Bond Fund Breakdown

Many investors who have stayed away from bond funds in the past are now pouring money into them.  A bond fund may be riskier than you think, let’s take a look at how to break down a bond fund.  

Let me first describe want a bond is.  Simple put it is a loan.  You can loan a company, government, or government agency money (principle).  They promise to pay you back with interest (coupon) over a certain period of time.  If you hold the bond until its maturity date you will get all your interest and principle. 

Bonds carrier a risk of default and therefore have a credit rating associated with them.  U.S. Treasury bonds, bills and notes have the highest rating of AAA. The scale goes down from there and it depends on how the rating agency assigns letter ratings to determine risk.  A bond fund will breakdown how much of the fund in is each rating or give you the average rating.  

The longer the term or maturity of a bond generally the greater the risk of price fluctuations.  Bonds are traded on the open market.  If you needed to sell your bond before maturity you may sell it for a gain or a loss.  Generally speaking if current interest rates are less than your bond you can sell it for a gain, but if current rates are higher you have to discount your bond and sell at a loss.  Bond funds have a measurement called duration expressed in years.  If the duration of a bond fund is 8 years, that means a 1% rise/decline in interest rates equates to an 8 percent loss/gain all other things being equal.   

For investors currently looking to add bond funds to their portfolio consider the environment.  Current interest rates are very low and have little room to go down and we are in a recession.  When analyzing a fund look for a fund with most of its money in A rated bonds and an duration of 5 years or less.  If you want to take less risk go with a fund whose duration is under 3 years.  

Since bond funds are interest bearing instruments the expense ratio is extremely important.  There are plenty of bond funds with expense ratios under .70%.  Any higher than that and I do not know how a company can justify the cost.  

Bond funds are a great addition to a portfolio but do carry risk.  With the current economic environment do some research before jumping in. 

Bank of America; Point of no Return

Back when Bank of America was trading under $5 a share I was thinking of buying some of the stock which I already own at about $42 a share. My logic was simple.

The government is at the point of no return with the big banks. They have poured billions of dollars into these institutions and are not going to let them fail now. I held off and did not buy. Then I read a Wall Street Journal article about the testimony of the CEO of Bank of America. What I got from the article is that the takeover of Merrill Lynch was forced on Bank of America’s shareholders and the shareholders were to be kept in the dark about the details of the deal. Correct me if I am wrong but as a shareholder, if BofA did fail I feel as though the shareholders have a class action suite against the government.

I am not concerned about starting a class action suite against the U.S. Government, but I think this supports my logic that there is no way the government is going to let BofA fail and is still a buy at its current price of $8 a share. I have not pulled the trigger, but will be watching the stock all week and in all likelihood will but is a market order.

Performance Guaranteed Variable Annuities

After the market collapse I was getting grief from some individuals that I talked out of purchasing variable annuities with a minimum guaranteed rate of return.  The annuities go by many names and are different in their benefits and features across companies.  The bottom line is that they all guarantee a minimum rate of return no matter what the performance of the underling funds you select.  This made many individuals pick some of the riskiest investments offered in the product.  The philosophy was that by going into the riskiest funds you had unlimited upside potential but the downside risk is a guaranteed minimum return by the company of 6-7 percent. 

So why would I not recommend this product to investors?  Number one is you have to read the fine print in all of these annuities and there is a lot of it.  None that I know of would actually let you take the entire balance out of the fund.  Most allow you to collect income off the accumulation.  Two, with most of them you have to hold them for a ten to fifteen year period.  If you held a well diversified portfolio of stocks, bonds and other assets for the same period of time there a few periods in history that the annuity guarantee would be needed.  So you paid for the guarantee in the form of higher fees for no reason most of the time.  Lastly, the guarantee is backed by the insurance company who may not be able to keep its promise. 

It turns out that my last reason should be the biggest concern for those who own these annuities.  A recent Wall Street Journal article, “Investing in Funds: A Quarterly Analysis-Brokers Fear Many Insurers Ignorant of Annuity Risk” points out that the rating agencies are downgrading the ratings of many of the insurance companies who sold these annuities. 

