11. What’s a “stock split”?
When a company splits its stock, it’s dividing its outstanding shares into more outstanding shares. Since the actual value of the company doesn’t change, the share prices drop. For example, if a company’s stock is priced at $100 a share, and the company executes a 2-for-1 stock split, the number of outstanding shares doubles and the stock price drops to $50 a share. For every one share you owned, now you’ll own two. (But, of course, each share will be worth less.)
A company might do this to make its stock accessible to more investors. (Presumably, more people would be able to afford that $50 stock price than $100.) And if more people buy it at the cheaper price, the stock will soar even higher.
12. Is it safer to buy a company’s stock or bonds?
When you buy a company’s bonds, you’re essentially giving it a loan, and it’s promising to pay you back with interest. Unless the company goes belly up, you’re making a relatively safe bet you’ll get your money back and then some.
Of course, some bonds are riskier than others. You can check out ratings from Moody’s (which rates the riskiest entities as C and the least risky bets as Aaa) and Standard & Poor’s (D to AAA) to get an idea of how risky a company’s bonds are.
13. What’s the difference between buying an exchange-traded fund and a mutual fund?
Because most ETFs track indices, and are therefore more passively run, they tend to charge lower fees than mutual funds. The former are also traded like common stocks at varying prices throughout the day. Conversely, shares of mutual funds are priced based on their net asset value (NAV) once at the end of the trading day. (That’s calculated by dividing the total value of all the securities in the fund, based on the closing prices that trading day—minus any debts or obligations the fund has—by the total number of shares outstanding)
14. Why would someone buy a fund instead of a single stock?
“Single-stock investing is risky and does not provide diversification,” says Ponnapalli. In other words: If you invest all your money in one stock, and it goes down, you can lose a lot of money (assuming it doesn’t go back up before you need to sell). And putting together a well-diversified portfolio of individual stocks requires a lot of homework.
On the other hand, if you invest in a stock mutual fund or an ETF, the fund managers are doing most of the hard work for you. They can put together a portfolio of possibly hundreds of different stocks, allowing you broad diversification with just one investment.
Target-date funds, on the other hand, are designed to be the only fund you ever have to own. You simply choose the year in which you expect to reach your financial goal—usually it’s your retirement year—and the fund’s managers build a portfolio to suit your time horizon, adjusting it when necessary as the deadline approaches.
“[They’re] the little black dress of the investing world,” says Francis. “The only thing an investor needs to do is to choose the right risk tolerance, then let the fund go to work.”
15. How much tax do I pay on money I make from selling stocks? What if I lose money?
First off, Ponnapalli says it’s important to remember that the tax hit for stocks only comes when you sell; if you’re holding a stock, you don’t have to worry about taxes.
You will, however, be taxed on dividends paid out on stocks you own. The good news is that qualified dividends (which include many paid on corporate stocks) are taxed at long-term capital gains rates, which are lower than ordinary income tax rates, as long as you hold onto the stock for a specified period of time after the dividend is issued.
When you are ready to sell a stock, understand that if the stock price has gone up since you bought it, you may owe Uncle Sam capital gains taxes. If you owned the stock for less than a year, the tax rate is higher than if you had held it longer. But if you own another stock that has gone down, you can sell it and use that loss to offset your gains. “A little tax planning comes in here,” says Ponnapalli.
For example, if you bought one share of Stock A for $10 and want to sell it at $50, you’d owe taxes on that $40 gain. If you also own one share of Stock B, which you bought for $50 and is now priced at $10, you could sell it in the same year and deduct your $40 loss to wipe away your $40 gain from Stock A on your tax bill. One catch: Once you take the tax benefit of the loss, you cannot buy that stock or a similar one again for 30 days.
Of course, if you’re investing within a 401(k), individual retirement account or similar tax-sheltered plan, this is all moot. You won’t be taxed on gains, and you can’t deduct losses.
April 5, 2016
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