In your quest for financial wellness, you have probably heard countless times the importance of investing as part of a well-rounded financial plan. While this is true, most articles don’t tell you how to invest wisely, what role investments play in your wealth-building journey or even what the Market can tell you.
We understand that you want to invest in a way that’s aligned with your goals and values. But you can’t do that without a clear understanding of what the financial market is, how it operates, and strategies to approach it. In this three-part series, each piece will provide a more holistic understanding of investing and how it works with your financial plan.
Today, we’ll be defining and demystifying the market to give you a more comprehensive view of how investing works.
Breaking It Down
The first thing to define is what we mean when we talk about “the market.” In most news stories and media outlets, it is often referring to the activity of the U.S stock market. But the financial market as a whole is far more comprehensive and includes any medium through which securities can be traded.
While the stock market is one facet, it is far from the only one. Other types include bonds, derivatives, foreign exchange, and commodities. Each of these serves a different purpose, either gaining capital or offsetting risk. They are public which makes them a great place to set transparent pricing and knowledge about trading.
Most of what you will need to know about your investments centers around the stock market.
What is the Stock Market?
It is a subset of a financial market where successful corporations seek expansion (a.k.a cash) through investors. Stocks are shares of ownership in a particular public company that are sold to investors, and profits happen when the company does well and increases its earnings. This is the bare bones of how the stock market functions.
What does it mean for you when it is doing well or is floundering (like during the global pandemic)? For the general state of these activities, we turn to two tough animals: a bull and a bear. Each of these represent a different phase of the market and economy.
The Bull Market
Bull indicates rising stock prices. But beyond this, a bull market is a term often reserved for rising prices over long stretches of time — like what was seen before the global pandemic crash in March.
While there is no set criteria to trigger a bull market, it’s often associated with the rule of 20:
- 20% rise in stock prices
- This rise proceeds a 20% fall in prices
- The rise precedes another 20% drop
These are hard to predict and there’s no prescription for how long they last; it could be months or even years. We experienced the largest bull market run in history from 2009 to March 11, 2020. These market conditions happen when the economy is strong, there is a solid gross domestic product, decreased unemployment, and overall optimistic investor morale.
The Bear Market
Bear indicates falling stock prices — a day all investors know will come but hate when it does anyway. Although there are no hard and fast rules, they are often marked by at least a 20% drop in stock prices. A market correction, on the other hand, is more in line with a 10% drop in prices. In bear markets, the economy tends to slow down along with a spike in unemployment numbers.
How did these animals become an economic metaphor for market health? It has to do with each animal’s preferred method of attack: a bull plunges its horns in the air, a bear swipes its paws downward. Interesting tidbit for your next Zoom family party.
Understanding Market Volatility
You may hear talk about market volatility and wonder what that really means. Market volatility measures the fluctuation of stock prices. If the volatility is low, there is little change; but when volatility is high, big changes can be expected.
How is volatility measured?
Since volatility is a matter of statistics, it’s usually measured by the standard deviation or variance between the returns of a specific security (stock, bond, etc.) or market index across a certain time frame. Time is a crucial factor when it comes to volatility as the volatility of something can be measured in days, weeks, years, etc.
So when talking about volatility on a larger scale, we are really talking about risk. If a security has higher volatility, it is often a riskier asset than one with lower volatility. Since volatility looks at the statistical return of a specific asset or index, it’s important to understand how it works and what influence it may have on your risk tolerance and portfolio management.
Introducing Market Indexes
An index helps indicate market movement by tracking a certain basket of securities. These securities are monitored for performance and intended to represent a certain part of the market. Each index has different weighting systems to measure progress.
Indices are a great way to get a sense of what the market is doing. While there are several indices out there, the two most popular are the DOW and the S&P 500.
The Dow Jones Industrial Average (DJIA) index tracks 30 blue-chip stocks representing the major market sectors like IT, pharmaceuticals, finance, chemical, and more. The only sectors it doesn’t represent are utilities and transportation (which have their own index).
The DJIA is a price-weighted index, meaning overall performance is primarily determined by the price of the stocks within the index. This type takes the price of all stocks in the index and divides it by the number of companies to get the index’s value. This means a higher-priced stock gets more weight than a lower-price stock, making a change in stock prices an important determinant of its performance.
The S&P 500
Unlike the DOW which tracks 30 stocks, the S&P 500 tracks 500 stocks across all economic sectors. To enter this index a company has to meet specific criteria:
- It must be a U.S company
- It must reach market capitalization of at least 8.2 billion (as of 2020)
- 50% of the stock must be available to the public
- Four consecutive quarters of positive earnings are required
- Possesses positive liquidity
The S&P 500 is weighted differently than the DOW. It tracks the market capitalization of all companies in the index. This just means the index tracks the total value of a company (in terms of the market) measured by stock price and number of shares.
Which Is More Reliable?
Indices are designed to represent the market as a whole, making a comprehensive view important. The S&P 500 tracks more securities and also looks at the total market value of each company (as opposed ascertaining true value with just the stock prices). These factors make it more reliable than the DJIA, giving investors a better overview of market activity.
The Bottom Line
The financial market is a fascinating arena and an excellent way to help you reach your goals. But before investing, it’s important to know how the system works so you and your financial advisor can create a portfolio that truly reflects your needs.
Look for Part Two of our series where we delve into types of investing strategies!
Need help with your investment plan? Give us a call today.
Disclosure: Abacus Wealth Partners, LLC (Abacus) is an SEC registered investment adviser with its principal place of business in the State of California. Abacus may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements. This brochure is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Abacus with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Abacus, please contact us or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).
This is not an offer to sell any type of security, and there is no investment currently available through Abacus. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell this security. This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Information was based on sources we deem to be reliable, but we make no representations as to its accuracy. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this article will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.
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My heart is heavy from the events taking place across the country. The recent deaths of George Floyd, Ahmaud Arbery, and Breonna Taylor are tragic events in a long series of injustices that have yet again exposed the layers of historical prejudice and systemic racism that Black people endure in our country. I stand with the Black community against injustice and racism.
My husband and I have been having a lot of conversations about our privilege. About how we want to raise and educate our children and about our desire to listen, learn and to get uncomfortable.
We are works in progress, but we can’t stay silent.
My personal response through Workable Wealth has been delayed as I spent the week with our leadership team at Abacus Wealth ensuring that our collective company voice was utilized to speak up about these issues. As a firm that manages close to $3 billion in assets, I made the call that the power of our collective voice took precedence over my single voice this week. Especially when so many in the financial services industry will stay silent.
