Mutual funds are a collection of investments owned by a group of investors that have pooled their money together. The capital can be invested in stocks, bonds, money markets, and many other types of securities, including other mutual funds. (Read More…)

With April 15^th less than a month away, you are probably already thinking about how to spend your tax return. But instead of buying something that depreciates in value, why not make that tax return work for you. Here are a few ideas for getting the best return on your tax return.

1) Pay Off Debt

One of the best investments you can make is paying off high interest debt. It is a sure investment, because you know how much you will “make” (save) in interest and there is no risk of losing money. Paying off any debt is like opening a savings or money market account (or buying bonds, CDs, whatever) at the interest rate of the debt. Finding a money market account, bond, or CD that will pay you what you are paying in interest debt is unheard of, so paying off high interest debt is a no-brainer investment.

The 10 year Treasury Bond is currently at 3.30%, and my money market account is only earning 3.4%. For example, if your credit card is charging you 12% APR, by using your tax return you would profit an 8.6% return on your money buy using your tax return to pay off debt.

2) Buy Stocks (or Index/Mutual Funds)

As of last week, the majority of economists agreed that the U.S. economy is in a recession. The Dow Jones Industrial Average has fallen from 14000 to 12000 in the last six months and other economic factors are indicating that we are now in a recession. It’s not a crisis though, just another buying opportunity for the smart investor. The markets have not hit the bottom yet, but timing the market to only buy at the bottom is extremely hard, and usually a losing game because the market takes off before you can jump on the upswing. Better to buy consistently when you know the market is down. So what if the markets fall another 10% or more before the upswing? It’s not a big deal because the upswing will cover any short term dips of the market. Also, because of the decline in price of many stocks, the dividend yields are also looking quite attractive.

As always, you should do your research and analyze stocks before buying them. If you do not want to do the stock research, you could also look at an index fund, or even a mutual fund. With the current market conditions, any of these investments would be a great long term strategy for your income tax return.

Investing in stocks involves risk, please see my disclaimer.

3) Buy A House

This third option is not for everyone, but would also be a great investment for some of you out there. For those of you that were already thinking of buying your first home, or maybe thinking about purchasing a vacation or rental home, now might be the perfect time to put your tax return towards that purchase. Home prices are down, way down. It truly is a buyer’s market out there right now. On average home prices are down almost 20% and staying on the market for 12 months or more. This is creating a lot of motivated sellers that need to sell their homes quickly. The home bargains are out there, so if you were thinking about buying a home, now might be the time to use your tax return to help with the down payment.

Simply put, stocks are small pieces of a company that represent ownership of the company. Commonly known as securities, they have been traded on stock markets for many years. Stocks and stock trading are easily misunderstood, even among some people that already call themselves stock traders.

Types of Stock

Common Stock

When referring to “stocks,” most people are speaking of common stock since the majority of all stock is classified as common stock. Each share of stock represents a piece of the company, and therefore each stockholder is a partial owner of the company. As a partial owner of the company, each shareholder also controls 1 vote per share at shareholder meetings.

Classes of Stock

Some companies have multiple classes of stock, such as “Class A” and “Class B” shares. Usually the difference between the classes of stock is the voting rights which the shares hold. For example, a company may issue class B shares with 5 votes per share, and class A shares with 1 vote per share. Although many companies only issue common stock, it is important to know whether the company issues different classes of stock.

Preferred Stock

Preferred stock is sometimes confused with being a class of stock, but preferred stock is a little different. Preferred stock is superior to common stock (or any class of stock) and takes precedent over common stock in certain situations. Preferred stockholders receive a dividend that is usually much higher than the common stock dividend. They are also entitled to the assets of the company if the company files for bankruptcy, whereas common shareholders are not.

Stock Trading

Stock Markets/Exchanges

Stocks are traded on stock markets, or stock exchanges. In the United States, the three major markets are the New York Stock Exchange (NYSE), the NASDAQ stock market, and the American Stock Exchange (AMEX).

The NYSE and the AMEX are both listed exchanges where transactions still take place on the trading floor. Market professionals, who are called “specialists,” act as an auctioneer for certain stocks. They are responsible for matching buyers and sellers together and ensuring that the orders do not become unbalanced (keeping the number of buy orders approximately equal to the number of sell orders).

