Reviewed by Khadija Khartit

Mutual funds are investment vehicles that purchase stocks with investor capital in the hopes of capital appreciation. They are considered equity securities because investors purchase mutual fund shares, which represent ownership in the fund, giving them access to equity securities.

Shareholders, however, do not own the underlying assets (the stocks) but just a piece of the fund’s overall portfolio. By participating in a mutual fund, investors benefit from diversification and professional management and are considered equity investors.

Key Takeaways

• Mutual funds allow investors to pool their capital and gain exposure to a mix of stocks, benefiting from diversification and professional management.
• Unlike buying individual stocks, mutual fund investors own shares of the fund, not the underlying asset; however, they are still considered equity investors.
• Mutual fund investors benefit from capital appreciation and dividend payouts just as investors holding individual stocks do.

Equity Securities

An equity security is any investment vehicle in which each investor is a part owner of the controlling company. If an individual investor purchases 10 out of a total of 100 shares in a given equity security, they own 10% of the venture and are entitled to 10% of its net profit in the event of liquidation.

Investing in equity securities also grants the investor various rights to participate in the running of the company and may generate regular income in the form of dividends.

The most commonly traded equity securities are ordinary shares of stock bought and sold daily on the stock market. When an investor purchases a share of a company’s stock, they own a small piece of the company.

Note

An alternative to mutual funds is exchange-traded funds (ETFs). ETFs offer equity exposure and are often easier to manage as they can be bought and sold daily on exchanges like traditional stocks.

Mutual Funds

The difference between investing in stocks and investing in mutual funds is like the difference between selling your car to make a couple of bucks and buying a car dealership with 10 of your closest friends.

If you simply buy and sell your own car, you get to keep all the proceeds for yourself. However, you may not turn much of a profit if you cannot afford to buy a high-end car in the first place.

If you buy a car dealership as a group, you can leverage the sum of all your funds to invest in something that can generate a much larger profit. Though you have to split the proceeds, you can use your collective investment to sell a broader range of products.

Similarly, mutual funds are simply companies that allow many investors to leverage their combined funds to produce greater gains all around. Individuals purchase shares of the fund, which uses that money to invest in a diverse range of stocks, bonds, Treasury bills, or other highly liquid assets.

Shareholders are entitled to a portion of the profits commensurate with their financial interest in the fund. However, shareholders must avoid wash sales and other unethical practices.

What Is the Difference Between a Mutual Fund and a Stock?

A stock represents ownership in a single company. When you buy a stock, you’re buying a part of that company and your share comes with some features, such as voting rights. A mutual fund is a collection of investments, such as stocks, bonds, or other assets. When you buy a mutual fund, you’re buying a share in the fund, not the underlying asset (stock, bond, etc.).

With a stock, you have exposure to that one company, with a mutual fund, your investment is spread out over multiple stocks (in an equity mutual fund), which increases diversification, reducing risk. Additionally, mutual funds are professionally managed and choose stocks based on a theme, removing the work that you’d have to do in picking a stock.

Is an ETF a Mutual Fund?

No, an exchange-traded fund (ETF) is not a mutual fund. While both an ETF and a mutual fund are investment vehicles where investors pool capital to invest in a variety of securities, there are significant differences. ETFs trade on an exchange like stocks, so you can buy and sell them throughout the day at market prices. Mutual funds do not trade on exchanges and their prices are determined at the end of the trading day.

Additionally, ETFs are usually more affordable than mutual funds because they generally have lower expense ratios. Mutual funds also often come with minimum investment amounts, whereas with ETFs you can buy as little as one share, making them a less capital-intensive investment.

What Is One Example of an Equity Security?

An equity security is simply equity ownership of a company, meaning you own a portion of a company. This most commonly translates to the stock of a company. When private companies need to raise money, they go public through an initial public offering (IPO), offering shares to the public. These shares represent ownership in that company. An investor can buy that share (stock) and they now have an equity security. For example, if you bought Apple stock, you would have an equity security.

The Bottom Line

Mutual funds allow investors an easy way to gain access to a broad swath of equity securities without having to analyze and choose each stock on its own.

While shareholders don’t own the underlying stocks, and thereby do not have some traditional shareholder privileges, such as voting rights, the benefits of diversification and professional management often outweigh some of the drawbacks.

Reviewed by Robert C. Kelly

In the first quarter of 2020, the People’s Republic of China recorded its first contraction in gross domestic product (GDP) since official records began in 1992. The National Bureau of Statistics of China reported a year-over-year GDP decline of 6.8% for the quarter.

However, bolstered by its efforts to contain the COVID-19 pandemic and reopen its factories, China experienced a GDP rebound, with the government reporting a 3.2% GDP increase in the second quarter of 2020. This was followed by a 4.9% GDP increase in the third quarter and a 6.5% GDP increase in the fourth quarter, along with a 2.3% GDP increase for all of 2020.

What impact did China’s swift ability to restart its economic engines have on the U.S. economy and the global economy? To answer these questions, you need to first assess the economic position of China within the world economy.

Key Takeaways

• The economies of the United States and China are intricately linked, due to the two nations sharing a large trading partnership of goods and services.
• In 2020, China started the year with a historic GDP decline of 6.8% caused by the impact of the COVID-19 pandemic.
• After reopening its factories, China’s growth rebounded dramatically; the International Monetary Fund (IMF) accurately predicted China would be the only major world economy to experience growth in 2020.
• China’s economic growth in 2020 was attributed to its ability to meet the world’s demand for medical equipment, electronics, and other items needed during the pandemic.

The Size of China’s Economy

The International Monetary Fund (IMF) predicted China would be the only major economy to grow in 2020, with projected real GDP growth of about 1.9% for the year. This was in stark contrast to the U.S. economy, which was expected to shrink by 4.3% in 2020. The IMF expected European nations to post negative growth numbers in 2020 as well, with the United Kingdom estimated to contract by 9.8%, Germany by 6%, and France by 9.8%.

How did the IMF’s predictions turn out? China’s real GDP growth was 2.2% for 2020, compared with -2.2% for the United States. As for European nations and their real GDP, France shrank by 7.6%, Germany by 4.1%, and the U.K. by 10.3%.

The sheer size of China’s economy had a lot to do with its ability to regain positive momentum. China, the most populous country in the world, has the second-largest economy, ranked below the U.S. with a GDP of $17.79 trillion in 2023, the most recent data available. However, this high GDP did not necessarily indicate the wealth of the country. The country’s GDP per capita was only $24,569 as of 2023 compared to the U.S., which had a per capita GDP of $82,769.

Over the decades, many global manufacturing companies have located their manufacturing units in China, attracted by the nation’s low labor costs and cheap supply materials. This allowed companies to produce goods cheaply, and it explains why many of the products we use in our daily lives are made in China.

Relationship with the U.S. Economy

China is the third-largest trading partner (the first and second being Canada and Mexico, respectively) of the United States, with $582.4 billion in total goods traded in 2024. Of that amount, U.S. export goods to China accounted for $143.5 billion and U.S. import goods from China were $438.9 billion, bringing the U.S. trade deficit with China to $295.4 billion.

This deficit is financed partly by capital flows from China. China holds more U.S. Treasury securities than any other foreign country except Japan. According to the Treasury, China owns $759 billion in U.S. debt securities as of December 2024.

All of these statistics show the importance of the Chinese economy and why any developments in China, negative or positive, can influence the world’s largest economy, the United States.

24%

The total of all U.S. bulk agricultural commodity exports that were sent to China in 2024. That narrowly made China the largest destination for such exports, which include corn, cotton, rice, sorghum, soybeans, and wheat.

