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What is the S&P 500?

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DEFINITION:


The S&P 500 Index tracks the share prices of 500 of the largest publicly-traded companies in the U.S. This Index helps you to understand the current stock market performance.

 

Understanding the definition of S&P 500
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The Index is formally known as the Standard & Poor’s 500 Composite Stock Price Index, but conventionally is referred to as the S&P 500, with its ticker symbol is “SPX.” The signature stock market index created in 1957 appears to be the primary tool for answering the question “what’s happening in the stock market?”. It contains about 500 largest publicly traded companies in the U.S., including 11 different sectors of the economy.

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Company Weighting in S & P =  Total of all market caps/Company market cap​

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‍This Index’s formula confines the stock prices of 500 companies from various industries, and it’s weighted using each company’s value by market capitalization. Therefore, the most valuable and most prominent companies move the S&P index the most, thus, making it a more helpful reflection of the U.S. stock market. And by following the S&P 500 Index, you could easily identify whether the most significant stocks are gaining or losing value.

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About the members of the S&P 500
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Generally speaking, as it’s been mentioned above, the S&P 500 consists of the top 500 publicly traded U.S. companies by market capitalization. As of October 2021, a company’s cutoff for size is $13.1B in a market cap to be allocated in the Index. Indeed, the firms must be based in the U.S., have publicly traded stocks available for all, and be profitable in the past year. While highly valued but not profitable, companies aren’t allowed to join the S&P 500 even if their value would fit in the criteria of the top 500 companies. What is more, the final word about the membership in the S&P goes to the administrator of the Index, S&P Dow Jones Indices. Altogether, those approximately 500 members count for about 80% of all the publicly traded stock in the United States.

 

The calculation of the S&P 500
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As of December 20222, Apple, Microsoft, and Amazon are the first three companies in the Index and are reaching $1 trillion market caps. In addition, these three companies have the highest weight in the S&P 500, so their stock movements affect the Index more than the other companies. To calculate such a proportion of the weight a particular company has in the S&P 500, you have to divide the company’s market cap by the total market cap of the S&P 500.

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Why is the S&P 500 useful?
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Firstly, it depicts “how stocks are doing”: S&P includes about 80% of all currently available stocks in the U.S. market. Therefore, it gives you a holistic picture of how the market is doing in general.

Secondly, it could be a benchmark for your portfolio: An investor usually has a collection of stocks, which they call a portfolio (read more about investment portfolio in our library). To check if your portfolio is performing well or not, you could look at the raw percentage gain (up or down). Comparing your portfolio performance to the S&P 500 is an excellent way to check if your portfolio is outperforming or underperforming in the market.

Thirdly, it’s tracked by funds: Many investors prefer not to pick their stocks by themselves but to invest broadly in the U.S. stock market. An easy way to do so is to purchase shares of a mutual fund or ETF. In its turn, the mutual funds’ approach mimics the makeup of the S&P.

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S&P 500 vs. the Dow
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There are some critical differences between the two (a number of companies included):

The Dow is a very exclusive club – it gives prestige to the Dow’s 30 members, while it’s also not that representative to use it as a tool of measuring the stock market’s overall performance.

The S&P 500 is more inclusive — 500 companies. It’s way more objective than the Dow and could tell you more precisely on “what’s happening today?”

It’s important to note that: Companies with a higher share price influence the Dow the most, while the highest market cap companies affect the S&P 500 the most.

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Takeaway:
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S&P 500 = weighted by market capitalization = stock price and shares outstanding

Dow = weighted by stock price only.

What is Dow Jones Index?

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DEFINITION:


‍The Dow Jones Industrial Average or simply “the Dow” is an index of the 30 largest and prestigious public companies — and it’s used to determine the overall direction of stock prices in general.

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Understanding the Dow
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The audience always wants to know how does “the market” does in general? Created in 1896 by Charles Dow and Edward Jones, the Dow consists of 30 large “blue chip” U.S. companies chosen by a selection committee. Such companies have to be big, profitable and have a long track record as publicly-traded companies. The Dow index is calculated using a weighted average of those 30 stock prices. So once people are saying that the markets go up, they’re usually making a reference to the Dow. Its ticker symbol is DJIA.

The Dow’s 30 companies are always the most prestigious and very well-known brands in the U.S. Investors always look at the Dow to check how markets are doing at the current moment. It’s important to note that the Dow is price-weighted, so it becomes a bit less useful tool than the S&P 500, which is value-weighted (read more about the S&P 500 in our library). As the Dow depicts only 30 companies, the index shouldn’t be used to evaluate a broader stock market.

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Who are the members of the Dow?
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If you become a member of the Dow 30, you’re officially a “blue chip” stock. Nowadays, despite its full name, the Dow’s 30 members include industrial and non-industrial companies to show a more inclusive mix of sectors. At the same time, previously, it was made of mainly industrial companies.

There are no quantitative criteria for the “blue chip” club or for those who’re willing to join them. However, there’s a tendency that a company should be U.S. based, have a strong reputation, and perform satisfactorily with sustained growth. In addition, their stock must be listed on the New York Stock Exchange or the Nasdaq. Finally, the selection committee could make changes to the index. |

Although there are no official quantitative criteria for “blue chip” or who gets to join the Dow’s 30-member club, the selection committee looks for US-based companies with an excellent reputation and who’ve demonstrated sustained growth. In addition, it’s a must for them to have their stock listed on the New York Stock Exchange or the Nasdaq. The selection committee changes the index from time to time – recently, as of August 2020, Amgen, Honeywell, and Salesforce.com replaced ExxonMobil, Pfizer, and Raytheon Technologies.

