If you want to walk the walk in the world of investing, it helps to be able to talk the talk.
When you make money by selling a capital asset, your profit is known as a capital gain. For example, say you buy 100 shares of stock at $20 a share and then sell at $22 a share. You’d have a capital gain of $2 a share, for an overall gain of $200.
If you’ve owned the asset for less than a year when you sell it, you have a short-term capital gain. If it’s been longer than a year, it’s a long-term capital gain. The good thing about holding on to stock until your capital gains become long term is that they’re taxed at a much lower rate than other income—only 15% if your marginal tax rate is 25% to 35%, and at 0% if it’s 15% or lower. That means investing for the long run can be tax-savvy as well as just plain smart.
If you lose money on an investment, you have a capital loss. You can subtract these losses from your gains before figuring the tax you owe.
Indexes track changes in a specific financial market or markets, usually expressing these changes as percentages of a total point value. Each index tracks its market or markets from a different starting point. This, and the fact that indexes include different investments from within the same market, are among the reasons why each index reports different results for the same time period.
Index funds allow you to invest in the performance of a major stock or bond index. Since these mutual funds invest in the securities included in the index, they go up and down in value along with the index. Investing in an index fund can be a smart move in a bull market, since the index’s rising prices will raise the fund’s value. But during an economic downturn, a more actively managed fund might be able to seek out good opportunities that an index fund would miss—or avoid the dogs that an index has to include.
But over time, index funds tracking the S&P 500 have consistently outperformed actively managed funds investing in large-cap stocks.
The dividends you earn on most US stocks and some international stocks are considered qualified, and are taxed at the same federal rate as your long-term capital gains, or a maximum of 15% for most investors. That’s not the case with interest income, dividends paid on real estate investment trusts (REITs), or collectibles.
That may be an incentive to include stocks and stock funds in your taxable investment portfolios as well as in your tax deferred accounts. Withdrawals from taxdeferred accounts are taxed at your regular income tax rate.
Not all profitable companies pay dividends, though, preferring to reinvest in the company, make acquisitions, or buy back shares.
When you’re investing for growth, calculating an investment’s total return is the best way to judge how well it’s doing. To find return, add an investment’s change in value to any earnings it provides. For example, if you bought $2,000 worth of stock that’s now worth $2,150, and it paid you $50 in dividends, your total return would be $200 ($150 + $50).
To help compare return on investments of different sizes, you can figure the percent return, which is the return divided by the original price of the investment. So in the example above, your percent return would be 10%, or $200 ÷ $2,000.
If you want to measure what you’re actually making on an investment, find its yield. Yield is an investment’s dividends or interest payments divided by the original amount you invested. So if you earned $50 a year on a $1,000 bond, your yield would be 5% ($50 ÷ $1,000). Similarly, you find current yield by dividing your annual income from the investment by its current market price.
Yield can be a good way to evaluate an income-bearing investment like a bond or money market fund. But for other types of investments, it doesn’t provide as complete a picture as total return does.
If your image of investing is a rollercoaster ride of big gains and equally big losses in rapid, heart-stopping succession, you’re mistaking one tiny segment of the investing community for all investors. In fact, there are almost as many approaches to investing—sometimes called investment styles—as there are people who invest.
In broad terms, investors are generally described as conservative, moderate, or aggressive.
Conservative investors are primarily concerned with safeguarding the assets they already have. While they may choose some investments they expect to grow in value, they try to minimize the chance of losing any principal, or the amount they’ve invested.
Moderate investors seek growth and some income from a substantial portion of their portfolio, while investing a smaller percentage to protect their principal and a smaller percentage still on speculative investments.
Aggressive investors concentrate on investments with the potential for significant growth provided by highrisk investments, although they run a greater chance of losing some or all of their principal.
Your approach to investing may be a combination of these three styles. For example, you might invest some of your portfolio conservatively, most of it moderately, and a small portion aggressively. That combination is sometimes described as an investment pyramid—a base of safety, a main structure of moderation, and a cap of risk.