I do not want to spread fear and panic like Jim Cramer or Suze Orman last October, but you should be concerned.  There is little chance you will lose all of your money in one of these annuities.  The more likely scenario is that you do not get the guaranteed rate of return, but will get the balance in your account with the market losses.  This would mean that you paid higher fees for investing than you would of in just mutual funds without the annuity rapper.

Hopefully everyone is learning from this downturn.  There is no guy (Madoff and others) out there that can defy the laws of investing with above average returns without volatility. There will be no product out there (performance guaranteed variable annuities) that can give you the upside potential of riskier investment without the downside risk. 

In hindsight I stand by my recommendation to those individuals who I told to stay away from those annuities. 

Finding the bottom with Behavioral Finance

I was having a debate of sorts with an individual on an online forum about actively managing your portfolio verses passively managing your portfolio. During the discussion I explained that I use Behavioral Finance to decide when to change my allocation.

Below is an explanation of behavioral finance from Wikipedia.com

"Behavioral economics and behavioral finance are closely related fields that have evolved to be a separate branch of economic and financial analysis which applies scientific research on human and social, cognitive and emotional factors to better understand economic decisions by consumers, borrowers, investors, and how they affect market prices, returns and the allocation of resources.

The field is primarily concerned with the bounds of rationality (selfishness, self-control) of economic agents. Behavioral models typically integrate insights from psychology with neo-classical economic theory. Behavioral Finance has become the theoretical basis for technical analysis. [1]

Behavioral analysts are mostly concerned with the effects of market decisions, but also those of public choice, another source of economic decisions with some similar biases towards promoting self-interest."

I use behavioral finance along with other information to help me find the top and bottom of the market. I can do this because I talk to many individuals a week about there investments. I start to see patterns in the questions and behaviors of investors and get an idea if we are near the top, bottom or still have further to go in either direction.

Let me give you some examples. In late 2004 and early 2005 many of the people I talked to who sold there stocks back in the bear market of 2000-02 were telling me that they did not want to get back into stocks until the market started doing better. The S&P returned 28.7% in 2003 and 10.87% in 2004. The market recover was well on its way, yet I was meeting people who did not realize it. At the time I was thinking about reducing my equity position but from talking to individuals and realizing that the turnaround did not hit the average American I held on to my stocks.

In 2006 everyone I talked to wanted to buy and sell real estate. That is one signal we could be near the top. Think of gold right now. Then I started to hear people talk irrational, which is when I start to think about taking action. Several people I talked to made the same statement, “you can never lose money in real estate”. So in 2006 I put one of my investment properties up for sale and realized that the slow down had all ready begun.

So the question is, using behavioral finance are we at the bottom. It is harder for me to tell this time around because no strategy will work if the financial system is broken. I do have some signs that make me optimistic that we are nearing a turnaround. One sign is the local news cashing in on the crisis with stories like, “Recession Sex” brought to you by Fox news of course. I have not met with an investor in weeks who wanted to sell their stocks. All I need now is some people making irrational statements. Then there is a more fundamental sign, a record amount of money going into treasury securities. Some people are calling it a treasury bubble and I have to agree.

It is important to point out that I only make slight changes to my allocation like going from 80% equities to 60%. I just take some off the table. This way if I am wrong I do not get hurt that bad. I also want to point out that I  moved all my retirement money into equities when the Dow dipped below 8000 the first time. I did not use behavioral finance but I got anxious.  If I was using behavioral finance I would not of bought.  

As somebody who advises people on investing I still think the vast majority of individuals are best served with a buy and hold strategy with the occasional rebalancing of their portfolio.  Your average worker in a 401K plan just does not want to sell when they see their investments making money and do not want to buy the investments losing money.  

Are you a buy and hold investor or do you actively management your portfolio?

America’s Lost Confidence

I try not to let the current state of our economy get me down or the losses in my retirement portfolio. For the most part they have not. What has got me down and angry is the failed leadership of both our corporate and political leaders. First the tax issues of President Obama’s picks. If our political leaders cheat on their taxes, what do they expect the average American to do? Our system works because millions of Americans line up every year to pay their fair share of taxes to keep the country running.

