Types of Business Ownership

Types of Business Ownership

A key first step for any entrepreneur is setting up an organization that will be used to formally embark on the business journey, but many new business owners struggle to identify the best way to move forward. These are the most common ways to organize a business, from the simplest through the most complex.

Sole Proprietorship

Small shops are often owned and operated by one person
Small shops are often owned and operated by one person

A sole proprietorship is the most basic form of business ownership, where there is one sole owner who is responsible for the business. It is not a legal entity that separates the owner from the business, meaning that the owner is responsible for all of the debts and obligations of the business on a personal level. In exchange for that liability, the owner keeps all the profits gained from the business. This form of business ownership is easy and inexpensive to create and has few government regulations, making it a more flexible type of ownership with complete control at the discretion of the owner. In addition, profits are taxed once, and there are some tax breaks available if the business is struggling. Sole proprietorships often are limited to the resources the owner can bring to the business. For these reasons, sole proprietorships are often most appropriate during the early stages of a business where the owner has little capital/resources to work with but also has few debts to pay.

Partnership

Partnerships are very common with friends going into business together
Partnerships are very common with friends going into business together

Partnerships are a form of business ownership where two or more people act as co-owners. There are two forms of partnerships, which are General Partnerships and Limited partnerships, differentiated primarily by the liability coverage by the owners.  In a general partnership, all owners of the business have an unlimited liability in the business (the same as a Sole Proprietorship). For a limited partnership, at least one of the partners has a limited liability, meaning they are not personally responsible for the debts of the business. Regardless of the type of partnership, they are relatively easy and cheap to create, have few government regulations and are only taxed once, like a sole proprietorship. The added benefit of a partnership is the combination of knowledge and resources that are brought to the table thanks to the additional owners. Profits do have to be shared between owners and there is always the potential for conflicts to arise between partners over business decisions. This type of ownership is often useful in the early stages of the business where multiple people are involved. Due to the sharing of profits and the additional resources, this type of ownership is often expected to yield higher growth rates then a sole proprietorship.

Corporations

Walmart logo
Walmart is currently the world’s largest corporation by revenue

Unlike the previous two examples, Corporations are a form of ownership that is a legal entity separate from its owners. This creates a limited liability for all owners, but results in a double taxation on profits (first as a corporate income tax, then as a personal income tax when the owners take their profits). Corporations tend to have an easier time raising capital then sole proprietors or partners in large part due to the greater sources of funding made available to them, such as selling stock. However, this does result in greater government regulations for corporations, such as requirements for more extensive record keeping. In addition, setting up a corporation is much more difficult, requiring more resources and capital to cover expenses and create legal documentation. This ownership form is best suited for fast growing or mature organizations that have owners looking for limited liability.

Limited Liability Company

doctorsA form of business ownership that is taxed like a partnership but enjoys the benefits of a limited liability like a corporation is a “limited liability company”. In comparison to a corporation, it is simpler to organize and does not receive double taxation. While simultaneously receiving more credibility then a partnership or sole proprietor when it comes to gathering resources such as working capital. Unfortunately, this form of ownership is usually reserved for a group of professionals such as accountants, doctors and lawyers.

S Corporation

A lesser known ownership style, an S corporation is a type of business ownership that allows its owners to avoid double taxation because the organization is not required to pay corporate taxes. Instead, all profits or losses are passed on to owners of the organization to report on their personal income tax. This form of ownership does allow for limited liability, similar to a corporation, but without the double taxation. The disadvantages of this organization’s special nature is the increased level of government regulations and the restrictions on the number and type of shareholders it may have. This type of ownership is used in the mature stage of a businesses lifecycle and often by private organizations due to the restrictions on ownership.

Franchise

mcdonalds logoFranchising is a form of ownership far different from the ones previously mentioned. This form of ownership allows a franchisee to borrow the franchisor’s business model and brand for a specified period. It comes with a list of advantages including: training on how to operate your franchise, systems and technologies for day-to-day operations, guidance on marketing, advertising and other business needs, and a network of franchise owners to share experiences with.

The main disadvantages to this ownership structure are franchising fees, royalties on sales or profits, and tight restrictions to maintain ownership. Franchise owners also have limited control over their suppliers they can purchase from, are forced to contribute to a marketing fund they have little control over. If a franchisee wants to sell their business, the franchisor must approve the new buyer. Despite these disadvantages, franchises are great for owners who are looking for an ‘out of the box’ to owning their own business.

Co-operative

Cooperatives are organizations that are owned and controlled by an association of members. This form of ownership allows for a more democratic approach to control where each share is worth the same amount of votes, similar to a corporation with common stock. It also offers limited liability to its owners and equal profit distribution based on ownership percentage. Disappointingly, the democratic approach to decision making results in a longer decision making process as participation from all association members is required. Conflicts between members can also arise that can have a big impact on the efficiency of the business. Co-operatives are often used when individuals or businesses decide to pool resources to achieve a common goal or satisfy a common need, such as employment needs or a delivery service.

 

Type of Corporation Advantages Disadvantages
Sole Proprietorship ·         Easy and inexpensive to create

·         Flexibility and control to your liking

·         Few Government regulations

·         Tax advantages if struggling

·         Profits taxed once

·         Unlimited liability, meaning business debts are personal debts

·         Limited source of financing

·         Limited resources

Partnerships (General/Limited Partnerships) ·         Easy to organize

·         Combined knowledge, skills and resources

·         Few Government regulations

·         Taxed once

·         Unlimited liability for some partners*

·         Possible conflict development between partners

·         Shared profits

Corporation ·         Limited liability

·         Easier to raise capital due to greater sources of funding

·         Being taxed twice (as a legal entity and as an owner)

·         Greater Government regulations to adhere to

·         More expensive to set up

·         Extensive record keeping required

Limited Liability Company ·         Simple to organize and operate

·         Flexible in nature

·         Taxed as a partnership

·         Generally only available to a group of professionals such as lawyers or accountants
S Corporation ·         Limited liability for owners

·         Greater credibility for financing

·         No double taxation

·         Greater Government regulations to adhere to

·         Restrictions on number and type of shareholders

 

Franchise ·         Superior training and systems offered

·         Guidance on marketing, advertising, financing, accounting etc.

·         Franchise networks to share experiences (great knowledge base)

·         One-time Franchising Fee for owning a franchise location

·         Recurring royalty fees as a percentage of sales or profits

·         Tight restrictions that limit control

·         Purchases must be made from specific suppliers

·         Contributing to marketing fund, but having no control over it

·         Selling franchise location requires approval from franchisor

Co-operative ·         Democratic control

·         Limited liability

·         Equal profit distribution

·         Longer decision making process

·         Participation of all members required

·         Conflict possibility between members

·         Extensive record keeping required

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Price Controls

Price Controls

Definition

“Price Controls” are artificial limits that are put on prices. If the limit is put in place to prevent prices from getting too high, they are called Ceilings. If they are in place to prevent the price from getting too low, they are called “Floors”.

Price Ceilings

price ceilingPrice Ceilings are controls put in place to prevent the price of some good or service from getting too high. This type of control is most common with food, where there might be a maximum price that businesses can charge for things like flour or electricity.

These controls are put in place to protect consumers and to prevent price gouging, particularly so the poor are able to afford basic goods and services. When there is a price ceiling, suppliers cannot sell above a certain price, and this creates a Market Shortage.

With a Market Shortage, the quantity producers are willing to supply is less than the total quantity that consumers demand at the given price. This can result in rationing, or lottery systems to determine which consumers are able to buy.

In extreme cases, it can result in “Bread Lines”, where essential goods are not supplied in sufficient amounts, so consumers need to join waiting lists to get their necessary share.

Price Floors

price floorPrice Floors are the opposite – a control put in place to ensure that a certain amount of something is produced by making sure producers are guaranteed at least a certain price for what they supply. These types of control are common for milk.

These controls exist to prevent shortages, by making sure suppliers get at least a certain price, it encourages production. When there is a price floor, the producers are willing to supply more than consumers demand at a given price, creating a Market Surplus.

With a Market Surplus, the government needs to buy the excess production, or else the market price will collapse back down. In the case of milk, the government typically buys the excess production and stores it, uses it as part of disaster relief, or tries to sell it on international markets.

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The Business Cycle

The Business Cycle

What Is The Business Cycle?

The Business Cycle is the broad, over-stretching cycle of expansion and recession in an economy.

The Business Cycle is concerned with many things – unemployment, industrial expansion, inflation rates, but the most important indicator is GDP (Gross Domestic Product) growth. Below you can see a graph of the GDP growth rate in the United States since 1946 – the grey bars highlight periods of a recession.

GDP growth

The Business Cycle can also be thought of as how Real GDP moves above and below its Potential Levels.

What Is Real GDP?

GDP, or “Gross Domestic Product”, is the total amount of finished goods and services produced in an economy during a given year (for more information, read our full article on Common Economic Indicators). If you just add up the value of all the finished goods and services in one year, you will have the Nominal GDP.

Unfortunately, you cannot directly compare the Nominal GDP of one year with the Nominal GDP of another year, because the same goods and services change price over time. If we want to compare the GDP of different years, we need to adjust the Nominal GDP by the Inflation Rate. Once you adjust your Nominal GDP by the Inflation Rate between years, you have the Real GDP, which you can use to directly compare different years.

