Financial Goals Archives - Hanover Mortgages

November 27, 2021

The Difference Between Current Balance and Available Balance

Numbers don’t lie, but they may play a trick or two.

And one of the most bothersome can be determining whether the current balance or the available balance on a bank account is the most correct. In actuality, they both are. A current balance is the amount of cash presently sitting in a checking or savings account at any given time. However, the available balance is the current balance minus any pending transactions that haven’t been fully processed yet.

Financial institutions provide both of these balances in an effort to provide account holders with the most detailed picture of their funds, however, it has been known to confuse many uninformed account owners. Understanding the differences between a current balance and an available balance is extremely important as it provides a clear guide for future spending.

What is Current Balance?

The current balance of an account is a reflection of the amount of funds that are moving throughout a checking account or savings account at any given time. This is a compilation of both credits and debits — incoming and outgoing funds — within an account. It includes transactions that have been completely processed on both ends and posted to an account.

Pending transfers or payments that have been authorized but have not been fully processed yet may be listed in your transaction history but are not included in the tally. So any debit card payments, mobile deposits, or automatic bill payments that haven’t been fully processed will not be calculated into the current balance.

For example, let’s say Brian’s checking account balance is $200. On Monday, his employer deposits an $800 payment into his account that clears and posts on the same day, raising Brian’s current balance to $1,000. On Wednesday, Brian uses his debit card to pay $100 for dinner, and the restaurant places a hold on his account for the amount. Because the payment is pending and awaiting processing, Brian’s current balance is still $1,000. However, if on Friday the restaurant charge is fully processed and posted onto his account, his current balance would drop to $900.

What is Available Balance?

An available balance is the current balance of a checking or savings account, minus any pending payments and deposits. At essence, it takes the total amount of all fully processed and posted credits and debits, and subtracts the total amount of any pending payments that have yet to be fully processed, providing a more accurate reflection of the money in your account that remains available to be spent.

For example, Danielle’s checking account balance is $500. She uses her debit card to pay a $100 internet bill, and her landlord cashes her $300 check for her rent — both payments appear on her account as pending. Despite her current balance being $500, her available balance is only $100 due to the pending payments. If she were to make other payments totaling more than $100, she will risk an overdraft fee.

Recommended: Different Types of Savings Accounts You Can Have

What is the Difference Between Current Balance and Available Balance?

If an account goes a week or two without any activity, its available balance and current balance will likely be in sync. However, once purchases and payments are made with a debit card, that is when the available balance is likely to fluctuate.

The key difference between a current balance and an available balance is “promised payments.” A current balance is the total amount of money in an account including money that has been promised to other people or businesses. An available balance, on the other hand, is the specific amount of money available that has not been promised to any person or business. While spending the full amount of a current balance with pending payments could result in overdraft fees, spending the full amount of an available balance will not.

Generally, when a current balance and available balance differ, the available balance is the lower of the two, and it’s nearly always due to a pending payment. In some rare cases, however, an available balance may appear larger than the current balance. This could be due to receiving a refund from a purchase or the reflection of a bank overdraft protection buffer on an account. Either way, in this case, it would be wise to contact your bank for a better understanding of your current account standing.

How Long Does It Take for a Current Balance to Become an Available Balance?

The amount of time it takes for an available balance to sync back up with a current balance depends on the specific amount of processing time needed to complete each pending transaction, and those times can vary depending on the type of transaction and how quickly the establishment processes it. The account holder’s ability to refrain from spending with their debit card and adding more pending payments to the account is also a major factor.

As a general rule of thumb, individual pending payments can take as little as 24 hours, or as long as 3 days to be completely processed and posted to an account. The process requires communication and confirmation between the banks of the account owner and the establishment they purchased from. If a transaction remains pending for up to a week, that is when it would be wise to contact the merchant or your bank for clarity.

Which Balance Should I Rely On?

The current balance and available balance each serve their own purpose and both can be relied upon as an accurate representation of a checking or saving account. However, there are specific instances when it would be better to reference one over the other.

If you’re planning on making a purchase or withdrawal, that is an instance where it would be more beneficial to reference the available balance on your account. It’s the best way to know exactly how much money is available to be spent without disrupting any other pending payments. Checking the available balance will give the most exact account of what is freely available to be spent and will also help you avoid incurring any overdraft fees.

If you’re more interested in your account balance as a whole and how much money you have flowing through your account at any given time, that is when you’ll want to reference your current balance. It accounts for every dollar entering and exiting your account at the very moment you check it. Do keep in mind, however, that the available balance total may change quickly due to any sudden pending transactions, therefore it would be wise to check it daily for the most up-to-date tally.

Recommended: How Often Should You Monitor Your Checking Account?

The Takeaway

Knowing what your account balances mean and how to interpret them is a basic financial skill that can literally save you money. Even the slightest misinterpretation of the two could result in costly overdraft fees and disrupt your financial goals.

SoFi Money® is a cash management account that can help you keep tabs on your cash and help you reach your financial goals. You can save, spend, and earn all in one account with no account fees.

Check out SoFi Money.

Photo credit: iStock/fizkes

Source: sofi.com

November 27, 2021

Fixed Expense vs Variable Expense

Budgeting is the best way to get a better handle on where your money is going — which can help you get a better handle on where you’d like to see your money go.

But before you dive into the nitty-gritty of each individual line item on your ledger, you first need to understand the difference between fixed expenses and variable expenses.

As their name suggests, fixed expenses are those that are fixed, or unchanging, each month, while variable expenses are the ones with which you can expect a little more wiggle room. However, it’s possible to make cuts on items in both the fixed and variable expense category to save money toward bigger financial goals, whether that’s an epic vacation or your eventual retirement.

Let’s take a closer look.

What Is a Fixed Expense?

Fixed expenses are those costs that you pay in the same amount each month — items like your rent or mortgage payment, insurance premiums, and your gym membership. It’s all the stuff whose amounts you know ahead of time, and which don’t change.

Fixed expenses tend to make up a large percentage of a monthly budget since housing costs, typically the largest part of a household budget, are generally fixed expenses. This means that fixed expenses present a great opportunity for saving large amounts of money on a recurring basis if you can find ways to reduce their costs, though cutting costs on fixed expenses may require bigger life changes, like moving to a different apartment — or even a different city.

Keep in mind, too, that not all fixed expenses are necessities — or big budget line items. For example, an online TV streaming service subscription, which is withdrawn in the same amount every month, is a fixed expense, but it’s also a want as opposed to a need. Subscription services can seem affordable until they start accumulating and perhaps become unaffordable.

Recommended: Are Monthly Subscriptions Ruining Your Budget?

What Is a Variable Expense?

Variable expenses, on the other hand, are those whose amounts can vary each month, depending on factors like your personal choices and behaviors as well as external circumstances like the weather.
For example, in areas with cold winters, electricity or gas bills are likely to increase during the winter months because it takes more energy to keep a house comfortably warm. Grocery costs are also variable expenses since the amount you spend on groceries can vary considerably depending on what kind of items you purchase and how much you eat.

You’ll notice, though, that both of these examples of variable costs are still necessary expenses — basic utility costs and food. The amount of money you spend on other nonessential line items, like fashion or restaurant meals, is also a variable expense. In either case, variable simply means that it’s an expense that fluctuates on a month-to-month basis, as opposed to a fixed-cost bill you expect to see in the same amount each month.

To review:

• Fixed expenses are those that cost the same amount each month, like rent or mortgage payments, insurance premiums, and subscription services.

• Variable expenses are those that fluctuate on a month-to-month basis, like groceries, utilities, restaurant meals, and movie theater tickets.

• Both fixed and variable utilities can be either wants or needs — you can have fixed-expense wants, like a gym membership, and variable-expense needs, like groceries.

When budgeting, it’s possible to make cuts on both fixed and variable expenses.

Recommended: Grocery Shopping on a Budget

Benefits of Saving Money on Fixed Expenses

If you’re trying to find ways to stash some cash, finding places in your budget to make cuts is a big key. And while you can make cuts on both fixed and variable expenses, lowering your fixed expenses can pack a hefty punch, since these tend to be big line items — and since the savings automatically replicate themselves each month when that bill comes due again. (Even businesses calculate the ratio of their fixed expenses to their variable expense, for this reason, yielding a measure known as operating leverage.)

Think about it this way: if you quit your morning latte habit (a variable expense), you might save a grand total of $150 over the course of a month — not too shabby, considering its just coffee. But if you recruit a roommate or move to a less trendy neighborhood, you might slash your rent (a fixed expense) in half. Those are big savings, and savings you don’t have to think about once you’ve made the adjustment: they just automatically rack up each month.

Other ways to save money on your fixed expenses include refinancing your car (or other debt) to see if you can qualify for a lower payment… or foregoing a car entirely in favor of a bicycle if your commute allows it. Can you pare down on those multiple streaming subscriptions or hit the road for a run instead of patronizing a gym? Even small savings can add up over time when they’re consistent and effort-free — it’s like automatic savings.

Of course, orchestrating it in the first place does take effort (and sometimes considerable effort, at that — pretty much no one names moving as their favorite activity). The benefits you might reap thereafter can make it all worthwhile, though.

Saving Money on Variable Expenses

Of course, as valuable as it is to make cuts to fixed expenses, saving money on variable expenses is still useful — and depending on your habits, it could be fairly easy to make significant slashes. For example, by adjusting your grocery shopping behaviors and aiming at fresh, bulk ingredients over-packaged convenience foods, you might decrease your monthly food bill. You could even get really serious and spend a few hours each weekend scoping out the weekly flyer for sales.

If you have a spendy habit like eating out regularly or shopping for clothes frequently, it can also be possible to find places to make cuts in your variable expenses. You can also find frugal alternatives for your favorite spendy activities, whether that means DIYing your biweekly manicure to learning to whip up that gourmet pizza at home. (Or maybe you’ll find a way to save enough on fixed expenses that you won’t have to worry as much about these habits!)

