Your utility bills likely make up a significant part of your monthly budget, so itâs important to keep a close eye on them. But while your rent or mortgage stays the same month to month, your utilities donât.
Sweltering summer days and icy winter nights can lead to budget-blowing spikes in your utility bills, and no matter how hard you try to budget and plan, you canât predict the total each month. Or can you?
Budget billing may offer the consistency you crave. Here, personal finance experts describe how budget billing works and explain who may benefit from it, empowering you to answer this question for yourself: Does budget billing save money?
What is budget billing and how does it work?
As you consider this option, your first question might be: What is budget billing? Budget billing is a service offered by some utility companies that provides a set monthly bill for services like gas or electricity.
How does budget billing work? To calculate your monthly budget billing amount, a utility company will look at your past usage, typically over the last year, and average it to determine your monthly charge, says Sara Rathner, financial author and credit cards expert at NerdWallet. This will give you a predictable bill to pay each month, rather than one that fluctuates.
Keep in mind that if you recently moved into your home, the charges used to calculate your budget billing amount may be based on the previous ownersâ or rentersâ usage, says Rathner. Your actual usage may end up being more or less than theirs.
Another point to remember on how budget billing works: While budget billing gives you a steady amount to pay each month, this amount can, and likely will, change over time. Some providers update bill amounts quarterly, some annually. Thereâs no universal timeline for these updates, so be sure to ask your utility provider about its specific process, says Lance Cothern, CPA and founder of personal finance blog Money Manifesto.
These changes are made to capture your actual usage, whether that usage has decreased (a mild summer allowed you to keep the AC off more often) or increased (a brutally cold winter forced you to blast the heat). Typically, you will be notified in advance of the change.
Now that you know how budget billing works, you may be wondering: Could it save me cash?
Does budget billing save money?
âBudget billing won’t save you money; it just evens your bill out over time,â Cothern says.
How does budget billing work if you end up using less energy and overpay? You may be reimbursed for the amount you paid above your actual energy usage, or the amount overpaid will be applied to next year.
âAnyone who sticks to a strict, detailed monthly budget may prefer the predictability of budget billing.â
How does budget billing work if you underpay? Youâll have to pay the extra amount to make up the difference. These payments or credits happen in addition to any adjustments your provider makes to your monthly bill if your usage changes over time, Cothern says.
What are the benefits of budget billing?
Overall, thereâs a fairly straightforward answer to what budget billing is, and the benefits are clear, too. While it doesnât save you money per se, it may allow you to more easily manage your monthly budget.
For example, if you know your monthly electricity bill will be $100, you can account for this expense in your budget and more precisely allocate funds into other expenses or savings.
âAnyone who sticks to a strict, detailed monthly budget may prefer the predictability of budget billing,â Rathner says. âYou know exactly how much your utility bill will be each month and can plan your other spending around it.â
Combine budget billing with autopay and you can set and forget your utility bills, ensuring theyâre paid on time and in full, making money management a lot simpler. This could also help you deal with financial stress.
What are the downsides of budget billing?
While budget billing has its pros, it also comes with cons. Does budget billing save you money? To help answer that question, consider the following:
You may face extra fees. Some utility companies charge a fee for budget billing. In Cothernâs view, this negates the benefit since thereâs no reason to pay tacked-on fees for this service. Itâs important to find out whether there are fees before signing up when youâre researching how budget billing works.
You may ignore your utility usage. Budget billing puts your monthly utility charges, as well as your actual usage, out of sight and out of mind. Without the threat of a higher bill or the reward of a lower one based on your energy habits, some people get complacent, Rathner says. They leave lights on or turn up the heat instead of grabbing a blanket. If this sounds like you, budget billing may actually cost you money in the long run.
âAlways keep an eye on your monthly bill even though you pay a level amount for months at a time,â Cothern says. Most utility companies provide your usage information right on your bill.
If you can financially handle the seasonal swings of each bill, budget billing may not be much of a benefit for you, Cothern says. Paying the full amount also means youâre paying attention to the full amount, he says, which may motivate you to reduce your energy consumption. And thatâs where the real opportunity to save money lies.
