Realized versus Unrealized Gains

When the value of your investment goes up, your profit (or the amount it went up) is called a gain. If you haven't sold the investment, that amount is called an unrealized gain. It's not realized because it's actually not your money yet. The investment value can still go up and down.

When you sell the investment and the profit (plus the original amount) is in cash in your account, that's a realized gain. Currently, you only pay taxes on realized gains.

Long-Term Investing Wins the Tax Game

In your retirement accounts (and other tax-advantaged accounts like a 529 plan – we covered them in the previous chapter– and an HSA, discussed in Chapter 10) you don't pay taxes on your capital gains (which is a huge gain for us, pun intended). In our nonretirement accounts we do. When we buy and sell an investment within a year, we pay short-term capital gains tax on the growth, which is the equivalent of our income tax rate. So if I earned $50 on an investment when I sold it, and my income tax rate is 30%, I'd owe $15 when I file my taxes.

If we hold our investments for over a year before selling, we pay long-term capital gains tax, which is 0% if you are single and earn under $41,675, 15% if you earn $41,676 to 459,750, and 20% if you earn over $459,750 in 2022. Let's say I earn $50,000; my $50 capital gain is now taxed at 15%. I'll owe an additional $7.50 at tax time.

What If You Lose Money?

I know, I'm so optimistic. So far I've only talked about making money. When your investment goes down in value, that's a loss. If you still own the investment, that's an unrealized loss. Once you sell your investment at a loss, the amount your investment went down is a realized loss. Losses decrease our taxes.

Okay, cool-cool-cool. But you might be wondering, where does this magical investing happen?

On Your Own

To get started, you'll need a brokerage account, some money (it can be a very small amount), and your investment choices. That's only three things. Not too bad, right? You are the one who logs into your brokerage account and buys and sells the investments.

PRO: It is the least expensive option. You are not paying an advisor's management fee. Georgia Lee Hussey says that up until you hit about a million dollars in investments, doing it on your own works great and can keep your costs low, letting the magic of compound growth work for you.

PRO: It is great for control freaks. You can choose from any and all investments available to you under the sun. Nothing happens to your money without you initiating it.

PRO: It is accessible to those who are ready to invest. As long as you meet the account minimum (which can be very low), you're in.

CON: We're not always rational with money. Having some barrier, like a person we can call or software we can trust, between us and our money can keep us from making emotional decisions. Talking to a person doesn't mean you have to hire a financial advisor. I talk about other financial professionals you can hire to mitigate this con later.

CON: You're doing the work. Rebalancing is on you. Checking in is on you. The truth is, you should be checking in regardless of how you invest, but with the other ways you have some more support.

With a Robo-Advisor

A robo-advisor is a digital platform that invests your money for you for a management fee (usually 0.25–0.35%). Typically, you'll open an account, answer some questions about your goals, timeline, and risk tolerance, and the robo-advisor will invest accordingly. Some you might have heard of are Ellevest, Wealthfront, Betterment, and SoFi.

PRO: They do the work. You answer the questionnaire and voilà! Your money is managed for you. Set up some automatic contributions and you can be very hands-off.

PRO: Most robo-advisors invest your money in low-fee index fund investments. I'm a fan!

PRO: Robo-advisors are accessible to those who are ready to invest. Your money is being handled by “expert” software for a low price and that can give you peace of mind.

PRO: They may offer the opportunity to talk to a CFP. You may have a person to reach out to if you get nervous during a market dip or have a question.

PRO: Many offer tax-loss harvesting, which can save you money in taxes. Tax-loss wha? Remember capital gains and losses? Well, robo-advisors sell your investments for a loss and buy similar securities (jargon for tradable investments) to keep your overall portfolio composition the same for the lower price. This locks in the loss (now a realized loss) and saves you money in taxes while not sacrificing your investments. This is something that happens digitally – it's not something you'd want to spend your time replicating on your own.

