Subsidized vs. unsubsidized loans

The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

The federal direct loan program offers subsidized and unsubsidized loans to college students. A federal direct subsidized loan is a loan where the government pays the interest while the student is in school. A federal direct unsubsidized loan is one in which the student is responsible for paying all interest, receiving no additional federal aid.

What Is the Difference Between Subsidized and Unsubsidized Student Loans?

The main differences between federal direct subsidized and unsubsidized loans are the qualification criteria, the maximum limits and how the loan interest works.

A chart displaying the differences between subsidized and unsubsidized student loans.

Loan Qualifications

Subsidized: To qualify for a subsidized loan, you must be an undergraduate student who can demonstrate financial need based on the information you submit through the Free Application for Federal Student Aid (“FAFSA”).

Unsubsidized: Unsubsidized loans are available to both undergraduate and graduate students, and there is no requirement to demonstrate financial need.

Maximum Loan Limits

Subsidized: Your school will determine exactly how much you can borrow each year, but there are federal limits. These limits are based on what year of school you are in and whether you file as a dependent or an independent. Subsidized loan limits tend to be lower than unsubsidized limits. The aggregate limit for an independent student with subsidized loans is $23,000.

Unsubsidized: Unsubsidized loan limits tend to be higher than subsidized loan limits. The aggregate limit for an independent student with unsubsidized loans is $34,500.

How Interest Accrues

Subsidized: The U.S. Department of Education pays the interest for subsidized loans as long as the student is enrolled in school at least half-time. They will also pay the interest during your grace period—defined as the first six months after leaving school—and any period of deferment. This means that the amount of the loan will not grow once the student graduates, since the government has been paying the interest.

Unsubsidized: Whether you’re an undergraduate or a graduate student, you’re responsible for paying all of the interest during the entire life of your unsubsidized loan.

What Are the Similarities Between Subsidized and Unsubsidized Student Loans?

When it comes to interest rates, fees and the “maximum eligibility period”—the amount of time you’re able to take out loans—subsidized and unsubsidized loans are virtually the same.

Fees

On top of interest, you can expect to pay a small fee for both types of loans. This is approximately 1.06 percent of your total loan amount, and it is deducted from each loan disbursement. 

Both subsidized and unsubsidized student loans have a fee of 1.06% of the total loan amount.

Undergraduate Interest Rates

The interest rates for both subsidized and unsubsidized loans for undergraduate students are the same. Currently, the rate is at 2.75 percent for loans first disbursed from July 1st, 2020, to June 31st, 2021. The one exception is for direct unsubsidized loans for graduate students, which have an interest rate of 4.30 percent. 

Maximum Eligibility Period

For both loan types, the time in which you’re eligible for your loans is equal to 150 percent of the time of your program. For undergraduates pursuing a four-year bachelor’s degree, this means they will be eligible for their loans for six years. Those pursuing a two-year associate’s degree will be eligible for three years. This ensures that students can still receive loans even if they’re unable or choose not to graduate within the program’s time frame. 

How to Apply for Subsidized and Unsubsidized Loans

Once you’re ready to apply for a federal direct loan, fill out the FAFSA. Your school will send you a detailed report of what student aid you’re eligible for. Any grants or scholarships are free money, so make sure to accept them. They’ll also decide which loans you’re eligible for, the amount you can borrow each year and what loan type you can get—subsidized or unsubsidized. 

No matter what type of student loan you go for, it’s important to understand how they affect your credit so that you can set yourself up for financial success after graduation. With responsible, on-time payments, you’ll be well on your way to healthy credit for life.


Reviewed by Cynthia Thaxton, Lexington Law Firm Attorney. Written by Lexington Law.

Cynthia Thaxton has been with Lexington Law Firm since 2014. She attended The College of William and Mary in Williamsburg, Virginia where she graduated summa cum laude with a degree in International Relations and a minor in Arabic. Cynthia then attended law school at George Mason University School of Law, where she served as Senior Articles Editor of the George Mason Law Review and graduated cum laude. Cynthia is licensed to practice law in Utah and North Carolina.

Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.

Source: lexingtonlaw.com

What’s Your Strategy for Maximizing Your Social Security Benefits?

Deciding when to take social security is a bit like playing chess. You’ll need to strategize and think a few moves ahead to maximize your benefit because age and timing matter. Applying at the youngest age possible, 62, reduces a monthly benefit 25% to 30% for the rest of your life than if you had waited until full retirement age. Delay until the latest age possible, 70, and that monthly benefit increases 8% each year you wait past your full retirement age, a bonus of 24% to 32% depending on your birth year.

Your birth year matters because the full retirement age is rising — from 66 for people born between 1943 and 1954, to 67 for those born in 1960 or later. If your birth year falls between 1955 and 1959, the full retirement age rises two months every year.

The retirement age isn’t the only thing that’s changing. The rules for claiming Social Security are different for those born after Jan. 1, 1954. This includes the majority of people filing for benefits today, and the changes especially affect married, two-earner couples.

First, the basics: Individuals pay into Social Security their entire working life in order to receive a steady stream of income in the form of a monthly benefit once they retire. The benefits are based on the person’s 35 highest years of earnings. If you don’t have 35 years of earnings, then zeroes are entered for the remaining years, reducing the monthly benefit.

