Dollar Cost Averaging – Everything You Need To Know

Posted on by Ryan

As an investor, you want to get the most for your money. You want to get the highest return and pay the least for your investments. This ensures that you get the most for your money.

What is dollar cost averaging?

If you want to make the most money, dollar cost averaging is the way to go. Dollar cost averaging is a very simple principle. You buy stock on a regular basis paying the same amount each time. For example, you invest $500 every month into the stock market. One month you might buy 50 shares, another you might buy 60.

By doing this, you are buying more shares when the price is lower and less when it’s higher. For example, let’s say you put $500 into the same company each month. In month one, the price is $10 per share, so you buy 50 shares. In month two, the price is $9 per share, so you buy approximately 56 shares, 6 shares more than before.

In month three, the price goes down to $9 per share, so you are able to purchase approximately 63 shares. Then in month 4, the price moves up to $11 dollars per share and you purchase approximately 45 shares. Finally, in month 5, the price is $13 per share and you are able to purchase 38 shares.

What have you gained from dollar cost averaging?

By the end of the four months, you have purchased 251 shares for $2,000. At $13 per share, it is worth $3,263. If you had spent all the $2,000 in month one, you would have only been able to have 200 shares now worth $2,600.

Even if you spent all the shares in the third month, you would end up with about the same amount of shares. The reason this works so well is because you are spreading out your risk. When investing, you should always buy low and sell high, but you never really know when it will be at the all-time low or high.

A Good Habit

Investing regularly is not only good to get the benefits of dollar cost averaging, but you can also reap the benefits of continuous the investing. If you only invest sporadically when you can, you are likely to invest less. Investing less means fewer capital gains and less interest earned.

Mutual Funds Vs Stocks (Equities)

Posted on by Ryan

Understanding mutual funds vs stocks and the benefits of each will help increase your basic investment knowledge, while better preparing you to make an informed decision on which investment is right for you. So what do they have in common? You might be thinking “They both have to do with owning a company, right?”. A better question to ask is, “what is the better about one than the other?”

Both of these investments are meant to make you money, and which one is better depends on what you are looking for.

Do you enjoy researching and following the ups and downs of the market?

You may find yourself leaning towards investing in stocks. When you invest in stocks, you are investing in just one company at a time.

You decide which companies you’re going to buy. You decide when you’re going to buy them. You decide how many shares you are going to buy.

When investing directly in stocks, you are in control. The problem is, you may feel inexperienced and unsure about your choices. Maybe if you’ve been investing longer you would have known not to put $1,000 into that company that lost you so much?

When investing in stocks, that is not the way to look at it. Yes, researching and knowing a little bit about the company, both in the past and present, might help and is completely necessary, but you have just as much of a chance to gain a lot from an investment as an experienced investor. Besides, everyone starts somewhere, and it’s best to learn from your own mistakes.

Do you want to invest but worry about the risks?

When you invest in mutual funds, you are investing in several companies at once. A money manager of the mutual fund you chose is deciding which companies to buy, when to buy them, and how many shares.

It’s important to remember that just because you are investing in a mutual fund doesn’t mean there is no possible way you could lose money. There are risks just as when you invest in stocks directly yourself.

There is less effort on your end with mutual funds, but there are other perks, too. You are able to obtain a large amount of diversification that you may not have been able to get with only your money. You’re pooling all your money with other investors and the money manager is able to stretch your money farther.

Either way, you’re making money

And either way, you could lose money. However you choose to invest, stocks, mutual funds, bonds, etc. just remember the risks you are taking. In one instance, you may be doing more work yourself, but in either instance, you are not guaranteed anything.

Stock Market Definition – Investing 101

Posted on by Ryan

The stock market. It sounds like a simple concept. It’s a market for stocks. You go to the stock market and buy stocks just like you go to the supermarket and buy food, right?

You can browse stocks like you browse through chips down the snack isle, but what you choose to buy and how you buy them is very different. Instead of choosing what you like best in a few seconds, it takes a lot more careful thinking and instead of jumping on line at the cash register, well, that’s just entirely different.

Here are the basics of the stock market.

1. What are stocks?

When a corporation wants to expand or needs to raise money for their company, they may decide to sell stock. A stock signifies ownership in the company. When an investor buys a share of stock they are called a shareholder and become a part owner of that company.

