is going to go up in price in the coming days, weeks, or months, you can purchase a long call option to buy that stock for today’s price sometime in the future and make a profit by selling it on the stock market at the then- higher price.

Example: You believe ABC stock, selling today for $100 a share is going to be worth more in a couple of months. You purchase a long call option contract for 100 shares, set to expire in three months, at a strike price (a preset price) of $100 per share, and a premium (fee) of $3 per share for the option itself.

ABC does as you expect and in two months shares are worth $150 apiece. You exercise your option, buy 100 shares at $100 each, sell them for $150 each, and you’ve made a tidy profit of $4,700.

How a long put option works

If you believe a company’s stock is due for a drop, you would purchase a long put option contract giving you the right to sell shares of that stock in the future for today’s (higher) price.

Example: You believe ABC is going to decline in a couple of months. You purchase a long put option contract for 100 shares, set to expire in three months, with a strike price of $100 per share, and a premium of $3 per share.

ABC does as you expected and in two months shares are selling for $50. You buy 100 shares at $50 each, exercise your option, and sell them for $100 each, and you’ve made a tidy profit of $4,700.

Exercising your long call or long put option

Whether you buy a long call or a long put, you can’t make money unless you exercise your option. Exercising your option means to buy or sell before the expiration date set in the option contract. 

Naturally, you’d exercise the option if things go the way you expect – the stock moves in the manner you thought it would, so you get to buy it (with a call) or sell it (with a put) at a price that’s better than the current market rate.

Why would you let the option expire without exercising it? Simple: The price of the stock goes against your prediction, moving in an opposite direction from the strike price. If that happens, the option becomes worthless. You let it expire, and you lose the premium you paid. 

The good news is, that’s all you lose.

Why take a long position in options?

Going long lets you take chances with less risk. Both long calls and long puts limit your loss to the premium, the cost of the options contract. You don’t have to buy the stock (in a call) or sell the stock (in a put) unless you expect to profit – by the shares moving as you anticipated before the contract ends.

In contrast, in regular investing, you’re committed to an actual purchase. And that could cause you to lose a lot of money if the stock doesn’t move in the direction you expected.

In addition to being less risky, long options also include an unlimited profit potential to the upside in the case of a long call option or the downside with a long put option. As long as the stock is above or below your option’s strike price – for the call or the put, respectively – you stand to win.

Both types of options are considered long, in the sense that both are buy positions and both let you make money on the direction of the underlying stock. However, the long call is the more bullish sentiment, because you’re betting that the stock price will rise. 

The long put option is a more bearish view because you’re anticipating, and hoping to profit from, a fall in the stock price. 

A long put option can also serve as a hedge, or insurance, against a bad outcome with a long call option or an outright purchase of stock. Yes, you’re betting against yourself, in a way, but at least you stand to benefit a bit if the stock falls instead of rises, mitigating your overall loss. 

The financial takeaway

With options, going long refers to a position in which you buy:

  • a long call option, meaning that you expect the underlying asset to increase in price, which increases the value of the option. This option is bullish on both the underlying stock and the option itself.
  • a long put option, meaning you expect the underlying asset to decline in price, which increases the value of the put option. A long put option is bearish on the underlying stock but bullish on the outcome of the option.

Long option positions require less investment, or cash down, than outright investments. Instead of spending thousands on a stock, you just spend a few hundred on the option, giving you more leverage for less money.

Of the two options, long calls are more common – or at least, what’s more commonly thought of as a long options position. And, like buying stock outright, they are essentially optimistic. Long puts, pessimistic bets that a stock will fall, are more often used as insurance against a bad outcome with a long call, or with an actual ownership position.

But in a way, both long options can be considered bullish: Both are buy positions, affording you a chance to make money on the moves of the underlying stock.

Related coverage in Investing:

A short squeeze happens when a stock suddenly spikes – a bind for traders who bet borrowed money it would drop

Margin trading means buying stocks with borrowed funds – it’s riskier than paying cash, but the returns can be greater

‘Buy the dip’ means purchasing a promising stock when its price drops, assuming a fast rebound and future profits

What is a bear market? How to make sense of a prolonged period of decline in the stock market and invest wisely

A bull market means that stocks are rising, but it pays to understand how it works before you charge

Read the original article on Business Insider

A short squeeze happens when a stock suddenly spikes – a bind for traders who bet borrowed money it would drop

short squeeze
A short squeeze afflicts short-sellers, investors who have sold stocks they don’t actually own, in hopes of buying them back later for less money. If the stock rises instead, the strategy goes awry.

  • A short squeeze refers to a stock rise in price, adversely affecting investors who’d expected a decline.
  • Signs of an imminent short squeeze include heavy buying or a high amount of a stock’s shares being sold short.
  • Buy-limit orders and hedging strategies offer short-sellers some protection against a short squeeze.
  • Visit Business Insider’s Investing Reference library for more stories.

In late January 2021, shares of a company called GameStop stock, which had been trading around $2.57 per share, suddenly shot up, eventually as high as $500 – when users of the Reddit website subgroup Wall Street Bets began buying up shares. 

This was bad news for a lot of other investors, known as short-sellers, who had bet the stock would keep falling. Unlike most investors, who want their stocks to appreciate, short-sellers make money when stock prices go down and lose money when they go up. 

So when GameStop started gaining, these short-sellers were caught in what’s called a short squeeze. They had borrowed to support their pessimistic investment, and they now had to pay it back – by buying GameStop shares at the higher prices. Or else, hang on – and risk losing even more money.

 A short squeeze is a stock market phenomenon, something that happens to investors and traders who have acted on the assumption that an asset (a stock, usually) is going to fall – and it rises instead. Here’s how it happens.

What is a short squeeze?

To understand a short squeeze, it helps to understand short selling, aka shorting, a sophisticated investment strategy in which traders or investors sell stocks they don’t actually own, in hopes of buying them back later for less money. 

It works like this: A short-seller borrows shares (usually from their broker) they think are due for a fall or to keep on falling, and sells them on the open market at the current price. When the stock’s price drops, as the short-seller was betting it would, they then buy the shares back for the new, lower amount. They return the borrowed shares to their stockbroker, keeping the difference in price as profit. In the interim, they’re charged margin interest on the shorted shares until they pay them back.

The entire strategy hinges on the bearish view that the stock is going to drop in value. But what if it goes up instead? That’s when a short squeeze happens. 

When a stock rises sharply and suddenly, short-sellers scramble en masse to buy shares to cover their position (their loan from their broker). Each of these buy transactions drives the stock even higher, “squeezing” the short-seller even more. They have to keep covering their positions or get out totally – at a loss.

 How does a short squeeze happen?

