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McLan Accounting’s Financial Guide

Financial planning is important for everyone whether you are just entering the workforce, or well into retirement. Unfortunately, it can also be quite difficult. This guide will help you to make smart decisions for today, and tomorrow. Each section provides an overview of important points and advice on a wide-range of different subjects. For specific advice tailored to your unique situation, please contact McLan Accounting to speak with a professional.

Thinking About Long-Term Financial Goals

Long-term financial goals are very important. The earlier you start thinking about them, the more options you will have available to you. Even a modest amount of money set aside from each paycheck can add up to a very comfortable retirement. No matter your age or situation, however, you can always start making some smart long-term financial decisions.

What are the Best Guidelines for Preparing for a Comfortable Retirement

The absolute best thing you can do to prepare for a comfortable retirement is to start as early as possible. Any investments you make in your 20’s, for example, will have a very long time to earn interest and compound over the years. In general, if you invest just 10% of your annual income each year, and start in your 20’s, you will have a comfortable retirement.

If you have already gone past your 20’s without starting to save for retirement, don’t worry, it isn’t too late. If you start in your 40’s, you’ll still have lots of time. It is likely best to try to put away about 20% of your income each year, however, in order to meet your retirement goals. If you’ve waited even later, you will want to start putting as much money as you can toward your retirement plan in order to catch up.

Things to Think About when Starting to Invest

There are many things that you will need to think about when starting to invest. Among the most important are as follows:

  • Risk vs. Return – All investments come with some risk. You want to decide how much risk you are willing to take since the higher the risk, the more potential for high returns you will have.
  • Asset Allocation – You need to decide what types of investments you want to make. Stocks, bonds, real estate, and many others are available.
  • Diversification – Spreading your investments around will help to not only mitigate risk, but also maximize reward.
  • Monitoring – Investments shouldn’t just be made and forgotten. You will want to follow them closely to help ensure they are performing as expected.

What Are the Risks to Investing

There are some very real risks associated with all types of investments, and it isn’t wise to ignore them. For example, if you buy stocks in a particular company, the risk is that the company will have trouble and the stock value will go down. In a worst-case scenario, the company could perform so poorly that they actually go out of business, in which case your investment is worthless.

Another risk is if your investments don’t make a strong enough return to beat out inflation. Inflation is typically around 2%, so you need to make sure your investments are making at least that much just to break even. Of course, much higher returns are desirable.

How to Avoid Unnecessary or Excessive Risk

While risk is always present when investing, there are things you can do to keep it as low as possible while still allowing for strong returns. The following are simple tips you can follow to minimize the unnecessary risks with investing:

  • Work with a Reputable Broker
  • Don’t Buy Investments from Solicitors
  • Don’t Put All Your Money in One Investment
  • Review All Monthly Statements for Accuracy
  • If it Sounds Too Good to be True, It Probably Is

Questions to Ask Before Investing in a Stock

Stocks are one of the most popular investment options available today. There are thousands of different companies that you can buy stock in, many of which will provide a great return on investment. Some questions you should ask before buying any particular stock include:

  • Is This Stock Too Risky for Me?
  • Do I Have Any Moral Conflict with This Business?
  • Is the Stock Registered with the SEC?
  • What Sort of Fees, if Any, Are Associated with This Stock?
  • How Liquid Is This Stock?
  • How Long Am I Comfortable Holding This Stock?

Considering Mutual Funds

Mutual funds are an excellent way to get the benefits of investing in the stock market while keeping your risks to a minimum. A mutual fund is a group of dozens, or even hundreds, of different stocks all purchased together. This way, if one of the company’s stock drops significantly, it won’t impact the total value of your investment very much. There are many mutual funds to choose from, so consider these points before picking one:

  • How Long has This Mutual Fund Been Around?
  • How Has it Performed Over the Past Five Years?
  • What Stocks are In This Fund?
  • Is This Fund Considered High Risk/High Reward?
  • Are There Any Fees Associated with This Fund?

