?> August 2021 - projectfinance

Investing for Beginners in 2022

Investing for Beginners in 2022

The world of investing is an intimidating place for beginners. I know how it feels.

Sadly, the finance industry is full of complex terminology that confuses beginners and makes them feel like they aren’t smart enough to manage their own money, so they leave it to the professionals.

That changes today. In this comprehensive guide, you will learn how to think about investing and discover the popular ways you can start investing your money.

Why Invest?

The obvious goal of investing is to grow your money. But it helps to think about what that means on a deeper level.

Money represents our energy. We spend time working at our jobs to earn money that we can use to spend, save, or invest. 

In that sense, we convert our life energy (time and effort spent working) into monetary energy (money to use for whatever we want later on).

If We Grow Our Money...

If we grow our money, we amplify the time and energy we've spent working.

If We Lose Our Money...

If we lose our money, we destroy the time and energy we've spent working.

The goal of investing is to take each hour of time and energy spent working and grow it into more than one hour of earnings.

If we succeed, we can work fewer hours in our lifetime. If we fail, we’ll need to work more hours in our lifetime, leaving less time to do the things we truly love.

Example: Let’s say I earn $20/hour and work 100 hours. I earn $2,000. If I invest that money and grow it into $4,000, I have 200 hours of earnings when I only spent 100 hours working. The result is 100 hours that I get to spend doing interesting things other than working.

If I lose my $2,000 of earnings, I worked 100 hours and have zero hours of earnings. I’ll have to work another 100 hours just to get back to even, resulting in working 200 hours for only 100 hours of earnings.

I hope putting money management in this perspective helps motivate you to learn and make better decisions with your money.

Investing Pre-Requisites

What do you need to start investing? Of course, you’ll need cold, hard cash available to invest.

The second thing you’ll need is an account at the financial institution you’re going to use. The type of investing you want to do will determine what type of account you’ll need, and where.

A brokerage account is a popular type of investment account that allows you to invest on your own. If you want to buy shares of AAPL or TSLA, a brokerage account is what you’ll need.

There are many popular brokerage firms you can choose from that will allow you to do the same thing: buy and sell financial products such as stocks, options, and futures.

I trade and invest with tastyworks, a Chicago-based brokerage firm specializing in options trading. Since I do a lot of options trading, tastyworks works for me (pun intended). I can also buy and sell stocks commission-free with tastyworks.

How Much Money Do You Need to Start Investing?

What’s the ideal amount of money you need to start investing? Good news: not much!

Many new investors feel that they need thousands of dollars to start investing, which isn’t the case. In fact, I believe it’s good to learn with a small amount of money. That way, mistakes early on won’t lead to catastrophic losses.

With just a few hundred dollars, you can start investing in low-cost funds that give you exposure to hundreds of different companies. We’ll discuss how that works later in this guide.

Invest Yourself or Use a Robo-Advisor?

invest yourself or use a robo-advisor?

As a beginner investor, you can choose to invest yourself (self-directed investing), or you can use a platform that makes it easy to invest without much thought.

If you want to invest your money yourself, such as buying shares of AAPL or a stock market index exchange-traded fund (ETF) like VOO, you’ll use your brokerage account we talked about earlier.

If you want to automate your investing and don’t want to think about it, you can use a “robo-advisor” like Wealthfront.

There’s no right or wrong answer! 

You can always have an account where you have fun investing in individual companies you know and love, while also using a robo-advisor like Wealthfront for a portion of your investments.

How Do Robo-Advisors Work?

Robo-advisors like Wealthfront are very easy to use.

It takes a few minutes to sign up for an account. During the signup process, they’ll ask you about your risk-tolerance, like if you want to follow a high-growth, high-risk approach, or a low-risk wealth preservation approach.

After that, simply deposit money into your Wealthfront account and they will buy a portfolio of low-cost funds for you. 

You don’t have to think about investing for one second because a robot is making the decisions. All you have to do is deposit money into your account, which you can automate by setting up recurring deposits.

I love these mindless investing approaches because I tend to forget that it’s happening—which is the point.

By using an automated investing strategy with a robo-advisor, you can invest following Warren Buffett’s advice of buying stocks as often as possible.

Assuming you want to invest on your own, you’ll need to learn about the types of things you can invest in.

What to Invest In? Exploring Asset Classes

Well done! You’ve successfully opened up your first brokerage account and you’re excited to start investing. But what do you buy? It’s time to explore the world of financial assets to learn the types of investments you can make.

In finance, an “asset class” is a group of investment products with similar characteristics. For example, shares of AAPL and MSFT are in the “stocks” asset class because they are both publicly-traded stocks.

Bitcoin and Ethereum reside in the “cryptocurrency” asset class.

In the following sections, I’ll walk you through stocks, bonds, real estate, cryptocurrency, and cash/savings accounts.

Investing in Stocks

In the early 1600s, the Dutch East India Company was the first company to issue shares of stock for public investors. Since then, stocks have been at the heart of the investing world.

Stocks allow individual investors to buy part ownership in companies.

By purchasing shares of NVIDIA (NVDA), you’ll be a small owner of the company.

If NVDA performs well over time, the stock price will increase and your investment will grow. If NVDA doesn’t do so well, the stock price will decrease and your investment will lose money.

Fortunately, NVDA investors have done well in recent history. In late 2016, NVDA shares were trading for $15/share, increasing 15x to $220 in August of 2021.

Price Appreciation and Dividends

There are two ways to make money buying stocks: share price appreciation and dividends.

Price Appreciation

If you buy a stock for $100 and the stock price goes up to $110, you've made a 10% return on your investment.

Stock Dividends

Many public companies pay dividends to their shareholders. If a company pays a $2.50 annual dividend, you'll earn $2.50 for every share you own. If the stock price is $100, the "dividend yield" is 2.5%.

The Power of Stock Investing

The wealthiest people in the world obtained their wealth by having massive upside from getting paid in percentages—such as sales commissions or owning shares of a company they started.

The beauty of stock investing is that anyone in the world can buy shares of a publicly-traded company and “get paid in percentages.” Warren Buffett made his billions by purchasing shares of companies and holding them long-term.

Own Something

Stock investing allows anyone to own a piece of a company and potentially build life-changing wealth. One way to manage your money like the wealthy is to own stocks.

