With artificially intelligent technology on the rise across industries, learning about investing in AI is top-of-mind for many Americans. As people observe the rapid growth of innovative companies utilizing AI tech, there’s been a natural spike in interest around AI investing. Predictions that the AI market size will be worth $390.9 billion by 2025 motivates people to understand more about this business sector.
From machine learning to pattern recognition and predictive modeling, it’s not easy to keep up with different subsets of artificial intelligence and how they’re impacting businesses. Since AI is such a broad category of technology, sometimes it’s overwhelming to even understand the basics. When you’re considering investing in an AI-driven company, it’s crucial to learn as much as possible about these types of investments. If you’re curious about delving more into the topic of AI investing, check out our guide.
This guide will cover:
What Is AI Investing?
Artificial intelligence (AI) is a series of programs and algorithms that mimic human intelligence to efficiently perform tasks usually completed by humans. The term “artificial intelligence” was coined in 1956, so AI isn’t a new concept. However, the capabilities of AI have improved drastically over the past two decades, ushering in a new era of technological advancements.
AI touches almost every aspect of our lives. It’s hard not to notice the influence of AI technology, whether it’s at home with smart devices like Google Home and Amazon’s Alexa, or shopping online with chatbots that recognize our consumer behavior.
AI investing, or learning how to invest in the AI market, is spiking in popularity thanks to its rapid growth. As AI becomes more integral to various companies and industries, stocks across various industries are becoming more desirable to some investors.
However, even though research and development in this area are growing exponentially, people still need to be careful about placing bets on developing technology and tools. As with any type of investment, there will always be an element of risk involved when investing in AI.
Trends in AI Investing
With AI investing rapidly spreading across the globe, it’s no wonder that people are paying attention to its growth more than ever. Across various fields, there are over 400 use cases and applications for AI. Leaders in AI development include tech giants like Google, Microsoft, Amazon, and IBM. At the same time, startup funding for lesser-known AI disruptors has been steadily climbing as well.
What makes AI investing particularly interesting is its potential to be sustainably lucrative. Banks and financial services firms are building powerful AI strategies and utilizing the technology to streamline fraud detection, wealth management, underwriting, and more. In construction and manufacturing, AI can streamline products and experiences. AI also majorly impacts industries in healthcare, education, and safety.
Three main signs indicating AI investing trends are the following:
Factors to Consider Before Investing in AI
Before diving into the world of AI investing, it helps to consider both qualitative and quantitative factors. The ability to find quality investments based on market opportunities isn’t enough, because even solid, profitable companies can be a poor financial investment if the stock prices are too high for you. To position yourself to wisely purchase AI stocks with strong return potential, understand performance and valuation metrics.
Before you decide if an AI-driven company is worth your investment, you’ll probably want to take note of the following:
Research companies fully. Understand a company’s business plan and its track record for success so far. What are their guidelines and processes, where are their headquarters and manufacturing facilities, and what are their growth plans for the future?
Look for the company’s price-to-earnings ratio. Even if you feel strongly about investing in a company, don’t let those emotions cause you to give them the benefit of the doubt. When it comes to their financials, you need to understand the ins and outs. How much debt do they have? Are they currently profitable? Understand the current share price relative to its per-share earnings, too.
Figure out how much risk is involved. How can you tell how much risk is involved with one company’s stock compared to the rest of the market? You can start by determining a company’s beta, or measure of volatility in relation to the broader market, before investing any funds. Calculating a company’s beta isn’t difficult, and it can save you trouble in the long run.
Determine if the stock has a high enough dividend to be worth it. Investors can determine which stocks pay dividends by researching financial news websites. Don’t have false expectations — you shouldn’t expect a dividend from a startup.
Keep an eye on the company’s stock chart. Look for some of the most simple cues from stock charts to gauge price movement. Also, consider how the company would be affected by different economic factors and potential changes to the market it serves.
Companies Shaping the Future of AI Technology
Many of the companies providing AI technology through their cloud platforms are household names, like Google, Amazon, IBM, and Microsoft. However, there are still plenty of other companies in other sectors that are shaping the future of AI investing. Below are six of the AI-investing business leaders to keep an eye on. We are not in any way recommending that you invest in these companies, rather these are examples of the leaders in investing in AI.
1) Amazon. Amazon Web Services offers both consumer and business-oriented AI products and services and many of its professional AI services are built on consumer products. For example, the Amazon Echo brings artificial intelligence into the home through the AI bot, Alexa.
2) Alphabet. Google’s parent company Alphabet is deeply invested in furthering its AI capabilities, along with acquiring numerous AI startups in the last several years. In addition to using AI to improve its services, a number of AI and machine learning services are sold to businesses via the Google Cloud Platform.
3) IBM. IBM has always been a leader in AI innovation, but its efforts in recent years are around IBM Watson, including an AI-based cognitive service. IBM has been acquiring multiple AI startups over the years as it competes with other industry leaders in this space like Google.
4) Microsoft. Microsoft has a wide range of AI projects that can benefit both businesses and consumers. For example, Cortana, the digital assistant that comes with Windows, is designed for business clients. On its Azure Cloud Service, Microsoft sells AI services such as bot services, machine learning, and cognitive services.
5) Alibaba Cloud. Alibaba is the top cloud computing platform in Asia. It offers business clients a sophisticated Machine Learning Platform for AI, including an intuitive, user-friendly visual interface.
6) Salesforce. Salesforce developed Salesforce Einstein, their artificial intelligence service. Their latest initiative, which includes an extensive team of data scientists, uses machine learning to help employees streamline various tasks. It looks like this technology will also become more widely available in the near future.
Additional Resources
There are tons of helpful resources for decision-making about investing in AI. Regardless of how financially savvy you are, there’s always more to learn about how to invest in the most efficient way possible. Your financial portfolio should be as diverse and robust as possible to set you up for long-term success.
One of the best ways to start the process of educating yourself is by reading free insights from reputable technology and finance research publications. Try reading MarketWatch and Morningstar on a daily basis to keep track of the latest and most accurate company information. By analyzing a company’s financials with a critical eye before making investment decisions, you’ll protect your personal financial health.
We hope this piece could be a solid introduction to some of the concepts and trends that explain why AI has promising potential in the world of investing. AI investing presents various exciting possibilities for the future, but investors should still proceed with caution. When it comes to investing, always do your due diligence to avoid losing money. AI technology is seamlessly integrated into aspects of almost every industry. Focus on budgeting and consider investment decisions that are best for your long-term financial health.
You’ve got several factors to consider — ATM access, interest rates, monthly fees, minimum balances, mobile app reviews, and more.
Another factor to consider: bank promotions. These are cash bonuses you can earn when opening a new checking or savings account with a bank or credit union during the promotion window, meeting any specific criteria and keeping the account open at least long enough to earn the extra cash.
While a savings or checking bonus shouldn’t be your top reason to choose a bank, don’t rule it out entirely. After all, wouldn’t it be nice to fund your shiny new account with some extra cash?
Many banks offer such sign-up bonuses, but often, these bonuses aren’t advertised, meaning finding the best bank account bonuses can be tricky. That’s why we did some digging for you and found some hefty cash offers.
Best Bank Promotions of March 2021
We’ve researched the best cash bonuses available this month so you don’t have to. Below, you’ll find our favorite checking and savings account bonuses.
Keep an eye on what it takes to qualify, as well as any limitations. Direct deposit and minimum balances are commonly factors in securing these bonuses. Also pay attention to any monthly fees the account might carry; over time, these could weigh out the actual cash bonus. Otherwise, happy bank bonus shopping!
1. Aspiration Account: $100
Bonus amount: $100
How to get the bonus: To earn your $100, here’s all you need to do: Open your Aspiration account and deposit at least $10. Aspiration will send you a debit card associated with the account. Use the Aspiration debit card to make at least $1,000 of cumulative transactions within the first 60 days of opening your account. There’s no need to spend extra money — just use your card to buy groceries and pay your utilities.
Where to sign up: Enter your email address here, and link your bank account.
When you’ll get the bonus: Allow up to 120 calendar days from account opening to receive the bonus; you must have completed the requirements within the first 60 days.
The fine print: With Aspiration, your money is FDIC insured and under a military-grade encryption. The account offers up to 1.00% APY on savings and allows fee-free withdrawals at more than 55,000 ATMs. There are no hidden fees with Aspiration (monthly fees are on a “Pay What is Fair” policy, and that can be zero every month!), and you’ll earn cash back when you spend at socially conscious businesses (up to 5%).
No offer expiration.
2. Aspiration Plus Account: $150
Bonus amount: $150
How to get the bonus: To earn your $150, here’s all you need to do: Open your Aspiration Plus account during signup or within the first 60 days of enrollment in the regular Aspiration Account. Deposit at least $10. Aspiration will send you a debit card associated with the account. Use the Aspiration debit card to make at least $1,000 of cumulative transactions within the first 60 days of opening your account. There’s no need to spend extra money — just use your card to buy groceries and pay your utilities.
Where to sign up: Enter your email address here, and link your bank account.
When you’ll get the bonus: Allow up to 120 calendar days from account opening to receive the bonus; you must have completed the requirements within the first 60 days.
The fine print: With Aspiration, your money is FDIC insured and under a military-grade encryption. The account offers up to 1.00% APY on savings and allows fee-free withdrawals at more than 55,000 ATMs. Unlike the typical Aspiration Account, there is a $15/month fee (or $12.50/month if you pay annually). However, you’ll earn more cash back when you spend at socially conscious businesses (up to 10%), get monthly out-of-network ATM reimbursement and receive carbon offsets for all gas purchases.
No offer expiration.
3. TD Bank Beyond Checking Account: $300
Bonus amount: $300
How to get the bonus: Open a new TD Beyond Checking account. You must receive a total of $2,500 or more via direct deposit within 60 days of opening your new account.
Where to sign up: Visit this TD Checking page. Click the orange “open account” button, and follow the instructions to open a TD Beyond Checking account.
When you’ll get the bonus: The $300 bonus will be deposited into your account within 140 days of opening.
The fine print: While this bonus offer sounds too good to be true, it is definitely attainable. However, only open the account if you regularly get sizable monthly deposits or can maintain a healthy minimum balance. That’s because the account charges a monthly maintenance fee, but TD will waive the fee if you receive monthly direct deposits of $5,000, keep a minimum daily balance of $2,500 or maintain a combined balance across all your TD bank accounts of a whopping $25,000.
TD fees—and the bank’s capacity for waiving them—extend to ATMs. You won’t face fees for making withdrawals at TD’s own ATMs, and it’ll reimburse all fees for withdrawing at non-TD ATMs as long as you keep your daily balance at $2,500 or more.
No offer expiration.
4. TD Bank Convenience Checking Account: $150
Bonus amount: $150
How to get the bonus: Open a new TD Convenience Checking account. You must receive a total of $500 or more via direct deposit within 60 days of opening your new account.
Where to sign up: Visit this TD Checking page. Click the orange “open account” button, and follow the instructions to open a TD Beyond Checking account.
When you’ll get the bonus: The $150 bonus will be deposited into your account within 140 days of opening.
