Understanding the Basics of Finance
By Jenny Hoff
Sponsored by Frost
“What determines your wealth is not how much you make, but how much you keep of what you make.”
– Alina Tudor, Assistant Vice President | Private Banking
Alina.tudor@frostbank.com
737.224.0887
There are many terms thrown around regarding finances, which can feel overwhelming to know what next step to take besides simply saving money in your bank account. Knowing even the basic terms of finance can help you in planning for your future and how to use your money to make more. This guide will cover the differences between treasury bonds and stocks, the basics of a 401(k) and its equivalent for business owners and the distinctions between Roth and traditional IRAs. Plus you’ll gain some handy financial resources for low-cost investing.
Treasury Bonds vs. Stocks
Treasury Bonds and stocks are two fundamental investment options, each with its own characteristics and benefits.
- Treasury Bonds: These are debt securities issued by the government to finance its spending. When you buy a treasury bond, you’re essentially lending money to the government in exchange for periodic interest payments and the return of the bond’s face value at maturity. Treasury bonds are considered very safe investments because they are backed by the Full Faith and Credit Clause. Treasury bonds typically offer lower returns compared to stocks.
- Stocks: When you purchase stocks, you buy a share of ownership in a company. Stocks have the potential for higher returns because their value can increase significantly, if the company performs well. However, they also come with a higher risk, as the value of stocks can drastically fluctuate based on the company’s performance and market conditions. A good rule of thumb is to look at stocks as long-term investments. Ask yourself if you can stomach the plunges in the stock market and not feel the need to withdraw your investment when it hits a low point. The stock market can be a wild ride.
Basics of a 401(k) and Individual Business Owner Equivalent
A 401(k) is a retirement savings plan sponsored by an employer. It allows employees to save and invest a portion of their paycheck before taxes are taken out. Taxes are paid when the money is withdrawn, typically in retirement. Many employers offer matching contributions, which can significantly boost your savings.
For individual business owners, the equivalent is often a Solo 401(k) or a SEP IRA:
- Solo 401(k): This plan is designed for self-employed individuals or small business owners with no employees, other than a spouse. It allows for both employee and employer contributions, providing a higher contribution limit compared to other retirement plans.
- SEP IRA: The Simplified Employee Pension (SEP) IRA is another option for small business owners. It allows employers to make contributions to their own and their employees’ retirement savings. Contributions are tax-deductible, and the plan is relatively easy to set up and maintain.
Roth IRA vs. Traditional IRA
Both Roth IRAs and Traditional IRAs are individual retirement accounts with tax advantages, but they differ in how and when you receive the tax benefits:
- Traditional IRA: Contributions are made with pre-tax dollars, meaning you earn a tax deduction in the year you make the contribution. However, withdrawals in retirement are taxed as ordinary income.
- Roth IRA: Contributions are made with after-tax dollars, so there’s no tax deduction when you contribute. The benefit comes in retirement when withdrawals are tax-free, provided certain conditions are met.
Handy Resources for Low-Cost Investing
Getting started with investing doesn’t have to be expensive. Here are some resources to help you invest at a low cost:
- Low-Cost Index Funds: These funds track a market index and typically have lower fees than actively managed funds. Some top options include Frost Investment Advisors, Vanguard Total Stock Market Index Fund and Fidelity ZERO Total Market Index Fund.
- Robo-Advisors: Services like Betterment and Wealthfront offer automated, low-cost investment management. They use algorithms to create and manage a diversified portfolio based on your risk tolerance and goals.
- Educational Resources: Websites like Investopedia and NerdWallet offer free articles, tutorials, and tools to help you learn about investing and personal finance.
By understanding these basics and utilizing available resources, you can take control of your financial future with confidence. Happy investing!