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Here’s How to Set Up a Trust

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

While there aren’t many things you can control after you pass away, one thing you can have a direct impact on is who receives the property you own afterwards. But how do you gain this type of protection for your assets and avoid the probate process? You might find a solution in a revocable trust. Below, we’ll explain how to set one up along with the advantages and disadvantages of doing so.

What is a trust?

A revocable trust, also sometimes called a living trust or inter vivos trust, is an estate planning tool you can set up during your lifetime to hold your assets. When you pass away, the trust controls who receives the assets and under what terms. Typically, trust beneficiaries receive their inheritance outright, without restrictions, or in trust, which can control when and how they receive trust income and principal.

Parties to a trust

There are typically three parties to a trust.

  • The grantor is the person who sets up the trust and funds it with his or her assets.
  • The trustees are the people who manage the trust assets. You would generally name yourself as a co-trustee during your lifetime. You have the option of naming one or more co-trustees, who might be family members or close friends.
  • The beneficiaries are the people who will benefit from the trust and its assets when you pass away. This might include your spouse, children, grandchildren or other close family members.

In addition to controlling the distribution of your assets at death, you can also use a revocable trust to determine what happens to your assets if you become disabled and are unable to make financial decisions. During your lifetime, you have full control over the assets in the trust. But if you become unable to manage those assets, a revocable trust will typically give co-trustees the ability to manage trust assets until you are once again in a position to manage them yourself.

Setting up a trust

The mechanics of setting up a trust are fairly straightforward. A revocable trust must follow the laws of the state where you have your primary residence. The best way to make sure this happens is to consult an attorney licensed in that state. While online tools are available to help you set up a trust, the legal complexity suggests that you may be best served to use an attorney to draft the trust.

Choose co-trustees and beneficiaries

After you hire an attorney, you will need to make several decisions. The first will be who — besides yourself — should be a co-trustee. People typically choose family members. At least some of your co-trustees should be younger than yourself so that they are more likely to survive you and can manage the trust when you are no longer able to do so.

Second, you have to decide who will be the trust beneficiaries. Typical candidates include your spouse, your children and grandchildren. You’ll also have to decide if they will receive money outright when you pass away or in trust. Often, younger beneficiaries might have their inheritance held in trust until they are old enough to manage it. A trust can also be a good way to protect an adult child who has shown he or she isn’t yet responsible enough to handle money or may be involved in a divorce or other situation where full access to assets might complicate things.

Customize the structure

Revocable trusts are easy to customize. As the owner or grantor of a trust, you decide when the trust begins operating, who benefits from it and under what circumstances beneficiaries can use the money. The trust structure allows you to grant beneficiaries access to funds at certain ages or for certain purposes, such as education or to purchase a home.

Trusts also come with some attractive benefits for beneficiaries. For example, if you name your adult child as a beneficiary, the assets in the trust are not part of his or her estate once you (the grantor) die and the trust becomes irrevocable. This helps protect these assets for future beneficiaries (perhaps your grandchildren) from events such as bankruptcy or divorce.

Draft the trust and retitle assets

There are also some mechanical tasks you need to handle. Your attorney will generally do a draft of the trust so you can comment on its provisions. Then he or she will use those comments to draft a final document for your signature. Your attorney will also get a taxpayer ID for the trust from the Internal Revenue Service.

The biggest mistake some people make after creating a trust is not completing the next step — retitling their assets in the trust’s name. If you want to include your bank and brokerage accounts in the trust, you need to change the ownership of each account to the name of the trust. For example, your savings account might now be owned by the Mary Smith Revocable Trust.

Some assets, however, are not well-suited for a trust. Most people don’t include things such as clothes, jewelry, furniture and other personal property. Rather, they use their will to pass this property to the people they want to have it. If in doubt about what property works well in a trust, it’s a good idea to consult an attorney.

What are some advantages of trusts?

There are a number of advantages to setting up a revocable trust.