Personally I do not see why anyone would need to cheat on their taxes. Individuals like Timothy Geithner should know the system well enough to barely pay taxes. I get my effective tax rate below 15% and some years 10% because I know the system.

On The Journal with Bill Moyers he played a sound bite of a top Morgan Stanly official basically explaining to management about their “retention award” in his own words, “…please don’t call it a bonus…” What a slap in the face to the American people. Not so much the fact that they are paying out a bonus, but that they believe the people are so stupid that we would believe rebranding the word bonus to retention award would have us believe it is any different. I guess the managers were being lured away by Merrill Lynch or Lehman brothers.

On top of this entire financial crisis you have the Madoffs of the world coming out of the woodworks. Guys who work hard, not to make you money, but to rip you off. As someone who works in the industry I want these guys to do hard time in the same prison with criminals who rob us with a gun instead of a pen.

Then the icing on the cake or should I say peanut butter. One of the largest manufacture’s of peanut butter blatantly let a tainted product be consumed by millions, killing about 8 people that we know of. As far as I am concerned this is a capital punishment case.

I know there will be people who say that it is easy to point out what is wrong and we need to focus on what is right. I think we need to point out what is wrong, demand change and do what ever it takes to get it. I am optimistic about America’s future because at the end of the day it is a government by the people and we can change what is wrong.

Spend More, Save Less

There is a lot of talk among economist that Americans need to spend more and save less to help get the economy moving again.  There is a reason why they are called economist and not financial planners.  It is true that Americans are saving more than they have in the past, but it may not be what you think.  Including in the savings rate are those who are paying down debt.  So if you put an extra $100 a month toward your credit card bill that is counted as savings.  What economist are saving is true, when everyone starts to “save” at the same time it has a negative impact on the economy, but telling people to spend in this environment is poor financial advice.

Americans are doing the right thing by paying down debt and padding their bank accounts.  It is not the role of the individual to get the economy moving in such a crisis.  Let the government borrow and spend.  They have the power to print money and tax the people.  They will not lose their home or go hungry from borrowing. 

In theory government spending should grow the economy and create jobs.  As individuals get a 3-5 year contract to build a bridge or road they will feel confident in their employment and start spending again.  Their spending will ripple through the economy and put more money in the pockets of merchants who may hire help or spend more themselves.  That is the theory, but before you start spending again the advice from the financial planning community is, pay down debt, build your savings and cut expenses. 

If the government stimulus does turn the economy around, then you will be in a better position and can always start spending again.  

Mutual Fund Share Classes

Many investors have no idea what mutual fund share class they are in or why. If you are about to do business with a broker or advisor a little education will go a long way.
There are three main share Classes; A, B, and C. Class Y will represent other share Classes explained later.

	Class A	Class B	Class C	Class Y
Managemant Fee	.50	.50	.50	.50
12b-1 Fee	.25	1.00	1.00	0
Other	.10	.15	.20	.15
Total annual Expense Ratio	.85	1.65	1.70	.65

Excluding class Y, you can see from the table above that Class A has the lowest annual expense ratio. The annual expense ratio is the fee taken from the fund each year. It is somewhat of a hidden expense because you never see it come out of your personal account. Instead it is taken from the fund's assets. The net effect to you is a total return minus the expense ratio. So if you own Class A shares and the fund returned 10% the fund company takes .85% and you get 9.15% versus Class B where you would get 8.3%. So why would anybody by Class B or C? Class A carries a 5% or more front end sales load. A front end sales load is taken from the amount you put into the fund. If you contribute $10,000, only $9,500 is invested.

Class B has a back end or contingent deferred sales load. The load is on a declining scale. For example if you sell your shares in the year one or two you pay 5%, year three you pay 4% until the load goes to zero in year 6 or more.

Class C you will only pay the load if you sell the shares within the first year. After the first year the load usually is zero.