Investing Basics: Mutual Funds and ETFs

When I was first learning about investing, I paid a lot of attention to mutual funds. 

My dad worked at Fidelity, and I remember spending hours on the Fidelity website looking at mutual funds when I visited him in Boston. I’d daydream about all the money I could make from pouring money into well-performing mutual funds. 

Too bad I was a broke 20 year old.

In this section, you’ll learn about mutual funds and exchange-traded funds (ETFs). They are similar, but there are key differences to know about that can save you lots of money and headaches.

What Are Mutual Funds?

A mutual fund is a pool of money from many investors that is invested in specific assets. If you have a 401(k) plan, chances are your money is sitting in mutual funds.

How do they work? Mutual funds collect money from investors around the world, giving each investor part ownership of the fund’s total assets.

The benefit is that individual investors can invest in diversified portfolios of assets without needing a pile of money to buy up all the assets in the fund themselves.

Why Invest in Mutual Funds?

By pooling together money from lots of investors, each person owns a share of a portfolio of assets that would otherwise be too expensive to buy.

Let’s create our own fictitious mutual fund to illustrate how it works.

Say 100 investors from around the world each deposit $1,000 into the mutual fund, giving the fund $100,000 to invest.

The mutual fund’s objective is to invest in 100 of the largest technology companies in the U.S.

The fund manager will invest the $100,000 into each of these stocks to create a diversified portfolio of U.S. technology stocks.

Since each investor put $1,000 into the fund, each of them owns 1% of the fund from the start.

Let’s say things go well and the tech portfolio grows to 40% to $140,000. Since each investor owns 1% of the fund, their investments are now worth $1,400 each.

If the portfolio doesn’t perform well and falls 20% to $80,000, each investor’s 1% share would be worth $800.

Pooling together money from lots of individuals allows each investor gain exposure to a large basket of stocks without much money. In our example, each person wouldn’t be able to buy 100 different technology stocks with $1,000, which is why mutual funds are so powerful.

However, mutual funds can come with big downsides: investment minimums, lockup periods, high management fees, and load fees.


Some funds require a minimum deposit, such as $2,500, to get started.

Lockup Periods

A lockup period of six months means an investor cannot withdraw their funds until six months after deposit.

Expense Ratio and Load Fees

An "expense ratio" of 1% means the fund will take 1% of your assets each year as a management fee. A "load fee" is a lump sum fee the fund takes when you enter (front load fee) or exit the fund (deferred load fee). A 5% front load fee means the fund takes 5% of your assets when you make your initial deposit.

Fortunately, there’s a solution to the dark side of mutual funds: exchange-traded funds (ETFs).

What Are Exchange-Traded Funds (ETFs)?

As the name suggests, exchange-traded funds (ETFs) are funds that are traded on exchanges. They are similar to mutual funds, as ETFs offer shareholders part ownership of the fund’s assets.

Shares of ETFs trade on stock exchanges like shares of AAPL and NVDA.

Mutual funds do not trade publicly. You need to set up an account directly with the mutual fund company to buy their funds, which can only be traded once per day.

ETFs offer investors the same benefits as mutual funds without the downsides:

Low Fees

Many ETFs have expense ratios close to 0% and no load fees. The Vanguard S&P 500 Index ETF (VOO) charges investors 0.03% in management fees each year.

No Investment Minimums

There are no minimum investment requirements to buy ETFs aside from the cost of a single share.


Mutual fund investors can only trade once per day. ETF holders can trade shares during normal market hours. The average daily trading volume of popular ETFs can be in the 10s of millions of shares.

Efficient Pricing

Institutions called Authorized Participants keep ETF share prices close to their Net Asset Value (NAV).

As an example, for $375, you could buy one share of QQQ, the Invesco Nasdaq-100 index ETF.

QQQ offers investors ownership of the 100 largest non-financial companies listed on the Nasdaq Stock Exchange:

Unlike mutual funds, ETFs do not have any of the sinister load fees or lockup periods mentioned earlier. Many ETFs have expense ratios or annual management fees close to 0%.

Lastly, since ETFs trade like shares of MSFT, you can buy and sell shares of ETFs during normal stock market trading hours. You can only buy or sell mutual funds once per day.

Popular Stock Market Index ETFs

Popular stock market ETFs include:

SPY — S&P 500

IWM — Russell 2000

QQQ — Invesco Nasdaq-100

DIA — Dow Jones Industrial Average

VTI — Vanguard Total Stock Market

Check out each of the fund pages above to learn more about each one. It’s a good practice to learn how to navigate fund websites!

Investing in Bonds

Bonds are the next asset class to learn after stocks. Bonds typically come with lower levels of risk compared to investing in stocks, but not always!

Recent data estimates the global value of the bond market to be around $120 trillion, so they’re kind of a big deal.

What is a Bond?

A bond is a form of debt where the issuer receives money up front—effectively a loan, pays a fixed income stream each year, then returns the initial investment to the buyer. 

On the other side, the buyer acquires the bond with a lump sum payment up front and receives the fixed interest payments each year until the bond reaches maturity—the end of its life.

A bond is debt to the issuer because they must pay the bondholder interest payments each year and return the initial investment to the buyer upon maturity.

A bond is an asset to the buyer because they receive regular interest payments each year and, hopefully, get their money back when the bond matures.

Bonds are referred to as “fixed-income” due to the regular interest payments of equal amounts that the bondholder receives.

Bond Investment Example

Let’s walk through a simple example together to understand how it works and learn the lingo.

Example: Acme Corp. issues (creates) a 10-year, $1,000 bond paying a 3% coupon payment.

Here are the key bond terms to know:

Par Value / Face Value

The bond's "par value" or "face value" is the amount the investor receives when the bond reaches the end of its life. In our example, the par value of the bond is $1,000.

Maturity Date

A bond's maturity date is when the bond reaches the end of its life and the par value is returned to the investor. In our example, the maturity date is 10 years from the day of issuance.

Coupon Payment

The coupon payment is the amount of interest paid each year to the bondholder. In our example, that's 3% of $1,000, or $30. Coupon payments are typically paid twice per year, so the bondholder would receive $15 every 6 months.

If I buy this bond for $1,000, I’ll receive $30/year for the next 10 years, then I’ll get my $1,000 back.