As a white woman who is part of a predominantly white firm in a predominately white profession (only 1.5% of 85,000 Certified Financial Planner professionals identify as Black), I recognize that more action is needed. I want to be very conscious of our family’s (and my personal) steps forward. I am and always will be a believer that actions speak louder than words.
We are still in discussion about what this holistically looks like for us as a family, and are ensuring we move forward intentionally, with actions that stretch us, create a lasting impact, and that we can hold ourselves accountable to.
The following books are being read:
We spent this morning watching Coming Together: A Sesame Street & CNN Townhall on Racism as a family.
We’re making donations to organizations like NAACP, The Conscious Kid, and the Equal Justice Initiative.
We’re referencing this anti-racist resources document (which is the most comprehensive I’ve seen) to continue our education. More will transpire in the weeks and months ahead. We do not view this as a one-time sprint. This is a journey we’re embarking on for a trip that is long overdue.
On a final note, it’s critical to acknowledge that, in the midst of the protests and activism happening this week, we must avoid either/or statements.
Black lives matter AND I’m a former military spouse.
Black lives matter AND I have friends and family who serve our country as military, border patrol and police officers, whom I love.
Black lives matter AND there are systemic issues at play across most industries and governments.
Black lives matter AND there are implicit biases at play in each of us.
Black lives matter AND this topic deserves the attention, undoing, relearning and unpacking that it is receiving at this moment.
Black lives matter AND saying these words does NOT imply that other lives don’t.
Black lives matter AND it’s time to do the work to support and lift them up in ways that we haven’t been.
This is a collaborative effort and it’s one that takes humility, love and patience. I believe we are on the precipice of change. Change that happens when we work together.
Economic and social impacts of the coronavirus are still unfolding and the federal interest rate has moved to near zero. From stressing our healthcare system to millions of layoffs to business closures to mandated social distancing, we haven’t been faced with an economic crisis of this scale since the Great Depression.
In response, the Federal government is doing what it can to keep the economy afloat. On March 15, 2020, the Federal Reserve cut interest rates to near zero in an effort to balance the economy.
So what are federal interest rates? How do they work? In what ways will this “near-zero” rate impact you? Let’s find out.
Breaking Down the Federal Interest Rate
When people refer to interest rates they are often talking about the target federal funds rate or short term interest rates. But what does that really mean?
The federal funds rate refers to the rate that banks charge other banks for lending them money to meet their bottom line.
By law, a bank must have a cash reserve that equals a certain percentage of their deposits. This law is in place to make sure banks have enough money to handle the ebbs and flows of customers’ deposits and withdrawals.
If a bank is concerned about falling short on their reserve requirements, they can get a loan from another bank who anticipates a surplus of cash during that period. The interest rate that the banks charge each other is the federal funds rate, or the fed funds rate.
Who Sets the Fed Funds Rate?
A monetary policy-making body from the Federal Reserve called the Federal Open Market Committee (FOMC) gets together to set the federal funds rate. This group meets eight times each year, and sets the rate based on the economic climate. In extenuating circumstances, the FOMC can meet outside this schedule, which is what they did in March.
But this committee doesn’t have as much power as you think.
The FOMC can’t exactly force banks to charge a certain rate, so they set a target federal funds rate which is a range that they encourage. In March, the target federal funds rate was set from 0%-0.25% which is where the phrase “near-zero” originates.
The actual interest rate that a bank charges is determined through negotiations between the two banks and the weighted average among all transactions of that nature is referred to as the effective federal funds rate.
So how can the FOMC get that into their target range? They may not be able to mandate an exact fed funds rate, but they can have the Federal Reserve system adjust the money supply to sway interest rates in a certain direction by adding or removing money from the financial system. By adding money, they increase supply and drop the effective rate. The opposite is true for taking money out. By doing this, supply decreases which makes the effective fed fund rate rise.
How the Economy is Impacted
The federal funds rate is one of the most important interest rates in our economy because it impacts our financial condition as a country, which causes a ripple effect on other aspects of our economy like employment and inflation.
The Federal Reserve’s ability to add or detract money from the financial system can have a secondary effect on interest rates that we encounter in daily life like auto loans, home mortgages, credit cards, and savings accounts.
Many lenders set their rates based on the prime lending rate, or the rate of interest the bank charges their A+ clients (top credit) which is also impacted by the federal funds rate.
Investors also keep an eye on the fed funds rate as its activity tends to correlate with market trends. The market often reacts strongly to this rate which makes it an area of interest for many investors, brokers, and analysts.
Let’s look a little more at how the addition and subtraction of funds work for the economy at large.
Why Lower Interest Rates?
When the federal funds rate decreases, interest rates tend to fall along with it. This can be a really good thing, especially in terms of debt like auto loans, home mortgages, and credit cards. But this also decreases the amount of interest you can expect to get from your savings account or certificates of deposit (CDs).
For you, this means that when the federal funds rate drops, the government is encouraging spending over saving. By promoting borrowing money with better interest rates, the economy can be filled with some much-needed cash. When the economy needs some help, which it does now, lower interest rates will promote greater economic activity.
Why Raise Interest Rates?
Just like the Fed can decrease rates to bolster the economy, they can also raise rates to help ward off inflation. When the fed funds rate increases, interest rates tend to climb which is good news for your savings accounts and CDs as they will often see a greater return. But it isn’t so wonderful for other loans like credit cards or home mortgages.
When interest rates go up, it benefits people more to save money as opposed to spending it. Why would the government want to slow down spending money? The main reason is to keep inflation at bay and discourage a level of economic growth we couldn’t keep up with.
Practical Ways 0% Interest Impacts You Today
So now that you have an understanding of how the federal interest rate system works, you probably want to know how this “near-zero” situation affects your day to day life. COVID-19 has changed the way our economy has functioned and not for the better.
To incentivize greater economic activity, the government wanted to slash interest rates as close to 0% as possible. This will (hopefully) help promote regular economic activity so businesses can run, pay employees, and give people money to put back into the financial system. Let’s take a look at a few ways these low-interest rates could impact you.
Look Into Refinancing
Since lower interest rates can have a significant impact on your debt, now is a good time to reevaluate the debt you have to see if you can refinance or consolidate any of it for a more lucrative rate.
First, take a look at the type of debt you have, and what interest rate is associated with each. Some interest rates are fixed whereas others are variable. Many variable interest rates on credit cards, for example, might be lower during this time which can help you pay that debt off quicker. For credit card debt, you can also look for 0% balance transfers but be sure to read the fine print as that rate may only be in effect for a short period of time.
