Unrealized gains

Q. What are “unrealized gains”? — N.H., Maryville, Tennessee

A.

After you make an investment, it will often rise or fall in value, giving you a gain or loss. You “realize” the gain or loss when you sell it. Until then, it’s “unrealized.”

For example, if you bought 100 shares of Buzzy’s Broccoli Beer (ticker: BRRRP) for $2,000 and they’re now worth $3,000, you have an unrealized gain of $1,000. You might be sitting on huge unrealized gains from some great stocks, but until you actually sell the shares, you haven’t reaped, or realized, those gains — and they might shrink or grow by the time you sell them.

Unrealized gains are gains in theory only. Another term for them is “paper profits.”

Q. I’m thinking of selling a stock that pays no dividend and a stock that hasn’t grown much since I bought it last year. Would it be worth moving that money into CDs? — T.D., Philadelphia

A.

Stocks are arguably the most profitable longterm investments for most people. Certificates of deposit, with interest rates that have been very low for many years, have been best for shorter-term investments. But interest rates have risen recently, and some CDs are offering 4.5%. If you don’t think your stocks will do much better than that, do consider CDs.

But you might want to hold those stocks if the companies seem to be performing well, increasing their revenue and earnings over time. Dividends are terrific, but many great companies pay small or no dividends, especially if they’re reinvesting profits to further their growth. And lots of strong stocks will head south or be stagnant for a while — especially when the overall market experiences a downturn.

It’s hard to beat index funds

Great wealth can be amassed through investments in the stock market, but don’t jump in if you don’t know what you’re doing or you don’t have the time, skills and inclination to study lots of companies, deciding when and if to buy into or sell out of them.

Fortunately, there’s an easy and effective way to invest in stocks that requires very little time or knowledge: index funds. An index fund is a mutual fund (or an ETF, an exchange-traded fund) that tracks a particular index of securities. It holds roughly the same securities as the index does, and thereby aims to deliver roughly the same return as the index (minus fees).

So an S&P 500 index fund will track the S&P 500 by holding most or all of the stocks in the index. The S&P 500 includes 500 of America’s biggest companies, from Apple and Amazon.com to Campbell Soup and Hasbro. Invest in an S&P 500 index fund, and you’ll instantly be a part-owner of hundreds of strong companies, with your wealth growing as theirs does.

Many index funds have extremely low fees, too, so they can perform just about as well as their underlying indexes. The SPDR S&P 500 ETF (ticker: SPY), for example, charges just 0.095% annually — or about $9.50 per year for every $10,000 you invest in it.

Best of all, you won’t sacrifice much performance with index funds: The overall stock market has averaged annual returns close to 10% over many decades (though over a shorter investing period your return is likely to be higher or lower).

Over the 20 years ending in the middle of 2022, fully 95% of all U.S. large-cap stock funds underperformed the S&P 500, and over the previous 10 years, 90% underperformed. The news isn’t better for smaller companies: Among U.S. small-cap stock funds, 94% underperformed their benchmark index (the S&P 600) over the past 20 years.

It’s hard to beat index funds — and you can probably invest in them via your 401(k) or an ordinary brokerage account.