As pensions disappear and life expectancies rise, a guaranteed lifelong income that isn’t tied to the stock market has tremendous value. “Social Security is the best deal out there,” says Diane M. Wilson, a claiming strategist and founding partner of My Social Security Analyst in Shawnee, Kan. “It’s an annuity that lasts a lifetime, and it’s indexed to inflation.”

Maximizing that benefit has produced a cottage industry of claiming strategists to help retirees determine the best time to start taking benefits, but it’s not a simple calculus. “In the end, it’s a longevity decision,” says Kurt Czarnowski, who counsels clients about Social Security at Czarnowski Consulting in Norfolk, Mass. “If you knew when you were going to die, all this would be a snap.” Instead, people should understand their choices and make an informed decision, he says.

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The Differences Between Restricted Filing and Deemed Filing

A stack of Social Security cardsA stack of Social Security cards

For married couples, that decision involves accounting for two people’s earnings and benefits, as well as the likelihood of one spouse outliving the other. Spouses are not only entitled to the benefit based on their own work history, but they also may be eligible for additional money when the spousal benefit is factored in, what Wilson calls “add-ons.” The spousal benefit equals 50% of the higher-earning spouse’s benefit if the lower-earning spouse takes it at full retirement age. The amount is reduced when taken early, and you can’t claim the spousal benefit until your spouse begins taking Social Security. To be clear, you do not get to take two benefits, but rather Social Security increases your benefit to equal half of your spouse’s if the one based on your own work history is smaller.

People born on or before Jan 1, 1954, can maximize benefits while still receiving some Social Security. By taking whichever benefit is lower — their own or a spouse’s — when they first apply, they let the larger benefit grow before switching to it at a later age. That option, known as “restricted filing,” isn’t available for people born after Jan. 1, 1954. For them, there’s no choice. Social Security simply bestows their own benefit and any add-ons the person is eligible for when they file for benefits, a practice known as “deemed filing.”

Let’s say the higher-earning spouse is the husband and the lower-earning spouse is the wife. Under deemed filing, when the wife applies for Social Security at her full retirement age, she is given the highest amount she is eligible for, which in this instance is 50% of her husband’s benefit, assuming he started taking it. If he hasn’t, she will be given only the benefit based on her own work history. Once her husband applies for his benefits, Social Security will increase hers so that it equals half of his. If the wife was the higher earner and her benefit was more than 50% of his, she won’t get any additional money when he starts claiming Social Security. She will simply continue collecting her own higher work benefit.

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Maximizing Social Security Benefits for Married Couples

A couple looks at a laptop. A couple looks at a laptop.

Deemed filers may have fewer options, but there are other strategies to consider, such as when to start claiming and which spouse should file for Social Security first. Those decisions can change cumulative lifetime benefits substantially, sometimes by as much as six figures, says Wilson. When she advises couples affected by the new rules, she generally recommends the higher earner to delay as long as possible, ideally until age 70, while the lower earner can file, giving the retired couple some income.

The couple’s age difference matters, particularly if the younger spouse is also the lower earner, says Jim Blair, co-owner of Premier Social Security Consulting in Cincinnati. In that case, “if they’re five years or more apart in age, you want the younger person filing as early as possible, at 62, and the older person delaying as long as possible,” he says. “Odds are the younger person is going to receive a survivor benefit before they reach their breakeven point, which is about 12 years past retirement age.” The breakeven point is the age when the total value of cumulative benefits, whether taken early or later, is roughly the same.

If the situation is reversed and the younger spouse is the higher earner, “we’ll look at what the younger individual will need in retirement,” Blair says. “If taking that benefit early at age 62 means a 25% reduction, they’re going to have to live with that for the rest of their life.” There will need to be other income to compensate for the reduction, he adds.

Couples who straddle the 1954 birth year, with one spouse falling under the old rules and the other under the new, have more ways to move the pieces on the Social Security chess board. For instance, if the wife is the younger, lower earner, she may want to apply early, taking her own reduced benefit. That would allow the husband, who was born before the 1954 cutoff date, to use a restricted application and request only a spousal benefit. Meanwhile, his benefit based on his own work history continues to grow 8% per year from his full retirement age until he turns 70. He can switch to his own higher benefit later, whether at 70 or sooner.

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Understanding Social Security Survivor Benefits

A man sits alone on a swing. A man sits alone on a swing.

Couples should try to postpone taking whichever spouse’s benefit is higher to ensure a larger survivor benefit. This is particularly important when the lower earning spouse is younger and likely to outlive the higher earner by many years. “You want that higher benefit to take care of the survivor,” says Wilson, who warns clients of expenses, like home health aides, that someone living alone will almost certainly have.

A spousal benefit turns into a survivor benefit when a spouse dies, but the benefits are not the same. A surviving spouse who is at least full retirement age can receive 100% of the deceased spouse’s benefit, as opposed to 50% for a spousal benefit. The amount is reduced if the surviving spouse claims the benefit before full retirement age. You can claim a survivor benefit as early as age 60 (50 if you are disabled). But you don’t have to take it early, and you may not want to if you’re still working.

Social Security imposes an annual earnings limit for anyone younger than full retirement age who collects benefits, a rule that also applies to surviving spouses. For every $2 earned above the limit, which is currently $18,960, Social Security will deduct $1 in benefits, with the money restored later in the form of a higher benefit when you reach full retirement age. The earnings rule is more generous the year you reach full retirement age with Social Security deducting $1 for every $3 in earnings above $50,520. There’s no limit on earnings once you are full retirement age.