If you have multiple private student loans, consider refinancing those to a lower interest rate. In most instances, refinancing federal student loans isn’t as beneficial as they have more flexible repayment options and low-interest rates to begin with.
For those of you with a home mortgage, now is a great time to shop around for other lending options. Even if you closed recently, refinancing to a lower interest rate will impact the amount you pay over the lifetime of your loan.
Most people recommend refinancing if the interest rate is at least a full percentage point lower than your current one, but each person’s needs will be different. Keep in mind that in the refinancing process, you will need to have extra cash on hand for closing costs which can be significant depending on if you need to purchase points to lower the rate, the total amount you have left on the loan (private mortgage insurance) and the lender fees.
The pandemic has caused a lot of turmoil for people’s personal financial health, impeding some from being able to pay their bills and make ends meet. Should you be under tough economic distress, take some time to look at the options available to you.
The first thing will be to take advantage of the CARES Act stimulus check, which is $1,200 for those who filed taxes single and $2,400 for those who filed jointly. As a business owner, be sure to look into other CARES Act relief funds like the payroll protection plan and other provisions designed to help keep your doors open.
If you need to borrow money, now could be the time to do it. Start by looking at all of the options you have available to you: personal loan, credit card, business loan, etc. and start with the one that has the lowest interest rate. Also, look for a fixed interest rate so as not to incur a massive surprise when the fed funds rate increases again. It is always important to borrow money with caution. Do your research and only borrow what you need to.
Know Your Savings Accounts Won’t Grow As Much
Seeing the numbers on your savings account grow from interest payments is a great feeling, but with the fed funds rate so low, don’t anticipate as large of an interest payment as usual.
Many savings accounts’ interest rates have a close relationship with the target federal funds rate. With the current range from 0-.25%, most banks aren’t making any money on the bank to bank loans which doesn’t give them a lot of wiggle room when it comes to interest rates they pay on savings accounts.
The world of federal interest rates can be a bit overwhelming, but know that you don’t have to tackle it all on your own. Our team is here to help you make smart money choices that give you the power to live life on your own terms. Even in these uncertain times, we are here to help you. Get in touch with us today.
COVID-19 has brought about many changes, including fluctuations and volatility of the market leaving many people uncertain about their next move, especially with their investments. You might be asking yourself:
Will I be okay? How are my investments really impacted?
Let’s talk about a few resources you can leverage to make intentional decisions about your investments when the market (and the world at large) feels unpredictable.
Defining the Market
Sometimes the world of finance can seem really unapproachable. That misconception stems from wading through the jargon used to define different processes and systems. Today, we’ll break down what some of these common terms mean to help you get a better grasp of the lingo, and empower you to make informed decisions.
What do you think of when you hear the phrase “the market”? Sometimes it can feel like the market is just a vortex of money bouncing up and down without rhyme or reason. But the market is, of course, much more complex than that.
Markets, in general, are places where two or more parties can come together to exchange goods or services. There are many different types of markets but the one most applicable to this question is the financial market, which is a place where any security is traded.
The financial market consists of varying parts – like the stock market, exchanges, bond market, and foreign exchange markets. However, when you hear the phrase “the market” in the media, most of those sources are often referring solely to the U.S stock market.
How are markets measured? In other words, what system is used to gauge the total market performance? The short answer is an index.
An index measures the performance of a basket of securities (stocks, bonds, etc.) that is intended to represent a certain area of the market. You’re probably familiar with a couple of big indexes like the Standard & Poor’s 500 (S&P 500) and the Dow Jones Industrial Average (DJIA). While there are other indexes, let’s take a closer look at these two to compare how they operate.
How The DJIA Works
The Dow Jones Industrial Average was the first stock index to track American markets. Today, it tracks 30 blue-chip stocks ranging from all the major sectors (IT, finance, petroleum, chemical, pharmaceuticals, etc.) except utilities and transportation which have their own separate index.
Since the DJIA is a price-weighted index, the price of the stock is the primary determinant of the overall performance. A price-weighted index takes the price of all the stocks in the index and divides it by the total number of companies in order to ascertain the index’s value. This means that a higher-priced stock will get more weight than a lower-priced stock, making the change in stock prices a key factor in it’s performance metrics.
How The S&P 500 Works
The S&P 500 tracks 500 stocks across all economic sectors and in order for a company to be selected by the committee, it has to meet the following criteria:
- The company has to be in the U.S
- Reach a market cap of at least 8.2 billion
- 50% of the stock must be available to the public
- Four consecutive quarters of positive earnings
- Good liquidity
Unlike the DJIA whose performance is predominantly measured by stock prices, the S&P 500 tracks the market capitalization of the companies in the index. This just means that the index tracks the total value of a company measured by the stock price and the number of shares.
Why the S&P 500 is More Reliable
Since indexes are representations of the market as a whole, it’s important that the representation itself paints as accurate a picture as possible.
Let’s put this in terms of a poll. Polls are used to determine how a candidate is performing. Each method is designed to ascertain a candidate’s ranking among their competitors. The methods that are more comprehensive are often the better indicator of how the candidate is doing.
The S&P 500 tracks a more comprehensive part of the market not only by tracking more companies but also by tracking the total value of each company as opposed to just the stock prices, making it a more reliable system.
What “The Market” Means for You Now
With so many market fluctuations happening in response to uncertainty surrounding COVID-19, many people are concerned about the state of their investments. We know that the stock market is volatile and will experience dips and drops from time to time. However, this season has brought more than a few ups and downs, leaving investors concerned.
We want to help shift your focus from the things you can’t control to the things you can control. Here are a few action items to get your investments and financial plan back on track.
Give Yourself a Break
With our 24/7 news cycle, new information is at our fingertips every time we refresh our browsers. Sometimes that is a good thing, but other times it can just be overwhelming. Give yourself the grace to take a break and take care of your mental and physical wellbeing.
Take Another Look at Your Plan
When you’re stressed, separating reality from the story you’re telling yourself can be tough. Looking at your investment plan will help you get a sense of where you really are and can help eliminate fear or anticipation.
Remind yourself of your short-term and long-term investment goals as these are the benchmarks for your investment strategy and what type of securities (stocks, bonds, etc.) you buy. How have your goals changed due to these market changes? Odds are many of your long-term goals will stay the same. If this is the case, it is often best to stick with the plan you have.
This is also a good moment to look at your risk tolerance and see how your investments are allocated to best reflect that. Perhaps some minor changes need to make you more comfortable moving forward or maybe it’s best to keep it the same. No matter what, gathering all of the facts is so important before you make any decisions.