While this sounds very cool, I have been skeptical about how much savings this actually generates. Tony Molina was able to share that “while there is no way to quantify what tax-loss harvesting is going to do for someone (it depends on market movement and specific investments),” for Wealthfront, “the average client typically gets back at least three times the value of our 0.25% fee in the benefits of tax-loss harvesting – about 0.75%.” If you harvested losses of $3,000 and your income tax rate is 30%, you are now paying $900 less in taxes.

CON: That fee. It's small but it's a fee nonetheless. What does that mean in real dollars? Take 0.25% (.0025) and multiply it by the amount of money you have invested. If you have $10,000 invested, that's $25 per year.

CON: You could replicate the portfolio on your own. Many robo-advisors choose simple low-fee investment options for you, which is great and one of the reasons I'm a fan of them. But at the same time, you can also replicate what they are doing on your own. It just takes more work on your end.

CON: There may be no person to talk to (this is a pro for some and a con for others). If there is support available, you are probably not going to be talking to the same person every time.

CON: There is not much of a barrier to emotional investing decisions (very similar to investing on our own). Having a better understanding of how investing works can really help with this (for investing on your own, too!). Tony says, “Know that you will have to deal with the downturn as well as the upturns in passive investing. You'll get hit hard in the downturn but know that you're going to come out ahead.” It helps to keep this in mind.

Hiring a Financial Advisor

Hiring a human (vs. software) to manage your investments for you.

PRO: There is more support. Some people really want to be able to call their person up and talk about their investments or calm their fears when the market is down. And they are happy to pay more for that (four to five times more).

PRO(ish): They can help you get more nuanced. You might think that hiring an individual (which costs more money) will mean you get more nuanced financial planning to meet your needs. You might even expect the advice to include your holistic financial picture. This is the ideal scenario and usually only happens once you have some very considerable wealth. You'll want to get clear on what support you will be getting when you interview potential advisors.

CON: This is the most expensive option. Advisors typically charge a percentage fee to manage your funds (usually 0.5–1.5%). If you have $100,000 invested with a financial advisor and their fee is 1.5.%, that's $1,500 per year. Another way to look at it? If your portfolio earned 6% and you paid a 1.5% fee, you're now only keeping 4.5% of that profit. That being said, it's best to work with a fee-only advisor who doesn't sell you products to earn commission.

Tony shares, “If you are high net worth, some advisors will be able to put you into alternative assets not available to everyone else. Otherwise, you're paying a higher fee just to talk to someone. There's no competitive advantage.” Georgia says that “investment management is highly replicable. We have all the evidence we need to know how to invest well. There are some differences in philosophy but they are just nuances.”

CON: This option is inaccessible to most. Many advisors only take on clients who have a certain amount of money to invest (they call this their minimum). Minimums can range from $50,000 to $1,000,000 so for most, hiring a financial advisor is not a possibility.

CON: They may try to sell you expensive products you don't need. Another thing that gives advisors a bad rep is that fee-based (different from fee-only) or commission-based advisors can hawk products – specifically, products that earn them commissions (a conflict of interest that I've had an issue with for the entirety of my career). These products might be in the form of insurance products (more on this in Chapter 10) or expensive funds with high expense ratios, load fees (a percentage fee you pay to purchase the fund), exit fees (a percentage fee you pay to sell the fund), and 12b-1 fees. This is another con that can be eliminated by working with a fee-only fiduciary.

Regardless of which option you choose, you want to understand what's happening with your investments. If you are working with an advisor, you want them to be open to educating and listening to you.

What Is a Brokerage Account?

A brokerage company is a firm that enables you to buy and sell investments. When you open up a brokerage account, you can then transfer money into the account and buy and sell investments there. There are many brokerage companies. Some you might have heard of are Vanguard, Fidelity, Charles Schwab, TD Ameritrade, E-trade, and there are many more (this list is by no means exhaustive).

How Much Money Should I Invest?

If you've never invested before, you might have a chunk of savings you want to invest and/or a monthly amount you'd like to put toward your investments. You can go back to Chapter 3 for help in prioritizing which goals should come first and how to break down your goals into monthly targets. You can test out different amounts in your financial plan (or happiness allocation). There's a common investing myth that you need a lot of money to invest. Depending on how you decide to do it (coming soon), you can start with as little as $5.

