your financial details.
Setting priorities in the process of creating a solid financial position can be challenging. The financial planning pyramid provides a visual explanation and reminder to help people make the right moves at the right time. It aims to keep people from taking inappropriate risk by gauging the relationship between risk and reward. The pyramid also takes into consideration the element of time as a person makes progress towards his or her financial goals. It is a simple way to suggest how much of a person’s assets he or she should commit to different investments and other financial products.
Deciding how to allocate your financial assets and when to do so is something a financial advisor can offer invaluable advice on.
Levels of a Financial Planning Pyramid
There’s no single version of the financial planning pyramid. Some varieties have just a few levels and others have several. Some describe a wide variety of specific investments, asset classes and financial products and others just a handful of broad categories.
A core element of all versions of the pyramid is that the least risky financial moves are at the bottom, while the riskiest ones are at the top. The width of the pyramid at the level where a financial product appears suggests how important it is and how much of a person’s assets should be committed to it.
Here are levels of the financial planning pyramid:
Level 1 – The lowest level is the widest, which indicates its importance and where it should be in terms of priorities. It is also the least risky and, in fact, focuses on reducing financial risk. This level includes automobile, home, life, health, disability and liability insurance.
Level 2 – Once the first level is addressed, people can concern themselves with the second level. This level is focused on emergency savings. It includes money put into safe investments such as federally insured bank checking and savings accounts, certificates of deposit and government bonds.
Level 3 – The third level consists of savings and investment vehicles that may pay better interest rates than the very safe ones in the second level, at the cost of somewhat greater risk. They include money market accounts and high-grade municipal and corporate bonds and bond funds.
Level 4 – At the fourth level investments in equities begin to appear. These take the form of balanced mutual funds and high-grade shares of preferred stock and convertible bonds.
Level 5 – The fifth level consists of shares of blue-chip public companies as well as investments in growth-oriented mutual funds and real estate.
Level 6 – The sixth level represents investments in collectibles, speculative stocks and lower-grade bonds and mutual funds.
Level 7 – At the very top of the pyramid is a narrow wedge representing the small amount of assets that may be prudently committed to highly speculative investments. These could include commodities, over-the-counter penny stocks and the like.
The main idea of the financial pyramid that the width of pyramid at a given level expresses how much a person might wisely commit to the investments in that level. That is, more of a portfolio should ordinarily be invested in blue chip common stocks than speculative penny stocks. Time is also a factor. This means people are advised take care of the risk-management tools in the first level before starting to build emergency savings or begin investing in the stock market.
Different investors have different situations, which can affect the pyramid. For instance, a person in the middle of his or her career may be more heavily invested in growth mutual funds than someone approaching retirement, who would likely emphasize safety of principal with investments in high-grade bond funds.
Some versions of the financial planning pyramid have an even lower level. This may include the creation of a financial plan. Another item sometimes included as part of the lowest level is a budget that aims to make sure a person has cash left at the end of the month to stock an emergency fund and, ultimately, invest.
While financial products at the bottom of the pyramid are lower risk than those on higher levels, there is no risk-free investment. Even government bonds may generate a negative return in terms of buying power if the return does not keep up with inflation. There is also a risk of paying insurance premiums without ever making a claim on the coverage benefits.
The financial planning pyramid is a road map to help people decide where to put their emphasis today in preparing to reach their ultimate financial goals. It is a reminder of the relationship between higher risk and higher reward, and helps to ensure that people have the building blocks of a solid financial foundation in place before chasing better returns with riskier investments. While financial products at the bottom of the pyramid are lower risk than those on higher levels, there is no riskless investment. Even government bonds may generate a negative return in terms of buying power if the return does not keep up with inflation. There is also a risk of paying insurance premiums without ever making a claim on the coverage benefits.
Tips for Investing
- If making and implementing a financial plan seems like a complicated challenge, consider working with an experienced financial advisor. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- Once you’ve decided to start investing your money, you’ll have to decide on an asset allocation that’s appropriate for your goals, age and risk tolerance. And unless you invest in a target date fund that automatically adjusts that asset allocation, you’ll have to rebalance your assets over the course of your investing time frame. That’s where a free, easy to use asset allocation calculator can be extremely helpful.
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Before investing in a retirement plan it will be highly beneficial for employees to understand what’s a 401k and how it works for them. The traditional 401k is one which employers provide to their workers by taking some money out of each paycheck to contribute to their personal account. In addition, many participating employers also contribute money to the worker’s 401k plan, often matching the employee’s contribution. When employers match their employees’ contributions, this is called a matching 401k. The traditional 401k is a stock investment plan, which means the money invested in a 401k is used to buy a set of stocks for an investment portfolio. When an employee invests in a pre-tax 401k plan, they incur some tax benefits, which include not owing any Federal income taxes on income that is invested in the 401k. In addition, money is automatically added to the employee’s 401k account from each paycheck, so they aren’t required to take action to ensure contributions are properly made. The ultimate purpose of a 401k is that it is a pension plan, which means that it is income that workers set aside for their retirement years. The goal of a 401k is to ensure that retired people do not have to worry about making ends meet in their later years of life.