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Calculating the Dow
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Since it’s a price-weighted index, the stocks with the highest prices of all club members affect the index the most. So, the index is calculated by adding the stock prices and dividing that sum by the “Dow Divisor” number. Long ago, that Divisor was always a constant number. So, it was much easier to calculate the index by simply adding up all the stock prices and dividing by the number of companies included, only 12 at the time.
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Undoubtedly, today it gets a bit more complicated. The Dow Divisor appears to be way more complex. The administrator of the S&P Dow Jones Indices determines the Dow Divisor number. By that, ensuring the index remains appropriate and useful over time regardless of various corporate actions. Therefore, the index goes up and down based on the share prices of all 30 members. And the Dow Divisor number changes when there’s a need to adjust the corporate actions and remain more consistent. Nevertheless, one should always remember the main principle, that the companies with a higher share price move the market more.

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The differences between the Dow and the S&P 500?
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Both the Dow and the S&P 500, with their ticker symbol SPX are used to measure how the stock market is currently doing. However, there’re some crucial differences between the two:
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  • The number of companies: The Dow is a very exclusive club – it gives prestige to the Dow’s 30 members, while it’s also not that efficient to use it as a tool of measuring the stock market’s overall performance. Of course, you can’t fully estimate the current situation in the market by looking only at the 30largest companies. The S&P 500’s brings it on— it includes 500 companies. Therefore, it’s way more objective than the Dow and could tell you more precisely on “what’s happening with the market today?”
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  • The way the stocks are weighted: The number you see for the Dow is about 33,200 as of December 2022. That number is calculated by the index method and is based on the 30 stocks index weighted by the stock price. And a company with the highest dollar stock price affects the index the most. The S&P 500 is counted by a market capitalization. It accounts both for the stock price and the number of shares outstanding in the market.
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Companies with a higher share price affect the Dow the most, while companies with the highest market cap affect the S&P 500 the most.

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Has the Dow changed over time?
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Industrial roots:

Back in time, when the Dow was created in 1896, it was fully industrial. It only had 12 members selected to reflect the big and bold American companies at the time. Among them were tobacco companies, leather, oil, animal feed, and rubber industries. The Dow has changed its membership 55 times within 125 years of its existence.
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Now it’s becoming more inclusive:

The index has expanded to today’s 30 members. And its club has also changed to reflect the changing of the American economy. For example, a few years ago, the Bureau of Economic Analysis declared that manufacturing made up just 11% of the American economy. Therefore, the Dow had to adjust to the changing trends and become more inclusive to give a more holistic picture of the economy of the United States.
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As of December 2022, the Dow includes companies from a variety of different industries.

What is the VIX?

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If the VIX is high, it’s time to buy. When the VIX is low, look out below!


DEFINITION:


The CBOE Volatility Index (VIX) is a real-time index, an indicator that estimates the degree of volatility the stock market may be in the near term and could gauge the fear among market participants.

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Understanding the CBOE Volatility Index or simply “the VIX.”
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The VIX helps gauge the volatility of the stock market. It is often called the fear index as it depicts the level of either fear or optimism in the market. Once people are too optimistic or fearful, there would always be a chance that the market would behave chaotically. The Chicago Board Options Exchange (CBOE) calculating the VIX Index. So, when the VIX gets higher, there’s more fear. The option prices from the S&P 500 are used to calculate the Index. In its turn, a stock option is an agreement that provides an owner with the right to buy or sell some stocks but does not oblige him to do so. It’s important to note that there is the CBOE EFA ETF Volatility Index for the international stocks.

If the weather concerns you, you could always check the forecast and decide the best time to go on vacation. The same principle works with the VIX. So if you’re concerned about the time for the investments, you could check the VIX and explore how other investors consider the nearest future of the stock market. ‍

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What is the CBOE Volatility Index (VIX)?
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Let’s have a look more deeply into the Index. The Chicago Board Options Exchange made the CBOE Volatility Index to estimate volatility over the next 30 days. It measures market risk and expresses a general feeling of investors towards the market.

As it’s been mentioned above, the prices of the S&P 500 index options provide the groundings for the VIX: where buyers and sellers determine option prices. The current price of an option contract is called the option premium. And in case they’re more buyers, the option premium goes up. But if there were more sellers, the option premium would go down respectively.

The calculation of the VIX is made in a manner where the average of those prices is counted, giving a sense of what investors are ready to sacrifice for their opportunity to buy or to sell the S&P 500 index. Thus, the VIX provides a holistic picture of whether there is optimism or fear in the stock market. Generally speaking, if the VIX goes above 30, the market is considered to be volatile. And when the Index goes below 20, investors see the market as stable and calm.

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How does the Index work?
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The VIX goes up when more investors are purchasing the put options. And it falls when more investors are buying the call options on the S&P 500 index. Put and call options are to give the buyer the right, but not the obligation, to sell and purchase stocks at certain prices during a certain period of time. And more market volatility leads to the higher option prices. The volatility reflects the fear in the market.