The Takeaway

Fixed expenses are those costs that are in the same amount each month, whereas variable expenses can vary. Both can be trimmed if you’re trying to save money in your budget, but cutting from fixed expenses can yield bigger savings for less ongoing effort.

Great budgeting starts with a great money management platform — and a SoFi Money® cash management account can give you a bird’s-eye view that puts everything into perspective. You’ll also have access to the Vaults feature, which helps you set aside money for specific savings purposes, no matter which goals are the most important to you, all in one account.

Check out SoFi Money and how it can help you manage your financial goals.

Photo credit: iStock/LaylaBird

Source: sofi.com

November 24, 2021

Money Personality Quiz: Learn How Your Beliefs Affect Your Budget

Take this money personality quiz to learn how your subconscious beliefs about money impact your day-to-day spending decisions.

Ted Klontz knew he should save for retirement. He claimed he wanted to save, and he even hired a financial advisor to help him create a plan. But when the time came to direct funds into his retirement account, he didn’t do it.

Frustrated with himself, Klontz—researcher, author and co-founder of the Financial Psychology Institute^®—asked a friend for advice. The friend asked what retirement would mean for Klontz, and he instantly responded: It means you quit.

“In my family history, people who retired never did anything related to their entire work career—that part of their life just stopped. I loved what I was doing and couldn’t imagine ever quitting,” Klontz says.

After saying it out loud, Klontz, who has a doctorate in psychology, realized what had been holding him back. His internalized beliefs about retirement didn’t reflect his true vision for his future, but they shaped his actions in the present. By making that realization, he was able to imagine his dream retirement. In that dream, he would do work that inspired him, complete it on his schedule and live where he wanted to live.

Once this vision was clear to Klontz, he began catching up on his retirement savings. He put a plan together for selling his business so he could create the retirement he imagined for himself and his family.

“Evolving my belief about retirement shifted everything for me,” he says. “Sometimes those massive changes happen just by getting another piece of information, either from inside you or from somebody from the outside.”

Try this money personality quiz

A desire to understand how money shapes people’s beliefs and actions has informed the last 25 years of Klontz’s career. He has come to realize the importance of decoding people’s money beliefs—the subconscious ideas, typically learned in childhood, that drive their actions. Along with a team of researchers, he has developed a rigorous assessment to help people determine which money belief they are most impacted by.

What’s your money personality? Uncover how your own beliefs are shaping your financial behaviors by taking this money personality quiz, inspired by Klontz’s research.

Let’s explore why it’s important to understand your money beliefs and dive into the most common financial personalities:

What’s the value of knowing your money personality?

As a leader in the emerging discipline of financial psychology, Klontz—along with others in his field—has made the case that in order to improve your financial outlook, you need to understand your underlying financial beliefs.

Once you understand what your financial personality is, you can begin to change your behaviors, whether that’s your everyday spending habits or your long-term savings plan, Klontz says.

“The best financial plan, or the best investment advice in the world, isn’t a substitute for understanding one’s own relationship with money,” says Deborah Price, CEO and founder of The Money Coaching Institute and author of “Money Magic: Unleashing Your True Potential for Prosperity and Fulfillment.”

Understanding your relationship with money means digging deep into your money patterns and behaviors as well as what you learned growing up, where most behaviors are formed, Price says. The problem is that many people have blind spots and cannot easily understand these dynamics without guidance and support, she adds.

Maybe you say you are focused on building up your emergency savings, but you still overspend on clothes or travel instead of diverting that cash to your emergency fund. Or perhaps you want to prioritize saving for long-term financial goals, but you’re leaving extra cash in your checking account instead of transferring it over to your online savings account.

Learning to understand your financial behaviors can help you to spot ways in which you may unconsciously undermine your best efforts to improve your financial life, such as by saving or investing, Price says.

As you learn what your financial personality is and reflect on what type of spender you are, you can begin to understand why you spend a certain way, even though you say you want to do otherwise.

You can also transform your beliefs into steps that will help you manage your finances.

Uncover the most common financial personalities

It’s this gulf—the difference between what people say and what they do—that has motivated Klontz in his research over the years. He has worked with fellow researchers to collect data from thousands of people to analyze their subconscious beliefs about money. From that data, Klontz says they identified four primary financial behavioral patterns.

No one person will match one of these belief systems 100%. But by learning about the attributes of the common financial personalities, you can reveal your own tendencies and be able to answer the question: What’s my financial personality?

Here’s a rundown on these four behavioral patterns. You can see which one resonates with you by taking the money personality quiz above.

Money Avoidance

People with this pattern tend to believe money itself is bad and that people with too much money are ostentatious, Klontz says. “They don’t even bring the subject of money up,” Klontz adds. Money Avoidance may also mean not checking in on your bank account and avoiding a regular review of your bills, Klontz says. If you’re this type of spender and saver, you may believe there’s virtue in living with less money.

Money Worship

If you relate to Money Worship, you may feel that more money will mean greater happiness, Klontz says. You might believe that money can help solve the problems you encounter. Someone with this trait may be wary of other people managing their money. This type of spender is also more likely to carry credit card debt if they are spending to find fulfillment.

Money Status

With this pattern, people connect their self-worth with their financial success, Klontz says. While there are similarities with Money Worship, people with this trait focus more energy on outward displays of wealth. This type of spender may buy more than they can afford as a result.

Money Vigilance

Money Vigilance is defined as being careful about finances and being focused on saving. These beliefs can lead to positive behaviors, such as saving for a rainy day and planning for your financial future. At the same time, however, this type of spender may be anxious about money, Klontz says, and potentially even embarrassed by their financial success. These feelings may limit their ability to enjoy the benefits of financial security.

Learn which type of spender you are with a money personality quiz.

Tap into your own money personality to reach your goals

As you examine your deep-seated beliefs about money, you’ll learn a lot about yourself and be able to answer: What is your financial personality? This process will help you understand what type of spender you are today, and also shape how you spend and save for your future.

Once you’ve taken the money personality quiz, continue your journey with a financial vision board, which can help you align your financial decisions to your priorities in life.

Learn how creating a financial vision board can empower you to realize your major life goals—and even have some fun along the way.

Articles may contain information from third-parties. The inclusion of such information does not imply an affiliation with the bank or bank sponsorship, endorsement, or verification regarding the third-party or information.

This content is for illustrative and informational purposes only and may not apply to your individual circumstances.

Source: discover.com

November 18, 2021

What Our Dream Job Winner Learned from a Month of No Spending

Updated November 16, 2021

This is a photo of the Dream Job Winner Brittany Cantu. The quote says,

Brittany Cantu saved $621 during the Dream Job challenge. Photo courtesy of Brittany Cantu

Brittany Cantu was in shock when she found out she was chosen for The Penny Hoarder’s “Dream Job” challenge in October.

To earn her $5,000 paycheck, Cantu had to kick one of her most persistent spending habits and save money for 30 days — all in an effort to find new and healthier ways to manage her money.

Cantu was up for the job: She saved an impressive $621 simply by not buying stuff online during the course of the month.

As a registered nurse, wife, and mother of three, Cantu stays busy. In her free time, she had built a habit of online spending.

“I definitely have a shopping problem,” she said. “I use a deal website that gives me deals at places like Target and Amazon. It’s easy to overspend because my 10-month-old son doesn’t like to nap by himself so I get really bored when he’s sleeping on me.”

Her growing kids also factored into her online buying habit. “The kids grow out of their clothes constantly, so kids’ clothes is a huge item that we usually need to buy,” she said. And, shoes, don’t forget about the shoes. “Shoes are a big one for me. I have way too many shoes. I just like shoes.”

She was excited about the challenge because of the progress her family wanted to make toward their financial goals. “We want to buy a house in the next year or two, so it really helped us to get going on that a little quicker,” she said.

Not only will her newfound habit of spending less help toward that goal, but her $5,000 paycheck will as well. “We’ll probably use that toward a down payment,” she added.

She said the month-long experience helped her be more content with what her family already has — and actually provided an opportunity to make even more cash by selling some of that stuff.

I definitely felt like I built more of a habit of saving, rather than spending.

“I still browsed a little bit to see if there was anything I really needed, but honestly we have everything we need,” she said. “So I started going through some old stuff that we have and getting rid of it and making money that way too.”

She sold $200 worth of stuff during the month. Add that to the $621 she saved and that’s an $821 turnaround. Pretty impressive!

Did she find the challenge to stop online spending difficult?

“It definitely feels rewarding when you buy stuff and you get packages every other day. It was kind of hard the first week or two because I had such a habit of spending,” she said. “But it got easier as I went. I was actually surprised that it got much easier. I definitely felt like I built more of a habit of saving, rather than spending.”

She says she only gave in once because of a deal she couldn’t pass up. “I saw a sale on snow boots, and the kids definitely needed snow boots this year.”

The key, Cantu learned, is to remember how small purchases add up over time.

“Most of my purchases were around $30. That doesn’t seem like a lot, but when you keep buying that $30 stuff it becomes hundreds to thousands of dollars,” she said. “At the end of the month, I’m thinking, ‘Where did this money go?’ And then we don’t even use these things that we’re buying that often. So it’s definitely a habit you can break.”

She had a great experience meeting The Penny Hoarder Dream Job challenge, and she’s learned a lot over the course of the month.

“I was happy to be picked and challenged, and I think I really needed it. It was eye opening.”

What spending habit could you give up for a month to make progress toward your financial goals?

Robert Bruce is a Senior Writer for The Penny Hoarder.

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Source: thepennyhoarder.com

November 18, 2021

Acorns Review: An App that Lets You Invest Without Thinking About It

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You’ve probably heard of Acorns. It’s a popular micro-investing app — even among people who don’t know a lot about investing — that helps you save money in a diversified portfolio.

By using one of its most popular features, you invest money without even really thinking about it. We love that convenience.

But investing is actually a serious endeavor. In this Acorns review, we’ll cover the app’s features, investing strategy and cost, along with other important details you should know before you get started.

What Is Acorns?

Acorns is a California-based fintech company that helps simplify and automate investing. Users can contribute money to a passively managed, diversified portfolio through recurring transfers and/or spare change round-ups.