The term 401(k) refers to a pension and profit sharing plan that is based on a defined contribution system. It is named after a section in the IRS tax code which came into existence through the Revenue Act of 1978. Even though financial planners were aware of the new Revenue Code 401(k), it wasn’t until 1981 that the IRS explained the rules for taking advantage of the new system. In the beginning, few companies offered this benefit to their employees, but by 2005, the 401k defined contribution pension plan became the most common private-market retirement plan offered by employers in the United States. By that time, the total nationwide value of all 401k plans combined, reached over two trillion dollars.
A major part of knowing what is a 401k plan involves knowing how it is funded. Employees participating in a 401k plan typically choose their investment vehicles, or what they invest their 401k funds into. These investments usually mean stocks, but investment vehicles can also be bonds, mutual funds, exchange traded funds, or derivatives. When employers pay into to the plan, it is called a profit sharing plan. In this case, employees may or may not be required to match the employer’s contribution to their 401k plan. There are limits to how much employees and employers can contribute to a person’s 401k, however. According to IRS law, an employer can only contribute twenty-five percent of the employee’s yearly income. The individual, on the other hand, can contribute up to $50,000 of their annual income to their 401k as of 2012, or the equivalent of their yearly salary, if it is under $50,000.
While 401k account holders do not get assessed taxes for the income that they put into their 401k at the time of contribution, there are restrictions that apply. Withdrawing money from one’s 401k plan before the age of retirement incurs a tax penalty of ten percent. This can be waived under certain hardship-related situations. This includes the employee’s death or complete and life-long disability, or when they need the money to pay for certain qualified medical emergencies. Upon retirement, money withdrawn from one’s 401k plan is taxed as ordinary income.
By Kelly Anderson
Molly Ward is a Texas mother, wife and certified financial planner. With nearly three decades of financial planning experience, she focuses her practice on helping women achieve financial independence and live up to their financial potential.
An advisor with Equitable Advisors in Houston, Texas, Ward’s been helping her clients navigate their way through the COVID-19 crisis. She’s got some solid advice for how to lower your financial stress level.
Here are six questions that we’ve gotten from women who read The Penny Hoarder — and Molly Ward’s answers.
1. How Can I Prepare for Life’s Difficulties?
Q: Life has its inevitable derailments and obstacles: We take care of our aging parents; we have health concerns; deaths in the family; experience disabilities and often, women live longer than men. How can we prepare, financially?
A: “I have seen so many brilliant businesswomen and hardworking moms unnecessarily suffer when they experience life’s inevitable difficult seasons,” Ward says. “If a woman is proactive and thoughtfully and thoroughly prepared, she can change the course of her life and her family’s.”
Ward notes that women typically take more time out of careers to take care of loved ones — kids, husbands, aging parents. Also, women tend to live longer than men. Due to longevity and fewer earning years, a woman must:
- Save more.
- Acquire insurance on herself and possibly her spouse, and perhaps long-term care insurance on her parents.
Here at The Penny Hoarder, we recommend a life insurance company called Bestow. You could leave your family up to $1 million, and we hear people are paying as little as $16 a month for insurance policies. (But every year you wait, this gets more expensive.)
It takes just minutes to get a free quote and see how much life insurance you can leave your loved ones.
2. How Do I Invest?
Q: My husband recently passed away, and he took care of all the investing. What do I do?
A: “Start with a realization that investing comes after planning,” Ward says. “Investing without a plan is like driving on a trip without a map.”
She recommends talking to a financial planner. When it comes to investing, Ward stresses long-term planning and logic versus focusing on the hot stock of the day or the political climate. Those will pass.
If you’re new to investing, you can start small. Investing doesn’t require you throwing thousands of dollars at full shares of stocks. In fact, you can get started with as little as $1.*
The Penny Hoarder likes Stash, because it lets you choose from hundreds of stocks and funds to build your own investment portfolio. But it makes it simple by breaking them down into categories based on your personal goals. Want to invest conservatively right now? Totally get it! Want to dip in with moderate or aggressive risk? Do what’s best for you.
If you sign up now (it takes two minutes), Stash will give you $5 after you add $5 to your investment account. Subscription plans start at $1 a month.**
3. Why Do I Feel Out of Control?
Q: Why do I feel out of control with my money?
A: “Taking control of your finances should be a priority,” Ward says. “You wouldn’t knowingly leave your child’s college decision, or even your next summer vacation to chance. So why would you leave your financial future up in the air?