My benefit is a stream of income on my cash. The benefit to Acme Corp. is $1,000 they can use to fund their business operations. It’s a win-win.

Total Return

A total return in investing is the combination of profits and losses that an investment can produce.

What’s the total return from my bond purchase in our example?

Coupon Payments: $30/year x 10 years = +$300

Profit/Loss on Bond Price: Paid $1,000 then Received $1,000 = $0

My total return over the course of 10 years would be $300, or 30% on my initial $1,000 investment. 

When Should You Buy Bonds?

While buying a bond for the income stream sounds wonderful, there are investment risks you need to know about. The biggest risks bond investors face are default risk, interest rate risk, and inflation risk:

Default Risk

If a company's performance declines and they "default" on their debt, they can no longer pay back the debt they owe. As a bond buyer, you risk losing your investment if a company goes bust.

Interest Rate Risk

Bond prices are sensitive to changes in interest rates. If I buy a bond and rates increase, newly-issued bonds will be more attractive to investors and my bond's price will fall. If I buy a bond and rates fall, newly-issued bonds will be less attractive to investors and my bond's price will increase.

Inflation Risk

If prices rise, the real return on a bond will fall. If I purchase a bond with a 1.5% yield and inflation soars to 3.5%, the real return is -2% because my bond returns are lower than the growth in prices.

Before investing in bonds, you should consider the type of bonds you’re buying, the interest rate environment, and inflation expectations.

Bond investing in 2021 is tricky because we are in a low interest rate environment with high inflation. If you buy bonds now and the Federal Reserve starts increasing the Fed Funds Rate, bond prices will fall (yields will rise). And if inflation runs hot, bond investors will suffer negative real returns as prices of goods and services outpace the returns on their bond positions.

Source: MacroTrends

Since the 1970s, U.S. Treasury investors enjoyed much higher returns on their investments compared to now, as yields were above 5% until the 2000s. Additionally, falling yields over time meant bond prices were increasing as newly-issued bonds offered lower coupon rates than older bonds issued in a higher rate environment.

How to Buy Bonds

You’re probably wondering how you can buy bonds.

To buy bonds directly, you need to have an account with a bond broker. You can buy bonds directly from the U.S. government on the treasurydirect.gov website.

If that doesn’t sound like fun, you can buy bonds by purchasing shares of bond ETFs. We’re saved by ETFs yet again!

By purchasing shares of a bond ETF, you’re buying ownership in a basket of bonds held by the fund. The ETF share price will change as the bond prices change, and they’ll pay you the bond coupons through dividends.

Popular Bond ETFs

There are many ETFs you can use to invest in bonds. Here are a few of the popular ones:

BND — Vanguard Total Bond Market Fund

HYG — High-Yield Corporate Bond Fund

TLT — 20+ Year U.S. Treasury Fund

BND invests in a broad basket of various investment-grade (low default risk) bonds.

HYG invests in high-yield corporate bonds, which have higher risk of default because the issuing companies do not have the strongest financials.

TLT invests in 20+ year U.S. Treasuries, which have virtually no risk of default as they are issued by the U.S. Government.

Click on each fund’s link above to learn more about each ETF.

Investing in Real Estate

We’ve all heard stories of people getting wealthy from real estate investing. Figures such as Robert Kiyosaki (Author of Rich Dad, Poor Dad) have long been proponents of buying real estate.

Traditional real estate investing offers many benefits, including:

  • Leverage
  • Expense Deductions
  • Tax Strategies
  • Owning a hard asset that generates cash flow

But traditional real estate investing can be inaccessible to those without lots of cash in the bank and time to manage properties.

Fortunately, there are modern ways to invest in real estate without buying physical property. One way to do so is by purchasing shares of a real estate ETF or investment trust. Another accessible approach to buying real estate is using a crowdfunding platform like Fundrise.

What is a Real Estate Investment Trust (REIT)?

A REIT is a publicly-traded fund that holds real estate properties that produce income. When you buy shares of a REIT, you participate in cash flows generated by the properties held in the REIT’s portfolio. Each year, REITs must pay out 90%+ of real estate income to shareholders through dividends.

Popular Real Estate ETFs

The following funds are REIT ETFs, meaning they invest in a broad basket of REITs, offering more diversification than investing in specific real estate trusts.

VNQ — Vanguard Total Real Estate ETF

IYR — iShares Real Estate ETF


Investing in Cryptocurrency

Cryptocurrencies are the newest asset class on the block.

In January 2009, Bitcoin was born. Created by a pseudonymous figure named Satoshi Nakamoto, Bitcoin aims to provide everyone in the world equal access to sound money that is trust-minimized and borderless.

The native currency of the Bitcoin network, bitcoin (lowercase ‘b’), has averaged triple-digit-percentage annual returns since its creation in 2009. As of August 2021, each bitcoin is worth nearly $50,000, giving bitcoin a total market capitalization of $900 billion.

The creation of bitcoin was the catalyst for the invention of thousands of other cryptocurrencies with various use-cases.

While cryptocurrencies can spark controversy, there’s no denying that investors globally have been warming up to the idea of cryptocurrencies having a spot in their investment portfolios.

Historically, bitcoin’s correlation to the S&P 500 stock market index has been low:

Source: ARK Invest

Adding a historically low-correlation, high-return asset like bitcoin to a portfolio may help improve portfolio returns.

Bitcoin is often compared to gold as a store-of-value asset because bitcoin has all the money properties of gold, but better in many categories:

1) More divisible

2) More transportable

3) Safer to secure

4) Inelastic, capped supply

5) Can be sent anywhere in the world in minutes

The total market value of gold is somewhere around $10 trillion, while the market value of bitcoin is currently around $900 billion. Many believe bitcoin will eventually become larger than gold, suggesting a bitcoin price of $500,000+ per coin.

Whether bitcoin ultimately ends up being worth $0 or millions, there won’t be an in-between. Bitcoin is an asymmetric return bet (exponentially higher return potential compared to risk), making it an attractive consideration for investors globally.