  • A trust can help manage your assets if you become disabled.
  • A trust makes it easier to distribute assets to heirs and avoid probate when you pass away.
  • Revocable trusts are easy to change, including the trustee. Depending on the nature of the change you want to make, most changes can be made easily and inexpensively with an amendment to the original trust.
  • Revocable trusts are transparent for income tax purposes. Tax rules are no different than if trust assets were titled in your name.
  • You can name a revocable trust as beneficiary of your 401(k) and IRA plans and have the trust govern how to distribute those assets.
  • A revocable trust can protect heirs from creditors.

What are some disadvantages of trusts?

There are some disadvantages to revocable trusts as well.

  • You generally need an attorney’s help to set one up and will have to pay for this service.
  • Revocable trusts don’t allow you to designate a guardian for your minor children. You will need a will to do that.
  • The trust may become irrevocable when you pass away, limiting the ability to make changes after that time.
  • If you decide to have a professional administer the trust and manage the assets, doing so may be costly.

Trust costs vs. probate

Trust and probate costs vary by geographic area. Generally speaking, the cost to probate a portfolio of assets is around 5% of their value, split between the executor and his or her attorney. In contrast, the cost to administer similar property in a trust would be less than half that amount. Speak to a local attorney for exact information about local costs in your area.

Who should set up a trust

For many people, deciding whether to set up a revocable trust depends on their stage in life. Marianela Collado, a CPA and certified financial planner with Tobias Financial Advisors in Plantation, Florida, says that for single clients just starting out in life with not very many assets, “There is no need for a trust.” Most of these clients will find estate planning is relatively simple, including how they title their assets or who they designate as the beneficiary of life insurance or retirement plans.

As you start to accumulate assets, a revocable trust may be “a necessary and effective tool,” according to Collado. A trust, she emphasized, can do more than just pass assets to the next generation. It gives you a level of control and the ability to avoid probate. While probate varies from state to state, Collado said the probate process is the last thing many families want to deal with after a loved one has passed away. Collado has encountered some clients who believe having a will avoids probate. “It doesn’t,” she said. “But assets in a revocable trust do.”

Collado emphasized that clients who want to set up a revocable trust should seek the help of an attorney. After the trust is set up, “I get a list of every asset the client owns and retitle them with the trust as the owner,” Collado said. She points to a quote from one of the attorneys she works with as a good way to conceptualize their value: “A trust is like a house. After you build it, you have to fill it.”

Speaking about the benefits of revocable trusts, Collado cited a situation where a client’s son had gotten married for a second time and also had children from his previous marriage. She explained to her client that if her son died not long after she did, without a will, his mother’s money would likely go to his second wife and not to her grandchildren. A revocable trust could help ensure that the money went to her grandchildren instead.

Collado told another story about a client who developed dementia. Before she got sick, she added her two daughters as co-trustees of her existing revocable trust, which held all of her assets. The mother is now in the hospital and unable to make decisions for herself. “With a revocable trust, the family doesn’t need to go to court to prove Mom is incapacitated to manage her assets,” Collado said. “A revocable trust eliminates that frustration.”

Bottom line

Many Americans will find revocable trusts are a good way to manage their assets and avoid the probate process. Adding a co-trustee can also ensure that someone can manage their assets if they become disabled. And for many people, the only cost of the trust is likely the legal fees to set it up. (You may have to pay a recording fee to retitle real estate, including your home.) While revocable trusts aren’t right for everyone, they deserve a second look by people who want to have a say over when and how their heirs receive their assets.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

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Investing

The 7 Best Robo-advisors of 2020

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

If you’re new to the world of investing in stocks and bonds, knowing where to begin can be an intimidating prospect. Robo-advisors could be the best choice to start your investing journey. They make putting money in the market simple and intuitive utilizing smartphone apps and sophisticated computer algorithms.

Robo-advisors invest your money in diversified portfolios of stocks and bonds that are customized to your needs. Since computers do the work, they are able to charge much lower fees than traditional wealth advisors.

They begin the process with a questionnaire to assess your financial goals and your risk tolerance. Based on your answers, robo-advisors purchase low-cost exchange-traded funds (ETFs) for you and adjust the portfolio — or rebalance, as they say on Wall Street — on a regular basis, with no further intervention required from you.

To match your risk tolerance, robo-advisors offer more aggressive portfolios containing a greater percentage of stock ETFs, or more conservative ones containing a greater percentage of bond ETFs. The robo-advisor will also consider your age in developing your portfolio.