The Chinese Slowdown

Starting in 2010, China’s economic growth rate began a decade of decline. The GDP growth rate dropped from 9.6% in 2011 to 7.4% in 2014 (see graph below). The rate continued its decline to 6% in 2019 and 2.2% in 2020. The 2020 GDP growth was impacted by the coronavirus pandemic.

The trend reversed in 2021, as China’s GDP grew 8.4%. It declined again in 2022, growing only 3%, before resurging in 2023 (the most recent data available), growing 5.2%.

Economists have raised concerns that a slowdown in the Chinese economy like that of 2010–20 would have negative impacts on the markets that are closely related to this economy, such as the United States.

China’s Silver Lining in 2020

China’s role as “the world’s factory” was a key factor in its ability to quickly rebound in 2020. The nation is well-known for its abundance of lower-wage workers, a strong network of suppliers, lower tax rates that keep the cost of production low, competitive currency practices, and government support that reduces regulatory hurdles.

While the rest of the world struggled to regain its economic footing, China’s ability to reopen its factories and post impressive GDP numbers in the second through fourth quarters of 2020 proved that the nation’s economy was still growing.

If anything, the COVID-19 pandemic cemented China’s importance in the global supply chain. Much of China’s 2020 growth was attributed to its factories meeting the world’s demand for personal protective equipment (PPE), medical equipment, electronics (such as laptops), and other items that were in short supply as the rest of the world shuttered its factories while complying with mandatory stay-at-home orders.

What Is the Status of U.S.-China Trade Relations?

On Feb. 1, 2025, President Donald Trump ordered 10% tariffs on China. The tariffs took effect three days later, when China retaliated with duties on the imports of some U.S. goods and an antitrust probe of Google.

What Form Does the Chinese Economy Take?

China has a unique socialist open-market economy, with both tight government control and free-market elements. As a manufacturing and export-driven economy, the Chinese currency forex rates also significantly impact money supply.

What Would Be One Possible U.S. Impact of a Slowdown in the Chinese Economy?

U.S. companies that generate an important portion of their revenues from China are likely to be negatively affected by lower domestic demand in China. This would be bad news for both shareholders and employees of such companies. When cost-cutting is necessary to remain profitable, layoffs are usually one of the first options to consider, which increases the unemployment rate.

The Bottom Line

China, with its giant economy, has a huge influence on world economies. In 2020, the nation proved its resilience and was able to reopen its factories relatively early in the year, supplying the U.S. and other global economies with much-needed exports.

However, one of the biggest long-term risks to China’s economy could come in the form of economic decoupling. Tensions between the United States and China have escalated over a number of issues, including Hong Kong, the prolonged trade war, and increased tech rivalry. An economic decoupling could mean a reduction or severance of ties between the world’s two largest economies. China, for its part, has taken steps to reduce its dependence on the U.S. economy, building partnerships with other nations through its One Belt One Road (OBOR) initiatives.

Discover which forces pose the biggest threat to Delta

Fact checked by Timothy Li
Reviewed by Chip Stapleton

As one of the largest airline carriers in the world, Delta Air Lines faces competitive challenges and threats that can impact its performance and profitability. However, the shrewdest investors will go beyond looking at Delta’s financial position and will study the potential effects of external forces on the company’s health. One of the most effective tools for this is Porter’s Five Forces.

Key Takeaways

• Porter’s Five Forces is an analytical framework that helps investors evaluate a company based on its position within an industry and the kinds of horizontal and vertical threats it might face in the future.
• A horizontal threat is a competitive threat, such as a new company entering the marketplace and gaining market share.
• A vertical threat puts a company at a competitive disadvantage, such as buyers or suppliers gaining bargaining power.
• In the airline industry, buyers have tremendous bargaining power because they can quickly and easily switch from one carrier to another using third-party trip-booking websites and apps.

Overview of Porter’s Five Forces Method

Porter’s Five Forces is an analytical framework developed in 1979 by Harvard Business School professor, Michael E. Porter. Porter’s goal was to develop a thorough system for evaluating a company’s position within its industry and to consider the types of horizontal and vertical threats the company might face in the future.

Horizontal Threats and Vertical Threats

A horizontal threat is a competitive threat, such as customers switching to a substitute product or service, or a new company entering the marketplace and appropriating market share. A vertical threat is a threat along the supply chain, such as buyers or suppliers gaining bargaining power, that can put a company at a competitive disadvantage.

The Five Forces model evaluates three potential horizontal threats and two vertical threats. Industry competition, the threat of new entrants, and the threat of substitutes represent the horizontal threats. The vertical threats come from the increased bargaining power of suppliers and the increased bargaining power of buyers. Using the Five Forces framework, investors can determine the most viable threats to a company. With this information, they can evaluate whether the company has the resources and protocol in place to respond to likely challenges.

An Overview of Delta Air Lines

Delta Air Lines, Inc. (DAL) is the oldest airline still in operation in the United States. The company was founded in 1928 and has its headquarters in Atlanta, Georgia. From December 2023 to November 2024, Delta ranked first in domestic market share for U.S. airlines at 17.8%. Delta’s sheer size and status as a longtime leader in the airline industry have helped ensure its continued success.

Industry Competition

The level of competition in the airline industry is high. The big airlines essentially fly to the same places out of the same airports for about the same prices. The amenities, or lack of amenities, they offer are similar, and the seats in coach are just as cramped no matter which airline you choose. Delta’s traditional rivals include United and American, but the company also faces major competition from the growing popularity of value carriers, most notably Southwest, but also JetBlue and Spirit.

70 million

Delta reported 141.75 billion billions of “domestic revenue passenger miles”.

Because the air travel experience for customers is remarkably similar no matter which airline they take, airlines are constantly threatened by the prospect of losing passengers to competitors. Delta is no exception. If a customer is planning to book a flight from Houston to Phoenix on Delta but a third-party price aggregator, such as Priceline, reveals a better deal from United, the customer can make the switch with a simple click of the mouse. Delta manages these competitive threats with extensive marketing campaigns that focus on brand awareness and the company’s longstanding reputation.

Bargaining Power of Buyers

Buyers have some bargaining power over airlines because the cost and effort required to switch from one carrier to another is often minimal, and there are several airlines to choose from. The popularity of third-party trip-booking websites and smartphone apps exacerbates this issue for the airlines. Most travelers do not contact an airline, such as Delta, directly to book a flight. They access sites or apps that compare rates across all carriers, enter their trip itineraries, and then choose the least expensive deal that accommodates their schedules.

However, there are millions of consumers and a limited number of airlines, which gives those airlines more power. While consumer choice can force airlines to maintain competitive pricing, consumers do not actually have the power to set air travel prices. Moreover, if Delta is one of the only airlines offering flights on a particular route, that further limits the bargaining power of buyers, who may have no choice but to take the Delta flight that gets them to their destination—no matter the price.

In response to the challenge of consumer choice and the emergence of third-party travel websites, Delta can conduct market research and offer more direct flights at low prices to the destinations fliers search for most frequently on third-party platforms. Additionally, the company could strengthen relationships with credit card companies and strive to offer the best reward programs; customers may be less likely to switch carriers when they have accumulated what they view as “free” miles with a particular airline.

The Threat of New Entrants

Potential new entrants to the marketplace represent a minimal threat to Delta. The barriers to entry in the airline industry are remarkably high. The operating costs are massive, and the government regulations a company must navigate are numerous and exceedingly complex. JetBlue, founded in 1998, represents a newer airline to make a dent in the industry, and the company’s market share is still less than one-third of Delta’s.