Can I Invest Before I Pay Off My Student Loans (or other debt)?

The short answer is yes. A few things to consider here. First, what's the best use of your money? If you can expect to earn 7%, on average, adjusted for inflation in the market, and your student loans have an interest rate of less than that, then it makes more sense financially to invest than to aggressively pay down your student loans. Lauren Anastasio and Brian agree with this 7% cutoff and Rachel Sanborn Lawrence prefers 5%.

The tricky part is, we have no way of knowing what the market will look like in the years you invest instead of paying down your debt, so it's not a cut-and-dried answer. Is it ever? To make decisions easier, I like to look at the numbers. The following chart shows what kind of trade-off we are talking about.

Let's say you have $10,000 in student loans, with an interest rate of 5% and a $250 monthly payment. In scenario #1, you pay $750 toward student loans and in scenario #2 you pay $250 toward student loans and invest $500 with an interest rate of 7%. You can run a similar comparison with your own debt information (there's a template in the Financial Adulting toolkit).

Another important thing to consider is your relationship toward your debt. Some feel very comfortable and happy having student loans and making the monthly payments, where others want to pay them down as soon as possible.

Time Is Very Important

Understanding your goals for the money you are investing is important because of time. When you need the money will determine whether you should be investing it in the first place and how risky those investments should be. For any money you need in the short term (the next one to three years), you will want to keep that in cash (like a high-yield savings account).

After we're covered for the next three years, Brian recommends breaking down the remaining investments into goals for the next three to seven years (a medium-term bucket) and longer than seven years (a long-term bucket). For medium-term goals he says, “It's a balancing act. There's no perfect answer because it's long enough where I want it to grow, but it's short enough where a market decline could have a bad impact. It's typically a mix of stocks and bonds.” For the long-term goals, he usually recommends that everything (or almost everything) be invested in stocks because that's the best for long-term growth.

When we invest for the long term we have the opportunity to wait out the market dips because we don't need the money for anything pressing. It's a much more powerful and much less stressful place to be. In some cases we may not even know what the money we are investing is for. That can be a good sign that we don't need the money in the near future. Can you hear the major privilege in this? I hope so.

Are You Ready to Level Up Your Risk Knowledge?

There are two types of risk, systematic and unsystematic. Systematic risk is the risk that the entire market can go down. This can happen when there's a recession, a global pandemic (oh, hey, 2020), or even when there's bad news. Following is a chart showing the total stock market over the past 30 years. Overall, the trend is far upward (yay long-term investing) but there are days or months where the market is down. Systematic risk is inevitable, unsystematic risk is not.

Unsystematic risk is the risk of loss in a certain industry or for a specific company (during the pandemic when no one was traveling, airline stocks took a big hit). Or when a company announces that their profit will be lower than expected, their stock price may go down. By investing in many industries and even more companies, we can mitigate this risk. And this is why investing in one company's stock is more risky than buying a fund that holds 3,000 companies, where the movement of one company or industry won't have too much of an impact on the whole.

What's in These Funds?

Outside of bonds versus equities, funds are often broken down by sector (industry) and/or size of the companies in the fund. As you can imagine, with a fund that's only invested in one sector, you are much more exposed (jargon alert) to anything happening in that sector, but at the same time, if it does really well, you will also earn more return than if you were invested in a bunch of other sectors at the same time.

Georgia says, “Invest in passively managed, low cost, broadly diversified funds – keep it super-unsexy.”

What Does Broadly Diversified Mean?

It means that your portfolio is invested across a lot of sectors (e.g., tech, healthcare, etc.), geographic regions, and companies of different sizes.

Geographic locations are often broken down by U.S./domestic, international developed (e.g., Australia, Sweden, and Germany), and emerging markets (e.g., India, Mexico, and China).

Company size is determined by market capitalization, often shortened to “market cap.”

Large-cap companies are large companies that are typically viewed as more stable and less risky, like Apple, Microsoft, and Johnson & Johnson. Small-cap companies tend to be more volatile but have a larger opportunity for growth (many you probably haven't heard of), and mid-cap are somewhere in the middle.