A widow who is, say, 60 when her husband passes away could hold off and take the survivor benefit when she reaches her full retirement age and stops working. There’s no reason to wait beyond that age because the survivor benefit won’t increase.

A survivor benefit is also not subject to the deemed filing rule. Someone born after the 1954 cutoff date can choose to take either their own or the survivor benefit when applying for Social Security. That opens a whole new avenue of claiming strategies. A widower, for example, could take the survivor benefit first if he needs the income and let his own larger benefit continue accruing delayed retirement credits before switching to it at age 70. If his own benefit is smaller, he could take that early and switch to the larger survivor benefit when he reaches full retirement age. The survivor benefit won’t be reduced because he took his own benefit early. The survivor benefit is only reduced if he takes it before his full retirement age.

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How Death, Divorce and Remarriage Affect Social Security Benefits

picture of wedding photo cut in halfpicture of wedding photo cut in half

A divorced spouse is also eligible for benefits based on a former spouse’s earnings history. If your ex is still alive and both of you are at least age 62, you can collect a spousal benefit even if your ex hasn’t started collecting, provided that the marriage lasted at least 10 continuous years, the divorce was two or more years ago, and you haven’t remarried. Your ex won’t know you’re taking the benefit. A divorced spouse who is full retirement age can get 50% of the former spouse’s benefit; it’s reduced if taken early. Deemed filing rules still apply if you were born after New Year’s Day 1954, with only the highest benefit amount given to you.

If your ex has passed away, you can collect a survivor benefit as early as age 60, but the other requirements — a marriage that lasted at least 10 years and a divorce that was finalized two years ago — remain. You also can’t have remarried before age 60.

If you remarry after age 60, you are allowed to keep the survivor benefit from a former spouse whether you were divorced or not, but timing is everything. Wilson had a client, a widower, who was two months away from turning 60 and collecting a survivor benefit. He was also about to remarry. “I told him about the rule, and he said, ‘I can’t reschedule this now.'” He went ahead with the wedding as planned, sacrificing the survivor benefit at the altar. Wilson points out that her client could collect a survivor benefit from his first marriage if the second one ends for any reason.

As with any survivor benefit, there’s no deemed filing. A divorced spouse has the option of choosing which benefit to take first — their own or the survivor benefit — and let whichever is larger continue to grow before switching to it later on.

Remarriage brings other claiming strategies, such as applying for a spousal benefit based on the new spouse’s work record, but there is a waiting period. To collect a spousal benefit, you generally need to be married one year, Czarnowski says. An exception is made for someone who is already collecting a Social Security benefit and remarries. Then the waiting period is waived, he says. For example, a widow over age 60 who is collecting a survivor benefit and remarries is “immediately eligible to collect 50% of the new husband’s benefit, assuming he is collecting his benefit,” Czarnowski says. You will need to choose which benefit you want — the survivor benefit from an earlier marriage or the new spousal benefit.

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When Singles Should File for Social Security Benefits

A man works on a computer. A man works on a computer.

For single people who never married, there’s no survivor to consider so the decision of when to claim is based on the need for income and how much they’ll get at any given age between 62 and 70. “It’s really which point along this continuum makes sense,” Czarnowski says. You can get an idea of how much your benefit will be at different ages based on your current earnings by using Social Security’s quick calculator. You can also enter your earnings history for a more precise figure.

Most of Wilson’s single clients start claiming at full retirement age so that their benefits aren’t reduced. Should they wait until age 70 to get the highest possible benefit? “They may want to if they’re still working and they don’t need Social Security,” Blair says. “The flip side is when they pass away, the benefits end. If they pass away at 72, they didn’t collect very long.”

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You Can Pause Your Social Security Benefits

Someone pushes a red button that is labeled "No!"Someone pushes a red button that is labeled "No!"

Social Security also gives people who regret taking a benefit early the chance to reverse that decision. If you change your mind within the first 12 months of claiming your benefit, you can withdraw the application. All the benefits you received will need to be repaid, including any spousal benefits based on your work record, but you’ll get a higher monthly benefit when you restart later on.

The second way is to suspend your benefit, which you can only do once you reach full retirement age. You won’t need to repay the benefits you’ve received, and you earn delayed retirement credits of 8% per year until age 70, enabling you to reverse some of the damage from claiming early. Keep in mind, however, that when you suspend a benefit, you also suspend any other benefits based on your work record, such as a spousal benefit. If your spouse was getting $1,500 per month and $500 was based on your work record, she’ll only get her own $1,000 benefit when you suspend.

Source: kiplinger.com

7 Things to Do After College Besides Work

Numerous college students have a trajectory in mind for navigating life after college. For some, getting a job is their top goal. But, are there other things to do after college besides work?

Beyond looking for a traditional entry-level job, there are alternative choices for new grads—including internships, volunteering, grad school, spending time abroad, or serving in Americorps.

Naturally, the options available will differ depending on each person’s situation, as not all alternatives to work come with a paycheck attached.

Here’s a look at these seven things to do after college besides work.

1. Pursuing Internships

One popular alternative to working right after college is finding an internship. Generally, internships are temporary work opportunities, which are sometimes, but not always, paid.