Now you are thinking why buy Class A or B. The answer is because of the expense ratio. Class A has the lowest expense ratio and Class C the highest. Over long periods of time Class C becomes the most expensive. The class with the lowest expense ratio will have the highest rate of return. You pay less year after year so you keep more of the return. Eventually the compounding of the higher return makes up for the front end load in Class A. With most companies Class B shares will convert to Class A shares after a number of years and to the lower expense ratio. The Class C shares never get a reduction in expense ratio.

If you are going to hold your shares for 10 or more years more often you are better off with Class A. If you think you are going to hold your shares for 5 years or less, Class C may be your best bet and between 6 and 10 years Class B.

I also put Class Y in the table above. I picked any letter to describe the next set of share classes. Some companies may have one or two more share Classes and other will have several. Most of the other share classes have to do with shares offered in pension plans, 401(k) plans or sold through fee only advisors. They are generally the lowest priced share Class.

The information above is very general including the table. There are many variations to the share Classes by company. For example the spread in the over all expense ratio between the Classes, how long the contingent deferred sales charge is and when and if Class B converts to Class A. The aim here was to give you a general understanding of how share Classes work. I also wanted to point out that what seems like the obvious choice when looking at the sales loads, may not be your best bet when you consider the entire expenses of the fund.

The details about overall expenses can be found in the mutual fund’s prospectus. I encourage everyone at a minimum look at the expense section of the prospectus before you invest.

Recessions, Painful but Healthy

There has been a lot of news lately about a change in America’s attitude toward saving and becoming more fugal.  Americas have gone from a negative savings rate to a positive one.  It is now common place to hear people talk about how they are trying to save money on purchases.  This change in the savings rate and attitude was brought about by the recession.  Going back years you could read about how disturbing it was to financial professionals that we were at a negative savings rate.  People did not change their behavior until they had to. 

Recessions happen because we stray to far from the basics or fundamentals.  This time both individuals and companies over extended by borrowing or leveraging to much.   We ignored the fact that allowing individuals to borrow 100% or more with closing cost to purchase a home is a fundamentally flawed practice. At some point something has to give.

Take a look at the auto industry.   The companies that have been more efficient like Toyota, Honda, and Ford are doing much better than General Motors or Chrysler.  Without government intervention both GM and Chrysler would have failed and other auto makers would have become more profitable.  All the companies, even with the bailout are currently being forced to become more efficient. I am not trying to start a debate about the auto industry’s bailout, but most economists believe that a bailout only prolongs the economic cycle. In the end the recession will bring about long needed change in the auto industry.       

So what has changed for investors this time, nothing!  It really never does.  If you stick with the fundamentals and have time to wait out the corrections you will do well.  The hard part is turning off the noise coming from the talking heads.  Here is a question to ask if you are paying for managed money.  Did your advisor, trust company, broker etc. do any better for you than the market itself?  It will be hard to get a straight yes or no, but the answer will be no the majority of times. 

The fundamentals of investing are simple but hard to follow. 

Keep expenses low. 

Stay diversified.

Do not chase returns, like technology in the nineties, real estate this last go around and gold/commoditiess now.

Pay attention to taxes.

Buy good companies with good management and hold on to them.

Tune out the noise.

I do not know when the recession will be over, but it will end.  Those who follow the fundamentals will soon see profits again.

Reaquainting Myself with the Food Saver

Currently my household is running at a deficit and I do not think there is anything in the stimulus bill with my name on it, so I have been trying to think of ways to cut my expenses. The first thing I did was change my cable package. I all ready have a programmable thermostat and compact fluorescent light bulbs throughout the house. My wife and I have not been out to eat in months or done anything for entertainment. I just could not think of many other expenses to cut.

I kept thinking and finally it hit me, I stopped using my Food Saver. The Food Saver allows you to buy in large quantities and freeze food for a very long time without worrying about freezer burn. I looked in my freezer and it was almost empty. I made two lists one for my local supermarket and one for Sam’s Club. I checked out the prices at my local supermarket for items like ground beef and chicken to do some comparison shopping. One pound of ground beef at the supermarket was over $4 a pound. A package of chicken breast ranged from 8-9 dollars (I forgot to look at the weight). One pound of frozen peas, which I bought, was $2.50.