 Here is how a short squeeze scenario unfolds:

  1. You identify a stock you believe is overvalued, and take a short position: borrowing and selling shares at today’s high price in anticipation the price will go down and you will be able to buy replacement shares at a much lower price.
  2. Instead, something happens causing the price of the stock to start going up. That “something” can be the company issuing a favorable earnings report, some sort of favorable news for its industry – or simply many other investors buying the stock (as happened with GameStop).
  3. You realize you are unable to buy the stock back at a low price. Instead of sinking, it’s climbing – and it exceeds the price you bought it for. At this point, you must either buy replacement shares at a higher price and pay back your broker at a loss, or buy even more shares than you need – in hopes that selling them for profit will help cover your losses.
  4. All this increased buying causes the stock to keep going up, forcing even more short-sellers like yourself into a tighter vise. You have the same choices as above, only the stakes keep mounting, and so do your potential losses.

Protecting yourself against a short squeeze 

There are specific actions you can take to try to protect yourself against a short squeeze or to at least alleviate its grip. 

  • Place stop-loss or buy-limit orders on your short positions to curb the damage. For example, if you short a stock at $50 per share, put in a buy-limit order at a certain percentage (5%, 10% or whatever your comfort level is) above that amount. If the shares rise to that price, it’ll automatically trigger a purchase, closing out your position. 

  • Hedge your short position with a long position – that is, buy the stock (or an option to buy the stock) to take advantage of rising prices. Yes, you’re betting against yourself, in a way, but at least you lessen the damages of the losses and benefit from the price appreciation. 

Predicting a short squeeze

Short squeezes are notorious for descending quickly and unpredictably. Still, there are signs a short squeeze may be coming:

  • Substantial amount of buying pressure. If you see a sudden uptick in the overall number of shares bought, this could be a warning sign of a pending short squeeze.
  • High short interest of 20% or above. “Short interest” is the percentage of the total number of outstanding shares held by short-sellers. A high short interest percentage means a large number of all a stock’s outstanding shares are being sold short. The higher the percentage, the more likely a short squeeze may be building. 
  • High Short Interest ratio (SIR) or days to cover above 10. SIR is a comparison of short interest to average daily trading volume. It represents the theoretical number of days, given average trading volume, short-sellers would need to exit their positions. The higher this number, the more likely a short squeeze is coming. Both short interest and SIR are on stock quote and screener websites such as FinViz.
  • Relative Strength Index (RSI) below 30. RSI indicates overbought or oversold conditions in the market on a scale of 0 to 100. A stock with a low RSI means it’s oversold – that is, trading at a very low price – and possibly due to increase; a high RSI indicates the stock is extremely overbought – trading at a high price – and possibly due to drop. Any RSI below 30 signals an imminent price rise, which could lead to a short squeeze. A company’s online stock listing usually includes its RSI, often under its Indicators section. 

The financial takeaway

A short squeeze can result when a stock – especially one that had been declining in price – suddenly goes up for whatever reason. 

This puts short-sellers, who bet the stock would drop or to keep on dropping, in a bind. They sold shares they didn’t actually own, and now, to cover their positions – repay the stock they borrowed -they have to buy increasingly expensive shares. Each of these buy transactions drives the stock even higher, forcing more short-sellers to spend more or get out at a loss. They call it a squeeze but it becomes more like a vicious cycle. 

There are indicators to predict a short squeeze, and ways to protect yourself against one. But overall, a short squeeze is one of the facts of life for a short-seller – and a reminder of the risks that sophisticated trading strategies like short selling carry. 

Related Coverage in Investing:

‘Buy the dip’ means purchasing a promising stock when its price drops, assuming a fast rebound and future profits

Goldman says the stock market is undergoing its biggest short squeeze in 25 years – and that has hedge funds dumping stock exposure at the fastest rate since 2009

Options let you lock in a good price on a stock without actually buying it – here’s how option trading works

A margin call means your broker is asking you to repay the money it lent you to buy stocks – and if you don’t, it could mean big losses for your portfolio

Trading and investing are two approaches to playing the stock market that bring their own benefits and risks

Read the original article on Business Insider

How to invest in equity crowdfunding, a way to give small private firms a boost – and possibly profit yourself

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Equity crowdfunding provides an online platform that puts private companies and individual investors together. Firms receive funding, and investors an ownership share in the business.

  • Equity crowdfunding lets individuals invest in private companies in return for an equity stake.
  • You can invest via equity crowdfunding platforms, which vary in their standards and specialties.
  • Equity crowdfunding investments are riskier and less liquid than publicly traded securities.
  • Visit Business Insider’s Investing Reference library for more stories.

Have you ever made a donation to a worthy cause or budding business enterprise in response to an online crowdfunding appeal? If you’re looking for a reward beyond a stuffed animal or a branded pen, you might be interested in a variation of Kickstarter, GoFundMe, and other crowdfunding models we’ve come to know and love: equity crowdfunding.

Equity crowdfunding provides a platform for private companies and individual investors to meet. Individuals provide funds for firms seeking capital to grow, in exchange for an equity stake in that company. It can be risky since these young companies don’t have much of a track record, but it can also present a chance to earn some substantial money – and of course help a business you believe in. 

Anyone who wants to invest can get involved with equity crowdfunding, but there are rules as well as risks. Let’s take a closer look at how you can invest, how equity crowdfunding platforms differ, and some overall strategies.

What is equity crowdfunding? 

Also known as crowd-investing, equity crowdfunding allows startups and small companies to raise capital from investors, in exchange for an ownership stake – shares of stock – in the business. 

Investing in private companies – that is, ones who don’t trade on public stock exchanges – used to be the province of extremely wealthy or institutional investors. But in 2016 the JOBS Act, which enabled more companies to sell shares without going public, was expanded to allow less-affluent individuals to play, too. 

“So someone who doesn’t have a million-dollar net worth, can now diversify their investment portfolio into startups, which, prior to now, was completely off-limits,” says Brian Belley, founder of Crowdwise, an online equity crowdfunding community. 

And with COVID-19 lockdowns encouraging online investing, equity crowdfunding really took off in 2020, raising $214.9 mi lion in 2020 (a 105% growth from 2019) for 1,035 new companies, according to data gathered by Crowdwise.

Types of equity crowdfunding investments

Actual crowdfunding investments can be in the form of different financial securities. These include:

  • Common stock: This method may come along with dividends, depending on the company’s maturity and success. Later-stage startups are more likely to offer shareholders returns in the form of either fixed dividends per share or a percentage of profits.  
  • Preferred stock: Like common stock, but without voting rights for shareholders.
  • Debt: This also comes in various forms, with some companies offering simple loans with fixed repayment schedules and others offering revenue shares, which return a fixed amount of money in a time frame that depends on the company’s success.
  • Convertible notes: This method will eventually convert your debt investments to stock if the company raises a “priced round” from major investors. A priced round is an equity investment based on a company’s negotiated valuation. Essentially, investors serve as equity-owning shareholders and will see a return if the value of that stock goes up over time and can be sold for a profit. 