What is the Potential Level of GDP?

The “Potential Level” of GDP is the total output an economy can sustainably produce in a year.  This is the potential output if every laborer is using their skills the most efficiently, with businesses using their capital goods to the best of their design at the current levels of technology, and public institutions are operating at their peak efficiency. Every time workers learn new skills, technology increases that allows us to make new goods (or the same goods but more efficiently), or changes to the government or culture take place that promote economic growth, the Potential Level of GDP increases.

The Real GDP growth rate swings above and below the Potential GDP growth rate, which is called the Business Cycle.

Running Below Potential Levels

It is easy to see how an economy can be running below the potential levels – if workers are not matched with jobs that make the best use of their skills, or if machines are not properly maintained, or even if the government has poor leaders that make less-than-optimal laws and policies, it will cause the Real GDP growth rate to fall below the potential level. If it falls too far below, the economy could enter a Recession. Inflation is usually low when an economy is running below its potential levels.

Running Above Potential Levels

The economy can also run above Potential Levels. Remember – the Potential Level is based on what can be sustainably produced. This means that if current growth levels are the result of over-borrowing, or asset bubbles, output might actually be growing at a higher-than-sustainable rate. Economies very often run above their potential levels for short periods of time with no problems, but going too far above for too long can result in a crash. Inflation is usually higher when the economy is running above its potential, which serves to bring the Real GDP back down to its potential levels.

Expansions and Recessions

When the GDP growth rate is positive and unemployment is relatively low, it is called an Expansion. If the GDP growth rate is very low or negative, with higher unemployment, it is called a Recession.

Economic Expansions

stock broker
This part-time lifeguard would prefer to be a full-time stock broker

Most of the time, the economy is an “Expansion” phase. This does not mean everyone is doing well – even during very strong expansions, the unemployment rate usually stays around 5% (meaning 1 out of every 20 people who wants a job can’t find one), with the underemployment rate (people who are working part-time but want a better job) is usually much higher.

What an Expansion does mean is that new jobs are being created, and the total value being produced by an economy is going up. Growth also promotes growth – the more resources that are available, the more resources can be allocated towards researching new technologies and building new skills.

Economic Recessions

Recessions typically occur every 7-15 years, often following an asset bubble bursting, followed by a large loss of value in an economy. Recessions typically have higher levels of unemployment, with low or negative GDP growth. Even if GDP growth is never negative, recessions hurt. Other than GDP, the biggest indicator of a recession is a sharp decrease in consumer spending, and inflation tends to fall.

Higher unemployment rates mean that people lose their jobs, and new workers have a hard time finding their first position. Losses in the financial sector hurt retirement accounts and individual savings and investments, which can severely disrupt life plans. Thankfully, recessions are temporary, and the business cycle can usually move back into an expansion phase fairly quickly.

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Credit Cards

Credit Cards

What are Credit Cards?

Credit cards is a form of unsecured credit (meaning a loan without collateral) that you can use to make everyday purchases. All credit card purchases are made using a loan – you borrow money from your credit card issuer, and later pay it back with interest.

Credit Cards Vs Debit Cards

credit cardCredit cards can be used at all the same places as debit cards. In fact, some business only take credit cards (like most car rental companies and many hotels) specifically because it works as a line of credit – a business accepting a transaction from a credit card knows it will be paid immediately. If you have both a debit card and a credit card, you should choose carefully which you use most for your everyday transactions.

Advantages over Debit Cards

There are some good reasons to use credit cards for every-day purchases instead of your debit card:

  • Your debit card may have a transaction limit or transaction fees – credit cards typically do not
  • Credit cards often offer “Cash back” and other rewards programs for most purchases
  • Credit cards are accepted more widely than debit cards (especially if you are travelling overseas)
  • Using your credit card will build your credit history, which can lower your interest rate and increase your credit limit on other loans
  • You can “Float” credit card purchases, using it as a short-term loan before your next paycheck

Disadvantages over Debit Cards

There are also some good reasons to use your debit card instead of a credit card:

  • If you miss your grace period, your purchases will be charged interest with a credit card, making them more expensive
  • Since you do not need to pay the full balance on credit card purchases every month, it makes it easier to over-spend
  • If you start to fall behind on your payments, it can be very difficult to fully escape credit card debt
  • Credit card billing cycles are usually 20-25 days instead of one month, making it more difficult to schedule payments compared to other types of bills.

Credit Balance Types

When you use your credit card, there are several different types of balances that will appear on your credit card statement:

New Purchasespurchase

Your new purchases are the things you’ve bought using your credit card during the current billing cycle. You will not be charged interest on this balance until the end of your grace period, so it is usually a good idea to pay off this balance first and avoid finance fees. If you miss your grace period, you will be charged interest on the balance for every day you had it.

Balance Transfers

If you don’t pay off all your purchases in a month, the remaining balance will carry over to the next month as a Balance Transfer. Balance transfers do not have a grace period, so they will accumulate interest for the entire billing cycle.

Cash Advancesincome

This is the most expensive type of charge you can make on your credit card. Cash advances are when you take money out of an ATM using your credit card. Cash advances also typically do not have a grace period, and they usually have a higher interest rate than balance transfers.

Finance Charges and Interest Rates

Credit card companies have finance charges as a condition to using the credit card – the most important one is your interest rate.  Each one of your balance types has a different way interest is charged

How Interest is Calculated

Different credit cards may calculate the interest you owe differently, and this difference might make a big difference on your bill. The two most common methods are “Daily Balance” and “Average Daily Balance”.

Previous Balance

The previous balance method uses your balance at the beginning of the billing cycle to calculate your interest. This means that payments you make during the billing cycle will not lower your total interest payment, but will only impact your bill next month.

Adjusted Balance

This method is similar to the previous balance, but also subtracts any payments you make. This method gets you the lowest total interest charges, but is very rare for credit card companies to offer it.

Ending Balance

totalsThe ending balance adds your balance transfer to all the charges you made during this billing cycle, and subtracts any payments you made. The interest is then calculated based on that final total.

Average Daily Balance

This method is the most common. Your credit card company takes the average balance of all days and multiplies that by your daily interest rate, then adds it together for every day in the billing cycle.

Grace Period

card billEvery credit card has a grace period, usually about 21 days. If you pay off any new purchases within 21 days of making them, you will not get an interest charge for those purchases. If you miss the grace period, you will be charged the full interest amount. There is no grace period for balance transfers and cash advances, so you will be charged for every day you have a balance outstanding on these balances.

Minimum Payments

Your credit card will have a minimum payment every month, which is the absolute least you can pay to keep your account in good standing. Your minimum payment is based on your outstanding balance. The payment is generally enough to pay off new interest, plus some of the principle balance.

Just making the minimum payments is the absolute longest way to pay off credit card debt, and it will result in the absolute highest possible amount you pay in interest.

Note that there are some conditions that can cause your minimum payment to be less than interest, in which case you will never fully pay off the debt. If your minimum payment is lower than or equal to your interest charge, you can continue making payments on interest forever without ever paying off your debt.

Missing Payments

Missing your credit card payments can result in defaulting on your account. Defaulting on your account has a few impacts:

  • If you had any promotional interest rate, you will retroactively lose it (meaning all your previous outstanding balances will now use the higher interest rate instead of the promotional rate, making your bill even higher)
  • You will get “Late Payment” fees, which is added to your balance transfer into the next billing cycle
  • Missed payments are reported to the credit reporting agencies and will lower your credit score
  • Your credit card may also lower your credit limit and increase your interest rate

If you miss a certain number of payments, your credit card may cancel your line of credit entirely, and send your case to a collections agency. This will further damage your credit score, and make it extremely difficult to get any new credit cards or loans for the next several years.

The CARD Act of 2009

In 2009, the federal government passed the Credit Card Accountability, Responsibility, and Disclosure Act of 2009, which bans certain types of behavior from credit card companies. It also gives credit card holders more tools to help keep their credit cards in good standing.

The CARD act bans credit card companies from:

  • Increasing your interest rate on existing balances (so if your rate goes up, it only applies to new purchases). This doesn’t apply to removing promotional rates
  • Your interest rate cannot go up in the first year of holding your account (except if you have a variable rate credit card, then your base rate can’t do up but the variable rate can)
  • Processing your payments late (all payments must be processed on the day they are received)
  • Charging fees for different methods of payment
  • Using a double billing cycle (where you would be charged interest based on the last period’s balances instead of just the current period)
  • Issue credit cards to people under 21 without a co-signer

As the card holder, you also get new rights with your credit card:

  • If you default on one credit card, credit card companies can’t automatically charge you a higher “penalty rate” on other cards you have
  • You have at least 21 days after your bill is mailed to pay it without any interest charge
  • If you pay more than the minimum payment, all the extra is paid towards your balance with the highest interest charges first (so if you make higher than the minimum payment, the extra would go towards your cash advances before your balance transfer)
  • You can opt-out of over-the-limit fees. If you do, trying to charge more than your credit limit would result in a declined transaction instead of letting it go through with a fee
  • You can opt-out of interest rate increases. If you do, your credit card will be cancelled once you pay off your balance (this might impact your credit score).

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All About Budgeting

All About Budgeting

If you want to start building your first workable budget, it is important to know exactly what should be in it, how to keep it updated, and the specific reason you want to have this budget.