A broadly diversified portfolio will likely also include bonds and a bit of cash. It can include diversity in who issues the bond (e.g., government or corporate bonds) and the length of the term of the bond (short or long term). There's also a subsection of government bonds called “munis,” which is short for municipal bonds issued by local governments.

Start with Recommendations

Now that you have a better idea of how you want to invest, keep that in mind in your research – meaning, you plan to focus on highly rated ESG funds, or funds in general. You want to start with a list of a few names. You can google, look to experts, or ask friends. We also have a list for you in the toolkit. When googling, be wary of top-10 lists. Sometimes companies pay to be on those, so you'll still want to do your own research.

When you have a list of names, take a look at customer reviews. It's important to see what people are saying who are actually using and experiencing the platform. Is it easy to get in touch with customer service? Do they have text support or do you have to hop on the phone? Do the investment options match how you plan to invest? Do customers like the website/app? How do you prefer to communicate? A lot of this is personal preference.

Look for a Low or No Minimum

Depending on how much money you are starting with, certain account minimums will be a dealbreaker. Many accounts have low or no minimums.

Make Sure There Are No Trading Fees

Back in the day when I started investing, you had to walk up the hill barefoot both ways to make a trade. Just kidding. But many brokerage accounts did charge a fee or commission each time you made a trade (unless you were trading their securities). The good news is, it's now easy to find accounts with $0 commissions, all the time. Trading fees are a dealbreaker.

Say No to Other Fees

Are there any other fees like a monthly or annual account maintenance fee? There are plenty of account options that don't charge any other fees, so this one is also a dealbreaker for me.

Do They Pass Your Consumer Activist Criteria?

Back in Chapter 6, you made your own consumer activist criteria. The financial services space is evolving (albeit more slowly than I'd like). There are new companies being founded and the more established brands are implementing changes to do better. You might not be able to find a perfect fit but you can definitely factor this in.

SIPC Insurance

Any reputable brokerage firm will be SIPC insured. This is similar to the FDIC insurance that we talked about in Chapter 6 in that if the brokerage firm goes under for any reason, your money is protected. That being said, it's very important to understand that being insured doesn't protect your investments from losses as far as ups and downs in the market.

Once you choose, you'll follow the brokerage firm's process for opening an account. It will feel very similar to opening a bank account.

Start with Asset Allocation

We calculated your asset allocation for your retirement investments in Chapter 7. The asset allocations for your other investments are a different story. In the Financial Adulting toolkit you can find some of my favorite resources for finding your ideal asset allocation.

Answer the questions in the calculators with the specific money you are looking to invest in mind. You'll probably answer the questions differently if you are investing the money you plan to use to buy your house in 7 years than your retirement money that you don't need for over 20 years.

Now On to the Funds

You're ready to choose some investments. Some of the calculators in the Financial Adulting toolkit give specific fund recommendations or genres to get you started. You researched funds for your retirement in Chapter 7. You'll do the same thing here (just with lots more options) and if you decide to, you can now add your ESG criteria. If you need some funds to get you started, I have a list in the toolkit.

Great! Now research these criteria for three to seven funds.

A Couple of Things to Note

• If the fund is tracking an index, Tony recommends looking at the tracking error. How good of a job is it doing at tracking the index it's supposed to track?
• If adding the ESG component feels overwhelming and will keep you from getting started, no judgment. This is something you can come back to later.

The Ways You Can Purchase and Sell

The easiest way is to make a market order. That just means you'll purchase (or sell) the investment at the market price at that time. This is what I now do and I recommend it for everyone, unless you find it fun to try to earn a few extra cents per share.

Only if you're interested: You can also use stop and limit orders to name your price. Specifically, a limit order has you purchase a share at a named price or better and a stop order activates a market order when the investment hits a certain price. To make it more “fun” you can combine them in a stop limit order. At the levels most of us are investing, it's not worth the extra work and time to do these fancy orders for a few cents.