Internships may give recent grads a chance to build up hands-on experience in a field or industry they believe they’re interested in working in full time. For some people, it could help determine whether the reality of working in a given sector meets their expectations.

Whatever grads learn during an internship, having on-the-job experience (even for those who opt to pursue a different career path) could make a job seeker stand out afterwards. Internships can help beef up a resume, especially for recent grads who don’t have much formal job experience.

A potential perk of internships is the chance to further grow your professional network—building relationships with more experienced workers in a particular department or job. Some interns may even be able to turn their short-term internship roles into a full-time position at the same company.

Starting out in an internship can be a great way for graduates to enter the workforce, “road testing” a specific job role or company.

2. Serving with AmeriCorps

Some graduates want to spend their time after college contributing to the greater good of American society. One possible option here is the Americorps program—supported by the US Federal Government.

So, what exactly is Americorps? Americorps is a national service program dedicated to improving lives and fostering civic engagement. There are three main programs that graduates can join in AmeriCorps: AmeriCorps NCCC, AmeriCorps State and National, and AmeriCorps Vista.

There’s a wide variety of options in AmeriCorps, when it comes to how you can serve. Graduates can work in emergency management, help fight poverty, or work in a classroom.

However graduates decide to serve through AmeriCorps, it may provide them with a rewarding professional experience and insights into a potential career.

Practically, Americorps members may also qualify for benefits such as student loan deferment, a living allowance, education awards (upon finishing their service), and skills training.

It may sound a bit dramatic, but AmeriCorps’ slogan is “Be the greater good.” Giving back to society could be a powerful way to spend some time after graduating—supporting organizations in need, while also establishing new professional connections.

3. Attending Grad School

When entering the workforce, graduates may encounter job postings with detailed employment requirements.

Some jobs require just a Bachelor’s degree, while others require a Master’s–think, for instance, of being a lawyer or medical doctor. Depending on their field of study and career goals, some students may opt to go right to graduate school after receiving their undergraduate degrees.

The number of jobs that expect graduate degrees is increasing in the US. Graduates might want to research their desired career fields and see if it’s common for people in these roles to need a master’s or terminal degree.

Some students may wish to take a break in between undergrad and grad school, while others find it easier to go straight through. This choice will vary from student to student, depending on the energy they have to continue school as well as their financial ability to attend graduate school.

Graduate school will be a commitment of time, energy and money. So, it’s advisable that students feel confident that a graduate degree is necessary for the line of work they’d like to end up in before they apply or enroll.

4. Volunteering for a Cause

Volunteering could be a great way for graduates to gain some extra skills before applying for a full-time job. Doing volunteer work may help graduates polish some essential soft skills, like interpersonal communication, interacting with clients or service recipients, and time management.

Another potential benefit to volunteering is the ability to network and forge new connections outside of college. The people-to-people connections made while volunteering could lead to mentorship and job offers.

Volunteering is something graduates can do after college besides work, while still fleshing out their resume or skills.

New grads may want to volunteer at an institution or organization that syncs with their values or, perhaps, pursue opportunities in sectors of the economy where they’d like to work later on (i.e., at a hospital).

On top of all these potential plus sides, volunteering just feels good. It makes people feel happier. And, after all of the stress that accompanies finishing up college, volunteering afterward could be the perfect way to recharge.

5. Serving Abroad

Similar to the last option, volunteering abroad can be attractive to some graduates. It may help grads gain similar skills they’d learn volunteering here at home, while also giving them the opportunity to learn how to interact with people from different cultures, try to learn a new language, and see new perspectives on solving problems.

Though it can be beneficial to the volunteers, volunteering abroad isn’t always as ethical as it seems. And, not all volunteering opportunities always benefit the local community.

It could take research to find organizations that are doing ethically responsible work abroad. One key thing to look for is organizations that put the locals first and have them directly involved in the work.

6. Taking a Gap Year

According to the Gap Year Association , a gap year is “a semester or year of experiential learning, typically taken after high school and prior to career or post-secondary education, in order to deepen one’s practical, professional, and personal awareness.”

While a gap year is generally taken after high school or after college, one common purpose of the gap year is to take the time to learn more about oneself and the world at large—which can be beneficial after graduating from college and trying to figure out what to do next.

Not only might a gap year help grads build insights into what they’d like to do with their later careers, it may also help them home in on a greater purpose in life or build connections that could lead to future job opportunities.

Graduates might want to spend a gap year doing a variety of activities—including:

•   trying out seasonal jobs
•   volunteering
•   interning
•   teaching or tutoring
•   traveling

A gap year can be whatever the graduate thinks will be most beneficial for them.

7. Traveling Before Working

Going on a trip after graduation is a popular choice for graduates that can afford to travel after college. Traveling can be expensive, so graduates may want to budget in advance (if they want to have this experience post-graduation.

On top of just being really fun, travel can have beneficial impacts for an individual’s stress levels and mental health. Research from Cornell University published in 2014 suggests that the anticipation of planning a trip might have the potential to increase happiness.

Traveling after graduation is a convenient time to start ticking locations off that bucket list, because graduates won’t be held back by a limited vacation time. Going abroad before working can give students more time and flexibility to travel as much as they’d like (and can afford to!).

With proper research, graduates can find more affordable ways to travel—such as a multi-country rail pass, etc. It doesn’t have to be all luxury all the time. Budget travel is possible especially when making conscious decisions, like staying in hostels and using public transportation.