How we chose the best robo-advisors

We regularly review the latest robo-advisor offerings — we’ve evaluated 19 different ones in this round — and have selected our top choices. All of the robo-advisors on this list may well be worth considering, with those at the top scoring the best in our methodology.

To determine our list of the best robo-advisors, we focused on management fees and account minimums, and also considered ease of use and customer support.

The top 7 robo-advisors of 2020

Robo-advisorAnnual Management FeeAverage Expense Ratio (moderate risk portfolio)Account Minimum to Start
Wealthfront0.25%0.09%$500
Charles Schwab Intelligent Portfolios0.00%0.14%$5,000
Betterment0.25% (up to $100,000), 0.40% (over $100,000)0.11%$0
SoFi Automated Investing0.00%0.08%$1
SigFig0.00% (up to $10,000), 0.25% (over $10,000)0.15%$2,000
WiseBanyan0.00%0.12%$1
Acorns$12/yr0.03%-0.15%$5
Fees
N/A
Account Minimum
$100 one-time deposit or $20 monthly deposit
Promotion
N/A
Fees
N/A
Account Minimum
$0
Promotion

Three months free for new customers who are referred by an existing Betterment account holder

Fees
N/A
Account Minimum
$100
Promotion

N/A

Wealthfront — Low fees, high APR for cash account

Wealthfront
Wealthfront’s stand-out features are its low annual cost and free financial planning tools. The 0.25% management fee and 0.09% average ETF expense ratio adds up to one of the lowest annual costs on this list. In addition, Wealthfront includes a cash management account with an attractive 1.27% APY.

Wealthfront continues to steal share in wealth management as customers fed up with high fees leave traditional brokerages and wealth advisors. Human interaction is intentionally minimal at Wealthfront: This could be a benefit to those who want to be left alone, or a drawback for those who would prefer personal attention or who have complicated tax situations.

Wealthfront’s key attributes:

  • Fees: Management fee of 0.25%, plus 0.09% avg ETF expense ratio
  • Minimum starting deposit: $500
  • Investing strategy: Wealthfront invests your money in one of 20 different automated portfolios. Each portfolio is a different mix of 11 low-cost ETFs, which are rated with risk scores from 0.5 (least risk) to 10.0 (most risk).
  • Average annual return over the past five years: 5.40% per year, based on Wealthfront’s mid-level 5.0 risk score.
  • Other notable features: Tax-loss harvesting (see below for a full explanation of tax-loss harvesting) comes standard, also includes an FDIC-insured cash management account yielding 1.27% APY.

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Charles Schwab Intelligent Portfolios — Brand-name brokerage

Charles Schwab
Intelligent Portfolios can be a smart choice, but do not be misled by the 0% management fees — investing with this robo-advisor still comes at a cost. Intelligent Portfolios requires users to hold 6% to 30% of deposited funds in cash at a 0.70% APY, which will eat into overall returns in years where the market returns above 0.7%. This is on top of an average 0.14% expense ratio for a moderate portfolio. The $5,000 minimum deposit to open an account may also be too high a bar for investors just starting out.

That said, Intelligent Portfolios has an exceptionally detailed description of their ETF selection methodology, and a major brokerage like Schwab can be a good launchpad for folks who anticipate getting deeper into investing. Intelligent Portfolios users get access to Charles Schwab’s 300 U.S. branch locations where you can talk to advisors and handle administrative tasks in person.

Key attributes of Intelligent Portfolios:

  • Fees: Zero management fee, but customers must hold 6% to 30% of their portfolio in cash at 0.7% APR, plus 0.14% avg ETF expense ratio.
  • Minimum starting deposit: $5,000
  • Investing strategy: Schwab invests your money in a custom portfolio with two main components: ETFs representing up to 20 different asset classes, including stocks and bonds; and cash, in the form of a FDIC-insured cash sweep program earning 0.7% APY. Cash must be between 6% and 30% of the portfolio.
  • Average annual return from 3/31/2015 to 12/31/2018: 3.1% per year for medium-risk portfolio
  • Other notable features: Tax loss harvesting available for accounts over $50K, includes access to in-person assistance at over 300 U.S. branch locations.

