3 Topics That Could Put You To Sleep But May Also Help Create Your Financial Freedom
No little kid tells his parents, “When I grow up, I’m going to be a financial planner!”Cowboy, fireman, doctor – lawyer, even, yes. Financial planner, never. And that’s too bad, because, it’s a pretty, pretty glamorous life.OK, not really. We do get a ton of satisfaction from helping people achieve their goals and dreams. But we’re not exactly bringing back sexy here in the Wela offices. In fact, we spend a lot of time dealing with the same issues and questions – over and over again. Honestly, taking a deep dive on some of these issues would put you to sleep faster than an Ambien. But, hey, that’s why you turn to money pro for help, right? It’s my job to give you a basic understanding of the things that impact your investments and then manage those issues in your best interest.Here are three perfect examples of questions that might make your eyes glaze over, but are extremely important to growing your wealth.
What is compounding?
Compounding is the process in which an asset generates earnings or value, which is reinvested to generate even more value.Related: Inside CompoundingExample: Let’s say you invested $10,000 in Stark Industries and your shares rose 20% in value in Year One to a value of $12,000. In Year Two your stock goes up another 20% to $14,400. That extra $400 is the result of compounding. Rather than growing just $2,000 as your investment did in Year One, you get an additional $400 because the $2,000 you gained in Year One also grew 20%. At that 20% annual growth rate, your initial $10,000 would be worth nearly $1 million in 25 years.See why compounding is often called a miracle?The important take-away from this math lesson: Start Early. The sooner you start saving for retirement, the more time your money has to compound and grow.
How do you figure a bond yield?
Some new investors stay away from bonds because the relationship between a bond’s price and its yield can seem confusing. But it’s not that hard to follow. Stay with me.Bonds are publically traded, so a bond’s price can change daily, just likes a stock’s. Bond prices are heavily influenced by overall interest rates. As rates go up, bond prices fall.A bond’s “coupon” is the amount of interest it will pay you every year until it matures. Yield can be figured using this formula: coupon/price. So, if you buy a bond at its initial face or “par” value, the yield is equal to the interest rate. But when the bond’s price changes, so does the yield.Related: The Unknown Ocean That Is The Bond MarketExample: If you buy a bond with a 10% coupon at its $1,000 par value, the yield is 10%. But if the bond’s price drops to $800 in public trading, the yield jumps to 12.5%. That’s because you are guaranteed the same $100 that you were promised when the bond was priced at $1,000. Conversely, if the bond goes up in value, the yield goes down.So you reap a similar benefit with bonds when buying them low, just like stocks.
What the heck is the Federal Funds Rate?
The FFR is the interest rate banks charge when they make overnight loans to other financial institutions from funds held by the Federal Reserve. (These loans are made to cover a bank’s temporary shortfall in a bank’s cash reserves or to allow the bank to make more loans.)Because such loans are made to only the most creditworthy borrowers, the FFR is really the baseline for all interest rates in the U.S. When the FFR goes up, it gets more expensive to borrow money for most anything – buy a house, lease a car, or start a business.The Fed’s Open Market Committee sets a target level for the FFR based on what’s happening in the economy. If the Fed sees inflation as a threat, it may seek to slow growth by hiking the FFR. Conversely, if the economy is soft (as in the past decade) the Fed tends to keep the rate low to maximize access to the credit necessary to fuel expansion.The Fed can’t set the FFR, but it does influence the rate by manipulating demand for those overnight loans. If the Fed wants to lower the rate, it buys securities from banks, thus putting cash in their Fed accounts and reducing the demand for overnight lending.Related: The Bond Market BubbleOn the flipside, the Fed can boost the FFR by selling government bonds to the big banks, thus taking cash out of their Fed accounts and increasing the demand (and thus interest rate) for overnight borrowing.Whew. See? You asked for the time and I told you how to build a watch. We financial guys know this stuff cold – and we’re waaay into it. That’s why we’re better in the conference room than in the club.