If graduates are determined to travel before working, they can accomplish this by saving money and budgeting well.

Navigating Post Graduation Decisions

Whether a recent grad opt to start their careers off right away or to pursue one of the above-mentioned things to do after college besides work, student loans are something that millions of university students have taken out.

After graduating (or if you’ve dropped below half-time enrollment or left school), the reality of paying back student loans sets in. The exact moment that grads will have to begin paying off their student loans will vary by the type of loan.

For federal loans, there are a couple of different times that repayment begins. Students who took out a Direct Subsidized, Direct Unsubsidized, or Federal Family Education Loan, will all have a six month grace period before they’re required to make payments. Students who took out a Perkins loan will have a nine month grace period.

When it comes to the PLUS loan, it depends on the type of student that’s taken one out. Undergraduates will be required to start repayment as soon as the loan is paid out. Graduate and professional students with PLUS loans will be on automatic deferment while they’re in school and up to six months after graduating.

Some graduates opt to refinance their student loans. What does that mean? Well, refinancing student loans is when a lender pays off the existing loan with another loan that has a new interest rate. Refinancing can potentially lower monthly loan repayments or reduce the amount spent on interest over the life of the loan.

Both US federal and private student loans can be refinanced, but when federal student loans are refinanced by a private lender, the borrower forfeits guaranteed federal benefits—including loan forgiveness, deferment and forbearance, and income-driven repayment options.

Refinancing student loans may reduce money paid to interest. For graduates who have secured well-paying jobs and have improved their credit score since taking out their student loan, refinancing could come with a competitive interest rate and different repayment terms.

Graduating from college means officially entering the realm of adulthood, but that transition can take many forms. There are various financial tips that recent graduates may opt to look into.

Thinking about refinancing your student loans? With SoFi, you could get prequalified in just two minutes.



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Source: sofi.com

What Is a Bond Mutual Fund – Risks & Different Types of This Investment

Investing is an important part of saving for the future, but many people are wary of putting their money into the stock market. Stocks can be volatile, with prices that change every day. If you can’t handle the volatility and risk of stocks or want to diversify your portfolio into a less risky investment, bonds are a good way to do so.

As with many types of investments, you can invest in bonds through a mutual fund, which gives you easy diversification and professional portfolio management — for a fee.

Are bond mutual funds a good addition to your portfolio? Here are the basics of these investment vehicles.

What Is a Bond?

A bond is a type of debt security. When organizations such as national and local governments, government agencies, or companies want to borrow money, one of the ways they can get the loan they need is by issuing a bond.

Investors purchase bonds from the organizations issuing them. Typically, bonds come with an interest rate and a maturity. For example, a company might sell bonds with an interest rate of 5% and a maturity of 20 years.

The investor would pay the company $1,000 for a $1,000 bond. Each year, that investor receives an interest payment of $50 (5% of $1,000). After 20 years, the investor receives a final interest payment plus the $1,000 they paid to buy the bond.


What Is a Mutual Fund?

A mutual fund is a way for investors to invest in a diverse portfolio while only having to purchase a single security.

Mutual funds pool money from many investors and use that money to buy bonds, stocks, and other securities. Each investor in the fund effectively owns a portion of the fund’s portfolio, so an investor can buy shares in one mutual fund to get exposure to hundreds of stocks or bonds.

This makes it easy for investors to diversify their portfolios.

Mutual fund managers make sure the fund’s portfolio follows their stated strategy and work towards the fund’s stated goal. Mutual funds charge a fee, called an expense ratio, for their services, which is important for investors to keep in mind when comparing funds.

Pro tip: Most mutual funds can be purchased through the individual fund family or through an online broker like Robinhood or Public.


Types of Bond Mutual Funds

There are many types of bond mutual funds that people can invest in.

1. Government

Government bond funds invest most of their money into bonds issued by different governments. Most American government bond funds invest primarily in bonds issued by the U.S. Treasury.

U.S. government debt is seen as some of the safest debt available. There is very little chance that the United States will default on its payments. That security can be appealing for investors, but also translates to lower interest rates than other bonds.

2. Corporate

Corporate bond funds invest most of their assets into bonds issued by companies.

Just like individuals, businesses receive credit ratings that affect how much interest they have to pay to lenders — in this case, investors looking to buy their bonds. Most corporate bond funds buy “investment-grade” bonds, which include the highest-rated bonds from the most creditworthy companies.

The lower a bond’s credit rating, the higher the interest rate it will pay. However, lower credit ratings also translate to a higher risk of default, so corporate bond funds will hold a mixture of bonds from a variety of companies to help diversify their risks.

3. Municipal

Municipal bonds are bonds issued by state and local governments, as well as government agencies.

Like businesses, different municipalities can have different credit ratings, which impacts the interest they must pay to sell their bonds. Municipal bond funds own a mixture of different bonds to help reduce the risk of any one issuer defaulting on its payments.

One unique perk of municipal bonds is that some or all of the interest that investors earn can be tax-free. The tax treatment of the returns depends on the precise holdings of the fund and where the investor lives.

Some mutual fund companies design special municipal bond funds for different states, giving investors from those states an option that provides completely tax-free yields.

The tax advantages municipal bond funds offer can make their effective yields higher than other bond funds that don’t offer tax-free yields. For example, someone in the 24% tax bracket would need to earn just under 4% on a taxable bond fund to get the equivalent return of a tax-free municipal bond fund offering 3%.