Keep Investing If You Can
It may seem counterintuitive to continue with your investments during these hard times, but it can actually help you a lot in the long run. Keep contributing to your retirement accounts (401k, 403b, IRAs) as it will give you access to tax benefits while also bolstering your savings, especially if you have an employer match. Investing, even if it is smaller amounts, can help you stay on track to reach your goals and give you the momentum you need to keep saving.
Understand Your Cash Needs
A strong cash reserve is on the minds of many due to a significant drop or loss of income for business owners and individuals alike. Start with making a 6-month plan of all your expenses: bills, food, rent/mortgage, etc. Then, take a look at the cash you have available to use.
- Can you draw from an emergency fund or savings account?
- Have you used the CARES Act stimulus check?
- If you are a business owner, have you applied for CARES Act relief provisions like the paycheck protection program?
- Can you take out a small loan or a limited line of credit?
There are many different things you can do to help cover your expenses during this tough time. Your financial advisor should be able to help recommend avenues that make the most sense for you and your unique situation.
Work With an Advisor You Trust
Trusted advisors are beneficial in times of hardship. When you are working with someone you trust, you will be able to have more confidence in your plan moving forward. We are here to help you create an investment plan aimed at reaching your goals. Get in touch today.
Taxes play an important role in your financial life. Their reach extends far beyond the dreaded April 15 (now July 15th for 2020) date and come into play much more than once per year. Taxes are actually involved in nearly every financial decision you make, chief among them being investing.
Taxes are to investing as textbooks are to education—you can’t have one without the other. So how do taxes work when you are investing and in what ways can they impact and inform your investment strategy?
Let’s find out!
What Accounts are Taxable?
Before we dive into the type of taxes to look out for, let’s review what type of accounts generate taxes.
Investment Accounts and Taxes
A taxable investment account, otherwise known as a brokerage account, is an account that is funded by after-tax dollars and allows the account owner to invest in nearly any type of security. Those securities could be
- Mutual Funds
- Real estate
With taxable investment accounts, you will be required to pay taxes on any gain in the year that gain happened. So if you had a capital gain of $5,000 in 2020, that money will need to be claimed on your 2020 tax return.
But what happens if your investments lose money? If you sell an asset at a loss (less than what you paid for it) that is known as a capital loss and doesn’t require any taxes. You can work to balance your tax bill by strategically balancing your capital gains and capital losses in a year as these losses can be used to reduce your taxable gains. In addition, you can deduct up to $3,000 in capital losses each year on your tax return with an option to carry forward the remainder.
Your long savings journey to retirement won’t come without its fair share of tax responsibilities. There are a couple of accounts that are tax-deferred accounts, which means the accounts contribute and accrue gains tax-free until distribution in retirement. The top two tax-deferred accounts are 401(k) and a Traditional IRA.
Both of these accounts are funded with pre-tax dollars. All of the gains continue to grow tax-free and are only subject to tax when you take distributions in retirement as ordinary income.
A Roth IRA and Roth 401(k), on the other hand, requires you to pay taxes when you contribute the money but not when you take it out, making it a vital savings vehicle for retirement. Roth IRAs do have income thresholds so if you make over $139,000 for single filers or $206,000 for married filers your options are limited, but you may be able to still contribute to a Roth by initiating a Roth transfer or backdoor Roth IRA in which you transfer funds from a traditional IRA into a Roth.
What Taxes Will You Owe (And Why)?
If you are earning money on an investment, the IRS will want a portion of that gain. Below are three main types of tax you might deal with when investing.
Capital Gains Tax
Capital gains tax is triggered when you make money, or realize a gain, on an investment. This comes from the sale of an investment at a higher price than what you paid. Sounds simple right? Well, the IRS has come up with a couple of stipulations to determine the percentage of capital gains tax that you will owe.
- Household income
- Length of time you held the investment
These two factors work to determine the percentage of tax you will pay on a capital gain. The first factor is based on your household income and your ordinary tax bracket and this number really informs the second criteria of how long you held the investment.
If you retain an asset for less than a year, that is considered a short-term capital gain and will be taxed at a higher rate, anywhere 10%-39.6% depending on your tax bracket. But, by holding onto your investments for a year or more, you will be eligible for the more favorable long-term capital gains rate, which ranges from 0%-20%, though most people pay about 15%. Again, that percentage will depend on your tax bracket.
Since selling assets costs you money, why is it worth doing? There are many reasons for people to sell assets including
- Withdrawing money
- Rebalancing a portfolio
- Desire to make a change to investment strategy
- Changing risk tolerance
- Diversification needs
- Market performance
The bottom line here is that your investments aren’t stagnant. They are moving and changing as your needs change. It is important to keep up with your investment strategy and understand what your needs and goals from it are to better create a plan that works for you.
Ordinary Income Tax
The second type of tax that you will need to factor into your investments is the ordinary income tax. This tax comes into play when you earn income through your portfolio in the case of dividends and interest payments.
Dividends are an interesting category and another way for you to experience tax on your investments. Some investments pay quarterly or annual dividends to their individual investors which are basically just a check that goes into your account. Interest works in a similar way. As a shareholder, some investments will pay you regularly, resulting in income.
This income is taxed at your ordinary-income rate. There are, of course, exceptions to this rule. Interest from municipal bonds is exempt from federal tax and for those lucky to live in California, they are exempt from state tax as well. If a dividend meets certain IRS regulations, it can be a qualified dividend that is taxed at the capital gains rate.
How to Keep Taxes in Mind When Investing
Tax planning is an important step to get the most out of your investments. As you can see, they play a major role in your overall profits. When factoring in taxes into your investment plan there are a couple of strategies to keep in mind.
- Asset allocation
- Asset location
Asset allocation is a strategy that looks at the specific securities that you invest in, like stocks and bonds, as well as the balance between those securities. Based on your aggressive risk tolerance, one account might be allocated to have 80% stock and 20% bonds, as an example.
If asset allocation is the balancing of securities, asset location takes it a step further by determining the best place to house those securities in order to make them as tax-efficient as possible. Believe it or not, where your securities live makes a huge difference in your overall return. Creating a strong plan around the role taxes play in your investments can help you come up with a strong, balanced, comprehensive investment plan.
Your investment goals will change and evolve as you do, so don’t be afraid to make changes when you need to. A situation might happen when you want to rebalance your portfolio or the market fluctuations support a different allocation depending on your risk tolerance and investment horizon.
The most important thing is to remember the investment goals that you set and employ a level of flexibility so that your strategy stays in line with where you are at in your life now.
Ready to change the way you approach your finances? Schedule a time to talk with us.