Founded in 2014, Acorns has quickly become one of the most profitable and popular micro-investing apps in North America. The start-up has an estimated 8 million subscribers and was valued at roughly $2.2 billion in May 2021, according to CNBC.

The company has steadily expanded its financial services over time. The Acorns app now offers banking products (including a checking account), educational resources, a debit card, custodial accounts for kids and an automated retirement account service.

Acorns derives about 80% of its revenue from monthly user subscription fees. The other 20% comes from interchange fees and brand partnerships.

Acorns offers two membership options to subscribers. Both accounts charge a flat monthly fee:

Personal

$3 per month. You get access to an investment account, a retirement account and a checking account.

Family

$5 per month. In addition to all the Personal account features, the Family account grants access to custodial investment accounts for children.

Let’s dive into what these services include and other features in the Acorns app.

How Does Acorns Work?

Getting started with Acorns is easy. You open an account by visiting the Acorns website or mobile app, enter some personal information and then link your banking account to the app.

Acorns has a $0 account minimum balance, but requires at least $5 to start investing.

Acorns Services

Acorns markets its saving and investing features with five different names: Invest, Later, Spend, Early and Earn.

Most features are available with the $3 account, but Acorns Early is only available with the $5 Family account.

Acorns Invest (Taxable Brokerage Investment Account)

This is a taxable investment account that puts your money into a collection of exchange-traded funds (ETFs). Acorns creates your portfolio based on a questionnaire designed to gauge your risk tolerance and financial goals. You’ll answer these questions when you create your account.

You can add money to your Acorns investment portfolio via round-ups, recurring transfers from your bank or one-time deposits.

We’ll discuss more about how Acorns invests your money.

Acorns Later (Traditional IRA, Roth IRA, SEP IRA)

This is a tax-advantaged retirement account.

A retirement savings account is an investment portfolio, but it comes with some specific federal tax perks (and a few penalties, especially for early withdrawals).

The Acorns app lets you pick from either a traditional or Roth IRA. They also offer a SEP IRA option for self-employed people.

Saving for retirement is important. If your employer doesn’t offer a 401(k) plan, opening your own individual retirement account is a great way to start growing your nest egg.

The Acorns Later (IRA option) is a separate account from your Acorns Invest (taxable brokerage account). You get access to both with the $3 tier.

Like Acorns Invest, your IRA portfolio is made up of ETFs. You can also set up recurring transfers from your linked account to your Acorns retirement account.

Acorns Spend (Checking Account/Debit Card)

Acorns Spend lets you open a checking account through the app’s partnership with Lincoln Savings Bank.

You’ll also get access to a Visa debit card connected to your Acorns Spend account.

The Acorns checking account doesn’t charge overdraft fees. Instead it pauses your account until you add funds and get your balance out of the red. It also doesn’t charge foregin transaction fees if you use your Acorns debit card abroad. Plus your card can withdraw cash from more than 55,000 fee-free ATMs globally.

You can fund your Acorns checking account four ways:

Direct deposit
Recurring deposit
One-time deposit
Mobile check deposits

Acorns Early (UGMA Custodial Accounts)

Acorns Early lets you set up investment accounts for your children, also known as a UTMA/UGMA account.

You can open multiple UTMA/UGMA accounts with an Acorns Family plan — whether they’re for your child, a grandchild, a niece or even a godson.

To get started, you’ll need the child’s full name, date of birth and Social Security number. Like Acorns’ other offerings, you only need $5 to get started with Acorns Early, and your money funds an automated, diversified portfolio of exchange traded funds.

A UGMA account is a custodial brokerage account for children. You can transfer this investment account to your child when they become a legal adult.

Unlike a 529 plan that can only be used for educational expenses, a UTMA/UGMA is more flexible on how the money can be spent (you can use the funds for anything that benefits the child).

Once the child reaches the age of transfer, usually 18 or 21, they become the account’s owner and can use the money for any reason.

Make sure to research the different types of investment accounts for kids or speak with a financial advisor to find the best account for you.

Acorns Earn (Cash Back Feature)

Formerly known as Found Money, Acorns Earn is the app’s online marketplace with over 200 brands.

When you shop with these merchants, extra money will be added to your Acorns Invest account, usually as a percentage of your order total or a flat dollar amount. For example, you can earn 50 cents on each Uber ride but 3.5% back on Uber Eats orders.

For “Tap and Get” offers, you have to go through the Acorns app and complete a purchase with their partner using your mobile phone.

For “Simply Spend” offers, you’ll receive cash back any time you use your Acorns-linked card to make purchases with partner brands.

Make sure to read the instructions carefully on each offer or you’ll likely miss out on the cash back.

Aa a final note: While there are some good offers on Acorns Earn, many are incentivizing you to buy things you may not really need. Purchasing a fancy product or service just to get a few bucks invested in your Acorns account kind of defeats the purpose of saving for your future.

Acorns also has a few features common to all of its investment accounts.

Round-Ups

Round-up is probably Acorns’ best-known feature. After linking a debit card, your purchases are rounded up to the nearest dollar and the spare change is swept into your Acorns investment account.

For example, if you spend $10.20 on Amazon, you’ll be charged $11 and the 80 cent difference will be invested into your portfolio. This makes round-ups an easy way to invest when you spend money on everyday purchases.

If you have the Acorns Visa debit card, round-ups are automatically deposited into your account. If you don’t, Acorns transfers the money from your linked account to your investment account once it reaches at least $5.

Recurring Investments

You can set up automatic transfers from your linked banking account to your Acorns account on a daily, weekly or monthly basis.

Enabling recurring contributions is a great way to take advantage of dollar-cost averaging and consistently invest money for your future without thinking about it.

You can opt in for recurring transfers in addition to spare change round-ups to grow your account balance even faster.

Acorns also lets you make one-time lump-sum deposits.

Acorns Grow Your Knowledge

This is the hub for Acorns’ educational articles and advice on personal finance and investing.

Articles are broken into different categories, like retirement and borrowing, and they’re written in simple terms digestible in an app-friendly format.

For more educational resources, you can check out the grow.acorns.com site, powered by CNBC, which features articles on market trends and financial literacy topics.

How Acorns Manages Your Money

Acorns is a robo-advisor, meaning it uses computer software and algorithms to select a pre-made portfolio based on your age, income, risk tolerance and time horizon (how long before you may need to access your funds).

After answering a brief questionnaire, Acorns invests your money into a portfolio of exchange traded funds (ETFs), which bundle numerous stocks or bonds into a single fund. (FYI: ETFs are sometimes referred to as index funds.)

Acorns uses iShares and Vanguard ETFs, which come with very low expense ratios. An expense ratio is the operating fee charged by an ETF.

Acorns offers five different portfolios, ranging from conservative to aggressive. The aggressive option consists of stock ETFs while conservative options expose you to more bond ETFs.

You can choose a different portfolio if you disagree with the algorithm, but you can’t pick your own individual stocks or bonds with an Acorns account.

Acorns uses modern portfolio theory, an investment strategy that works by diversifying you across different asset classes to help lower risk and maximize returns.

ETFs span six different asset classes:

Corporate bonds
Government bonds
Domestic large company stocks
International large company stocks
Small company stocks
Medium company stocks

Because ETFs can cost hundreds of dollars per share, Acorns builds your portfolio with fractional shares. That’s how you can get started with as little as $5.

Once you start investing, your portfolio will be periodically rebalanced to maintain its target asset allocation. You also get the benefit of automatic dividend reinvestments.

Acorns Sustainable Investing Portfolio

Acorns gives users the option to save and invest in a sustainable portfolio made up of ETFs graded using environmental, social and governance (ESG) criteria.

Acorns says these socially responsible investing portfolios are designed to provide exposure to more sustainable companies, while still striving to perform as well as a traditional portfolio.

You can opt into Acorns’ sustainable portfolio for no additional monthly cost. However, the ETFs in this ESG portfolio come with slightly higher expense ratios.

Acorns Cost and Fees

Acorns charges a flat monthly management fee for its services. It advertises two different membership tiers: a $3 option and a $5 option.

Prior to Sept. 21, 2021, Acorns offered a third membership option for $1 per month. Acorns Lite gave you access to its automated portfolio and investment services. If you wanted an IRA or checking account, you had to upgrade to the $3 option.

Acorns recently phased out Acorns Lite. Existing customers can (potentially) still keep the $1 option, now called Acorns Assist, by following these steps on the company’s website.

Acorns Account Pricing

Membership	Price per month
Acorns Assist (for existing customers facing economic hardship)	$1
Acorns Personal	$3
Acorns Family	$5

We suggest locking in that $1 Acorns Assist price if you can. Otherwise, spending $36 a year for a brokerage account is pretty expensive, especially if your account balance is low.

Other robo-advisors, such as Wealthfront and Betterment, charge a management fee as a percentage of your portfolio balance instead of a flat monthly fee. That may not sound like a big deal, but imagine this.

Let’s say you funded a new investment account with $100. Betterment charges an annual management fee of 0.25% for its basic account, which would cost you just $0.25 a year. Compare that with investing $100 in the Acorns Personal account, where the annual fee would total $36.

Obviously, Acorns’ management fees take up a smaller proportion of your balance as you invest more money. Still, you’d need about $13,000 in an Acorns Personal account to get down to an annual fee of 0.25%.

However, if you’re more comfortable with Acorns or want to give it a try, at the end of the day, we’re just happy you’re investing. It’s a good first step, just mind those management fees over time.

What Acorns Offers

Here’s a closer look at the nuts and bolts of Acorns accounts.

Acorns Review: Services and Features

Feature	Details
Account minimum	$0 to open, $5 to invest
Account management fees	Personal, $3; Family, $5
Portfolio mix	Stock & bond ETFs
Socially responsible portfolio options	Higher expense ratios
Tax strategy	No tax loss harvesting
Automatic rebalancing	Free for all accounts
Human advisor option	None
Bank account/cash management account	Checking w/ no overdraft
Customer support	Email [email protected]

Pros and Cons of Acorns

Acorns offers several advantages, but it’s not for everyone. It’s important to understand the pros and cons of any investing app before you sign up.