The NASDAQ market is quite different; it is an “Over the Counter” market where brokerages act as “market makers” to buy and sell stocks directly over a centralized computer system. Instead of matching buyers and sellers, market makers actually keep an inventory of stock, so that they can purchase or sell shares directly when orders are placed (sometimes, but very rarely, market makers match buyers and sellers). For this reason, the volume (volume is the number of shares traded that day) numbers are misleading when comparing to NYSE volume numbers because the NASDAQ will count the transaction twice. For example, when trading buying 10 shares in the NASDAQ market, a market maker would purchase those ten shares from a seller, then sell 10 shares to you and the volume would be 20. On the NYSE, a specialist would match the buyer and seller and only one transaction of 10 shares would be made, and the volume would be 10.

Stock Price: Bid, Ask and Spread

Stock prices are never set; the actual stock quote lists the price of the last transaction that took place.

The bid price is the price that a buyer is offering to pay, while the ask price is the price that a seller is willing to sell at. Naturally, the ask price is always a little higher than the bid price. The difference between these prices is called the spread. The spread is kept as profit for the specialist and to pay other trading fees.

Other Useful Terms to Know

Volume: The number of shares traded that day for a particular stock, or the entire exchange as a whole.

Commission: The fee that a brokerage charges you for a trade.

Portfolio: The stocks/investments than an individual owns.

How to Buy Stocks

Stocks are almost always purchased through a brokerage. Brokerages vary widely in the level of services they offer and the commissions they charge.

A full service brokerage will offer many services, investing advice, and will even completely manage your portfolio for you, all for a hefty fee.

Discount brokerages offer less services, and usually never offer investing advice, but they also charge low commissions (about $7 a trade, or even as low as $4). If you are serious about learning to pick stocks yourself, I highly recommend finding a discount brokerage.

You will have to deposit a certain amount of money into your brokerage account to begin trading; the amount varies by brokerage, but some minimums are as low as a few hundred dollars.

Market Order

A market order is when you tell your brokerage to buy X number of shares of XYZ company. If you place this order you will pay the current asking price.

Limit Orders

A limit order is where you tell your brokerage to buy X number of shares of XYZ company, at a limit price of (for example) $35.50. This means that you will not pay more than $35.50 (actually, you will probably only pay $35.00, no less). If the asking price is more than $35.50, your order will not be completed immediately. The specialist/broker will hold your order until the asking price falls to your limit price, or until the market closes. If the asking price falls to $35.50, your trade will be executed. Since this order is a little more advantageous for the trader, commissions are usually a little bit higher for limit orders.

Stock Shorting

Shorting stocks is a way to profit from a market downturn. The normal strategy of stock trading is “buy low, sell high,” but in stock shorting the basic strategy is “sell high, buy low.” Yes, you can actually sell stock when you do not own it! But you are obligated to purchase the same amount of shares of stock at a later date. So therefore the purpose is to sell now and buyback the stock later, after a downturn in the stock price.

Stock Options

Stock options will be discussed in detail in a future article, but without going into great detail the basic idea is that when purchasing stock options you are purchasing an opportunity to buy (or sell) the stock. You do not actually own the stock unless you execute the option.

Buying on Margin

“Margin” is another term for loan. When buying on margin, your brokerage is lending you the money to buy stock. They are also charging interest on the loan, and they reserve the right to sell your stock if they think the load is in jeopardy, a “margin call.” Even though using margin to purchase stocks increases the amount of stock that you can buy (and possible profits), the combination of risk and the interest accumulating against me is the reason why I personally do not use margin to buy stocks.

One of the easiest ways to increase your wealth is to prevent credit cards from eroding away your hard earned money. Ideally, credit card balances (or the statement balance for the current period) should be paid off at the end of each month to prevent paying interest rates. If you already do this, congratulations! You are in the minority, but you might want to keep reading anyway as this article applies to anyone. If you are currently carrying a balance on your credit card and are not able to immediately pay off the balance, this article is here to help you.

For those of you with 700+ credit scores, you might be able to find a credit card interest rate of less than 10%, although even the lowest credit score I have seen is 8%. Even at this low credit card rate, paying an 8% markup on all of your purchases is no way to increase your wealth! For the majority of people though, your rates are somewhat higher than this and can be as high as even 29%!

Ironically enough, the credit card companies can be used to help get you out of credit card debt, and debt free. This is possible because there is fierce competition between the credit card companies for your business.