How much can I invest in equity crowdfunding?

Anyone can participate in equity crowdfunding, regardless of income. But because these are highly speculative investments – your funds are tied up in untried, unregulated companies and you might not see a payout for years, if ever – the Securities & Exchange Commission (SEC)  dictates how much and how often individuals can invest in equity crowdfunding offerings. Calculated on a sliding scale, the exact amount is based on your annual income and net worth.

How to find equity crowdfunding projects 

Equity crowdfunding takes place through online platforms – websites that put companies and investors together. Although the companies seeking crowdfunding capital may not be subject to government oversight, the equity crowdfunding platforms are.

An equity crowdfunding platform must be either operated by a licensed broker-dealer or registered with the SEC as a “funding portal.”  A platform must also become a member of the Financial Industry Regulatory Authority (FINRA), which oversees brokerages.

The platforms all are pretty user-friendly, generally working along the same lines. Investors sign up on the platform’s funding portal site and verify relevant financial information, like their income and assets. Then they can see all the offerings from companies soliciting capital: info on the firms, their plans, and details of the deal, like the company’s price per share.

Investors select the offerings they’d like to participate in, and submit their funds – you can even charge them on a credit card. Investment amounts range widely, starting as little as $100. 

Investors often can track their investments via a dashboard online. In addition, you’ll receive an annual report and, in some cases, quarterly updates on the company.

How equity crowdfunding platforms work

While the basic investing procedure is the same, equity crowdfunding platforms do operate in different ways. Some charge investors processing and other payment fees, while others take their compensation out of the money the company raises – a percentage cut of a company’s capital campaign.  

They also screen companies differently. Some platforms basically list anything; others, more exclusive, present thoroughly vetted deals. Some provide a lot of intel, others call on investors to do additional research themselves. Some stick to tried-and-true industries; others feature less traditional enterprises, like a new indie film.

Finally, platforms vary in their areas of specialization, with some focusing on specific industries like technology and others offering a wider array of investment opportunities.

“Looking forward, I see a lot more vertically-integrated or industry-focused portals popping up,” says Belley. “I think as more people come in, more people are going to start needing to find a way to sort through the noise of all these offerings, and I think they will start gravitating towards those portals.”

Which are the major equity crowdfunding platforms?

Here’s a list of a few leading players in equity crowdfunding: 

  • WeFunder: This is the largest equity crowdfunding site and top funding portal in terms of capital raised. It offers notable transparency in terms of investment results, but does not require featured companies to be focused in a specific industry.
  • StartEngine: As the #2 funding portal in terms of capital raised and the #1 ranked portal by number of deals, StartEngine specializes in technology companies.
  • Republic: In 2019, Republic became the third biggest platform in terms of capital raised, and stands apart because of the extra due diligence required for startups to get approved and featured on its site.
  • SeedInvest: This site also emphasizes how highly vetted its offerings are. They’re a diverse lot too, ranging from financial apps to sports gear to biotech. 
  • Netcapital: This platform has a strategic partnership with Techstars, a start-up mentor and company for investment and innovation. 
  • MicroVentures: This platform’s a generalist, but known for some savvy picks. Past investment opportunities it’s offered have been from such firms as included Slack, Pinterest, Uber, and Lyft.
  • NextSeed: Investments are focused on ventures that support the growth of local communities: existing small businesses, startups, and commercial real estate.

Tips for successful equity crowdfunding investing

Be aware that equity crowdfunding is a business: You’re investing money, not donating it, as you do with regular crowdfunding. As such, it behooves you to be careful. Here are some things to bear in mind.

  • Be aware of the risks: These are usually young firms with not much of a track record. The fact that they’re not publicly listed means they are unregulated, and therefore can be less transparent. Also, your money is less liquid here than it would be if invested in traditional stocks, ETFs, or mutual fund, which trade daily and have posted prices. 
  • Do your due diligence: Find out exactly where your money is going by reading about how the company plans to use its capital. The Q&A portion of a campaign page can serve as a valuable resource, giving you a sense of how the company’s management thinks. You may also benefit from reading available financial paperwork, where information can sometimes be hidden away.
  • Always go through the platform: Beware of companies reaching out directly to seek money from you. All transactions should go directly through a credible, SEC- and FINRA-registered platform. In fact, many companies use the platform to communicate and solicit investor feedback, with platforms like Republic allowing businesses to regularly survey their many small investors.
  • Think long-term: Think of equity crowdfunding as a speculative, growth investment rather than one that will offer a current return. With so much uncertainty surrounding early-stage businesses, it’s nearly impossible to predict which will or will not succeed. The amount of time it takes to see a return varies significantly, depending on both the type of investment and the company’s success. 

The financial takeaway

Equity crowdfunding gives large groups of everyday investors the ability to support businesses they believe in, in exchange for an ownership stake. It’s done online, via equity crowdfunding platforms.

Equity crowdfunding platforms don’t all follow the same model, charging different fees, offering different types of financial securities, and specializing in different sectors.

Equity crowdfunding is open to all, but the SEC limits investors in how much they can put in annually, depending on net worth and annual income.

Equity crowdfunding investments are long-term, illiquid ones. Your shares are tied up for an indefinite period – no unloading them quickly, as you can with publicly traded stocks and other securities. There is definitely a high degree of investment risk, too, as these companies are untried, unregulated, and may be hard to get information on.

Equity crowdfunding is definitely on the more speculative end of the investing spectrum. While it can have enormous payoffs, don’t go betting your retirement nest egg on it.

Related Coverage in Investing:

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Dividends are taxed in different ways – here’s how to figure what you owe on your stocks’ payouts

dividends2
Dividend income is taxable, but the rate varies, depending on how long you’ve owned the stock shares that pay the dividends.

  • Dividends from stocks or funds are taxable income, whether you receive them or reinvest them.
  • Qualified dividends are taxed at lower capital gains rates; unqualified dividends as ordinary income.
  • Putting dividend-paying stocks in tax-advantaged accounts can help you avoid or delay the taxes due.
  • Visit Business Insider’s Investing Reference library for more stories.

When you invest in a company by purchasing individual stocks, mutual funds, or exchange-traded funds (ETFs), you may be rewarded with dividends. A dividend is a per-share portion of the company’s profits that gets distributed regularly to its stockholders – sort of like a quarterly bonus. 

Like most other types of investment income, the IRS deems dividends to be taxable. However, not all dividends are treated – or taxed – equally. 

Here’s everything you need to know about paying taxes on dividends.

How are dividends taxed?

A variety of unearned or passive income (as opposed to income from your work or job), dividends are subject to both federal and state taxes. For tax purposes, dividends are classified as either qualified or unqualified, depending on how long you hold the underlying shares in a US corporation or a qualifying foreign corporation.