What does a budget look like?

spreadsheetA budget is usually a spreadsheet or table. On one side or column, you will list your planned expenses, while on the other side you list your planned income.

You can use a budget for many different things, depending on the budget type. Using a mix of different budget types, as each situation finds appropriate, can be one of the most effective ways to reach your short term financial goals.

Budget Types

There are two types of budgets, each of which has its own place in your personal finance toolkit.

The Project Budget

A project budget is something you make just once for a specific purpose. For example, you might make a single-use budget when evaluating apartments you might move to (outlining costs of rent and transportation between a few different alternatives).

The project budget is the easiest budget to make because you do not necessarily need to keep managing it in the long term – this is a “one and done” way to address a specific problem.

The first budget most people make is a project budget to help look at their current expenses and see what adjustments need to be made. The problem with this approach is that project budgets work very well for short-term thinking, but tend to be difficult to follow for longer periods of time.

Project Budget Components

Your project budget is looking at a snapshot in time. This means you are comparing some known fixed expenses to a specific amount of income or money you can dedicate towards paying for it. The specific components are:

  • Itemized list of known expenses for this period in time
  • Total expected income or starting cash you have to allocate to this period in time
  • Surplus – the total income minus the total expenses.

The purpose of the Project Budget is to maximize that surplus, or the money you have left over to allocate to other things.

Common uses for a Project Budget

  • Comparing alternative apartments (building a sample budget for each alternative to compare)
  • Planning a vacation
  • Paying off short-term debt
  • Other short-term crisis or goals

The Living Budget

Unlike the Project Budget, a Living Budget is meant to “grow” and adjust over time. These budgets are not designed for a specific goal or purpose, but instead to help you keep a general idea of where your money is going from month to month, and help you adjust your spending to reach your financial goals.

One of the major differences with a Living Budget is that while you make them looking forward, you also should look back regularly and make adjustments (not start over as needed).

Living Budget Components

grocery billYour living budget needs to be regularly adjusted and updated. To set up an effective living budget, you will need the following components:

  • Regular monthly income (things like your paycheck)
  • Variable income (gifts, one-off payments, ect)
  • Regular monthly expenses
  • Regular contributions to savings or other financial goals
  • Expected variable expenses

Using Your Living Budget

Unlike the Project Budget, the goal of the living budget is not necessarily to maximize your surplus. Instead, your Living Budget has your savings and other financial goals built in, and you can adjust these every month or two along with your variable expenses.

With your Living Budget, having a big surplus every month is not necessarily a good thing, since that might be a sign that your financial goals might be set too low.

Expense Categories

With the Living Budget, you will notice that there is a difference between “regular”, or fixed, income and expenses with the “variable” income and expenses. When you set out to outline your budget, it is important to keep these distinctions separate.

There are 2 types of expenses, which each have 2 flavors.

  • costsTypes:
    • Fixed Expenses
    • Variable Expenses
  • Flavors:
    • Needs
    • Wants

Most people new to budgeting only consider needs and wants, but without fully breaking down where your money is going, it will be much harder to build a workable budget.

Category Breakdown

Each category has its own place in your budget, and when you want to reach a specific savings goal, these separations make it much easier to hit your targets.

Fixed Needs

Your “Fixed Needs” are things like paying rent, utilities, car payments, and groceries. These costs should not change very much from month to month.

When you are engaging in short-term financial planning, there is not much you can do to change your Fixed Needs expenses. With mid-term and long-term planning, finding ways to cut down or reduce these costs (or any increases to them, like getting a better apartment or car) will likely make the biggest changes impacting your long-term goals.

Fixed Wants

coffeeYour “Fixed Wants” are the costs that add up quickly over time, but most beginners frequently forget to include in their budgets. This includes things like morning coffee from Starbucks, going out for lunch with your friends or co-workers instead of bringing lunch from home, having dessert after dinner, and any other regularly-occurring expenses.

Your “Fixed Wants” include all the little pleasures or extras that you normally get in your day-to-day life – things that you know you could probably live without, but removing them would really sour your days.

Variable Needs

Your “Variable Needs” are expenses that are important, but you may not have them every month. This includes the extra money you will probably spend on heating in the winter, or semi-annual visits to the dentist, or Christmas/birthday gifts for friends and family.

Unlike your Fixed Needs, even with long-term financial planning, there probably will not be very much you can do to change your Variable Needs costs in the long run – you will always need heat in the Winter, always need your teeth fixed when they break, and always need oil changes on your car.

Variable Wants

“Variable Wants” are your expenses that come more “spur of the moment” – things like a night out for drinks with friends, shopping for some new clothes, or buying a new video game.

You usually will not be able to make a line-item budget for your variable wants, but you can estimate how much you spend each month based on your receipts and account reconciliation from the previous month. Once you know how much your Variable Wants are costing you, the next step is taking steps to make sure those costs are under control.

How To Use Your Living Budget

When you are making your Living Budget, you should do so shortly after your latest account reconciliation, where you lay out your 10 or 20 biggest purchases over the last month and consult your bank account. You may know off hand how much you spend on rent and electricity, but building realistic estimates for your variable expenses (both wants and needs) means you need to look at exactly how much you are already spending.

Once you have your expense breakdown from the previous month, you can build your budget for moving forward. This means setting some specific financial goals:

  • Deposit $300 per month into your savings account
    • This means you need to already have a surplus of $300, or make a separate goal to get this money from somewhere else
  • Reduce Fixed Wants costs by $50 per month by brewing your own morning coffee 3 times per week
  • Increase surplus by $100 per month to afford a nicer apartment
  • Reduce Variable Wants costs by $75 per month, and apply that savings towards a yearly vacation savings fund

Putting Your First Goals Into Practice

coins-currency-investment-insurance-128867To help make sure you hit your savings goals, split your “Savings Targets” in half for your budget. One half should go into your “Fixed Needs” category – this is money you are setting aside as soon as you get paid. The other half should be filed as a “Variable Want”, meaning a target you are setting, but until you have a few months of practice adjusting your budget, you might not be able to reach.

One common problem beginners face is combing both of these items together, then simply trying to increase their surplus by the amount they want to save per month. This tends not to work, simply because there is no concrete line item that you can admit to not reaching – it becomes easy to just roll over that goal by saying “I can just save more next month to make up for it!”.

By separating your first goal into smaller parts, it makes both parts easier to obtain. Having the fixed necessary savings means that you will make progress towards your goal even if everything else goes poorly, while the second half works as an extra incentive showing you have effective money management.

As you become more experienced building your Living Budget, you can shift a bigger percentage of your savings goals into your Fixed Needs category to have more stability, and more effective planning for the future.

If you want to start building your first budget, click here to try the Home Budget Calculator!

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Trailing Stops Have Arrived!

Trailing Stops Have Arrived!

If you have ever wanted to protect your portfolio on HowTheMarketWorks from losses, you have definitely used Stop Orders. The biggest downside of stop orders is, of course, the fact that you have to constantly update them as your investments grow to “lock in” your gains…

What are Trailing Stop Orders?

Trailing Stop orders work a lot like regular stop orders evolve with the market. This means you can set a Trailing Stop sell order to sell if your stock’s price falls by $2.00, or even 2%. As your stock’s price grows, the trailing stop price goes up with it. It will only execute when the stock’s price falls by your Trailing Stop threshold from its peak – meaning you lock in your gains without constantly updating your stop orders.

How Does It Work?

Good question! Check out our tutorial video below to see how to use Trailing Stops with your portfolio.

The Dashboard Has Arrived!

The Dashboard Has Arrived!

Do your students have a hard time getting started with their portfolio? Do you want a place where you can see all your tools in one place? Us too, which is why we added the new Dashboard to HowTheMarketWorks!

dashboard

The dashboard is just the newest addition to our new design, with your entire suite of tools at your fingertips.

We have divided up all the tools into 5 categories:

  • My Portfolio – here you can find things you own, your assignments, account balances, and graphs
  • Trading – Make a trade, or see your transaction histories
  • Contests – See your ranking, join a new contest, or create your own
  • Research Tools – Start doing some investment research, with a wide range of tools to choose from
  • Trading Ideas – See the most popular stocks and mutual funds, what the brokers are saying, and a lot more

We have more great new features coming, so stay tuned!

New items added to assignments!

New items added to assignments!

Update time!

HowTheMarketWorks is growing – and the list of great educational articles you can include in your class assignments is growing too!

creditcard

Last week we added 3 new Personal Finance and Investing articles, plus one great new personal finance calculator!

New articles

New Calculator

We add new articles to the Education Center every week, but when we add new items to the Assignments, you know they are special!

Articles we add to Assignments can be integrated with your HowTheMarketWorks contest – you can assign these as reading to your students, and track their progress. These articles have been written to cover topics that are part of the National Standards for Personal Finance and Economics, part of the Common Core curriculum.

Click Here to learn more about assignments!

Credit – Using Borrowed Money

Credit – Using Borrowed Money

What Is Credit?

“Credit” is when you have the ability to use borrowed money. This can come in many different forms, from credit cards to mortgages. There is a wide range of ways to use credit, which means that it is often a challenge for beginners to learn all the different ins and outs of using credit.