Bargaining Power of Suppliers

The list of airline suppliers is actually quite long. The list of airlines for suppliers to sell to, however, is short. This asymmetry places the bargaining power directly in the hands of the airlines. Bargaining power is particularly strong for Delta, given its position as the world’s largest airline by passenger revenue. Put simply, Delta’s suppliers have a strong incentive to keep the relationship on good terms. Delta can likely find a replacement supplier without a problem if the relationship goes bad. The supplier, by contrast, is unlikely to find another buyer capable of replacing the sales volume represented by Delta.

Threat of Substitutes

A substitute, as defined by the Five Forces model, is not a product or service that competes directly with the company’s offerings but acts as a substitute for it. Thus, a United flight from New York to Los Angeles is not considered a substitute for a Delta flight with the same start and endpoints. Examples of substitutes are making the trip by train, car, or bus. Unless a trip is very short, such as traveling from Los Angeles to Las Vegas, no methods of travel rate as viable substitutes for air travel. New York to Los Angeles is a 6.5-hour flight. The trip takes 41 hours by car or bus, and a train cannot get you there much faster. Until a new technology comes along that supplants air travel as the fastest and most convenient way to travel long distances, Delta faces little threat from substitute methods of travel.

What Is Porter’s Five Forces Model?

Porter’s Five Forces is a framework developed by Michael Porter to analyze industry competition. It examines five key forces that shape profitability: competitive rivalry, the bargaining power of suppliers, the bargaining power of buyers, the threat of new entrants, and the threat of substitutes. This model helps companies assess their strategic position and identify factors that could impact their profitability and market standing.

How Does Porter’s Five Forces Apply to Delta Airlines?

Delta Airlines, as part of the airline industry, faces intense competition, high operational costs, and external pressures that shape its profitability. The airline’s ability to manage these forces—such as negotiating with powerful aircraft manufacturers and dealing with price-sensitive customers—determines its competitive advantage.

What Is Competitive Rivalry Like in the Airline Industry?

The airline industry is highly competitive, with major players like American Airlines, United Airlines, and Southwest Airlines competing on routes, pricing, and service. Since air travel is a largely standardized service, price wars and loyalty programs are common. These types of airlines have to differentiate themselves with quality of service and operational efficiency.

Do Customers Have High Bargaining Power in the Airline Industry?

Yes, customers have considerable bargaining power due to the availability of online price comparison tools and the relatively low switching costs between airlines. Price-sensitive travelers often choose the cheapest available option, making customer loyalty difficult to maintain.

The Bottom Line

Delta Airlines faces intense competitive rivalry, with major airlines competing on pricing, routes, and customer loyalty programs. The bargaining power of suppliers is high due to reliance on a few aircraft manufacturers and fuel providers. Buyer power is also strong since customers can easily compare prices and switch airlines. There are high barriers to entry that limit new competition, but the threat of substitutes poses a challenge for Delta.

Reviewed by David Kindness
Fact checked by Jiwon Ma

Variable Costs vs. Fixed Costs: An Overview

Fixed costs are expenses that remain the same no matter how much a company produces, such as rent, property tax, insurance, and depreciation. Variable costs are any expenses that change based on how much a company produces and sells, such as labor, utility expenses, commissions, and raw materials.

Fixed costs are normally independent of a company’s specific business activities. Variable costs increase as production rises and decrease as production falls. Understanding the difference between these costs can help a company ensure its fiscal solvency.

Key Takeaways

• Companies incur two types of production costs: variable and fixed costs.
• Variable costs change based on the amount of output produced.
• Variable costs may include labor, commissions, and raw materials.
• Fixed costs remain the same regardless of production output.
• Fixed costs may include lease and rental payments, insurance, and interest payments.

Variable Costs

Variable costs are any costs that a company incurs that are associated with the number of goods or services it produces. A company’s variable costs increase and decrease with its production volume. When production volume goes up, the variable costs increase.

But if the volume goes down, the variable costs follow suit. If a company has a product line that is underperforming or outdated, it may choose to stop production of that line. The costs associated with this product are considered avoidable costs.

Examples of variable costs generally include:

• Labor
• Commissions
• Packaging
• Utility expenses
• Raw materials for production

Calculating variable costs can be done by multiplying the quantity of output by the variable cost per unit of output. Suppose ABC Company produces ceramic mugs for a cost of $2 per mug. If the company produces 500 units, its variable cost will be $1,000.

However, if the company doesn’t produce any units, it won’t have any variable costs for producing the mugs. Similarly, if the company produces 1,000 units, the cost will rise to $2,000.

One important point to note about variable costs is that they differ between industries, so it’s not at all useful to compare the variable costs of a car manufacturer and an appliance manufacturer. That’s because their product output isn’t comparable.

If you’re going to compare the variable costs between two businesses, make sure you choose companies that operate in the same industry.

Important

Companies may also have semi-variable costs. These costs are a mixture of both variable and fixed costs.

Fixed Costs

Fixed costs remain the same regardless of whether goods or services are produced or not. Thus, a company cannot avoid fixed costs. As such, a company’s fixed costs don’t vary with the volume of production and are indirect, meaning they generally don’t apply to the production process—unlike variable costs.

The most common examples of fixed costs include lease and rent payments, property tax, certain salaries, insurance, depreciation, and interest payments.

To demonstrate, let’s use the same example from above. In this case, suppose Company ABC has a fixed cost of $10,000 per month to rent the machine it uses to produce mugs. If the company does not produce any mugs for the month, it still needs to pay $10,000 to rent the machine.

But even if it produces one million mugs, its fixed cost remains the same. The variable costs change from zero to $2 million in this example.

Note

A company’s net profit is affected by changes in sales volumes. That’s because as the number of sales increases, so too does the variable costs it incurs.

Special Considerations

The more fixed costs a company has, the more revenue a company needs to generate to be able to break even, which means it needs to work harder to produce and sell its products. That’s because these costs occur regularly and rarely change over time.

While variable costs tend to remain flat, the impact of fixed costs on a company’s bottom line can change based on the number of products it produces. So, when production increases, the fixed costs drop. The price of a greater amount of goods can be spread over the same amount of a fixed cost. In this way, a company may achieve economies of scale by increasing production and lowering costs.

For example, let’s say that Company ABC has a lease of $10,000 a month on its production facility and produces 1,000 mugs per month. As such, it may spread the fixed cost of the lease at $10 per mug. If it produces 10,000 mugs a month, the fixed cost of the lease goes down to the tune of $1 per mug.

Is Marginal Cost the Same as Variable Cost?

The term marginal cost refers to any business expense that is associated with the production of an additional unit of output or by serving an additional customer. A marginal cost is the same as an incremental cost because it increases incrementally in order to produce one more product.

Marginal costs can include variable costs because they are part of the production process and expense. Variable costs change based on the level of production, which means there is also a marginal cost in the total cost of production.

Are Fixed Costs Treated As Sunk Costs?

The term sunk cost refers to money that has already been spent and can’t be recovered. While sunk costs may be considered fixed costs, not all fixed costs are considered sunk. For instance, a fixed cost isn’t sunk if a piece of machinery that a company purchases can be sold to someone else for the original purchase price.

How Do Semi-Variable Costs Separate Fixed and Variable Costs?

Semi-variable costs are also called semi-fixed or mixed costs. These types of expenses are composed of both fixed and variable components. They are fixed up to a certain production level, after which they become variable. Costs remain fixed even if no production occurs. It’s easy to separate the two, as fixed costs occur regularly while variable ones change as a result of production output and the overall volume of activity that takes place.