The fine print: While this bonus offer sounds too good to be true, it is definitely attainable. Unlike the TD Bank Beyond Checking account, this checking account option is easier for financial beginners to manage. You only need to maintain a minimum balance of $100 to have the monthly maintenance fee waived. And if you are between the age of 17 and 23, there are no minimum balance requirements and no monthly maintenance fee.
However, the Convenience Checking account does not earn interest; the Beyond Checking account does.
No offer expiration.
Carmen Mandato/ The Penny Hoarder
5. Bank of America Advantage Banking Account: $100
Bonus amount: $100
How to get the bonus: Open a new Bank of American Advantage Banking account online using the offer code DOC100CIS. You must then set up and receive two qualifying direct deposits, each totaling $250 or more, within 90 days of opening the new account. This offer is only available to new Bank of America personal checking account customers.
Where to sign up: Visit the offer page and use the offer code DOC100CIS when opening the account.
When you’ll get the bonus: Bank of America promises to “attempt” to deposit the bonus into the account within 60 days of satisfying all requirements. Though the “attempt” disclosure seems a little suspect, we could not find traces of reviews citing unpaid bonuses.
The fine print: A qualifying direct deposit means the direct deposit must be regular monthly income, whether through salary, pension or Social Security benefits. Deposits through wire transfer, apps like Venmo or ATM transfers will not qualify.
Advantage Banking accounts come in three varieties: SafeBalance, Plus and Relationship. All three carry monthly maintenance fees that can be waived:
To waive the SafeBalance monthly maintenance fee of $4.95, enroll in Preferred Rewards.
To waive the Plus monthly maintenance fee of $12, receive a qualifying minimum direct deposit, maintain minimum daily balance requirements or enroll in Preferred Rewards.
To waive the Relationship monthly maintenance fee of $25, maintain the minimum combined balance in all linked accounts or enroll in Preferred Rewards.
Offer expires June 30, 2021.
6. Associated Bank Access Checking Account: Up to $500
Bonus amount: Up to $500
How to get the bonus: Open a new Associated Access Checking account with a minimum deposit of $25 and receive direct deposits totaling at least $500 within 90 days of opening your account. Bonus values will vary based on the sum of the average daily balance of all Associated Bank deposit accounts from days 61 to 90:
Average daily balances of $1,000 to $4,999.99 will earn a $200 bonus.
Average daily balances of $5,000 to $9,999.999 will earn a $300 bonus.
Average daily balances of $10,000 or more will earn a $500 bonus.
Where to sign up: Visit this Associated Bank account sign-up page and select the appropriate account.
When you’ll get the bonus: You will receive the bonus as a deposit to your account within 120 days of account opening.
The fine print: Must be a new Associated Access Checking customer. If easy access to a physical branch is important to you, note that the bank has locations in Illinois, Minnesota and Wisconsin, but members have free access to MoneyPass ATMs nationwide. Account must remain open for a minimum of 12 months; if you close it early, Associated Bank reserves the right to deduct the paid out bonus before account closure.
The account requires a minimum deposit of $25, charges $4 a month if you require paper statements and does not earn interest.
Offer expires May 31, 2021.
7. Associated Bank Balanced Checking Account: Up to $500
Bonus amount: Up to $500
How to get the bonus: Open a new Associated Balanced Checking account with a minimum deposit of $100 and receive direct deposits totaling at least $500 within 90 days of opening your account. Bonus values will vary based on the sum of the average daily balance of all Associated Bank deposit accounts from days 61 to 90:
Average daily balances of $1,000 to $4,999.99 will earn a $200 bonus.
Average daily balances of $5,000 to $9,999.999 will earn a $300 bonus.
Average daily balances of $10,000 or more will earn a $500 bonus.
Where to sign up: Visit this Associated Bank account sign-up page and select the appropriate account.
When you’ll get the bonus: You will receive the bonus as a deposit to your account within 120 days of account opening.
The fine print: Must be a new Associated Balanced Checking customer. If easy access to a physical branch is important to you, note that the bank has locations in Illinois, Minnesota and Wisconsin, but members have free access to MoneyPass ATMs nationwide. Account must remain open for a minimum of 12 months; if you close it early, Associated Bank reserves the right to deduct the paid out bonus before account closure.
The account requires a minimum deposit of $100 and does not earn interest.
Offer expires May 31, 2021.
8. Associated Bank Choice Checking Account: Up to $500
Bonus amount: Up to $500
How to get the bonus: Open a new Associated Choice Checking account with a minimum deposit of $100 and receive direct deposits totaling at least $500 within 90 days of opening your account. Bonus values will vary based on the sum of the average daily balance of all Associated Bank deposit accounts from days 61 to 90:
Average daily balances of $1,000 to $4,999.99 will earn a $200 bonus.
Average daily balances of $5,000 to $9,999.999 will earn a $300 bonus.
Average daily balances of $10,000 or more will earn a $500 bonus.
Where to sign up: Visit this Associated Bank account sign-up page and select the appropriate account.
When you’ll get the bonus: You will receive the bonus as a deposit to your account within 120 days of account opening.
The fine print: Must be a new Associated Choice Checking customer. If easy access to a physical branch is important to you, note that the bank has locations in Illinois, Minnesota and Wisconsin, but members have free access to MoneyPass ATMs nationwide. Account must remain open for a minimum of 12 months; if you close it early, Associated Bank reserves the right to deduct the paid out bonus before account closure.
The account requires a minimum deposit of $100. This account is the only Associated option that earns interest and offers complimentary checks.
Offer expires May 31, 2021.
9. Chase Total Checking Account: $200
Bonus amount: $200
How to get the bonus: Open a new Chase Total Checking account as a new Chase customer. Within 90 days of opening the account, have a qualifying direct deposit made into the account from your employer or the government.
Where to sign up: Visit this page on Chase’s website to sign up for the account and receive the $200 bonus. You can also open the account at a Chase location near you.
When you’ll get the bonus: Chase will deposit the $200 bonus into your account within 15 business days after you meet the criteria.
The fine print: Direct deposits from person-to-person payments do not qualify for the sake of this bonus. The Total Checking account carries a $12 monthly service fee, but you can have it waived if you receive direct deposits each month totaling $500 or more, keep a minimum balance in the account at the start of each day of at least $1,500, or keep a minimum balance across all your Chase accounts at the start of each day of at least $5,000.
If you close the account within six months of opening, Chase will deduct the bonus amount at closing.
Offer expires April 14, 2021.
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10. Chase Savings Account: $150
Bonus amount: $150
How to get the bonus: Open a new Chase Savings account as a new Chase customer. Within 30 days of opening the account, deposit at least $10,000 in new money and then maintain a balance of at least $10,000 for 90 days.
Where to sign up: Visit this page on Chase’s website to sign up for the account and receive the $150 bonus. You can also open the account at a Chase location near you.
When you’ll get the bonus: Chase will deposit the $150 bonus into your account within 15 business days after you meet the criteria.
The fine print: The new money deposited into the account cannot be $10,000 that you already hold in another Chase account. The Chase Savings account carries a $5 monthly service fee, but you can have it waived if you keep a daily balance of at least $300 at the start of each day, have $25 or more in Autosave, have an associated Chase College Checking account for Overdraft Protection, have an account owner who is 18 or younger or link one of several Chase checking accounts.
If you close the account within six months of opening, Chase will deduct the bonus amount at closing.
Offer expires April 14, 2021.
11. Citibank Account Package: $300
Bonus amount: $300
How to get the bonus: Open new checking and savings accounts in the Account Package. Within 30 days, deposit $15,000 in funds that are new to Citibank between the two accounts. Maintain a minimum balance of $15,000 for 60 days in a row.
Where to sign up: Click “apply now” for the Account Package on this page to have the bonus applied.
When you’ll get the bonus: Citibank pays out the cash bonus into your account within 90 days of meeting the criteria.
The fine print: The deposited funds must be new to Citibank, meaning they can’t come from another Citibank account. Citibank charges a $25 monthly service fee, but you can have it waived if you maintain a combined monthly average of $10,000 or more in all linked accounts.
Rates and promotions may vary by location; verify your promotion details by entering your ZIP code on the site.
Offer expires April 1, 2021.
12. Citibank Priority Account Package: $700
Bonus amount: $700
How to get the bonus: Open new checking and savings account in the Priority Account Package. Within 30 days, deposit $50,000 in funds that are new to Citibank between the two accounts. Maintain a minimum balance of $50,000 for 60 days in a row.
Where to sign up: Click “apply now” for the Account Package on this page to have the bonus applied.
When you’ll get the bonus: Citibank pays out the cash bonus into your account within 90 days of meeting the criteria.
The fine print: The deposited funds must be new to Citibank, meaning they can’t come from another Citibank account. Citibank charges a $30 monthly service fee, but you can have it waived if you maintain a combined monthly average of $50,000 or more in all linked accounts.
Rates and promotions may vary by location; verify your promotion details by entering your ZIP code on the site.
Offer expires April 1, 2021.
13. HSBC Premier Checking Account: Up to $600
Bonus amount: 3% cash bonus up to $600
How to get the bonus: Open a new HSBC Premier Checking account, then set up qualifying direct deposits into the account once per calendar month for six consecutive months. You will then receive a 3% cash bonus based on the amount of your qualifying direct deposits, with a max of $100 a month for six months.
Where to sign up: Use this offer page to sign up for the offer. Click “apply now” on the HSBC Premier Checking account.
When you’ll get the bonus: You will receive your 3% cash bonus in your account approximately eight weeks after completing each month’s qualifying activities.
The fine print: To get the bonus, you cannot have had an HSBC account from January 7, 2018, through January 7, 2021. You must also have been a U.S. resident for at least two years and must be 18 or older.
HSBC applies a monthly maintenance fee of $50 unless you maintain a balance of $75,000 across your accounts, receive monthly recurring deposits of $5,000 or more or have an HSBC US residential loan with an original loan amount of at least $500,000.
Offer expires March 31, 2021.
14. HSBC Advance Checking Account: Up to $240
Bonus amount: 3% cash bonus up to $240
How to get the bonus: Open a new HSBC Advance Checking account, then set up qualifying direct deposits into the account once per calendar months for six consecutive months. You will then receive a 3% cash bonus based on the amount of your qualifying direct deposits, with a max of $40 a month for six months.
Where to sign up: Use this offer page to sign up for the offer. Click “apply now” on the HSBC Advance Checking account.
When you’ll get the bonus: You will receive your 3% cash bonus in your account approximately eight weeks after completing each month’s qualifying activities.
The fine print: To get the bonus, you cannot have had an HSBC account from January 7, 2018, through January 7, 2021. You must also have been a U.S. resident for at least two years and must be 18 or older.
HSBC applies a monthly maintenance fee of $50 unless you maintain a balance of $75,000 across your accounts, receive monthly recurring deposits of $5,000 or more or have an HSBC US residential loan with an original loan amount of at least $500,000.
Offer expires March 31, 2021.
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How to Search for Bank Bonuses on Your Own
In the spirit of not listing approximately 193 bank promotions, we kept this list short and sweet — only highlighting the best bank promotions for checking and savings accounts.
But maybe you’re interested in banking with your local credit union, opening up a small business checking account or finding the perfect investment account? There are often bonus offers attached to these account openings, too.
The banks don’t always make finding these promotions easy, so here are a few tips to help you get your hands on that cash bonus.