Investors can also gain access to bitcoin via ETFs, such as BITO by ProShares. These funds, however, come not without risks

How to Buy Bitcoin

So how do you buy cryptocurrencies such as bitcoin? The most common way to buy cryptocurrencies is to set up an account at crypto exchanges such as Coinbase or Gemini. Or, you can setup recurring bitcoin purchases with low fees using Swan Bitcoin. Click here to learn more about Swan Bitcoin and earn $10 of free bitcoin when you sign up.

Small crypto purchases are costly. I use Swan to buy bitcoin everyday because they have a great fee structure for recurring purchase plans.

Some stock trading brokerages offer crypto trading functionality, but many of them do not yet allow you to send your crypto to different wallet addresses. You have to keep your crypto with the brokerage firm, which is not good practice with large investment positions. If you do want to transfer your crypto out, you’ll have to sell your position, move the cash elsewhere, then repurchase the crypto asset. Doing so isn’t ideal because you’ll realize capital gains if you have profits on your position, increasing your year-end tax bill.

For now, the popular options for buying crypto are using exchanges like Coinbase or Gemini, and/or using a recurring purchase platform like Swan Bitcoin (bitcoin only).

Savings Accounts

Savings accounts have historically been a way for people to generate low-risk income on their savings.

Unfortunately, even the best savings accounts offer interest rates near 0%.

As of April 2021, Wealthfront’s Cash Account was yielding 0.10% interest per year.

That means if you deposit $10,000 into this savings account, you’d generate $10 in income after an entire year. Ouch!

Remember when we talked about bonds and I mentioned the concept of “real” returns?

A savings account earning 0.10% has negative real returns if inflation is 2% because the return is lower than the increase in prices (inflation).

Inflation of 2% means a basket of goods/services costs $100 today and $102 in a year.

If my $100 savings account generates 0.10%, then my $100 in savings is worth $100.10 next year. Since I didn’t grow my money to $102, I lost purchasing power.

The bottom line: savings accounts are basically checking accounts in this low interest rate environment. The name of the game in investing is to grow purchasing power. Growing purchasing power means our money grows faster than the prices of our everyday purchases.

Unfortunately, in a near-zero interest rate environment, we have to invest in riskier assets if we want a chance at returns that beat inflation. If we don’t, we’ll see our hard-earned money degrade in value, effectively wasting some of the time we spent earning that money. 

What's Your Risk Tolerance?

If you’ve made it this far, give yourself some credit! We’ve gone through a ton of investing content thus far.

Now that you’ve learned about the various asset classes you can invest in, which ones are right for you?

That ultimately comes down to your risk tolerance, age, and wealth.

There isn’t a “one-size-fits-all” approach to investing. Everyone is different.

Risk vs. Reward

In life, everything has a risk and a potential reward. The key is to know when the risk is worth the potential reward.

Risk and reward have a direct relationship: the higher the risk, the higher the potential reward; the lower the risk, the lower the potential reward.

In July of 2016, I quit my first job out of college. I spent three years working at a company creating presentations and performing data analysis on options trading strategies.

I always knew I would one day do something on my own, but I didn’t yet have any knowledge about anything. After three years learning about the stock market and options trading, I had the confidence to go off on my own to create my own online business/brand.

Quitting my job in 2016 was risky: I chose an uncertain path and deleted my predictable income stream.

But the potential reward was high: the opportunity to work for myself, make whatever content I wanted, create my own schedule, work from anywhere, and have virtually no limit to how much money I could make.

Fortunately, after many years of a ton of work and making no money, things turned around. The risky decision turned into a rewarding situation.

Taking risks doesn’t always work out, which is why it’s risky! It’s essential to analyze when a risk is worth taking. Some aren’t.

Age and Wealth

In an investing context, an 18-year-old college student named Charlie and a 65-year-old retiree named Jane will have different risk tolerances and goals.

Charlie can swing for the fences and take big risks because he has decades of earnings to recover any early investing losses. Charlie also doesn’t have much money to lose because he’s just starting to build his wealth from ground zero.

Young investors can afford to take higher risks with their money because they have decades of earnings ahead of them and not much to lose.

Jane, on the other hand, is 65 with $1,000,000 in the bank. She’s saved and invested well over the course of her career. Having built a fortune, she can’t afford to take big risks because she has a lot to lose.

Older investors with sizable wealth can't afford to take high risks with their money because they have a lot to lose and not many years of earnings ahead of them.

Comparing these two scenarios, Charlie has little to lose and a lot of time, allowing him the opportunity to take big risks. If Charlie was a Tesla and Apple fanatic, he might want to invest all of his early earnings in TSLA and AAPL stock.

But Jane has a large portfolio of assets, and it wouldn’t be wise to put all of her money into TSLA and AAPL stock. Instead, a wise approach for Jane is to diversify her portfolio into many different asset classes.

What is Diversification in Investing?

Diversification in investing is allocating your portfolio in many different assets. A well-diversified portfolio will have small allocations to many different asset classes, even multiple assets within each asset class.

Buying an S&P 500 ETF is an example of stock diversification because you’re buying 500 different companies. If one of the 500 companies goes to zero, the basket of 500 companies won’t collectively go to zero.

If Jane is diversified and one asset class in her portfolio does poorly, she won’t lose everything.

Wealth preservation is the name of the game when you have a lot of money. It can take a lifetime of investing and risk-taking to build wealth. It doesn’t take much time to lose wealth.

A diversified portfolio consists of positions in many asset classes, and even many different positions within each asset class. Some investors like to keep it very simple and buy a few ETFs that have diversified holdings instead of buying hundreds of assets themselves.

The Downside of Diversification

While diversification is great for wealth preservation, it hinders explosive growth. Charlie, our 18-year-old friend who is just starting to invest, may not want to diversify too much because he wants the opportunity to grow his money quickly. Fast growth can only happen with concentrated bets.

In fact, when we analyze the world’s wealthiest people, it turns out they didn’t build their wealth buying broad stock market index funds. 

Jeff Bezos earned over $100 billion by holding nearly all of his wealth in Amazon (AMZN) stock for over 20 years.

Elon Musk has a majority of his wealth in Tesla Inc. (TSLA) stock, which started from nothing and is now a $700 billion company.

Starting a business is a concentrated bet.

Even Warren Buffett has spoken against diversification:

The truth is, while diversification prevents you from losing all of your money in one position, it’s impossible to build wealth quickly investing in a broadly diversified portfolio like the S&P 500. 