How Can a Business Reduce Variable Costs?

There are many ways that a business can reduce its variable costs. For instance, increasing output using the same amount of material can dramatically cut down costs, provided the quality of goods isn’t impacted.

Developing a new production process can help cut down on variable costs, which may include adopting new or improved technological processes or machinery. If this isn’t possible, management may consider analyzing the process to spot opportunities for efficiencies and improvement, which can bring down certain variable costs like utilities and labor.

The Bottom Line

Businesses incur all sorts of costs. Some of these remain static regardless of output, while others will fluctuate. Understanding the differences between fixed and variable costs will allow businesses to better manage their operations, margins, and overall strategy.

Legendary investor Warren Buffett has smart estate-planning advice for all parents, regardless of their wealth level: Let your adult children read your will before you sign it.

In a revealing November 2024 letter to shareholders, the Berkshire Hathaway (BRK.A) CEO explained that this simple act could prevent family conflicts and strengthen relationships after a parent’s death.

“Over the years, I have had questions or commentary from all three of my children and have
often adopted their suggestions,” Buffett wrote. “There is nothing wrong with my having to defend my thoughts. My dad did the same with me.”

Key Takeaways

• Warren Buffett recommends letting adult children review your will before signing it to ensure they understand your decisions and their future responsibilities.
• Buffett said he takes questions and comments from his three children and has often adopted their suggestions when updating his will.
• Open discussions about inheritance plans can prevent family conflicts and jealousies that often arise after a parent’s death.

Why Sharing Your Will Matters

Buffett’s advice stems from decades of observing families torn apart by unexpected or confusing inheritance decisions. When children discover the contents of a will only after their parent’s death, questions about fairness and childhood memories of favoritism can surface, potentially damaging sibling relationships forever.

“While it’s important to have well-written estate documents, we see most estate planning go awry because of emotional issues,” Mitchell Kraus, a certified financial planner at Capital Intelligence Associates, told Investopedia. “For most families, the best way to make sure there aren’t fights after death is to have cross-generational conversations.”

Buffett said parents should be prepared to defend their choices and listen to their children’s input while they are still alive—just as his father did with him.

Note

Buffett has been candid about his views on limiting generational wealth transfers through inheritance. “I’ve never wished to create a dynasty or pursue any plan that extended beyond the children,” he wrote in the November 2024 letter, explaining his “belief that hugely wealthy parents should leave their children enough so they can do anything but not enough that they can do nothing.”

Making Changes and Taking Feedback

The “Oracle of Omaha” practices what he preaches. He said he updates his will every couple of years, sometimes making minor adjustments based on conversations with his three children. He said this has helped his family maintain strong relationships while managing the responsibilities that come with inheriting significant wealth. Indeed, Buffett believes that discussing inheritance plans openly can help families grow closer rather than drift apart.

“Be sure each child understands both the logic for your decisions and the responsibilities they will encounter upon your death,” Buffett wrote. “If any have questions or suggestions, listen carefully and adopt those found sensible. You don’t want your children asking ‘Why?’ in respect to testamentary decisions when you are no longer able to respond.”

Note

Up to 3% of wills are contested in the United States. Will contests can be emotionally devastating and financially draining for families. Legal battles over inheritances can take years to resolve in probate court and can cost thousands of dollars in legal fees.

The Bottom Line

“The biggest stumbling block is often older generations not wanting to address that there might be problems,” Kraus said. Buffett suggests that parents disclose their wills to their children before finalizing them to prevent future family conflict. This reflects his broader beliefs about inheritance management and family communication: Parents who openly discuss such decisions and solicit input from their adult children can avoid misunderstandings and build stronger family connections while ensuring their wishes are well understood.

Buffett’s estate planning strategy can be a chance for meaningful family discussions instead of potential discord. But what if your family relations are already pretty heated? The professionals have a way to deal with that, too. “For more dysfunctional families,” Kraus said, “we recommend professionals who will run family meetings and make sure things do not get out of control.”

Fact checked by Hans Daniel Jasperson
Reviewed by Thomas Brock

Most people who read the financial press or watch financial news will have heard the term “beat the street.” This refers to companies posting earnings results that are better than the forecasts for earnings made by investment and financial analysts.

Wall Street analysts’ consensus earnings estimates are used by the market to judge stock performance. Here we offer a brief overview of consensus earnings forecasts, and what they can mean to investors.

Key Takeaways

• Large brokerages hire analysts to publish reports on various corporations’ upcoming profit announcements, including earnings-per-share and revenue forecasts.
• Consensus earnings estimates refer to the average or median forecast of what a company is expected to earn or lose for a given period of time, typically quarters and full years.
• While there are some flaws in the system, consensus estimates are perceived as significant for understanding a stock’s valuation.
• They are monitored by investors and the financial press.
• Whether a company meets, beats or misses forecasts can have an impact (usually short term) on the price of its underlying stock.

What Are Consensus Earnings Estimates?

Investors measure stock performance on the basis of a company’s earnings power.

To make a proper assessment, investors seek a sound estimate of this year’s and next year’s earnings per share (EPS), as well as a strong sense of how much the company will earn even further down the road.

That’s why, as part of their services to clients, large brokerage firms employ legions of stock analysts to forecast companies’ earnings for the coming years.

Consensus earnings estimates or forecasts are normally an average or median of all the forecasts from individual analysts tracking a particular company and its stock.

Consensus earnings estimates are far from perfect, but they are watched by many investors and play an important role in measuring the appropriate valuation for a stock.

Various Forecasts, One Average

When you hear that a company is expected to earn $1.50 per share this year, that number could be the average of 30 different forecasts.

On the other hand, if it’s a smaller company, the estimate could be the average of just one or two forecasts.

A few companies, such as Refinitiv and Zacks Investment Research, compile estimates and compute the average or consensus.

Consensus numbers can also be found at a number of financial websites, such as Yahoo! Finance. Individual estimates are found by looking up a particular stock, such as Amazon.

Some of these sites also show how estimates get revised upward or downward.

Important

Consensus earnings estimates are not fixed. Analysts typically revise their forecasts as new information comes in, such as company news, or regulatory or industry-specific information.

Forecast Coverage

Consensus estimates of quarterly earnings are published for the current quarter, and forward for about eight quarters.

In some cases, forecasts are available beyond that. Forecasts are also compiled for the current and next 12-month periods.

A consensus forecast for the current year is reported once the actual results for the previous year are released.

As actual numbers are made available, analysts typically revise their projections within the quarter or year they are forecasting.

Calculating Earnings

The basic measurement of earnings is earnings per share. This metric is calculated as the company’s net earnings—or net income found on its income statement—minus dividends on preferred stock, divided by the number of outstanding shares.

For example, if a company (with no preferred stock) produces a net income of $12 million in the third quarter and has eight million shares outstanding, its EPS would be $1.50 ($12 million/8 million).

The Importance of Earnings

Investors can keep an eye on consensus numbers to gain an idea of how a stock is likely to perform.

Many investors, including sophisticated institutional investors such as mutual fund and pension fund managers, rely on earnings forecasts to gauge a company’s growth potential and to time their trades.

Stocks are assessed according to their ability to generate and increase earnings as well as to meet or beat analysts’ consensus estimates for earnings.

This influences a company’s implicit value (the personal perceptions and research of investors and analysts), which in turn can affect whether a stock’s price rises or drops.

Analysts’ forecasts also are critical because they contribute to investors’ valuation models.

Institutional investors can move markets due to the volume of assets they manage. They follow analysts at big brokerage houses to varying degrees.