Check the bank’s website first. Sometimes it’ll advertise its promotions right there. This is rare, but it’s worth a quick check — it could save you a ton of time.
If you don’t have any luck, reach out to the bank’s customer service team through phone, email or chat. Let them know you’re shopping for a new account, and you’d like to know if it’s running any promotions. More often than not, the nice representative will send you a special link.
If this doesn’t work, turn to your trusty friend Google. Look for the best bank account bonuses. Because you’ll likely dig up some offers from third-party sites, you’ll want to take a few minutes to make sure the offer:
Hasn’t expired.
Is legitimate. Make sure the bank is FDIC-insured and has a positive Better Business Bureau rating. You can even read some online reviews.
Doesn’t require outrageous qualifying activities. For example, it might not be realistic for you to maintain an average daily balance of $50,000 and carry out 60 qualifying debit card purchases or receiving five direct deposits before the end of your first 30-day statement cycle.
You can also reach out to your family, friends and social network to crowdsource bank recommendations. Sometimes banks have impressive referral programs, so both you and your friend could benefit from you signing up.
Overall, be smart. Don’t let that promise of an account bonus blind you. Also, read the fine print so you don’t get stuck paying high monthly fees, interest rates or closing penalties.
Will Opening a Bank Account Hurt Your Credit Score?
Don’t be worried that opening a new bank account or closing an old one will hurt your credit score. Your bank accounts are not included in your credit report and therefore have no effect on your credit score, unless you have an outstanding negative balance that the bank turns over to a collection agency.
Sometimes when you go to open a new bank account, banks will do a soft credit check. However, that won’t affect your credit score.
Now, go enjoy your fresh new bank account and that nice cash bonus you’re about to pocket. Add it to your savings account, put it toward student loan payments or, heck, treat yourself!
The Penny Hoarder Shop is always stocked with great deals, including technology, subscriptions, courses, kitchenware and more. Check it out today!
Editorial Disclosure: This content is not provided by the bank advertiser. Opinions expressed here are the author’s alone, not those of the bank advertiser. This site may be compensated through the bank advertiser Affiliate Program.
Tina Hay is the author of “Napkin Finance: Build Your Wealth in 30 Seconds or Less,” a book that offers visual money guides. Photo courtesy of Tina Hay
Many of us weren’t taught personal finance at school, and money wasn’t discussed at the dinner table.
We’ve developed our financial education by browsing articles online, reading books and through a lot of trial and error.
“There’s a big difference between those people who are educated and understand how they can make their money work for them versus the rest who never [had] the basic understanding and then [got] into debt and [paid] for their decisions later,” said Tina Hay, CEO of Napkin Finance.
The Penny Hoarder recently invited Hay to join us for a discussion about her book “Napkin Finance: Build Your Wealth in 30 Seconds or Less” and all things money-related. We hosted a live chat on Facebook where audience members were able to submit questions and hear from Hay directly.
The following is an abridged version of that conversation, edited for length and clarity.
The Penny Hoarder’s Q&A With Tina Hay of “Napkin Finance”
The Penny Hoarder: Can you tell us about Napkin Finance?
Tina Hay: Napkin Finance is a visual guide to money and finance. We help people understand complex topics in a simplified, more digestible way with snackable content — everything from Napkins (our branded infographics) to videos to articles, storyboards, charts and tables. We also add humor and some fun to the content to make it more engaging and interesting.
TPH: What role do visuals play in grasping financial concepts?
Hay: Visual learning is a classic concept. Mozart, DaVinci and Freud all used visual images and graphics to solve their biggest problems. Human beings are visual learners and they process images 60,000 times faster than they process text. Also, 90% of the information that we process to the brain is visual. The visual graphics and assets that we create have been really powerful because it makes the subject matter less intimidating and creates higher comprehension, better retention of the content and also enhanced retrieval.
TPH: Can you walk us through how you go about creating a Napkin?
Hay: We have a team that’s a mix of creatives and financial experts. We start with an article or blog and then we pull out the elements that are the most interesting or important to distill into a Napkin. The Napkin comes to life with our designers and then we create a video or other content based on that. At the end of the day, the ultimate test is: If you’re new to this topic, would you be able to look at this and understand the topic in 30 seconds or less?
Audience Question: How can I convince my young adult kids to start saving for retirement now?
Hay: One thing is to automate so a certain percentage is taken out from their allowance or income every month and transferred automatically into a retirement account. The second thing is to show the power of time and how money compounds. The most powerful asset people have when they’re young is time. It can be extremely powerful to see the impact of how much money can grow if people start saving and investing in their 20s versus their 30s and 40s.
Audience Question: As a single parent going through the pandemic, how can you rebuild credit and rebuild savings successfully and effectively?
Hay: Traditionally, we always say you need three to six months of emergency savings. The pandemic has shown that people really need to have a year’s worth of savings for emergencies, which is considerable and not an easy thing to do. But I think what is important is to always follow a budget to start putting money aside — even if it’s a small amount — and to understand where your money’s coming in and where it’s going out. We have a section on budgeting on our website and in the book. Having a plan in place is the best way to reach your goals.
Pro Tip
Hay suggests a 50/30/20 budget, where you spend half your income on essentials, set aside 30% as fun money and dedicate the remaining 20% to your financial goals.
Audience Question: How do I start a fund for my child? Can my child invest in the stock market? How old does a person have to be to invest?
Hay: Many brokerages allow you to have a custodial account to have your children start investing, which I think is a great idea because you can manage what they’re doing and then help teach them along the way. You can also start saving for their education through a 529 plan. One of the things I think is great is to empower them to learn and then show them how the markets work. There are a lot of fun ways to get them engaged. They can invest in companies that they care about or that they’re interested in or that they use.
Pro Tip
Read our ultimate guide to saving for college and beyond with a 529 Plan.
TPH: What is the best piece of personal financial advice you’ve ever received?
Hay: I have three pieces of advice I believe are really the most impactful. The first one is diversify — so don’t have all your eggs in one basket. The second is: Keep costs low. Many people don’t realize all the fees that we pay for, whether it’s for advisers or financial products. The third piece of advice is buy and hold. I’m a big believer in investing for the long run. One of the things that’s been proven over and over is the most solid and most reliable strategy is really to buy and hold. Most people shouldn’t be day traders and aren’t trained to be.
Audience Question: Do you have advice for transitioning from full-time employment to retirement?
Hay: It depends on what your time horizon is, what your investments are and what you have saved up for retirement. Most people have not saved up adequate money for their retirement and are depending on Social Security, which no one even knows if it’ll be there in the next 20 or 30 years. You want to be secure that you’ll have — from your retirement savings — enough to have the same lifestyle that you’ve had while working full time. If your company provides matching retirement contributions, make sure you take advantage of that. You’d be surprised at how many people don’t. Even if you’re saving later in life or investing later, it’s okay. Don’t worry about what’s happened in the past, but be proactive in the future.
TPH: What do you hope that people get out of reading “Napkin Finance?”
Hay: The beauty of the book is that I think it’s really comprehensive. It covers so many areas within money and finances — everything from taxes to retirement to credit. What we hope is that this book is a way for people to engage and get more interested in learning about money and use it as an opportunity to have discussions with their loved ones.
To listen to the conversation in its entirety, watch the Facebook Live replay.
Nicole Dow is a senior writer at The Penny Hoarder.
What Is a Financial Planning Pyramid? – SmartAsset
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Setting priorities in the process of creating a solid financial position can be challenging. The financial planning pyramid provides a visual explanation and reminder to help people make the right moves at the right time. It aims to keep people from taking inappropriate risk by gauging the relationship between risk and reward. The pyramid also takes into consideration the element of time as a person makes progress towards his or her financial goals. It is a simple way to suggest how much of a person’s assets he or she should commit to different investments and other financial products.
Deciding how to allocate your financial assets and when to do so is something a financial advisor can offer invaluable advice on.
Levels of a Financial Planning Pyramid
There’s no single version of the financial planning pyramid. Some varieties have just a few levels and others have several. Some describe a wide variety of specific investments, asset classes and financial products and others just a handful of broad categories.
A core element of all versions of the pyramid is that the least risky financial moves are at the bottom, while the riskiest ones are at the top. The width of the pyramid at the level where a financial product appears suggests how important it is and how much of a person’s assets should be committed to it.
Here are levels of the financial planning pyramid:
Level 1 – The lowest level is the widest, which indicates its importance and where it should be in terms of priorities. It is also the least risky and, in fact, focuses on reducing financial risk. This level includes automobile, home, life, health, disability and liability insurance.
Level 2 – Once the first level is addressed, people can concern themselves with the second level. This level is focused on emergency savings. It includes money put into safe investments such as federally insured bank checking and savings accounts, certificates of deposit and government bonds.
Level 3 – The third level consists of savings and investment vehicles that may pay better interest rates than the very safe ones in the second level, at the cost of somewhat greater risk. They include money market accounts and high-grade municipal and corporate bonds and bond funds.
Level 4 – At the fourth level investments in equities begin to appear. These take the form of balanced mutual funds and high-grade shares of preferred stock and convertible bonds.
Level 5 – The fifth level consists of shares of blue-chip public companies as well as investments in growth-oriented mutual funds and real estate.
Level 6 – The sixth level represents investments in collectibles, speculative stocks and lower-grade bonds and mutual funds.
Level 7 – At the very top of the pyramid is a narrow wedge representing the small amount of assets that may be prudently committed to highly speculative investments. These could include commodities, over-the-counter penny stocks and the like.
Key Concepts
The main idea of the financial pyramid that the width of pyramid at a given level expresses how much a person might wisely commit to the investments in that level. That is, more of a portfolio should ordinarily be invested in blue chip common stocks than speculative penny stocks. Time is also a factor. This means people are advised take care of the risk-management tools in the first level before starting to build emergency savings or begin investing in the stock market.
Different investors have different situations, which can affect the pyramid. For instance, a person in the middle of his or her career may be more heavily invested in growth mutual funds than someone approaching retirement, who would likely emphasize safety of principal with investments in high-grade bond funds.
Some versions of the financial planning pyramid have an even lower level. This may include the creation of a financial plan. Another item sometimes included as part of the lowest level is a budget that aims to make sure a person has cash left at the end of the month to stock an emergency fund and, ultimately, invest.
While financial products at the bottom of the pyramid are lower risk than those on higher levels, there is no risk-free investment. Even government bonds may generate a negative return in terms of buying power if the return does not keep up with inflation. There is also a risk of paying insurance premiums without ever making a claim on the coverage benefits.
Bottom Line
The financial planning pyramid is a road map to help people decide where to put their emphasis today in preparing to reach their ultimate financial goals. It is a reminder of the relationship between higher risk and higher reward, and helps to ensure that people have the building blocks of a solid financial foundation in place before chasing better returns with riskier investments. While financial products at the bottom of the pyramid are lower risk than those on higher levels, there is no riskless investment. Even government bonds may generate a negative return in terms of buying power if the return does not keep up with inflation. There is also a risk of paying insurance premiums without ever making a claim on the coverage benefits.
