Four More Terms

Hopefully you’ve been finding these weekly posts about financial terms to be helpful and informative. We’ve typically been reviewing two terms per week, but let’s switch it up a bit this time and look at shorter definitions of four: dividends, garnishment, FICO score and IRAs.

Dividends – Dividends are what companies pay to investors who own shares of company stock. These payments typically occur quarterly and, over time, make a big difference in an investor’s total return. How much of a difference? Going back many decades, reinvesting dividends has contributed about 40% of the S&P 500’s (the typical stock benchmark) historical average annual return of almost 10%.

But not all companies pay dividends. Apple Inc, Berkshire Hathaway, Amazon and Google are some of the largest companies in the index and don’t pay a regular dividend. Partly due to this, the index currently averages about 2% versus a historical average of about 4%.

Most folks receive their dividends from the mutual funds they own. These funds hold the stocks, receive the dividends and then pass them through to fund shareholders, usually every quarter.

While dividends help boost your return, they are taxable in the year received unless, of course, they’re owned in a retirement account, but we’ll get to that later.

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Premiums and Mortgage Insurance

Before we start this week’s post, I’m pleased to announce that Brayden Cleland has accepted a full-time position at Ridgeview Financial Planning as my assistant. Brayden has earned a degree in finance and will be starting his Certified Financial Planner studies in the coming weeks. Welcome, Brayden!

Also, I took our new website live this week. The format is more mobile friendly, and I’ve updated some of the content. The links you might have used the in the past (logging into your portal, sending documents securely, etc) will now be found in the “Clients” dropdown list on the homepage.

This week let’s review two more finance terms from the YouGov poll: premium and mortgage insurance. Like last week, I’m wondering if folks know of the terms but don’t necessarily understand the details. For example, most people know what a premium is because they pay it. But do they understand how premiums differ from deductibles and the associated tradeoffs?

This post will address those sorts of details as succinctly as possible, even though whole chapters of a book could be devoted to them.

Premium – “Premium” has multiple uses within the realm of personal finance. For example, investors may pay a premium to buy a higher-quality stock or bond, and there are “term premiums” that investors want to receive when buying longer-term bonds. There are many examples in this vein, but this week let’s focus on “premium” as it pertains to insurance and the tradeoffs that come into play.

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What's a Mutual Fund?

You know that feeling when you're flying on an airplane and the plane hits an air pocket and the drop makes you feel like you're wearing your stomach as a hat? Well, you'd be forgiven if December's market volatility generated a similar sensation. And you'd be forgiven again if the recent upsurge caught you equally by surprise.

Through last week, the S&P 500 (our best barometer for US stocks) had surged over 10% after declining almost 20% during the recent correction. It's not normal for stocks to do this, but it's not unprecedented either. According to my research partners at Bespoke Investment Group, this kind of move has happened just 12 times since WWII. Historically, returns trend higher in the year following these sorts of gyrations but there's also a chance the market reaches what's called a "lower low" during that timeframe. If nothing else, this should accentuate the point that it's impossible to successfully "trade" market volatility.

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Let's review two more finance terms from the YouGov poll we've looked at in recent weeks: Yield and Mutual Fund. Almost half of Americans polled report little knowledge of both terms. Please don't be one of them.

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Diversification and Bonds

This week let’s review two more finance terms from the YouGov poll: diversification and bonds. Now we’re starting to get into terms that about 60% of people tend to be comfortable with.

Honestly, I’m a little surprised that people weren’t more comfortable with “diversification”. I understand some confusion about “bonds” because, well, bonds can be confusing. But diversification is a concept in wide use, right? We even have catchy sayings about not putting all our eggs in one basket.

My guess is that folks understand the concept but not how it applies to investing. Assuming that to be true, here is my real-world-financial-planner explanation of diversification. Oh, and for bonds too.

Diversification – Assume you had $1,000 to invest back in 2002. You wanted the money to grow and weren’t afraid of losing it. This was right around the time of the first iPod but still five years before the global phenomenon of iPhone. Maybe you loved your iPod and thought you’d invest in Apple. We know now that this would have been a great investment.

If you were able to ride out the low points (there were many) and not sell shares along the way, you would have made over $100,000 from your initial investment. Maybe you’d consider yourself an amazingly astute investor. Maybe you’re honest and would consider yourself simply lucky. Either way, you’re still in the money.

Or you could have invested in Webvan, the biggest flop of the dot-com era. You could have invested after the company’s Initial Public Offering in late-1999 at about $25 per share. It was exciting times. The grocery delivery service was riding high in the press and you might have been counting your millions… for about a month. Shares fell precipitously into the new decade and would eventually trade for pennies per share the following summer.

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Quarterly Update

The fourth quarter (Q4) of 2018, and the year itself, was marked by volatility, rising anxiety for investors, and a shift in the market environment. It was a year that saw record highs for the stock market in January and the worst December since the Great Depression. Investors began the year feeling "bullish" but ended by expressing extremely low market sentiment.

The economy remained strong throughout the year, however, while a variety of headlines seemed to coalesce at times to rile the markets. Stocks have recovered from their lows somewhat, but anxiety remains high amid a myriad of risks.

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Liquidity & Compound Interest

This week let's review two more finance terms: liquidity and compound interest. Both terms are entering the comfort zone of Americans polled by YouGov, a research firm, with a little over half of respondents reporting being comfortable with the terms.

As a reminder, the poll was trying to gauge awareness of 35 finance terms and phrases. Americans claimed to know about three quarters of the list, but how well do they (or you) really know them? I think we'd all agree that awareness doesn't necessarily equal understanding. There's the textbook definition and then there's the real-world, "how does this apply to me" definition. With these posts I'm aiming at the latter.

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