Pros

Easy-to-navigate interface you can access on your computer or mobile device.
Diversified portfolios with risk-appropriate, low-cost investment options.
Round-ups to the nearest dollar and recurring transfers from a linked credit or debit card make investing easy and effortless.
You get the option to bank, invest and save money for retirement in a single app.
There’s no account minimum and you can start investing with $5.

Cons

Acorns’ management fees are relatively high for accounts with low balances.
No tax loss harvesting feature.
No access to human financial advisors.
You can’t tweak individual investments inside your portfolio. (Nope, you can’t buy individual shares of Tesla or Apple with Acorns).

Frequently Asked Questions

Can You Make Money With Acorns?

Yes, that’s the whole idea! You’ll make money as your investments gain value over time. You can also earn bonus investments, known as Found Money, by participating in offers from the company’s business partners. Finally, Acorns also offers referral bonuses to users who get their friends and family to sign up for the app.

Is It Safe to Invest With Acorns?

Yes, Acorns is a safe and secure financial services app. Just like other brokerage accounts, Acorns complies with federal law and is registered with the U.S. Securities and Exchange Commision. Its checking account is also FDIC insured, giving you the same protection as a traditional bank.

What Are the Cons of Acorns?

Probably the biggest drawback of Acorns is that its $3 or $5 per month account options are relatively pricey for people with low account balances. Acorns phased out its $1 Acorns Lite option for new users in September 2021.

Rachel Christian is a senior writer for The Penny Hoarder.

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Source: thepennyhoarder.com

November 17, 2021

Do You Have Too Many Bank Accounts â or Too Few?

How Many Bank Accounts Should You Have? – SmartAsset Close thin Facebook Twitter Google plus Linked in Reddit Email

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Stephanie Colestock Nov 16, 2021

These days, bank accounts can do a lot. They make it easy for you to track your spending and receive transaction alerts, often in real-time. They allow you to transfer between accounts and even send money to others in just seconds, even from a smartphone. And many of these accounts also help you reach your savings goals with budgeting tools, automation and competitive interest rates. However, odds are that you won’t be able to achieve all of this with just one bank account. Here’s a look at how many bank accounts you should realistically have and why you truly do need more than one.

Consider working with a financial advisor as you fine-tune your personal finance strategies and priorities.

Why You Need a Checking Account

A checking account is intended to be an everyday transaction account. It allows for both deposits and withdrawals and can be used for a variety of day-to-day spending.

You’ll typically use your checking account as a landing pad for your paycheck, before re-allocating funds elsewhere. From your checking account, you can pay bills, make daily purchases, transfer funds and more. These funds are usually considered short- to medium-term in nature, as they are constantly being spent and replenished.

Money in a checking account can be accessed a number of different ways, depending on the financial institution and even the specific account type. Generally, though, checking accounts offer a combination of debit cards and paper checks, as well as online transfer options.

Why You Need Savings Accounts

Savings accounts, on the other hand, are better suited for medium- to long-term funds, rather than daily spending. The money you keep in a savings account can be tagged for a range of future savings goals, from next month’s vacation fund to your child’s college savings and beyond.

These accounts may be linked to other bank accounts you hold, such as checking. That way, you can easily transfer funds over and track your savings progress. Some banks also allow you to use a linked savings account as automatic overdraft protection on your checking account.

Additionally, most savings accounts offer interest on the balance held. This is often much greater than the interest offered on your checking account (if that account accrues interest at all). This can help amplify your savings and ensure that your money is always working for you.

While you are generally allowed to make as many deposits into a savings account as you’d like, you’re limited in the number of withdrawals you can make in a single statement cycle. Per Regulation D of the Federal Reserve, deposit accounts classified as “savings” are limited to no more than six withdrawals per month. If you exceed that limit, you may incur a fee or see your account closed.

How Many Bank Accounts Should You Have?

So, the question is, how many bank accounts do you actually need? And the answer really depends on your financial situation and your goals.

In general, you should aim to have at least the following bank accounts.

One account for everyday spending: You need at least one checking account for day-to-day transactions. This account is typically where your paycheck will be deposited, and is what you use for small purchases and payments.
One account for short-term savings: Short-term savings goals might include vacations, holiday spending, the down payment on a new car or other big purchases. Choosing a high-yield savings account can help boost your balance without extra effort.
One account for long-term savings: Longer-term savings goals might include emergency savings, college expenses or the down payment on a future home. Since these funds don’t necessarily need to be immediately accessible, you can afford to choose a bank that offers competitive features and returns.

You might also consider opening a separate bank account for:

Monthly bill-paying or budgeting: If you use the envelope method for budgeting, or simply want to set cash aside for monthly bills, consider using a separate bank account. This can make it easier to track spending throughout the month. It also ensures that you always have enough money available for important bills.
Specific savings goals: You may already have emergency savings, retirement savings and even college savings accounts. If you have smaller, specific savings goals, though, you may even want to open separate bank accounts for those. For example, this could be where you keep savings for this season’s Christmas gifts, so you aren’t bombarded with expenses at the end of the year.
Separate/shared household funds: Yours, mine and ours — that’s how many of today’s couples choose to manage their finances. It may make sense for you and your partner to each have individual bank accounts (even if it’s just for your own guilt-free spending money) as well as one joint “household” account. In this case, you’ll need at least three bank accounts between you.

What to Keep in Mind

Whether you decide to have two bank accounts or 12, there are few things to keep in mind.

Some bank accounts have fees. Certain checking and even savings accounts may charge monthly maintenance fees. These fees are often waived if you meet certain deposit or average balance thresholds; if you don’t meet these requirements, though, the costs can really add up quickly.

Make sure you’re maximizing interest rates. Right now, according to the FDIC, the average savings account has an APY of just 0.06%. However, you may be able to earn much, much more than that by shopping around for a high-yield account, like those offered by many online institutions.

Keep good records of your accounts. The more accounts you have, the easier it is to mix them all up or even forget about some small savings you set aside. Make sure you keep good (but secure) records. You may also want to make a note of these accounts in an In Case of Emergency (ICE) folder, in case something were to happen to you and your spouse needed to manage the funds.

The Bottom Line

For most adults, a single bank account isn’t enough to juggle incoming funds, manage daily spending, and save for future financial goals. How many bank accounts you need really depends on how you manage your money and what your personal goals are, both short- and long-term. For some folks, two or three bank accounts might be perfect. Others could need 10 or more to meet all of their needs.

Tips on Banking

A trusted financial advisor can help you determine which bank accounts are necessary and how they should best be managed. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re investing on your own, you should be prepared for what the investment markets can throw at you. SmartAsset is here to help you on your investment journey, with a number of free online resources. For example, check out our free investment calculator today.

Photo credit: ©iStock.com/Credit:AndreyPopov, ©iStock.com/Credit:sorrapong, ©iStock.com/Credit:NicoElNino

Stephanie Colestock

Tips for Becoming Financially Independent

Few things may sound as appealing as the idea of becoming financially independent. Though financial independence can mean different things to different people, it typically refers to being able to live comfortably off one’s savings and investments with no debt whatsoever.

In some cases, it may also mean the ability to retire early, though financial independence doesn’t necessarily have to mean leaving a career you love. It’s about working because you want to, not because you have to.

Sound appealing? Achieving financial freedom could be easier than you think. The process of getting there often comes down to a relatively simple principle: Spending less and saving more.

Below, we take a look at what it means to become financially independent and explore some practical strategies for achieving it.

What Does Financial Independence Look Like?

While there is no set definition for financial independence, the term often means getting to a point where you don’t have to work to pay your living expenses. Usually, financial independence is achieved by relying on savings, investments, and other forms of passive income to pay the bills.

Though financial independence doesn’t have to mean leaving behind a job or career path, it can. In fact, the term is often used as a synonym for early retirement, and the two phrases are commonly strung together in the popular acronym FIRE, which stands for “financially independent, retire early.”

Benefits of Financial Independence

There are myriad benefits to becoming financially independent. One of the biggest perks is the ability to have choices. You can choose to keep working if you enjoy it, or you can kick back and relax. You can save money to pass on to future generations or you can splurge on a trip around the world.

Becoming financially independent can also enable you to enjoy work more. If you’re no longer doing it for the money, you can structure your job responsibilities so you’re only doing the things you want to do.

It can also benefit your mental and physical health. Having the ability to work less allows you to exercise more and get more sleep. Financial independence may also allow you to spend more time with a partner, kids, family, and friends. Having stronger relationships can lead to increased happiness in life.

How to Be Financially Independent

Becoming financially independent typically requires having a clear plan in place and being willing to roll up your sleeves and get to work. Here are some key steps that can help you get there.

Setting Realistic Goals

Being financially independent can look different for everyone, so a good place to start can be to define what being financially independent means to you. What do you visualize? Maybe you want to be debt-free by 40, or you’d like to retire at 50. Or, perhaps you’d love to relocate to some place warm and sunny in ten years.

As you develop your goals, you may want to give them a reality test by consulting with a financial advisor or chatting with a trusted financial mentor. You may find that you need to re-jigger your vision based on your financial situation and how much time you have to achieve your dream.

Once you’ve honed in on some specific, achievable long-term goals, you can begin to figure out what you’ll need to do to make them a reality — whether that’s cutting your spending, boosting your income, and/or saving and investing more than you currently are each month.

Understanding That Income Isn’t Everything

Many people have a tendency to fixate on how much money they are making. And while income is an important part of your financial big picture, it isn’t everything. Yes, it’s easier to amass assets if you have more monthly income, but one key to increasing your net worth is to spend less than you make.

For example, if you are making a comfortable salary but haven’t gotten into the habit of saving and investing, then you may not be leveraging your income to its full potential. Becoming financially independent often requires an understanding that the amount of money you make is just one piece of the puzzle.