What’s the difference? Qualified dividends meet a special holding period. That means you owned the stock issuing them for at least 60 days during the 121-day period that started 60 days before the ex-dividend date. The ex-dividend date is the day after the cut-off date (aka the “record date”) the company uses to determine which shareholders are eligible to receive the dividend.

Yeah, that definition is pretty confusing. So here’s a real-life example, sort of a timeline. 

  • Say you purchased 100 shares of IBM stock on March 1, 2020.
  • On April 28, IBM’s board of directors announced a dividend of $1.63 per share to stockholders of record.
  • They set the record date as May 8, 2020. So the ex-dividend date was May 9, 2020.
  • Since you purchased the shares more than 60 days prior to the ex-dividend date (May 9, 2020), the $163 in dividends your shares earned you are qualified. On the other hand, if you’d purchased shares on April 1, you would have owned the stock for fewer than 60 days, and the dividends would be unqualified.

How much tax do you pay on dividends?

Why do dividends being qualified or unqualified matter? Because it affects the amount of tax you pay on them. 

Unqualified dividends are taxed at your ordinary income tax rate – the same rate that applies to your wages or self-employment income. So, if you fall into the 32% tax bracket, you’ll pay a 32% tax rate on all your unqualified dividends, also known as ordinary dividends.

Qualified dividends get preferential treatment. You pay the same tax rate on qualified dividends as you do on long-term capital gains. Depending on your tax bracket, this rate can be a lot lower than your ordinary income rate.

The exact rate you pay depends on your filing status and total taxable income for the year.

capital gains 06
Capital gains tax rates.

Returning to the IBM example above, let’s assume you fall into the 32% tax bracket for ordinary income and the 15% tax bracket for long-term capital gains.

If your IBM dividends are unqualified, you’ll pay roughly $52 in taxes on your $163 of dividends. But if those dividends are eligible for qualified tax treatment, you’ll pay only $24 in taxes.

How can you avoid paying taxes on dividends?

There are a few legitimate strategies for avoiding or at least minimizing the taxes you pay on dividend income.

  • Stay in a lower tax bracket. Single taxpayers with taxable income of $40,000 or less in 2020 ($40,400 or less for 2021) qualify for the 0% tax rate on qualified dividends. Those income limits are doubled for married couples filing jointly. If you can take advantage of tax deductions that reduce your income below those amounts, you can avoid paying taxes on qualified dividends, though not unqualified dividends.
  • Invest in tax-exempt accounts. Invest in stocks, mutual funds, and EFTs within a Roth IRA or Roth 401(k). Any dividends earned in these accounts are tax-free, as long as you obey the withdrawal rules.
  • Invest in educationoriented accounts. When you invest within a 529 plan or Coverdell education savings account, all dividends earned in the account are tax-free, as long as withdrawals are used for qualified education expenses.
  • Invest in tax-deferred accounts. Traditional IRAs and 401(k)s are tax-deferred, meaning you don’t pay taxes on earnings until you withdraw the money in retirement.
  • Don’t churn. Try not to sell stocks within the 60-day holding period, so any dividends will be qualified for the low capital gains rates. 
  • Invest in companies that don’t pay dividends. Young, rapidly growing companies often reinvest all profits to fuel growth rather than paying dividends to shareholders. You won’t earn any quarterly income from their stock, true. But if the firm flourishes and its stock price rises, you can sell your shares at a gain and pay long-term capital gains rates on the profits as long as you owned the stock for more than a year.

Keep in mind: You can’t avoid taxes by reinvesting your dividends. Dividends are taxable income whether they’re received into your account or invested back into the company.

The financial takeaway

Dividend stocks can be a good way to build wealth and supplement your income, so don’t let worries over taxes keep you from investing in dividend-paying stocks. 

Still, by knowing how dividends are taxed, you can do some planning to ensure you pay as little to the IRS as possible. 

Qualified dividends benefit from being taxed at lower capital gains tax rates. And you may be able to lower the tax bite even more if you keep the high-dividend-payers in tax-advantaged accounts.

Related Coverage in Investing:

What are the best college-savings investments? 5 ways to grow your money for the ever-higher costs of higher education

Dividend yield is a key way to evaluate a company and the regular payouts from its stock

Capital gains tax rates: How to calculate them and tips on how to minimize what you owe

How to invest in dividend stocks, a low-risk source of investment income

Interest income from your investments is taxable – here’s how to calculate what you owe and ways to lower it

Read the original article on Business Insider

Interest income from your investments is taxable – here’s how to calculate what you owe and ways to lower it

interest income1
Most interest income earned by your savings and investments counts as taxable income. It’s taxed at the same rate as your regular income.

Paying income taxes is a fact of life. And when the IRS says income, it means all the money you make – both earned, from your work, and unearned, from your investments. That includes interest income – money generated by bank or brokerage accounts, and from certain assets, like bonds or mutual funds.

A few exceptions aside, most investment interest is taxable income. You’re required to report it on your return and give the government a cut of it.

 So it helps to know a little more about how interest income impacts your tax bill.

What is interest income?

Most types of interest income are subject to both federal and state taxes. This includes the interest you earn on or from:

Is any interest income tax-free?

Only one major type of asset generates non-taxable interest income: municipal bonds (“munis” for short) and private activity bonds. These are issued by states, counties, cities, and other government agencies to fund major capital projects, such as building public hospitals and schools, highways, power plants, and other civic buildings. 

All munis, along with municipal bond funds, are exempt from federal taxes. If the bond is issued by your home state, the interest income it provides is also free from state and local income taxes. 

Fast fact: Municipal bonds free of federal, state, and local taxes are dubbed “triple-tax-exempt” bonds. 

You also get a bit of a break on US Treasuries and savings bonds. You pay federal income tax on them, but they’re exempt from state and local income taxes. 

What’s the tax rate on interest income?

Interest income doesn’t have a special tax rate the way profits on your investments, aka long-term capital gains, do. You pay taxes on the interest as if it were ordinary income – that is, at the same rate as your other income, such as wages or self-employment earnings. 

So, if you’re in the 24% tax bracket, you’ll also pay a 24% rate on your interest income.