Earnings vs. Other Results

Why does the investment community focus on earnings rather than other metrics such as sales or cash flow?

First, any finance professor will tell you that the only proper way to value a stock is to predict the long-term free cash flows of a company, discount those free cash flows to the present day and divide by the number of shares.

But this is much easier said than done, so investors often shortcut the process by using accounting earnings as a substitute for free cash flow.

Secondly, accounting earnings are a much better proxy for free cash flow than sales. They’re also fairly well defined. And public companies’ earnings statements must go through rigorous accounting audits before they are released.

As a result, the investment community views earnings as a fairly reliable, not to mention convenient, measure.

Note

Most investors, including large institutions, lack the resources to track thousands of publicly-listed companies in detail, or even to keep tabs on a fraction of them. So they welcome consensus earnings forecasts.

The Basis of Analysts’ Forecasts

Earnings forecasts are based on analysts’ expectations of company growth and profitability. To predict earnings, most analysts build financial models that estimate revenues and costs.

Many analysts will incorporate top-down factors such as economic growth rates, currencies, and other macroeconomic factors that influence corporate growth.

They use market research reports to get a sense of underlying growth trends. To understand the dynamics of the individual companies they cover, really good analysts will speak to customers, suppliers, and competitors.

In addition, companies themselves offer earnings guidance that analysts build into the models.

Revenues

To predict revenues, analysts estimate sales volume growth and the prices companies can charge for products.

On the cost side, analysts look at expected changes in the costs of running the business. Costs include wages, materials used in production, marketing and sales costs, interest on loans, and more.

Important

Consensus estimates are so consistently tracked by so many stock market players that when a company misses forecasts, it can send a stock tumbling. Similarly, a stock that merely meets forecasts might get sent lower, as investors have already priced in the in-line earnings.

Actual Earnings vs. Consensus Estimates

Consensus estimates of earnings are so powerful that even small deviations between estimates and subsequent reports of actual earnings can send a stock higher or lower.

If a company exceeds its consensus estimates, it is usually rewarded with an increase in stock price. If a company falls short of consensus numbers—or just meets expectations—its share price can take a hit.

With so many investors watching consensus numbers, the difference between actual and consensus earnings is perhaps the single most important factor driving share price performance over the short term.

This should come as little surprise to anyone who has owned a stock that missed the consensus by a few pennies per share and, as a result, tumbled in value.

For better or for worse, the investment community relies on earnings as its key metric. Stocks are judged not only by their ability to increase earnings quarter over quarter but also by whether they are able to meet or beat a consensus earnings estimate.

Why Do Earnings Matter?

One reason they matter is because a company with growing net income, or earnings, is growing in value. Investors who own the stock of such a company should see the price of their shares rise. That, in turn, increases the overall value of the investors’ portfolio and their wealth.

How Can Analysts Forecast a Company’s Earnings?

Publicly traded companies are required by the Securities and Exchange Commission to make financial details public. In addition, companies often provide guidance for analysts and investors concerning their future financial results. So analysts can research a wealth of data to come up with their estimates for earnings.

How Do Companies Give Earnings Guidance?

A good source of earnings guidance is the Management Discussion and Analysis (MD&A) section of the annual report. There you’ll find information on a company’s financial condition and results of operations, including analysis and financial projections.

The Bottom Line

Financial analysts provide earnings forecasts in advance of actual earnings reports so that investors can gauge a company’s performance and stock valuation.

For convenience, the figures of many forecasts are averaged and become a consensus earnings forecast that investors may use to size up their investments and to make trade decisions.

An In-Depth Look at the Economic and Market Influences on Gold

Gold has captivated human kind for millennia-serving not only as a symbol of wealth but as a cornerstone of the global financial system.

Understanding what drives gold prices is crucial for investors, economists, and anyone interested in the value of this precious metal. This guide explores the factors that drive its price.

Key Takeaways

• Gold’s price is influenced by central bank reserves and their purchasing trends.
• Economic and political instability increase demand for gold as a safe haven.
• Global gold production and mining challenges affect gold’s supply and price.
• Demand for gold in jewelry and technology sectors also impacts its price.

Understanding Gold as an Asset

Gold’s distinctive characteristics set it apart from other investments. Beyond its luster, the metal’s limited supply and indestructible nature have contributed to its stability as a long-term store of value. Gold cannot be printed like currency or created out of thin air. Its scarcity and permanence have made it a hedge against currency devaluation or inflation and economic instability.

Unlike stocks or bonds, gold is tangible. It maintains high liquidity across global markets and is universally recognized as valuable, regardless of political or economic conditions. Its value tends to rise when confidence in other financial assets declines, particularly during periods of high inflation, economic uncertainty, or geopolitical instability.

These properties make it an attractive part of diversified investment portfolios.

Historical Price Trends of Gold

The modern era of gold pricing effectively began in 1971 with the end of the Bretton Woods system, which had previously fixed gold’s price to the U.S. dollar. Gold prices have been allowed to float freely, leading to significant volatility throughout the 1970s as stagflation drove investors toward safe havens. The decade culminated in January 1980 with gold reaching what remains its inflation-adjusted peak of about $3,300 in today’s dollars. The metal would then enter a lengthy decline through the 1980s and 1990s, bottoming at just $253 per ounce in 1999 amid a strong global economy.

The 21st century ushered in a new chapter for gold prices, marked by several dramatic rallies tied to major economic crises. The 2008 financial crisis saw gold surge from $730 to $1,300 between October 2008 and October 2010, while the European sovereign debt crisis pushed prices to $1,825 by mid-2011. More recently, the pandemic triggered another significant rally. High inflation kept that rally going, and political instability kept the trend going once inflation pulled back from the highs in early 2020. Gold ultimately reached a new nominal record high above $2,900 in February 2025.

When viewing gold’s performance in a broader context, however, it’s important to take a comparative approach. If you invested $100 in gold in 1972, that would have grown to about $4,500 by 2024, an impressive return, until you compared investing the same $100 invested in the S&P 500, which would have grown to over $18,500. The chart below compares the annual returns for gold and the S&P 500 over time:

This historical perspective reveals gold’s dual nature: while it serves as a useful hedge during specific conditions like high inflation or market uncertainty, it may underperform other assets during periods of stability and growth.

Key Factors Influencing Gold Prices

Gold Supply and Mining Production

As with any produced commodity, the law of supply and demand fundamentally drives the price of gold. Yet, gold is fairly unique because new supply each year is small compared with the total existing stock, making prices particularly sensitive to fluctuations in demand or sentiment rather than production levels.

Annual mine production adds approximately about 2% to 3% to the above-ground gold stock. However, changes in production levels, whether due to discoveries, technological advances, or regulatory constraints, still influence prices. For example, environmental regulations and increasing extraction costs have made new mining projects more challenging, potentially constraining future supply growth.

Major gold producing countries include China, South Africa, the United States, Australia, Russia, Ghana, Indonesia, and Peru.

Central Bank Reserves

Central banks influence gold prices through their reserve management policies. They hold about one-fifth of all gold ever mined.

Central banks buy gold to maintain stability and credibility in their monetary systems and preserve national wealth against various economic risks-and when they do make large purchases, their actions can drive up global gold prices by both reducing available supply and signaling confidence in gold as a strategic asset.

In recent years, there has been an increase in gold purchases by central banks, particularly from emerging market economies seeking to diversify their reserves away from the U.S. dollar.

Inflation and the Value of the U.S. Dollar

Since gold is often dollar-denominated on world markets, its price tends to exhibit an inverse relationship with the U.S. dollar.