The path to financial independence may become a little less daunting once you realize that a high income alone is not necessarily going to lead to sustainable wealth. There are several other factors that play a role in how much you are able to grow your finances, such as how much interest your investments are making and the rate at which you are able to save.

More than a high salary, financial independence typically requires foresight, long-term thinking, and a holistic understanding of how your income overlaps with your expenses, lifestyle, and future goals.

Recommended: How Much of Your Paycheck Should You Save?

Building a Budget

No matter what your income level, one of the keys to getting ahead and achieving financial freedom is to spend less — and potentially a lot less — than you are earning. And, doing that typically requires coming up with a budget.

Budgeting is the process of measuring income, subtracting expenses, and deciding how to divert the difference toward reaching your goals. It’s often considered the essential first task in achieving financial independence.

You can set up a monthly budget by first assessing what you are currently earning (after taxes) each month. Next, you can tally up your actual spending by looking at the last three to 12 months of bank and credit card statements and recording your expenses on a spreadsheet.

Seeing it all laid out in black and white can help you identify unnecessary expenses you might be able to cut out. You can then put the difference towards your long-term goals instead. One rule of thumb is to try to put 20 percent of your monthly take-home income into savings or investments. Working couples might try to bank a substantial part of one salary if possible.

Recommended: How Much Money Should I Save a Month?

Establishing A Safety Net

Achieving financial independence also means thinking about financial security. Having a dedicated emergency fund that can help you weather a health emergency or another large, unforeseen expense means you may not have to run up credit card debt or dip into your investment or other savings account in order to cover these costs.

If you haven’t already started an emergency savings account, consider whether or not you would be able to afford a sudden car repair or if you could handle paying out of pocket for an unexpected dental procedure.

Experts often recommend having at least three- to six-months worth of living expenses set aside in an account that earns interest but can be easily accessed when you need it.

The more effective you are at dealing with financial emergencies, generally the faster your savings and investments can grow.

Putting a Debt Pay-Off Plan Into Action

Taking care of your debt is another important step to achieving financial independence. Today, debt can take many forms — whether it’s student loan debt, a home mortgage, a car loan, or credit card debt.

If you currently have debt, consider incorporating a debt reduction plan into the budget you create and calculate how you would need to tweak your current spending habits in order to prioritize becoming debt-free.

It can be wise to start with the debt that has the highest interest first, since borrowing from those creditors is costing you the most money.

If you have multiple credit card balances, you may want to target them one at a time. You can do this by paying more than the minimum each month on one balance (paying just the minimum on the others) until that balance is wiped out, then move on to the next.

Recommended: Three Ways to Help Pay Off Debt Faster

Being a Smart And Savvy Investor

Becoming a smart investor is another key step you can take on your journey to financial independence. The world of investment can be confusing and carries risk, but it also has the potential to be lucrative. Because you earn interest not only on your contributions, but also on accumulated interest, small amounts can grow over time.

You may want to first focus on tax-advantaged accounts. If you have an employer-sponsored plan, such as a 401(k), it can be a good idea to contribute some of each paycheck, especially if your employer offers to match your contributions. Depending on your situation, you may be able to open a traditional IRA, Roth IRA, or SEP IRA, as well.

If you have children, you may also want to start a 529 plan to help you invest for their college educations.

If you’re able to invest additional funds, you can choose a financial firm you want to work with and then open a standard brokerage account. From there, you can put your money in a mutual fund or an exchange-traded fund (which bundle different types of investments together), or, if you’re prepared to do a fair amount of research, pick and choose your own stocks and bonds.

If you’re new to investing, you may want to consider opening an investment account through a robo-advisor, an investment management service that uses computer algorithms to build and look after your investment portfolio, and typically charges relatively low fees.

Recommended: How Much Should You Have Saved for Retirement by 40?

The Takeaway

Not everyone inherits a fortune or makes a huge salary. But even if you don’t have those advantages, it doesn’t mean you can’t achieve financial independence. Getting there, however, can take work and spending discipline.

Some steps that can help you get there include: creating a budget, trimming expenses, building an emergency fund, paying off debt, and setting up a smart saving and investing strategy that factors in your timeline and tolerance for risk.

Once you set up a plan to work towards financial independence, it can also be a good idea to check-in regularly on how well the plan is working, and to make adjustments when necessary.

Whether you decide to schedule quarterly meetings with a financial advisor, monthly money talks with your significant other, or use apps that help you track your expenses and investments, consider creating habits that help you stay on top of your goals.

With a SoFi Money® cash management account, you can track your weekly spending (and make sure you’re staying within your budget) right in the dashboard of the SoFi app. You can also use SoFi Money’s “vaults” feature to separate your spending from your savings, while earning competitive interest on all your money.

Learn how SoFi Money can help you work towards your financial goals today.

SoFi Money®
SoFi Money is a cash management account, which is a brokerage product, offered by SoFi Securities LLC, member FINRA / SIPC . Neither SoFi nor its affiliates is a bank. SoFi Money Debit Card issued by The Bancorp Bank.
SoFi has partnered with Allpoint to provide consumers with ATM access at any of the 55,000+ ATMs within the Allpoint network. Consumers will not be charged a fee when using an in-network ATM, however, third party fees incurred when using out-of-network ATMs are not subject to reimbursement. SoFi’s ATM policies are subject to change at our discretion at any time.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
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Source: sofi.com

November 15, 2021

20 Ways to Pay Off Your Student Loans Faster

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Congratulations! You graduated college or grad school and boosted your earning potential. But if you’re like millions of other graduates, you’re also now saddled with burdensome student loan debt.

And while you’re paying off your loans, you could miss out on meeting other important financial goals, like buying a house, starting a family, or saving for retirement. Take it from me. I’m in my mid-40s and still repaying my student loans.

Wouldn’t it be nice to get rid of it sooner than that? Thankfully, tons of strategies can help you pay off student debt faster — and the faster you pay them off, the faster you can get on with the rest of your life.

How to Pay Off Your Student Loans Faster

Student loans can eat up a big chunk of your paycheck, leaving you strapped to pay for much else. So if you want an upgraded lifestyle, you likely need to offload those loans as fast as possible. That means adopting a few key repayment strategies.

1. Avoid Consolidating Your Student Loans

You may have graduated with several loans. And you may have heard of student loan consolidation as a way to manage them all.

Student loan consolidation refers to combining multiple student loans into one. In essence, you take out one large loan to pay off several smaller loans.

But it isn’t always the best strategy for paying off your loans quickly.

Consolidation doesn’t change your interest rate. And when you consolidate, any outstanding interest is added to your principal balance (capitalized). That means you’ll then be earning interest on top of interest.

So there’s little benefit to doing it. Think carefully before taking this step because you can’t undo it.

And contrary to popular belief, it’s not the only way to pay all your loans in one place with a single payment. These days, the U.S. Department of Education does a relatively good job of ensuring a single servicer manages all your loans.

In that case, you typically make one payment that covers all your loans. Generally, you only have to make multiple payments if you have multiple servicers or a mix of federal and private loans.

Another common myth of student loan consolidation is that it lowers your payment. It can if you enroll in an income-driven repayment plan, but those aren’t typically the fastest ways to pay off your loans.

And when they consolidate, many borrowers end up extending the loan period as much as 30 years, potentially increasing the amount of time it takes to pay it back.

Besides, if you have private loans, you can’t consolidate them with your federal loans. The only way to combine federal and private loans is with refinancing.

2. Refinance Your Student Loans

Refinancing your student loans involves working with a private lender to replace your existing loans with a single new loan with a lower interest rate.

If you refinance federal student loans, you give up the benefits that come with them, including more flexible repayment options, generous deferment and forbearance terms, and the potential for loan forgiveness. Thus, it’s generally best to avoid refinancing federal student loans.

But if you’re determined to pay them off quickly, student loan refinancing can help by reducing the overall amount you have to repay. Reducing your interest rates means less interest accrues over time. Thus, the total amount will be lower, and you can pay them off faster.

For example, if you repay $37,000 in student loans over 10 years at 7%, your loan will have cost you a total of $51,552. But if you can refinance at 3% interest, it will only cost you $42,873. That’s a savings of $8,679.

Best of all, your monthly payment will be lower. At 7% interest, your monthly payment will be $430 with a 10-year repayment term. If you keep the same repayment term and refinance at 3%, your new monthly payment will be $357.

And that’s where the real magic happens. Instead of paying the minimum, you keep paying the old $430 monthly payment. That lets you pay off your loans in just over eight years, almost two years early. Plus, you’ll save even more money — an additional $2,786.39 in interest.

Only the most creditworthy borrowers qualify for the best rates. You must have good credit with a high credit score (typically above 700) and sufficient income to demonstrate an ability to repay the debt. So your savings might vary.

You can see what kinds of rates you qualify for using a tool like Credible, which matches you with prequalified rates from up to eight lenders without impacting your credit score.

Applying with a co-signer may help you achieve even lower student loan interest rates.

3. Activate Autopay Discounts & Interest Rate Reductions

Another way to reduce the amount of accumulated interest is to activate any interest rate reductions for making automatic payments. Autopay allows your servicer to automatically deduct your monthly payment amount directly from your bank account every month.

Signing up for autopay typically shaves 0.25% off your interest rate, whether you have private or federal loans. It may not be the world’s biggest discount, but every penny counts. Plus, autopay means you won’t get hit with fees or penalties for accidentally missing payments.

If you have private or refinanced student loans, some lenders, like Citizens Bank and Laurel Road, offer additional interest rate reductions for opening accounts with their bank branches. That may be a perk you want to look for when choosing a refinance lender.

4. Stick to the Standard Repayment Schedule

The standard repayment plan for federal student loans is 10 years. Ideally, you don’t want to be in repayment longer than that. And if you’re on the fast track to paying off your loans, you may even take less time by employing other repayment strategies.

There are many repayment options available for student loans. But the longer you take to repay them, the more trapped you could become thanks to accruing interest.

It’s when borrowers take advantage of multiple deferments, forbearances, and extended and graduated repayment plans that you hear student loan horror stories. For example, many talk of repaying two or three times what they borrowed or getting stuck taking their debt to the grave.