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Betterment — Low fees for balances under $100K

Betterment
Betterment offers a full suite of robo-advisor features at low cost with no minimum deposit. The annual management fee for accounts under $100,000 is 0.25%, plus an average 0.11% expense ratio. Unfortunately, accounts over $100,000 will see the annual management fee jump to 0.40%. One advantage Betterment gives to accounts above the $100,000 threshold is that they can actively manage some assets. If active management is your goal, though, you can avoid Betterment’s 0.40% fee by opening a free brokerage account — so if you are managing more than $100,000, you may want to consider a different robo-advisor.

Betterment’s key attributes:

  • Fees: If total balance is less than $100,000, the annual management fee is 0.25% of assets; for balances over $100,000, management fee rises to 0.40% of assets. The average ETF expense ratio is 0.11% (for a 70% stock and 30% bond portfolio).
  • Minimum starting deposit: $0
  • Investing strategy: Betterment invests your money in an automated portfolio comprised of stock and bond ETFs in 12 different asset classes.
  • Average annual return over five years: 6.2% per year on a 50% equity portfolio (July 2013 to July 2018).
  • Other notable features: Tax-loss harvesting comes standard; active management features for clients with $100,000+ balance; several premium portfolios available.

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SoFi Automated Investing — Low costs, great perks

SoFi
SoFi Automated Investing’s 0.00% management fee and ultra-low 0.08% average expense ratio makes it one of the most competitively-priced robo-advisors in the market. Valuable perks come with opening a SoFi account, including free access to SoFi financial advisors, free career counseling and discounts on loans.

Automated Investing’s main downside is that their portfolios are less customizable than its peers’, with only five different risk levels to choose from, as opposed to at least 10 available from others. SoFi does not offer tax loss harvesting yet, though this may change in the near future.

SoFi Automated Investing’s key attributes:

  • Fees: Zero management fee, plus 0.08% avg expense ratio.
  • Minimum starting deposit: $1
  • Investing strategy: All SoFi Automated Investing portfolios are actively managed. This means that real humans at SoFi decide the makeup of the five model portfolios, which they believe will add value beyond what passive investing offers. SoFi invests your money in one of five portfolios of low-cost ETFs, covering 16 different asset classes. Each of the five portfolios has two versions: one is for taxable accounts and the other for tax-deferred or tax-free accounts, like IRAs and Roth IRAs. SoFi only rebalances portfolios monthly, versus some peers which check for this opportunity daily.
  • Average annual return over five years: 6.78% per year on the moderate risk portfolio (60% stocks / 40% bonds).
  • Other notable features: Commission-free stock trades in separate Active Investing accounts. SoFi’s combined checking/savings product, SoFi Money, offers 1.10% APY on deposits. Customers must open this account separately.

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SigFig — Free access to advisors

SigFig
Free access to financial advisors by phone and 0.00% management fees on the first $10,000 deposited are SigFig’s biggest strong points. On deposits over $10,000, management fees rise to 0.25%. Expense ratios are on the high side compared to the competition, at an average of 0.15%.

One of SigFig’s peculiarities is that they do not hold your assets. If you open a new account, SigFig will open an account at TD Ameritrade for you and then manage it. Current TD Ameritrade, Fidelity and Charles Schwab customers can also use SigFig’s robo-advisor services.

The $2,000 minimum deposit may put SigFig out of reach for some, but SigFig is worth a look for investors looking to keep robo-advisor costs low.

SigFig’s key attributes:

  • Fees: Zero annual management fee for the first $10,000; management fee rises to 0.25% of assets on balances over $10,000. Average ETF expense ratio of 0.15%, depending on allocation.
  • Minimum starting deposit: $2,000
  • Investing strategy: SigFig invests your money in an automated portfolio based on how you indicate you want to invest. Each portfolio is made of ETFs from Vanguard, iShares and Schwab, comprising stocks and bonds in nine different asset classes. The specific ETFs SigFig invests in will vary based on whether your account is held at TD Ameritrade, Fidelity, or Schwab.
  • Average annual return over five years: 5.45% per year for moderate portfolio (as of 4/24/2019)
    Other notable features: SigFig has a free portfolio tracker that allows investors to track their entire portfolio’s performance across multiple brokers.