Basic Credit Terms

Before diving in to how each piece works together, you should know some of the basic terms that come up a lot with credit.

Principle

This is the amount of money that you need to re-pay. This includes the amount you originally borrowed, plus any extra interest.

Interest Rate

This is how much you are charged for the right to use borrowed money. This is an annual interest rate.

Credit Limit

Your credit limit is the total amount you are allowed to borrow.

Grace Period

This is the time between when you borrow money and when interest begins to be charged on the principle.

Minimum Payment

This is the least amount you can pay back per month before your credit card company considers you defaulting on your debt. This is a percentage of your total principle balance.

How Does Credit Work?

creditcard2Credit works based on trust. You, as the borrower, ask a lender for a “line of credit”, or the ability to borrow money to use for your own needs, and you promise to pay it back. The lender will agree, with certain terms and conditions. These terms are generally based on what you intend to buy, how likely you are to make all repayments on time, how trustworthy you have proven yourself in the past with borrowed money, your income, the overall conditions of the market, and a few other factors.

At the end of the day, the more trustworthy you have proven yourself to creditors, the better terms you can get when borrowing money, because they see it as a lower risk. If creditors do not see any reason to think you’re trustworthy (or if you have proven yourself untrustworthy in the past), you will get worse terms.

What Are My Credit Terms?

Your credit terms refers to how much you can borrow, and how expensive it is to borrow. Having “Good Terms” generally means higher credit limits (meaning you’re allowed to borrow more money at a time), lower interest rates (making it less expensive to borrow), and other perks like cash back and flight miles. For beginners, focusing on lower interest rates should be your biggest concern when shopping around for credit cards or car loans.

How Can I Improve My Terms?

Since your credit terms are determined by trust, the best way to improve your terms are by using credit and reliably paying it back. This shows creditors that you are able to manage regular payments and will very likely be able to pay back your borrowed money on.

From a creditor’s point of view, every time they lend money it is an investment. Their return on investment would be the interest rate you are charged to borrow money, while their risk is the likelihood you are not able to pay back on time, or not at all. If you have shown that you can reliably make your payments, they believe you’re a safer investment, and so you get better terms. If they don’t have much credit history, or (worse) a credit history with lots of late or missed payments, they see you as riskier, so they charge more to use the service.

Creditors use credit reports to share information with each other about who does, and who does not, pay their bills, so you won’t be able to get out of a bad credit history by switching to a different lender.

Credit In Practice – A Credit Card

When you use your credit card to buy something, say a television at $300, you open a new principle balance for $300, which you borrow from the credit card company. You can only borrow up to your Credit Limit, we will assume your credit limit is $300 in this example so the TV used it all up.

The credit card company then gives you a Grace Period, or time between when you first make the purchase and when they start charging you Interest. The grace period is usually 3-4 weeks, but this can vary a lot depending on your credit card company

After the Grace Period ends, the credit card company will start charging you an Interest Rate. The interest rate is a percentage of the principle balance that is added as a charge – this is the primary cost of borrowing money. The Interest Charge is added to your Principle Balance.

You will need to make at least your Minimum Payment every month in order to remain in good standing with the credit card company. The minimum payment is a percentage of the Principle Balance, but beware – if your minimum payments are less than the amount being added by interest and fees, you will never fully pay off your debt. Many young people have been stuck paying off relatively small credit card debts for many years by only making the minimum payments, meaning they ended up paying many times extra in interest more than they originally borrowed! You can always pay more than the minimum payment.

As you make payments to reduce your principle balance, you can use the difference between your principle balance and your credit limit to continue making extra purchases on your credit card.

Once your principle balance is zero, no more interest will be charged, and you will be back to the beginning. To see how this works out, check out our Credit Card Payments Calculator.

Credit In Practice – A Mortgage

houseIf you need to buy a house or property, you will have a mortgage. The biggest difference between a mortgage and a credit card is that with a mortgage, you are borrowing the money for a very specific purpose, usually to buy a house. The house you are buying then becomes collateral in the loan, meaning that if you fail to pay back, the creditor can take your house.

This risk of losing your house works both ways – it also means that your creditor has a lot lower risk in lending you the money, since they are able to claim something back if you aren’t able to repay. This means that with a mortgage, you will have much higher credit limits and better interest rates than a credit card, even with the same credit score and credit history.

Otherwise most of the mechanics are the same as a credit card – minimum payments, interest and principle all work the same.

Unlike credit cards, there are two types of interest rates used with mortgages, Adjustable and Fixed.

Fixed-Rate Mortgages

Fixed-Rate mortgage is how it sounds, the mortgage interest rate is fixed for the entire duration of the mortgage. This means your rates and payments will be predictable for the entire duration of the mortgage. As a trade-off, fixed-rate mortgages might be (on average) slightly higher than adjustable.

Adjustable-Rate Mortgages

With an adjustable-rate mortgage, your interest rate can move up and down over the term of your mortgage based on the overall market rates. Lenders prefer these – it means they can increase or decrease how much they’re charging based on prevailing market rates.

For lenders, you lose some predictability in your payments. However, to compensate, banks generally offer lower average adjustable rates than fixed rates (but this may not always be the case).

What Else Impacts My Credit?

There are a lot of other factors besides your credit history that will impact your credit and payments. The biggest of these can be the “Extra fees”, or money credit card companies charge for using certain services. These can be tricky and add up fast.

Fees vary widely, both in type and amount, between credit card companies, so should definitely be on your list of things to check when shopping around.

Other factors are more mundane, like your income and the general market. If you earn more money, you will likely have higher credit limits and lower interest rates, since creditors see that you have a greater ability to pay. If interest rates in the overall market are low or high, this will also play a significant role on the rates you get.

Another hidden cost could be your interest rate calculation. Some creditors will make one calculation per month, others will charge per day. These differences can make a big impact on how your payments work- if there are monthly calculations, you benefit by making a big payment once per month right before the calculation. If it is daily, you benefit most by making many smaller payments throughout the month.

Pop Quiz!

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Credit Reports

Credit Reports

Credit Reports are basically a report that contains your credit history – both the good and bad. If you watch late-night TV, you have probably seen a few commercials offering free credit reports, so you might know that these are important. Most people, however, don’t know just how big a role a credit report can play.

What is a Credit Report?

question fileA credit report, at its core, is a document that keeps a record of (most) of your regular bill payments. There are three main organizations that provide credit reports in the United States: Experian, TransUnion, and Equifax.

Each of these organizations is specially licensed to collect information on all individuals in the US related to their credit and payment history, criminal record, bankruptcies, and lawsuits. Your “Credit Report” is basically your file that they have on all of these activities for the last 7-10 years.

Companies and organizations from whom you are requesting credit can then ask one of those 3 agencies for a copy of your credit report to help them assess your application for credit. This would include any time you want to open a credit card, take out a loan, get insurance, or renting a home. Sometimes even potential employers might request a copy of your credit report, although in this case you need to provide consent.

What is the difference between a “Credit Report” and a “Credit Score”?

Your credit report is a complete credit history, meaning the bills you have paid (or didn’t pay), and their amounts. A “Credit Score” is a single number.

Since a credit report can have a lot of different information from different sources, this is consolidated by using what is called the “FICO score”. The “FICO score” basically distills all your credit history down to a number – the bigger this number is, the more likely the credit agencies think you will pay your bills on time. If you have a clean credit report you will have a high credit score. On the other hand, if you have a poor credit score, you probably have a lot of late payments or complaints in your credit report.

Your income does not impact your credit score, but repeated requests to review your score do have a negative impact, since the credit rating agencies assume that if you are trying to get a lot of different credit from a lot of different places, your financial position might be unstable.

Why Do I Need To Care?

Your credit report, and credit score, are important, and can have a huge impact on your financial life. Anyone who would need to assess your financial trustworthiness will probably be looking at your credit report, so it is absolutely in your best interest to keep it looking good.

Applying For A Credit Card

credit cardThe first time your credit report might come up is when you apply for a credit card. Based on the length credit history (meaning the total size of your credit report), your credit score, how well you have kept up with any previous payments, and your income, you will have a very wide range of credit options available.

Generally speaking, people with a poor credit history have lower spending limits, higher interest rates, and less likely to get any leeway with their credit card company with late payment forgiveness or credit card perks. On the other hand, if your credit report looks good, you will have a wide pick of different credit card companies offering increasingly attractive terms to attract your business.

Applying For A Mortgage

When you want to buy a house, you will see the same kinds of terms as when you apply for a credit card, but with much higher stakes. This means more banks and lenders willing to lend to you in the first place, better interest rates (which can save you tens of thousands of dollars over the life of the loan), and more flexible down payments.

Renting an Apartment

When you rent an apartment, your potential landlord will probably look up your credit report. Renters often use the credit report to compare different candidates and determine the size of the security deposit. Remember – a person renting an apartment is primarily concerned with making sure the rent is paid on time. If you have a poor credit report, they might rather wait for the next applicant than take a risk.

Getting Insurance

While it might not play as large a role as direct lines of credit, insurers also look at your credit report when they determine your premiums and deductibles. This is because they want to make sure all of their clients are paying on time. The entire idea behind insurance is that the insurance provider is taking in at least as much money from premiums as they are paying out in claims, so they need to make sure all of their clients are paying their premiums on time.