Gold is comparatively less expensive for foreign buyers when the dollar weakens against other major currencies, potentially increasing demand and driving up prices. Conversely, a stronger dollar often corresponds with lower gold prices.

Relatedly, when U.S. interest rates are low, the opportunity cost of holding gold (which pays no yield) decreases, making it more attractive to investors. When interest rates rise, gold demand may fall. This relationship becomes particularly important during periods of high inflation. If rates lag behind inflation, creating negative real interest rates, gold often benefits as investors seek to preserve purchasing power.

That said, in the mid-2020s, gold prices continued to rise even as interest rates and inflation have come down.

Economic Uncertainty and Safe Haven Demand

Market volatility, geopolitical tensions, and economic crises often drive investors toward gold as a safe haven asset. During periods of uncertainty, gold’s historical stability and lack of correlation with other financial assets make it particularly attractive.

In this way, gold has often served as a sort of insurance against extreme market events and systemic risks that could impact traditional investment portfolios. Gold’s physical nature and its 5,000-year history as a store of value make it uniquely suited to satisfy this deeply rooted human instinct for security during turbulent times. This psychological anchor helps explain why gold often experiences increased demand precisely when other assets are sold in a panic, creating characteristic countercyclical price movements.

Investor Demand Through ETFs and Mutual Funds

Investment demand for gold through specialized mutual funds, exchange-traded funds (ETFs), and other investment vehicles has emerged as a major force in the gold market since the early 2000s, fundamentally changing how both institutional and retail investors access gold. These financial products allow investors to gain exposure to gold prices without the logistical challenges of storing and securing actual bullion, effectively democratizing gold investment.

When investors buy shares in gold ETFs, the funds typically purchase and store physical gold to back up these shares, creating a direct link between fund flows and physical gold demand.

As of the first quarter of 2025, SPDR Gold Shares ETF (GLD), one of the largest gold ETFs, along with its lower-cost sister fund GLDM, collectively held more than 31.6 million ounces of gold—worth more than $90 billion.

Consumer Demand for Gold: Jewelry and Technology

The jewelry sector traditionally dominates gold demand, accounting for approximately 50% of annual consumption. This demand is deeply rooted in cultural traditions and economic behavior, which is particularly evident in markets like India and China, where gold jewelry serves a dual purpose as both fashion/adornment and as a store of wealth. The cultural significance of gold in these markets creates distinct demand patterns, such as predictable spikes during wedding seasons in India or Chinese New Year celebrations.

While industrial applications consume smaller quantities of gold, they represent an increasingly significant and more stable source of demand, primarily due to gold’s unique physical properties that make it difficult to substitute in critical applications. The electronics industry uses gold for its superior electrical conductivity and resistance to corrosion, making it important in manufacturing sophisticated devices, from smartphones to medical equipment.

Investment Demand

Gold also sees demand from ETFs. These are securities that hold the metal and issue shares that investors can buy and sell, just like stocks. The SPDR Gold Trust ETF is the largest and it held about 863 tons of gold in September 2024.

When expected or actual returns on bonds, equities, and real estate fall, the interest in gold investing can increase, driving up its price. Gold can be used as a hedge to protect against economic events like currency devaluation or inflation.

Important

While some ETFs represent ownership in the actual metal, others hold shares of mining companies rather than actual gold.

The Bottom Line

Gold prices are determined by a range of factors, from central bank policies to industrial demand and investor sentiment. Understanding these drivers is crucial for anyone considering gold as an investment or seeking to comprehend its role in the global financial system.

Fact checked by Vikki Velasquez
Reviewed by Chip Stapleton

The S&P 500 consists of 500 companies that have issued a total of 504 stocks. Some companies such as Alphabet have issued multiple classes of shares. The top 10 largest holdings are listed on the official S&P Global website. An S&P 500 company must meet specific requirements to be included as a constituent within the index.

S&P doesn’t provide the total list of holdings, however, at least not for free. Subscribers to S&P’s research unit, Capital IQ, can get access to the entire list. S&P 500 companies represent the top companies within their industries and they’re a gauge of U.S. economic activity.

Key Takeaways

• The S&P 500 includes some of the top companies that are leaders within their industries and represent a gauge of the U.S. economy.
• Companies must meet certain requirement criteria determined by the publishers of the index before being added to the S&P.
• The S&P 500 index is market capitalization-weighted so it gives a higher percentage allocation to companies with the largest market cap.
• A stock must meet certain criteria including a total market cap of $14.5 billion to join the S&P 500.
• Companies can be removed from the S&P 500 if they deviate substantially from these standards.

S&P 500 Inclusion Criteria

The S&P 500 was created in 1957 and it’s one of the most widely quoted stock market indexes. S&P 500 stocks represent the largest publicly traded companies in the U.S. The S&P 500 focuses on the U.S. market’s large-cap sector.

An S&P 500 company must meet a broad set of criteria to be added to the index:

• It must have a total market capitalization of at least $14.5 billion.
• Must be a U.S. company
• A float-adjusted liquidity ratio (FALR) greater than or equal to 0.75
• A positive sum of the most recent four consecutive quarters of trailing earnings
• Positive earnings for its most recent quarter
• Must meet certain liquidity requirements

Companies may be removed from the S&P 500 if they deviate substantially from these standards.

$53.7 Trillion

The total combined market cap of the 504 constituents in the S&P 500 as of Feb. 25, 2025.

S&P 500 Calculation

The S&P 500 is a free-float market capitalization-weighted index. Market capitalization represents the total dollar market value of a company’s outstanding equity shares. Market cap is calculated by multiplying the total number of outstanding shares of stock by the company’s current stock price. A company with 20 million shares outstanding in which its stock is selling for $100 per share would have a market cap of $2 billion.

The more valuable an individual company’s stock becomes, the more it contributes to the S&P 500’s overall return as a result. It’s not uncommon for three-quarters of the index’s return to be linked to only 50 to 75 stocks.

The addition or subtraction of smaller companies from the index therefore doesn’t have a noticeable impact on the overall return of the index. The removal or addition of even just one of the largest stocks can have a major effect, however.

S&P 500 Sector Breakdown

These are the top sectors and their weightings within the S&P 500 index as of Feb. 25, 2025.

Being aware of the S&P’s sector weighting is important because sectors with a smaller weighting may not have a material impact on the value of the overall index. This can be the case even if they’re outperforming or underperforming the market.

If oil prices are rising and leading to increased profits for the energy sector, those stocks represent only 4.4% of the S&P 500. Oil stocks may not lead to a higher S&P if the more heavily weighted information technology sector is underperforming.

Important

S&P 500 components are weighted by free-float market capitalization so larger companies can affect the value of the index to a greater degree.

Top 25 Components by Market Cap

The exact weightings of the top 25 components aren’t available from S&P directly so the weightings below are from the SPDR S&P 500 Trust ETF (SPY). SPY is the oldest exchange-traded fund (ETF) that tracks the S&P 500. It holds $625.5 billion in assets under management (AUM) as of Feb. 25, 2025 and is highly traded.