Moving jobs can come with many changes: cleaning out your desk, onboarding and learning a role at your new employer, and adjusting to a different team and office environment. One thing people don’t always think about is what to do with all the money accrued in their 401(k).
After all, it is your money! Having a game plan is critical.
In general, you have three options:
- Keep the money where it is
- Cash it out (except don’t do that unless you want up to half of the value taken away by taxes)
- Roll the funds over into a different account, usually your new company’s 401(k) or an IRA
A 401(k) rollover can be a beneficial strategy to maximize your money while still keeping it safe to grow and yield returns. So what’s a 401(k) rollover, how does it work, and which account makes the most sense to store your assets?
Let’s find out.
What Is a 401(k) Rollover?
A 401(k) rollover is a process where you transfer funds from one 401(k) provider into another tax-advantaged retirement account. This process gives you the opportunity to take your money with you from job to job.
Did you know that on average people will change jobs 12 times throughout their career? That would be a lot of open 401(k) accounts if you never transfer your plan when you move. 401(k) rollovers can also be beneficial for keeping track of your accounts and encouraging active participation in your retirement savings.
How a 401(k) Rollover Works
A 401(k) rollover allows you to transfer money in your old employer account into a new tax-advantaged retirement account (such as a new 401(k) or an IRA). You can do this in two ways: through an indirect or direct transfer.
An indirect transfer is slightly more complicated than a direct transfer in that the money passes through more hands before it ends up in your new account.
With an indirect transfer, you notify both your new plan administrator (401(k) or IRA that you want to start a rollover, and you let your old 401(k) provider know that you want to empty your account. Your old provider will mail you a check to you personally as the employee. You then must deposit the check into your new IRA account within 60 days in order to avoid owing full taxes on the distribution plus penalties.
Under IRS rules, your old employer is typically required to withhold 20% of your account balance in case you don’t deposit the money in your new account within 60 days.
After you deposit your first check, you’ll then need to make out another one to cover the 20% initially withheld (or else this could be deemed a distribution). That means you’ll need to have enough in a savings or other account to replace that 20%. When all is said and done, you will get that 20% back at tax time should you meet the 60-day deadline.
While totally do-able, this process requires you to put in more work, fork over the additional 20% balance, and keep track of deadlines and changing hands. Plus you’re limited to one indirect rollover in a 12 month period. It is often much smoother to go ahead with a direct transfer.
A direct transfer is much more, well, direct. With this process, you still notify your new provider that a rollover is initiated, and let your old provider know you want to roll the funds over into your new plan.
What’s different is that your old provider will either mail or electronically deliver a check directly to your new plan provider, and it’s automatically deposited for you. This option is much more straightforward, and ensures that you won’t owe additional taxes assuming that the transfer is done with equal accounts, for example, a traditional to a traditional or a Roth to a Roth.
Important Rules to Know About 401(k) Rollovers
As with most things in life, there are a set of rules that you should know before you initiate a 401(k) rollover. The most important being the 60-day rule.
In the case of a 401(k) rollover, 60 is the magic number. When you begin a transfer, you have 60 days to transfer the funds into your new account. Should you miss that deadline, you will be faced with massive tax consequences. Bypassing the 60-day limit triggers the IRS to think that you simply cashed the funds, which will all be counted toward your ordinary income.
There are some notable exceptions to this rule. In 2016, the IRS created a list of 11 reasons why you can be late to make the transfer including a lost check, severe home damage, or a death or illness in the family.
Handling Company Stock
If your old 401(k) held stock from your previous company, it’s important to know that by transferring to an IRA, you will miss out on tax benefits. Your new 401(k) asset allocation will be determined by your employer which means that they probably wouldn’t allow you to retain stock in your old company. Be sure to work with a tax professional to navigate this situation and come up with a plan that makes the most sense for you depending on how much stock you owned in your old company and what a full transfer might mean for your tax bill.
Why Do a 401(k) Rollover?
Sometimes it makes sense to leave your money in your old employer’s 401(k) plan. In fact, if you have over $5,000 in the account, your employer has to give you the option to keep the money in the account.
More likely than not, while you were working for them, they were also paying for the administrative fees associated with the account upkeep. They may no longer be willing to do that, even if you keep your money in their plan.
If you have anywhere from $1,000-$5,000 in your account, your employer is legally obligated to send you a letter and document in writing the options that you have. It is then up to you to inform them what you want to do. If you choose not to respond, they can roll the money over to an IRA on your behalf which is called an involuntary cash-out.
For accounts with $1,000 or less, many employers will write you a check. Just be sure to deposit that check in a new 401(k) or IRA within 60 days to avoid the tax penalty.
What Accounts Can You Roll the Money Into?
Now that you know what a 401(k) rollover is, understand how it is done, and the rules to keep in mind, it’s time to take a look at the specific accounts you can use to give your retirement savings a new home.
Today, we are going to look at two options, transferring the money into your new 401(k) or moving it into an IRA.
Rollover Into a New 401(k)
Your new 401(k) is an excellent option for your rollover. The 2020 contribution limit is $19,500 or $26,000 for those over 50. The good news? Your rollover won’t count toward that contribution limit.
Take some time to evaluate your new company’s 401(k) policy. Are you happy with your investment choices? Is there enough diversity in the type of investment options you have? Does the company offer a competitive match program? Understanding what you will get from the new employer should be an important factor in deciding if you want to roll the money over.
If you have an incredible employer match and good investment opportunities, rolling it over into this new account might make a lot of sense for you. 401(k) accounts are also generally quite safe from creditors and lawsuits, providing extra protection than the looser lines of an IRA.
Another important factor is the required minimum distributions (RMDs) in retirement. Your 401(k) will have you take your RMDs once you turn 72, thanks to the SECURE Act. You will need to pay ordinary income tax on those distributions, so be sure to factor that into your tax plan.
Rollover Into an IRA
An Individual Retirement Account (IRA) is another great choice for investors to consider. In general IRAs have more flexibility and customization in your investment choices which can allow you to allocate your money as you see fit. 401(k) accounts are often quite stringent and strict with how you diversify your investments but an IRA gives you more flexibility and freedom in that department.
An IRA can also help you consolidate your financial picture and give you a better sense of where you are in your financial journey. Having multiple accounts can get tricky to forecast where you really are and how close you are to reaching your savings goals.
You also have more flexibility on what fees you pay with an IRA. Since you can decide where you want to open your account, you have more control over the type and amount of fees that you pay. With a 401(k) you have little control over administrative and other fees since the program is set up through your employer.
IRAs also have more wiggle room when it comes to distributions. The government will allow you to take money out of your IRA early without penalty for things like college costs and that can’t happen with a 401(k).
