diff --git a/content/public/finances/concepts/content.md b/content/public/finances/concepts/content.md index c69fee72..1baad9ca 100644 --- a/content/public/finances/concepts/content.md +++ b/content/public/finances/concepts/content.md @@ -21,11 +21,11 @@ With that said, a house is also an asset and would be considered a relatively il The only way to lose money from an investment is to sell the asset for less than you purchased it for. -This bares repeating: +This bears repeating: > The only way to lose money from an investment is to sell the asset for less than you purchased it for. -Technically I can also look at it a different way. The moment I purchased the asset, I've "lost" the money because it's no longer cash. From that point forward, the question is: What is the fair market value of the asset? If the fair market value is more than I paid for it, I haven't made money—unless I sell it for the higher amount (converting it to cash). If the fair market value is less than I paid for it, I haven't lost money—unless I sell it for the lower amount. +Technically I can also look at it a different way. The moment I purchased the asset, I've "lost" the money because it's no longer cash. From that point forward, the question is: What is the fair market value of the asset? If the fair market value is more than I paid for it, I haven't made money—unless I sell it for the higher amount (converting it to cash). If the fair market value is less than I paid for it, I haven't lost money—unless I sell it for the lower amount. Instead, the asset has simply increased or decreased in value. Finally, just because I use cash to purchase an asset doesn't mean I've made an investment. @@ -35,7 +35,9 @@ I think it will be easier and more direct to take these in reverse order compare I go to a casino (or a [Chuck E. Cheese](https://en.wikipedia.org/wiki/Chuck_E._Cheese)). I trade my cash for tokens or chips. I use those tokens or chips to participate in various games. As I play I win and lose tokens. If I win tokens, the value of the asset I purchased (my pool of tokens) has gone up. If I lose tokens, the value of the asset I purchased has gone down. At the end of my time playing, I can exchange the tokens for cash. The majority of people lose money; that's what makes it gambling. -In the case of carnival-like systems, such as Chuck E. Cheese, it's pretty clever. I trade a dollar for [four metal tokens](https://en.wikipedia.org/wiki/Chuck_E._Cheese#Video_arcade) that can only be spent at Chuck E. Cheese; metal feels more expensive than paper. I spend those to play [skee-ball](https://www.skeeball.com). As I play, I earn paper tickets (feel less expensive than the tokens). Further, I often receive a higher quantity of the paper tickets compared to the number of tokens used to play the game in the first place; I'm getting more, so to speak. Then I can trade those paper tickets in for a toy of some kind, which is usually worth less than the amount of actual cash it took for me to play the game. Gambling (or, in this case, most of us would probably just consider this spending money not expecting a higher return on the investment; unlike the casino). +In the case of carnival-like systems, such as Chuck E. Cheese, it's pretty clever. I trade a dollar for [four metal tokens](https://en.wikipedia.org/wiki/Chuck_E._Cheese#Video_arcade) that can only be spent at Chuck E. Cheese; metal feels more expensive than paper. I spend those to play [skee-ball](https://www.skeeball.com). As I play, I earn paper tickets (feel less expensive than the tokens). Further, I often receive a higher quantity of the paper tickets compared to the number of tokens used to play the game in the first place; I'm getting more, so to speak. Then I can trade those paper tickets in for a toy of some kind, which is usually worth less than the amount of actual cash it took for me to play the game. The activity and contrast of the trades makes it feel like I'm winning though. So, it's gambling. + +In the case of carnivals we'd most likely call it spending money and not gambling because we're most likely not hoping for nor expecting a higher value return compared to the cash put in, which is different than how many feel about going to the casino or playing the lottery. Speculating is similar to gambling only the probability of a positive return on the cash spend is higher but still highly uncertain. Cryptocurrencies, for example, as of this writing could be considered speculative. The speculative nature comes in part because they are highly volatile when it comes to fair market value, they're a newer technological implementation of the [old guard concepts](https://www.investopedia.com/terms/c/community_currencies.asp) (like community currencies, casino chips, Chuck E. Cheese, and, yes, government-backed currencies), and the regulations for them specifically and the services that have emerged to support them haven't been nailed down. Further, the primary way to increase profit compared to