4. High-Yield

High-yield bond funds invest in bonds that offer higher interest rates than other bonds, like municipal bonds and government bonds.

Typically, this means buying bonds from issuers with lower credit ratings than investment-grade bonds. These bonds are sometimes called junk bonds. Their name comes from the fact that they are significantly riskier than other types of bonds, so there’s a higher chance that the issuer defaults and stops making interest payments.

Bond mutual funds diversify by buying bonds from hundreds of different issuers, which can help reduce this risk, but there’s still a good chance that some of the bonds in the fund’s portfolio will go into default, which can drag down the fund’s performance.

5. International

Foreign governments and companies need to borrow money just like American companies and governments. There’s nothing stopping Americans from investing in foreign bonds, so there are some mutual funds that focus on buying international bonds.

Each country and company has a credit rating that impacts the interest rate it has to pay. Many stable governments are seen as highly safe, much like the United States, but smaller or less economically developed nations sometimes have lower credit ratings, leading them to pay higher interest rates.

Another factor to keep in mind with international bonds is the currency they’re denominated in.

With American bonds, you buy the bond in dollars and get interest payments in dollars. If you buy a British bond, you might have to convert your dollars to pounds to buy the bond and receive your interest payments in pounds. This adds some currency risk to the equation, which can make investing in international bond funds more complex.

6. Mixed

Some bond mutual funds don’t specialize in any single type of bond. Instead, they hold a variety of bonds, foreign and domestic, government and corporate. This lets the fund managers focus on buying high-quality bonds with solid yields instead of restricting themselves to a specific class of bonds.


Why Invest in Bond Mutual Funds?

There are a few reasons for investors to consider investing in bond mutual funds.

Reduce Portfolio Risk and Volatility

One advantage of investing in bonds is that they tend to be much less risky and volatile than stocks.

Investing in stocks or mutual funds that hold stocks is an effective way to grow your investment portfolio. The S&P 500, for example, has averaged returns of almost 10% per year over the past century. However, in some years, the index has moved almost 40% upward or downward.

Over the long term, it’s easier to handle the volatility of stocks, but some people don’t have long-term investing goals. For example, people in retirement are more concerned with producing income and maintaining their spending power.

Putting some of your portfolio into bonds can reduce the impact of volatile stocks on your portfolio. This can be good for more risk-averse investors or those who have shorter time horizons for their investments.

There are some mutual funds, called target-date mutual funds, that hold a mix of stocks and bonds and increase their bond holdings over time, reducing risk as the target date nears.

Income

Bonds make regular interest payments to their holders and the majority of bond funds use some of the money they receive to make payments to their investors. This makes bond mutual funds popular among investors who want to make their investment portfolio a source of passive income.

You can look at different bond mutual funds and their annual yields to get an idea of how much income they’ll provide each year. For example, if a mutual fund offers a yield of 2.5%, investors can expect to receive $250 each year for every $10,000 they invest in the fund.

Pro tip: Have you considered hiring a financial advisor but don’t want to pay the high fees? Enter Vanguard Personal Advisor Services. When you sign up you’ll work closely with an advisor to create a custom investment plan that can help you meet your financial goals. Read our Vanguard Personal Advisor Services review.


Risks of Bond Funds

Before investing in bonds or bond mutual funds, you should consider the risks of investing in bonds.

Interest Rate Risk

One of the primary risks of fixed-income investing — whether you’re investing in bonds or bond funds — is interest rate risk.

Investors can buy and sell most bonds on the open market in addition to buying newly issued bonds directly from the issuing company or government. The market value of a bond will change with market interest rates.

In general, if market rates rise, the value of existing bonds falls. Conversely, if market rates fall, the value of existing bonds rises.

To understand why this happens, consider this example. Say you purchased a BBB-rated corporate bond with an interest rate of 2% for $1,000. Since you bought the bond, market rates have increased, so now BBB-rated companies now have to pay 3% to convince investors to buy their bonds.

If someone can buy a new $1,000 bond paying 3% interest, why would they pay you the same amount for your $1,000 bond paying 2% interest? If you want to sell your bond, you’ll have to sell it at a discount because investors can get a better deal on newly issued bonds.

Of course, the opposite is true if interest rates fall. In the above example, if market rates fell to 1%, you could command a premium for your bond paying 2% because investors can’t find new bonds of the same quality that pay that much anymore.

Interest rate risk applies to bond funds just as it applies to individual bonds. As rates rise, the share price of the fund tends to fall and vice versa.

Generally, the longer the bond’s maturity, the greater the effect a change in market interest rates will have on the bond’s value. Short-term bonds have much less interest rate risk than long-term bonds. Bond funds usually list the average time to maturity of bonds in their portfolio, which can help you assess a fund’s interest rate risk.

Credit Risk

Bonds are debt securities, meaning they’re reliant on the bond issuer being able to pay its debts.

Just like people, companies and governments can go bankrupt or default on their loan payments. If this happens, the people who own those bonds won’t get the money they lent back.

Bond mutual funds hold thousands of bonds, but if one of the issuers defaults, some of the fund’s bonds become worthless, reducing the value of the investors’ shares in the fund.