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WiseBanyan — No-frills choice for beginners

WiseBanyan
A 0.00% management fee for core robo-advisor functionality makes WiseBanyan a good choice for beginning investors who can get by with a no-frills offering. Make sure to notice that they still charge a 0.12% average ETF expense ratio, so it is not completely free.

WiseBanyan charges premiums for features that come standard with other robo-advisors, including tax loss harvesting (0.24% of assets up to $20/month max), expanded investment options ($3/month) and auto-deposit ($2/month). If you care about these other features, do the math based on your own portfolio size to compare WiseBanyan to its peers.

WiseBanyan’s key attributes:

  • Fees: Zero management fee, plus average ETF expense ratio of 0.12%. Premium features carry additional fees and higher expense ratios.
  • Minimum starting deposit: $1
  • How WiseBanyan invests your money: For basic Core Portfolio users, portfolios comprise ETFs across nine asset classes, with an average expense ratio of 0.03% to 0.69%. If you upgrade to the Portfolio Plus Package, you gain access to 31 total asset classes with exposure to ETFs tracking oil and gas, precious metals and other industries, with an average expense ratio of 0.03% to 0.75%.
  • Average annual return over five years: Not provided
  • Other notable features: Premium offerings, including tax loss harvesting (0.24% /month up to $20/month max), Fast Money auto-deposit ($2/month) and Portfolio Plus ($3/month).

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Acorns — Unique savings functionality

Acorns
By rounding up the spare change from your transactions and placing it into an investment account, Acorns provides a clever way to get started with investing. The main drawback is that, until you have more than $4,800 deposited in an Acorns Core account, the $1/month fee will actually be proportionally higher than the 0.25% management fees that most competitors charge.

Acorns does not offer tax loss harvesting, joint accounts, or access to financial advisors currently. Still, if you’re looking for an easy way to start investing, give Acorns a shot.

Key attributes of Acorns:

  • Fees: $1/month for Acorns Core, plus ETF expense ratios ranging from 0.03% to 0.15%
  • Minimum starting deposit: $5
  • How Acorns invests your money: Acorns invests your money in one of five automated portfolios— notably, this is a more limited number of portfolios than some other competitors. Each portfolio comprises ETFs across seven asset classes.
  • Average annual return over past five years: Not provided
  • Other notable features: Offers two add-on accounts for expanded functionality with Acorns Later retirement product ($2/month) and Acorns Spend checking account ($3/month).

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What is a robo-advisor?

A robo-advisor is a service that uses computer algorithms to invest customers’ money in portfolios customized to their needs. Since robo-advisors create these portfolios using automated algorithms, they can charge a fraction of what human advisors do and still offer advanced benefits like auto-rebalancing and tax-loss harvesting to boost overall returns. Most robo-advisors start with a questionnaire to assess your financial goals, risk tolerance and assets. Based on the answers, the robo-advisor allocates your investments accordingly.

How do I choose the right robo-advisor?

When considering which robo-advisor to choose, you should focus on management fees, minimum balances, ease of use and customer support. The lower the fees, the more money stays in your account. The top robo-advisors typically charge a flat management fee of 0.00% to 0.50% of your deposited balance. In addition, you pay an expense ratio to cover the fees charged by the companies offering the ETFs that comprise your investment portfolio. Note that some robo-advisors claim to offer zero management fees, but still charge an expense ratio.

Make sure you are comfortable leaving your deposits with a robo-advisor for the medium to long term — think five to eight years. There are a number of robo-advisors with $0 account minimums and most are under $5,000 today.

How do I open a robo-advisor account?

Most robo-advisors can have you up and running with an account in a few minutes. Typically you create a username, fill out a questionnaire to assess your financial goals and risk tolerance and connect your profile to a bank account. There may be some additional steps required for verification depending on the robo-advisor.

What other features should I consider?