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What does the VIX actually measure?
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The VIX rises when investors buy put options on the S&P 500, and it goes down when more call options are in higher demand. Thus, the VIX is used by investors as an indicator of instability in the market. And the Index provides a forecast of the future market volatility in the S&P 500. Also, it gives an understanding of how much people are willing to pay for the call or put options.

However, the VIX doesn’t measure the precise volatility but the market’s expectations of the volatility. Once there is more risk, more people are about to buy options. As investors often see the option prices as the degree of the risk in the market.

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The VIX calculation formula
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Option prices are part of the VIX calculation, but the CBOE does not use an option pricing model. Instead, CBOE uses a formula that looks at the variance of options prices with the same expiration date. To calculate the VIX, CBOE selects options for the Index. It includes a series of call and put strikes on two successive expiration dates. Then the CBOE will calculate each option’s influence on the total variance.

CBOE will then calculate the total variance for the first and second expiration dates. They then calculate the 30-day variance by interpolating the two variances. The standard deviation is the square root of the 30-day variance. Finally, the CBOE multiplies that standard deviation by 100 to get the VIX.

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‍The importance of the VIX
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The VIX is important for both traders and investors:
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For the investors – it could guide them with predicting the market movements; the VIX is rising when the market goes down and decreases once the market is up.
For the traders – the higher the VIX Index means the higher option prices.

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Is there a “normal’ VIX value?
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The simple answer is no; there’s no “normal” value of the VIX. However, there are some numbers that investors or traders can consider. A calm marker would have the VIX level below 20. The volatile number would increase the VIX above 30. Of course, such numbers are just preliminary and subject to change. The VIX isn’t a perfect tool for the market assessment, and it appears to be only one mechanism of forecasting and a tool for the investors to stay aware of the volatility. One could never predict the stock market trends precisely, and all of the prediction tolls carry a risk, so the investments do.

What is the Sharpe Ratio?

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DEFINITION:

The Sharpe ratio (also known as the Sharpe index, the Sharpe measure) – is a tool that helps investors to measure the amount of risk they are taking versus the performance of their investment. It was developed by and named after William F. Sharpe in 1966.

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Understanding the Sharpe ratio

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‍The Sharpe ratio was developed by a professor of finance and Nobel Laureate William F. Sharpe. His goal was to give investors a broader perspective on the amount of risk they are taking to achieve a desirable ROI (return on investment). The Sharpe ratio estimates the performance of their investments after deducting the risk-free rate of return and then dividing by the standard deviation of the surplus revenue. The risk-free rate is the theoretical rate of return with a relatively safe investment where the risk is close to zero. The standard deviation constitutes a risk indicator that measures price oscillation from the average price.

The Sharpe ratio appears to be a useful tool for those investors who need to juxtapose risk-adjusted returns of particular portfolios and assets. In its turn, the portfolio with a higher Sharpe ratio theoretically would have a better performance once it’s been adjusted for the risk.

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Recap
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‍Everybody tends to gain as much as possible from their investments. And we are all aware of the necessity of the importance of the risk assessment. The Sharpe ratio could provide you with certain support and help you to evaluate all the risks you’re taking with your assets and investment portfolio. Who wouldn’t like to achieve the same returns but also take significantly less amount of risk?

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‍Is there a “good” Sharpe ratio?
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As we know already, the Sharpe ratio is a remarkable instrument for comparing the returns of different investments. Also, it helps us to understand whether adding an asset to a portfolio would affect the risk-adjusted returns. When the Sharpe ratio is high, your risk-adjusted returns are better. It’s widely accepted that a ratio below 1.0 isn’t satisfactory, i.e., the risks you’re taking are certainly excessive. The acceptable risk would be in a range of 1 to 1.99; 2.0 – 2.99 would be good enough, and 3.0 + would be considered as the excellent one.

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The difference between the Sharpe ratio and the Sortino ratio.
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Both of the ratios could help us to estimate the risk-adjusted returns. However, they have different approaches. The main difference lies in the fact of how one should address the standard deviation and also volatility.

The Sharpe ratio uses the total volatility and takes the standard deviation of both the positive and the negative surplus returns. It’s important to note that the upside volatility and the increasing price movements could distort the results and then give a lower Sharpe ratio.

While the Sortino ratio relies on only negative volatility and uses only negative excess returns, by removing the upside volatility, the Sortino ratio doesn’t treat the positive volatility as a “risk’ or a “threat.” However, lots of investors tend to prefer the Sharpe ratio for assets that have low volatility with the low price oscillation. And in the case of a lot of volatility, there’s a strong tendency to rely on the Sortino ratio, with its isolation of the declining deviation.

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What about the limitations?
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The fact that the Sharpe ratio is taking into account both the positive and the negative volatility could be seen as a significant limitation. Even with the positive price swings, the ratio could be lower. That happens due to the lack of distinguishing the positive and the negative price fluctuations.

Another limitation we should take into account is that the ratio could be adjusted and manipulated in a way. You could either play with the time period; the ratio would be different in case you measure only daily returns or if you measure longer time periods. The daily ones would always be higher than the weekly or monthly ones.

One more reason why the Sharpe ratio could be tricky is that you can always choose the period you’re assessing. And by that, you could present the best potential risk-adjusted returns. For instance, one could choose a period with low volatility and to smooth the ratio calculations.

What is a Stock?