the cash spend is based on someone else in the future being willing to pay more than you paid. @@ -43,33 +45,133 @@ Investing is similar to speculating only the probability of a positive return on ## Net worth isn't the same as cash on hand -As of today, I'm part of the six-figure club, which is to say I have a net worth of roughly 100,000 [.United States Dollars](USD); this doesn't mean I have that in liquid cash. When we say someone is a millionaire or billionaire it's because, if we liquidated their assets, they would, in theory, have that much cash. However, if we liquidated their assets, eventually the fair market value of the assets would drop. +As of today, I'm part of the six-figure club, which is to say I have a net worth greater 100,000 [.United States Dollars](USD) and less than 1 million USD; this doesn't mean I have that in liquid cash. When we say someone is a millionaire or billionaire it's because, if we liquidated their assets and paid off their liabilities, they would, in theory, have that much cash. However, if we liquidated their assets, eventually the fair market value of the assets would drop. The United States government can't tax the same dollar twice. So, as of right now and my understanding, if I put 100 USD of after-tax money into a savings account and that 100 USD earns 10 USD in dividends, I could get taxed on the 10 USD but not the 100 USD which was already taxed. -Further, if I take that same 100 USD and buy shares in a mutual fund or a stock, I can't be taxed on that 100 USD (cost basis). If that stock generates dividends, the dividends could be taxed. If the fair market value of the stock goes up to 110 USD and I sell the the stock, I can be taxed on the capital gain of 10 USD…but not the original 100 USD. If I don't sell the stock, I don't get taxed on it. Stocks aren't taxed in the same way other hard assets are; like houses, cars, and so on. +Further, if I take that same 100 USD and buy shares in a mutual fund or a stock, I can't be taxed on that 100 USD (cost basis). If that stock generates dividends, the dividends could be taxed. If the fair market value of the stock goes up to 110 USD and I sell the stock, I can be taxed on the capital gain of 10 USD…but not the original 100 USD. If I don't sell the stock, I don't get taxed on it. Stocks aren't taxed in the same way other hard assets are; like houses, cars, and so on. + +I'm still looking for non-partisan primary sources for the following and, given the rules of the game, this seems reasonable. The majority (over 80 percent) of taxes collected by the federal government are collected from individuals, not corporations (not speculating why). 97 percent of taxes paid comes from 50 percent of tax payers. 40 percent of taxes are paid by the top 1 percent of earners (those earning over 500,000 USD per year in taxable income). (Again, haven't found primary sources that didn't include some for of slant or misrepresentation of those numbers.) -I'm still looking for non-partisan primary sources and, given the rules of the game, this seems reasonable. The majority (over 80 percent) of taxes collected by the federal government are collected from individuals, not corporations (not speculating why). 97 percent of taxes paid comes from 50 percent of tax payers. There are two ways to pay 0 taxes: +There are two ways to pay 0 taxes: - have a taxable income of 0 USD or -- have acquired less than a certain in long-term capital gains. +- have acquired less than a certain amount in long-term capital gains. + +(Taxes in the United States are weird; I think I understand how we got here from a gaming perspective, but still.) + +Gross income and taxable income aren't the same thing. + +Let's say you work somewhere and earn less than or equal to 12,500 USD in 2021 and you are filing your taxes as a single person. Your taxable income is 0 USD because of the standard deduction everyone gets to take. Let's say you earned 32,000 USD and you contributed the full amount of 19,500 USD to your 401k, you're taxable income would be at 0 as well. Let's say you earned 35,600 USD you maxed out the 401k and maxed out an [.Health Savings Account](HSA) contribution for the year; taxable income of roughly 0. (Check out [this calculator](https://www.taxact.com/tools/tax-bracket-calculator).) + +Now, let's say you threw 100 USD of after-tax money into the aforementioned stock then sold it 10 months later for 110 USD. The 100 USD wouldn't be taxed, but the 10 USD would count as regular, taxable income. + +Federal long-term capital gains rules have [their own progressive tax](https://www.fool.com/research/capital-gains-tax-rates/). If it's less than 40,000 USD or so, you pay 0 percent in tax. Similar to the regular tax bracket if you do all the saving ever. + +Basically, looking at it from an ethical social engineering perspective, the federal government is trying to incentivize long-term saving and investing through the tax code with tax deductions, tax-free growth, and in the