The SPY’s portfolio weightings provide a good proxy for investing in the underlying S&P 500 index as a result. The two may not be exactly the same, however. These are the 25 largest S&P 500 index constituents by weight as of Feb. 25, 2025:

1. Apple (AAPL): 7.35%
2. NVIDIA (NVDA): 6.29%
3. Microsoft (MSFT): 5.91%
4. Amazon (AMZN): 3.91%
5. Meta (META), formerly Facebook, Class A: 2.86%
6. Alphabet Class A (GOOGL): 2.06%
7. Broadcom (AVGO): 1.91%
8. Tesla (TSLA): 1.81%
9. Berkshire Hathaway (BRK.B): 1.79%
10. Alphabet Class C (GOOG): 1.69%
11. JPMorgan Chase (JPM): 1.44%
12. Eli Lilly (LLY): 1.36%
13. Visa Class A (V): 1.19%
14. Exxon Mobil (XOM): 0.96%
15. Costco (COST): 0.90%
16. Mastercard Class A (MA): 0.90%
17. UnitedHealth Group (UNH): 0.83%
18. Netflix (NFLX): 0.83%
19. Walmart (WMT): 0.80%
20. Procter & Gamble (PG): 0.79%
21. Johnson & Johnson (JNJ): 0.77%
22. Home Depot (HD): 0.74%
23. AbbVie (ABBV): 0.70%
24. Bank of America: (BAC): 0.58%
25. Salesforce Inc. (CRM): 0.58%

How Many Companies Are in the S&P 500?

There were generally 500 companies within the index but that number has grown to 504 stocks as of Feb. 25, 2025 because some companies such as Alphabet have multiple classes of equity shares.

How Are Companies Selected for the S&P 500?

A company must meet certain requirements for inclusion in the S&P 500, which include:

• A market cap of at least $14.5 billion
• Must be a U.S. company
• A float-adjusted liquidity ratio (FALR) greater than or equal to 0.75
• Positive earnings over the most recent four consecutive quarters summed together
• A profitable earnings report for the company’s most recent quarter
• Liquidity requirements

How Can I Buy the S&P 500?

The S&P 500 is an index so it can’t be purchased directly but exchange-traded funds that mirror or track the index can be purchased. They include the State Street Global Advisors’ SPDR S&P 500 Trust ETF (SPY).

The Bottom Line

The top 25 companies in the S&P 500 are some of the most well-known companies in the world. A large portion of the top 10 are tech companies such as Apple, Microsoft, and Google. Investors can purchase the individual stocks of the companies or invest in a fund that tracks the S&P 500.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read our warranty and liability disclaimer for more info.

Here’s how to use your donations to save on taxes

Fact checked by Vikki Velasquez

What Is the Charitable Contribution Deduction?

The Internal Revenue Code (IRC) includes a tax break for charitable giving. However, claiming the charitable contribution deduction is subject to numerous rules. For instance, your donation must be made to a qualifying organization, and the deductions for some contributions are limited.

You must also itemize to claim this deduction, but that’s not always the best option for every taxpayer. Learn more about charitable giving rules and how to use these deductions to minimize your tax bill.

Key Takeaways

• The charitable contribution deduction is an itemized deduction that’s claimed on Schedule A of the Form 1040 tax return.
• Taxpayers can’t claim the standard deduction for their filing status if they itemize.
• The fair market value of anything you receive in exchange for your gift must be subtracted from the amount of your deduction.
• Only donations made to qualified charities are eligible.
• Deductible contributions are limited to a percentage of the taxpayer’s adjusted gross income.

Rule #1: You Must Itemize

The Internal Revenue Code requires taxpayers to either itemize their deductions or claim the standard deduction for their filing status. They can’t do both. A primary consideration is which option subtracts more from their incomes so they don’t end up paying tax on more than they have to.

However, you’re not comparing just your charitable contribution to your standard deduction. Itemizing requires completing Schedule A and submitting it with your tax return. This schedule also includes other expenses you can deduct, such as home mortgage interest and state and local taxes paid during the tax year. Compare the total of all your deductions on Schedule A to the standard deduction you’re entitled to claim to decide which one makes sense for you.

The standard deductions for the 2024 tax year are $14,600 for single taxpayers, $21,900 for those who qualify as head of household, and $29,200 for married taxpayers who file jointly. They increase to $15,000 for single taxpayers, $22,500 for heads of household, and $30,000 for married taxpayers filing jointly for the 2025 tax year (filing in 2026).

Note

The Internal Revenue Service adjusts the standard deductions annually to keep pace with inflation.

Rule #2: You Can’t Be Rewarded

Deductible donations are subject to what the IRS calls quid pro quo adjustments. You must subtract the value of anything you receive in return for your gift.

Let’s say you contribute $500 to a raffle conducted by a charitable organization to raise money and win the prize, which is a $95 tablet. You must subtract its fair market value (FMV) from your charitable contribution: $500 – $95 = $405. Thus, you can only claim $405 as a deduction.

Rule #3: The Charity Must Qualify

Paying your out-of-work neighbor’s utility bill this month won’t result in a charitable contribution deduction. Your gift must be made to a qualified, tax-exempt organization under IRC rules. Eligible organizations include religious groups (churches, synagogues, temples, or mosques), war veterans’ groups, the Salvation Army, United Way, and certain homeless shelters.

The IRS takes the headache out of this rule by providing a Tax Exempt Organization Search tool on its website. You can enter the name of the organization you’re considering or its employer identification number (EIN) if you have it. You can search by city, state, or country.

Rule #4: Cash Gift Limitations

The IRS limits cash contributions to no more than 60% of a taxpayer’s adjusted gross income (AGI). You’ll need a written “contemporaneous” receipt from the organization if you donate more than $250. The acknowledgment must state the amount of cash you gave and any property you might also have donated. The receipt must also be provided to you when you contribute.

You’ll also need proof of your payment. This can be a canceled check, a credit union or bank statement, a credit card statement, or an ETF receipt.

Rule #5: Non-Cash Gifts

The 60% of AGI rule doesn’t apply to non-cash gifts you make to a qualifying organization. The limits for this type of donation are less: 20%, 30%, or 50%. Each percentage covers several categories of gifts depending on the nature of the organization you give to.

Clothing and household items must be in “good used condition or better,” according to the IRS. An exception exists if your gift will result in a deduction of more than $500. You can provide a qualified appraisal of its value and submit it to the IRS along with IRS Form 8283.

The deduction for a vehicle with an FMV of more than $500 is limited to what the organization receives for it when it’s sold or its fair market value as of the date you donated it, whichever is less.

Written documentation of the gift will be required in virtually every case and for every type of non-cash gift. Donating an item with a fair market value of more than $5,000 needs a written, contemporaneous receipt, an appraisal, and Form 8283.

The Bottom Line

Giving is golden and can be gratifying, but the IRC imposes numerous rules and limitations. You should claim a tax benefit for your generosity if it’s available to you and if itemizing your deductions works to your advantage; however, you should check with a tax professional to make sure you get all the rules and requirements right.

Fact checked by Kirsten Rohrs Schmitt
Reviewed by JeFreda R. Brown

Individual investors seeking income, preservation of capital, capital appreciation, and diversification often consider adding bonds to their portfolios. 

Unfortunately, they can be unaware of the potential risks associated with investments in debt instruments.

In this article, we’ll take a look at seven common mistakes and issues sometimes overlooked by fixed-income investors.

Key Takeaways

• Bonds and other fixed-income investments are often portrayed as more conservative and less risky than stocks, but they have specific risks.
• Uninformed investors can make costly mistakes when investing in the bond market.
• Interest rate volatility is considered to be the primary risk associated with bonds.
• If you plan to hold a bond until it matures, interest rate risk poses no threat (unless the bond is called).
• Investors also face risk from inflation because it can erode the value of income provided by bonds.

Bond Basics

Bonds are debt instruments. Debt instruments include fixed and variable bonds, debentures, notes, certificate of deposit, and bills.

Those who issue bonds are known as issuers and investors who buy bonds are bondholders. Bondholders act as lenders.