According to statistics compiled by the Education Data Initiative, the average time students take to repay their loans is 20 years. But if you opt for that length of repayment, you’ll be stuck in repayment a decade longer and repay thousands more in accrued interest.

To get an idea, play with the loan simulator on StudentAid.gov. It shows you potential monthly payment amounts, estimated payoff dates, and total amounts you’d have to repay under different repayment plans.

Then, if you’re already on a longer repayment term, ensure you pay off your loans in 10 years or less by paying the simulator’s higher estimated payment for that plan rather than the minimum you owe.

5. Pay Down the Principal First

Your monthly student loan payments cover your principal, accrued interest, and any owed fees. But at the beginning of your loan, most of your payment goes toward interest and fees, with very little paying down the principal balance.

However, interest accrues according to the current principal. So any time you reduce the principal, you reduce the amount of interest that accumulates and, therefore, the overall amount you have to repay. That enables you to repay your loans faster.

To do that, you can send more than your minimum payment. Even a small amount makes a difference.

For example, if you make your regular $430 per month payment on a 7%-interest loan and then tack on an extra $20 every month, you’ll shave seven months and almost $1,000 in interest off your student loan repayment.

But whatever you do, don’t just send the money. Servicers automatically apply your funds to accrued interest first and then to the loan with the highest interest rate. So if you want to be strategic in how you repay your loans, tell them exactly how you want your money applied.

You can do that by indicating on your servicer’s website how you want to apply your additional payments. For example, you can tell your servicer to apply any extra amount to the principal of the highest-rate loan first.

But check afterward to ensure the loan servicer applied your funds correctly. Contact customer service if something doesn’t look right.

Fortunately, the balance flips toward the end of the loan, and you’re paying off more of your principal than the interest and fees.

6. Apply for Public Service Loan Forgiveness

To qualify for student loan forgiveness, you must enroll in an income-driven repayment plan. Under ordinary circumstances, income-driven repayment could string out your payments for as long as 20 to 25 years.

But if you qualify for Public Service Loan Forgiveness (PSLF), you could have your remaining loan balance forgiven in as little as 10 years. Meanwhile, you’ll make payments based on your income.

Thus, PSLF could help you pay off your loans faster than you otherwise could, especially if you have high debt compared to income. But it could also save you significant money since you may be paying significantly less per month than you otherwise would. That’s a double win if you qualify.

To qualify, you must make 120 payments (10 years’ worth, though they don’t need to be consecutive) while working full time in a public sector job.

Doctors working in most hospitals qualify. So do public defenders, firefighters, police officers, and public or nonprofit school teachers. Pretty much anyone working in a public or nonprofit job, such as a public accountant working for the government or a nonprofit or social worker, qualifies. However, politicians and government contractors do not. See the list of eligible jobs at StudentAid.gov.

7. Take a Job With a Loan Repayment Assistance Program

There are hundreds of federal, state, and local programs collectively known as loan repayment assistance programs (LRAPs). They help borrowers get some or all their loans forgiven. Typically, you must work in a specified career field in a high-need area for a certain number of years to qualify.

Most LRAPs are for service fields like health care, teaching, and law enforcement. But there are some available for other types of careers, such as automotive professionals. So it’s worth looking to see if you qualify for one.

Note that LRAPs often require working in less desirable locations for low pay. That’s their draw. The LRAP is a benefit offered to attract quality candidates to fill high-need positions.

See our article on jobs that qualify for repayment assistance to determine whether you could be eligible for an LRAP.

8. Look Into Employer Repayment Benefits

Public agencies aren’t the only ones with student loan repayment programs. Thanks to recent tax incentives, a growing number of employers are also establishing employee student loan repayment assistance programs.

One of the most significant shifts in workers’ financial priorities over the last decade has been away from saving for retirement and toward paying off student loans. That’s placed a considerable emphasis on student loan repayment as a sought-after job perk over 401(k) matches.

Fortunately, in August 2018, the IRS approved an Abbott Laboratories plan to qualify employees who contribute a portion of their paychecks toward their student loan payments for the company’s 401(k) match. And other companies have followed suit.

More recently, the Consolidated Appropriations Act of 2021 has enabled employers to contribute up to $5,250 tax-free annually toward each employee’s education debt. Though the provision is only through Dec. 31, 2025, some experts believe it could become permanent. And even just four years of this benefit is over $20,000 of student debt relief.

Although not every employer provides repayment assistance, it’s worth looking into. Ask prospective employers if they have a program set up. Or ask your current human resources department if your company has one. Just like your company’s 401(k) match, if you don’t use it, it’s like leaving money on the table.

If your company doesn’t offer this benefit, speak with human resources to let them know about the advantages of providing it. It helps them attract top job candidates, retain the best employees, and reduce stress on the overall economy.

9. Reduce Your Expenses

By the time you graduate, you’re likely more than ready to put the days of being a broke college student behind you. But if you’re serious about paying off your student loans quickly, you may have to keep living like one for a bit longer.

Thus, the most vital part of your repayment plan is your budget. So if you haven’t already, make a budget with your student loans in mind.

Building your monthly budget around your student loans could help you avoid payment options like deferment or forbearance or getting stuck in income-driven repayment plans for decades. These kinds of things cause borrowers like me to continue repaying loans into middle age or beyond.

Once you have your budget, identify places you can cut back to free up money to put toward your student loans. Ways to save are individual to every person, but a few ideas include canceling cable services or gym memberships or forgoing eating out.

It may mean going without some luxuries for a while. But remember: This part of your life won’t last forever. The idea is to make a short-term sacrifice to get the debt out of your life as quickly as possible.

10. Ask for a Raise

If you can’t reduce the size of your loan, the next step is to search for any and every way to throw extra money at it. Boosting your income is a crucial step, and if you can do that without adding too much additional stress, all the better.

Requesting a raise may seem like too big an ask. But according to a 2018 PayScale survey (via CNBC), approximately 70% of people who asked for a raise ended up getting one.

Note that race and gender play a role in your likelihood of getting a raise. And you’re also potentially more or less likely to get a raise based on your location and job position. But your chances are likely higher than you think, regardless.

So if you’re doing good work at your job and making a contribution you feel your employer isn’t adequately compensating, it’s worth speaking up.

Just don’t let your raise disappear due to lifestyle inflation. Immediately apply any salary boost toward knocking out your student loans. You’ll be glad you did once they’re gone.

11. Switch Jobs

You may love your current job, but if the pay isn’t enough to manage your current expenses, it might be worth transitioning to a higher-paying career field.

It’s the No.1 move I wish I’d made a decade ago. I graduated with a Ph.D. and six-figure student loan debt hoping to be a professor in an era when higher education is amid a massive crisis that’s only getting worse.

As a result, I got stuck for well over a decade in what The New York Times calls “adjunctopia” (along with 70% of other college instructors).

Meanwhile, I used my Ph.D. to work for minimum wage as part-time faculty at multiple colleges and universities, often working more than 60 hours per week. Additionally, I got a side gig as a writer because even working at three schools at once wasn’t enough to make ends meet.

Today, I make more money writing than I ever did teaching. But over the past 10 years, I’ve deferred, forbore, and put my loans into income-driven repayment because I couldn’t manage on my teaching income. And thanks to a loophole in Public Service Loan Forgiveness, adjunct teachers don’t qualify.

Using these federal repayment programs designed to help with financial hardship and low income has caused my loan balance to grow to twice what I originally borrowed thanks to payments too low to pay off the quickly accruing interest.

It’s one of my biggest regrets and the reason I write about student loans today.

If I could go back in time, I would have switched careers. As much as I’ve enjoyed teaching, the weight of crippling debt that influences every aspect of your life just isn’t worth it.

If you can make more money and pay off your loans quickly, you probably should. You can always go back to what you love once you’ve paid off the loans.

12. Take on a Side Hustle

If asking for a raise or switching careers isn’t an option, picking up a side hustle should be your next move.

Just be careful it doesn’t take too much time or focus away from your primary job. If you put your full-time job at risk, you could jeopardize being able to make your student loan payments at all.

The best side gigs for paying off student loans have a low cost of entry. They don’t require you to invest in a lot of equipment, classes, or licensing.

So avoid money-making schemes like multilevel marketing, which often requires investing in kits and typically involves a lot of effort that doesn’t pay off.

Service gigs like babysitting, elder care, or pet sitting don’t require much overhead. Check out Care.com to get started. If you’re willing to care for animals, including boarding them overnight, try Rover.

If you have a specific skill set you can offer — like writing, graphic design, or Web development — freelancer matching sites like Upwork or Freelancer.com are good places to find work.

Other side gigs that let you work around your full-time job include sharing economy jobs like driving for Uber or Lyft; becoming a delivery driver for DoorDash, Instacart, or Postmates; or becoming an Amazon Prime shopper.

Or try making crafts or printables to sell on craft sale sites like Etsy or Amazon Handmade.

13. Sell Your Stuff

If you can’t take on a second job, turn your clutter into cash. Look around the house for anything you can sell.

For example, you can recycle used electronics, including nonworking devices. And while the small payouts may not seem like much toward a student loan, every penny counts.

Take our hypothetical $37,000 in student loans at 7% interest. Paying just an extra $100 per year over 10 years lets you pay off your loan five months earlier, saving $1,150 in interest. And it’s likely possible to find $100 of old, unused stuff to sell just by looking around.

Granted, it’s unlikely you can pay off your student loans just by selling your old stuff. But you can use this tactic to take a bite out of your loans from time to time, reducing the overall repayment term.

Once you’ve gathered your stuff, host a garage sale or take your things to a consignment sale or shop. For a wider audience, go online. List locally with a Facebook group, Nextdoor, OfferUp, or Craigslist. Or if your stuff is small and shippable, list it on Amazon or eBay.

14. Rent Out Your Stuff

If you’ve got spare things you aren’t using, or even extra space, you can make money renting it to others.

If you have a spare room, accessory dwelling, or even vacation home, you can make significant money as an Airbnb host. There’s a bit more work involved, as you’ll need to routinely clean and set up the space. But it won’t be nearly as time-consuming as a second job.