Robo-advisors offer a host of additional features, including tax loss harvesting, cash management options, checking accounts and rewards programs. Cash management can provide a meaningful compliment for users who keep some of their portfolio in cash. Some robo-advisors offer an APY of more than 2.00% on cash management accounts. Tax loss harvesting can make a difference for users looking to lower tax exposure.

What is tax loss harvesting?

Tax loss harvesting is a tax strategy that some robo-advisors offer to help clients reduce their tax bill. Generally, this involves selling an asset that has lost value for a loss, using that loss to offset capital gains taxes or income taxes, then purchasing a similar but not “substantially identical” asset to maintain exposure to the asset class. The details behind each robo-advisor’s strategy can get complicated and should be looked at in detail to make sure you understand what you are getting into.

Capital losses from tax loss harvesting can be used to offset capital gains and can potentially offset up to $3,000 (or $1,500 if married and filing separately) of ordinary income.

What if my robo-advisor goes out of business?

While not a pleasant thought, it is possible that a robo-advisor could go out of business. Most robo-advisors insure clients’ assets through the Securities Investor Protection Corporation (SIPC). This is different from the bank account coverage provided by the FDIC; generally, SIPC coverage includes up to $500,000 in protection per separate account type, with up to $250,000 of cash assets protected.

Keep in mind that the SIPC will take necessary steps to return securities and account holdings to impacted clients, but will not protect against any rise or fall in value of those holdings. This means that if you make a bad investment in a stock, the SIPC ensures you still own that bad stock, but do not replace losses from a poor investment. Some brokers also insure assets beyond the $500,000 in SIPC coverage through “excess of SIPC” insurance.

See the full list of SIPC members at their site, along with a detailed explanation of how SIPC coverage works.

The bottom line

Robo-advisors can be an excellent option for users who are starting their investing journeys, rolling over a 401(k) or who want to minimize the time needed to manage their investments. By creating a customized portfolio based on your financial goals and automatically rebalancing your account, a robo-advisor can help to maximize your return while taking on the right amount of risk.

Because robo-advisors run off of automated algorithms, you should be comfortable with little or no human touch for your investments. The upshot to low human interaction is that fees are generally much lower than with a registered investment advisor, which may be worth the tradeoff as part of an overall financial plan.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Advertiser Disclosure

Investing

What Are Equities and Should I Invest in Them?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Equities are shares of ownership in a company. Equity is just another way to describe stock — you’ll hear people use the terms “equity markets” and “stock markets” interchangeably. Investing in equities can be one of the best ways to build your long-term savings. This article covers the basics of what are equities, how do they work and what else you should know about investing in this market.

Equities are how you invest in the stock market

The broad equities definition is the value of a property or a business to the owners after subtracting debts. When you buy a house and begin making mortgage payments, you build home equity, which is the value of your property that you own outright.

Publicly traded companies, like Nike and Tesla, sell shares of their equity to investors to raise money. When you buy a company’s equity — aka its stock — you become a partial owner of the company. This comes with several benefits, including dividends.

Equities pay dividends

As an equity shareholder in a company, you are entitled to a share of its profits based on how much of the company’s stock you own. Companies from time to time will send their shareholders a cash payment called a dividend. The frequency of it depends on the company’s strategy.

Newer growing companies like Uber typically do not pay much in dividends because they reinvest their cash in operations to keep growing. On the other hand, established companies like Coca-Cola focus on paying more dividends to shareholders. So how do you start buying equities as an investor?

The equity market

Investors buy and sell equities from each other through the equity market. When you watch financial news and hear people talking about stock markets, this is what they mean. Some of the larger equity markets in the United States include the New York Stock Exchange and the Nasdaq.

If investors believe a company is doing well and will earn higher profits in the future, the price of its equities will go up. On the other hand, when a company runs into financial trouble, the price of its equities will fall. To access the equity markets, you sign up for a broker who will process your buy and sell trades. We list some of the best online brokers on our site you can use.

Common equity vs. preferred equity

A company can sell two types of equity to investors: common and preferred. With common equity, you earn money when the stock price goes up and when the company issues dividends. You also get the right to vote on certain company matters, like picking the board of directors.

Preferred equity has a few differences. First, preferred stock typically pays a fixed dividend rate, so you get money each year. On common stock, the company can choose when to pay dividends and it might not be every year.