If the insurance company suspects that you will lapse on your coverage, just to start catching up right before filing a claim, they will likely charge you higher premiums to make up for it.

Applying For A Job

applyMore and more employers are requesting the credit history from potential job applicants. This trend first started in the finance and banking industry, but has been spreading to other sectors as well. Potential employers see your credit history as your overall professional trustworthiness, particularly if you have a long history of late payments.

What Exactly Is In My Report?

Your credit report follows your basic payment history to creditors. This includes:

  • Credit Card Payments
  • Cell Phone Payments
  • Cable/Internet Payments
  • In-Store Financing For Large Purchases
  • Unpaid Parking Tickets
  • If You Have Been Sued
  • Any Other Outstanding Debt
  • Mortgage Payments
  • Rent
  • Utilities (Gas, Phone, Water)
  • Car Payments
  • Unpaid Taxes
  • If You Have Declared Bankruptcy
  • Pay Day Loan Payments

Items in your credit report do not stay there forever, so even if you make credit mistakes when you are young, you might not need to suffer from them forever. Generally speaking, missed bill payments, collections, and most other items expire after 7 years. Bankruptcies and other civil judgments (like unpaid taxes) usually have a longer expiration, up to 10 years.

How Does This Information Get In My Credit Report?

The three credit reporting agencies get all of this information from your creditors, meaning everything in your report was given to them by someone you did business with (or sued you). Not every creditor supplies this information. For example, if you rent an apartment, the payments might not appear in your credit report unless your landlord makes a point to report it. This is sometimes unbalanced, since landlords might not always report timely payments (or even late payments), but almost certainly will report judgments and collections.

Your creditors report this information, which is linked to you through your Social Security Number and your address. The Social Security Number is the main way it is linked, but they address is also used to help prevent fraud and identity theft.

The Fair Credit Reporting Act

All of these details so far have been helpful for creditors and employers, but you also have some control over your credit report that comes from the Fair Credit Reporting Act. This is a law that gives all consumers certain rights to their credit report, along with restrictions on businesses on what they can include in the report (and how they can use that information).

Consumer Rights

Once you have your credit report, you can also dispute any claims on it if you feel they are not legitimate. This means you can call the agency who provided the report and file a “dispute”. You also need to contact the lender who made the report to ask them to issue a correction if it is inaccurate. If the claim was because of an error, it will be removed from your report.

inspectEven if a claim is not an error, you can contact the business who filed the claim and try to get it removed – if the person who files the claim withdraws it, it also is removed from your report. This is most often the case when people move out of their home without paying the final utility bills. If you contact the utility company and pay the outstanding bills (plus a fee), they may withdraw the claim entirely from your report. If you do have any such claims, it is always in your best interest to find them and take care of them as soon as possible, since it will impact your overall ability to obtain credit. For more information on disputing claims, visit http://consumer.ftc.gov.

If a potential employer wants to see your credit report, they need to get your written permission, only use it for the purposes of hiring you (and tell you what those exact purposes are), give you a copy of the report if they decide not to hire you (or fire you), and give you an opportunity to dispute any outstanding claims before they make their final decision.

If you get denied credit (or a job) because of the contents of your credit report, you also have the right to get a free copy for your own reference.

User Responsibilities

Businesses who order credit reports also have limits on how they use them. Generally speaking, a business who orders a credit report must:

  • Only use the report for deciding the terms of your financial agreement
  • Notify someone if something in their credit report affected their final decision
  • Tell the consumer which company they got the report from so the consumer can verify it.

Data Provider Responsibilities

People and businesses who provide the data that is included in credit reports also have their own responsibilities. The most important of which is to make sure all the information they report is accurate and up-to-date.

This means that if you file a dispute, the data provider has 30 days to verify that the claim is accurate, or else it is removed from your report until they do so. The data provider must also take some safeguards to prevent against data theft. This is why they require both a social security number and an address, so these items can be cross-referenced to check for identity theft.

The data providers also need to tell consumers before they file a claim and give them a chance to resolve it before it appears on their credit report.

The Bottom Line

Your credit report is important, so don’t forget about it. You get one free look at your credit report each year (note – this report does NOT include your credit score), so you should take advantage of it. Some studies have shown that up to 30% of credit reports have some inaccurate information, and it is always in your best interest to have these resolved as soon as possible.

Pop Quiz!

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Assignments Have Gone Mobile!

Assignments Have Gone Mobile!

Mobile assignment previewHave you ever been working on a trading assignment on HowTheMarketWorks, only to be frustrated when you want to check your progress on a mobile device?

Not anymore!

Mobile Assignments Are Here

Whether you are trading on an Android tablet, Windows smartphone, or Apple Watch, you can monitor your assignment progress from anywhere!

As always, no software to download, app to install, or other restriction between you and your portfolio. Just log in to HowTheMarketWorks from any mobile device, and select “Assignments” from the main menu!

TFP.com – A New Personal Finance Resource For Teachers

TFP.com – A New Personal Finance Resource For Teachers

teach personal financeTeachPersonalFinance.com is a new resource for teachers that opened in the last year. It is a collection of recommendations, resources, and suggestions from a veteran personal finance teacher with over 30 years of experience.

There is a “Personal Finance Toolkit” of recommended resources and supplements for teachers (including HowTheMarketWorks!), along with the best ways to add both free and paid supplements to any personal finance class.

There are also recommendations for setting up personal finance-focused after school programs, crash courses for teachers, textbook recommendations, and much more.

Click Here To Visit Teach Personal Finance

 

Real-Time Rankings Are Here!

Real-Time Rankings Are Here!

rankingsFrustrated with the delay between the updates in your portfolio value, and how fast you move on the rankings page?

Not Anymore!

Real Time Rankings on HowTheMarketWorks

In the past, we needed to check everyone’s account and revalue them in a loop to update the rankings page – a process that could take up to 2 hours! We sped this up a few months ago by only showing people who have placed at least 1 trade, but get ready for true high-speed competition!

The value showing on the rankings page now updates every time you place a trade, and your position with it. This means every buy, sell, short and cover can move you up or down in real time. Users who don’t log in or trade are still updated every hour.

This also means we are now including every participant in every contest in every ranking – a feature teachers have been dying for, so now it only takes a second to see who is – and who is not – correctly registered in your contests.

More new features coming soon!

 

What is Economics?

What is Economics?

Definition

“Economics” is often called the Dismal Science – it studies the trade-offs between making choices. The purpose of economics is to look at the different incentives, assets, and choices facing people, businesses, schools, and governments, and see if there is any way to improve outcomes.

This is done by looking at how supply and demand are related throughout the economy, exploring different allocation methods, and investigating how to change (and what impacts there are from changing) the distribution of wealth.

Examining Costs and Benefits

The central problem in all economics is exploring different costs and benefits of choices made by everyone in an economy. This is not just the dollar cost of an action, but also what is being given up.

Every time a road is built in one place, that means there are not enough resources to build it somewhere else, so governments need to carefully plan construction to make sure each project gets the most possible benefit given all available alternatives. Likewise, if a school decides to build a new computer lab, they cannot use that money to hire a new teacher, do renovations on classrooms, or improve the school lunch menu.

Every choice made is a balancing act – trying to make sure the benefit you get from one action is greater than the benefit you would get from any other alternative.

Supply and Demand Throughout The Economy

At a bigger scale, when there are many people making the same kinds of decisions all at the same time, the economy as a whole also needs to balance everyone’s choices. This is how “Supply” and “Demand” appears, and how prices are determined.

For more examples on how prices are determined through Supply and Demand, read our full article on Supply and Demand Examples in the Stock Market.

Supply and Demand together are called “Market Forces“, large trends that result in one market outcome or another (such as the price of a good, and how much pollution is made in the production of those goods). When the supply and demand result in a particular number of goods to be produced and sold at a certain price, this is called a “Market Outcome“.

Market Outcomes

Just like how different Market Forces can produce one Market Outcome, all of the different Market Outcomes in an economy will result in different “Resource Allocations“. Resource Allocations refers to everything from how many people work in coal mines, to how long (on average) students stay in school, to how much workers earn, and everything in between.

This means that all of the Market Outcomes are related – if a change in supply or demand cause the price of a good to go up, the people who make that good will earn more, and more people will start making it. This means that the income of those people goes up, which means the goods they like will have an increase in demand, and the cycle continues. The specific market outcome, and resource allocation, depends mostly on the total resources available (all raw materials, all available capital, and the entire work force number and skill level), previous market outcomes, and government policies.

Not Just Prices – Different Allocation Methods

Using “Prices” is just one of many possible ways to allocate the total resources available. Depending on what market outcome we are focused on, a different allocation method might be better or worse. Economists often try to determine what the best allocation method is for particular goods or services to try to improve market outcomes.

Market Prices

“Prices” let individuals measure their own individual level of demand against a prevailing market price – how much they have of a good or service depends on how much others are willing to make it, and how much everyone else values it.

Auctions

Auctions are commonly used when there is a large imbalance between the number of potential buyers and sellers of a good or service, and the quantity available is limited. Economists spend a lot of time analyzing auction systems

For sellers, individual goods or services are left for potential buyers to “bid” on. This means that the person who values the good or service the most (in this case, who is able to pay the most) will get the good, and the seller gets the best possible price.