Choosing the Number of Shares

When you purchase an investment you typically have to enter in the number of shares you want to buy. Take the amount you want to invest and divide it by the share price. If you have $100 to invest and the share price is $35, then you can buy two shares. The extra cash waits until next time.

It Won't Happen Immediately

I share this so you don't freak out while your money is in limbo. It takes time for an order to execute and the shares to show up in your account. Don't fret when it's not immediate. You can come back and check in a day or two (depending on the platform) and the shares will be there.

Should I Choose to Reinvest Dividends?

Some companies pay dividends, which means they share profits (in cash) with their investors (a certain amount per share). If you don't choose to reinvest your dividends, the cash will sit in your account. If you choose to reinvest your dividends, the cash will be used to purchase more shares. Dividends are great if you are looking for some income (side note: they are taxed as income!) so they are a great tool in retirement. While we're growing our money, it typically makes sense to reinvest.

How Do I Know What's a Good Price?

Want to know a little secret? No one really knows. Not even people who do this for a living. Yes, you'll hear buy low and sell high. Sounds easy enough, right? But in practice you can't know when the market is at its peak or low. Constant investing over time (either per month or per paycheck) is the way to go.

Am I Buying at the Right Time?

This is pretty similar to the last question in that no one really knows, but it's helpful to understand some terms you'll hear thrown around. A bull market means stocks are going up or whoever said it thinks stocks will go up. A bear market is the opposite; things are going down. A bubble means that prices are high (things are overvalued) and will eventually “pop” or go back to a much lower level. A correction is when there's a drop in prices because things were overvalued or too high.

Do I Invest All My Money at the Same Time?

If you have a chunk of money, should you invest it all at once? There are mixed reviews. Dollar-cost averaging means that instead of investing all of your money at once (and getting one price), investing over time at different prices will reduce your risk of buying in when the stock price is high. This happens naturally when we invest on a regular basis, like every month or every paycheck, which is great.

To do this with a chunk of money, you could, as an example, invest a quarter of it (25%) every week until it's all invested. This takes some extra work. But research shows that it usually turns out better to get all of it invested at once because over time markets tend to go up.⁹ When something is easier and better for our money, that's a win-win. Plus, you're less likely to forget to invest.

When Do I Sell My Investments?

Sell your investments when you're ready to use the money for whatever goal you've been saving for. Yay! Or maybe you are no longer a fan of an investment and are looking to make a switch to a different one. Just know that with investments outside of your retirement accounts, selling is a taxable event. If you made money (which I hope you did if you're selling it), you will pay capital gains tax.

What the Heck Is Bitcoin?

Understanding Bitcoin is not necessary to understand investing, but it's everywhere, so you might still want to know what it is. Bitcoin is a form of cryptocurrency (the most popular form of “crypto”), which is digital currency not tied to any banks or government (traditional money is part of the fiat system). Bitcoin is created and trades on a decentralized system known as blockchain.

You can invest in different cryptocurrencies like Bitcoin and Ethereum, but you can also invest in diversified crypto ETFs. Farnoosh got started investing in the space by investing in an ETF of companies that work in the space more tangentially or that support crypto technology. Even though she chose a more diversified crypto investment rather than choosing one of the currencies, she shared that it's still very risky and only makes up a very small piece of her investing portfolio.

You might have also heard the term NFT, which stands for nonfungible token and is a photo, video, or other digital file stored on a digital ledger that people trade.

Is Individual Stock Picking Like Gambling?

Individual stock picking (also called speculative investing) can be fun for some investors but it doesn't have to be part of your strategy. While I sometimes have FOMO when people make it big off of a certain stock, I also remember the big losses we don't hear about but that happen more often. I am happy with my long-term 8% return I get with diversified index funds.

Brian says you should only consider speculative investing once you have your financial foundation in place (those boxes checked!) and even then he recommends keeping it to 5% or less of your portfolio. Georgia calls this “hunches and fun” and recommends keeping it to 2–5%. She says, “Let's not bet your whole future on whether you think Tesla or Bitcoin is going to make it or not, because these markets are too small and volatile to make them a large part of your portfolio. You want this to be money you are okay with losing.”