Another difference is if the company ends up going bankrupt, they legally have to pay out preferred equity shareholders first — before they distribute whatever’s left of their remaining money to common shareholders. The downside of preferred equity is that it does not have voting rights. It’s also rarer. While you may be able to buy preferred stock for some companies, most shares on equity markets are common equity.

Why should you invest in equities?

Equities can be one of the most effective ways to build wealth and save for retirement. Over the past few decades, they have posted one of the highest average annual returns, better than other investments like bonds or gold.

By regularly saving money and investing in equities, your savings will benefit from compounding, which is simply where your money makes money. A dollar you put aside now could double, triple and possibly become more valuable in the future thanks to your investment gains.

On the other hand, if you just kept your savings in cash or a bank account with no interest, they won’t grow. This actually decreases your future buying power because of inflation, as prices go up over time. By growing your money with equities, you put yourself in a stronger position in the future while also generating income for today with dividends.

Finally, you can receive tax benefits by investing in equities using a retirement plan, like a 401(k) or a traditional IRA. You can deduct the amount you contribute to these accounts. You save on taxes today while putting aside money for the future. These accounts also delay taxes on your gains, so you don’t owe tax until you take money out.

What is an equity fund?

As a beginner investor, it can feel intimidating figuring out which equities to buy. One way to make things easier is by buying into an equity fund, which is a mutual fund that invests in stocks. Equity funds are mutual funds that combine the money from many small investors to build a large portfolio of different equities. The portfolio is then managed by a professional to meet the fund goals. Some common types of equity funds include:

  • Index fund: Index funds look to mimic the performance of an equity market, like the S&P 500. Rather than trying to guess the top performers, they buy shares of all the companies listed to keep costs low and track the average market return.
  • Active equity fund: In an active equity fund, the manager tries to find and buy the best equity shares in a market to hopefully earn a higher return. Fees can be higher on these funds though versus index funds.
  • Growth equity fund: These funds invest in companies focused on growth, meaning they aren’t paying as much in dividends with the long-term goal to grow their stock price by more.
  • Dividend equity fund: In comparison, dividend equity funds focus more on companies that generate income. Their share price may not grow as much long-term, but they generate more consistent dividend payments.
  • Sector-focused equity fund: Equity funds can also target companies in a specific part of the economy, like energy companies or health care companies.

How does shareholders’ equity work?

Shareholders’ equity shows how much value would be left for a company’s shareholders if it used all its assets (everything it owns) to pay off everything it owes (debts/liabilities). If the company had to shut down today, they would distribute this remaining money to their shareholders.

When a company has high shareholders’ equity, it means that it has more than enough assets to cover its debts. This could be a sign that the company is profitable, shown by a high level of retained earnings on the balance sheet. On the other hand, it could also mean that the company has raised a lot of money from investors. However, if a company has negative shareholders’ equity, it is running into financial trouble because it doesn’t have enough assets to pay off its debts.

How to calculate shareholder equity

Publicly traded companies release their financial statements so investors can check their performance before buying. They list their total shareholders’ equity on the balance sheet so you can look it up there.

You can also do the calculation yourself by adding up all the listed assets, then subtracting all the company liabilities on the balance sheet. If a company has $200 million in assets and $150 million in liabilities, its shareholder equity is $50 million.

You might get equity from your employer

Besides buying shares on the markets, you could also receive equity from your employer. Sometimes they just give shares directly through an equity grant. You could also receive equity stock options, where you are guaranteed to buy shares of a company’s equity at a set price.

If the market price goes higher than that, your options make money. For example, if your employer gives you the option to buy shares at $50, then if the market price goes to $80, you could cash in your option for a $30 per share profit.

When employers offer equity in a compensation package, they usually do so to reward loyal employees. You may need to work a minimum number of years to receive all your equity grants — for example, an employer may offer 1,000 shares, but you only get 20% for every year worked, so you’d need to stay on for five years to earn it all.

If you have any more questions about what are equities, which ones you should pick or your company’s compensation package, consider speaking with a financial advisor. They can help you plan your investments and figure out what role equities should play in reaching your long-term goals.

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