Be wary of companies that promise to “settle” or “negotiate” with the credit card companies on your behalf to reduce your debt, as this will usually ruin your credit in exchange for some (possible) reduction in bills!

Basically there are a limited number of consumers, and many credit card companies are willing to “buy” your debt for a lower price. They “buy” your debt by you transferring your debt to their company. They will pay off the balance (or any amount you qualify for) at your old company, and you will now be indebted to the new credit card company. The incentive for you is that by transferring you will receive a drastically reduced interest rate (frequently as low as 0%) for a limited period of time.

Transferring a credit card balance will also have effectively no effect on your credit score!  Whenever you apply for a line of credit (a credit card, mortgage,  non-federal student loan, personal loan, etc.), your credit score takes a small “hit,” and is generally reduced by 5-9 points.  So whenever you apply for a credit card (balance transfer or not), yes your credit score will be slightly reduced.  The other side of the equation is your debt to credit ratio.  This ratio is the amount of your debt divided by your total credit.  A lower ratio means a higher credit score.  For example, if you have 2 credit cards each with $3000 credit limits, your total credit will be $6000.  If you have a total credit card balance of $2000 on the cards (combined), your debt to credit ratio would be 33% ($2000/$6000).  Now say that you applied for a balance transfer and transferred your current balance of $2000 to a credit card with a $3000 credit limit.  Now your debt to credit ratio is 22% ($2000/$9000).  Generally, the credit inquiry and the improved debt to credit ratio effects on your credit score will negate each other and there should be no significant change in your score.

Using credit card balance transfer offers will only temporarily delay interest accumulation of your balances. The key to using balance transfer offers is to pay off the debt by the end of the introductory period. The low interest rate helps you with this because more of your money (or all if you get a 0% offer) will be applied to the principle amount, not interest. In step 1 of this article I will explain how to evaluate balance transfer offers, and in step 2 I will explain strategies for paying down the debt before the end of the introductory period.

Step 1: Finding the Right Credit Card Balance Transfer Offer

The Terms of the Deal

Although these balance transfer offers can be great offers, there are some terms of the offers to watch out for, and other terms can make the deal downright worse than keeping the balance on your current card. The three main terms to look out for are:

• Balance Transfer Fees, 3% or less
• Conditions under which the introductory rate will reset (and the reset interest rate)
• Whether the introductory rate applies to balance transfers, balance transfers and purchases, or only purchases (see below, Three Types of Credit Card Offers)

Most balance transfer offers require a “balance transfer fee”, commonly 3%. If you find an offer with less than 3%, fantastic! If the balance transfer fee is more than 3%, it does not automatically make the deal bad but usually is a good indicator.

The conditions under which the rate will reset are also very important. There are specific terms to which you must abide to receive the especially low introductory interest rate. Usually the main points of these terms are:

• Making the “minimum payment” on time, each month
• Not exceeding the credit limit of the new credit card (if you are actually using the card to make purchases)

Three Types of Credit Card Offers with Introductory Rates

1) Introductory rates for balance transfers only

These fairly common offers have an introductory rate for balance transfers, and a different (higher) rate for purchases made with their card. If you find an offer like this that seems to be good in every other aspect but only has an introductory interest rate for balance transfers, it can still be a good deal if you do not use the card for purchases. The reason for this is described below (see “The Terms are Stacked Against the Consumer”).

2) Introductory rates for balance transfers and purchases

These are probably the most common type of offer with the same introductory rate for both balance transfers and purchases. These offers mean that you can transfer a balance to the card, and then make purchases on the card at the same low introductory interest rate. Using the card for purchases is probably not the best idea (ideally the balance should be decreasing!), but in certain situations it might be better to make some purchases on this card as long as the entire balance is paid off by the end of introductory period.

3) Introductory rates for purchases only

This type of offer is as common. The terms of such an offer would transfer a balance at a normal interest rate but allow you to make purchases at an introductory offer. Usually there would be no reason to ever transfer a balance to company with such an offer.

The Terms are Stacked Against the Consumer

When a credit card has a low introductory interest rate for balance transfers and a higher rate for purchases (or vice versa), the way interest is calculated and payments receive is definitely not good for the consumer. Let me explain with an oversimplified, but useful, example.