For the 2020 and 2021 tax years, there are seven tax brackets: 

2020 Tax Brackets (tax returns filed in 2021)

Tax Rate Single Head of Household Married Filing Jointly Married Filing Separately
10% Up to $9,875 Up to $14,100 Up to $19,750 Up to $9,875
12% $9,876 – $40,125 $14,101 – $53,700 $19,751 – $80,250 $9,876 – $40,125
22% $40,126 – $85,525 $53,701 – $85,500 $80,251 – $171,050 $40,126 – $85,525
24% $85,526 – $163,300 $85,501 – $163,300 $171,051 – $326,600 $85,526 – $163,300
32% $163,301 – $207,350 $163,301 – $207,350 $326,601 – $414,700 $163,301 – $207,350
35% $207,351 – $518,400 $207,351 – $518,400 $414,701 – $622,050 $207,351 – $311,025
37% $518,401 and up $518,401 and up $622,051 and up $311,026 and up

2021 Tax Brackets (tax returns filed in 2022)

Tax Rate Single Head of Household Married Filing Jointly Married Filing Separately
10% Up to $9,950 Up to $14,200 Up to $19,900 Up to $9,950
12% $9,951 – $40,525 $14,201 – $54,200 $19,901 – $81,050 $9,951 – $40,525
22% $40,526 – $86,375 $54,201 – $86,350 $81,051 – $172,750 $40,526 – $86,375
24% $86,376 – $164,925 $86,351 – $164,900 $172,751 – $329,850 $86,376 – $164,925
32% $164,926 – $209,425 $164,901 – $209,400 $329,851 – $418,850 $164,926 – $209,425
35% $209,426 – $523,600 $209,401 – $523,600 $418,851 – $628,300 $209,426 – $314,150
37% $523,601 and up $523,601 and up $628,301 and up $314,151 and up

Interest income can also be subject to another tax called the Net Investment Income Tax (NIIT). The NIIT is a 3.8% tax on the lesser of:

  • Your net investment income, which is generally all of your investment income (including interest, dividends, capital gains, distributions from annuities, income from passive activities, rents, and royalties) minus investment expenses, or
  • The amount of your modified adjusted gross income that exceeds $200,000 for singles/heads of household, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately.

How do I report interest income on my tax return?

Around January 31 of each year, you should receive Form 1099-INT from any bank, brokerage firm, or other sources of interest income showing the interest your investments earned in the prior year. 

In most cases, it’s easy to take the numbers from Form 1099-INT and transfer them to the appropriate place on your tax preparation software or tax return. The figures to focus on are in boxes 1, 3, and 8.

Boxes 1 and 3 of Form 1099-INT show regular taxable interest income and taxable interest from US Savings Bonds and Treasury Bonds. Box 8 shows tax-exempt interest. 

Where is taxable interest income reported on the tax return?

If you received more than $1,500 of taxable interest or dividends during the year, you report all of that interest and dividend income on Schedule B attached to your Form 1040. If your earnings didn’t reach that threshold, you don’t need to fill out Schedule B. Instead, you just report tax-exempt interest and taxable interest on lines 2a and 2b of your Form 1040.

Your 1099-INT forms should have all the info you need. They may not be complete, though. Banks and brokerage firms are only required to send you a form if they paid you more than $10 in interest during the year. So if you earned $5 in interest from a savings account, it’s still taxable – you just might not get a 1099-INT.

So, it’s a good idea to keep track of it yourself, too – because you’re required to report all interest income on your return, no matter how small. If you have lots of accounts in various places, it could add up.

Is there any way to avoid taxes on interest income?

It’s hard to avoid paying taxes on your interest income, but there are a few strategies to try, especially with assets that generate a lot of income. 

  • Keep assets in tax-exempt accounts, such as a Roth IRA or a Roth 401(k). No matter what the investment, you never owe taxes on anything earned in such accounts, as long as you obey the withdrawal rules. 
  • Keep assets in education-oriented accounts, like 529 plans and Coverdell education savings accounts. All earnings in these accounts are tax-free, as long as they’re used for academic expenses.
  • Invest assets in tax-deferred accounts, such as a traditional IRA or 401(k) to put off paying taxes until you withdraw the money in retirement, and you’re presumably in a lower tax bracket.
  • Invest in municipal bonds issued in your home state to qualify for the triple-tax-exempt treatment. 
  • Invest in US Treasuries to avoid state income taxes, especially useful if you live in a highly taxed locality. 

The financial takeaway

No matter the source, most interest earned by your savings and investments counts as taxable income. It’s taxed at the same rate as ordinary income – based on your regular tax bracket for the year. 

Avoiding interest income tax boils down to seeking out certain exempt assets – mainly municipal bonds and US Treasuries – and using tax-advantaged accounts, in which money earns tax-free or at least tax-deferred. 

The financial institutions holding your accounts send annual statements of your interest income called Form 1099. So keep track of these, and report all of your investment income. The IRS gets copies of all of your 1099s, so they’ll know quickly if you leave anything out. 

Related Coverage in Investing:

Where to invest when interest rates are low – 6 fixed-rate vehicles that offer the best returns

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The S&P 500 is seen as a gauge of the stock market itself – here’s how this widely watched stock index works

S&P
Changes in the S&P 500 index flash constantly in stock exchanges and online during the trading day. The index is seen as a stand-in for the performance of US equities and the economy overall.

  • The S&P 500 is a broad-based stock market index, consisting of the 500 largest US public companies.
  • The diversity and size of the companies it tracks make the S&P a proxy for the entire stock market.
  • You can’t invest in the S&P 500 itself, but you can buy an index fund that duplicates its stocks and performance.
  • Visit Insider’s Investing Reference library for more stories.

People often say “The stock market is up,” or “The market is down.” But the stock market is an amorphous thing, encompassing thousands of equities and dozens of stock exchanges. What they actually mean is a particular stock market index, or group of publicly traded companies, is up or down.

And if they’re in the US, odds are that index is the Standard & Poor’s 500, or S&P 500

Named for the number of companies on its list, the S&P 500 is “a broad-based index that includes the cross-section of economic sectors like information technology, healthcare and consumer discretionary, as well as major companies in the financial, energy, industrial, and consumer durable sectors,” says Solomon Tadesse, who heads North American equity quantitative research at Société Générale. 

“As such, the S&P 500 is a good proxy of the US equity market and, by implication, the economy and its near-term trends.”

Understanding the S&P 500 can be important for investors. Here’s everything you need to know about this influential index. 

What is the S&P 500?

Developed by Standard & Poor’s (now S&P Global), the S&P 500 launched in 1957. But its status as a proxy for the US equity market was cemented in 1968, when the S&P 500 became one of the indicators used by The Conference Board, the business membership and research organization, to forecast economic trends. 

It’s what’s known as a weighted index, meaning companies with a higher market capitalization (the total value of all their stock shares), carry more clout in the calculations, so the overall index correlates more closely to the broader market.

The index’s relative level – or the collective worth of the stock shares within it – is expressed in points. In January 2021, it stood at 3,750. So if the S&P 500 goes up by, say 10% during 2021, it would mean an overall index gain of 375 points. 

What is the S&P 500 made up of?

One reason the S&P 500 is so widely quoted is its makeup: the 500 largest public corporations in the US (though it actually contains 505 stocks because some companies issue more than one class of shares). They’re organized across 11 industrial sectors.