You will still need to factor in distribution requirements. A Traditional IRA operates in the same way as the 401(k), where all distributions are taxed at your ordinary-income rate. Whereas a Roth IRA doesn’t have taxes upon distribution since the money contributed is after-tax.
The Bottom Line
401(k) rollovers are an excellent strategy for you to bring your money with you as you change jobs and advance in your career. It is important to know the options that you have in order to make the best decision for you and your financial future.
Are you ready to initiate a 401(k) rollover but want to talk through your specific situation? Give us a call today.
If you’re a member of the modern workforce, you likely have access to a 401(k). A 401(k) is a retirement savings vehicle sponsored by your employer. Through your 401(k), you’re able to contribute funds and invest them according to your risk tolerance and retirement timeline. The goal is to grow a sizable retirement nest egg for yourself over the course of your career by leveraging compound interest as you continue to contribute to your 401(k).
As a financial planner, one thing I’m always surprised by is how many people have access to a 401(k), but don’t necessarily know what to expect from their plan (or how to use it). In fact, many people contribute on auto-pilot without updating their investing preferences, if they contribute at all.
It’s time to change that. Let’s go over ten unique things about your 401(k) that you may not have known before – and how they benefit you and your retirement savings.
#1: Your 401(k) is Directly Connected to Your Employer
The contributions you make to your 401(k) are 100% yours, but the account itself is technically sponsored by your employer. To contribute to a traditional 401(k), you’ll need to find out if your employer offers a plan, and set one up through them. Your 401(k) is funded by contributions deducted from your paycheck, which can be a great way to automate your retirement savings.
#2: You’ll Want to “Roll Over” your 401(k) If You Change Jobs
Because your 401(k) is connected to your employer, you’ll want to roll your 401(k) over when you change jobs. Usually, you have a few options for how you want to use your old 401(k) when making this transition:
- You can leave your 401(k) alone, stop contributing, and let the funds continue to grow tax-deferred.
- You can “roll” your 401(k) to your new employer’s 401(k) plan and continue to contribute there.
- You can “roll” your 401(k) to a Traditional or Roth IRA. If you choose to roll it to a Roth IRA, you will have to pay income tax on the funds that you roll over. This will give you greater flexibility around your investment options.
#3: There are Contribution Limits
In 2020, you can contribute up to $19,500 to your 401(k). If you’re 50 or older, you can increase that to an annual total of $26,000 by leveraging the “catch up” contribution limit. Usually, you contribute to your workplace 401(k) by allocating a percentage of your paycheck.
If you want to max out contributions this year, make sure you have your percentage contribution dialed in so that you don’t go over the limit. If you do, you’ll be subject to a 6% excise tax.
#4: Anyone Can Participate
There is no income minimum for opening and contributing to a 401(k) through your employer. Some employers even offer their 401(k) to part-time employees. In other words, it doesn’t matter if you’re a brand new employee or if you’ve been there for 10+ years – you’ll be able to leverage your 401(k) to save for retirement no matter what!
There’s also no income maximum for contributing to a traditional 401(k). Unlike similar Roth accounts, your income has no bearing on how much you’re allowed to contribute according to the IRS.
#5: You Have to Start Withdrawals at Age 72
Although the funds in your 401(k) are yours to use as you please once you hit retirement, you can’t just let them sit in your account forever. There are specific withdrawal requirements you have to meet as you age.
According to the new SECURE Act, retirees must start taking Required Minimum Distributions (RMDs) from their 401(k) by age 72, which is up from the original age limit of 70½. This new withdrawal requirement gives retirees more flexibility when creating a retirement income strategy. It’s especially useful as more and more pre-retirees are choosing to work well into their 60s or 70s (and want to continue contributing to their 401(k)s, not withdrawing from them).
#6: You Can’t Withdraw (Without Penalties) Until Age 59½
Just like there are specific rules about when you have to start withdrawing from your 401(k), there are also specific rules around what age you’re allowed to start taking withdrawals. If you take a withdrawal from your 401(k) before age 59½, you’re subject to regular income tax on the funds you withdraw and a 10% penalty – ouch.
Of course, there are a few exceptions to this rule. If your 401(k) is set up through the employer you’re retiring from, you may be able to start taking withdrawals at age 55. There are also rules in place that allow you to leverage your 401(k) for disability and specific medical expenses. These special circumstances are referred to as “hardship withdrawals” and they help you sidestep the 10% early withdrawal penalty if you use them for:
- Medical expenses exceeding 7.5% of your annual gross income.
- Permanent disability.
- Substantial equal periodic payments.
- Separation of service.
Some plans also allow you to take out a loan against your 401(k). You pay the loan back through additional payroll deductions. However, as appealing as this may sound, you need to think carefully before pursuing a 401(k) loan. If you’re unable to pay the loan back before you change jobs, or before age 59½, you’ll likely owe income taxes and the 10% early withdrawal penalty on the funds.
Additionally, 401(k) loans essentially “rob” your retirement to help you achieve a short-term financial goal. The money you take out of your 401(k) now loses any potential capital gains or growth that could be achieved through investing.
#7: You Can Contribute to a Roth or a Traditional 401(k)
There are two different types of 401(k)s – Traditional and Roth. Usually, employees choose to contribute to a traditional 401(k) through their employer. However, many employers offer a Roth 401(k), as well. This type of account is funded with contributions that have already been taxed.
As a result, the funds grow tax-free until you retire, at which time you can take withdrawals without paying income taxes. It’s often wise to diversify the type of taxable (or non-taxable) accounts you have to pull a retirement income from, so if a Roth 401(k) is available through your employer, you may want to start contributing there, as well.
#8: There Are Fees Associated With Your 401(k)
As is the case with many investment accounts, your 401(k) will be subject to a set of fees for maintaining the account. Your 401(k) fees will cover the setup of your account and ongoing management. Fund fees, on the other hand, are fees directly related to the investments within your account.
The company that holds your plan charges these to run your account on an ongoing basis. It’s important to familiarize yourself with the fees you’ll be paying because they can add up depending on the investments in your portfolio!
#9: Your Employer May Have a Matching Policy
Many employers have a standard contribution matching policy for their employees who fund a company 401(k). This type of incentive helps you to grow your retirement nest egg on your employer’s dime! Contribution matching may range anywhere from 3-6% of your salary.
If you aren’t currently contributing up to your employer’s match, you should adjust accordingly to take advantage of this perk. If you don’t, you’re essentially leaving free money on the table – which is never a wise financial move.