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DEFINITION:

A stock – is a piece of a business property. Owning a share you become a stockholder which means you have rights on getting dividends in case your company scores a success and you also have some voting rights.

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What is a Stock?
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Stocks are a crucial part of the world economy. They allow companies to find money for the business by selling shares (or pieces of ownership) to the public . They can be sold in such stock markets as NASDAQ and many others. Sometimes stocks can be bought in a private way. The Securities Exchange Commission (SEC) establishes some specific rules which control the abilities of companies to operate with shares. There are two types of shares – common stocks, which allow investors to vote in business processes, and preferred stocks, which, on the one hand, aren’t able to give shareholders any vote rights, but on the other provide them an unlimited constant payment for dividends.

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EXAMPLE
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As you can see, shares seem to be a piece of property in the donuts company.

Let’s pretend that you want to create your own donuts business. However, there is a problem – the 1000 dollars you have are not enough to start the business. Then you ask your family members or friends to increase your seed capital and buy on this money all the things you need for the baking. If three relatives give you 1000 dollars per head, the final sum will consist of 4000 dollars so you can easily get started with the business. You can propose 25% of ownership in your company in exchange for their investment. This is a simple example of the shares working process.

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A page from the history
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The first people who started using a tool similar to stocks were the Romans. The state was hiring business owners to sell something kind of stocks and debt capital for their projects. This process is now known like “lease holding”.

In the 1600’s the first stock selling business was considered the British East India (EIC) company. It was called like this because of selling commodities all over the Indian ocean region. This company is believed as the parent of modern joint-stock companies.

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The difference between stocks and other financial instruments
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There is a big difference between stocks and bonds. First of all, bonds are based on the debt issues which means governments or companies borrow money from investors and in exchange for this provide them % from the bond value. Bond holders aren’t able to take part in business decisions, however their investment is more guaranteed than the shareholders’ one. Another thing which differs stocks from bonds is the way of  how they are traded. Shares are usually traded on stock markets while bonds are sold over the counter (investor has to contact only with the issuing company).

What differs futures and options from stocks? The greatest difference is that first ones, unlike shares, are considered as derivatives, so their value is connected to another assed as commodities or currencies. Their conception is based not on ownership but on contracts.

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Stock market operating principle
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The definition of the “stock market” is a general term that includes a large number of markets where stocks are sold, bought and issued on an ongoing basis.

The “stock market” consists of many other separated stock exchanges. The Better Alternative Trading System (BATS), the New York Stock Exchange (NYSE), the Chicago Board Options Exchange (CBOE) and Nasdaq are the most popular stock exchanges in the USA. These stock exchanges in aggregate constitute the whole stock market of the U.S.

In spite of being called “stock exchanges”, they also provide the ability to trade bonds, derivatives and commodities.

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Stock types
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Common Stocks. Company stocks are most likely to belong to this category, so if you own a company stock it is probably a common stock. The greatest priority of this type is the fact that they bring owners voting rights. In many cases every share is rated as one vote. Common stockholders are able to bear a part in annual meetings and vote for business issues (like choosing company strategy).

Preferred Stocks. This type of shares is usually bought by some who are interested not in corporate issues but in stable dividend payments. These stocks can also be redeemed by the emitter.

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Some more actual terms
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Free/public float – shares which are published on the market and traded on the stock exchanges. The higher rate of this index shows the bigger amount of money a company tries to receive from investors.

‍Stock splits – the process of making the stock value more available for investors. There won’t be any changes in the market capitalisation whereas the number of accessible shares will increase.

‍Short-selling – means selling shares without being an actual shareholder. It is used when an investor is trying to speculate on the decrease of prices. It also needs borrowing stocks from others.

Stockholders equity – is based on the assets which stay in the company after paying all the issues. This index better explains the value of shares.

Blue-chip stocks – some companies which are large, liquid and well-capitalized, are usually traded on such stock exchanges as NYSE or Nasdaq.

Broker – a person or a company makes deals in the place of an investor and in exchange for this receives a commission.

Buying on margin – is a deal when an investor borrows money to buy some shares.

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What is a Bond?

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DEFINITION:

A bond is similar to an IOU (‎«‎I owe you»‎ ) that is issued by a company, government or other financial institution in exchange for cash. Like stocks, it can be traded in financial markets.

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An understanding of bonds
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When a company needs money, there are two choices: to sell stocks in themselves or to borrow money. In this case, a bond-issuing organization is borrowing money from investors. Bond investors are lenders because the bond issuer owes them repayment of their funds. They can sell their bond to other investors, allowing the bond to trade in the market. When the bond is due (when it “matures”), the bond issuer repays the bond’s owner and usually makes interest payments (“coupons”) along the way. However, because businesses can fail, there is no guarantee that bondholders will be paid back.

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‍The main point:
a bond = an IOU you can trade, but without the guarantees

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A bond establishes a borrower-lender relationship. The borrower is the company that issues the bond, and the lender is the investor who purchases the bond. Borrowers receive cash, while lenders typically receive interest payments. However, companies, entities, and governments that issue bonds may go out of business, which may result in the bond investor not receiving the IOU repaid.

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Bond issuers

There are four main groups:

1. Corporations: they issue bonds to raise cash for launching the projects, leasing new properties, acquiring another company, or other aims.