I got 6 lbs of ground beef at Sam’s Club for under $11.00. I got what would be the equivalent to 4-5 packages of chicken breast for $23.00. The same brand of frozen peas that I paid $2.50 a pound for was 5 lbs for about $5.30.

When I got home I repackaged everything with the food saver into one pound packages. My family consumes about 1 lb of meat at dinner. Ok, I eat most of it and my wife and kids eat some. By buying some of my food at Sam’s Club and using the Food Saver I am getting five meals for the price of one. That can add up to big savings over the course of a year.

The other thing I stop dong was buying my produce from the produce store that sell for example 3 heads of lettuce for $1.50 versus the supermarket that was $1.99 a head. Often when I buy produce from one these stores much of it goes to the compost pile. So I am going to ask my neighbors if they want to split the bill and the produce. This should save us even more money and I won’t feel guilty for wasting food.

I know many of you may all ready be doing the above, but I figure if I forgot about the Food Saver in the cabinet maybe others did to. Now if I can only start using the bread and pasta maker.

Share your suggesting on cutting expenses.

Investing, Who can you trust

With the news about Bernard Madoff and another “investment manager” Joseph S. Forte who took investors for about 50 million in the Philadelphia area, many investors are asking who you can trust for financial advice. The good news is there are basic things you can do to protect yourself.

Joseph S. Forte was not licensed or registered with the state or federal government. You will find that the majority of individuals committing securities fraud are not licensed or properly registered. This is your first line of defense. Go to the Financial Industry Regulator Authority’s website FINRA.org and use their BrokerCheck tool. This tool will let you know if the individual is registered with FINRA and if they have any violations. It also allows you to look up a registered investment advisor firm who may not be required to be licensed but should be registered. If the RIA has fewer than 25 million dollars under management you will need to check their record with the state government. If the individual is not on record with FINRA or the state you do not want to give them your money.

You want to avoid individuals who make claims that they can provide specific rates of return. An advisor may be able to put you into an investment that will guarantee 4% over 5 years with some strings attached, but if they are claiming market beating returns and above average fixed rates be careful. That leads us to the next line of defense.

Know what your money is invested in. You should receive a report of what investments you are in. The advisor should be able to tell you were your money is and you should receive detailed statements with the holdings. Avoid advisors who claim they can not disclose how or where they invest your money. This is a major red flag.

If the advisor is providing returns to good to be true or if your balance never fluctuates while earning above average returns, fraud is most likely involved. This was the biggest tip off in the Madoff scandal. It is simply impossible to provide above average returns without volatility in your account.

You can also protect yourself by understanding what type of financial service you need. A life insurance agent may be able to provide advice for protecting your family in case of death, but you should not seek tax advice from them. Do not be afraid to ask questions like; how long have you been working in this area of finance, what companies have you worked for in the past, and how are you compensated.

FINRA has a very good section on their website under the tab “Protect Yourself” with many more tips to avoid being scammed. I encourage everyone to read it before working with a financial professional.

As someone who works in the industry I can tell you that the majority of professionals are just that, professionals. They do what they do because they love helping people with their finances and want to build a business doing it. In any business you have a few bad apples that ruin it for the rest. As a consumer you need to protect yourself. Taking the few simple steps mentioned above will help you avoid most of the bad apples.

Ten Ways to Save on Taxes

Contribute to your 401K or a Traditional IRA.  

You get two tax benefits with these accounts.  Your contributions are before tax with the 401K and tax deductible in an IRA if you are within the income limits (IRA Pub 590).  A pretax benefit and a deduction is basically the same thing except the first in done through your payroll and the other is taken on your tax return. The advantage is an individual in the 25% tax bracket contributing $100 would have an out of pocket contribution of $75.  The other $25 is being put up by Uncle Sam.

The interest or earnings is these accounts grow tax deferred which means you do not have to pay taxes until the money is withdrawn.  Generally there is a 10% penalty for withdrawals prior to age 59 ½. 

Flexible Spending Accounts

Take advantage of flexible spending accounts.  These accounts are set up by your employer and allow you to pay for things like health care expenses, and childcare cost with before tax dollars.  There are limits to how much you can put into these accounts and if you do not use the funds by a certain date you lose them.  