Things to Avoid when Investing

When making investments for your future there are many mistakes to watch out for. The following are some things to keep in mind, and avoid, whenever possible:

  • Emotional Investments – Never invest based on a ‘feeling’ or emotion related to the investment.
  • Question Tips – Most people you ask about investments will have a hot tip that they want to give you. Unless then person is a professional investor who has had years of success, it is best to discard these tips.
  • Don’t Set and Forget – Never just make your investment and then let it sit for years at a time. Investments require active participation to get the best returns.
  • Adjust Over the Years – When you are young and have many years ahead of you before retirement, you will typically want higher risk/higher reward investments. As you approach retirement, however, you’re going to want to move the investments to something a little safer.

What are Derivatives?

Derivatives are a type of investment that offers a lot of benefits, but they are certainly not without risk. They get their value from a security that they are based on. For example, you can get mortgage backed derivatives that are based on the value of a large portfolio of mortgages. You can also get stock option derivatives, or any number of other options. While anyone can invest in these options, they are typically only used for those who graduate into a high net worth portfolio.

Cumulative vs. Annualized Returns

When looking at your portfolio, you’ll likely see two important numbers. Your cumulative return and your annualized return. The annualized return is how much your investments have made in the past year, while cumulative return is the amount your investments have made since you first started them.

What is the Rule of 72?

This is a simple calculation that allows you to estimate how long it will take for your investment to double in value. To figure this out you take your rate of yearly return on your investment and divide by 72. The result will be the number of years it will take for you to double your investment.

Why is Total Return Important?

The total return amount is how much money a specific fund makes after calculating in all reinvesting and dividends. This is going to get the most benefit from the years of compounding interest. This will also help you to gauge the actual return you are getting on your investment.

What is Yield?

When it comes to an investment, a yield is the amount that is paid out annually. This is typically shown as a percentage of the market price. It won’t take into account any appreciation. For investments like money market funds and CDs, the yield is typically going to be the same as the total return since the value doesn’t fluctuate significantly like stocks do.

What is an Annuity?

An annuity is a type of investment based on an insurance contract. The insurance company will take the money you invest into different stocks and bonds using tax deferred money. Once you turn 65, you will begin receiving payments that will vary based on the value of the securities underlying the investment. This investment helps to guarantee that you will receive payments until your death. This type of investment comes with charges and fees that can vary significantly based on the company you work with so make sure to shop around before choosing an annuity.

Types of Annuities

There are quite a few different types of annuities that you can invest in. Each of them offers different advantages and disadvantages. The types of annuities are as follows:

  • Single Premium Annuity – If you put your investment in all at once right up front.
  • Flexible Premium Annuity – This is where you put in your investment over the course of multiple payments.
  • Immediate Annuity – With this type of annuity the payments will begin immediately.
  • Fixed Annuity – With this type of annuity your principal is fixed and guaranteed for a set amount of time.
  • Variable annuity – You can invest in stocks, bonds, cash equivalents over time but your principal is not guaranteed.

How to Collect an Annuity

Deciding how and when to collect on an annuity is an important decision. There are quite a few different options. Each of these options has different pros and cons to be aware of. You’ll typically want to talk to your accountant before choosing one of these options:

  • Fixed Amount – With this option you will get a set amount each month until the annuity runs out.
  • Fixed Period – With this option you will get a payment for a set amount of time.
  • Lifetime or Straight Life – With this option you will receive a payment each month until you die. If you die young, however, there will be no payment to your beneficiary.
  • Life with Period Certain – With this option you will receive payments until you die, but if you die young, there will be a payment to your beneficiary.
  • Installment – With this option any excess funds that remain in your account after you die will go to your beneficiary.
  • Joint and Survivor – With this option the payments are made to joint annuitants, and in the event of one’s passing, the other party will keep receiving a payment each month, though it will be a lower amount.

How are Annuity Payments Taxed?

There are different tax rates based on whether the plan is qualified or non-qualified. Annuities can be tax-qualified, which qualifies as a retirement plan. With this type, the tax laws will be the same as tax deferred plans during the gestation period, and the earnings aren’t taxed until you start withdrawing funds. A non-qualified annuity, however, is purchased with after-tax dollars, which means that you will receive the benefit of tax deferred savings.