So when you’re considering what to invest in, think about your risk tolerance, age, and current wealth. The lower your age and wealth, the higher the risks you can afford to take. The higher your age and wealth, the lower the risks you can afford to take.


Learning how to invest can be an anxious task. Like learning anything else, it takes time. The more you think and learn about investing, the more prepared you’ll be to take advantage of life’s opportunities.

I hope this guide stretched your mind beyond its original dimensions. It can be slightly uncomfortable, so don’t forget to rest after absorbing all of this content!

I had a lot of fun writing this up, and I hope you learned a lot.

Recommended Reading

Chris Butler portrait

How to Manage Covered Calls: Tips w/ Visuals

How to Manage Covered Calls (And Make More Money)

Covered Call P&L Graph
The above graph represents the profit/loss of a covered call position at expiration, where X is the strike price.

If you’re looking for a strategy that both generates income and hedges against a stock market decline, the covered call strategy may be for you. Because of its simplicity, the covered call is a great options trading strategy for amateur and seasoned options traders alike.

Covered Call Components:

Though this options strategy in itself is relatively easy to initiate, understanding how to manage the components of your covered call can be less intuitive. Terms like time decay (theta), extrinsic value, and the “Greeks” must all be in your toolbox in order to adequately manage the short call portion of your “buy-write”, which is another way of saying covered call.

In this article, projectfinance will closely examine how covered calls perform in numerous market cycles, as well as offer several ideas on how to manage your covered call position in these markets. 

If you’d prefer to watch our video on this subject instead, please feel free to check it out below.

How to Manage Covered Calls (Improve Your Trade Results)


  • In a bearish market, the best practice is to buy back a short call for a profit.
  • During a neutral market, do nothing and wait for the short call to “decay”. Then, buy the call back when (if) it later approaches zero. 
  • In a steady bullish market, buy back your short call for a loss early if you believe the stock will continue to rise.
  • Assignment risk is all about understanding “Extrinsic” value.
  • Extrinsic Value measures the difference between the market price of an option (premium), and its intrinsic value (how much the option is in the money by).
  • The lower the extrinsic value, the higher the odds of assignment.
  • An option with an extrinsic value of under 0.25 has a high chance of being assigned as expiration nears. 

Covered Call #1: Bearish Stock Price

In our first example, we are going to look at how a covered call performs in a falling, or “bearish” market. This scenario will perhaps be the most intuitive for those new to covered calls to understand. 

Let’s jump right into it by looking at the details of our trade:

Trade Inputs

Stock Position:

Buy 100 Shares @ $135/share

Option Position:

Short the 140 Call for $3.25

Time To Expiration:

39 Days

In summary, we are collecting $3.25 in premium for selling the 140 call. We can see that the stock is trading at $135 currently. As long as the stock closes under $140 at expiration (our strike price), in 39 days, we will collect the full premium of the option. 

Chris Butler, founder of projectfinance, created a few visuals to help us better understand how covered calls work. Let’s take a look at the first one now:

Covered Call in a Bearish Market

If you were to only own the stock during this duration, the profit/loss of your position would look as the solid line in the  top chart looks, where our short strike is illustrated by the dotted line. 

We are going to be mostly concerned with the bottom graph as this illustrates how the different components of a covered call perform over time.

How a Short Call Loses Value Over Time

Let’s start off by looking at the green line in the lower graph. This line represents our short call. A short call position profits when the underlying security stays the same, or decreases over time. A short call will profit faster with a decline in stock price, which is what happens above. 

It is because of this our short call (as seen in the green line) profits as the stock price falls.

Short Calls Offset Stock Losses

When comparing the dotted line on the lower graph (stock only) with the solid middle line (covered), we can see that we made more money by selling a call against that stock. 

Take a look at the widening gap between these two lines. 

Do you see how the profit/loss on a covered position is much milder than that of the shares alone? 

We said before that a short call profits when the stock goes down. But at what pace does that option lose value?

Since our option expires in 39 days, it will take time for the option to approach zero in value. This is known as “theta”, or time value, and it on of the option “Greeks”. Since the stock could in theory jump back above our stock price with only a few days left, there will usually be some premium left in the weeks and days leading up to expiration. 

In order to reap the full benefit from our short call here, we must wait until it expires (relatively) worthless. 

But is the full benefit of the short call option what we’re looking for? Usually not. Why? Let’s take a look at how to manage a covered call in a declining market next to understand.

Managing a Covered Call in a Declining Market

Glancing again at the details of the above trade, we can see we sold this call for a net credit of $325. This is the most we can make on our call. As long as the call stays widely out of the money, it will approach zero as expiration nears. 

So do we wait until expiration to close this position, where no action will be required on our end because the position will expire worthless? 

Probably not. To understand why, let’s take a look at the profitability of our short call option, as seen below.

Short Call Approaching Max Profit

We can see that with 23 days to go until expiration, our short call position has nearly realized its maximum profit of $325 (the yellow arrow). Why take a chance in waiting 23 more days if we are almost at 100% profit today? Couldn’t the stock in theory still skyrocket higher? Yes!

Additionally, buying back the short call will return our long stock position to infinite profit, as it no longer has that short call tethering its maximum profit to strike price + premium. 

This is why it is sometimes wise to buy back short options before expiration when the majority of the profit is already realized. Buying back (relatively) worthless options allows us to:

So what are the reasons to not buy our call back in this scenario? On a risk level, I can’t think of many. 

Let’s next take a look at a more interesting scenario: a neutrally trending stock price with a twist at the end.

Covered Call #2: Neutral Stock Price With a Surprise

Now that you understand how to manage a covered call with a simple outcome, let’s shake things up a bit. Let’s get right into it by looking at the details of our trade:

Trade Inputs

Stock Position:

Buy 100 Shares @ $121/share

Option Position:

Short the 130 Call for $3.08

Time To Expiration:

43 Days

Key to note here is the premium we are receiving from selling our call, which is $3.08. Let’s take another look at one of Chris Butler’s visuals:

Covered Call in a Neutral Market

As we can see from the above image, our stock trades relatively neutral throughout the duration of the trade. Additionally, we can see that the short call steadily loses value, thus steadily generating profits on this component of the trade.  

Remember, short call sellers want the price of their option to approach zero, which happens when the stock price remains below the strike price as time passes. 