By considering potential fees and the impact on your energy usage, youâll have a good sense of whether budget billing saves you money in the long run.
Make the most of how budget billing works with this hack
After scrutinizing how budget billing works, the potential downsides have led some financial pros, Cothern among them, to develop a new hack for paying utility bills.
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Instead of signing up for budget billing, open a savings account online specifically for utilities, Cothern suggests. Youâll also want to sign up for a rewards credit card, if you donât have one already.
Next, grab your last 12 months of utility bills, total them up and divide by 12 to get your monthly average. Youâll then want to set up an automatic transfer of that amount from your checking account into the utility savings account each month.
When the utility bill comes, pay it with your rewards credit card and then pay that bill with the money in your savings. You reap the benefits of maintaining a consistent amount coming out of your budget, as well as credit card rewards and any interest earned on that money from your savings account.
Do your homework before signing up for budget billing
After weighing your options and considering your personal budgeting style, you may decide that budget billing is right for you.
If thatâs the case, itâs important to read your utilityâs program rules in detail. Yes, that means digging into the fine print to understand how budget billing works at the specific company, Cothern says, because budget billing is a general term for a wide variety of utility company programs. Budget billing may be called something else, like flat billing or balanced billing, and it may carry different nuances and terms.
Before signing up for budget billing, Rathner suggests calling your provider and asking the following questions:
Are there startup or maintenance fees?
How is the monthly amount calculated? How often is it updated?
What happens if you overpay or underpay?
What happens when you move or end service?
With the answers to these questions, youâll have a better idea of how budget billing works for your provider. Armed with that info, you can determine whether budget billing saves you money and make the call on whether enrolling is right for you.
Whether you opt for budget billing or not, small adjustments to your home can result in major savings on your energy bills. For starters, check out these four ways to save energy by going green.
Articles may contain information from third-parties. The inclusion of such information does not imply an affiliation with the bank or bank sponsorship, endorsement, or verification regarding the third-party or information.
The post What Is Budget Billing and Is It Right for You? appeared first on Discover Bank – Banking Topics Blog.
This page may include affiliate links. Please see theÂ disclosure pageÂ for more information. How do many wealthy people get that way? They invest in real estate. It is a proven way to build wealth. 90% of millionaires became so through owning real estate. So said famous industrialist (and billionaire) Andrew Carnegie. Yet only 15% of Americans…
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One of the best things you can do for your future self is to save for retirement. Unfortunately, according to recent research, about one-third of Americans have $5,000 or less set aside for retirement. Itâs…
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For investors with short-term saving goals, short-term bonds can be appropriate investments for your money.
They are stable and they certainly provide a higher return than a money market fund.
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However, even with the best short term bond funds, there’s also a risk of losing a percent or two in principal value if interest rates rise.
There are many options available to you, but your best option is to invest in taxable short-term bond funds, U.S. Treasury short-term bond funds and federally tax-free bond funds.
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What are short-term bonds?
Short-term bonds, or any bonds for that matter, are debts instruments that companies and the government issue. They typically mature in 1 to 3 years.
When you buy a bond, you are essentially lending money to the issuing company or government agency.
They are obligated to pay back the full purchase price at a particular time, which is called the “maturity date.”
Short-term bonds are low risk investments and you can have access to your money fairly quickly.
As with all bond funds, one of the risk of short term bond funds is that when interest rates rise, the prices of the bonds in the fund decrease.
But short term bond funds have a reduced risk of default, because the bond funds are backed by the full faith and credit of the U.S. government.
Moreover, because the term is short, you will earn less money on it than on an immediate-term or long term bond fund.
Nonetheless, they are still competitive and produce higher returns than money market funds, Certificate of Deposits (CDs), and banks savings accounts. And short-term bonds are more stable in value than stocks.
At a minimum, don’t buy a short-term bond fund if you’re saving for retirement or if you want to hold your money longer.
If you’re looking to invest your money for the long term and are still looking for safety, consider investing in Vanguard index funds.