“Managing your own personal finances and investments requires a completely different emotional muscle, one that is often paralyzed by any number of experiences that can cause you to make easily avoidable mistakes — including the biggest mistake: Doing nothing at all.”
To assess your finances, Ward recommends making a list of all your assets and investments, along with any recurring payments or debts.
Take it from The Penny Hoarder: Credit card debt is the worst! Your credit card company is just getting rich by ripping you off with high interest rates. Take control with a website called AmOne, which will match you with a low-interest loan you can use to pay off your balances.
The benefit? You’ll be left with one bill to pay each month. And because personal loans have lower interest rates (AmOne rates start at 3.99% APR), you’ll get out of debt that much faster.
It takes two minutes to see if you qualify for up to $50,000 online.
4. How Else Can I Take Control?
Q: What else can I do to take control of my finances?
A: “Goal-setting may sound trite, but it’s an excellent starting point toward gaining control of your finances and your future,” Ward says. “Discussing and stating your short- or long-term plans for your life help you understand what financial goals you should set.”
“Financial assessment, goal setting and budgeting should become something you do out of habit — like brushing your teeth, giving your dog his flea medicine, scrolling through Instagram. Making these steps part of your monthly routine will bring a sense of control and order to your life.”
Here at The Penny Hoarder, we recommend taking control of your credit score. It’s important because the higher your score, the better deal you’ll get on a mortgage, a car loan, a credit card, or even a deposit on a car rental or an apartment.
Try using a free website called Credit Sesame. Within two minutes, you’ll get access to your credit score, any debt-carrying accounts and a handful of personalized tips to improve your score. You’ll even be able to spot any errors holding you back (one in five reports have one).
5. How Should I Leave an Inheritance?
Q: I’m going to be leaving an inheritance to my children. How do I make sure there is peace amongst them after I die?
A: “When it comes to passing down wealth and last wishes, I’ve witnessed success and sadly, on the other hand, I’ve seen feuds and litigation,” Ward says. “The negative outcomes tend to happen when there is either too much complication or at the other extreme, complete lack of planning. An internet legal document is not sufficient!
“Sometimes there is a ‘problem asset’ — for example, a piece of property that has emotional attachment. Along with poor planning, such as an unclear title or problems with a deed, emotions are high following the death of the guiding force of a parent. Feelings can get hurt, which can create a hotbed of controversy and fighting among the children.
“Thoughtful communication, in which the parent’s important values are discussed is key. Estate planning should be completed and regularly reviewed. Sometimes, hiring a trust company to be named executor or trustee of the estate can help keep the peace. When given to a family member, the executor or trustee role can often be a thankless job that comes with liability and creates unnecessary turmoil in the family.”
6. Why Do My Spouse and I Disagree About Money?
Q: My spouse and I disagree about money. Why?
A: “It might have something to do with your embedded money scripts,” Ward says. “Your money memories — those embedded in you by parents and or grandparents — highly influence your financial success or struggles.”
“In fact, many experts believe our habits and views surrounding money were formed as children watching our parents and other adults with it. After you learn what yours are, have a peaceful discussion with him/her about money scripts to see where each other are coming from.”
“Also, planning when you are in love and things are going well is a great time to talk about your incomes, assets and debts. Truthful conversations about money at the beginning will serve you well later!”
Mike Brassfield ([email protected]) is a senior writer at The Penny Hoarder.
Good Financial Cents, and author of the personal finance book Soldier of Finance. Jeff is an Iraqi combat veteran and served 9 years in the Army National Guard. His work is regularly featured in Forbes, Business Insider, Inc.com and Entrepreneur.
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Whether you’re a seasoned investor or are just getting started, chances are you come across one investing term more often than others: dividend yield.
While defining “ In this post, we’ll explain what dividend yield means, why it matters, and show you how to use the dividend yield formula. Use the links below to navigate ahead, or read end to end for a more detailed overview of the topic.
What is Dividend Yield?
Before we define and learn how to calculate dividend yield, let’s make sure we’re all on the same page about dividends. Dividends are payments that companies make out to their shareholders for owning stock in their organization. Dividends can be earned from stock across a myriad of industries, including, real estate investments and consumer staples. Dividends are typically based on the company’s profit and performance throughout the year, and are generally paid out quarterly.
Definition of Dividend Yield
Dividend yield is the metric that can be used to help dividend investors anticipate how much a company pays out to shareholders in the form of dividends on an annual basis, compared to the current price of their shares.
Why does it matter? By comparing a company’s annual dividend share with the individual cost per share, investors can estimate their profit margins, and thereby, make more informed investment decisions.