Yes, that means if you own a share of Disney, you are a part owner of the company. With one share, you don’t get much say in anything, but you can vote at the annual shareholder meetings.

When you invest in a company, you may get a stock certificate. The stock certificate is a written indications or proof that you own part of the company. Most brokerages will keep the stock certificates with them. This is a good thing so you don’t have to worry about losing or damaging them.

If you want to own a purchase shares of a company, you will need a brokerage firm to facilitate the transaction. They are good gift ideas. You can buy one share of many different companies that they offer and the certificate is dressed up and looks very fancy. You can buy them framed as well.

2. Stock Exchange

The three major stock exchanges are the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the National Association of Securities Dealers Automated Quotations System (NASDAQ). A stock exchange is a place where stocks and other securities are bought and sold.

3. Buy and Hold vs. Trading

There are two different common ways to buy and sell stock. Long term investors often use the buy and hold method. This is pretty self explanatory. You buy a certain amount of stocks and you keep them long term. Usually this means you don’t sell them for at least 1 to 5 years.

With trading, you buy a sell very often. Sometimes you may buy and sell the same stock in one day. The point is you are trying to get the short term gains. I wouldn’t recommend this method, especially if you are trying out. If you are a trader, you would need a certain brokerage that caters to it.

Some say that the gains made through trading over the long term aren’t any higher than the gains from a well diversified buy and hold portfolio.

4. Diversify

It is very important that when you have a portfolio it be well diversified. A diversified portfolio means that you don’t have all your eggs in one basket. You must have a wide variety of companies in order to minimize risk.

If you have $10,000 all in one company and the company loses 20% for the year, you have a total loss of 20%. If you hade $10,000 divided between 5 companies evenly, $2,000 each, and the same company goes down 20%, but the rest go up 10%, you will gain 20% in the end. Basically, if you have several different companies in different industries and one goes down, the ideal effect is that an increase in another will help balance it out and relieve some of the burden.

Of course, ideally you will want all of the companies to go up, but it’s impossible to predict, so you might as well reduce the risk.

5. Stock Symbol

The Stock symbol is a short symbol used on the stock exchange to symbolize each company. For example, the stock symbol for Johnson & Johnson is JNJ.

6. Fundamental Analysis

Fundamental analysis is used to analyze stocks. You wouldn’t go out and buy just any old car without knowing anything about it and you shouldn’t go out and buy any old stock without knowing anything about it.

With this type of analysis you would examine the company. A great way to start is by finding a company through certain criteria at an online stock researcher such as at MSN money’s stock screener. You type in what you want such as the industry, market cap, dividend yield, and P/E ratio.

Do you have no idea what I am talking about? A great book to read and find out more about researching stock you should read The five rules for successful stock investing. They will go into all the details about analyzing stocks.

Here is just a basic background about investing in stock market.

Why Do We Pay Taxes?

Posted on by Ryan

When April 15^th comes you have to file a tax return and pay taxes. But why do we pay taxes? Is it because you’re “supposed to,” or because most everyone else does? Is it because of tradition, or social convention? Do you pay taxes out of patriotic duty, or even as a practical matter, knowing the government has to have money to function? Or do you file a tax return because of the IRS, for fear of the consequences of what they might do if you don’t? While some, none, or all of these reasons may come into play for you, what I want to focus on is helping you to understand the legal basis upon which the government of the United States (through the IRS) compels Americans to file Federal income tax returns and pay taxes.

How the Internal Revenue Code became the law of the land

Prior to 1776, the King of England was the supreme sovereign authority over the 13 Colonies. This included authority in matters of taxation. So if the king said there was a tax on tea (or whatever), there was a tax on tea.

In 1776 representatives of the 13 Colonies signed the Declaration of Independence, setting forth the rational, legal, and moral basis for America to sever the ties of British authority, including the right of the British to tax the American colonies. The 13 Colonies fought and won the Revolutionary War in order to preserve that newfound freedom and independence.

Recognizing the need for a governing body “to promote the general Welfare,” in 1789 the 13 Colonies ratified the United States Constitution “in Order to form a more perfect Union.” At that time, the Constitution became the supreme law of the land.[1]

As prescribed by the Constitution, Congress became the lawmaking branch of the United States government. In accordance with this authority, Congress has the power to pass legislation which, when signed by the President (and not overturned by the Supreme Court), becomes the law of the land.