Auctions can also go in the other direction – a buyer could ask for sellers to “bid” to sell their good at a particular price, and the buyer will take the offer of the seller who can offer the lowest price. This is generally the case when a government hires a contractor to build a road – many competing companies provide “bids”, and the government makes its choice based on the bid price and the expected quality of the work.

Entitlements

Entitlements is a different allocation method – everyone gets a certain amount of a good or service, which is then paid for by taxes. This allocation method is generally used for “Essentials”, or otherwise things where it is impossible to charge someone based on their usage. The availability of public parks, drinking water, and clean air all use an “Entitlement” distribution system. Certain levels of basic housing and food is also generally provided as an Entitlement.

Price Controls

Even in a normal supply and demand system, price controls can be put in place by the government if a society is not satisfied with the pure market price allocation. This can be things like adding extra taxes to increase the price, giving subsidies to decrease the price, or telling sellers they can’t sell a good or service above or below certain prices.

Changing The Distribution Of Wealth

The distribution of wealth is more complicated than just how much the top 1% earn compared to the bottom 99% – it also examines how wealth is distributed between industries in an economy, how much different skill levels are worth relative to others, how taxes are paid and collected, and much more. When economists look at changes in the distribution of wealth, it is usually by making subtle changes to these smaller factors which add up to changes on a bigger scale, rather than trying to find a single way to transfer wealth from the “Rich” to the “Poor”.

Taxes and Transfers

Taxes and Transfers refers to the last point – taking money directly from the rich through taxes, and refunding that money directly to the poor through a subsidy or other transfer. This is the most blunt way to change the distribution of wealth, but it also has the largest implication for the total market allocation in an economy.

For example, the Rich use most of their income for investment, while the Poor use almost all of it for direct consumption. This is because the rich generally don’t get much benefit out of an extra $100 worth of groceries in a month, but that might be a very large boost in living standards for the poor.

By giving a single rich person an extra $10,000 in taxes, and using that revenue to give $100 directly to 100 people, those 100 people will almost certainly be made much better off than the one rich person was made worse off. However, that means that $10,000 would not be invested to help new companies grow, which in turn means fewer jobs are created to help build new wealth. A central problem of economics is trying to balance the consumption and benefit of people today against taking measures to help more growth for the future.

Government Spending

Economists also try to influence the distribution of wealth through government spending. This includes things choosing to use government money between giving grants to start-up businesses to create new jobs, or using that money to give scholarships to students to get a college education. Both outcomes are directed towards growth, but it is challenging to determine how to balance different spending alternatives to encourage different kinds of growth.

Another example comes from direct government spending – some countries spend a large amount of money on biotechnology research to build a new sector of their economy, while other countries spend more on building more public housing connected to public transit, to try to help the poor get better jobs in economic sectors that already exist.

Every part of economics is measuring these trade-offs – the benefits and costs of one choice versus another.

Types of Companies

Types of Companies

Have you ever wanted to start a business? Maybe you want to know the difference between a lemonade stand and Minute-Maid, besides just the size of the companies.

Different types of companies have different levels of liability (meaning level of responsibility) for the owner or owners. What this means is that the more liability an owner has, the more that owner is responsible for the company’s debts. Different types of businesses also have different rules on how they can be managed, and how the owners can be paid.

Sole Proprietorship

Sole ProprietorshipThis is the simplest type of business – the entire business is owned by one person. There generally are no requirements to operate a sole proprietorship – if you ever sold something, you have already worked as a sole proprietor.

Sole proprietorships can have many employees, but the key factor is that the business itself is owned by just one person.

Ownership Liability

In a sole proprietorship, the owner takes the full liability for the entire company’s debt. That means that if, for example, the owner took out a loan to start the business but then goes bankrupt, he or she could have their other assets seized by creditors (such as their car or home).

This also means that if someone wants to sue the business, they can also just sue the owner directly (even if the business has already closed).

Most larger businesses don’t want to always have that much liability, so usually as businesses get larger, then tend to move on from sole proprietorships into other business types.

Owner Compensation

With a sole proprietorship, everything that is owned by the company is owned directly by its owner. This means that most owners can (and usually do) mix their personal finances and business finances. An example of this would be taking money directly from your cash register to buy your personal groceries.

This means that the owner keeps 100% of the profit from the business for him or her self, and reports all the income, profit, and loss on their own personal taxes.

“Doing Business As”

A sole proprietor may still want to register a company name (although this is optional), which they can then use for bank accounts and legal paperwork. This is known as “doing business as” another name, and the rules vary by state. In this case, the sole proprietor still has unlimited liability, but can use another name for their business.

Partnerships

Partnership“Partnerships” exist when two or more people decide to run a business together. There are “General Partnerships” and “Limited Partnerships”.

Unlike a sole proprietorship, a partnership requires a contract in order to exist, where the partners establish the existence of the partnership. Like a sole proprietorship, the owners still own the entire company themselves, along with all its profits (and losses), but the partners can choose to use a “Doing Business As” name.

General Partnerships

With a general partnership, the business works just like a sole proprietorship, but with several owners instead of just one.

Ownership Liability

All of the partners are fully liable for the entire business, just like a sole proprietorship. Partners are also liable for the actions of their other partners any time one of them is acting on behalf of the business.

For example, if you have a partnership that sells stereos, and your partner agrees to sell them at $1 each, you are obligated to honor that agreement.

Ownership Compensation

All of the profits and losses are divided equally between the partners (although in the initial contract, the partners can specify that one gets a greater share than the others).

Limited Partnerships

Limited PartnershipWith a “Limited” partnership, there is at least one general partner, plus at least one “Limited Partner”. The limited partner does not have all the rights, responsibilities, and obligations as the general partner, but also does not share the full liability either.

Ownership Liability

The general partner has the same liability has the same rights as a general partnership, but the limited partner has somewhat less (usually only as much as they invested in the company to start with). This also means that the general partner might not be liable for the agreements made by the limited partner, if he or she can show that those actions were “negligent” or purposely harmful.

Ownership Compensation

The limited owner usually has their compensation set to the same restrictions as their liability – there might be a cap to how much they can “take out” of the business. The specific rules depend on the terms in the partnership contract.

Corporations

CorporationThe biggest type of business is a corporation. These operate under different rules from sole proprietorships and partnerships – a Corporation is its own legal entity (meaning it can have its own bank accounts, and be sued directly). Corporation’s most useful feature (as far as the owners are concerned) is totally limited liability, but this comes at a high cost of management and organization.

Ownership

When a corporation is created, it exists with a certain number of shares of stock. Whoever holds those shares is a part owner in the company – how much they own is based on how many shares they hold.

Instead of the company being managed directly by the owners (like a sole proprietorship or partnership), the shareholders then elect a “Board of Directors”. The day-to-day management of the company is overseen by the Board, but for some larger decisions there are occasionally calls for each stockholder to vote. The Board of Directors is also responsible for hiring and firing the highest levels of management (like the CEO), and the Board is the direct “boss” of those managers.

Ownership Liability

The owners of the company (stockholders) have entirely “limited” liability – they can only lose as much as their stock is worth. This means that if a Corporation goes bankrupt, the individual stockholders will lose the entire value of their stock, but nothing more.

Ownership Compensation

The shareholders of a corporation are entitled to the company’s profits, which are paid out as dividends. Read our full article on Stocks for more information.

 

Contract

Contract

Definition

ContractA “Contract” is a legally binding agreement between two parties (people, companies, or both). Having a contract means that if one party does not keep their word, the other can sue them in court to either force them to fulfill their side of the agreement, or pay back compensation.

What Makes A Contract Binding?

Not every agreement is a binding contract, but every contract has a few necessary parts.

Consideration

“Consideration” means both parties have something required of them, something they would not normally be doing except as part of the agreement. If one party is agreeing to do something but the other party does not need to do something else in exchange, it would be considered a gift and not a contract.

Offer and Acceptance

The “Offer” is what each party says they will do. The offer needs to be very clearly defined to make sure both sides know exactly what they are agreeing to do, and what they are getting in return. The “Acceptance” means that both parties agreed to take each other’s offer. If you do not have a very clearly defined offer, you do not yet have a contract. Likewise, if both parties have not yet fully agreed to the offers, they do not yet have a contract.

For example, if Alice owns 10 shares of Google stock and offers to sell some of her shares to Bob, and Bob agrees that he will buy them. They do not yet have a contract. This is because the Offer was not yet clearly defined – the agreement does not include how many shares, at what price, or when Bob would receive them.

Now let us say that Alice comes back and says she will sell 5 shares of Google at $700 each to Bob, and he will get them next Monday morning. In this case, we still don’t have a contract yet. Bob agreed that he wanted to buy some shares, but he did not yet agree to this specific offer of 5 shares at $700 each next Monday, so we do not yet have an agreement.

Intention To Make A Legal Contract

Both parties need to actually intend to make a legally-binding contract. This might seem obvious, but this is the key difference between an informal agreement and a binding contract. For example, you might have an agreement where you mow your neighbor’s law for $10 a week. There is a clear offer and clear acceptance, but since the consideration is so low for both parties, it may not be clear that both parties intended the contract to be legally binding – just an informal agreement.

What Can Void A Contract?

If you have your Consideration, Offer, Acceptance, and Intent, you might still not have a contract because of a few factors that can break them.