Things to Consider when Shopping for Annuities

When shopping for an annuity you will want to think about a number of important points that will have a big impact on the overall benefits from this investment. These things include:

  • Commissions – How much of a commission will your broker take? It will typically be between 3 and 8%.
  • The Company – Always make sure that you are buying an annuity from a trusted company that has a good track record and reputation.
  • Penalties – What penalties are associated with your annuity if you start taking payments early, need to withdraw money, or some other unexpected event.
  • Fees – What fees apply to your annuity? This could include maintenance fees, mortality fees, investment advisory fees, and others.

Investing in Bonds

Bonds are another investment option, and one that is typically considered a lower risk way to store your money. With lower risk, however, you can also expect a lower rate of return.

What is a Bond?

A bond is a type of investment where the borrower promises to repay a set amount of money over a set period of time. This is a very simple type of investment where you agree to let an entity use your money for some amount of time, and they will repay the full amount plus some amount of interest. Bonds are usually purchased from government entities at the local, state, or federal level or from companies.

Unlike buying stocks, you won’t own any amount of the company or agency when you hold a bond. There are no voting privileges, dividends, or other benefits. In many ways, a bond is similar to a savings account where you are paid interest on the amount invested. The difference, however, is that they last for at least a set amount of time. This extended length of time helps to allow a higher rate of return than you would receive from a savings account.

What Does Bond Quality Mean?

The bond quality is the rating that the issuing organization has received in terms of creditworthiness. This is how you would evaluate risk when purchasing bonds. While bonds are typically considered extremely safe, there is still risk. The higher the bond quality rating, the lower the risk. The ratings are put out by two organizations, Moody’s and Standard & Poor’s. They are as follows:

  • Highest Quality – AAA
  • Good Quality – AA
  • Medium Quality – BBB
  • Speculative Elements – BB
  • Speculative - B
  • More Speculative – CCC
  • Highly Speculative – CC
  • In Default – D
  • Not Rated – N

What is Maturity for Bonds?

One of the most important factors to look at when investing in bonds is the maturity time. The longer it takes for a bond to mature, the greater the return on investment. A five year bond will provide a lower return on investment than a 20 year bond, for example. Of course, you will have longer to wait to receive your money back with a 20 year bond, and there is a longer period of time over which problems could arise, so there is more risk.

Understanding Taxes on Mutual Funds

Mutual funds are one of the most popular types of investments, and with good reason. They are a great way to purchase stocks with a lower level of risk while still providing great returns. Learning about how mutual funds are taxed will help you to understand this investment so you can get the returns you need.

How are Mutual Funds Taxed

Any distributions from mutual funds need to be reported as income. This applies whether the money is distributed to you to spend or reinvested back into the fund. Taxable distributions can occur in two different ways. Capital gains or ordinary dividends. Capital gains are the total gains from the sales of securities within a fund and will be taxed differently than normal dividends. Ordinary dividends are the net earnings of a fund, and are paid out on a regular schedule to shareholders.

There are times when mutual funds will distribute funds back to shareholders. This is considered a non-taxable distribution since the money was taxed when it was put in, and there weren’t any gains.

Understanding Stocks

When you buy a stock you are actually buying a small portion of a company. All stockholders in a company share the ownership of that business. If you were able to accumulate 51% of a company’s stock, you would have controlling interest in that business. Of course, there are so many shares of stock for each company, and the majority of them are held by either an individual or the company itself, that the average investor can’t get to 51%.

How to Trade Stocks

You can buy and sell stocks through any exchange. There are hundreds to choose from, many of which will be run by investment firms. You can either buy and sell them on your own, or you can have a financial advisor manage these types of investments on your behalf.

Common Stock vs Preferred Stock

Most of the time when you are buying stocks, you are buying common stock. The other type, known as preferred stocks, will provide certain advantages to the holder. Preferred stockholders usually don’t have the same voting rights, but will enjoy greater dividends. Preferred stocks are also going to have a set dividend, compared to common stocks that have a dividend based on the performance of the company.

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