Over time the laws of the United States have been organized into what is known as the U.S. Code. The U.S. Code is further organized into Titles covering specific areas of law.

In 1913 the 16^th Amendment of the United States Constitution was ratified. It states, “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived… (italics added).”

In accordance with the authority granted to it by the Constitution, Congress created Title 26 of the U.S. Code, which is also known as the Internal Revenue Code. The Internal Revenue Code contains the tax laws of the United States.

The Internal Revenue Code requires U.S. citizens and residents to pay taxes

Now that it’s been established that the Internal Revenue Code (or “IRC”) is the law of the land, where does it say in the Code that people have to file income tax returns and pay taxes?

Congress didn’t beat around the bush answering that question. At the very beginning of the Code, IRC Section 1 states, “There is hereby imposed on the taxable income of [single and married persons]…a taxdetermined in accordance with the following table[s] (italics added).” Tables are then laid out in the Internal Revenue Code showing the tax you owe on your taxable income based on your filing status (single, married filing joint, head of household, etc.).

If your tax is based on “taxable income,” how is that defined according to the Code? IRC 63 states, “…the term ‘taxable income’ means gross income minus [allowable deductions].”

And what’s “gross income?” You’re going to love this. According to IRC 61, “…gross income means allincome from whatever source derived…” And what exactly does that mean? It means that unless the Internal Revenue Code itself provides an exception, the income of all people everywhere is subject to taxation in the United States, and all people, whether married or single, foreign or domestic, on Earth or living in outer space, owe tax on their “taxable income.”

Wow! Asserting tax jurisdiction over everyone everywhere…that’s bold! But how can that be? Did the United States Congress really throw down the gauntlet and declare tax warfare on the rest of the world and you just missed it? Not quite. Without getting into mind-numbing detail, I’ll just say that according to IRC 871 it turns out that nonresident aliens are only taxable in the U.S. to the extent that they have meaningful business, employment, or investment connections to the United States. While that’s good news for foreigners, the flip side is that all of following categories of people are required to pay taxes on their “taxable income.[2]”

United States citizens who live anywhere in the world (or anywhere in the known universe for that matter).
Green card holders (otherwise known as “lawful permanent residents”) who live anywhere in the world.[3]
Non-U.S. citizens who are “effectively connected” to the United States for tax purposes.

The Internal Revenue Code requires you to file tax returns

Okay, you’ve now come to the realization that you legally have to pay taxes. So how much do you owe? And how do you determine how much tax you owe? You do that by filling out the applicable tax return, which for most individuals is Form 1040, “U.S. Individual Income Tax Return.” [4]

As intimidating and confusing as a 1040 can be, it’s actually far better than the alternative, which would be to read through the Internal Revenue Code and manually determine what you owe in taxes with pen and paper or a spreadsheet. Said another way, Form 1040 is designed to provide you with an organized framework to calculate your income tax obligations in accordance with the laws of the Internal Revenue Code.

But let’s just say for argument’s sake that you don’t feel like filling out a 1040, or any other IRS-published income tax form. Can you just calculate your tax by hand, send a check to the U.S. Treasury and be done with it? The answer is no. IRC Section 6011 states, “…any person made liable for any [income taxes]…shall make a return or statement according to the forms and regulations prescribed by the Secretary [of the Treasury] (italics added).” And what are the prescribed forms? It’s those developed and published by the Internal Revenue Service, the division of the U.S. Treasury charged with administering and enforcing the revenue laws of the United States.

There are no exceptions to paying taxes if you have enough income

After reading all of this you might say, “But wait, you probably didn’t realize there’s an exception to paying Federal taxes for me because I’m…” You’re what? A senior? A child or a student? A descendent of an enslaved, oppressed, or persecuted people? A member of a certain religion? That you’re opposed to the current President or other elected officials? That you’re against some aspect of U.S. foreign policy? Or perhaps you’ve been led to believe that you’re exempt from Federal income taxes based on some kind of intellectual, pseudo-legal, wacko argument that you found on the Internet? Despite all of the myths, misinformation, and clever scams out there, none of these are exceptions to filing income tax returns and paying taxes. In short, all Americans whose income exceeds a certain threshold are subject income taxes…period.

Follow the law…or face the consequences

Here’s what it all boils down to.