Recalling what we learned from the previous example, we can understand why our short call approaches maximum profitability before the option expires. In this instance, we approach that $308 maximum profit with about 15 days to go until expiration

Now wouldn’t this be a good time to close the short call portion of this trade? It’s trading for a fraction of the price that we bought it for. Remember, closing a relatively worthless covered call allows us to:

  1. Lock in the profits on the call.
  2. Free up our stock to rise with the market.
  3. Eliminate early assignment risk.

The Risk of Not Closing a Worthless Short Call

Now let’s take a look at the right side of the lower graph from our trade. 

Stock Rallying During Last Days of Trading

During the last few days of trading, the stock skyrocketed in value from $120/share to $133/share, leaving our short call in the money at expiration.

Why? Perhaps the company adjusted their future earnings forecast, maybe a CEO stepped down, or perhaps the stock was boosted by a better than expected unemployment number. Whatever the case, we can see how not closing that short call when we had the chance hurt our overall position. That call went from almost 100% profit to 0% profit in only a few days!

This example perfectly illustrates the second reason why it is important to close worthless short calls early: to free up our stock to run with the market. 

The maximum profit on covered calls is always strike price plus premium sold. In our trade, that price is $130 (stock price) + $3.08 (option premium) = $133.08. What if the stock went all the way up to $150? It wouldn’t matter one bit to us: we are always locked in to strike price + premium sold. 

Do you see why it is important to close (relatively) worthless calls early now?

Let’s shake things up a little bit by looking at a scenario where the stock price steadily increases over the duration of our trade. 

Covered Call #3: Bullish Stock Price

This third example of managing covered calls can be a bit frustrating for the holder of a covered call.  Here, the underlying stock slowly appreciates in price over the duration of our trade.

Trade Inputs

Stock Position:

Buy 100 Shares @ $125/share

Option Position:

Short the 135 Call for $0.80

Time To Expiration:

45 Days

In this trade, we short the $135 call for 0.80 when the stock is trading at $125. As long as the stock stays below strike price + premium (135 + 0.80 = $135.80), we will make some money off of our covered strategy (and won’t miss profits on our long stock). If the stock rises above this price, we will still see a maximum profit, we just won’t realize any additional stock gain. 

Compliments of Chris Butler, here is a graph of this bullish scenario.

Covered Call in a Bullish Market

As shown above, we can see that the stock price rises very steadily over the duration of the trade, rising from $125/share to $145/share at expiration. 

By looking at the green line, we can see that our short call is losing money over the duration of this trade. This should make sense by now; short calls don’t like bullish markets, particularly when the underlying stock price blows through our short strike price, which does indeed happen. 

By the end of this trade, our call has lost about $1,000. In other words, the price of the option increased in value by about $10. When compared to only owning the stock outright, the covered call position in this instance has vastly underperformed.

Managing A Covered Call in a Bullish Market

So how would we manage our covered call in this scenario? We have a few options:

If we let our short in-the-money call go into expiration, the option will be exercised. When a call is exercised, the seller of that call is forced to sell 100 shares of stock at the strike price of the option. In our trade, that price would be $130 since we are short the 130 call.

In this scenario, the maximum profit of our trade is realized (but you may miss the extra profit you could have received from only owning the shares!)

But what if we wanted to keep our shares in this situation?

Simply buying back the short call is also an option here. However, if we bought back this short call the moment before it expires, we would realize a loss of $1,100 on the call. Not ideal. However, we still have another option when closing a losing short call in a bullish market. Let’s look at that one next.

Perhaps the best way to close a covered call in a bull market is to close it before expiration. Why? Let’s take another look at the graph to understand.

Covered Call as Expiration Approaches

Stock Price Increasing vs Option Extrinsic Value

Take particular notice on the lower chart of how slowly the profit/loss of the covered call (blue line) gaps away from the profit/loss on the outright shares (dotted line). They separate from each other very slowly, with the covered call losing most as expiration approaches.

Wouldn’t it make sense then to close the short call before these two lines really begin to deviate? 

 Absolutely. If you see a stock trending away from you, it’s better to act sooner than later (assuming you are OK with the risk of owning the stock outright).

So why does this gap in profitability happen so subtly?

Understanding the “Greeks” in Covered Calls

In the above trade example, the options extrinsic value offsets the losses from the increase in the stock price. In terms of option “Greeks”, what we mean here is that the short calls positive theta, or “time decay”, was enough to offset the negative delta over the first 20 days. This results in a small change in the options price. 

Confused? Don’t worry, this is complicated stuff. Basically, a negative delta means our short call will lose money as the stock price increases. The theta, however, is positive, which means our short call will make money from the passage of time. They even each other out.  

Because of this, in the early stages, we’re not really seeing any losses on our short call. Therefore, it is an opportune time to buy back the option.

The below image may help you to better understand this:

Extrinsic Value and the Greeks

Keep in mind that this closing strategy works best when the market is rising slowly yet steadily. 

For more volatile markets, the profitability gap between the outright stock and covered will widen very rapidly. Let’s take a look at this scenario next, where the stock rockets upward.

Covered Call #4: Up & Down Stock Price

In our last example (you’re almost there!) we’re going to look at a few different ways to manage covered calls in an “up and down” market. 

Here’s our trade:

Trade Inputs

Stock Position:

Buy 100 Shares @ $130/share

Option Position:

Short the 140 Call for $3.50

Time To Expiration:

46 Days

So here we are short the 140 call for $3.50 while the stock is trading at $130/share.

Here’s a visual of our trade:

Covered Call in an Up and Down Market

What concerns us in this graph is the abrupt rise, and subsequent fall in stock price during the middle of the covered calls life. 

Remember in our last example how subtle the deviation in profitability was between the covered and the stock outright? That was because the stock rose steadily. 

In this example, the stock explodes upward. This results in immediate and deep losses on our short call.

Subsequently, our covered call position underperforms the outright stock dramatically. Buying our short call back during this market will not be so advantageous because of its very elevated price. 

So what should you do in this scenario?

Managing A Covered Call in A Volatile Market

Personally, I would wait to see how the trade plays out here. Volatile markets tend to swing back and forth quite a bit. 

That is exactly what happened here (how convenient!).