There are plenty of other ways to rent out your space. A patio can become an event space, or a loft can become a photo backdrop. A garage can become a workshop. Your backyard shed or spare closet can store someone’s excess stuff. There’s no limit to how creative you can get to make money from your space.

For help finding people who need your spare space, list it with a service like Neighbor, Store At My House, or Peerspace. The added benefit of going with a service is most also provide insurance. But be sure to read all the legalese before signing up.

In addition to renting space, you can also rent your things.

If you have a spare car you’re willing to let others use, Turo, HyreCar, and Getaround are services that help you find renters.

You can also rent other in-demand stuff you have around the house. For example, you can list sporting equipment like bikes, skis, or paddleboards with SpinLister. Or let people rent your tools with the Sparetoolz app.

15. Build Savings You Can Put Toward Student Loan Payments

Micro-investing is another way to create extra amounts of money to put toward your student loans. Micro-investing lets you invest small amounts, including your spare change. So you can save a lump sum to put toward your student loans without a major impact on your budget.

Even better, your investments grow with interest, making it a way to earn passive income. If you’re lucky, that interest income could even surpass the interest hit you’re taking on your student loans.

And the government caps the interest rate on federal student loans at 8.25%, which means it can’t go any higher.

But most borrowers don’t have these higher-rate loans. For example, the federal student loan interest rate for undergraduate direct loans for the 2021-22 academic year is 3.73%. And the last time the undergraduate rate was above 6% was in 2008.

Meanwhile, the average market returns are 7.08%, adjusted for inflation. So it may be beneficial to invest money for a lump-sum payment rather than simply send extra payments to your student loan servicer.

There are several micro-investing apps that let you save and invest automatically by rounding up your change to the nearest dollar when you spend using a linked debit card. It’s an easy way to make saving effortless. Acorns and Stash are two popular options.

16. Use Cash-Back Savings

Sign up for an account with Upromise, and you can use cash-back savings on purchases you make regularly to help pay down your student loans.

Upromise works like grocery rebate apps or browser extensions. You earn cash rewards for shopping, dining, or buying groceries at your favorite stores and restaurants.

Upromise then automatically deposits funds in your linked 529 account or savings or checking account (opt for a high-yield savings account to save even more). Then, you use those funds to pay down your student loan debt.

Additionally, you can apply for a Upromise Mastercard for even more cash-back bonuses.

Remember all those birthdays when your aunts, uncles, and grandparents gave you cash toward your college savings? That doesn’t have to stop after you graduate. And wouldn’t you rather have Aunt Edna kick in toward your student loans than get you another tchotchke you can’t use?

Register your student loan account with Gift of College, an education registry. Then, share your profile with friends and family. Every gift-giving occasion, they can contribute funds directly to your debt.

18. Turn Windfalls Into Extra Payments

One of the best ways to pay down your student loan debt fast is to make more than the minimum payment. It knocks out the principal faster and reduces the overall amount of interest you have to repay.

That’s not a realistic monthly expectation for most people. But even a few one-off extra payments can make a significant impact on your student loan balance.

So any time you get extra cash in the form of a windfall — whether from a work bonus, a tax refund, or an inheritance — put it toward your student loan payment. You can even create your own windfall occasionally by participating in a no-spend month.

19. Make Biweekly Payments

A good trick to put extra money toward your student loans without even noticing is to make biweekly payments. Splitting your loan payment into two smaller monthly payments might even make it more manageable if you have a tough time paying it all at once.

For example, let’s say you owe $430 per month. Instead, you could pay $215 every two weeks. That way, if you get paid every two weeks, all the money isn’t hitting one paycheck.

But that’s not the only benefit.

There are only 12 months per year. But if you pay every two weeks, you’re making 26 payments, or 13 full payments — one extra — every year. That’s because months aren’t four weeks, as we tend to think. Every third month is actually around five weeks.

So you can shave almost two years off your repayment term and $3,870 in interest (assuming you’re paying 7% interest).

20. Use Proven Debt-Repayment Strategies

As long as you didn’t consolidate or refinance your loans, you can use debt-repayment strategies to pay off what you owe faster.

To see what you owe all in one place, check your credit report. You can use a credit score subscription service like Credit Karma or Credit Sesame, which lets you see how much money you owe to whom and monitor your credit score.

If you only borrowed federal student loans, log into StudentAid.gov. It’s a one-stop resource for checking on the life cycle of all your federal student loans, from approval through payoff.

Then choose a debt payoff strategy.

Avalanche Method. Pay the minimum amount on all but your highest-rate loan, which you throw any spare change you have at. Once that’s paid off, move to the next.
Snowball Method. Pay the minimum amount on all but your lowest-balance loan, sending any extra cash to knock that one out fast, then move on to the next-lowest-balance loan.

Choose the best strategy based on what’s right for you.

The debt avalanche method prioritizes high-interest debt. The rationale is simple: Your higher-rate loans are hurting you the most. So get rid of them the quickest.

The debt snowball method is costlier, but it has its advantages. It lets you knock out small balances quickly, boosting morale. And that positive feeling can help keep you going, especially if it takes many years to pay off your student loans.

Which one you choose depends on your circumstances and personal preference.

There are some cases in which it makes sense to pay off the lowest balances first. For example, if you have loans with unfavorable terms, like a lack of deferment options or the ability for co-signer release, it may be best to offload them faster.

Also note that if you have both private and federal student loans with the same interest rates, you probably want to get rid of the private loans first since federal loans typically have better terms.

And if you have any variable-rate loans, you may have to revisit the order you pay your loans in from time to time. The Federal Reserve periodically alters interest rates, so your variable-rate loans could get more or less expensive.

For more information, read our article on debt-repayment strategies, including avalanching and snowballing.

Final Word

Let my own experience be a cautionary tale. Interest that accrues over a long period keeps you in repayment for far longer and ends with you repaying twice or more what you originally borrowed, even with the promise of federal student loan forgiveness programs, which aren’t always worth it.

That said, as wonderful as it will feel to be rid of your student loan debt, there are some instances when getting rid of it as fast as possible isn’t the best approach. There may be other priorities you should tackle first.

For example, if the interest on your student loans is relatively low but you have high-interest credit card debt, focus on paying the credit card debt off more quickly.

You also want to ensure you’re saving enough for other long-term goals, like retirement. Don’t put off retirement savings until after you’ve paid off your student loans.

Retirement investments need the benefit of interest compounding over a long enough period. So you lose out significantly if you wait, especially since the returns from investing are typically higher than the interest on most borrowers’ student loans over the long term.

Thus, for any student loans with interest rates less than 5%, you’ll likely net more in the long run by paying the minimum on your student loans and focusing on investing instead.

The best tactic is often to find a balance between paying off your student loans and meeting your future financial goals.

For example, if your company has a 401(k) match, ensure you’re at least contributing the minimum to get the match before paying more than the minimum on your student loans. Otherwise, you’re missing out on free money.

But if you have all your financial ducks in a row and student loans are the last thing holding you back, then pay them off as fast as you can.

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Sarah Graves, Ph.D. is a freelance writer specializing in personal finance, parenting, education, and creative entrepreneurship. She’s also a college instructor of English and humanities. When not busy writing or teaching her students the proper use of a semicolon, you can find her hanging out with her awesome husband and adorable son watching way too many superhero movies.

Source: moneycrashers.com

November 15, 2021

The Monte Carlo Simulation & Its Use in Finance

A Monte Carlo simulation is a mathematical technique used by investors and others to estimate the probability of different outcomes given a situation where multiple variables may come into play.

Monte Carlo simulations are used in such a wide range of industries — e.g., physics, engineering, meteorology, finance, and more — that the term doesn’t refer to a single formula, but rather a type of multivariate modeling technique. Multivariate modeling is a statistical method that uses multiple variables to forecast outcomes. A Monte Carlo simulation is an example of this type of calculation, which provides a range of potential outcomes using a probability distribution.

Keep reading to learn more about the Monte Carlo method and how a Monte Carlo analysis can be used in investing and portfolio management.

What Is Monte Carlo Simulation?

Applying mathematics to investment or business scenarios is difficult precisely because there are so many random variables involved in any single decision or any single investment or portfolio of investments. That’s why a Monte Carlo analysis can be more informative compared with predictive models that use fixed inputs.

A Monte Carlo simulation calculates a probability distribution for any variable that has inherent uncertainty. It then recalculates the results thousands of times over, each time using a different set of random numbers pertaining to each variable, to produce a vast array of outcomes that are then averaged together. In this way, a Monte Carlo analysis enables researchers from many industries to run multiple trials, and thus to define the potential outcome or risk of an event or a decision.

The ability to apply mathematics to situations where many elements are probable, and then rank the likelihood of possible outcomes in order to gauge the potential for risk, is a chief advantage of Monte Carlo simulations. Money managers might use a Monte Carlo analysis to estimate risk levels for different investments when constructing a portfolio. Corporate finance managers might use a Monte Carlo simulation to assess the impact of variables like future sales, commodities prices, interest rates, currency fluctuations, and so on. Brokers might use a Monte Carlo analysis to calculate the risks of stock options.

Monte Carlo Simulation History

Using simulations to solve problems dates back to the 19th century or even earlier, when simulations were an experimental way to test theories, analyze data, or support scientific intuition using statistics. But these simulations typically dealt with established deterministic problems. A modern Monte Carlo analysis, however, inverts that structure by using probabilities to solve the problem.

One of the first known uses of a modern Monte Carlo simulation dates back to the 1930s, when physicist Enrico Fermi experimented with an early form of the method to understand the diffusion of neutrons.

Physicists Stanislaw Ulam and John von Neumann are credited with developing and refining the current Monte Carlo method while working at the Los Alamos National Laboratory on nuclear weapons in the 1940s. Of course the technique needed a code name, and Monte Carlo was chosen because the element of chance also drives the games at a casino (the Monte Carlo region of Monaco is renowned for its gambling).