The United States Constitution is the supreme law of the land.
The Constitution grants Congress the power to tax income.
The Internal Revenue Code contains the tax laws of the United States.
According to the law, United States citizens, green card holders, and certain foreigners have to pay taxes on their taxable income.
Taxes have to be calculated on official government (IRS) forms.

That said, the government realizes that regular people often have a hard time understanding and applying the tax laws, and they will generally work with you if you’re making an honest effort to meet your income tax obligations. But if you try to avoid paying taxes through the use flimsy or impassioned arguments that have no basis in the law, you’re going suffer some serious pain when the IRS brings your fantasy world comes crashing down on you because, like it or not, agree with it or not, or want it or not, the Internal Revenue Code is the law of the land.

[1] Quotes are from the preamble to the United States Constitution. The Constitution can be referenced at http://www.ushistory.org/documents/constitution.htm

[2] A “nonresident alien” is essentially a foreigner who does not reside in the United States. For a more formal definition see IRC 7701(b) and related references.

[3] Why would green card holders be subject to U.S. tax if they don’t even live in the States? It’s because they have the right to live and work in the U.S. anytime they want, and for that privilege the United States requires that they pay taxes.

[4] If you meet the qualifications, you can instead file a Form 1040A or a 1040EZ. In theory your tax will come out just the same as if you had filed a full-blown 1040, but these forms are designed to be shorter and easier to complete.

How Health Insurance Premiums Affect Your Paycheck and Save Taxes

Posted on by Ryan

If you have elected family health coverage through your employer and your premiums are $350 a month then it would be easy to think that the net effect on your paycheck would be $350 a month.[1] However, there is more to it than that, and to fully understand your paycheck you need to know the positive effects that your heath insurance premium payments have on your payroll-related calculations.

Health insurance premium contributions reduce your FICA (or payroll) taxes

If your employer deducts your health insurance premiums directly from your paycheck (as opposed to you writing a check to pay for health insurance) then it saves you taxes by lowering your FICA wage base. Note that Social Security and Medicare taxes combined together are known as “FICA” or “payroll” taxes. A comprehensive example of how to calculate your taxable FICA wages, as well as how health insurance premiums fit into that. However, just focusing on health insurance for now, here is an illustration of how your employee-sponsored health insurance premiums reduce your FICA taxes.[2]

What this example shows is, all things being equal, if your health insurance premiums are deducted from your paycheck then it will lower your taxable FICA wages by $350, and will result in a FICA tax savings of $19.77 a month (or $237.24 a year).

Health insurance premium contributions save you even more on income taxes

Following the principles above relating to FICA taxes, employer-sponsored health insurance contributions also result in substantial savings on your Federal and state income taxes, which is illustrated as follows.[3]

Based on these figures, being able to purchase health insurance through your employer would lower your income tax base by $350, and that would save you $73.50 a month (or $882.00 a year) in income taxes.

Summary

Having health insurance premiums deducted from your paycheck saves you a substantial amount in taxes. Why? Because it because it reduces your taxable wage base before FICA, Federal and state income taxes are applied. Based on the figures in the examples above, your combined FICA and income tax savings would be $93.28 a month ($19.78 plus $73.50) or $1,119.36 a year ($93.28 x 12 months).[4] That’s a substantial amount of money for a regular person! As a result, in evaluating your overall financial situation it’s very important to not only consider the availability of health insurance through your employer, but to take into account the tax-related benefits of health insurance contributions as well.

[1] The average annual cost of family health insurance premiums in 2010 was $13,770. Of that, employees had to cover approximately 27%, or $3,718. That averages out to be about $310 a month, which I have rounded up to $350 due to the higher cost of health insurance in many parts of the country. For reference, see http://ehbs.kff.org/?page=charts&id=1&sn=6&p=1 and http://www.consumerhealthratings.com/index.php?action=showSubCats&cat_id=179.

[2] The FICA tax rate of 5.65% is based on the 2011 Social Security tax rate of 4.2% plus the Medicare tax rate of 1.45%. As of this writing the 4.2% Social Security tax rate is slated to expire at the end of 2011 when it will go back to 6.2%, but it’s not yet clear whether the law will be extended, modified, or allowed to expire.

[3] The 21% tax rate assumes a 15% Federal tax rate and a 6% state tax rate.

[4] Looking at this another way, the net cost of your health insurance wasn’t $350, but $256.73 (the $350 premium less tax savings of $93.28).