Hello everyone happy New Year and I hope you are all doing well.
Last night I went out for drinks at my friend's bar/restaurant. He
asked me to help out an employee who is interesting in investing. Since I
will get more free drinks out of the deal sure why not I told him haha.
Anyhow, this employee is a young man 23 years old. We chatted and I asked
him why you are interested in investing? The keep the story short and not
bore you he was worried about his future. I started to explain to him how
to research stocks, the terminology, ways to get free and important information
and he was overwhelmed. I began to wonder how many people out there just
like this 23 year old man. I decide to come up with a series called Naked
Investing, where I will explain in simple terms what the Wall Street jargon
means and how to research companies.
Episode 1 will
begin with how to open an account and what are types of accounts an individual
can open. Opening an account to invest in stocks, bonds, mutual funds,
ETF and other types of investments is pretty easy and simple. One can
simple go to a discount broker, your bank or a full service broker and open an
account. You can do this online or in person. You ask what is a discount
broker? A discount broker is a broker/dealer company that will act as
agent to execute your trades for a small commission free but will provide
little to no investment advice. A full
service broker will act as your agent to execute your trades but will offer
investment advice. Full service brokers
will charge you a much higher commission fee.
What is a commission fee? A commission
fee or commission is a transaction cost a broker will charge you for
executing a trade. There are other fees
brokers can charge you but we will get there in later episodes when I will get
very detailed and bore you to death hahaha.
Now we understand the types of brokers and the commission they
charge now we can talk about opening an account. There are many different accounts one can
open. I will stick with the most common
ones. The most common type of account
one opens are called Individual Accounts or cash accounts. Cash account is an old Wall Street term.
An
individual account is a taxable account. This means interest,
dividends and capital gains or capital losses are reported to the IRS every
year for the benefit of the individual. Don’t
worry I will explain interest and dividends in later episodes. Your broker will
send you a 1099 form detailing all your trades with capital gains or losses,
interest and dividends earned for the entire calendar year. These transactions must be filled in your federal
and states tax forms.
Another type of account one can open with an individual account is
a margin account. What is a margin? Margin
is simply a broker will lend you cash to buy stocks. Usually you have to put up collateral either
in the form of stock you already own or cash. Although each broker/dealer’s rules are different,
Regulation T of the Federal Reserve requires a minimum of 50% collateral to
cover the margin. For example if you
borrow $10,000 from your broker/dealer you must put up $5,000 in cash or stock
to meet the margin. In addition, the
margin is calculated every day. If one
falls below 50% collateral level, you will receive a margin call from your
broker/dealers to cover the difference to maintain the 50% level. Simple
isn’t it? I know you are confused now
hahaha no worries. I will explain in later episodes why some will open up a
margin account.
Another
type of cash account is called Joint Accounts. As you guessed joint
accounts are the same as an individual accounts but there are two or more
parties. Joint accounts are when two
adults individuals agreed to have equal ownership of the assets in the account,
think partnership. I say adults because
a joint account with a minor is a little bit different. I will explain that too momentarily. Joint accounts are treated the same as
individual accounts by the IRS. All
interest, dividends, and capital gains and losses are report to the IRS. After the end of the calendar year your
broker/dealer will send you are a 1099 form.
That is it, nothing to explain it is that simple. Now let’s talk about joint accounts with
minors.
These
accounts are called custodial accounts (UGMA/UTMA). UGMA stands for Uniform Gifts to Minors Act
and UTMA stands for Uniform Transfer to Minors Act. These accounts allow the donor to give up all
possession or control of securities to be held for the benefit of the
minor. Once the child becomes of age and
is legally recognized as an adult the child will assume possession of the
assets. Very simple and easy, I know you
don’t believe me. Moving on to the next
most common type of account, retirement accounts.
Retirement accounts come in many forms, but I will stick with the
most common types. Let’s start with Individual Retirement Accounts (IRA). IRA is simple an individual account that is
setup for the benefit of the individual tax payer or their beneficiaries. Contributions made to an IRA are tax
deductible, money that is deposit before taxes are taken out. Once when one retires after the age of 57,
withdrawals of assets from an IRA will get a tax treatment like an individual
account. All withdrawals will be taxed at
one’s taxable income rate regardless of capital gains and dividends earned are
earned in the account.
Second type of retirement account is called Roth IRA. The term Roth in Roth IRA is named after
Senator William Roth. Contributions made
to a Roth IRA are after taxes have been taken out. However when one retires after age 57, the
withdrawals are tax free. Yes you read
that correctly tax free. All dividends,
interest and capital gains earned in the account will not be taxed.
There you have it various common account types made simple. Each account type has advantages and
disadvantages. I recommend one talks to
an account, financial advisor, attorney or other investment professionals to
discuss various options and strategies to receive the full benefit of any
account type.
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