case of HSAs and the Roth Individual Retirement Account, tax-free withdrawals. Further, if you're living strictly on capital gains from various investments (retired), you can live a modest lifestyle without paying any taxes; the moment you go over that 40,000 USD point though, you pay 15% tax on the amount you went over. So, also disincentivizing extravagant living. + +Now, let's say you purchased Stock A for 20,000 USD and Stock B for 20,000 USD. A year later Stock A is worth 70,000 USD and Stock B is worth 10,000 USD. Stock A has a capital gain of 50,000 USD and Stock B has a capital loss of 10,000 USD. You sell both and get 80,000 USD. Based on Stock A alone, you'd owe 15 percent on 10,000 USD (9,999 USD really, but still). However, you should be able to take a tax deduction for the 10,000 USD capital loss from Stock B, which means you would pay 0 tax…depending on the type of account and presuming the initial 40,000 USD investment was done with post-tax money. Now the new 50,000 USD has been taxed and can't be taxed again, because the government can't tax the same dollar twice. (There's something called a wash sale rule for you to be able to take the tax deduction for the loss though. It's related to how long it was since you last purchased the asset, even with dividends from the asset, when you sold it, and whether or not you purchased the same asset again within a certain period of time. In short, don't try to game the system, the house typically wins and its a gamble.) + + Some time later you purchase Stock A again for 25,000 USD and Stock C for 25,000 USD. A while later Stock A is worth 75,000 USD and Stock C is worth 15,000 USD. You sell both and get 90,000 USD. Reduced by the 50,000 put in and another 10,000 USD for the capital loss, you most likely pay 0 taxes. Now you can do the same thing with 45,000 USD to each stock. (Again, don't try to play this style of game; it's just messed up and weird and similar outcomes should be possible through easier means when we talk about accumulation and drawdown. What we're doing here is increasing our cost basis while minimizing the tax implications; letting the tax-tail wag the investment dog.) + +Also, net worth has nothing to do with actual worth as a human. To be more accurate it's just financial net worth. If all assets were liquidated and all liabilities were paid off, the difference is financial net worth. + +## Accumulation, drawdown, and rebalancing + +Finances can be divided into two primary modes: + +1. accumulation and +2. drawdown. + +When in accumulation mode, you receive revenue from an outside source; employment, sales, and similar. (Someone else’s assets become yours.) When in drawdown, you're giving your assets to someone else or otherwise liquidating them. + +In accumulation mode, you want to purchase assets that are less valuable per unit now. In drawdown, you want to sell assets that have increased in value compared to the overall portfolio. + +Being able to shift strategies between purchasing low and selling high is one reason for having more than one investment vehicle available; this is *not* the same as diversification. + +For example, I'm currently operating a variation on what is sometimes called the VTSAX and chill approach. In short, this approach asks us to increase income while reducing expenses and investing the difference in a total stock market index fund (specifically [VTSAX](https://investor.vanguard.com/mutual-funds/profile/VTSAX) in this case) and just hold on for the ride. As the cost per share of the index fund goes up, we are constantly buying in at the higher price; thereby, increasing our average cost basis. When the cost per share goes down, we are buying low. In no case are we selling or divesting to something else. For me, I'm using two index funds to allow me to divest a bit without selling. + +One index fund is a total stock market index fund and is distributed based on market capitalization, favoring larger companies; larger companies get a higher percentage of each invested dollar. The other index fund is also based on market capitalization and favors companies with smaller market capitalizations. This means one of the index funds may have a lower fair market value than the other and I can contribute to the one with the lower fair market value instead of continuing to push money into the companies with higher price per share. + +This isn't strictly rebalancing. Mainly because I'm not selling anything, however, the outcome is similar because I'm typically purchasing at lower cost first to get the portfolio into balance. One of the added benefits of rebalancing is that it's a way of increasing the average cost basis of your assets without having to play strange buying and selling games (see previous section). + +When I shift to drawing down, I will do the opposite. Selling at the higher value and maintaining the same overall percentages in my portfolio. + +For example, the targets I've established for my portfolio is to have