At around 15 days to expiration, we can see the short call profit was approaching $250. This represents the majority of the maximum $350 that we can collect from our option. As we said before, the more profitable a short call becomes, the more logical it is to buy the option back. 

Understanding the recent volatility of this stock, I personally would close the short call position while it was in my favor. 

Was that the right move?

We can see that if I would have held the option to expiration, I would have indeed received the full profit of $350. Whoops!

But I’m a risk-averse investor. What would you have done? 

Assessing Early Assignment Risk

If you’re trading a covered call and the stock prices rise above your strike price, most newbie investors panic. But you shouldn’t worry about assignment. Here’s why.

First off, if you are indeed assigned on your short call, you will realize the maximum profit of your covered call. That’s a good thing. The only situation in which this wouldn’t be desirable is if you wanted to continue holding your shares. 

That being said, it is always wise for an investor to know their assignment risk. Nobody likes being blindsided. 

Extrinsic Value and Assignment

The key to understanding whether an option is at risk for assignment or not is all about understanding the option’s extrinsic value. 

If you want to take a deep dive into extrinsic value (which you should understand if you’re a serious options trader) feel free to check out our video below.

Why Options Are Rarely Assigned

Extrinsic value measures the difference between the market price of an option (premium), and its intrinsic value. Intrinsic value is simply the amount an option is in-the-money by. Therefore, out-of-the-money options are all extrinsic value. 

Understanding an Options Premium

Extrinsic and Intrinsic Value Comprise an Options Value

The closer an option’s extrinsic value is to zero, the greater the odds that option has of being assigned. Generally (dividend risk aside), an in-the-money option is not at risk of early assignment if its extrinsic value is between 0.25-0.50 cents. This is a broad guideline. But below these levels, watch out.

To see how the relationship between extrinsic value and assignment works in practice, let’s revisit our volatile market trade, where the stock rapidly breached our short call price. Was there assignment risk then?

Extrinsic Value Example #1 : Low Risk Assignment

So here’s that volatile market trade we went over earlier. Let’s now evaluate the assignment risk of the short call during the stock run-up. 

So since the stock rallied past our short call price in this trade, was our short option at risk of assignment during this time? No!

Why? There is still a lot of extrinsic value left in that option.

If the holder of that option exercised their call, they would be giving this up. It is actually free money to us. How much money? By examining the chart, we can see the owner of this call would be forfeiting over $5!

If the owner of that call really wanted the stock, they would sell the option in the marketplace and simply buy 100 shares in a “synthetic” exercise.

Therefore, our chance of assignment was almost zero in this scenario. 

Now let’s look at another trade where there is indeed assignment risk.

Extrinsic Value Example #2: High Risk Assignment

In this example, we are going to revisit that trade where the stock price trended steadily upward.

As illustrated by the lower red line, the extrinsic value of an option is in constant flux with the market. When this call was first sold, its extrinsic value was about 0.75 cent. This means it’s assignment risk was very low. 

However, as that option became in the money, its extrinsic value rapidly declined. At expiration, the extrinsic value was zero. An option with an extrinsic value of zero at expiration has an almost 100% chance of being assigned. 

So what causes the extrinsic value of an option to decrease in price? 

Causes of Decreasing Extrinsic Value

There are three factors at play here. 

Options shed extrinsic value as time passes

The deeper in-the-money an option is, the less extrinsic value it has

Implied volatility = extrinsic value. They are synonymous. Decreased volatility leads to decreased extrinsic value

So remember when we said options with extrinsic values of between 0.25 and 0.50 need not worry about assignment risk?

In this last trade example, we can see that the extrinsic value of the option fell below this level with about 10 days to go. Therefore, assignment risk during this period is quite high.

Final Word

Hopefully, this article will help you to better understand how the various elements of a covered call may react to different market conditions. 

It’s important to remember that there is no need to panic if your short-call strike price is breached. Early assignment with extrinsic value (which most all in-the-money options have) is rare.

With that being said, assignment is not a bad thing. Remember, an assignment on a covered call means max profit! 

You should, however, always be prepared. In the long run, pleading ignorance rarely works in options trading. 

Happy trading!

Related Articles

Emotional Investing is Inevitable. Learn how to Cope.

brain vs heart

Let’s get this out of the way right off the bat: you will never be able to completely control your emotions in investing. It is an impossibility.

However, this is not a bad thing. Emotions play an integral part in both the cognitive and investing process. You are a better investor with them. 

In this article, projectfinance takes a deep dive into the emotional investor. We will examine how science has proven emotion is not only necessary but desirable for investors. 

Additionally, we will look at a few different coping strategies which may help trigger our emotions less.


  • Finance professionals are just as emotional as the rest of us retail investors. 

  • Pauline Yan tells us that working with your emotions is a better strategy than trying to ignore them. 

  • “Ignorance is Bliss” can be the best strategy for both long-term investors as well as active traders. 

  • Neuroscientist Antonio Damasio shows how emotions help the brain in filtering through vast data sets.

We like to believe that professionals have conquered their emotions. Politicians, doctors, retirement financial planners that handle our life savings; we like to think that emotionally charged thought plays little to no part in their thinking. 

But the truth is, emotion plays an important factor in the decision-making of all human beings. 

When I think of historical figures at the top of their game, Emerson’s “Representative Men” come to mind. 

Montaigne, Napoleon, Goethe (amongst others); they all had their demons; they all struggled at points in their lives with crippling emotions.

Goethe experienced “psychic threats and polar tensions often to the limits of destruction”, Napoleon sought refuge from the jealousy of his adulterous wooden toothed wife in world domination, and Montaine fell into a melancholic depression following the sudden deaths of numerous loved ones. 

The world’s greatest minds all suffered from intense emotional experiences. 

So if these pillars of human thought can’t conquer their emotions, how are financial professionals any different?

In an interview with the Wall Street Journal, Richard Taffler, professor of Finance and Accounting at Warwick Business School, says they aren’t.

Investment Pros Are Just as Emotional as You

In reply to the Journal’s statement, “Some people think pros are more rational than individual investors”, Prof. Taffler responded:

Professor Taffler, also an authority on behavioral finance, later explains that this acquiescence to emotion is not only ubiquitous amongst fund managers, but outright inevitable.