2. Municipal governments: Municipal bonds are issued by local governments or states in the United States. They are commonly referred to as “munis” for short. Depending on where they live, some investors may find that purchasing a muni bond in their home state has tax advantages over other bonds because home-state interest payments may be tax exempt.

3. Federal governments: Bonds issued by the federal government are among the least risky investments available because they are guaranteed by the US government’s “full faith and credit,” and they are known as “Treasury bonds” or “Treasuries.” The United States government issues Treasuries and uses the proceeds to fund government employee salaries, military contracts, public health initiatives, and other government spending needs

4. Others: There are some other organizations, which can also issue bonds to finance themself for growth opportunities, like universities or public transit agencies.

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Type of bonds
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Convertible bonds are corporate bonds that allow the bondholder to exchange the bond for proportionally priced company stock. Because the bondholder benefits from the option to convert the bond, the interest rate paid by the bond issuer is typically lower than that of a standard non-convertible bond. The bond issuer benefits from lower interest rates because you benefit from convertibility.

Zero coupon bonds are not paying a coupon interest payment to the bondholder. Instead of that, they are sold at a lower (discounted) price than their final face value. So the potential benefit to the investor is the difference between the amount paid to purchase the bond and the amount repaid at maturity. The bond issuer does not pay out any interest or coupons along the way.

Bonds that can be terminated early by the issuer or the investor are called callable or puttable bonds.‍


‍A callable bond. Prior to the bond’s scheduled maturity, the issuer of a callable bond has the right to “call” (demand) the bond. Since the potential to call a bond early is advantageous to the issuer and costly to the bondholder, the issuer typically charges the bondholder a higher interest rate to make up for it.

A puttable bond. This type of bond can be “put” (sold back to the issuer) by the bondholder at certain times before the maturity date. It is beneficial for bondholders to be able to put a bond back to the bond issuer. To compensate the issuer for that cost, the bond tends to offer a lower interest rate paid to the bondholder.

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Bonds in the markets
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Bonds are traded on public securities exchanges just like stocks. Government bonds may be purchased directly from government institutions or through a bond broker. Even buying funds made up of bond investments would expose you to bonds. The price and the interest rate are the two essential components of a bond that must be understood in order to determine its value, regardless of how you access bonds.

Interest rates: The issuer’s interest rate is what gives a bond its value to an investor. The interest rate that an issuer must pay depends on how creditworthy it is, or how likely it is to repay the bond when it matures. For riskier bonds, investors should anticipate higher interest rates.

Prices: Investors can benefit from purchasing a bond at a discount (lower) price and having it repaid at the full price. The “full price” is known as “face value,” and for a bond, it is typically $1,000. It is possible to purchase a bond at a discount price such as $900 and be repaid the full face value of $1,000 at maturity. The $900 bond may also lose value if the issuer is at risk of defaulting or actually defaults. Defaulting means failing to make legally required payments to the bondholder.

Interest rates and bond prices have an inverse relationship that resembles a see-saw. Bond prices tend to fall when interest rates in the economy rise.

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About bond risks
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There are no guarantees that an investor will generate a fair return from a bond investment. Bonds are claimed as less risky than stocks because issuers are legally obligated to repay bondholders but not shareholders. Bonds can be used by investors to diversify and reduce the overall risk of their portfolios by balancing what is invested in stocks. However, bond issuers can go bankrupt, and bondholders may lose their entire investment. Bond prices are less volatile than stock prices in general, but here are two major risks.

Default Risk: A default occurs when a borrower (the bond issuer) fails to pay the bondholder’s interest payments or even the entire principal. This is typically caused by the company becoming insolvent, which occurs when it incurs more debt than it can repay. Defaults are frequently associated with bankruptcies, which are legal proceedings that determine what happens to an insolvent company.

Interest Rate Risk: The bond issuer pays interest to the bondholder in the form of coupon payments, and the bondholder wants the highest coupon payments possible given the bond’s risk. If interest rates rise and other companies (with comparable risk levels) begin issuing bonds at higher interest rates, your bonds may become less appealing to investors. As a result, the bond’s price may fall.
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Always take into consideration:
Bond rating = risk level of the bond

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If your university friend asks you to borrow money to buy some food, you can analyze his ability to pay you back. Credit rating agencies take a similar approach when evaluating bond issuers, but they typically conduct more rigorous and complex analysis to determine an issuer’s creditworthiness. They also publish the results of their analyses, known as credit ratings, to assist investors in making decisions.

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Credit ratings
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Credit ratings are produced by different separate companies (such as Fitch or Standard & Poors) to evaluate the financial health and creditworthiness of an issuer of bonds. They use many factors, but focus on evaluating the company’s capability to repay its debts. If its business is growing in terms of sales and profits, its credit rating is more likely to improve than if it is not. When a country experiences an economic downturn, its government credit rating is more likely to suffer.
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  • Investment grade indicates a moderate to low risk of default. These are companies with ratings of Baa or higher (from Moody’s) or BBB or higher (from Standard & Poor’s) (for S&P). The highest grade is Aaa or AAA, which is held by only a few governments, corporations, and other bond issuers.
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  • Non-investment grade = high credit risk. These issuers, commonly referred to as “junk bonds,” have high debt levels — investors should be aware that their bonds have a significantly higher risk of default. In exchange, investors will typically demand higher interest rates to compensate for the additional risk they are taking on.