#10: You Get to Select Your Own Investments
In most 401(k) plans, you have the flexibility to select your investments. Some plans have more availability than others, but you should be able to (at a minimum) select a risk tolerance level based on your retirement horizon and set your plan up accordingly. When you are a long way from retirement, your risk tolerance will be higher than when you are a few years out.
That’s because the more time you have before retirement, the more time you have to recover from any dips in your portfolio that happen as a result of higher-risk funds. However, you also have more time to take advantage of potentially higher returns from those same higher-risk investments. As you get closer to retirement, you want to minimize your risk to maintain and protect your nest egg.
Have questions about your 401(k)? Contact us today! We’re here to help you organize a retirement savings strategy that matches your unique goals.
Retirement planning for the self-employed can seem complicated and, often out of reach. Without a traditional workplace 401(k), many business owners and freelancers aren’t sure how to start putting money toward retiring someday. There are, of course, individual options available, specifically Roth and Traditional IRAs. However, their contribution limits may limit your ability to save effectively – especially if your goal is to save 10% or more of your total annual income.
Enter: the SEP IRA. This specific type of IRA (Individual Retirement Account) opens up your options significantly when it comes to building your retirement nest egg. This retirement savings vehicle is perfect for small business owners or freelancers who are looking for a tax-efficient way to start saving.
What’s a SEP IRA?
A Simplified Employee Pension Individual Retirement Account (SEP IRA) acts similarly to how a traditional IRA would work. However, there are a few key changes that make it extra-appealing for small business owners. First and foremost, the business owner makes all contributions to a SEP IRA. That’s right, the funds come directly from the business – not out of your paycheck.
The other big change to keep in mind is that the contribution limits are notably higher than other IRAs. For example, both a Traditional and a Roth IRA have a contribution limit of $6,000 in 2020, or $7,000 if you’re over 50. A SEP IRA, on the other hand, allows contributions up to 25% of your earnings, or $57,000 – whichever is lower.
This is impressive, as it even outshines the contribution limits of traditional workplace 401(k)s – $19,500 in 2020 if you’re under 50. For a small business owner who may be behind when it comes to building their retirement savings, this option is often an excellent fit.
How to Calculate How Much You Can Contribute
To know how much you can contribute to your SEP IRA, you have to start by calculating your earnings. If you have a Schedule C for tax filing purposes, start here. In general, you can contribute up to 25% of your net-earnings (per your Schedule C income report) minus any deductions. This may sound complicated, but the IRS conveniently outlines how to calculate your retirement contributions and deductions here. However, if you earn over $285,000 per year, your contributions are capped at $57,000.
It’s also important to note that contributions do not have to be a consistent earnings percentage year over year. Theoretically, you could contribute 10% one year, and reduce it to 5% another year.
If you’re a solo business owner, this flexibility is very important. When your income fluctuates, being able to pivot and save more (or less) toward retirement can give you more breathing room to pay your bills and save for other short-term financial goals.
Who Qualifies to Use a SEP IRA?
All businesses qualify to open a SEP IRA. It doesn’t matter if you’re a sole proprietor or a multi-million dollar corporation. However, it’s important to remember that almost all employees are eligible to enroll. In order to participate, they must:
- Be 21 years or older
- Earn over $600 per year
- Have worked for the company for three out of the past five years
The rule is that the employer has to contribute the same amount for every employee who qualifies. So, if you want to contribute up to the full 25% limit to your account, you’d be on the hook for contributing up to 25% of everyone’s salary toward their respective SEP IRAs – yikes. This rule may mean that the SEP IRA isn’t the best fit for you and your business at this time.
All contributions made to a SEP IRA are pre-tax. In other words, you deduct the contributions now, and pay income tax on them when you withdraw in retirement. If you’re considering a SEP IRA, it’s in your best interest to reach out to a tax professional to help you maximize your deductions.
Are My Contributions Vested?
All contributions made by the business are immediately vested and available to employees.
How Do I Withdraw Funds?
You can’t withdraw funds from your SEP IRA until you’re age 59 ½ or older. If you do withdraw funds early, you’re subject to a 10% penalty and ordinary income tax on the funds. Let’s look at an example:
You have $10,000 in your SEP IRA. Of the $10,000 balance, only $2,000 is taxable. You’d pay ordinary income taxes on the taxable $2,000 and a 10% penalty for the full $10,000.
Depending on how much you have saved in your SEP IRA, this could result in a hefty tax bill. Of course, there are a few withdrawal exceptions that help you sidestep the withdrawal penalty. These include:
1. Death or disability.
2. A payment plan of “substantially equal payments” over your lifetime.
3. Medical expenses that are non-reimbursed, and total over 7.5% of your annual income.
4. Medical insurance (under special circumstances only).
5. Qualified higher-education expenses.
6. Home purchase or renovation up to $10,000.
However, if you are nearing retirement, you should know that while you qualify to take withdrawals from your SEP IRA at age 59 ½, you aren’t required to take them until age 72. This can help you extend the life of your savings, especially if you plan to continue working (and contributing) beyond age 59 ½.
Rolling Over Your SEP IRA
If for some reason you join a company or stop earning self-employed income, you can roll your existing SEP IRA over to a Traditional IRA tax-free.
Can You Contribute to Other Retirement Accounts and Your SEP IRA?
In a word – yes! Whether you have access to a Traditional or Roth IRA, or a workplace retirement account like a 401(k), you can continue to contribute to your other retirement savings accounts. However, if you’re planning to contribute to both a personal IRA and your SEP IRA, you may be limited when it comes to how much of your contributions you can deduct.
Having access to a SEP IRA means that, technically, you’re covered by an employer-sponsored retirement plan. This reduces the total income limit that allows you to deduct Traditional IRA contributions to $65,000 (single) or $104,000 (married filing jointly).
When Would a SEP IRA Be a Good Fit For You?
If you’re a solopreneur or a small business owner with no other W2 employees, a SEP IRA is something you should absolutely explore. When you only have yourself to worry about, taking the deduction and funneling a large percentage of your earnings toward retirement is often a good financial move.
This is especially true if you’ve spent a number of years as a freelancer or solopreneur without contributing toward retirement. Self-employed women, in particular, need to be thinking ahead when it comes to funding their retirement. Studies have shown that self-employed women face a 28% wage gap when compared to their male peers.
Having a potentially lower income from the onset of your self-employment journey can negatively impact your ability to save effectively for retirement. This is true both because there’s less total income to contribute toward your retirement savings goals and because there’s often a lack of willingness to part with income because of other, seemingly more pressing, financial obligations.