Bonds issued by organizations with higher credit ratings are generally less risky than those with poor credit ratings. For example, most people would consider U.S. government bonds to have a very low credit risk. A junk bond fund would have much more credit risk.

Foreign Exchange Risk

If you’re buying shares in a bond fund that invests in foreign bonds, you should consider foreign exchange risk.

Currencies constantly fluctuate in value. Over the past five years, $1 could buy anywhere between 0.80 and 0.96 euros.

To maximize returns, investors want to buy foreign bonds when the dollar is strong and receive interest payments and return of principal when the dollar is weak.

However, it’s incredibly hard to predict how currencies’ values will change over time, so investors in foreign bonds should consider how changing currency values will affect their returns.

Some bond funds use different strategies to hedge against this risk, using tools like currency futures or buying dollar-denominated bonds from foreign entities.

Fees

Mutual funds charge fees, which they commonly express as an expense ratio.

A fund’s expense ratio is the percentage of your invested assets that you pay each year. For example, someone who invests $10,000 in a mutual fund with a 1% expense ratio will pay $100 in fees each year.

Expense ratio fees are included when calculating the fund’s share price each day, so you don’t have to worry about having cash on hand to pay the fee. The fees are taken directly out of the fund’s share price, almost imperceptibly. Still, it’s important to understand the impact fees have on your overall returns.

If you invest $10,000 in a fund that produces an annual return of 5% and has a 0.25% expense ratio, after 20 years you’ll have $25,297.68. If that same fund had an expense ratio of 0.50%, you’d finish the 20 years with $24,117.14 instead.

In this example, a difference of 0.25% in fees would cost you more than $1,000.

If you find two bond funds with similar holdings and strategies, the one with the lower fees tends to be the better choice.


Final Word

Bond mutual funds are a popular way for investors to get exposure to bonds in their portfolios. Just as there are many different types of stocks, there are many types of bonds, each with advantages and disadvantages.

If you don’t want to pick and choose bonds to invest in, bond funds offer instant diversification and professional management. If you want an even more hands-off investing experience, working with a financial advisor or robo-advisor that handles your entire portfolio may be worth considering.

Source: moneycrashers.com

5 Mind-Altering Wealth Strategies for Successful Business Owners

I’m an entrepreneur and just so happen to be in the business of providing other entrepreneurs with financial advice. But I don’t typically offer up the usual status quo advice that tells you to do things that aren’t always in alignment with growing your business.

My views originate from my experiences and at times are contrarian to what’s being recommended by the usual tax preparer and other financial advisers, because I am in the trenches running a business just like you. I know what it takes to grow a business, make payroll, deal with IRS notices and manage cash flow.

The truth is that being an entrepreneur can be isolating at times as a result of being wrapped up in the day-to-day of running your business. When you are hyper-focused on your business, it is difficult to also be an expert at managing the profits of the company.  You may be great at making money, but once it’s made, what do you do with it?

Thinking differently about your company and how you will use it to build wealth is the key to true financial success.

In this article, I’ll outline five ways you can shift your mindset about money to transform how you define and operate your business and approach your financial decisions. It will help you identify what you really want to achieve: A Self-Managing Company®, a term coined by  Dan Sullivan of Strategic Coach.  

Mind Shift No. 1: Understand that Retirement Savings Plans Don’t ‘Lower’ Your Tax Bill

As a business owner, you are probably time-starved and used to making fast decisions. And you may be tempted to make fast decisions at tax time, especially when your tax preparer suggests that tax-deferred investments are the answer to lower your tax bill and save some money for retirement.  Easy enough, right?

This is what I like to call a half-truth. It’s true that you’ll get the deduction for that year’s taxes. But the other half of the story uncovers the problem with the use of SEP IRAs, 401(k)s and other tax-deferred options to “lower” your tax bill. The reality is that you are taking money from your business where you have some level of control and redirecting those dollars into the stock market where you have absolutely no control.  The money is tied up until you are 59½ years old and face potentially higher tax liabilities than you previously owed with no access to your cash if it is needed for growing or sustaining your business.

When you own a business, the half-truths you hear from many finance professionals and the mainstream media can at times negatively impact your ability to grow your business and protect your interests.  I have found there are other, more productive ways to build wealth outside of your business, beyond the base-level concepts of investing or putting money in an IRA or 401(k).

Mind Shift No. 2: View Your Company Not as Your Job, but as a Tool for Building Your Wealth

If you run a healthy business, you have a long-term strategy. You know what the end-goal is. You think about the business as a whole, rather than focusing on simply the day-to-day tasks.

We’ve all heard the old adage: Work on your business, not in your business. That’s because if you’re working in your business all the time, you’ve only created a job for yourself.  The goal is to build systems and develop people to slowly work yourself out of the role you have and allow the business to run on its own.  The sooner you shift your mindset to this way of thinking, the sooner you can begin to experience the results.

First, carve out the time in your day to think about your business. Many business owners I talk to don’t do this, because they are buried in the work. Take time to talk to your future self about what you want your life to look like in the future.  What would your future self say to you about the decisions and choices you are making?  It helps to outline your thinking time, keep a journal of your discoveries, meditate to de-stress, and use the time to reflect on what you are trying to accomplish in the business.

Next, think about your business as a piece of your financial plan. How much time and capital are you investing into the business, and what are you getting out of it?  What is your ROI?  I’ve found that a business can offer the biggest opportunity to build wealth, and in many cases — depending on your results — it can offer more than what you might get from investing in the market.