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Are bonds = fixed income?
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The answer is YES. That is the technical term referring to bonds in general. Because many bonds pay a consistent coupon payment to the bondholder, the bondholder receives a fixed amount of income from the company that issued the bond. Fixed income investments may be appealing to retirees who rely on their investments for consistent income streams to fund their lifestyles.

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What is a Portfolio?

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DEFINITION:

A portfolio is a collection of financial investments, such as stocks, bonds, cash, or cash equivalents, real estate, or other wide range of investments.

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Understanding a portfolio
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A portfolio is an aggregate of your financial assets, providing an overview of how you’ve decided to allocate your money. The general audience tends to believe that a portfolio is a collection that only consists of stocks, bonds, and cash. However, more broadly, it can include other assets, such as gold, art or etc. Different factors influence how you create your portfolio, but most of all, your willingness to take risks and your time horizon.

EXAMPLE

In case a person would like to invest $10,000 and divide between different asset types. First, it’s necessary to purchase $2500 in Microsoft stock and $1500 in Netflix. If they’re worried about the performance of just two companies, they could extend their selections and choose to invest in some other companies’ stocks. The investor could also purchase municipal bonds or an index fund.

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What is a portfolio?
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A portfolio is a 30,000-foot view of your investments. It’s a big picture that gives you a perspective to understand how the core elements of your assets look like, either stock, bonds, or any other financial asset you own. It is best that your portfolio could help you to achieve the best possible return bearing in mind your risk tolerance. The combination of your assets in the portfolio should comprise both your financial needs and for how long you would prefer to own each of the assets.

Portfolios could have different shapes and forms., but sometimes they could consist of only one type of asset class, like stocks or bonds. Nevertheless, there are recommendations and common practices for what to include in your portfolio. These depend on your earnings, your lifestyle, how risky you are, or even your retirement plans. Also, when a person is discussing an investment portfolio, usually they don’t include cars or houses.

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The main purpose of having a portfolio
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Portfolios provide a window into your financial life. They’re meant to help you monitor and manage your investments.

If you need, you could diversify your assets, mixing them between different stocks, bonds, and other purposes. You could also understand if your chosen strategy is working for you or not, and then either sell one type of asset or the opposite to buy more from the other asset class. People also use target allocations in case they want to plan for different strategies. A financial planner could help you to decide what percentage to invest in stocks or bonds.

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Important aspects while building a portfolio
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Building a simple portfolio can be as easy as just buying a few stocks. That’s why most people use this approach. Once you decide to build a more intentional portfolio where returns and risks are optimized, there appears a need to include a variety of assets. Such a mix that you choose is called an asset allocation.

Let’s have a look at the three main ways to build your portfolio:

1. Rely on your own views and do everything by yourself.

2. Investments in managed mutual fund or exchange-traded fund.

3. To address to a financial advisor, someone who could choose everything for you, who would provide some advice on investing.

Two crucial aspects of building your portfolio:

1. Time horizon.

2. Risk tolerance

To determine these two parameters could be very useful, as that would help you to decide on the types of investments you should rely on.

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Risky with a long time horizon
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Aggressive investors usually choose this type of strategy and tend to buy stocks and real estate. Besides being more volatile and riskier, this strategy presents greater upside.

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Not-so-risky with a short time horizon
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Conservative investors always choose certain financial stability that goes in line with expectable returns. They invest more of their money in income-oriented investments: bonds or dividend-paying stocks of larger, more established companies.

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What about a portfolio rebalancing?
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With time, the price of some assets will rise, and others will fall. As a result, your asset allocation is likely to change. For instance, if stocks have been performing well enough compared to other assets, your portfolio might have a higher concentration in stocks and lower in other assets.

Rebalancing implies a certain shift of your portfolio back to the initial target allocation (or also just a revision of those targets). Once you keep in mind your initial strategy, you could always sell some extra or buy in some areas where’s underweight. Rebalancing is a good tool to keep your portfolio up with your risk tolerance.

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A few words about a diversified portfolio
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A diversified portfolio is used to manage risks by spreading your investments across different types of assets. Usually, diversification helps you to reduce volatility and smooth returns. It is certainly wrong to allocate all your money into a single asset class, as that would put your portfolio at an extreme level of risk. For example, it would be much safer to have both stocks and bonds in case of an unpredictable stock market crash.

Most bonds are not to fall as dramatically as stocks—and bonds usually provide a predictable source of income. You could minimize your losses once you’ve diversified your portfolio. Of course, it is not always a rule, as in some cases, under different circumstances, one could experience losses across all the board.

You need to be smart enough to identify assets that aren’t dependent on one another, and eventually, those that won’t fall together. When one of the assets performs poorly, the other could counterbalance it. The same story would be when you’re trying to plan your vacation in an exotic place, once the weather is fine, you would go and explore nature, but in a case when it’s a thunderstorm, you would rather bring your favorite boardgames in advance to stay indoors. By that, you would have diversification in action.
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One should not forget that diversification doesn’t prevent losses, but it could help to limit it. When you build a diversified portfolio, you have to use a mix of stocks, bonds, cash or etc.
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Diversification doesn’t prevent losses, but it can help limit them. Building a diversified portfolio typically involves a mix of stocks, bonds, and cash, and if you add real estate or, for example, gold to your portfolio, you will only strengthen it. In case you prefer to invest only in stocks, a half-century ago, researchers suggested that as few as ten stocks could help in the pursuit of stable diversification; however, nowadays, you would need more to have a truly diversified portfolio.  