roughly 33 percent in small-, mid-, and large-cap United States stocks. If the fair market value of the small-cap portion is less than 33 percent, when I put more money, I will buy in to that portion of the portfolio; same if any of the portions fit shit criteria. If shifted to drawdown mode, I'd sell the assets that were above the 33 percent mark, which would cause the percentage of the lower percentage assets to increase by comparison. + +I feel a more detailed example with dollar amounts might be warranted. Let's say my portfolio has 100 USD in it. 25 USD in small-cap, 25 USD in mid-cap, and 50 USD in large-cap; the target is an even distribution across the three. If I was in accumulation mode and had 100 USD to put in, I'd purchase 42 USD in small- and mid-cap while only purchasing around 16 USD in large-cap, which would result in roughly 66 USD being in all three. If I were in drawdown mode and needed 50 USD, I would withdraw 34 USD from the large-cap and 8 USD from the small- and mid-cap portions, which would put the portfolio back into the target balance. If I were rebalancing the portfolio, I would sell 16 USD from the large-cap and put 8 USD into the other two. + +Purchase based on what's low and sell based on what's high using target percentages not the total of gains or losses. Granted this generically speaking and there sometimes other things to consider, however, these other considerations may not result in anything more than a micro-optimization compared to the primary consideration. + +Index funds are internally rebalanced regularly, however, these internal rebalancing events don't affect your cost basis, to the best of my knowledge. Rebalancing your portfolio by selling one thing to buy another thing will alter your cost basis. + +## Cost basis, capital gains (or losses), and methods + +You buy 100 shares of an index fund for 1 USD each (lot 1); 100 USD on day one. On day two you buy another 100 shares of the same index fund for 2 USD each (lot 2); 200 USD. Your total cost basis is 300 USD and you have 200 shares valued at 2 USD each. On day three the fair market value of the shares you own is 400 USD. + +300 USD is your cost basis and 100 USD is an unrealized capital gain, which is spread across two lots. (If the fair market value was 200 USD, the 100 USD is an unrealized capital loss.) + +Let's say you want to sell 50 USD worth of shares at 2 USD each; 25 of your 200 shares. There are multiple [methods the transaction can be performed](https://investor.vanguard.com/taxes/cost-basis/methods) (the link is for Vanguard and other brokerage firms should allow for similar): -(Taxes in the United States are freaking weird.) +1. average cost; +2. first in, first out; +3. highest in, first out; and +4. lot [.identifier](ID) (or specific ID). -Gross income and taxable income aren't the same thing. Let's say you work somewhere and earn less than or equal to 12,500 USD in 2021 and you are filing your taxes a single person. Your taxable income is 0 USD because of the standard deduction everyone gets to take. Let's say you earned 32,000 USD and you contributed the full amount of 19,500 USD to your 401k, you're taxable income would be at 0 as well. Let's say you earned 35,600 USD you maxed out the 401k and maxed out an [.Health Savings Account](HSA) contribution for the year; taxable income of roughly 0. (Check out [this calculator](https://www.taxact.com/tools/tax-bracket-calculator).) +I don't fully understand average cost yet, so, we'll skip it for now. Mainly, I'm not sure the implications when it comes to capital gains and losses except what is noted in the link; in limited circumstances, capital gains or losses may be converted to short-term instead of long-term. -Now, let's say you threw 100 USD of after-tax money into the aforementioned stock then sold it 10 months later for 110 USD. The 100 USD wouldn't have tax implication, but the 10 USD would. Further, because the capital gains were less than 12 months old, it would count toward your total regular income as opposed to falling under the long-term capital gains rules. +First in, first out sells the oldest shares purchased first. This increases the possibility that the sale will fall under long-term capital gain and loss rules. It also means, there's a chance, there will be more capital gains on those shares than younger shares. -Federal long-term capital gains rules basically have [their own graduated tax](https://www.fool.com/research/capital-gains-tax-rates/). If it's less than 40,000 USD or so, you pay 0 percent in tax. Similar to the regular tax bracket if you do all the saving ever. +Highest in, first out sells the shares based on the price paid, not the date of purchase and will sell the more expensive ones first. As a result, this method should take better advantage of both capital gain and loss, however, (as stated in the link) in limited cases short-term capital gains or losses may be realized before long-term. -Basically, looking at it from an ethical