Individual companies may rotate in and out. The S&P Global’s U.S. Index Committee re-examines and rebalances the roster at least quarterly, although it can happen anytime in an attempt to ensure “the index continues to provide a representative reflection of the large-cap U.S. equity market,” according to an S&P Global blog

For a company to qualify for the index, it has to meet these criteria:

  • Be based in the US (though it can have overseas operations)
  • Have a market capitalization of at least $9.8 billion
  • Be highly liquid, with at least 10% of its shares outstanding in the public market
  • Have positive earnings in the most recent quarter, and in the four previous quarters.

What companies are in the S&P 500?

The S&P 500 is full of familiar names, many of them blue-chip companies with strong performance histories of financial performance. As of December 2020, the 10 largest companies (by market capitalization) in the S&P 500 include:

  • Apple Inc. (AAPL)
  • Microsoft (MSFT)
  • Amazon Inc. (AMZN)
  • Alphabet Inc. Class A shares (GOOGL)
  • Alphabet Inc. Class C shares (GOOG)
  • Facebook Inc. (FB)
  • Tesla (TSLA)
  • Berkshire Hathaway (BRK.B)
  • Visa (V)
  • Johnson & Johnson (JNJ) 

What’s the average return for the S&P 500?

Over the past 10 years, the S&P 500 has posted annualized returns of 11.18%. In 2020, it posted a return of 15.15%.

Since the companies within the index are so diverse, and are collectively worth about 80% of all US stocks’ total value, these performance figures are widely seen as synonymous with the performance of the US stock market overall. 

Limitations of the S&P 500

Though seen as widely representative, the S&P 500 isn’t perfect.

The S&P 500 is a weighted index, meaning companies with a higher market cap carry more clout in the calculations. As a result, the index may give “disproportionate weighting to the largest companies,” cautions Leyla Z. Morgillo, a certified financial planner with Madison Financial Planning Group. “Those weightings can then skew the performance of the index, resulting in a handful of stocks driving the overall index performance. You wouldn’t be able to tell that just by looking at the overall performance of the S&P 500, which is why it can be misleading at times.”

Case in point: Just two high-tech companies, Apple and Microsoft, together account for more than 11% of the benchmark. “That can create some anomalies as other, relatively smaller relative companies can get lost in the sauce,” says Dan Veru, chief investment officer at Palisade Capital Management.

Then too, in an increasingly globalized economy and stock market, the S&P 500 only includes US-based companies. That means major (and sometimes market-moving) foreign stocks, like China’s Alibaba Group or Germany’s BioNTech SE, can’t figure in its performance – rendering it less useful as an indicator of economic trends.

Other significant stock indexes

Despite the S&P’ 500s prominence, investors watch other indexes as well. Among the competitors:

  • Dow Jones Industrial Average: One of the oldest indexes, the Dow tracks 30 leading US companies. Of course, that’s far fewer than the S&P 500 – too few, some financial pros feel. Also, its weighting system, which is based on share price instead of total market cap, may unfairly penalize a company that has a stock split.
  • Russell Indexes: The Russell 3000 considers 3000 U.S.-headquartered companies, significantly more than the S&P 500. So do two other indexes that are built off the Russell 3000: the large-cap Russell 1000 and the small-cap Russell 2000. Many investment fund managers favor the Russell 3000 and its smaller sisters, though the latter can be more volatile than the S&P 500.
  • The Wilshire 5000:This index encompasses about 3,800 stocks (despite its name), giving it bragging rights as the broadest stock market index – virtually all the publicly traded corporations based in the US. Though obviously larger than the S&P 500, and so arguably more representative, the Wiltshire also ignores the overseas markets. 
  • The Nasdaq-100: This growth-stock-oriented index includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq stock exchange. The index is attractive because of an emphasis on the technology sector, arguably the most influential, fast-growing industry in the US economy now. But its bandwidth is even narrower than the S&P 500’s and following it could put investors at risk in case of a sector downturn.

How to invest in the S&P 500 

You can’t directly invest in the S&P 500 – it’s just a list, not a stock itself. But a variety of publicly traded mutual funds and ETFs (exchange-traded funds) buy securities that track the S&P 500, or a particular group of the companies within it, like high-dividend-paying companies or more growth-oriented companies.

All the leading brokerages and financial services companies offer S&P 500 index funds: firms like Charles Schwab, Fidelity, and Vanguard. So do most online trading platforms and apps, like Robinhood and Stash. 

S&P 500 index funds are also popular with robo-advisors like Wealthfront and Betterment, which use computer algorithms to invest and monitor investors’ portfolios. 

The financial takeaway

For more than half a century, the S&P 500 has been a bellwether for the performance of the stock market overall. Because it represents the largest publicly traded corporations in the US, its performance is seen as a snapshot of the state of US business, and by extension, the US economy. 

But this index does have some shortcomings. Its market-cap weightings may favor some companies, or sectors, over others; the bandwidth doesn’t always reflect the entire domestic stock market; and it excludes companies that aren’t based in the US. 

Still, the returns of individual stocks, stock funds, and other assets are all compared against the S&P 500. So it can be a good tool for investors as well – to guide their individual investment choices, get a sense of how their picks are performing, and even to duplicate via S&P 500 index funds. 

Related Coverage in Investing:

A guide to stock market indexes: What they measure and how they can guide your investing

What is the Nasdaq? Understanding the global stock exchange that’s home to the fastest-growing, most innovative companies

How to invest in the S&P 500 – a guide to the funds that mimic the influential index’s makeup and moves

What is OTC? A beginner’s guide to over-the-counter markets, and the risks and rewards of investing outside the major stock exchanges

The Dow Jones Industrial Average is one of the most-watched stock indexes in the world – here’s how it works and why it’s so influential

 

Read the original article on Business Insider

How to take advantage of low interest rates – the best financial moves for investors and borrowers

low rates
There are ways to benefit when interest rates are low, from saving money on loans and credit card balances to seeking out income-generating investment and savings vehicles.

  • Low interest rates impact finances in different ways: good for borrowers, tough on savers and income investors.
  • Ways to take advantage of low interest rates include refinancing loans, selling bonds, and buying property.
  •  CDs, corporate bonds, and REITs offer the best investment income options when interest rates are low. 
  • Visit Business Insider’s Investing Reference library for more stories.

Interest rates have been at historic lows for years…and they just keep falling. In the US, the federal funds rate – the benchmark on which other rates are based – is near 0% in 2021, and the Federal Reserve has declared that it plans to keep it there until at least 2023. 

Why are interest rates so low? The Fed adjusts interest rates as part of its mandate to oversee the nation’s money supply, the amount of cash and easily obtainable funds circulating throughout the US. Reducing interest rates is part of what’s called an expansionary monetary policy, and the Fed does it to combat economic slowdowns or recessions, which mean business cutbacks and closures, and job losses. 