Tips for Investing
If making and implementing a financial plan seems like a complicated challenge, consider working with an experienced financial advisor. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
Once you’ve decided to start investing your money, you’ll have to decide on an asset allocation that’s appropriate for your goals, age and risk tolerance. And unless you invest in a target date fund that automatically adjusts that asset allocation, you’ll have to rebalance your assets over the course of your investing time frame. That’s where a free, easy to use asset allocation calculator can be extremely helpful.
Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
When it comes to saving for retirement, there are a multitude of options available to help you do just that. One of the more popular options people choose is an IRA, also known as Individual Retirement Account. The two main IRAs are Traditional and Roth IRAs and they can be used as alternatives to the traditional 401K.
An IRA is an investment account that allows workers to invest their earned income to encourage them to set aside money (earnings) for retirement. Unlike the traditional IRA, Roth IRAs are non tax-deductible which means you do not have to pay taxes when you qualify for your withdrawal. For this reason, Roth IRAs have become very popular.
If you decide to apply for a Roth IRA, it’s extremely important to be aware of the general rules and penalties associated when managing your account. Check out these simple rules and regulations associated with Roth IRAs.
Roth IRA vs Traditional IRA
Like we mentioned before, an IRA is an investment account that is designed to encourage workers to invest in retirement. With both Traditional and Roth IRAs, your contribution limit generally is the lesser of:
$6,000 ($7,000 if you are age 50 or older), or
Your taxable compensation.
Both options also allow you to invest in a variety of different investments such as stocks, bonds, mutual funds, annuities, exchange traded funds (ETFs), index funds, and so on.
ROTH IRA
TRADITIONAL IRA
Contributions made with after-tax dollars.
Contributions made may be tax-deductible.
Your earnings grow tax-free.
Your earnings grow tax-deferred.
You don’t pay income tax on distributions.
You pay income tax on distributions.
Contribution limit based on filing status and income thresholds.
Contribution limit is not based on income thresholds.
So what’s the difference between a Roth IRA and a Traditional IRA? The primary difference between the two is the way they are taxed. With a Traditional IRA, the amount you can contribute annually (up to $6,000) can be deducted from your taxable income which reduces the amount of income tax you’ll owe for the year–providing immediate benefits. However, when you withdraw your money in retirement, you will be taxed on those withdrawals.
On the other hand, contributions to a Roth IRA are non-tax deductible, but qualified withdrawals are tax and penalty free. Roth IRAs also offer flexibility with non-taxable withdrawals compared to a 401K. With that being said, Traditional IRAs are best if you think your tax bracket will be lower by retirement and Roth IRAs are better if you anticipate taxes to be higher when you retire.
When Can I Withdraw From My Roth IRA?
The contributions you make with a Roth IRA are not tax-deductible, but earnings can grow tax-free. Roth IRA withdrawal rules vary depending on your age and how long you’ve had the account. You can withdraw from your Roth IRA at any time, but before you make a withdrawal, keep in mind these guidelines so you can avoid the potential 10% early withdrawal penalty:
You must be the age of 59 ½ or older to make a withdrawal
You must have your Roth IRA for at least 5 years before you make a withdrawal
If you don’t qualify for withdrawal based on your age or how long you’ve had your account, have no fear, there are still exceptions to the early withdrawal penalty.
Exceptions to the Early Withdrawal Penalty
If you need to make an early withdrawal, but are under the age of 59 ½ or have not had your Roth IRA for at least 5 years, there are exceptions to the Roth IRA early withdrawal penalty.
You can avoid the Roth IRA early withdrawal penalty if you use the withdrawal:
to pay for a first-time home purchase
to pay for qualified education expenses
to pay for birth or adoption expenses
to pay for unreimbursed medical expenses or health insurance if you are unemployed
Unfortunately, if you don’t qualify for withdrawal or for the exceptions, you’ll have to pay taxes and penalties in order to withdraw from your Roth IRA.
Roth IRA Withdrawal Penalties and Rules to Consider
It is advisable, if possible, to avoid making an early withdrawal from your Roth IRA. Even though you can withdraw up to the total of your contributions at any time, once you have withdrawn your contributions, you will be hit with taxes and penalties if you don’t meet a qualified withdrawal or are under the age of 59 1/2. There may still be penalties if the account is younger than 5 years too.
Once you start dipping into your account’s earnings, it may be subject to a 10% early distribution penalty because that amount is considered taxable income and therefore the money would be treated as income.
Another thing to consider is the tax implications associated with a Roth IRA. If you contribute to your Roth IRA and then decide to withdraw within the same year, the contribution you make is treated as if it were never made as long as the distribution is taken prior to your tax filing date. However, keep in mind that you would have to report those earnings as investment income.
Pros and Cons of Withdrawing
When it comes to withdrawing, there are pros and cons to consider before making a decision. Weigh your choices and decide whether withdrawal is the best option for you.
Pros:
Roth IRA withdrawals are tax-free and penalty free when withdrawing contributions
You can possibly avoid the tax and penalty associated with early withdrawal in certain situations
Cons:
Most of the time, early withdrawal of the portion of the distribution allocable to earnings may be subject to tax and it may be subject to the 10% additional tax
Once you withdraw, you cannot pay back the money to your IRA account
If you withdraw early, you will miss out on years of growth
In summary:
Roth IRAs are investment accounts that are non-tax deductible, but qualified withdrawals are tax and penalty free
To qualify for a withdrawal from your Roth IRA, you must be over the age of 59 ½ and have the account for at least 5 years
If you don’t meet the qualifying requirements or the exceptions, your earnings may be subject to a 10% early distribution penalty
Once you withdraw from your Roth IRA account, you cannot pay back the money and you will miss out on years of growth in your earnings
With all that being said, the decision to withdraw from your Roth IRA should not be taken lightly. It is important to manage your money responsibly and make smart financial decisions so you can maintain your credit history.
For many, knowing where to invest their money can be nerve-wracking, especially if it’s in a long-term account that they can’t immediately access without facing fees or penalties. Fortunately, there are a variety of short-term investments that you can consider to grow your wealth and withdraw from in a shorter period of time.
Knowing what the best short-term investments are is hard, as it depends on current market conditions and your own financial goals. Today, short-term investments are even more challenging to understand as the COVID-19 pandemic is causing market conditions to fluctuate. However, there are a variety of short-term investments worth considering. Below, we’ll cover short-term investment examples throughout this post to give you a greater understanding of your options.
Read end-to-end to explore what short-term investments are available to you, or browse different short-term investments using the links below.
What Are Short-Term Investments?
You’ve probably heard the term thrown around here and there, but what are short-term investments? The short-term investment definition considers short-term investments, also referred to as temporary investments or marketable securities, as investments that can produce returns quickly, usually in 5 years or less.
People may place their money in short-term investment vehicles if they need their money to grow by a certain time. Unlike long-term investments like stocks and mutual funds that are riskier and can drop in price from bear markets, short-term investments are often safer, as the risk of losing gains is often lower.
There are a few reasons why someone may want to invest in short-term securities. For example, if you’re planning your wedding or hoping to place a down payment on a new home, you might consider short-term investments to grow your money and have access to it in a shorter period of time.
Another reason someone may become a short-term investor is because they want to take advantage of rising interest rates within a short period of time. While this strategy can be difficult, those knowledgeable on short-term investing can earn profits off of their marketable securities.
Common types of short-term investments include savings accounts, money market accounts, certificates of deposit (CDs), Treasuries, bond funds, peer-to-peer lending. In the next section, you’ll learn more about each of these types of short-term investments.
Types of Short-Term Investments
There are numerous short-term investments you can place your money in with hopes of gaining a return. Knowing how to start investing can be confusing, especially if it’s your first time and you know little about different types of investment vehicles. Below, we’ll cover some of the best short-term investments you may want to consider in 2020.
1. Savings Accounts
When you get paid, you most likely place your earnings in a bank account. There are two main types of bank accounts: checking and savings. Checking accounts are great for everyday spending, as you can withdraw funds for bills, groceries, and other transactions whenever you please. This is because checking accounts usually earn little to no interest.
Savings accounts, on the other hand, can earn interest. There are plenty of savings accounts where you can store your money, and one option is a high-yield savings account. High-yield savings accounts often offer high interest rates, which can earn you money over time. However, they usually place limits on how many withdrawals you can make each month – usually six. Savings accounts are FDIC-insured up to $250,000, which will protect your money in the event of a market collapse.
If you have robust savings or an emergency fund sitting around in a checking account earning no interest that you don’t plan on withdrawing from in the near future, you may want to consider placing your money in a savings account. Doing so can earn you more money in interest each month.
2. Money Market Accounts
A money market account is a high-interest earning account that typically pays a higher rate than a traditional savings account. However, these accounts often require a minimum investment, which means you may have to put down a sizable chunk of your savings to open one of these accounts. Money market accounts, similar to checking accounts, saving accounts, and CDs are FDIC-insured up to $250,000.
It’s important not to confuse money market accounts with their riskier counterpart, money market mutual funds. Money market mutual funds, which are not FDIC-insured, invest in debts and short-term maturities of less than one year.
3. CDs
Certificates of deposit (CDs) are a savings instrument that lock your funds for a fixed period of time. While locked, the bank or financial institution that offers your CD will pay a fixed-rate interest for the duration of the CD. Typically, the longer your CD term, the higher the interest rate you’ll receive. CDs typically offer higher interest rates compared to savings accounts and money market accounts. You can choose terms that can range from 7 days up to ten years. However, the most common CD terms are six months, one year, or five years.
When you open a CD, you typically agree to keep your money held in the account for the specified amount of time. If you withdraw money from your CD before it matures, you can face an early withdrawal fee or have to forfeit a portion of the interest you earned. Another drawback is if you tie your money up in a CD, you can risk missing out on another opportunity that offers a higher rate.
4. Treasuries
The U.S. Treasury offers a variety of securities you can invest in and grow your money. Some of the most common treasuries include:
Treasury Notes (T-Notes): Issued with maturities of 2, 3, 5, 7, and 10 years and pay interest every six months
Treasury Bills (T-Bills): Short-term securities that are sold as a discount from their face value and have maturities that range from a few days to 52 weeks
Treasury Bonds (T-Bonds): Long-term investments that pay interest every six months and mature in 20 or 30 years
Floating-Rate Notes (FRNs): Issued for a term of 2 years with interest being paid quarterly, with interest payments rising and falling based on discount rates for 13-week Treasury bills
Treasury Inflation-Protected Securities (TIPS): Marketable securities with maturities of 5, 10, ad 30 years with interest being paid every six months with the principal adjusting by changes in the Consumer Price Index
Besides Treasury Bonds, these Treasuries are all backed by the U.S. government and are short-term investments worth considering.
5. Bond Funds
Bond funds invest in a pool of bonds, such as corporate, municipal, and government savings bonds. Ultra-short bond funds are similar to mutual funds. However, instead of investing in a pool of stocks, they’re investing in a pool of bonds with short durations.
In short, a bond is a loan to a government or business that pays back a fixed rate of return. They are generally safer than stocks, but still pose risks, such as a borrower defaulting.
When it comes to bond funds, you might want to consider investing in ones that primarily own government bonds. This is because government bonds are usually less risky than corporate bonds and have a lower chance of defaulting because they’re backed by the government. Bond funds are a viable option if you’re looking for a short-term high-yield investment. Additionally, you most likely won’t face a penalty if you withdraw early.