social engineering perspective, the federal government is trying to incentivize long-term saving and investing through the tax code with things like tax deductions for putting cash into various savings vehicles, tax-free growth, and in the case of HSAs and the Roth Individual Retirement Account, tax-free withdrawals. Further, if you're living strictly on capital gains from various investments (retired), you can live a modest lifestyle without paying any taxes; the moment you go over that 40,000 USD point though, you pay 15% tax on the amount you went over. So, also disincentivizing extravagance. +Lot ID basically means you get to look at each individual lot and shares you have purchased and choose which to sell. This offers the most flexibility, requires the most work, and carries the most risk should undesired results occur. With this method, you may decide to sell a bunch of shares in something that had a lot of capital gains along with something else that had some capital losses and offset the gains and taxable footprint. + +In general, I would say that we don't want dividends to automatically reinvest. Instead, have the dividends kick out into the settlement account, then purchase back into whatever makes the most sense. The exception here might be for accounts that either don't have more than one asset, or, the account is tax-free or tax-deferred. + +## Bulls, bears, and corrections + +Most days, the United States stock market is, well, just the stock market. With that said, there are certain events that have been given names. It's also important to note that, from what I understand, there's a difference between events happening "the market" and events happening to folks in general, however, the two may experience good and bad at the same time. + +A bull market means fair market values of things are tending to increase roughly 20 percent in a two month stretch; a bear market is the opposite. A correction is a decrease of 10 percent in a short period of time. A crash is a decrease of 40 percent or more. + +So, from highest to lowest the market goes like this: + +1. bull (20 percent up), +2. stable, +3. correction (10 percent down), +4. bear (20 percent down), +5. crash (40 percent or more). + +Since 1900 corrections have occurred [about once a year](https://awealthofcommonsense.com/2013/11/difference-crash-correction/) and last about 4 months. Bear markets have happened roughly every 3.5 years and last roughly one year. Crashes have happened roughly once every 12 years. Of course, all of this depends what you're looking at and how it's reported and doesn't account for how long it took for the market to recover to its pre-crash value. + +Corrections are typically short-term events, as the name implies, once the market has corrected we should be in a roughly stable state. And, for the most part, historically the stable state is roughly an 8 percent increase year over year. + +A recession and depression are not necessarily related to the stock market. Instead these are general terms for how businesses and employment are functioning. Granted if business begins to shrink and employment does the same, chances are people won't be pumping money into the stock market. + +With that said, these are factors when consider risk tolerance and risk capacity. + +## Risk tolerance and risk capacity -And, let's say you purchased Stock A for 20,000 USD and Stock B for 20,000 USD. A year later Stock A is worth 70,000 USD and Stock B is worth 10,000 USD. Stock A has a capital gain of 50,000 USD and Stock B has a capital loss of 10,000 USD. You sell both and get 80,000 USD. Based on Stock A alone, you'd owe 15 percent on 10,000 USD (9,999 USD really, but still). However, you should be able to take a tax deduction for the 10,000 USD capital loss from Stock B, which means you would pay 0 tax…depending on the type of account and presuming the initial 40,000 USD investment was done with post-tax money. Now the new 50,000 USD has been taxed and can't be taxed again, because the government can't tax the same dollar twice. -As of this writing, the government doesn't tax ownership of assets like stocks and bonds. This distinguishes them from assets like homes and automobiles. ## Being rich and looking rich aren't the same +A couple more interesting sets of figures that I plan to consider further regarding sources and accuracy. + +The first set has to do with those with a net worth of a million USD or more. Roughly 80 percent of millionaires are considered first generation, which is to say they didn’t inherit a million USD. Further, 60 percent of them didn’t inherit more than 100,000 USD. Finally, a majority (over 50 percent) didn’t reach a net worth of a million USD until after age 50 and most of their net worth was inside an employer-sponsored retirement plan (like a 401k). + +The second set of figures has to do with generational wealth; what I’ve heard called the wealth wash cycle. 