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Short-term bonds: why do you need to invest in them?
You should invest in short-bonds if you intend to use the money in a few years or so. However, don’t push your emergency cash into bonds. That is what a bank savings account is for.
Also, you should not put too much of your long term investment money into bonds, either. If you have a long term goal for your money, it’s best to invest in mutual funds such as Vanguard mutual funds, real estate, or your own business.
Here are some situations where you should invest in short term bonds.
You want to stabilize your investment portfolio. If you have other aggressive investments, you may need to balance it out with short term bond funds. The reason is because short term bonds are safer comparing to stocks.
Buying a house.
Retirement. If you’re thinking of retiring in a few years, short-term bonds are appropriate.
Purchasing a car.
You’re a conservative investor. Not all investors can stomach the risk of losing all of their money due to the market volatility. So instead of investing in stocks, which falls on the riskier end of the securities spectrum, you should invest in short term bond funds.
Best short-term bond funds to consider:
Most people prefer to buy bonds through a broker such as Vanguard or Fidelity.
If you’re looking for the best short-term bond funds to buy now, consider these options:
Vanguard Short-Term Treasury Index Fund Admiral Shares (VSBSX)
Vanguard Limited-Term Tax Exempt Fund Investor Shares (VMLTX)
The Fidelity Short Term Bond Fund (FSHBX)
Vanguard Short-Term Tax-Exempt Fund Investor Share (VWSTX)
Vanguard Short-Term Investment Grade fund (VFSTX)
T. Rowe Price Short-Term Bond Fund (PRWBX)
Vanguard Short-Term Bond Index Fund (VBIRX)
Tax free short-term bonds
There are some short-term bond funds that are both state and federally tax free. But there are not too many out there.
However, the ones that are available are good investments. So, if you are in a low state bracket and in a high federal bracket, consider investing in these Vanguard bond funds.These are federally tax free bond funds:
Vanguard Limited-Term Tax Exempt Fund Investor Shares (VMLTX)
This Vanguard bond fund seeks to provide investors current income exempt from federal taxes. The fund invests in high-quality short-term municipal bonds.
This bond fund has a maturity of 2 years. So, if you are looking for a fund that provides modest income and is federal tax-exempt, the Vanguard Limited-Term Tax Exempt Fund is for you.
The fund has an expense ratio of 0.17% and a minimum investment of $3,000. This makes it one of the best short term bonds to buy.
Vanguard Short-Term Tax-Exempt Fund Investor Share (VWSTX)
Like the Vanguard Limited Short Term fund, this fund also provides investors with current income that is exempt from federal income taxes.
The majority of the fund invests in municipal bonds in the top three credit ratings categories. It also invests in medium grade quality bonds.
This fund too has an expense ratio of 0.17% and a minimum investment of $3,000, making it one of the best short term bond funds.
U.S Treasury Short-term Bond Funds: Vanguard Short-Term Treasury
If you’re interested in a bond fund that invests in U.S. Treasuries, then U.S.Treasury bond funds are a great choice for you. One of the best U.S.Treasury bond funds is the Vanguard Short-Term Treasury.
This bond fund seeks to track the performance of the Bloomberg Barclays US Treasury 1-3 Year Bond Index. The Vanguard Short-Term Treasury invests in fixed income securities with a maturity between 1 to 3 years.
This bond fund has an expense ratio of 0.07% and an initial minimum investment of $3,000. Currently, this short term bond fund has a 1-year yield of 4.51%, making it one of the best short term bond funds.
Of note, this fund is also available as an ETF, starting at the price of one share.
The Fidelity Short-Term Bond Fund (FSHBX)
The Fidelity Short Term Bond Fund is one of the best out there for those investors who want to preserve their capital. This fund was established in March of 1986 and seeks to provides investors with current income.
The fund managers invests in corporate bonds, U.S. Treasury bonds, and assets backed securities. Over the last 10 years, this bond fund has a yield of 1.98% and a 30-day yield of 1.98%. This Fidelity bond fund as an expense ratio of 0.45%. There is no minimum investment requirement.