6. Peer-to-Peer Lending
Peer-to-peer lending, or P2P lending, is an avenue for small businesses and individuals to access capital through the internet. P2P lending is similar to taking a loan out from a bank, but comes from a peer instead, such as your neighbor, family member, or friend.
To get started in peer-to-peer lending, you first need to join a lending platform and decide what types of loans you’ll offer and the risk you’re willing to accept. From there, you’ll be able to pick and choose borrowers based on their creditworthiness and begin making money through interest.
With P2P lending, you can often yield greater results compared to savings or CDs. However, a drawback is that P2P lending isn’t FDIC-insured, which means it can be a risky investment if the borrower defaults and can’t pay back your loan.
7. Roth IRAs
Saving for retirement is a common goal for many individuals. One way to save for retirement is with an individual retirement account, such as a Roth IRA. While the initial purpose of a Roth IRA is to save for retirement, it can be used as a short-term investment. Unlike a traditional IRA, Roth IRAs allow you to make withdrawals without facing a penalty or having to pay taxes on your contributions. Any gains, however, can face taxes and penalties if you withdraw early.
Investment Options for Short-Term Money
There are numerous investment options for short-term money at your disposal. You don’t want to fall victim to common investment mistakes like buying a security without doing your research. Refer to the chart below to view a side-by-side comparison of common short-term investments.
Key Takeaways on Short-Term Investments
If you’re looking to grow your money in a short amount of time, short-term investments might be the option for you. Here are some key takeaways on short-term investments:
Short-term investments are investments that can produce returns quickly, typically in five years or less.
There are numerous short-term investment examples, such as savings accounts, money market accounts, CDs, Treasuries, bond funds, peer-to-peer lending, and Roth IRAs.
The best short-term investments are those that match your financial goals. It’s important to do your research to find a short-term investment that works for you.
Sources
FDIC | Investor.gov; Certificates of Deposit | U.S. Treasury | U.S. Bureau of Labor Statistics | Investor.gov; Ultra-Short Bond Funds |
begin investing now, even if you don’t fully understand the process.
We’ll break it down, starting with showing you how to prepare your finances for investing.
Then we’ll give you some solid strategies that will help you up your game as you go along.
You may never be a complete expert, but you’ll know enough to get started after reading this article.
Expert status – if it’s even possible – will come with time.
Step 1: Have a Fully Stocked Emergency Fund
Probably the scariest scenario in the investment universe is watching your investments fall in value, at a time when you need the money for other purposes. But like everything else when it comes to investing, there’s a fix.
It’s called an emergency fund. An emergency fund is a completely safe, completely liquid financial account, that enables you to access the funds anytime you need them, and on very short notice.
There are two major purposes for an emergency fund:
To have ready cash to cover an unexpected expense, and
to prevent you from needing to liquidate investment assets to cover that expense.
Put another way, an emergency fund serves as a protective buffer between your budget and your investments. It prevents you from having to liquidate investments at prices that might lock in a permanent loss.
An emergency fund accomplishes something else that’s very important. It gives you sleeping money.
What’s sleeping money? The financial markets don’t always behave the way we expect them to. Sometimes they languish for what seems like forever. Other times there’s a lot of volatility, with the market swinging back and forth in unpredictable patterns.
And sometimes there’s a bear market, causing stocks to drop for several years. If you’ve got money sitting in a safe emergency fund, you won’t be as concerned about the ups and downs of the market. You’ll be able to sleep at night. Where should you hold your emergency fund?
We like online banks that pay high rates on savings, money markets, and certificates of deposit (CDs). Examples include:
Any of these banks keep your money safe, completely liquid, and pay interest rates well above local banks.
Step 2: Make Sure Your Debt is Under Control
There are some who will say you should start investing no matter what your financial situation is, even if you have a lot of debt. This is not a completely ridiculous concept.
It has to do with the time value of money – the sooner you begin investing, the more time your money will have to grow.
Simply put, you’ll have more money accumulated if you begin investing at 25 than if you start at 40. That’s the argument to begin investing no matter what your financial situation is. But while that strategy makes sense in a lot of situations, you also have to look at the math. Consider the following:
Interest: The average interest rate on credit cards is 17.14%.
Returns: The historic return on the S&P 500 is about 10% since 1928.
Reality: Even with 100% of your investments in the stock market, earning 10%, you’ll be losing 7% each year with an equivalent amount of credit card debt.
If you have a lot of credit card debt, you can see how this will work against you. That’s an arrangement you’re doomed to lose.
Now that doesn’t mean you need to be absolutely credit card free. If you have relatively small balances, there’s no reason to wait until you pay off the last dollar.
But if you have several thousand dollars in credit card debt, you must consider what a losing proposition that is. The better strategy will be to pay off the bulk of your credit cards before investing.
When it comes to investing, credit card debt is like a backdoor margin loan, but at rates so high as to defeat the purpose.
What About Other Types of Debt?
Other types of debt, like student loans and auto loans, are trickier. Student loans can run for 10, 15, or 20 years. That’s too long to wait to begin investing.
And car loans makes sense because they are secured by an asset that’s used to help you earn an income – your car.
And no, you shouldn’t wait to pay off your mortgage completely before you begin investing.
It’s long-term debt, like student loans, and it’s secured by an asset that provides a direct benefit, similar to a car loan. If you wait for these loans to be paid off, you may never begin investing.
Step 3: Start Small
Probably the biggest reason people don’t begin investing sooner is a lack of money.
But in today’s investment universe, a lack of money isn’t a serious problem. There are any number of investment platforms that will enable you to begin investing with very little money, or even none at all.
Betterment
For example, probably the best known of all robo-advisors is Betterment. You can sign up for an account with them, and you don’t need any money at all.
You can fund your account gradually, through regular monthly deposits. If you can contribute at least $100 per month, you’ll be surprised how quickly the account will build up.
Sign up with Betterment today >>
And as investment earnings increase your account value, you’ll begin to see the power of that time value of money concept in action.
Acorns
Another investment app that’s become increasingly popular – and will also enable you to begin investing with no money – is Acorns. It’s a smartphone app you attach to your bank account or credit card.
As you spend money the way you regularly do, Acorns will make small contributions toward an investment account.
For example, let’s say you purchase a latte at Starbucks for $4.50. The app will charge your bank account or credit card $5 even. $4.50 will pay Starbucks, and 50 cents will go into your investment account.
What’s more, the investment account is a robo-advisor. As money goes into the account, it will automatically be invested in a diversified portfolio.
From there, it will be fully managed, including periodic rebalancing to maintain the asset allocation, as well as reinvestment of dividends.
This is also how Betterment works, so you really can’t go wrong with either account. With each, you’re starting very small, then building up over time. Perfect!
Start investing with Acorns here >>
Step 4: Diversify Your Investments
A common mistake many new investors make is putting all their money into a very small number of stocks, or maybe even one. The theory is if that one stock takes off, you’ll become an instant millionaire. Sorry to burst your bubble, but that only works on TV.
In the real world of investing, you need to build a diversified portfolio. That means owning many different stocks, spread across different industries.
You’ll also want to counter your stock holdings with fixed-income investments. These will typically consist of bonds, but it could also be CDs held at an online bank.
The basic idea is that if the stock market starts misbehaving, your fixed income allocation will remain safe.
For a small investor, it can be very difficult to diversify. After all, it takes a lot of money to buy a lot of different stocks. But that’s another problem the investment industry has overcome.
We’ve already discussed robo-advisors like Betterment and Acorns. They’ll automatically create a balanced portfolio of stocks and bonds for you. This will spare you the trouble of having to create a portfolio yourself.
And since you’re investing flat dollar amounts, even a small investment can be spread across literally hundreds of different investments.
Step 5: Consider a Robo-advisor that Let’s You Choose the Investments
Eventually, you may get the confidence and knowledge, so you feel comfortable selecting at least some of your own investments. If you do, there’s an investment app for you. M1 Finance is a robo-advisor, but one that will give you a choice as to what you will hold in your portfolio.
Here’s a quick breakdown of what M1 has to offer:
Minimum: With as little as $500, M1 creates you a theme-oriented portfolio
Portfolio: Referred to as “pies,” they are comprised of stocks and exchange-traded funds (ETFs).
Advantage: You can choose the type of pie you want to invest in from 60 pie templates, or create your own.
Pies: Can be based on a specific investment sector or even a certain group of stocks.
Automated management: M1 then takes over and manages your portfolio for you. You choose your investments, but they handle the day-to-day management.
M1 Finance is an excellent platform to begin self-directed investing with. As you find yourself becoming more successful and confident in your investing activities, you can begin building your own pies from the ground up.
And just as important, M1 Finance has no fees. You may not start out with this platform, but you may want to get there eventually.
Start investing with M1 Finance>>
Step 6: Understand What You’re Investing In
Once again, it has to be emphasized that you should use robo-advisors if you’re a new investor. The advantage with robo-advisors is that you don’t need any investment knowledge whatsoever to participate.
As a new investor, you should never invest in anything you don’t understand. The advantage with robo-advisors is that they will both design and manage your portfolio for you. That’s especially important when you’re just starting out and don’t have much capital to invest.
But eventually, you may want to begin do-it-yourself investing. If you do, be sure to ease into it slowly.
It may be best to start with a base of investments in robo-advisors. Or you can even consider holding one or two mutual funds or exchange traded funds.
Each represents a portfolio of dozens or hundreds of stocks, so you don’t have to get involved in either the selection or the managing of those securities. Beyond a robo-advisor, or a fund or two, you can open up a self-directed account with a diversified brokerage firm.
Ally Invest
Let’s take a look at one of our top brokerages, Ally Invest. Here are a few quick facts:
Investment options: individual stocks, bonds, options, and even mutual funds or ETFs.
Flexibility: You can use the investment platform for your do-it-yourself investing, while holding your managed money with robos and funds.
Diversity: A platform like Ally Invest will give you the tools to learn more about investing, as well as individual securities. But it also provides tools to help you be a better investor.
But once again, move slowly with this process. You can lose a lot of money jumping in too quickly.
Step 7: Get Help If You Need It!
If you want to get into self-directed investing, but you don’t feel you’re quite ready, there are plenty of places where you can get help.
Some are free, but others charge a fee.
But if you plan to be a successful investor, you’re eventually going to have to start paying some fees for more advanced services.
You should think of investing like running a business. You’re running the business to earn money, but sometimes you have to re-invest in the business so you can earn more money. The concept is similar with investing.
Here are few resources that can help you along the way:
Bloomberg and MarketWatch: You should become a regular reader of sites like Bloomberg and MarketWatch. They’ll keep you up-to-date with what’s going on in the financial markets and offer a wealth of information on the companies you’ll want to invest in. Investing is largely a process of building a knowledge base, and you’ll need to do that gradually and consistently.
Morningstar: If you want more information about individual securities, particularly funds, you can look into services like Morningstar. You’ll pay for the service, but the information is virtually a standard in the investment world. If you’re serious about becoming a do-it-yourself investor, you’ll need this kind of resource.
Personal Capital: There’s also a way you can get hands-on investment assistance at a relatively low rate. A platform known as Personal Capital offers a wealth management service. The service functions like a robo-adviser, but also provides you with big picture financial advice, to help you manage your entire financial life.