It comes off as almost paradoxical. Taffler believes that an individual completely devoid of emotion would not be willing to take a risk-on position in the first place.

This makes sense, too. As humans, we must experience some degree of emotion. If our emotions were completely neutralized indeed, we’d derive as much pleasure from this life as a sedimentary rock. 

So if we must experience emotion as humans (as though that’s a bad thing); if we are indeed destined to be Epicureans and not Stoics, how do we make the best out of it? Where do we start at self improvement if that perfect person we aspire to become is unreachable?

Work With Your Emotions

Instead of trying to change our emotional response to market events, perhaps a better strategy is to work with our emotions. 

Pauline Yan, a portfolio manager in Toronto, Canada and founder of the Sunday Morning Brunch financial blog, recommends embracing negative emotions that pertain to investing, such as fear and greed. 

As quoted by CNBC, Yan believes individuals should, “Feel the fear, feel the greed”.

In contrast to fighting our impulses, her theory suggests that swimming downstream (psychologically speaking) allows investors and traders a realistic and steady platform upon which investment decisions can be made. Here are a few ways to get started when working with your emotions.

  1. Identify what emotion exactly you are experiencing when confronted with an adverse market event.
  2. Accept that emotion. Go with the grain. The results from this new approach may surprise you!
  3. Meditate until it no longer bothers you and a more rational response appears.

Another option, and my personal strategy, is the “set it and forget it” mentality. Let’s take a look at that one next. 

Ignorance is Bliss in Investing: Buy and Forget​

Richard Thaler, economist and Professor of Behavioral Science and Economics at the University of Chicago Booth School of Business, has his own strategy when it comes to managing emotion during volatile times. 

When asked on an early morning financial news TV program what an investor should do when they wake up and see the market down 3 percent, Thaler recommended, Change channels. Turn the show off.

Richard Thaler

Richard Thaler

Investing is Preparation, Not Work

In investing and trading, the vast majority of your work should be in preparation. Once a position is established, as long as the fundamentals haven’t changed, the best course of action is to stay the course. 

I can’t tell you how many times I messed with positions because of either boredom or desultory second-guessing. Whenever I fidget, I almost always end up donating cash to the market-makers.

Investing is not work. I know of several extraordinarily successful options traders who worked on the floor of the Chicago Board Options Exchange (CBOE) traders who would pass the time by putting on a green in their office above the trading floor, far away from the “madding crowd”. 

Perhaps they did this because being on the floor may make them second guess themselves. Not paying any attention to the “noise” helped them maintain their initial convictions when they put their positions on. 

When I look at where these traders are at today, I can tell their methods were obviously very successful. Here are a few steps to better become an “ignorant” trader.

  1. Before placing a trade or investment, forecast how you will react emotionally in an adverse market.
  2. Check the position only when it breaches your pre-establish parameters by setting alerts. 
  3. If the position goes against you, recall how you planned on reacting when you were less emotional.
  4. Understand the risk, and meditate the daily ebbs and flows out of your mind. 

In closing, we are going to look at a case study involving a man who had an operation on the part of the brain responsible for emotion. It is a profoundly sad case but also proves the crucial connection between the brain and emotion. One can not operate successfully without the other.

Be Careful What you Wish For: The Tragedy of “Elliot”

The ideal investor/trader, as seen through the eyes of most people, will not incorporate emotion into their financial decision-making. So what would happen if this ideal was actually met? What would happen if an individual could put their frontal lobe on permanent pause? Would this create a super investor? No. Quite the opposite, actually. 

The patient’s name was known throughout the medical community as “Elliot”. Elliot was an educated and successful businessman, a good husband, and had a solid grip on his wealth and finances. 

In the 1980s, Elliot experienced numerous headaches. It was discovered that Elliot had a brain tumor on his frontal lobe, that part of the brain which is responsible for higher cognitive function, including emotion. 

An operation was done; the tumor was removed. But Eliot was never the same again. 

Following the operation (which damaged his frontal lobe) Elliot lost his job, got divorced, and experienced numerous problems managing money. This led Elliot to declare bankruptcy. 

The Portuguese-American neuroscientist Antonio Damasio wrote a book on this particular tragedy called Descartes’ Error: Reason, Emotion and the Human Brain. The main case study in this book was that of Elliot.

Neuroscientist António Damásio


Rational Thought Incorporates Emotion

Outwardly, Damasio discovered Elliot to be very pleasant and capable. Elliot even tested surprisingly well on numerous cognitive tests. 

“He was always controlled,” wrote Damasio, “always describing scenes as a dispassionate, uninvolved spectator.”

But on the inside, Elliot’s personal and financial life was in disarray. Planning had become incredibly difficult. What was going on? These problems, which seemed subtle, took over Elliot’s life. 

Damasio proceeded to test Elliot with pictures that would evoke intense emotional responses from most people. But Elliot’s reactions were indifferent. Damasio was astounded, and wrote of his reaction in his book

Damasio asked Elliot whether or not he would buy more or sell stock that he owned over a previous month if he knew the performance. Elliot answered as reasonably as any other rational investor would. This was a perplexing case, given that Elliot’s personal finances were in disarray. 

The question about this stock was very specific, and there were only a few outcomes presented to Elliot.

Emotion Assists the Brain When the Choices Are Vast

The problems with Elliot arose, Damasio discovered, when the potential list of outcomes was manifold rather than binary. He simply couldn’t contemplate an outcome where there were many possible choices, as there are in the stock market. 

So what does the human brain rely upon when the potential outcomes for a scenario are too vast for it to comprehend?

Emotion. The frontal lobe, or that part of the brain in Elliot which was not working correctly, is responsible for emotion. In Damasio’s words:

Final Word

We are emotional creatures. Period. So how can an emotional person invest successfully?

One course of action, as recommended by Pauline Yan, is to work with our emotions. 

Additionally, we can alter our patterns so emotion plays less of a role, like those CBOE traders putting upstairs when the market was open. 

Emotions are completely subjective, and finding a custom coping strategy for yourself will likely take time. Perhaps more important than psychology in trading is philosophy. Check out our article on The Philosophy of Trading here. 

At the end of the day, just know that “eliminating” emotion from your investment decisions is both impossible and undesirable. Even if you were able to take emotion out of your life, what fun would that be?!