Taxable short-term bond funds: Vanguard Short-Term Investment Grade fund (VFSTX)
If you are not in a high tax bracket, then you should consider investing in a taxable short term bond fund. One of the best out there is the Vanguard Short-Term Investment Grade fund.
This bond fund provides investors exposure to high and medium quality investment grade bonds, such as corporate bonds and US government bonds. This fund has an expense ratio of 0.20% and an initial minimum investment of $3,000, making it one of the best short term bond funds out there.
T. Rowe Price Short-Term Bond Fund (PRWBX)
The T. Rowe Price Short-Term Bond Fund invests in diversified portfolio of short term investment-grade corporate, government, asset and mortgage-backed securities. This bond fund also invests in some bank mortgages and foreign securities. This fund produce a higher return than a money market fund, but less return than a long-term bond fund. The T. Rowe Price Short-Term Bond Fund has a minimum investment requirement of $2500, making it one the most favorite short term bond funds out there.
Vanguard Short-Term Bond Index Fund (VBIRX)
The Vanguard Short-Term bond is a good choice for the conservative investor. It offers a low cost, diversified exposure to U.S. investment-grade bonds. This has fund has a maturity date between 1 to 5 years. Moreover, the fund invests about 70% in US government bonds and 30% in corporate bonds. The bond fund as an expense ratio of 0.07% and a minimum investment requirement of $3,000.
How to Invest in Short-Term Bonds
If you’re considering in investing in these or any of Vanguard bond funds, you need to do your due diligence.
First, think about what you need the bond fund in the first place. Is it to diversify your investment portfolio?
Are you a conservative investor who need a minimize risk at all cost? Or, do you want to invest in a short term bond fund because you need the money to use in a few years for a vacation, buying a house, or planning for a wedding?
Once, you have come up with answers to this question, the next step is to do your research about the best bond fund available to you.
Use this list to start. If it’s not enough, do your own research.
Look into how much the initial minimum investment is to buy a bond fund. Most Vanguard short term bond funds require a $3,000 minimum deposit.
Some Fidelity bond funds, however, have a 0$ minimum deposit requirement.
Next compare expense rations, performance for different funds to see if they match your investment goals. But you have to remember that past performance is not an indication of future performance.
Your final step is to open an account to buy your bond funds. If you choose Vanguard, you can do so at their website.
How do you make money with short-term bonds?
You can make money with short-term bonds the same ways you make money with a mutual fund (i.e., dividends, capital gains, and appreciation). But most of your returns in a bond fund comes from dividends.
The bottom line
In brief, short-term bonds are great investment choices if you have short term saving goals. You may be interested in buying these bonds because you expect to tap into your investment within a few years or so. Or, you want a more conservative investment portfolio.
Short term bonds produce higher yields than money market funds.
The only problem is that the share prices can fluctuate. So, if you don’t mind market volatility, you may wish to consider short-term bonds.
Speak with the Right Financial Advisor
If you have questions beyond short-term bonds, you can talk to a financial advisor who can review your finances and help you reach your goals (whether it is making more money, paying off debt, investing, buying a house, planning for retirement, saving, etc).
Find one who meets your needs with SmartAssetâs free financial advisor matching service. You answer a few questions and they match you with up to three financial advisors in your area. So, if you want help developing a plan to reach your financial goals, get started now.
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The post 7 Best Short-Term Bonds Funds to Buy in 2020 appeared first on GrowthRapidly.
Taking control of your retirement begins with investing in retirement accounts. Here, I examine the best retirement accounts to get you on track.Taking control of your retirement begins with investing in retirement accounts. Here, I examine the best retirement accounts to get you on track.
The post Do You Have The Right Retirement Account? Check Out The Top 6 Best Retirement Accounts For 2021 appeared first on Money Under 30.
The Forex industry is a very interesting one in that Forex traders have the ability to trade in far more currency than their principal investments would generally allow. This is the result of what’s known as a “trading margin.” So what is this trading margin, and why exactly should you care? Let’s talk about it!