Step 8: Make Investing a Habit
Investing isn’t something you do once, or even occasionally. Your success is directly tied to how consistently you do it. That means not only making regular contributions to your investments, but also making sure you’re invested in all types of markets.
Let’s look at the impact regular contributions have on investing… If you invest $10,000 into a portfolio that averages 7% per year, for the next 30 years, it will grow to about $76,125.
But let’s say instead of making a one-time investment of $10,000, you contribute $5,000 each year, for 30 years – also earning an average annual rate of return of 7%.
After 30 years you’ll have over $490,000! There’s another benefit to regular periodic investment, and that’s dollar cost averaging. It’s one of the most time-honored concepts in investing.
When you make a one-time investment, you’re buying into the market at whatever prices are at that time.
If you make a $10,000 investment, and the market falls 50% in the next year, you’ll be down to $5,000. But by making regular contributions, into all types of markets, you’re never worried about where the market is at. In some years you’ll be investing at what’s considered to be a bad time.
In others you’ll be investing in what’s considered a good time. But by making regular contributions, you remove the guesswork. You’re investing in all types of markets, and your focus is completely on the long-term performance of your portfolio, and not in any attempts to time the market.
That’s important, because no successful market timing strategy has ever been developed. And by making regular contributions, you won’t need one anyway. When it comes to investing, consistency is more important than timing.
Step 9: Get Started!
None of this information matters if you don’t put it into action. The critical first step with investing is always to begin. You don’t need much money to do that, or even any money at all.
You can either open an investment account with just a few dollars, or open one with zero and set up regular contributions.
Those contributions will help you gradually build a growing investment portfolio through dollar-cost-averaging. In that way you won’t have to worry about what the market is doing at the time you invest.
Since you’ll be investing regularly, you’ll be investing in all types of markets, at all price levels.
Don’t Let Lack of Knowledge Stop You
There are plenty of investment apps and investment information services to will help you become a successful investor, even though you’re just starting out–hey, maybe you can call yourself an apprentice now, at a minimum!
Some will even fully manage your investments for you, and at a surprisingly low cost.
And once you’re ready to begin trying your hand at self-directed investing, go slowly.
Make sure you have a solid base of emergency savings and managed investment accounts.
Then gradually move into self-directed investing on a diversified investment platform, one with all the tools you’ll need to be a successful investor.
At some point you may even decide self-directed investing isn’t your thing, and that’s fine.
Very few people could remotely qualify as investment experts, so you’re in good company if you’re not one of them.
But you can still take advantage of managed accounts, like Betterment, to handle the work of investing for you.
The only requirements are a willingness to get started, and a decision to commit to the long-term, and you’ll have everything you need to be a successful investor.
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Good Financial Cents, and author of the personal finance book Soldier of Finance. Jeff is an Iraqi combat veteran and served 9 years in the Army National Guard. His work is regularly featured in Forbes, Business Insider, Inc.com and Entrepreneur.
When you’re working with investments and trying to make sound decisions, it’s best to use hard data and publicly available information instead of relying on subjective feelings like your instincts. Your emotions may easily be swayed, but it’s hard to argue with numbers and facts.
Fundamental analysis, or FA, is one method that can help inform your choices regarding whether or not a company makes a good investment option. FA isn’t just for finance experts; it can help you make independent decisions about your own investment portfolio. Below, we’ll explore the fundamental analysis basics, how to practice this method, and explore other investment tips.
What is Fundamental Analysis?
Fundamental analysis is a way to determine a security’s fair market value by examining different financial and economic factors. The state of the economy, industry conditions, or the effectiveness of a company’s leaders can all influence fundamental analysis.
The main purpose of FA is to decide whether or not a security’s current pricing is overvalued or undervalued. Ideally, you’ll be able to find a company whose value is greater than or will be greater than its current market value.
Understanding Fundamental Analysis
Fundamental stock analysis helps potential investors figure out whether a security’s value makes sense within the market at large. FA can be conducted on a micro or macro scale in order to choose securities.
Analysts typically start from a wider perspective, such as current economic conditions, and then hone in on an individual company’s performance. Variables like interest rates, the state of the economy, and the bond issuer’s credit ratings may all come into play. Basically, any public data can be used to evaluate a security’s value – but we’ll dive specifically into what kinds of data and information fundamental analysis evaluate below.
Quantitative Fundamental Analysis
When you start to investigate a company to determine its potential for growth and overall health, it’s essential to get a good read on the underpinnings of the business. Of particular importance is understanding the financial statements of a company. This is what’s called quantitative fundamental analysis since you’re focused on the hard numbers a company provides.
A business’s income statement, balance sheet, and statement of cash flows are three large indicators that determine the overall health and success of a business.
Income statement: The income statement shows a company’s profit after expenses are taken out. It also reveals a company’s performance within a specific time period.
Balance sheet: A balance sheet reveals business assets compared to its liability and shareholders’ equity. A balance sheet follows this simple equation: Assets = Liabilities + Shareholders’ Equity. Assets can be cash, buildings, inventory, or equipment.
Statement of cash flows: The statement of cash flows shows where money comes in, goes out, and for what purpose. In most cases, a statement of cash flows focuses on the activities below:
Cash from investing (CFI): Cash used for investing and from the sale of other businesses or assets.
Operating cash flow (OCF): Cash made from business operations.
Cash from financing (CFF): Cash received from borrowed funds.
Qualitative Fundamental Analysis
Numbers don’t always give you the full picture. That’s where qualitative fundamental analysis comes in to help. For example, part of your qualitative investigation might come from a company’s annual report. In an annual report, a company’s leaders will explain the company’s performance and mention a strategy for the future.
Qualitative information might also come from the company’s brand name recognition, patents, the performance of key executives and leaders, and proprietary tech. Here are some basic fundamentals you’ll want to pay attention to conducting a qualitative analysis:
Business model: Although this seems straightforward, it’s important to look at how the company makes its money (aka the business model). Does it sell a main product or mostly coast by on fees and franchising?
Competitive advantage: A company can do well for a while based on its own products and services… until another company comes along and does it better. That’s why it’s incredibly important for companies to show a competitive advantage and be able to maintain it over the long term. Need an example? Think about the staying power of large corporations like Coca Cola or Johnson & Johnson.
Leadership: There are a few experts that believe management is the most important part of the decision to invest in a company. And if you think about it, it makes sense. Even a company with a million-dollar idea can tank under the influence of incompetent leadership. With that said, it’s hard for small-time investors to go in and meet managers or vet them in an interview. Instead, you can look through the company’s main website to read about a company’s top executives. If you want to go a step further, you can even investigate board members and execs’ performance at their past companies.
Corporate governance: Corporate governance refers to the policies that guide the relations between management, directors, and shareholders. You’ll find references to these policies in the company charter. The rules and bylaws governing how a company does business are important to know. Why? Because it’s important to put your money into a company that’s ethical and fair. Make sure to note any sections referring to management and shareholder interests. As a potential shareholder, you’ll want to see transparency and fairness as guiding principles.
Qualitative information is more abstract, but it’s not any better or worse than quantitative information. In fact, qualitative indicators provide analysts with a way to put the numbers in context and can provide insight into the business’s future. Most fundamental analysts use a combination of both qualitative and quantitative data to arrive at their conclusions.
So, what does an analyst do with the information after they’ve conducted a fundamental analysis of a stock?
If an analyst finds that a stock’s value is more than the stock’s current price, they might publish a “buy” or “undervalued rating” for the stock.
If an analyst finds that a stock’s value is lower than the current price, they might publish a “sell” or “underweight rating” for the stock.
Investors who follow analyst recommendations use them to buy stocks with good ratings since they deem them to have a higher chance of growing in value over time.
Examples of Fundamental Analysis
There are different approaches analysts use for fundamental analysis but they can be placed into two main buckets: top-down analysis and bottom-up analysis. The first, top-down refers to an approach that takes in a larger perspective of the economy. That view gets narrower, from the economy, to the sector, to industry, and then whittled down to an individual company.
Bottom-up analysis starts with a particular stock and then zooms out to consider all the other variables that influence its market price.
The tools that a fundamental analyst uses depends on what asset is being traded. The tools that can be used in fundamental analysis can be found below.
Fundamental Analysis Tools
Fundamental analysts use a variety of tools to measure the value of a stock. Although an analyst might not use all of the ratios and calculations below, these represent common metrics you might find useful.
Return on equity: To get this metric, divide the company’s net income by the shareholders’ equity, this will give you the return on equity. Return on equity is also referred to as a company’s return on net worth.
Dividend yield: This is a stock’s yearly dividends in comparison to the share price, expressed as a percentage. To get the dividend yield, you need to divide dividend payments per share in one year by the value of a share.
Dividend Payout Ratio: This ratio shows what was paid out to the shareholders in dividends compared to the company’s net income. It shows you a security’s retained earnings.
Price to Book Ratio (P/B): Also referred to as price to equity ratio, this ratio compares a stock’s book value to its market value. To get this ratio, you can divide the stock’s most current closing price by last quarter’s book value per share. The definition of book value is the value of an asset, as it appears in a company’s books.
Price to Sales Ratio (P/S): The price-to-sales ratio tells what a company’s stock price is as compared to its revenue. It’s also referred to as the PSR, sales multiple, or revenue multiple.
Projected Earnings Growth (PEG): PEG is an estimate of what the one-year earnings growth rate of the stock will be.
Price to Earnings (P/E): This ratio compares the current sales price of a company’s stock to its per-share earnings.
Earnings Per Share (EPS): The number of shares or the earnings can’t tell you very much about a company isolated by itself, but if you put those numbers together, you get an EPS or Earnings Per Share. EPS gives you an idea of how much a company’s profit is assigned to each share of stock
How to Improve Your Understanding of Fundamental Analysis
Do you want to ensure that you have a concrete understanding of fundamental analysis? Consider giving yourself a homework project like the one below to practice your skills.
Follow two stocks for three months
Opt for one stock that you like and one that you don’t. Make sure you examine the fundamentals of each and try to make a choice about each stock according to the information you gather on those metrics. Take note of the progress of each stock pick and evaluate performance from the selection day up to the three-month mark.
Use a checklist
Now it’s time to get out the pencil and paper to compare hard numbers. Those ratios and other important numbers will comprise a checklist that you can use as your cheat sheet to evaluate a stock or security.
Figure out your benchmarks
When you analyze stocks that you’re interested in tracking, use another stock in the same industry to act as a benchmark. What’s a benchmark? Benchmarks serve as a standard way for analysts to study the stock you’re evaluating.
But remember, not all stock comparisons make sense – you’ll need to compare similar companies. Comparing Google with a heavy industry stock like Steel Dynamics Inc. won’t yield any useful information for you. Make sure you use ratios and comparisons among similar companies, industries, or sectors. For example, comparing JPMorgan Chase and Bank of America would potentially reveal usable information for you regarding each company’s health and value.
Pros and Cons of Fundamental Analysis
FA helps you better evaluate a stock within a broader context. Although this stock analysis method has many benefits, it also has a few drawbacks to consider as well. Below, we’ve laid out a few key pros and cons:
Pros of Fundamental Analysis
Easy to gather data: FA uses lots of publicly available data, which is fairly easy to acquire and analyze.