In return for their loaned money, bond issuers promise to pay lenders interest and the bond’s par value on a specific future date.

Debt securities are issued by governments and companies to raise funds to finance operations, activities, and projects. Companies that need such funds may choose to issue debt rather than shares of stock to avoid diluting the ownership percentages of existing shareholders.

Debt securities can offer different rates of return. The higher the rate, the greater the risk of financial loss.

Other important features of debt securities include:

• Coupon rate: The annual rate of interest to be paid to the bondholder.
• Maturity date: The date on which the security will be redeemed.
• Call provisions: The options the company has to pay back the debt before the maturity date.

Calls

Investors should understand how a bond’s call provisions work and the potential impact on them. (Look for the details in a bond’s prospectus.)

In general, a bond with a call can be redeemed by the issuer prior to the maturity date on the call date. That means the issuer will pay you back your principal early and stop all interest payments.

Issuers often call bonds when interest rates drop and they can issue new bonds (borrow money) at lower rates of interest.

So, the income you’re expecting to receive for perhaps years to come can dry up unexpectedly. You’ll get your investment money back but if interest rates have dropped, as is likely the case, you’ll have to invest it at a lower rate of interest.

Let’s now look at the seven mistakes bond investors often make.

1. Ignoring Interest Rate Moves

Interest rates and bond prices have an inverse relationship. As interest rates go up, bond prices decline, and vice versa.

This means that before a bond matures, the price of the issue may vary widely as interest rates fluctuate.

So if you plan to sell your bond before it matures, you may find that its price is less that what you bought it for, if rates have risen.

However, if you plan to hold the bond until maturity, you face no risk from a change in interest rates.

Bear in mind that, as with stocks, you don’t have to sell your bond investment to get your principal back or to realize a return. By holding it to maturity (as long as it’s not called or defaulted upon), you will receive all the interest to which you’re entitled and the bond’s par value.

2. Not Noting the Claim Status

Not all bonds are created equal.

Senior notes are often backed by collateral (such as equipment). They usually take precedence over other debt and bondholders’ payments should bankruptcy and liquidation occur.

Subordinated debentures are unsecured debt that is junior to other types of debt. Holders of subordinated debentures don’t get paid until the senior bondholders are paid in full.

Before you buy any bond, be sure you understand which type of debt you’re considering and the potential impact in case of bankruptcy. Again, look to the bond prospectus for this information. Your broker may also have the details.

3. Assuming a Company Is Sound

Despite a company having a solid reputation in the investment community, there is no absolute guarantee that a bond you’ve purchased will come through with interest payments or the return of principal. Investors should bear in mind that default is always a possibility.

Rather than simply assume that a bond investment is sound, review the company’s financial statements and look for any reason that it won’t be able to service its obligation.

Examine the income statement and then take the annual net income figure and add back taxes, depreciation, and any other non-cash charges.

This will help you to determine how many times that figure exceeds the annual debt service number. A figure of at least two times coverage can offer some assurance that the company has the ability to pay down its debt.

Note

You can buy bonds when they’re issued (on the primary market) or on the secondary market through a broker, after they’ve been issued. Treasury bonds can be purchased directly from the U.S. government, or through a brokerage or bank.

4. Misjudging Market Perception

As alluded to above, bond prices can and do fluctuate. While interest rates play a role in that, another source of volatility is the market’s perception of the issue and the issuer.

If other investors don’t like an issue or think the company won’t be able to meet its obligations, or if the issuer suffers a blow to its reputation, the price of the bond can drop. The opposite is true if Wall Street views the issuer or the issue favorably.

A good tip for bond investors is to take a look at the issuer’s common stock to see how it is being perceived. If it is disliked, or there is unfavorable research in the public domain on the equity, that could spill over and affect the price of the bond, as well.

5. Failing to Check Past Performance

It is important for an investor to consider a company’s past performance for a history of solid earnings and to verify that it has made all of its interest, tax, and pension plan obligation payments.

Specifically, read the company’s management discussion and analysis (MD&A) section of an annual report. Also, read the proxy statement. Both can yield clues about problems a company may have had meeting its financial obligations.

They may also indicate future risks that could adversely impact a company’s ability to service its debt.

The goal of this due diligence is to gain information that a company has paid its debts in the past and is likely to do so in the future. Such research can confirm that the bond you may purchase is likely to be honored.

6. Ignoring Inflation Trends

When bond investors hear reports of inflation trends, they need to pay attention. Inflation can erode a fixed income investor’s future purchasing power.

For example, if inflation is growing at an annual rate of four percent, then each year it will take a four percent greater return to maintain the same purchasing power.

This is important, particularly for investors who buy bonds at or below the rate of inflation, because they are actually guaranteeing they’ll lose money when they purchase the security.

Nominal Yields and Real Yields

Take a moment and consider nominal yields and real yields. A nominal yield is the coupon rate—the rate the issuer promises to pay an investor for the life of the bond. The real yield is the nominal yield minus the inflation rate.

If you are considering or own a bond with a 6% nominal yield and the inflation rate is 3%, then your real yield, without inflation’s impact, is 3%.

If inflation drops, your real yield increases. If it rises, your real yield decreases. A higher coupon rate also helps maintain a higher real yield as long as inflation remains stable.

Corporate bonds usually offer higher yields than U.S. Treasuries because the former aren’t backed by the full faith and credit of the government.

In addition, specific high-yield bonds are worth considering but remember that the higher rate indicates a higher level of risk, so do your research.

Asset diversification also can help investors to defend against inflation. For example, including equities, with their historically higher rate of return, along with bonds in your portfolio is considered a smart move.

7. Failing to Check Liquidity

Liquidity refers to how quickly and easily you can sell your bond at a price you like if you need or want to.

Financial publications, market data/quote services, brokers and company websites may provide information about the liquidity of the issue you hold. More specifically, one of these sources may yield information about the daily volume of bond trades.

Generally speaking, the stocks and bonds of large, well-financed companies tend to be more liquid than those of smaller companies. The reason for this is simple—larger companies are perceived as having a greater ability to repay their debts.

However, other factors can affect any company’s bond liquidity, including periods of market volatility, interest rate volatility, credit upheavals, and any other reasons for heavy bond selling. The status of a dealer’s bond inventory may also impact liquidity.

If an issue is traded daily in large volumes, is quoted by brokerages, and has a fairly narrow spread, it is probably liquid.

Are Bonds Less Risky Than Stocks?

You often hear that bonds are less risky than stocks. Certain bonds, such as those issued by the U.S. government, are virtually free of any risk of default. Also, bonds offer a guaranteed return where stocks do not. And they’re usually less volatile than stocks. But stocks outperform bonds over time, and have more upside potential. Whether bonds are less risky for you in particular depends on the risks that concern you. Risks to bonds include changes in interest rates, inflation, potential default, and more.

Can I Lose Money by Buying Bonds?

Yes, you can. For example, if the company that issues your bond defaults on its payment obligation, you can lose the money you invested plus the promised interest payments. If interest rates rise, the price of your bond will drop and you’ll lose money if you have to sell your bond for less than your purchase price.

Why Buy Bonds?

Bonds offer income, capital preservation, and the potential for some capital appreciation. They can also serve as a hedge against losses due to equities. They offer useful benefits if you seek to diversify your portfolio.

The Bottom Line

Investors may not realize that, while bonds are considered more conservative than stocks, they come with risks. These include interest rate risk, inflation risk, default risk, and more.

Be sure that you understand all the risks involved in bond investing before buying debt securities. Proper research can help you to make the most of what bonds offer and to avoid the mistakes that could produce low or negative returns.