Finally, think with the end in mind. At the end of the day, what are you trying to get out of your company? To build wealth through your business, you must identify what will build its value.

Building value revolves around creating a self-managing company, one that runs without you and has a strategy to sustain itself into the future. This allows you to sell it for maximum value, or even create a passive income stream without actually having to work in the business.

Shifting your mindset is important, because you probably didn’t start your business that way. Many business owners don’t, and that’s OK while you’re getting things up and running. But it’s important to remember that what got you started will not get you to the next level and will not build the wealth needed to successfully exit the business.

Mind Shift No. 3: Master Your Cash Flow

I tend to bust a lot of myths when it comes to financial matters, and one of them has to do with cash flow. This is especially important to understand as an entrepreneur. Your cash flow is not there to simply pay your bills. Yes, you must pay your bills of course, but there is more to it than simply making payroll.

Cash flow is a tool to help you build wealth and the value of your company.  Healthy cash flow allows for you to control your money, and there are strategies you can explore to help you maximize it.

I recently spoke with a partner of a business who was earning a W-2 salary of $400,000 per year. In working with his CPA, we were able to rework his partnership agreement, removing him as an employee and adding him as a consultant of his own LLC.  While this simple strategy reduced his tax liability by $20,000, implementing this strategy was about more than just lowering taxes.  This was about cash flow – everything is always about cash flow.  By making this little tweak, he increased his cash flow by $1,666 per month.

I’m not a CPA and don’t provide tax advice, but I ask a lot of questions and propose many scenarios for the tax professionals to consider – scenarios that can increase cash flow for business owners. Increasing and optimizing your cash flow should be a top priority for your business.

Mind Shift No. 4: Be Your Own Bank

Companies with cash are able to do many things without having to rely on a bank or other source of funding. In essence, they can be their own bank. Think about it. When you have cash, you can use it to work on your wealth-building strategy. You could buy a company, invest in equipment, hire more people (maybe even a replacement for yourself who can run the company while you collect passive income), buy property, or take advantage of any other opportunity that may come your way.

But there is another way you can be your own bank. Maybe you’ve heard of the concept of “BUILD Banking™,” a cash flow strategy using a specially designed life insurance contract. It’s a strategy that I use personally and with many of my clients who want to have greater control of their cash flow. It frees them from dependence on banks for capital infusions and avoids government red tape when they need to access their money.

For more information about BUILD Banking™, visit www.buildbanking.com.

This strategy enables business owners to grow assets tax-free and have access to those funds whenever they’re needed. In essence, you’re accessing cash when it is needed while having uninterrupted compounding growth for your future.

Mind Shift No. 5: Understand Your Legal Exposures and Protect Yourself

You likely have some form, or forms, of insurance in place for your business. And you may believe that these policies have you covered. Well, they may, and they may not. The coverage you need goes far beyond liability, even extending into punitive damages.

It’s important to work with an insurance professional who specializes in business coverage to ensure that you have the right type of policies and the proper level of protection for your specific business.

There are also certain types of insurance policies (including the BUILD Banking strategy I’ve described above) that can serve a strategic purpose for your business. It’s common, and valuable, for business owners to have a life insurance contract as part of their succession plan, acting as a funding mechanism for the beneficiary to purchase the deceased owner’s share of the business.

Again, you will want to have a collaborating team of insurance professionals who have expertise in their vertical and who understand your business, your goals and what you are trying to accomplish. It’s also a good idea to include your CPA, attorney and financial planner in on those discussions.

These five financial planning tips and mindset shifts will help you use your business as a tool to start building wealth (or build greater wealth). They may be things you’ve never thought about, or things you’ve considered but haven’t been able to implement.  Putting these ideas to work can get you on the path to true business success.

Results may vary. Any descriptions involving life insurance policies and their use as an alternative form of financing or risk management techniques are provided for illustration purposes only, will not apply in all situations, may not be fully indicative of any present or future investments, and may be changed at the discretion of the insurance carrier, General Partner and/or Manager and are not intended to reflect guarantees on securities performance. Benefits and guarantees are based on the claims paying ability of the insurance company.
The terms BUILD Banking™, private banking alternatives or specially designed life insurance contracts (SDLIC) are not meant to insinuate that the issuer is creating a real bank for its clients or communicating that life insurance companies are the same as traditional banking institutions.
This material is educational in nature and should not be deemed as a solicitation of any specific product or service. BUILD Banking™ is offered by Skrobonja Insurance Services LLC only and is not offered by Kalos Capital Inc. nor Kalos Management.
BUILD Banking™ is a DBA of Skrobonja Insurance Services LLC.  Skrobonja Insurance Services LLC does not provide tax or legal advice. The opinions and views expressed here are for informational purposes only. Please consult with your tax and/or legal adviser for such guidance.

Founder & President, Skrobonja Financial Group LLC

Brian Skrobonja is an author, blogger, podcaster and speaker. He is the founder of St. Louis Missouri-based wealth management firm Skrobonja Financial Group LLC. His goal is to help his audience discover the root of their beliefs about money and challenge them to think differently to reach their goals. Brian is the author of three books, the Common Sense podcast and blog. In 2017 and 2019 Brian received the award for Best Wealth Manager and in 2018 the Future 50 St. Louis Small Business.

Source: kiplinger.com