Combine that with the fact that only 6 out of every 10 self-employed individuals have retirement savings, and female entrepreneurs are at a notable disadvantage when it comes to building a nest egg for retirement. This makes the concept of a SEP IRA even more attractive to female entrepreneurs who are needing to play a bit of “catch up” with their retirement savings.
Setting Up Your SEP IRA
A SEP IRA is relatively easy to set up. You start by creating a SEP plan with a written agreement. The government even has an agreement template for you to get started.
If you’re the only qualifying employee at your company, you can move forward with setting up your very own SEP IRA through a financial institution of your choice. If you have employees, you’ll need to distribute a copy of the SEP plan agreement you’ve written, and make sure they each open their own SEP IRA, and choose their own investments.
Need help? Reach out to our team! Our team specializes in working with breadwinning women and entrepreneurs and would love to help you start making empowered decisions about your retirement savings.
If you’ve been a long-time reader of the Workable Wealth blog, you know our team advocates for taking charge of your finances, even when it’s uncomfortable, like asking for a raise. Nobody is as qualified as you to make the decisions necessary to move toward your goals and a life that has you excited to wake up each morning. One of the biggest areas we see women struggling to take responsibility for their own finances is their salary.
Talking about your salary can be intimidating, especially when reaching out to your boss about a raise. For a long time, women have been taught that asking for money is crass or rude, even if your performance and experience warrant a pay increase. Only 36% of women said they’ve asked for a raise according to a Marketplace-Edison poll.
Although asking for a raise isn’t always comfortable, and there’s no clear guarantee that you’ll get the salary increase you hoped for, it’s critical to advocate for yourself and your own financial well-being in the workplace. Between the gender wealth and wage gap, women are already at a disadvantage when it comes to earning a salary in line with their skillset. This makes it even more important for you to take charge of your income, and its ability to impact your long-term financial and lifestyle goals.
Understanding the Wage Gap
No matter which way you look at it, the gender wage gap is a persistent problem that has negatively impacted women for decades. According to recent studies, women earn on average 82% as much as their male counterparts in similar roles with similar levels of experience. In some states, this percentage is as low as 49%. This pay gap is seen across almost all states and all industries.
The unspoken rule that employees shouldn’t discuss their earnings continues to perpetuate the problem. Even if you feel like you make a comparable salary to your male peers, you may be surprised to find out that they make notably more than you do – you’ve just never talked about it before.
An even bigger problem is the gender wealth gap. This is talked about less than the gender wage gap, but equally important. On average, women own 32 cents for every dollar their male counterparts own. Although studies have shown that women tend to be better savers, it’s challenging to save more when they’re put at a disadvantage with lower earnings. Both the wage and the wealth gap are a problem that women, unfortunately, have been facing for a long time.
The good news is that by advocating for yourself in the workplace, you have the opportunity to stand up for your own earning potential and long-term financial wellness.
Why Ask For a Raise?
Still not convinced that you should ask for a raise? Let’s think about how an increased salary has the potential to impact your long-term savings. Imagine you ask for a $7,000 raise. After taxes, you’d take home an additional $5,000 per year. Assuming you take that $5,000 and put it towards your future self, that money could do a lot of work for you.
$5,000 per year invested at a 7% return over 20 years is $205,000.
That’s a pretty significant impact on your retirement savings. Just by asking a question.
Even if you don’t have a plan to invest the raise you receive, think about what it could do for your short-term financial goals. A $7,000 raise could mean a boosted emergency savings, faster debt repayment, saving for your child’s education, or paying to take your whole family on an amazing vacation.
Knowing the “why” behind your raise request can help you clarify exactly what that extra money could mean to you. Understanding the impact an increased salary might have both on your short-term lifestyle and long-term goals can remove hesitation or mental blocks you may have when it comes to discussing your salary with your employer.
How to Ask for a Raise
Now that we’ve talked about the “why” behind asking for a raise, we need to talk about the “how.” Walking into your boss’s office and demanding a raise may sound empowering, but in reality, it likely won’t get you the results you want. Have a plan in place for asking for your raise, even if you (and your employer) know you deserve it.
Do Your Research
What do people in similar roles earn within your company? If your coworkers aren’t comfortable sharing, look up jobs on Glassdoor to get more information about salaries reported at your organization. Once you know what your company typically pays, take your research a step further: What do competitors pay people in your role, or who have your level of experience? Compare your research to your current pay – is there a notable gap?
Learn to Sell Yourself
Even if you’re the most qualified person at your organization to do your current job, that doesn’t necessarily matter in this conversation. General comments about your qualifications, experience, or skill set are valuable, but they won’t necessarily bag you the salary of your dreams. Instead, ask yourself how you could set up specific measurements and data to prove your success. A few questions to ask yourself might be:
- Did I tackle any projects this year that made an impact on my team or the company as a whole?
- Do I have clear metrics to track my performance such as sales numbers, productivity, or revenue generated?
- Can I correlate my experience and skill set with monetary value to my company?
- Has my performance improved since my last salary increase? How has this positively impacted my team and my company?
Picture this conversation as an interview. You’re essentially interviewing for a promotion – even if you stay in the same role.
Consider What You’re Willing to Walk Away With
In a perfect world, you’d have a conversation about getting a raise and your company would give you the exact number you asked for, and your role would stay consistent. However, you might find that you either receive a counter-offer for a lower increase, or your boss may grant the raise but request that you take on additional responsibilities.
Now is the time to get very clear with yourself on what you’re willing to take on, and what your ideal minimum raise would be. Knowing these things before going into a salary negotiation can help you to offer concise and timely responses if your boss asks you questions in the initial meeting or presents a counter-offer later on.
Conversations about salary increases can be hard! Practice whenever you can. Ask your friend, your mom, and your spouse or partner if they’d be willing to listen to the points you’ve pulled together. It might feel goofy to role-play this conversation, but it can be useful. If you have time to field potential questions or rebuttals from loved ones who are pretending to be your boss in a practice conversation, you’ll be better equipped in the meeting itself. For your own confidence walking into this meeting, practice is key.
Set You – and Your Boss – Up For Success
Don’t blindside them with a meeting about a salary increase without warning. Sending an email, or asking them face-to-face if they have time to schedule a meeting about your current role and compensation allows them time to prepare ahead of time. If you don’t give them adequate prep time, you may get shot down right out of the gate because they’re caught off guard and don’t have time to consider your request.
Remember: when push comes to shove, your income and your ability to reach your financial goals are solely dependent on you advocating for yourself. That raise isn’t going to ask for itself! Don’t be afraid to take charge of your future, and ask for the salary you deserve.