Soon the simulation method gained traction in the fields of physics, chemistry, and operations research, thanks to its adoption by the Rand Corporation and the U.S. Air Force. From there, it spread to many of the natural sciences, and eventually found its way to finance.

Monte Carlo Simulation Method

The Monte Carlo simulation works by constructing a model of possible outcomes based on an estimated range of possible conditions. It does this by creating a curve of different variables for each unknown variable, and inserting random numbers between the minimum and maximum value for each variable, and running the calculation over and over again. A Monte Carlo experiment will run the calculation thousands upon thousands of times. Along the way, it will produce a large number of possible outcomes.

But even for a simple investment, there are a host of factors that will affect its outcome. There are interest rates, regulations, market swings, as well as factors innate to that investment, such as the sales and revenue of the underlying business, or its competitive landscape, or disruptive technology, and so on. And as an investor seeks to peer further into the future, more possible variables emerge. Using a Monte Carlo simulation to understand those risks requires using a growing number of inputs as the time horizon grows longer.

After an investor runs a Monte Carlo simulation, the calculation will deliver a range of possible outcomes, with a probability score assigned to each outcome. By weighing the probability scores of different outcomes, an investor can proceed with a better sense of the risks and possible rewards of a given investment decision.

Estimating Risk Using the Monte Carlo Method

Using a Monte Carlo simulation is a complicated process that requires a background in mathematics, though some investors have created Monte-Carlo-like models using Excel or a similar spreadsheet program. Some of those homespun programs can be used to try to project possible price trajectories of a given asset.

In Monte Carlo fashion, the user will repeatedly run the equation an arbitrary number of times, to see how often each outcome occurs. The frequency of each outcome will reflect the likelihood of each outcome. The results will most likely form a bell curve, with the most likely result in the middle of the curve. But as with any bell curve, those results also indicate that there is an equal chance that the actual result will be either higher or lower than the number in the middle.

But a Monte Carlo simulation is only as good as the data that’s programmed into it. No matter how well the simulation is run, its predictive powers can easily be undone by factors that haven’t been added into the equation. For example, when using a Monte Carlo simulation to decide whether or not to buy a given stock, the model could seem to deliver a clear picture of the risks and rewards of the investment.

In that example, the problems arise if the programmer or investor leaves out one single factor, such as macro trends, the effectiveness of company leadership, cyclical factors, political changes, and so on. There’s a chance that factor could be the one that completely subverts the simulation. And those variables are potentially without limit.

Who Uses Monte Carlo Simulations and How

Nonetheless, large institutional investors might use Monte Carlo simulations as a tool in their projections and decision making. And its use for investors isn’t limited to hedge fund managers and spreadsheet wizards. There are even online Monte Carlo simulators to help people save for retirement.

Those tools are designed for the average investor to input some basic information like their savings, and years until retirement to help them understand the likelihood that they will be able to reach their financial goals, and whether they will have enough income in retirement. Those calculators use a generic set of parameters for their calculations, with inputs such as interest rates, and a generic portfolio allocation.

The Takeaway

A Monte Carlo simulation is a mathematical technique used to estimate possible outcomes of an uncertain event, such as the movement of securities.

The basis of this analysis is that the probability of different outcomes cannot be determined because random variables cannot be predicted. Therefore, a Monte Carlo simulation will constantly repeat random samples to achieve certain results that can be used to gauge the likelihood of various outcomes, and therefore different risk levels associated with different choices.

So although investing always involves risk and many unknown factors, using a calculator or tool based on the Monte Carlo method can help provide a more sophisticated use of probabilities to make investment choices. You could get started investing today by opening a brokerage account with the SoFi Invest® investment app. SoFi Invest offers an active investing solution that allows you to trade stocks, ETFs, and cryptocurrencies without paying SoFi management fees.

Photo credit: iStock/PeopleImages

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November 13, 2021

What Are Corporate Bonds?

Bonds can make up an important part of a diversified portfolio, but you can find diversity within bonds as well. Corporate bonds are one type of debt security that may offer higher returns than government bonds, but they may also come with higher risk.

What Is a Corporate Bond?

A bond is a debt security that functions much like an IOU. Governments and companies issue these obligations as a way to raise capital. For example, a state might issue bonds to build a new bridge, and the U.S. Treasury issues Treasyry Bills (T-Bills) to cover its expenses.

Corporations also sell bonds to raise capital. They might use the money raised through the financial securities to reinvest in their business, pay down debts, or even buy other companies.

When investors buy corporate bonds, they are loaning a company money for a set period of time. In exchange, the company agrees to pay interest throughout the agreed upon period. When this time is up and the bond reaches “maturity” the issuer will return the principal. If a company can’t make interest payments or return the principal at the end of the period, they default on the bond.

How Do Corporate Bonds Work?

Bonds are a huge part of the broader securities markets. U.S. fixed income markets comprise nearly 40% of global securities. To understand bond market and how bonds work, you need to know a few important terms:

• Issuer: The entity using bonds to raise money.

• Par Value: Also known as the nominal or face value of the bond or the principal, the par value is the amount the bond issuers promise to repay when the bond reaches maturity. This amount does not fluctuate over the life of the bond.

• Price: A bond’s price is the amount an investor pays for a bond in the market. This amount can change based on market factors.

• Coupon rate: Also known as coupon yield, the coupon rate is the annual interest rate paid by the bond issuers based on the bond’s par value.

• Maturity: The date at which a bond’s issuer must repay the original bond value to the bondholder.

Benefits and Drawbacks of Corporate Bonds

While corporate bonds can add a lot of benefits to a portfolio, before investing it’s important to consider the drawbacks, as well.

Benefits	Drawbacks
Bonds, including corporate bonds, can be an important part of a diversified portfolio.	Bonds may offer lower returns than other securities, such as stocks.
Many investors consider corporate bonds as a riskier investment than government bonds, such as U.S. Treasuries. As a result, they tend to offer higher interest rates.	If the issuer cannot make interest payments or repay the par value when the bond reaches maturity, the bond will go into default. If an issuer goes bankrupt, bondholders may have some claim on the company’s assets and be able to recoup some of their losses.
Bonds are relatively liquid, meaning it is easy to buy and sell them on the market.	Some bonds are “callable”, which means issuers can choose to pay them back early. When that happens, bond holders won’t earn as much interest and will have to find a new place to reinvest.

Types of Corporate Bonds

There are three main ways to categorize corporate bonds:

Duration

This category reflects the bond’s maturity, which may range from one to 30 years. There are three maturity lengths:

• Short-term: Maturity of less than three years.

• Medium-term: Maturity of four to 10 years.

• Long-term: Maturity of more than 10 years. Longer-term bonds typically offer the highest interest rates.

Risk

Every once in a while, a corporation defaults its bonds. The likeliness of default impacts a company’s creditworthiness and investors should consider it before purchasing a bond. Bond ratings, assigned by credit rating agencies, can help investors understand this risk.

Bonds can be rated as:

• Investment grade: Companies and bonds rated investment grade are unlikely to default. High-rated corporate bonds typically pay a slightly higher rate than government securities.

• Non-investment grade: Non-investment grade bonds are more likely to default. Because they are riskier, non-investment grade bonds tend to offer a higher interest rate and are often known as high-yield bonds.

Interest Payment

Investors may also categorize bonds based on the type of interest rate they offer.

• Fixed rate: With a fixed rate bond, the coupon rate stays the same over the life of the bond.

• Floating rate: Bonds that offer floating rates readjust interest rates periodically, such as every six months. The floating rate depends on market interest rates.

• Zero-coupon bonds: These bonds have no interest rate. Instead, when a bond reaches maturity, the issuer makes a single payment that’s higher than purchase price.

• Convertible bonds: Convertible bonds act like regular bonds with a coupon payment and a promise to repay the principal. However, they also give bondholders the option to convert their bonds into company stock according to a given ratio.

Difference Between Corporate Bonds and Stocks

Bonds differ from other types of investments in a number of important ways. When investors buy stocks, they are buying ownership shares in the company. Share prices may fluctuate depending on the markets and the health of the company. If the company does well, the stock price may rise, and the investor can sell their shares at a profit. Additionally, some companies share profits with their shareholders in the form of dividends.

When an investor purchases a corporate bond, on the other hand, they do not own a piece of the company. The bondholder is only entitled to interest and the principal. Those amounts don’t change based on company profits or the stock price. When a company goes bankrupt, bondholders have priority over stockholders when it comes to claims on the issuer’s assets.

How to Buy Corporate Bonds

Investors can buy individual bonds through brokerage firms or banks. Corporations typically issue them in increments of $1,000. Much like investing in an initial public offering, it can be tricky for retail investors to get in on newly issued bonds. Investors may need a relationship with the organization that’s managing the offering. However, investors can also purchase individual bonds on the secondary market.

Another way to gain access to the bond market is by purchasing bond funds, including mutual funds and exchange-traded funds that invest in bonds. These funds can be a good way to diversify a bond portfolio as they typically hold a diverse basket of bonds that tracks a bond index or a certain sector.

Investors can purchase bonds through a traditional brokerage account or an Individual Retirement Account. They may be able to purchase bond funds through their 401(k), and possibly individual bonds through a brokerage window within the 401(k).

Recommended: IRA vs 401(k) – What is the Difference?

More sophisticated traders may choose to invest in bond options, which allow them to bet on the direction in which a bond price may go without actually purchasing the bond itself.

The Takeaway

Before buying bonds, it’s important that individuals consider how they’ll fit in with their financial goals, risk tolerance, and time horizon. For example, if you’re working toward retirement and have decades to save, you may want a portfolio that’s mostly stocks since stocks tend to outperform bonds in the long run. If you’re close to your goal — or have a low appetite for risk — you may want to stick with bonds.

Stocks are also typically more volatile, but those with a long time horizon may have ample time to ride out the ups and downs of the market. If you’re interested in using stocks to build your portfolio, a good way to start is by opening a brokerage account on the SoFi Invest® investment app.

Photo credit: iStock/Prostock-Studio

Source: sofi.com

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