Legal Capacity

child
Pictured: someone who could not enter a legally-binding contract to sell you that flower

“Legal Capacity” means that all parties need to be able to make a contract to begin with. There are a few ways someone might be considered to not have the legal capacity to enter a contract:

  • Anyone under the age of 18
  • Someone who went bankrupt in the last 5 years buying something worth more than $6,000 (without telling the other party they went bankrupt)
  • Anyone with a significant mental disability

There exceptions to these exceptions too – someone under the age of 18 can still enter a binding contract for a “necessity” (like food or shelter), but not for most other things.

Forced Agreement

All contracts must be entered in “Free Will”, meaning you can’ force someone to enter into a legally-binding contract (so the mafia can’t force you into a contract by threat, for example).

Illegal Contracts

Even if you have everything else, your contract might still not be valid because it is asking something illegal. For example, you can’t have a legally-binding contract to sell illegal drugs.

Does A Contract Need To Be In Writing?

It depends! Generally speaking, verbal contracts are a lot harder to prove they have all the necessary elements, but if you have witnesses, it might still be legally enforceable. Some contracts, such as land sales, do need to be in writing.

If you want to make sure you have a legal contract, you should always get it in writing.

Net Worth Calculator

Net Worth Calculator

Net Worth Calculator!

Knowing your net worth is the first step towards growing it! This tool will help you organize your assets in one place, and even help project how they will grow in the future.

If you have used our Home Budget Calculator to help see where you can improve your savings, the next step is measuring your net worth to see how to make it grow.

Once you have found your net worth, you can use our Saving to be a Millionaire Calculator to see what rate of return you need to reach to hit your savings goals!

Check out some of our other calculators:

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Janene’s March Trading Strategy

Janene’s March Trading Strategy

Contest: March Trading Contest

Final Portfolio Value: $131,022.78

Trading Strategy For This Contest

I’ve watched the market as it fluctuates, learning to buy and short gold as it adjusts. I tend to go with my gut instinct when buying stocks. Sometimes it works, sometimes, not so much. The best thing you can do, to help you succeed in the market, is homework. I also buy the cheaper stocks as they fluctuate more rapidly than do the expensive ones.

Final Open Positions and Portfolio Allocation

 

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Banks, Credit Unions, and Savings & Loan Institutions

Banks, Credit Unions, and Savings & Loan Institutions

When talking about Banking, people generally group Banks, Credit Unions, and Savings & Loan companies all in one group. They do provide similar services, but they each have specific differences that might make them a better or worse fit for your financial needs.

What They Have In Common

All three of these institutions can do all the things you would normally associate with a “bank” – opening checking and savings accounts, making commercial loans, and issuing residential mortgages.

Savings and Checking Accounts

When you deposit cash at a bank, credit union, or savings and loan, you will put it into a checking (also called “Current”) account or a savings account.

Savings Account

Savings accounts are usually the first type of bank account you might open as a child. This is an account where you can make deposits of cash, and earn interest. How much interest you earn can vary a lot based on how much you have saved, how often you withdraw, the overall market interest rates, and even just by institution.

Savings accounts pay interest because banks use the money you have saved to make loans to other people and businesses. This is also the reason that you might get a better savings rate if you keep the balance in your account higher – if the bank knows that your deposit isn’t going to suddenly be withdrawn, they are more secure in lending it out and so encourage you to keep it saved. If you tend to withdraw a lot of your money from a savings account frequently, the bank has a harder time maintaining that cash balance necessary to make loans, so they are not going to give as high a rate. Credit Unions generally specialize in savings accounts.

Checking Accounts

Checking accounts are where you store your “day to day” money, meaning you will have a lot of frequent deposits and withdraws. Your checking account is the account that gets drawn down when you write checks, use a debit card, and usually where you pull money from when you use an ATM.

Since banks have a lot more management necessary for a checking account (processing check payments, keeping many detailed transaction records, ect), there are usually fees associated with owning a checking account, and it does not usually pay interest. Some institutions might cancel your fees if you keep a minimum balance in your checking account (just like they give higher interest rates if you keep a minimum balance in your savings account), but this can vary widely by institution.

Making Commercial Loans

A “Commercial Loan” is a loan made to a business, usually to “start up” or to expand their operations. Banks, Savings and Loans, and Credit Unions differ a lot on how much of their business comes from commercial loans, but for small businesses looking to secure start-up loans, each institution might be a good choice.

Commercial loans have a lot of different types, from a commercial mortgage (to buy new land or build a new building) to just the costs of renting and renovating a storefront and getting open for business. The duration of these loans can be anywhere from 18 months (small, short-term start-up loans) to 25 years (larger commercial mortgages). Unlike a normal mortgage, it is rare for a business to pay off their entire loan. When a business pays off a certain percentage of its loans and has continued to grow, they will usually use the equity they have built up to make more loans to finance their continued growth. This does not apply to some small businesses without a large expansion strategy, but does apply to medium and large-sized businesses. Banks generally specialize in commercial loans.

Residential Mortgages

A residential mortgage is a loan that a person or couple takes from a bank, credit union, or savings and loan institution to buy a house. A residential mortgage is usually for a very large amount (usually over $100,000 and often more than $1 million), and is usually paid over 25-30 years. Residential mortgages are for very large amounts of money and take a very long time to pay off. This means that the institution you borrow from for your mortgage needs to have a lot of deposits available to make sure they have enough cash to make these loans. Savings and Loan institutions generally specialize in Residential Mortgages.

What is the difference between Banks, Credit Unions, and Savings and Loans?

Despite offering some similar services, there can be huge differences between these three types of financial institutions.

Banks

One of TD's commercial banks
Commercial bank branch. Photo by Mike Mozart

Banks are for-profit corporations with a charter issued at the local, state, or national level. They issue stock which is owned by investors, and those investors elect a board of directors who oversee the bank’s operations. Banks generally specialize in commercial loans – making loans to businesses to help them get started or expand.

Local banks are becoming less common, while national banks are becoming a lot more common. Over the last two decades, many local banks have been bought or merged with State banks, who in turn were bought or merged with National Banks. This has some advantages – by using a national bank, you will have access to a bank branch, ATMs, and in-person account services in a lot more locations than smaller institutions. Larger banks generally offer a lot more account management services and account types than other institutions. For example, a national bank might offer some types of checking accounts that offer points and rewards for certain types of purchases (like gas and groceries).

Because they are much larger, banks also generally have better online banking services, with more account management services. This includes things like transferring between your checking and savings accounts, viewing the checks you have previously written, checking balances with mobile apps, opening and closing credit cards, and managing automatic payments and deposits. Banks will also generally offer a lot more choice for residential loans as well.

There are some significant drawbacks as well. Banks generally have higher fees than other institutions for its services, with lower interest rates for savings (although this is not always the case). It is fairly rare to find truly “free” checking accounts at banks. The large amount of choice you have for your savings and checking accounts can be a drawback as well – if your life circumstances change from what they were when you first opened your account, you might end up with more fees and less benefits than with a different account type, but very few people consider changing very often.

Credit Unions

Credit Union
Credit Union, photo by Mike Mozart

Credit Unions are the financial opposite of banks – they are non-profit, almost exclusively local, and are owned by the people who make deposits. Every member who makes a deposit at a credit union is a part-owner, and can vote on issues relating to the union. They can also get elected to be the managers of the savings and loan.

Credit unions specialize in savings accounts and making short-term loans. Since they are non-profit, all the profits made by these loans are given back to the credit union’s depositors as dividends. Many depositors also prefer credit unions because of the more “Personal Banking”. This is because credit unions are almost exclusively local, and the credit union relies on the deposits to stay in business, and so they often have a reputation for excellent customer service. Since they are smaller with less management costs, Credit Unions will often have better savings account rates than a bank, and you are more likely to find free checking accounts.

Credit Unions also have their own drawbacks. They do not focus on commercial loans, and so if you want to start or expand a business, you might have to look elsewhere. They also prefer short-term loans, so you might also not be able to get many options for a residential mortgage. They are also much smaller than banks, which means you might not have access to as much of the online account management features, like bill payment and opening new accounts. If you travel a lot or move, the local credit union will also not be able to provide much service if you are outside their immediate area.

Savings and Loans

Savings and Loan. Photo by the Boston Public Library
Savings and Loan. Photo by the Boston Public Library

Savings and Loan institutions focus strongly on residential mortgages. In fact, by law they need to invest 65% of their assets in residential mortgages, and only up to 20% in commercial loans. They can also be local or national (like a bank).

Savings and Loans can be organized like a bank (owned by investor shareholders) or a credit union (owned by the depositors), but is always for-profit. Specializing in residential mortgages means that you might find the most flexibility for your mortgage at a Savings and Loan, and their smaller focus means that you will often see better terms for mortgages here than elsewhere (but not always!).

Savings and Loans do suffer from some of the same problems as credit unions. Their emphasis on slow-maturing mortgages means they are often lagging behind banks with account management and online services.

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Financial Records

Financial Records

Financial Records are what you use to have an easy way to tell where all your money and assets are, and exactly how much you have, at any given time.

They are not one document, or even one type of document. In fact, most people’s financial records will not look the same as anyone else’s, because each person has unique ways of organizing their information to make it most accessible for him- or herself.