Forex Trading Margin: What Is It?
A Forex trading margin is a ratio that defines the leverage a trader has in the market. Trading margins in the world of Forex range from 10:1 to 50:1 on average. So, when it comes to Forex trading, a $1 principal investment gives the trader the ability to trade from $10 to $50 worth of currency.
Forex Margins Are the Same as Stock Market Margins…Right?
For the most part, Forex margins and stock market margins are about the same. However, there are a few key differences:
Margin Interest –Â A trading margin is essentially a loan. For every dollar the investor puts up, the broker adds a significant amount of money in Forex. However, Forex brokers generally don’t charge interest on the money they put toward your investments. On the other hand, stock brokers generally charge interest on these loans.
Margin Size –Â In the stock market, brokers generally offer 2:1 margins; however, in the Forex market, the minimum margin a trader will generally find is 10:1. Therefore, Forex margins give traders more leverage in the market than stock market margins.
Margin Calls –Â Forex traders generally aren’t susceptible to margin calls. Unfortunately, that’s not the case for stock market investors. A margin call happens when a trade moves against the trader. At this point, brokers will require the investor to add to their cash deposits.
Forex Trading Margins: Why You Should Care
Margins can work for you, and they can work against you. To be profitable in Forex, it’s important to understand the advantages added by margins as well as the risks. Here’s how the advantages and risks work:
Added Advantage –Â Think about what leverage really does for Forex traders. With $200 as a principal investment and 50:1 leverage, Forex traders can take advantage of movements on $10,000 worth of currency. That gives traders a big advantage when it comes to realizing gains in the market.
Risks –Â On the other hand, high margins can also work against you. That’s because when trades don’t go in your favor, the size of the loss you take will be increased by the margin.
If you’re looking to trade Forex, it’s worth the time to do a bit of research on trading margins and how they can help you as well as hurt you. Leave a comment below if you have any specific questions!
This article was written by Joshua Rodriguez, owner and founder ofÂ CNA Finance.
The post Forex Trading Margin: What Is it, and Why Should You Care? appeared first on MintLife Blog.
For a long time, mutual funds have been a popular investment vehicle for millions of investors, largely because they offer an easy way to purchase no-fuss, diversified assets with relative ease. This out-of-the-box diversification and risk-mitigation is something that individual stocks canât match.
Though technology has made it easier than ever to buy securities like mutual funds online, one area of confusion persists. When it comes to tax on mutual funds, and calculating capital gains on mutual funds, many investors donât know where to start.
Discussing tax on mutual funds and other investments can be tricky, but it doesnât have to be. Read on to learn how tax on mutual funds works, what investors should expect or anticipate when it comes to dealing with mutual funds and the IRS, and some simple strategies for tax-efficient investing.
Quick Mutual Fund Overview
First, it makes sense to review the basics. Mutual funds are similar to exchange-traded funds (ETFs) in that theyâre not singular investments. Instead, theyâre a collection (or a âbasketâ) of many different investments like stocks, bonds, and short-term debt. When an investor buys into a mutual fund, theyâre essentially purchasing a spectrum of assets all at once.
Paying Tax on Mutual Funds
Like other types of investments, investors must pay tax on any income or profits they realize from their mutual fund holdings. Not every fund is the same, so it follows that the taxable income shareholders receive (or donât receive) from a fund isnât the same.
Since itâs up to investors to know when to pay taxes on stocks and report the amount of taxable income theyâve received from the sales of their investments and distributions (on IRS Form 1099-DIV) the most proactive thing an investor can do to get an idea of what type of tax liability a specific mutual fund may present is to research the fund before any shares are purchased. In other words, do your homework.
There are a number of online resourcesâincluding but not limited to Morningstar and Kiplinger Mutual Fund Finder âthat allow investors to conduct that research, with some also providing rating systems to help streamline the process.
Paying Tax on âRealized Gainsâ from a Mutual Fund
capital gains taxation rate will vary.