The terms of our deal are as follows: Introductory rate for balance transfers 0% APR for 12 months, 15% APR for purchases, 0% balance transfer fee. If I transfer $1000 to this card, my balance is $1000. If I decide to use the credit card for purchases, things become complicated. Let’s say I make $500 in purchases and now my balance is $1500. The problem is now I have balances in two different “buckets” with two different interest rates, one that I like (0%) and one that I do not like (15%). The $500 will begin to accrue interest, about $6.25 for the first month. The problem is, I cannot just sent the credit card company $500 and tell them to payoff the $500 balance in the 15% bucket. The credit card company will not let me pay off any of that balance until I have fully paid off the $1000 balance in the 0% bucket! Let’s say I cannot pay off the entire balance until the end of the introductory offer. This $500 purchase would cost me about an additional $80 in interest.

When interpreting how credit card companies calculate your interest rates, a good rule of thumb is, if it creates more interest for the credit card company that is how it will be calculated. If the balance transfer and purchase interest rates are different, it is best to only use the card for the introductory offer to avoid paying finance charges.

Step 2: Paying off the Debt

There are two strategies to pay off the debt after the transfer. The determining factor to which plan you should use will be your self discipline when it comes to spending money. A lot of people spend money before it is even earned, and a much smaller amount of people make sure they have the money before they earn it. Today’s culture of using credit to purchase anything is creating an increasing amount of people that purchase on credit without having the money to pay the entire bill, which creates credit card debt in the first place, which might be why you are reading this article. It’s not a flaw in you, it is a flaw in how we have been educated (or lack of education) about how to spend money. The good news is, anyone can learn to think differently about how to spend money more wisely.

Method 1 for paying off the debt is for people that have trouble with holding onto money when they earn it. If you are the type of person that will spend your paycheck as soon as you earn it, method 1 will be much safer, and have a higher probability that you will pay off the debt.

Method 2 is people who are able to set aside money and not think about spending it, or people that are willing to learn. This method will take a little more self control than the first method. Used correctly, the second method will also pay off debt faster than method 1.

Method 1: Making Your Own Payment Plan

This method involves making a monthly payment plan for yourself and sticking to it. The credit card statements you will receive each month after the balance transfer will tell you the minimum payment amount, which is usually very low. Only paying this amount will not pay off the debt by the end of the introductory interest rate offer, meaning that interest will be added to your balance for the remaining balance at the end of the introductory period (usually 12 months or so). This is where the new credit card companies make their money, and you loose all of your savings by making the balance transfer in the first place! This is why I stress that it is extremely important to pay off the entire balance (or at least the majority of the balance) before the end of the introductory period.

In order to calculate what your monthly payments should be to pay off your debt by the end of the introductory period, you will need to have 3 numbers: the current balance after the transfer (including balance transfer fees), the introductory interest rate, and the length of the introductory offer. The first two numbers can be found on your first credit card statement you receive from the new company after the transfer. The length of the introductory offer might be shown on the statement, or you might need to call the company and ask how long your introductory interest rate offer is in effect. You could also look back at your initial offer paperwork which you used to determine which offer you would use (Step 1 of this article), but you might want to also confirm how long the rate is in effect by calling the company.

If the interest rate is 0%, the next step is easy. Just divide the balance by the number of months of the introductory offer, and that will be your monthly payment amount in order to pay off the debt. For example, let’s say I transferred a balance of $2500 to a 0% card for 12 months (from a credit card with say, 15% APR), with a balance transfer fee of 3% (2500 x 3% = $75). My new balance would be $2575, divided by 12 months and my monthly payment would be $214.59. Paying this much each month would pay off the balance before the end of the introductory period and save a lot of money that would have been paid for interest.

If the interest rate is not 0%, this calculation becomes a little more difficult, so I created a simple calculator to estimate the payment needed each month in order to payoff the debt by the end of the introductory period.

Method 2: Making Interest off of Credit Card Debt

Method 2 can be used for maximum leverage of credit card introductory offers. The general strategy is to make only the minimum payment on the credit card that is required, while putting the money that you would have paid towards the bill into some money market or certificate of deposit (CD) that will generate a higher rate of return than your credit card is charging you. If the introductory interest rate of your credit card is 0%, and you can find a money market account paying 5%, you are making 5% off of the credit card company’s money! Be careful to keep up with the payoff date when you will need to pull the money out of the investment and payoff the balance of the credit card so you will not be charge any interest fees. Any interest fees will quickly eat up your previous profits. Since this method actually generates cash flow, the interest earned can be applied towards the credit card balance for early payoff.