Although calculating dividend yield can arm investors with essential information, it’s important to note that historical trends don’t always indicate future performance. In addition to finding a stock’s dividend yield, you may also want to consider some other variables and sources before making any investment decision—more on that a little later on.
How to Find Dividend Yield
To find dividend yield, you’ll need to start by identifying two important figures first: annual dividend per share and current share price. These numbers can both be found on the major stock market indexes. Note: to find the most accurate predictions, you’ll want to use the most updated data available.
Now that you have these details, you can calculate dividend yield using the dividend yield formula.
Dividend Yield Formula
To find the dividend yield, you must divide the dollar value of the annual dividend by the current share price.
Dividend Yield = Annual Dividend Per Share ($) ÷ Share Price ($)
Once you’ve divided the annual dividend per share by the share price, multiply the number by 100 to find the dividend yield percentage.
Dividend Yield Formula Example
To better understand how the dividend formula works, let’s take a look at a fictional example.
So if you buy shares today at $40 per share, you can estimate that you’ll earn 2.5% per year from dividends (before tax).
There are a few things to consider once you’ve calculated dividend yield:
- If you reinvest your dividends, you get 2.5% compounded. For example, if you had enough shares invested and received $25 in dividends, you could reinvest these dividends to buy 62.5% of an additional share of stock, and that portion of stock next quarter will then also pay you a dividend. You can increase the dividends you will earn each quarter by reinvesting them (assuming the dividend rate and share price stayed the same).
- The higher the stock price goes, the lower the current yield. For example, if the stock price rises to $55 per share, that $1 per share is reduced to 1.8% ($1 ÷ $55 = 1.8%). However, you should calculate your dividend yield based on the price per share that you paid when you bought stock, and not on what it becomes later.
- By the same mathematical reasoning, when the stock price falls, the dividend yield rises. For example, if the price per share falls from $40 down to $32, the dividend yield rises to 3.125% ($1 ÷ $32 = 3.125%).
Important Notes on Dividend Yields
Now that you know how to calculate a stock’s dividend yield, let’s take a closer look at how this metric can be applied to buying, selling, and strategizing for your investment portfolio.
Making the most of your dividends
Anyone who tries to time the purchase or sale of stock to maximize dividend income should be aware of how the dividend distribution dates are figured. The ex-dividend date is the date on which stockholders earn their respective dividends. However, investors should note that those dividends are not paid out until several weeks later. So before you buy or sell shares with the intention of earning dividend income, find out when the ex-date occurs. If you buy after that date (or sell before), you will not earn the quarterly dividend.
Using the dividend yield formula to evaluate investments
The dividend yield should be a part of your evaluation of your portfolio and in the selection of companies whose stock you are thinking of buying if you are using a dividend investment strategy. Some companies pay exceptionally high dividends and yet are considered very safe investments. This is not always the case, so if you just pursue the highest possible yield, it makes sense to perform a few fundamental tests first, and to determine whether or not it is safe to buy shares.
Never pick a stock based solely on dividend yield. But when all else is comparable, a higher dividend can work as a means for reducing your list of prospects.
In addition to calculating a stock’s dividend yield, here are some other things you can do to empower and inform your investment decisions:
- Think about investing in the context of your personal finances first. Only you can make the appropriate financial decisions for your lifestyle and goals. Use financial tools like Mint to help you gain perspective on where your budget and financial wellness stands.
- Understand the element of risk, and assess your comfort level. All investments involve some level of risk, from stock volatility to market changes, so it’s a good idea to establish your comfortability with investment risk first. Ask yourself how much you’d be willing to lose in the hopes that you’ll actually turn a profit.
- Consider your options. If you’re not comfortable plunging into the stock market just yet, you might look for other ways to start growing your wealth. High-yield savings accounts and retirement plans offer less-risky options to boost your bucks.
- Do your research. Publicly traded companies are required to provide consumers with important financial information so that those wanting to invest can make informed fiscal decisions. By looking to gov, Investor.gov, and other reputable sources, you can arm yourself with the knowledge to make the right decisions based on your goals.
Calculating dividend yield can provide some useful insight for investors looking to earn dividend income. To find this metric, simply divide the annual annual dividend per share by the current share price, then multiply by 100.
Investors should keep in mind that dividend yield is just one piece of the puzzle when it comes to vetting investment opportunities. Doing extra research, reviewing historical trends, and considering your own financial goals will help you make the best decision for your financial health.
Need help tailoring your investment strategy? Head over to our investment calculator to start crunching the numbers!
Michael C. Thomsett is author of over 60 books, including Winning with Stocks and Annual Reports 101 (both published by Amacom Books), and Getting Started in Stock Investing and Trading (John Wiley and Sons, scheduled for release in Fall, 2010). He lives in Nashville, Tennessee and writes full time.
Investing 101: How to Calculate Dividend Yield was provided by Minyanville.com.