Because funds contain investments that may be sold during the year, thereby netting capital gains, investors may be on the hook for capital gains taxes on their mutual fund distributions. As each fund is different, so are the taxes associated with their distributions. So reading through the fundâs prospectus and any other available documentation can help investors figure out what, if anything, they owe.
How to Minimize Taxes on Mutual Funds
When it comes to mutual funds, taxes are going to be a part of the equation for investorsâthereâs no way around it. But that doesnât mean that investors canât make some smart moves to minimize what they owe. Here are a handful of ways to potentially lower taxable income associated with mutual funds:
Know the Details Before You Invest
IRAs and 401(k)sâare tax-deferred. That means that they grow tax-free until the money contained in them is withdrawn. In the short-term, using these types of accounts to invest in mutual funds can help investors avoid any immediate tax liabilities that those mutual funds impose.
Hang Onto Your Funds to Avoid Short-term Capital Gains
If the goal is to minimize an investorâs tax liability, avoiding short-term capital gains tax is important. Thatâs because short-term capital gains taxes are steeper than the long-term variety. An easy way to make sure that an investor is rarely or never on the hook for those short-term rates is to subscribe to a buy-and-hold investment strategy.
This can be applied as an overall investing strategy in addition to one tailor-made for avoiding additional tax liabilities on mutual fund holdings.
Talk to a Financial Professional
Of course, not every investor has the same resources, including time, available to them. Thatâs why some investors may choose to consult a financial advisor who specializes in these types of services. They usually charge a fee, but some may offer free consultations. For some investors, the cost savings associated with solid financial advice can outweigh the initial costs of securing that advice.
Getting taxed on capital gain on a mutual fund is unavoidable, but with a little help from a tax professional, you can minimize the amount you get taxed.
Some of the above strategies can work in concert: Investors who are investing for long-term financial goals, like retirement, can use tax-deferred accounts as their primary investing vehicles. And by using those accounts to invest in mutual funds and other assets, they can help offset their short-term tax liabilities.
While itâs possible to buy some mutual funds with an online brokerage account, many have restrictions on the types of funds investors can buy, as theyâre specially-tailored toward specific financial goals, like retirement. With a SoFi InvestÂ® account, investors can get started building a portfolio, and even gain access to complimentary advice.
Find out how SoFi Invest can help you get your money in the market.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances. External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement. Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice. SoFi InvestÂ® The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individualâs specific financial needs, goals and risk profile. SoFi canât guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term âSoFi Investâ refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below. 1) Automated InvestingâThe Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (âSofi Wealthâ). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (âSofi Securities). 2) Active InvestingâThe Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation. 3) Digital AssetsâThe Digital Assets platform is owned by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business. For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, http://www.sofi.com/legal.
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A âbusiness cycleâ refers to the periodic expansion and contraction of a nationâs economy. Also known as an âeconomic cycle,â it tracks the different stages of growth and decline in a countryâs gross domestic product, or economic activity.
business cycles . Each business cycle is dated from peak to peak or trough to trough of economic activity.
During the expansion phase of the business cycle, GDP increases and the economy grows. This phase tends to be significantly longer than the contraction phase. Since 1945, the average expansion has been 65 months, while the average contraction has lasted 11 months, according to a congressional research report. Features of expansion periods include:
• GDP growth rate of 2-3%
• Inflation around 2%
• Unemployment between 3.5-4.5%
• Bullish stock market
• Increased demand for goods and services
• Interest rates move higher
• Job creation
• Stock prices usually increase
• Increased wages
• Increased real estate values
As economic growth slows down, an economic contraction begins as the nation enters a recession. GDP growth dips below 2% in this phase.
Companies that have taken out loans may struggle to repay them, so they have to lay off workers and slow down production. As workers lose jobs, they have to cut down on spending. This creates a cycle of economic decline. Features of contraction periods include:
• GDP growth falls below 2%
• Decreased demand for goods and services
• Interest rates move lower, making it easier to borrow money
• Loss of jobs, increased unemployment
• Reduced wages because people need jobs so theyâre willing to work for less, and companies canât pay as much
• Stock prices usually decline
• Real estate values plateau or decline
Stage 1: Recession
One definition of a recession is two consecutive quarters with a decline in real GDP. A recession could actually be defined more broadly as a period where there is significant decline in economic activity throughout the entire economy.
