Investing 102

Cost basis is the price at which an investment was purchased. This is necessary for determining how the investment will be taxed at the time it is sold. For the purposes of a taxable investment, the difference in price paid and price sold will be taxable, or in the case of a capital loss, could reduce tax liability.

Dollar cost averaging is an investment strategy where you invest a fixed amount of money at regular intervals, such as monthly, regardless of market conditions. By spreading purchases over time, you automatically buy more shares when prices are low and fewer when prices are high, lowering the average cost per share.

This approach helps reduce the emotional stress of trying to “time the market,” which is notoriously difficult even for professionals. It can also smooth out short-term market volatility, making it easier to stay consistent with your long-term investment plan.

Dollar cost averaging does not guarantee a profit or prevent losses, but it can be a disciplined way to build wealth gradually and avoid making decisions based on short-term market swings.

Direct indexing is an investment strategy where you own the individual stocks of an index, such as the S&P 500*, directly in your account instead of buying a mutual fund or ETF that tracks the index. This provides the same general market exposure but offers greater customization.

Because you hold the individual stocks, your portfolio can be tailored to exclude certain companies, emphasize others, or align with personal values or tax preferences. One of the biggest advantages is the ability to harvest tax losses more efficiently by selling specific stocks that decline in value.

* The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Net Investment Income Tax (NIIT) is an additional 3.8% tax on investment income for individuals, estates, and trusts who have income above certain thresholds, such as $200,000 for single filers or $250,000 for married couples filing jointly. It applies to the lesser of your net investment income or the amount your income exceeds these thresholds.

This tax includes income from interest, dividends, capital gains, rental income, and passive business income, among others. It does not generally apply to wages, Social Security benefits, or active business income.

The NIIT was introduced to help fund the Affordable Care Act and affects higher-income investors by adding an extra tax burden on investment earnings. Planning strategies like contributing to tax-advantaged accounts or harvesting investment losses can help reduce exposure to this tax.

Values based investing refers making investments that are in alignment with your personal values and beliefs. While some areas of values based investment are still an emerging market, we are seeing growth in the areas of environmental social and governance (ESG), Christian financial strategies and Halal investment.

While there is no established definition of what constitutes ESG investing, the strategy typically involves investing in companies that value issues like climate change, biodiversity, human rights and diversity of employees and board composition while divesting from companies that do not.

Christian financial strategies use a similar method of positive inclusion and negative screening of investments to avoid industries related to things like abortion, pornography, alcohol and tobacco.

Halal investing focuses on investment strategies that follow Islamic Shariah principles. Most conventional fixed income investments could constitute usury. Halal investment strategies avoid conventional bonds that earn interest. Halal investment also avoids equity investments in industries that would violate Shariah principles.

Actively managed funds have a fund manager that is buying, selling and holding investments to try to beat a market index or achieve some other objective of the fund. For funds that are passively managed, they are usually tracking an index and attempting to replicate it. Actively managed funds tend to have higher expense ratios while passively managed funds tend to have lower expense ratios.

A broker-dealer is a firm that acts as a broker when facilitating or executing orders on behalf of clients and dealer when it trades from its own inventory. Broker-dealers provide a range of services with some providing financial advice through registered representatives of the firm or may simply act as a custodian of investments for other firms.

A registered investment adviser is a firm that provides investment advice for a fee, rather than be compensated by commission. RIAs act in a fiduciary capacity and manage investments but typically utilize a separate firm as custodian to make trades. Broker-dealers employ registered representatives to provide investment advice while RIAs will employ investment adviser representatives (IARs) to provide investment advice.

A common misconception is in relation to the standard of care of broker-dealers relative to registered investment advisers. The SEC established Regulation Best Interest (Reg BI) which became effective June 30, 2020. Historically, broker-dealers were subject to the suitability standard for investment recommendations. Under this standard of care, investments only had to be suitable, even if the registered representative could have recommended another product that was more appropriate.

Reg BI removed the suitability standard for broker-dealers and replaced it with the best interest standard. Unlike the suitability standard, broker-dealers and their registered representatives must ensure that a recommendation is in the client’s best interest. This standard still does not rise to the fiduciary standard as the fiduciary relationship that exists in RIAs is one where the IAR provides ongoing financial advice, rather than a one-time recommendation. Registered representatives only have to ensure that the investment is in the client’s best interest at the time that the investment recommendation is made.

It is common for firms to be hybrid firms where they are a broker-dealer and registered investment adviser. These firms employ hybrid registered representatives and IARs that can provide fee based investment advice and can also use commissionable products.

The best way to see the background of a registered financial professional is through FINRA’s BrokerCheck platform. BrokerCheck will provide information about the financial professional such as years of experience, prior firms, which exams they have passed, official complaints and more. This can be found at https://brokercheck.finra.org/