Even if you decide to only invest in stocks, you can achieve a measure of diversification simply by owning more than one stock. In the 1960s, stock market researchers found that as few as ten stocks could help in the pursuit of diversification. That said, in contemporary times, many believe it takes more stocks to build a truly diversified portfolio. You could also try to diversify via acquiring stocks of both old, well-established, dividend-oriented companies and growth-oriented ones.

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The portfolio might be tricky.
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It is important to remember that no single asset allocation could be perfect for everybody. What would be best for one type of investor might never be useful for the others. Depending on the situation and one’s goals, everyone should find their best way to create an investment portfolio. Besides the ordinary risks of investing, there’re some others that require more deep research and the help of professional advisers.

Social Security Tax

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What is it?

Social Security is a tax that employees pay as a percentage of the salary they earn, and this tax funds their country’s Social Security program. By law, all employers, employees, and self-employed people must pay this tax in order to contribute to the Social Security program. Half of the tax is paid by employees, and the other half is paid by employers. In the case of self-employed individuals, they are responsible for the entire sum (being both the employer and employee).

The Social Security tax applies to wages up to a certain level, with the upper earnings limit adjusted annually based on the rate of inflation. These taxes support the Social Security program, which provides income for pensioners and other members of society who are claiming benefits, as well as their dependents. To support the Social Security program, everyone pays Social Security tax. Every eligible individual is then paid a monthly sum when they retire or become incapacitated.

How does it work?

Almost everyone who earns income is required to pay Social Security taxes. The Social Security tax is a payroll tax, which means that it is deducted from your pay before it reaches you (unless you are self-employed). Your employer deducts the required amount from your pay and is responsible for remitting the funds to the government on your behalf.

There are two elements to Social Security tax. Half of the tax is paid by the employee, while the other half is paid by the employer. For self-employed people, the tax system is a little different. They are accountable for paying 100% of their Social Security tax as they are both the employer and the employee in their firm, which means they pay twice as much as other workers.

Let us assume that Michael and Paula earn the same amount of money – $50,000 p.a. Michael is employed so therefore his employer pays half of his Social Security tax. Steve’s Social Security tax is $3,100 per year (6.2 percent of his salary). Michael’s company additionally contributes $3,100 to his Social Security taxes. Paula is self-employed, which means she does not have an employer who is responsible for paying half of her tax burden. Paula must pay $6,200 in Social Security taxes every year, or 12.4 percent of her income.

How much do I pay?

In the US the current Social Security tax rate is 12.4%, with employees paying 6.2 percent and employers paying 6.2 percent. Self-employed individuals are required to pay the entire 12.4 percent. Since 1937, when the tax was initially collected, the rate has gradually grown. The tax was just 1% at the start of the program. The most recent rise was in 1989, when the tax was raised from 6.06 percent for both employees and employers to the current 6.2 percent for both (12.4 percent  total).

You may not have to pay Social Security taxes on all of your wages, depending on your income. Only the first $137,700 of your earnings are subject to Social Security taxes in 2020, compared to $132,900 in 2019. An employee can contribute up to $8,537.40 in a single tax year, which is matched by their employer’s contribution of the same amount.

Are there any exemptions?

Almost all employees, employers, and the self-employed are required to pay Social Security tax. There are a few exceptions, however, that allow someone to opt-out. The following are the requirements that may allow someone to avoid paying Social Security taxes:

1.     Members of certain religious organizations: Some religious groups, such as the Amish, are typically opposed to claiming Social Security payments. Members of certain categories can qualify for a Social Security exemption to avoid paying the tax.

2.     Some non-resident aliens: Although most non-resident aliens are required to pay Social Security taxes, there are some exceptions, such as if you are a foreign student visiting the nation temporarily.

3.     Temporary students: Students who work for the institution where they are enrolled may be eligible to be exempt from paying Social Security taxes on their earnings.

4.     Employees of foreign governments: Employees of foreign governments may be eligible to avoid paying Social Security taxes on income earned via official activities. It’s important to note that if you opt-out of paying Social Security taxes, you won’t be able to collect Social Security benefits in retirement or if you become disabled.

Who benefits?

In the US, your Social Security taxes help to support the Old Age, Survivors, and Disability Insurance programs (OASDI). This program, which was established in 1935 and signed into law by Franklin D. Roosevelt, provides income to retired and disabled people in order to replace the income they would have earned if they were in employment. There are three main ways that a person might receive funding from the Social Security program.

Retirement

Meeting the age and job criteria is one method to be eligible for full Social Security payments. After reaching the age of 66, a person may be eligible for Social Security retirement payments. However, in order to qualify you must have at least 40 work credits, which is roughly ten years of labour for most individuals.

While the full retirement age (and the age at which you can begin receiving full Social Security payments) is 66 years (and is gradually being raised to 67), you can begin collecting benefits sooner, at the age of 62. However, be aware that your monthly payments will be at a reduced level — and those lower monthly payments will remain in effect for the life of your Social Security benefit. You can also wait to start receiving benefits until the age of 70. If you do this, your monthly payment will increase, and you’ll continue to receive that higher monthly income permanently.