The theory is that low interest rates stimulate the economy, encouraging companies and consumers to borrow, spend, and expand. For example, in the wake of the Great Recession, the Fed lowered the federal funds rate in 2008, and it stayed near zero until 2015. 

The Fed is currently depressing interest rates to keep the economy pumping despite the dragging effect of the ongoing COVID-19 pandemic.

But what do low interest rates mean for your personal balance sheet – your investments, savings, and debts? The answer is mixed: Favorable in some ways, unfavorable in others. But overall, you can take action to take advantage of the situation.

Here’s what you need to know to make the most of low interest rates. 

How do low interest rates impact your finances?

For bank account-holders, bad news: Falling interest rates typically mean lower returns on their savings. Whether the money is stashed in a savings account, a checking account, or a money market account, the interest earned on it will decrease.

Borrowers, on the other hand, might get some relief. Folks who are paying off debt whose interest fluctuates, such as a credit card balance or a variable-rate loan, will likely see a decrease in their annual percentage rate (APR). It won’t affect their overall balance – the amount they owe – but it will result in smaller interest charges. 

Consumers who are in the market to finance a major purchase, such as a car or home, will have access to loans with more favorable rates.

As for investors, it depends on what they’re invested in. Broadly speaking, though, low interest rates are good for people who have money in the stock market. When interest rates are low, consumers have more money to spend and banks are lending more. Companies generate more revenue and are able to take out loans that can help them expand – which can cause their stock share prices to rise. 

How to benefit from low interest rates

There are several key moves you to make when interest rates are low or falling – to take advantage of “money being cheaper,” as the financial pros like to say. 

Low interest rates strategies for borrowers

  • Refinance your loans: If you have a mortgage or student loans, consider refinancing- that is, paying off your old loan by taking out a new one. This new one will have a lower interest rate, of course; ideally, it should also be a fixed-rate loan, to lock in that lower rate. You’ll need to have good credit to qualify, but if you do, you stand to save a lot of money on interest fees.
  • Consolidate your debt: If you’re juggling multiple credit card balances or personal loans, taking out a debt consolidation loan can help you get all your liabilities under control. Debt consolidation loans by combining them into one big debt – and one monthly payment. This might make repayments more manageable, particularly if you can take advantage of a lower interest rate.
  • Transfer credit card debt: Use low interest rates as an opportunity to pay off your credit card debt faster by doing a balance transfer to a credit card with a lower interest rate. You can consider a low interest credit card with a favorable ongoing interest rate or a balance transfer credit card. The latter typically offer a 0% introductory APR on balance transfers for anywhere from 12 to 21 months, so you only want to go with that option if you can pay off your balance fairly quickly – or at least, within that time frame.

Low interest rates strategies for investors

  • Buy property: If you’ve been thinking about buying a home, there’s no better time to take out a home loan than when interest rates are at historic lows. Even if you already have a house, you might want to consider investing in a second home or other property if you can lock in a good mortgage rate.
  • Use the interest savings: If you’ve got a mortgage or a car loan whose interest rate has gotten extremely low, don’t pay it off. Instead, put the extra “income” – the difference in the interest amount you’re charged on your loan – into investments. You could boost the amount you contribute to your 401(k) plan, for example. 
  • Sell bonds: Bond prices tend to go up when interest rates are low. If newly issued bonds are paying lower interest, older bonds with higher yields become more desirable. So, if you don’t need the income from your bonds, seize the chance to sell them at a profit, or “above par” as the investment pros say. 

What should you invest in when interest rates are low?

Income-oriented investors will probably find that a low-rate environment isn’t ideal, particularly if they are seeking fixed-income or fixed-interest investments. However, there are still some options when interest rates tumble. Among the better ones:

  • High-yield savings accounts: When interest rates plummet, a high-yield savings account will at least offer better returns than what you’ll get with a basic savings account at most traditional banks. While this won’t be enough to help you build wealth, it’s better than watching your savings get devalued by inflation.
  • Certificates of deposit (CDs): If you can snag a decent rate before interest rates hit rock bottom, locking it in with a CD will help your savings maintain their value against inflation. Just keep in mind that CDs tie up your funds for a certain amount of time – the higher the interest rate, the longer the period, generally – and withdrawing your money early usually results in a penalty.
  • Corporate bonds and municipal bonds: Bonds appeal to fixed-income investors because of their low volatility, and they tend to offer better yields than savings accounts and CDs. Corporate bonds – debt issued by companies – pay more interest than US government bonds (called Treasuries), admittedly at slightly higher risk, though they’re still relatively safe. Municipal bonds, which are issued by cities, counties, and states, also offer higher yields as well as some tax advantages: The interest they pay isn’t subject to federal or state taxes.
  • Real estate investment trusts (REITs): When interest rates are on the decline, REITs – publicly traded funds that own and operate commercial properties – can prove a smart investment. Low interest rates benefit real estate. If REITs borrow at lower interest rates, they can expand construction, take on more projects, refinance their current loans – all of which improves their performance, and the earnings they share with investors.

The financial takeaway

Low interest rates might not be great for savers, but they’re great for anyone paying off debt. They can also be beneficial if you’re looking to borrow, especially for major purchases like buying a house. 

As for investors, it’s a mixed bag. Interest rates near zero might not be ideal for those dependent on investment income, especially if they want low-risk vehicles that pay a steady return. But there are still plenty of ways to invest in a low-rate environment that can help you at least maintain your wealth. And some investments, such as real estate and bonds, might post better returns, or be sold for a profit.

Related Coverage in Investing:

Where to invest when interest rates are low – 6 fixed-rate vehicles that offer the best returns

REITs are a way to own real estate without becoming a landlord – here’s how they work and ways to invest

How to invest in dividend stocks, a low-risk source of investment income

Fixed-income investing is a strategy that focuses on low-risk investments paying a reliable return

The federal funds rate is an interest rate set by the US’ biggest bank – and it influences everything from CD earnings to the national economy

Read the original article on Business Insider

A bitcoin IRA lets you profit from the cryptocurrency’s potential gains in a tax-advantaged way

bitcoin
You can invest in bitcoin via an IRA. But it has to be a certain type, called a self-directed IRA, which is held by special custodians and comes with extra responsibilities for investors.

Not a day goes by without bitcoin being in the news. And given the cryptocurrency’s phenomenal price rise, from zero to approximately $32,000 in a little over a decade, you – like many other individual investors – may be tempted to buy in. But how?

Actually, you can invest in finance’s newest asset via one of its most familiar vehicles: the IRA. Yes, you can buy bitcoin for a good old individual retirement account.

Cue the excitement? Maybe. In many ways, bitcoin investments are well-suited to an IRA. But, as with any investment strategy, there are pros and cons to consider. 

