Remember that episode of Friends where Joey is visited by a door-to-door encyclopedia salesman who asks him “do your friends ever have a conversation and you just nod along even though you’re not really sure what they’re talking about?”
Like Joey, I think that we’ve all experienced this situation at one time or another – especially when it comes to our finances. And while there’s no shame in asking questions about complicated financial concepts, we’re far less likely to ask more “obvious” questions that we think we should already know the answers to.
So for those of us who have nodded along while our friends were talking only to then secretly Google the conversation afterwards, here are the answers to some of your “embarrassing” finance questions.
1. Tell me again – What is a mutual fund?
A mutual fund is a professionally managed investment that pools together money from multiple investors in order to invest in a collection of securities (‘securities’ is finance speak that generally refers to stocks or bonds).
These securities might be difficult to afford on your own, especially if you only have a small amount of money to invest. In fact, one mutual fund could give you access to hundreds of individual securities at once!
By diversifying your investment portfolio in this way, if one of the securities in your fund doesn’t perform well the others could help to offset your risk.
2. What is compound interest and how does it work?
Everyone talks about the power of compound interest, but is it all it’s cracked up to be? Let’s start with the basics. Compound interest is when you earn interest on your interest. Yes, you read that right – interest on interest. Stick with me.
Let’s say you invest $1,000 at a realistic 2% interest rate per year. In one year, your money would grow to $1,020. If you let it sit there, the next year you’ll begin to earn interest on your original investment and the interest it has accumulated (i.e. your new principle of $1,020). This comes out to a whopping $20.40. Now you’re on the fast track to getting rich!
Joking aside, since $20.40 in growth isn’t exactly a ticket to retirement, how can you help things along?
Well, the more money you invest the more often you add to your investment. And the longer you leave it alone (i.e. let it compound) the faster it will grow. When it comes to harnessing compound interest, it’s all about the long game.
Going back to our example, let’s say you start contributing $1,000 every year. After 30 years of investing $1,000 annually at 2% interest your money will have grown to $43,190.80 and will have earned $863.82 in interest in the 30th year! You’ve come a long way from 20 dollars and 40 cents. And since most of us earn more money the longer we work, you’ll probably eventually be able to squirrel away more than $1,000 a year.
But compound interest isn’t always your friend!
It can also work against you when you’re dealing with debt because interest compounds on the money you owe. Something to keep in mind before you whip out your credit card for this season’s ‘must have’ item.
3. How do I actually ‘trade’ stocks?
Once you’ve done your research and have made an investment plan (I’m going to trust that you’ve done this) you’re ready to make your first ‘trade’, which is a fancy way of saying buying or selling a stock.
To trade stock you need the help of a broker-dealer – someone who is licensed to purchase securities on your behalf.
Depending on the level of support you need, broker services range from online brokers (essentially order takers), to discount brokers (who offer minimal assistance), to full service brokers (who provide a variety of financial planning services) to full money managers (who are similar to a financial advisors but they may take full management control over your account).
Just as broker services vary, so do their fees. To facilitate the transaction your broker may charge a commission and / or brokerage fee.
Some companies also offer a direct stock purchase plan, which allows for the purchase of stock without a broker.
4. How do financial advisors get paid?
This is actually an important question that you shouldn’t feel embarrassed asking your financial advisor. There are several different ways that financial advisors get paid. Here’s a breakdown of the most common payment methods:
- Fee-only financial advisors: These advisors are only compensated by fees and do not earn a commission off the sale of any particular financial product. Their fees can be charged hourly, as a flat retainer or as a percentage of your investments.
- Fee-based financial advisors: These advisors charge a fee and may also earn a commission. As an example, they could charge a fee for providing you with financial advice and receive a commission on the sale of the financial products that you purchase.
- Commission-based financial advisors: These advisors only make money off the sale of a financial product, and therefore don’t directly charge their clients for their services. Instead, the advisor is compensated by the companies that issue the financial products.
Which fee structure is the best? Well, that’s up to you to decide as there are pros and cons to each. Ultimately, it really depends on your personal preference. Above all you should work with an advisor that you trust and are comfortable with.
5. How can I raise my credit score…fast?
Sorry to tell you, there’s no quick fix to repairing a bad credit score. In some cases, negative marks such as foreclosures, bankruptcies and tax liens can remain on your record for up to seven years. But there are a few simple ways you can raise your score:
- Check your credit report: Visit AnnualCreditReport.com to get a free copy of your credit report and if you find any mistakes, dispute them with the credit bureau.
- Make regular payments: Even one late payment can damage your score, so set a reminder to pay your bills on time or consider setting up automatic payments.
- Pay down your debt: Determine how much you owe and focus on paying down your debt that is charging the highest amount of interest first, while still meeting your minimum payments on all accounts.
- Stay well below your credit limit: Credit utilization – the amount you owe on your credit card relative to your credit limit – has one of the biggest impacts on your credit score. So keep your balances low on credit cards and other forms of revolving credit.
So there you have it! Hopefully these answers have helped boost your confidence. But remember, there are no stupid questions when it comes to understanding your finances.
And in case you forgot, Joey ended up purchasing the “V” volume and really impressed his friends with his knowledge of Vesuvius and violent igneous rock formations – though I think what you’ve just learned is far more relevant and useful.
 Credit.com, January 29, 2016, K. Geldis, How to Fix Your Credit, https://www.credit.com/credit-repair/how-to-fix-your-credit/
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