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Health & Fitness

How Do I Make Money? Let Me Count the Ways

3 ways to put more money in your pockets and bank accounts.

By Colleen's Contributor, Lynn Torre

 

You all know that there are 3 ways to have more money in your pocket: 

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  1. Make more money
  2. Spend less money
  3. Both of the above

 

The question now becomes, (besides asking for a raise or selling more products/services), how do you make more money?  Of course, now I am referring to investments.

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Again, there are 3 ways to make money from your investments:

  1. Interest
  2. Growth or appreciation in value
  3. Dividends

 

Interest

As found in Barron’s Dictionary of Finance and Investment Terms, interest is “the cost of using money”.  You pay interest when you borrow money and you earn interest from your bank in your savings and money market accounts and also CDs.   Interest rates are quoted as an annual rate.  A 3-month CD may have an annualized rate of 1.2% but you will only receive ¼ of that (3 months/12 months) or .3%.  This is the cost to the bank for the use of your money.  In essence, you have lent money to your bank.

 

Bonds are also debt instruments.  When you buy a bond (Treasury, corporate or municipal) you are lending money to the US or a foreign government, a corporation or a tax-free entity such as a city, state or hospital etc.  Bonds also pay interest to the lender or bondholder.  For bonds, the interest rate on the original value of the bond is called the coupon rate.

 

Let’s say you purchase a new issue 30-year Treasury bond for $10,000, and its coupon rate is 3%.  The US Treasury promises to pay you $300 of interest per year for the next 30 years.  If you sell the bond before it matures, perhaps in year 10, you may or may not get your $10,000 back in full.  It will depend on the current interest rate at that time.

 

In this example, the interest rate is 3% and the yield is also 3%.  Let’s look at what happens if you purchase the same bond but after its original issue date.  You may have to pay less or more than $10,000.  Let’s say you had to pay $10,909.  You were receiving the same coupon rate of 3% or $300/year but the yield on your bond would be less > $300/$10,909 = 2.75%. Yield = interest/purchase price.  As you can see, as interest rates lower, bond values rise.  The converse is also true.   As interest rates rise, bond values drop.  Because rates are currently very low, bond values will inevitably drop as interest rates go up.  The shorter the term of the bond, the less the bond value will decrease (or increase if rates rise).  Interest may be paid monthly, quarterly or annually.  It depends on the terms at purchase.

 

WHEW!  As you can see, there is more to interest than just the rate you receive.  The above example is also related to the penalties you get charged if you cash in a CD before it matures.  The bank has already lent your money to someone else and now has to scramble to fund that loan again.

 

Appreciation

This is when an investment increases in value.  When you sell an investment that has appreciated you have a capital gain.  For example, you purchased 100 shares of the common stock of XYZ corporation.  You paid $15/share for a total of $1,500.  The stock is now valued at $20/share.  You sell all 100 shares for a total of $2,000.  You have a capital gain of $500.  The growth rate of the stock was 33%, or $500/$1,500.

 

It is important to note that you only have a capital gain if you sell the investment for a profit.  This is called a realized gain.  You may own stock that is worth more than the original purchase price.  The difference is called an unrealized capital gain because you have not sold it, even though it is a gain on your statement.  If you sell for less than you paid then you have a capital loss.  This is no different from having equity in you home or being “under water”.  It really only matters when you sell.

 

Dividends

Again from Barron’s, “a dividend is a distribution of earnings to a shareholder”.  Some corporations pay dividends to their common stockholders.  Typically this is from well-established companies who are not investing as much into growing the business.  Instead, it shares some of the earning with its stockholders.  Similarly, the yield of a stock dividend is calculated as dividend amount/current stock value.  As the value of the stock goes up and down, so does the yield.  The dividend amount is determined by the company’s board of directors and can be change at any time.

 

Stock dividends are usually paid quarterly but yield is measured and quoted annually, like the 3 month CD I mentioned earlier.  When you purchased XYZ stock, you also received an annual dividend of $37.50.  The dividend rate was 2.5%, calculated $37.5/$1,500 = 2.5%.  It was also the yield.

 

Preferred stock ALWAYS pays a dividend but don’t expect to get much appreciation from it.  It is designed to give you income, not a gain.

 

This is how you make money.  Any questions?

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