What is a bitcoin IRA? 

Bitcoin is a type of cryptocurrency (sometimes called a digital or virtual currency) – the oldest, and most popular of the dozen varieties available for trading and investment. So a bitcoin IRA is a type of investment retirement account that includes bitcoin within its portfolio. 

Although these accounts may carry the name “bitcoin,” they also allow you to invest in other cryptocurrencies, like ethereum, litecoin, and bitcoin cash. 

You can’t put bitcoin into a pre-existing, regular IRA that holds your stocks, bonds, ETFs, or mutual funds. Instead, you have to set up a special one, technically known as a self-directed IRA (SDIRA). The reason: The Internal Revenue Service (IRS) deems cryptocurrencies like bitcoin a type of property, which is off-limits to regular IRAs. 

“A self-directed IRA has a little bit looser IRS rules, so you can hold things like property,” or other alternative investments, confirms Victoria Bogner, a certified financial planner and chief executive officer of McDaniel Knutson.

How bitcoin IRAs work

In some ways, bitcoin IRAs work like regular IRAs. While you can set one up with any amount of funds, they have annual contribution limits set by the IRS: You can only contribute $6,000 a year for 2020 and 2021 (or $7,000 a year if you’re age 50 or older). Any returns, income, or gains generated by the investments within them grow tax-free.

You can also establish a bitcoin IRA as either a traditional account (for which contributions are tax-deductible, and funds taxed upon withdrawal) or a Roth account (no tax break on contributions, but distributions are tax-free). 

Of the two, the Roth version might have an edge, says Bogner, especially “if you are of the mindset that Bitcoin is going to explode” in price in the future. Roth IRAs are preferred by investors who project they’ll be in a higher tax bracket when they retire and start withdrawing money from the account. Since the Roth is funded with after-tax dollars, they won’t owe anything on their bitcoin gains – even if the currency has gone up 10 or 20 times. 

How to buy bitcoin in your IRA

Bitcoin IRAs do operate differently in a few ways, though.

As the “self-directed” implies, these IRAs are directly managed by the account holder (as opposed to a financial advisor or money manager). And your regular brokerage, bank, or investment app probably doesn’t handle them. Self-directed IRAs are only available through firms that specialize in the type of asset you’re interested in. 

So, to open a bitcoin IRA, you’d work with special custodians that can hold and deal in cryptocurrency. Some custodians require an application, walking you through the process. If you move forward, you can then fund these accounts via a rollover of funds from an existing IRA or another tax-advantaged account, or contribute new funds. 

Some of the better-known, well-established custodians for bitcoin IRAs include:

This is still a young field, and information on a firm may be hard to come by. Frankly, some are little more than sales platforms. So, no matter which custodian you’re considering, be sure to do your due diligence on it. 

Visit its website or call its customer service line to confirm and compare its fee structure, operations. Ask how your bitcoins will be stored, exactly, and about security procedures and measures – you don’t want your account holdings vulnerable to hackers. 

Why invest in a bitcoin IRA? 

There are plenty of positives to consider with bitcoin IRAs. 

  • Portfolio diversification. Bitcoin tends to be “a great diversifier” for your financial assets, Bogner explains. Holding a bit of bitcoin “can be a good way to own something that doesn’t move exactly like the rest of your investments move,” she says. It could also be a hedge against inflation as the dollar’s value against some other currencies has declined.
  • The potential for great gains. While there have been bitcoin drops, there also have been returns that outpace other markets. If its history weren’t enough, the fact that only a limited number of bitcoins (21 million) can ever be mined suggests great future promise. 
  • Positioning for a long-term hold. Though bitcoin fluctuates in price, it has generally trended up since its inception in 2009. Given its volatility, individual investors should consider it a long-term hold. That means it may be a good fit for an account that you don’t plan to access until retirement, anyway. 
  • Demonstrated tax savings. The IRS taxes Bitcoin as an investment – it’s subject to a capital gains tax when you sell it at a profit. But not if it’s held in your IRA. That gain is tax-shielded, as any transactions within an IRA are. You only pay taxes on funds that you withdraw, when you withdraw them – in a traditional IRA; and never if in a Roth IRA (if you obey the rules).

Are bitcoin IRAs safe?

No investment is without risk. Potential issues also exist with bitcoin IRAs. 

  • Volatility. Cryptocurrencies, including bitcoin, can have wide-ranging and sudden price fluctuations. This could be a problem if a decline hits about the time you were planning on withdrawing funds. If you don’t have the time to wait for market corrections, this kind of account may not be a fit for you. 
  • Higher fees. Bitcoin accounts can cost more to maintain or set up than other IRAs. For instance, a bitcoin account can reportedly have an initial buy-in fee of 10% or more, depending on the type and the custodian. Establishing a $50,000 self-directed IRA account can cost as much as $660 in annual charges, a Coinnotes article noted. And there can be wallet holding fees, transfer fees, and dues. All these fees can add up, eating into your returns. 
  • Investment minimums. Bitcoin IRAS can have investment minimums, some considerably high (again, compared to regular IRAs). For instance, BitcoinIRA currently has a $3,000 minimum; BitIRA currently has a $20,000 minimum. 
  • Responsibilities. While they’re called custodians, firms that offer self-directed IRA services – especially in the relatively young bitcoin IRA space – are not necessarily as responsible as conventional brokerages, registered investment advisors, and other financial services firms are. They are not overseen by regulatory agencies like FINRA, they are not SIPC-insured (reimbursing your funds if the firm goes under) and they are not bound by fiduciary rules that demand they put your interests first. In short, with bitcoin IRAs – as with any self-directed IRA – you’re solely responsible for making the decisions and taking on the risks of investing.

The financial takeaway

Bitcoin IRAs can offer an opportunity for investors who believe in the crypto’s future, but who want some tax savings along with their gains. Plus, the ease of dealing with a familiar type of account.

But there can be higher fees and account minimums when compared to other IRAs, so determine whether the trade-off is appropriate for you. Bear in mind that there are other ways to hold bitcoin, in regular accounts on crypto trading platforms like Coinbase and Binance US.

If you decide to open a bitcoin IRA, choose a custodian carefully. And only commit to bitcoin an amount that you can afford to lose, and think long term. Says Bogner: “Twenty years later, hopefully it’s worth more than what you put in.” 

Related Coverage in Investing:

How to invest in bitcoin: The major ways to buy, their pros and cons, and the strategies to consider

Cryptocurrency is an electronic, private type of money – here’s how it works and how you can invest in it

What is Bitcoin? A beginner’s guide to the world’s most popular type of cryptocurrency, and tips for investing in it

What is diversification? A portfolio strategy that uses a variety of investments to limit risk

Alternative investments are exotic assets that can diversify your portfolio – here are the five major kinds and everything you should know about them

Read the original article on Business Insider