The level of monthly Social Security payments received is determined by your 35 highest-paid years in employment, adjusted for inflation.

If a person retires at full retirement age, the highest amount receivable from Social Security is $3,011 per month. However, the majority of people do not earn sufficient income to reach that level. In reality, the average monthly stipend in 2019 was $1,461.

For many people, this will be less than their previous wages whilst in employment. To help people save and provide themselves with additional retirement income, the IRS has developed investment vehicles such as 401(k) programs and Individual Retirement Accounts (IRAs).

Disability

Social Security payments can also be claimed by someone who has become disabled. To be eligible for these benefits, an individual must have worked for a specific number of years and paid Social Security taxes. They must also have a medical condition that qualifies for Social Security disability benefits.

In general, if you are able to work and earn more than $1,220 a month, you are not eligible for benefits. You must also be unable to do a basic job for at least one year as a result of your medical condition. Your application may be refused if the Social Security Administration (SSA) determines that you are capable of doing basic activities and that you could be generating an income through employment.

You may also be eligible for Social Security disability benefits if you have specific medical conditions. These are referred to as “compassionate allowances” by the Social Security Administration. Certain malignancies and cognitive disorders, for example, have symptoms that would very likely qualify a person for disability payments.

Individuals receiving Social Security disability payments received an average monthly payout of $1,234 in 2019.

Survivorship

In some cases, an individual may be eligible for Social Security payments if they are the surviving family member of someone who was receiving Social Security benefits and has died.

The following are examples of those individuals who might qualify for continuing survivor payments:

A surviving widow or widower who is at least 60 years old.

A surviving spouse of any age who is caring for a child who is under 16 or is disabled.

An unmarried surviving child who is under 18, or is unmarried, over 18 and disabled.

Survivors of the deceased’s parents who were financially dependent on that individual.

In some circumstances, the surviving divorced spouse.

The circumstances for survivor payments to be made under the Social Security program vary greatly and are decided on a case-by-case basis. Those wishing to claim survivor Social Security payments must speak directly with a Social Security Administration representative and cannot apply online.

What is the Nasdaq?

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DEFINITION:
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Nasdaq Stock Market is an electronic stock exchange for buying and selling stocks.

Nasdaq Composite Index of 2,500+ stocks is listed on the Nasdaq exchange. The Nasdaq tends to reflect a current situation of the broader tech industry.

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Understanding the definition:
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Tech only: The Nasdaq Stock Market is a stock exchange with its roots in technology as the first global electronic marketplace. Being rigorously built in 1971, Nasdaq was launched to make trading fast and computer-centric. With this tech focus, Nasdaq attracted a large number of technology-oriented companies to IPO on its exchange. While the Nasdaq Composite Index displays that — It’s an index made up of over 2,500 companies listed on the Nasdaq exchange. Since mostly all of them are tech companies in there, investors look to the Nasdaq index to answer the question of  “how is it going on the tech stock market ?”
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While having its roots in technology and innovation, Nasdaq is known for attracting tech companies to list their shares for IPOs. And its Nasdaq Composite index is widely used by investors as a representation of the tech industry’s performance.

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The history of Nasdaq
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You could hear the term used in two ways:

1. As a question of “How’s the Nasdaq doing?” That applies to the Nasdaq’s stock index or the Nasdaq Composite

2. The Nasdaq Exchange – the world’s first electronic trading floor on which companies, mostly tech ones, list their shares. Many of those are included in the Nasdaq Composite index in order to give a sense of the current situation in the tech sector.
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The world’s second-largest stock exchange by market capitalization and first specifically tech one was launched in 1971 by the National Association of Securities Dealers. The main goal was to implement new technologies in trading, namely, at the time, computers, to allow automated quotations and therefore to provide trading of stocks.

There was an intense rivalry with its main competitor, the New York Stock Exchange (“NYSE”), and the technological focus appeared to be the main differentiator. What is more, Nasdaq was the first platform that allowed to trade online. And it’s ultimately electronic.

With time, most of the leading tech companies were attracted by Nasdfaq’s commitment to technology. That fact made Nasdaq a popular place for innovative tech companies’ IPO listings. Different partnerships and acquisitions contributed to the NASDAQ extension, however in 2006, Nasdaq separated from its original founding partner NASD and a year later, added a Scandinavian-based Exchange, OMX.

Nowadays, with its tremendous growth in the tech sector, the NYSE has increased its focus on tech enterprises.

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A few words about Nasdaq Composite
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It isn’t enough to look at just a few stocks to understand how the market is doing. That’s why looking at the stock indexes is conducive. Such indexes turn out to be specific formulas that create a number that reflects either a broader market or a particular industry.  

Once an investor gets curious about the tech sector, it’s necessary to turn to the Nasdaq Composite. Other companies have also been listed on the Nasdaq. And a selection of more than 2500 companies is included in the Index.

Nasdaq Composite key features:

  • It’s tech-oriented: and it has a heavy tech character.
  • It’s weighted: The stocks are weighted in the Index to account for their different sizes (their size is their value by market capitalization). And the Index uses a formula to account for that.
  • It’s not just stocks: The Index includes a variety of tech-related securities.
  • It’s international:   Unlike other indexes.

You can also read more about other Indexes like the S&P 500 or the Dow in our Grid Capital Library.

SPAC – lottery or stable income?

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