Provides more relevant context: Knowing you’re putting your money into a company with a healthy financial background is typically a good idea.
Gives you peace-of-mind: Although a company that performs well and has strong business underpinnings doesn’t guarantee success, it can still help you make a sound investment decision for the long-term.
Cons of Fundamental Analysis
Time-consuming: Each company needs to be analyzed and studied independently. Depending on what data you’re gathering and what numbers you’re crunching, this can be a significant investment of your time and effort.
Unique datasets necessary: Because fundamental analysis involves public information, it’s fairly difficult to find unique datasets that have limited publication to gain an edge.
Short term “blindness”: Short-term volatility can’t be predicted by past financial statements.
Fundamental Analysis vs. Technical Analysis
When you start researching fundamental analysis, you’ll likely see another analysis method come up in your search results: technical analysis. Technical analysis is based on only a stock’s price or on its volume data. Instead of predicting the future, technical analysis, or TA, attempts to figure out price patterns.
Technical analysts use chart patterns, trends, price, and volume behavior to identify stocks with the greatest chance for growth in value. It doesn’t take into consideration the business’ health or the broader economy.
The main difference between fundamental and technical analysis is that fundamental analysts want to figure out the difference between a stock’s intrinsic value versus its current market price. Technical analysis is focused on price action, which points to a stock’s supply and demand pattern. While this isn’t always the case, FA is often used for long-term investments, and TA is typically used for short-term investments.
The debate over fundamental and technical analysis is ongoing. Fundamental analysis can be more helpful for figuring out long-term investments while technical analysis is better served for short-term trading and timing the market. You can use both to plan investments over the short term and long term.
Top Research Tools for Fundamental Analysis
Finviz: Finviz allows you to screen stocks based on fundamental parameters you set. You can use the free version to access basic information or upgrade to the subscription model for more comprehensive access.
TD Ameritrade: TD Ameritrade is a very popular online brokerage with a huge section dedicated to stock research. You can use the site’s stock screener to filter stocks based on the fundamental benchmarks you choose. You’ll also be able to peruse other types of research like investing newsletters from major news sites.
Yahoo Finance: Yahoo is one of the oldest sites that shows investors stock data. You can use the search bar to explore different data sets. Explore a company’s historical data, financial reports, and statistics.
Fundamental Investing Tips
Every investor has their own strategy for investing in stocks. Fundamental analysis can be a great method to use, but it comes down to personal preference and your overall financial objectives.
For example, if you’re interested in steady growth, then you’d probably look for a company that would make a sound long-term investment. So, you’d focus on the fundamentals to evaluate what company to invest in, based on how the business is expected to grow over a longer timeline.
For value investors, the focus is on identifying a stock that makes a good buy. In turn, you’d use tools like dividend yields and low P/E ratios which show strong fundamentals within a market that undervalues it.
When you’re first getting started with fundamental analysis, focus on the basics in the beginning. It’s very easy to get overwhelmed when faced with a veritable tidal wave of ratios, figures, and numbers. Instead, focus on simpler numbers like profits and earnings or revenue to determine whether or not a stock makes a good investment. These fundamentals don’t guarantee future earnings, but it’s a way to “hedge your bets”. Once you feel like you’ve built up experience with looking at basic numbers, you can jump into more complex figures to evaluate your stock options.
It’s also a smart idea to think about what you’d gain from working with a professional advisor as opposed to working on your own. If you’re a brand new investor, you can use an online brokerage to make stock trading lower cost and user-friendly.
Wrapping Up: Learning Fundamental Analysis, One Stock at a Time
Investors use a variety of methods to evaluate whether a stock makes a good investment choice – fundamental analysis is just one of them. Although you can practice this approach on your own, you might find more success working with a financial advisor that can help you tailor your investment strategy to better align with your money objectives.
Here are a few main takeaways to remember before putting money in an investment and to help you avoid beginner investing mistakes:
Know your objectives: Make sure that you understand your objectives before you get started. Do you want long-term growth? Are you looking for short-term gains? Are you focused on value? How long will you hold the stock?
Decide on DIY or use an advisor: Do you feel confident in your knowledge and ability or will you rely on an expert (or robo-advisor) to help you plan your investment strategy?
Take care of other financial priorities: Do you have enough money to portion out for an investment, or are there financial priorities that demand your attention first? For example, you might want to pay off any high-interest credit card debt before funneling money into an investment since any returns might be negated by high interest rate fees from your debt.
Don’t forget all investments are a risk: All investments represent a risk, although it’s true that some investments are riskier than others. Even if you conduct an incredibly thorough fundamental analysis, it doesn’t provide you with any foolproof guarantees.
If you want to better comprehend how your investments will impact your overall finances, you may want to consider using Mint’s investment calculator. This online financial calculator can help you understand what gains you can expect over time. By entering in a few key numbers, you can generate your own investment goals, forecast growth, and look for potential opportunities to increase your portfolio’s success.
Want to learn more about investing and investment strategy? Both SEC.gov and investor.gov are good resources to help boost your investment comprehension.
You invest in making your money grow, but your chance of loss is much higher than anything else without asset allocation and diversification.
Fortunately, learning the basics of asset allocation and diversification is not as hard as it sounds. Check out this beginner’s guide to the investment strategies you should implement today.
What Is Asset Allocation?
Asset allocation is the way you divide your investments between different asset classes within your portfolio to help you reduce risk and possibly increase returns over time.
Chances are you will invest in the most common asset classes such as stocks, bonds, and cash investments. It is important to remember that there are many other investment options available to you. Investing in alternative options such as real estate, farmland, and commodities will help you diversify your portfolio and mitigate risk.
Investment Options
There are several asset categories to choose from when making your asset allocation plan. Here are a few investment options to consider when making the best choice for your financial goals.
Stocks
Stocks are a type of security that gives the company’s investor part ownership and a share in that company’s earnings. With stocks, anyone can invest in some of the most successful companies around the globe.
Bonds
Bonds are like an IOU. The investor who buys the bond is loaning money to the issuer for a fixed amount of time. At the end of that period, the bond is paid back to the investor. Interest is typically paid twice a year.
Cash
Cash investment is a short-term obligation, usually about 90 days. Investors can expect a return in the form of interest payments. They’re shallow risk and usually insured by the FDIC.
Alternative Investment Options
Any investment that falls outside of stocks, bonds, and cash would be considered an alternative investment. This would include tangible assets such as art, wine, antiques, coins, stamps, and financial assets like real estate, venture capital, hedge funds, commodities, and farmland.
Many people fail to consider alternative investments when creating their asset allocation plan, which is a huge missed opportunity. Take farmland, for example. When you invest in farmland, the risk is relatively low, and it’s resilient to inflation in times of market turmoil.
Farmland returns have been positive every year since 1990, yet several investors don’t know this is an option for their portfolios. Investing in farmland is easier than ever with companies like FarmTogether. FarmTogether provides an all-in-one investment platform that helps you grow your wealth and diversify your platform with investment minimums as low as $10,000.
Think of asset allocation as spreading your investments across various asset categories. You spread out the risk by investing in some or all asset categories since they typically work inversely (when one does well, another may decrease and vice versa). It’s important to do your research to build the best asset allocation for your portfolio.
Choosing the Best Asset Allocation
Wise investors will build a portfolio based on factors that include risk tolerance, time horizon, and overall financial goals.
Asset Allocation Based on Risk Tolerance
Risk tolerance is the degree of loss an investor can handle while making investment decisions. Investors usually fall into three main categories: aggressive, moderate, and conservative. For example, if you have a low-risk tolerance, your portfolio will consist of mostly conservative, low-risk investments. If you have a high-risk tolerance, you’re willing to take the risk of losing ‘everything’ in exchange for higher rewards.
A higher risk tolerance leaves room for heavier investments in aggressive assets, such as stocks, and a lower risk tolerance calls for more conservative investments, such as bonds.
No matter what category you fall within, you will still have a mix of different asset classes within your portfolio. It’s the percentage of funds you allocate to each class that’ll change.
Asset Allocation Based on Age
Your age and risk tolerance will have a large impact on your asset allocation decision. Many investors will use the common asset allocation rule called The 100 Rule when making investment decisions.
The rule states that you should take the number 100 and subtract your age. The answer should be the percentage of your portfolio that you invest in stocks.
If you’re 35, this rule suggests you should devote 65% of your money to stocks. The rest would be spread out between different asset classes. The rationale behind this rule is that younger investors will have longer time horizons to weather the volatile stock market’s storms.
If you’re nearing retirement, you need your money sooner. There are some risks in all investments. However, those close to retirement may want to focus more on low-risk investments such as high-grade bonds, money market funds, and certificates of deposits.
Asset Allocation Based on Goals
Some asset allocation plans are built with a specific goal in mind, like saving for the purchase of a car, house, or college tuition. Your goals are taken into consideration when building your risk profile and time horizon.
This means that someone nearing retirement may have a portfolio with higher risk investments if they put money aside for a new grandchild’s college tuition.
Note:Some critics are concerned that some investors may be taking on more risk than necessary with this asset allocation plan.
Still, every investor is different and has varying levels of risk tolerance.
Why Asset Allocation Is Important
Asset allocation helps investors lower risk through diversification. Historically, each of the asset categories has worked inverse of one another. When one does poorly, the others do well. Allocating your assets according to your risk tolerance and financial goals helps you make sound investment choices based on research rather than emotion.
What Is Diversification?
Diversification is the technique of spreading your investments around, so your exposure to risk in one particular asset category is limited. This practice was designed to help investors lower the volatility of their portfolios over time.
How to Diversify
There are numerous ways to diversify, but a good rule of thumb is to invest in various industries and/or companies.
For example, if you’re interested in investing in technology, don’t put all your money into one technology company. Instead, allocate a portion of your funds to a few technology companies, and the remaining funds should be invested in other industries not related to technology.
If you like a specific industry and feel strongly about investing a large portion of your portfolio in it, make sure you diversify your remaining funds as much as you can. The goal is to reduce risk. If that one industry were to become very volatile and tank in the market, so goes your portfolio with it if it’s not well-diversified.
When you have investments that you can depend on even during market downturns, it may be possible to take on more high risk, high reward investments in other areas of your portfolio.
Why Is Diversification Important?
Diversification is important because you can maximize your returns by investing in different areas that would react differently in the same volatile market.
For example, if you only carry a spare tire in your vehicle, that won’t be of much use if your battery dies. That doesn’t mean you get rid of the spare tire and go purchase jumper cables. To lower risk, you would carry both items and any other item that would help you if anything were to happen to your vehicle.
This is the same with investments. Since there will always be a risk for investing, diversification is one of the best ways you can mitigate that risk while maximizing your returns.
Can Diversification Reduce All Risk?
No diversification strategy eliminates all risk, but diversification can reduce unsystematic risk or risk specific to one company. This risk is an isolated event that happens to a particular company that is not likely to happen to other companies, such as a natural disaster.
If one company burns down, it’s improbable that every company in your portfolio will, too. Diversifying among different companies eliminates or reduces unsystematic risk.
This risk affects the market as a whole. Nationwide or worldwide events, such as war or inflation, are systematic risks because they could affect any or all companies within your portfolio no matter how much you diversify. Remember, the diversified portfolio definition aims to reduce risk. However, it doesn’t eliminate it.