Financial Record Basics

Your financial records are useful for many reasons, but they generally fall into two categories. First, they make it much easier to do financial planning (particularly managing your saving and investing). Second, they can be extremely important (often legally required) for tax purposes.

Financial Planning

When you are building or evolving your financial plans and setting new financial goals, you need to start with accurate financial records so you know exactly where you are starting from, and know exactly when you have reached your goals. For example, if you want to save $300 over the next 4 months, you need to know how much money you have now, and in 3 months you will need to be able to make the same measurements.

If your current bank balance is $250 and you want to save up to reach $400, your savings goal would be to earn extra cash or trim your savings to reach it. If, however, you find an uncashed check for $150 from your last birthday in a pile of papers on your desk and deposit it into your account, you will hit that $400 target without actually accomplishing anything. This is one example of poor financial records hindering your ability to set and reach your targets.

Taxes

tax return
Pictured: the money you can’t get back because you didn’t save your receipt

The government uses taxes and tax returns to try to encourage or discourage certain behavior, or to make some expenses more “fair”. For example, if you buy a car, you can usually get a partial return for the sales tax based on the vehicle’s value, how environmentally-friendly it is, or how much you use your car while at work as part of your job.

This means that if you want to claim these tax returns, you need to have accurate documents on how and when you bought it, and odometer readings showing a very close estimates of how much you use your car for work. Without these documents, you can’t claim the tax returns, and can end up missing out on a lot of money.

Types of Financial Records

There are dozens of types of records, but the key is keeping them all organized. You can divide all your records into two big buckets – “Primary” records (which will be extremely varied and scattered), and “Secondary” records (which you will generally maintain yourself to keep your primary records organized).

Primary Records

Receipts

receipt If you want to claim any tax breaks, you will need to keep careful track of your receipts. These are the most basic financial record there is, just a piece of paper showing that a transaction has taken place.

Depending on where you live, you should always save the receipts for large purchases (like your car’s bill of sale). Many cities also provide tax breaks if you use public transit, so it is also a good idea to save those receipts.

They are also useful to keep beyond your taxes. For example, utility bills and receipts are often required as a “proof of address” when you want to open a bank account. If you get in a conflict at a later date over a bill being paid, having a receipt can shut down the problem immediately, while proving otherwise can be a long and drawn-out process.

Bank Records

Your bank account will be one of your most important sources for financial records. Usually, your entire transaction history is saved for a few years (including every check you write), along with your current account balances. If you do not have a receipt for a payment (for example, if you write a rent check every month), you can still have a record of that transaction in your bank account.

You will have different records available based on different account types. For example, if you have a savings account, you might have more records on deposit amounts and dates, with accumulated compound interest. If you have a checking (or “Current”) account, you will have your current available balances, along with your transaction history of your checks, debit card transactions, and ATM withdrawals. Your bank records will be an invaluable resource when you are building and changing your Spending Plan.

Income Reports

W-2 form, perhaps the most important financial recordYour income reports are statements showing how much money you’ve earned, usually along with how much income tax and social security you have paid, in a given year. The most common of these is the W-2 form in the United States, but you might have others if you are self-employed or work occasional odd jobs on the side. These are necessary to file your taxes, but are also useful to see how your income evolves over time.

Investment Statements

If you have any stocks, bonds, or other investments, you will also get regular account statements from your broker. This will include your cash balances (available for withdraw or purchasing more securities), the total net market value of your portfolio, the amount of any dividends you have received, the total expenses of your investments (this is most important with mutual funds). Your investment statements are essential for tax purposes. Unlike claiming deductions for receipts, you are legally required to report any investment income you receive, so having ready access to these documents will be essential.

Personal Property Inventory

Unlike the other primary records, this is one you will make and maintain yourself. Your personal property inventory is basically a list of what you own, where it is located, and its estimated value. This seems fairly simple when you are still in school, but there are more than a few cases of large amounts of cash stashed and forgotten. Also unlike the other records, your personal property inventory is not used for taxes. The main benefit of keeping and maintaining it is purely organization – knowing exactly where your things are, and how much they are worth, can be very useful when your life circumstances change and you want to sell (or give away) things you no longer use or might have forgotten about. The self-service storage locker industry thrives on people making monthly payments to save things they do not regularly use!

Secondary Financial Records

Your secondary financial records are usually just bigger lists, putting together your different primary records into easy-to-read documents for your own personal reference. Usually these are reports you would put together yourself, but there are some cases where they would be automatically generated.

Income Tax Returns

After you’ve filed your income tax return, keep a copy for later reference. This also includes any receipts you have from taxes paid – these can be very important if you are audited one day. Legally you should hold on to all tax returns and receipts for 7 years, but it can be useful to keep them for longer if you want to occasionally work on long-term financial planning.

Net Worth Statement

Your “Net Worth” is basically a sum of all your assets, minus all your liabilities, in one document. This is where you would add up your personal property inventory, investment values, bank balances, and cash you have squirreled away in a bunker in the desert, and subtract the outstanding balances of your credit cards, student loans, car loans, and home mortgages. This should be a one-page document you update every couple of months that helps you see your entire financial standing in one place.

Personal Expense Records

You might end up accumulating dozens of receipts in a relatively short period of time. Every few months, try to group them together and keep them in a safe place (for example, all receipts for “January – March 2016” kept in a folder in a fire-proof safe). While you do this, copy the amounts and the reason for the purchase into an excel spreadsheet. This will make it easy to know how much you spent and where you spent it for later. Plus, you can use your spreadsheet to quickly and easily find the original receipt later if you need it. By filing away all your receipts regularly, you make it less likely for any to get lost or accidentally thrown out. Doing it regularly is important to avoid a backlog (and so having to take an entire afternoon to file your receipts rather than a few minutes every few weeks).

Keeping Your Records Secure

Now that you have all of this information, your main concern is keeping it safe. Identity theft is a major problem, and if someone were to get unauthorized access to just a few of your documents, they might be able to use it against you.

Storing Paper Documents

For things like your tax returns, receipts, and investment statements, you might have paper copies that need to be both easy to find and secure. One possible route is to buy a small safe you can bolt to the floor, keeping your documents safe and all in one place. Historically, people have also rented safety deposit boxes (small ones can be about $60 a year), which is a trade-off of extreme security with inconvenience of needing to visit the bank in person and paying the annual fee.

Storing Electronic Documents

Keeping your computer files safe from hackers and phishers is a much more challenging prospect. There are dozens of ways to keep your records safe, but these are the most common rules to follow:

Rule #1: Don’t Share Your Login Information

Despite what the movies show, most “hacking” is done not by forcing complex computer algorithms to hack a mainframe, but usually just because someone shares a password with someone they shouldn’t have. This goes not just for passwords, but other information as well – never give your account numbers, credit card numbers, usernames, or passwords over the phone or by email. If you absolutely need to share a username and/or password (sharing an account with a group, for example), make sure it is a username and password you don’t use on any other websites.

Rule #2: Don’t Re-Use Your Password

You can’t tell which sites you use let the administrators see your password, and which use proper encryption. If you re-use the same usernames and passwords in many places, you’re increasing the chances that a disgruntled employee steals data and breaks into your other accounts.

Rule #3: Change Your Passwords Often

Even the most secure, unique password in the world is vulnerable to keyloggers – a type of virus software that records every key you press, and reports it back to the virus’s creator. Even if you don’t have a keylogger on your home computer (which can be hidden for months or years before “activated”, it is possible one might be on a computer lab or public computer you might access. Changing your passwords every few months is a good way to keep them safe.

Rule #4: Pick Hard-To-Guess Passwords

Make it hard for someone to just get into your account by guessing, or a hacker just trying random letter combinations until they get in.This webcomic illustrates how this does not mean it has to be something difficult to remember, but there is no “golden key” to making sure your passwords remain secure.

Other Financial Record Tips and Tricks

See What Account Management Services Some Financial Institutions Can Provide

If keeping track of everything is a daunting prospect, see what kinds of services your bank or other financial institution can “bundle together”. For example, it is extremely common for a person to have their savings and checking accounts, investment portfolio, home mortgage, and credit card all through the same bank, and so they are able to access all of those financial records through the bank’s online portal.

This has a strength of convenience, but there are also some serious drawbacks. For example, if you have your password stolen for this online banking service, you might lose access to everything all at once, costing a massive headache and potentially tens of thousands of dollars.

Since you aren’t shopping around for the best rates on your different accounts (high interest for your savings, low for your credit card and mortgage, and the lowest possible fees for your checking and investment accounts), you will also very likely be getting a lot “less for your money” than if you shop around separately for each service.

Visit Tax Professionals or Financial Advisers

Even if you do not do so every year, taking some time to visit with a professional can end up saving you a lot of money in the long run. For example, they can help you tell when you need to save receipts versus not, saving you a lot of time and headache in organization, and they will help you tell exactly how to use them to claim all your possible tax credits.

You might be able to remember the basics – if you have an expense that is used primarily for business, you can probably claim a tax credit on it. However, you might not know the exact process of claiming time you used your car while working, or if you can claim sales tax exemptions for new renovations on your home. Meeting with a tax professional or a financial adviser is the easiest way to navigate the seas of red tape and get the most out of your tax returns, and minimize how much time and research you need to spend on your financial records out of your own free time.

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