During this stage, GDP, profits, sales, and economic activity decline. Credit is tight for both consumers and businesses due to the policies set during the last business cycle. This leads to shifts in monetary policy that lead to a recovery phase. Itâs a vicious cycle of falling production, falling incomes, falling employment, and falling GDP.
The intensity of a recession is measured by looking at the three Dâs:
• Depth: The measure of peak to trough decline in sales, income, employment, and output. The trough is the lowest point the GDP reaches during a cycle. Before World War II, recessions used to be much deeper than they are now.
• Diffusion: How far the recession spreads across industries, regions, and activities.
• Duration: The amount of time between the peak and the trough.
A more severe recession is called a depression. Depressions have deeper troughs and last longer than recessions. The only depression that has happened thus far was the Great Depression, which lasted 3.5 years, beginning in 1929.
Stage 2: Early Cycle
Following a recession, there tends to be a sharp recovery as growth begins to accelerate. The stock market tends to rise the most during this stage, which generally lasts about one year. Interest rates are low, so businesses and consumers can borrow more money for growth and investment. GDP begins to increase.
Just as a recession is a vicious cycle, a recovery is a virtuous cycle of rising income, rising employment, rising GDP, and rising production. And similar to the three Dâs, a recovery period, which includes Stages 2-4, is measured using three Pâs: how pronounced, pervasive, and persistent the expansion is.
Stage 3: Mid-Cycle
This is generally the longest phase of the business cycle, with moderate growth throughout. On average the mid-cycle phase lasts three years. Monetary policies shift toward a neutral state: Interest rates are higher, credit is strong, and companies are profitable.
Stage 4: Late Cycle
At this stage, economic activity reaches its highest point, and while growth continues, its pace decelerates. Monetary policies become tight due to rising inflation and low unemployment, making it harder for people to borrow money. The GDP rate begins to plateau or slow.
Companies may be engaging in reckless expansions, and investors are overconfident, which increases the price of assets beyond their actual value. Late cycles last a year and a half on average.
What Industries Do Well During Each Stage?
Historically certain industries have prospered during each stage of the business cycle.
When money is tight and people are concerned about the economy, they cut back on certain types of purchases, such as vacations and fancy clothes. Also, when people anticipate a coming recession, they tend to sell stocks and move into safer assets, causing the market to decline.
Basically, industries do better or worse depending on supply and demand, and the demand for certain products shifts throughout the business cycle. In general, the following industries perform well during each stage of the business cycle:
• Information technology
• Financial sector
• Industrial sector
• Consumer sector
• Stocks and bonds
• Real Estate
• Household durables
• Information technology
• Energy and materials
• Commodities such as oil and gas
• Bonds can be a safe haven
• Index funds
Who Should Invest With the Business Cycle?
Business cycle investing is an intermediate-term strategy, since it isnât as short-term as day trading but not as long-term as buy and hold strategies. Each stage of the business cycle can last for a few months to a few years.
the best strategy for beginner investors.
However, more experienced investors might choose to shift at least a portion of their portfolio along with the business cycle. Business cycle investing can also be a good option for younger investors because they will have more opportunities to take advantage of the ups and downs of future cycles.
Understanding the business cycle can also help people make decisions such as when to buy a home or search for a job. Itâs usually best to purchase a home, start a business, or look for a job in the early to mid-stages of the cycle.
No business cycle is identical but history shows there can be a rough pattern to which industries do better as the economy expands and contracts. Investors can take cues from which stage of the business cycle the economy is in in order to allocate money to different sectors.
One great way to invest and keep track of the market is using an online investing app like SoFi InvestÂ®. The investing platform features both active and automated investing.
For help getting started, SoFi has a team of professional financial advisors available to answer questions and offer guidance.
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