50 percent of inherited wealth will be lost by the second generation and 90 percent will be lost by the third generation. I’m not sure if this includes inheritance to multiple parties. What if 10 million USD is divided amongst 10 siblings; one million each? Does this data set mean 5 million USD will be lost by the second generation, that 5 of the siblings will lose all of their inheritance, or does it include both. (It’s worth noting that this isn’t to say generational wealth doesn’t exist or that something like trickle down economics works at a scale large enough to matter.) + +There’s a sort of template phrasing that goes like this: + +> X rich, Y poor. + +**Life rich, cash (or retirement) poor:** Is sometimes used as shorthand to describe some whose lifestyle gives the appearance of having a lot of money, however, when viewed from a per paycheck basis, they don’t have a lot of cash flow or discretionary funds. This could be traveling, owning expensive assets like cars, something else, or a combination. “They must be rich,” might be a response made when viewing from the outside. + +**House (or car) rich, cash (or retirement) poor:** Similar to the previous only this time it’s a particular type of asset. Having one million USD home or car that accounts for the majority of their net worth. + +There are plenty more of these turns of phrase out there, the point being that in one aspect the person looks rich, while in another aspect the person appears poor. [Yahoo! Finance](https://finance.yahoo.com/news/millionaires-america-2020-50-states-201203665.html) references research from Phoenix Marketing International stating there are over 8 million households who can claim millionaire status. With that said, most of them are unknown to us. We usually only hear about those who are more lavish or loud about it. + ## Glossary Bonds @@ -81,9 +183,18 @@ Capital gain Capital loss : A decrease in value of an asset compared to the cost basis. +Correction +: A decrease + Cost basis : The amount of money it took to acquire an asset. +Diversification +: Holding multiple assets wherein some assets may increase in value while others decrease in value at different degrees or direction. *One asset may increase while the other decreases or vice versa, or, one asset will rise or fall in fair market value faster or slower than another.* + +Expense ratio +: The ongoing cost for managing a mutual fund. *The percent is a per year number, however, the percent is usually divided by roughly 365 to generate a Daily percent, which is charged daily.* + Fair market value : The amount you can reasonably expect to receive when converting an asset into cash through the sale of that asset; usually based on recent sales of similar assets. @@ -102,18 +213,39 @@ Index fund Investing : You trade currency for an asset that historically increases in value over time with the intent of exchanging it for more currency than you paid at a later time. (Compare to saving, speculating, and gambling.) +Lot +: A pool of assets (ex. Stocks) purchased at the same time and at the same cost basis. + Management (active) : A style of asset management whereby an individual or team of individuals actively choose assets to buy and sell and when; often with the intent of beating the returns of a benchmark index. Management (passive) : A style of asset management whereby an individual or team of individuals choose assets to buy and sell based on a standardized methodology; often an index. +Market (capitalization) +: The estimated value of a company based on multiplying shares outstanding and price per share. + +Market (correction) +: A correction occurs when the overall value of assets in a broad-based collection of assets drop by 10 percent. + +Market (bear) +: A bear market occurs when the overall value of assets in a broad-based collection of assets drops by 20 percent or more. + +Market (bull) +: A bull market is when the overall value of assets in a broad-based collection of assets increases by 20 percent or more; usually in a two month period. + Mutual fund : A collection of assets held in trust; usually represented as shares using pooled resources of the shareholders and available to the public. *Mutual fund shareholders are not direct owners of the assets being purchased and do not have voting privileges.* +Net worth +: The amount remaining after adding together the fair market value of all assets and subtracting the fair market value of all liabilities. + Realized : Whether or not a capital gain or loss has occurred. *The point at which we can say money has been earned or lost.* +Rebalancing +: The act of selling an asset with higher fair market value than other assets and using the funds from that sale to purchase assets with the lower fair market value to bring the percentages of all assets back to their targets. + Unrealized : Whether or not a capital gain or loss *would* occur. *The point at which we can have an idea of the fair market value of an asset; an appraisal on a house, for example, establishes the unrealized gain or loss in value.*