When researching the best ways to diversify your portfolio, consider different factors that could affect your portfolio, reaching your financial goals. For example, you can choose between related diversification and unrelated diversification.
Review the risks and potential returns to ensure they align with your financial plan.
What Is a Well-Diversified Portfolio?
Every investors’ goal should be to minimize risk while maximizing performance. To create a well-diversified portfolio, you should invest in a variety of industries and assets. In other words, don’t put all your money into one category.
Even if you were to invest in all stocks (which you should not), a diversified portfolio would invest in companies across all industries. This way, if one industry, say farming, fell hard, while another industry, such as technology, did well, you’d offset your farming losses with your technology wins.
What Is Rebalancing?
Rebalancing of investments is the process of bringing your portfolio that has deviated away from your target asset allocation back into line. This deviation can occur due to adding or removing funds from your account or due to natural market fluctuation.
This offers investors the opportunity to sell high and buy low. And it takes gains from high-performing investments, reallocating them to securities or other investment options that have not yet experienced such growth.
How Rebalancing Works
Periodically, investors should review their portfolio asset allocations. Once you’ve determined your ideal asset allocation and ensured it aligns with your financial goals. And compare it against where your portfolio currently stands.
For example, if your ideal asset allocation is 50% stocks and 50% bonds and yet your portfolio has fluctuated to 63% stocks and 37% bonds, it would be time to make some adjustments.
Investors rebalance their investments by purchasing and selling portions of their portfolios to set each asset category’s weight back to the ideal asset allocation.
Dangers of Imbalance
If a portfolio has a much higher stock percentage than what the investor has listed in their ideal asset allocation, there’s a higher chance of risk. If the investor’s stocks are currently invested in experiencing a sudden downturn, their portfolio will suffer a great loss.
There’s no required schedule for rebalancing your portfolio. Due to fees that may be associated with buying and selling securities, you should choose a schedule that won’t be too costly or time-consuming.
Some financial advisors recommend reviewing and possibly reallocating your portfolio every 6 to 12 months. Every investor is different. So do your research and/or talk to an investment advisor to create the best plan for your goals.
Protect Your Investments with the Right Strategy
Asset allocation and diversification can be an active strategy to varying degrees. As an investor, you have the choice to review your investments on your own, hire a financial advisor, or use an automated service such as a robo advisor to ensure you have a well-balanced portfolio.
Having an asset allocation plan that works best for you will greatly impact your financial goals. Investing is rarely a ‘set it and forget it’ type of deal. Whether it be financial or otherwise, any goal will require a level of intentionality that cannot be skipped. This includes building a diversification plan to maximize your returns while reducing risk.
Final Thoughts
Creating an asset allocation plan and diversifying your assets is smart to begin planning for your retirement or building wealth. The best asset allocation plan varies from person to person. Ensure you do your research and work towards a plan that will help you reach your personal financial goals.
Master the art of asset allocation and diversification to ensure your portfolios make your money work for you. When you diversify and allocate your assets, you give your money the best chance to grow.
Monte Carlo Simulation is a cool, powerful, and simple method for modeling seemingly random scenarios. Today, I’ll go over the basics of Monte Carlo simulation. We’ll walk through a simple example together. And then I’ll link to some of the cool ways I’ve used Monte Carlo here on the Best Interest.
Table of Contents
The Basics of Monte Carlo Simulation
When you hear “Monte Carlo simulation” you should think “lots and lots of random trials.”
For example, you might ask, “How often does a Texas Hold ‘Em player get dealt two aces?” A true statistician would be able to use statistical equations to answer that question.
But you could also use Monte Carlo analysis. You could teach a computer to randomly deal a two-card hand, and then repeat than random dealing another billion times. Over those billion random trials, an accurate probability of a two-ace hand will become apparent.
Cards and dice and darts are easy targets for Monte Carlo simulations. But they can also be used to on more complex models, such as weather predictions.
For example, the “spaghetti plot” above is a product of a Monte Carlo simulation. Meteorological models utilize fluid dynamics—which is famously unpredictable. That “unpredictability” can be tamed using the Monte Carlo method!
Unsure whether the winds will shift faster or slower? Simulate both a million times. East or West? Warm water or cold water? A hurricane’s path might depend on a million different variables. Monte Carlo simulations can take those million inputs, vary them millions of times, and then output a huge range of results.
One set of inputs says, “Miami, get crushed.” Another set predicts the hurricane won’t even make landfall. Over millions of simulations, a probability distribution emerges. Miami might only get crushed in 0.001% of the results—it’s probably safe.
Monte Carlo Simulation Origin and Naming
You might recognize Monte Carlo as the name of the famous casino in Monaco. Indeed, the two mathematicians (including the famous John von Neumann) who developed the Monte Carlo method named it after the gambling house.
But their original purpose for Monte Carlo simulations was anything but fun and games. They were working on nuclear weapons at the Los Alamos National Laboratory.
Unsure how deep a high-energy neutron will penetrate fissionable uranium?
Just simulate its random path a billion times.
Monte Carlo Simulation – Finding Pi
Let’s put the Monte Carlo method to work!
The mathematical value π, or pi, is the ratio of a circle’s circumference to its diameter. The ancients—Egyptians, Babylonians, Greeks, Indians, Chinese—all realized that understanding pi was essential to mathematics, astronomy, and engineering.
But the problem is figuring out exactly what the value of pi is. We now know that it’s 3.1415926535…but how could we find that out without a complicated algorithm?
One answer, as you might guess: a Monte Carlo simulation.
The Monte Carlo Simulation Setup
This simulation is beautifully simple.
Imagine a 2 x 2 square. And inscribed in that square is a 2″ diameter circle. It looks like this.
Each small square is 1 x 1. We know that the area of the full square is 2 x 2, or 4 square units.
We also know that the area of the circle is π*r^2, where r is the radius of the circle. Conveniently, the radius here is 1. Therefore, the area of the circle is pi square units.
Now let’s introduce some Monte Carlo simulations. Imagine I had a million monkeys randomly throwing darts at this target. How many darts would we expect to land inside the circle?
The percentage of darts inside the circle would be equivalent to the area of the circle divided by the area of the square. 100% of the darts land in the square, but a lesser percent end up in the circle.
If the circle occupies about 70% of the square, then we expect about 70% of the darts to hit inside the circle. Makes sense, right?
Conveniently, we already know that ratio of areas. It’s equal to pi (the circle’s area) divided by 4 (the square’s area). If I had a million (or billion, or trillion) monkeys throw their darts into the square, the percentage of darts that land inside the circle would be equal to π/4.
If I take that percentage and multiply it by 4, then I’m just left with π. And that’s that.
I’ve discovered π.
Finding Pi in Action
Let’s get those monkeys working!
100 Darts
To keep things simple, let’s start with 100 darts. I ran one trial of 100 darts and 79 of them ended up inside the circle. If we use our equation above, we take 79/100 and multiply it by four. That gives us 0.79*4 = 3.16.
Our first estimate of pi is 3.16.
I could run this Monte Carlo simulation again and—perhaps—only 72 darts end up in the circle. Or 75. Or 81. There’s a random element at play here. Small data sets—like only 100 darts—are typically more affected by randomness than larger data sets.
That’s why Monte Carlo simulation is all about the power of big numbers. As we throw more darts, the noise of randomness becomes increasingly quiet. And it’s easy for computers—in this case, the software MATLAB—to simulate lots of monkeys throwing lots of darts.
100,000 Darts
So, next I asked my MATLAB monkeys to throw 100,000darts.
78,535 darts land inside the circle, which means this estimate for pi is 3.1414.
10,000,000 Darts
For good measure, let’s do one more. I’m going to employ every monkey on Earth, all ~10 million of them. I’m not even going to show you the target, because it just looks like a block of blue dart holes.
7,854,485 of the darts land inside the circle. That’s higher than most monkeys can count.
This estimate for pi is 3.141794.
The actual value of pi is 3.141592…
Out of 10 million darts, the monkeys hit the target about 600 times more than expected, for a percent error of 0.0006%. Not bad.
P.S.—For every dart, I randomly assigned it a landing point on the board, and then did some quick math to ask, “Is this dart inside the circle?” That math was calculated for each of the 10 million simulated darts. It took MATLAB 66 seconds to do all that math. Computers are fast.
1000 Trials, 100,000 Darts Each
One last simulation. This one will show you the variation that can occur from one trial to the next. 1000 trials, each of 100,000 darts.
Below is a histogram showing the frequency of results from those 1000 trials.
Some monkeys walk away thinking pi is 3.12. Others think 3.16. But a clear and correct pattern emerges when all the data is examined. The most likely value of pi is right around 3.14.
Monte Carlo Simulations and Money
Why did I bother writing about Monte Carlo simulations today? Am I suggesting that your best bet in personal finance is understanding the roulette table?
No, not at all. Most of the “secrets” of personal finance are simple, and most of your personal finance goals should be basic.
But Monte Carlo simulations have financial use (albeit limited) when the exact results of a future scenario are unknown and/or completely random. For example, the stock market!
Now, I know that some detractors will immediately have a visceral reaction to the idea of simulating the stock market. I understand. And I address those concerns below.
But if we are to believe that the stock market has a significant aspect of randomness to it, then a Monte Carlo simulation should help us understand a possible range of outcomes in the future. It could even help us create a probability distribution of possible outcomes.
For example, the last of these five helpful plots uses Monte Carlo simulations to examine portfolio performance.
And this updated Trinity Study 4% Rule also uses randomized Monte Carlo simulations to examine how the “4% rule” of retirement might change in the future.
Did you read the results of the Best Interest stock picking competition?I won’t spoil the results. But it’s a perfect example—and a great lesson—in simulation randomness.
But you can’t model the stock market!!
To the detractors—I understand. Anyone who builds simulation models for a living will tell you that the downfall of models is “garbage in, garbage out.”
Imagine I go back to the Monte Carlo model that predicts how often I’ll deal two aces. An important assumption that goes into that model is that a deck has 52 cards. Another important assumption is that 4 of those 52 cards are aces.
If I get those assumptions wrong—say, 4 aces out of 42 total cards—then my result will be completely wrong. My mistaken input—garbage in—will lead to an incorrect output—garbage out.
The same thing happens when simulating the stock market, except the market is significantly more complicated than a deck of cards. Anyone who tries to model the market—including yours truly—is getting something wrong. For example:
Is picking stocks just like a coin flip?
Is a ‘random walk’ truly random?
Do stock returns best fit onto a Gaussian distribution, a Laplacian distribution, or an Orstein-Uhlenbeck distribution? (Yes, the sharp nerds at Reddit called me out on this one.)
These are all good questions, and they rightly poke holes in my attempts to model markets using Monte Carlo simulations.
That’s why I constantly nag you to use boring investing methods. Just index and chill.
While I (obviously) think Monte Carlo simulations have their place, I’m not putting all my trust into dart-throwing monkeys. Nor should you.
Randomness happens, and Monte Carlo simulations can help tame that randomness.
I hope you continue to roll the dice and return for future Best Interest articles. If you’re feeling really lucky, consider signing up to get these articles dealt straight to your inbox.
Tagged model, monte carlo, simulation, stock market
Wrapping Up: Learning Fundamental Analysis, One Stock at a Time