Commuter Benefits

Another employer benefit is commuter benefits.  This allows you to pay for parking and mass transit through payroll deduction with pre-tax dollars.  

Deductions. 

Many people miss deductions that they qualify for.  Certain deductions like the ones above and others: alimony, educator deduction for teachers who buy supplies out of pocket for their class room, moving expenses for job relocation and more.  

Tax Credits.

Tax credits reduce your taxes dollar for dollar.  The energy tax credit which expired 12/31/2007 is not available for your 2008 return but has been reinstated for 2009.  So if you buy new energy efficient exterior doors, windows, insulation, or a high efficiency heater or water heater you can qualify for as much as a $500 credit.  

Tax harvesting investments.

If you sell certain investments at a loss you can write off the losses against the gains plus an additional $3000 (Married filing jointly) against ordinary income. Read Get Rich Slowly's blog on the subject. 

 Hold on to your investment for more than one year because long term capital gains top out at 15% for investments held greater than 1 year.  

Tax Favored Investments

As mentioned above employers sponsored plans and IRA’s are a great way to save on taxes but so are other accounts like education savings accounts and 529 for tuition.  The Roth IRA is a great way to save taxes in the future. See post, "To Roth or not to Roth". 

If you are in a high tax bracket you may be better off investing in tax free municipal bonds versus corporate bonds.  They have lower yields but on a tax equivalent basis you may be better off. 

Charitable donations

Most people donate to charity because they want to help the cause, but if you itemize it is also a deduction on your tax return. You will need to make sure the charity qualifies as one under IRS guidelines. You also want to write a check or use a credit card so you have a record of your donation.  If you are donating clothing or other items, get a receipt. 

Start a family business.

A family business will allow you to pass income to your kids who should be in a lower tax bracket.  You may also take the home office deduction if you use part of your home to run the business.  Pay attention to the rules for the home office deduction because if you take it, you want to get it right.  It is rumored that tax payers taking the home office deduction are more likely to be audited.  That takes us to our last tax saving tip.

Stay organized and keep good records.

Many people lose track of medical expenses, auto miles, charitable donation and other deductions that they could take if they only had the records.  Start a file in January and start putting all tax records for the current year in it.  You can organize it right before tax time.  If you are one of those people that can stay organized then keep separate files for certain deductions (like health care expenses) and credits.  Once you have your records organized and your tax return completed, hold on to them.

You can find out all the details on the above tips at IRS.gov. 

 

Are we Rewarding the Financial Irresponsible

I was sitting in traffic one morning and I started to recall a conversation between me, my wife and a few other people around 2002.  My wife asked a question something along the line, how is everybody affording all of these things.  Everybody being our neighbors, and things being in-ground pools, vinyl fences, pavers, new cars, and many other luxuries.   I stated, I guess they make loans and are in debt up to their eyeballs.  I went on to say that I can not live that way and what if something happens were people can not pay their debt.  Someone chimed in and said but everyone is in debt up to their eyeballs and what could happen to everyone.  

At the time I thought to myself that is no way to look at it.  Now with the bailout of financial institutions to big to fail and individuals who borrowed more than they can repay being bailed out one way or another, I am wondering who is better off.  I think the answer is those of us who acted responsible.  

For one thing if I get laid off from my job I have enough savings to get me through for 6 months or more.  The debt I am carrying is more than I would like, but manageable. Those individuals who made financial mistakes can not feel good about themselves and must have more stress than those who were responsible.  The ultimate test is would you want to trade places with one of the individuals going into foreclosure even if they are getting a deal.  I certainly would not.  

So the lesson is when mass numbers of people are irresponsible you can count on a government bailout but those who acted responsible will be in a better place.  

Tell us what you think.  Is the bailouts fair and do you wish you ran up your credit card or bought a house you could not afford?

Choosing a tax preparer; Do you need a CPA?

One thing that I have learned in my career is that people hate filling out forms.  It can be the simplest form with basic information and people would still pay someone to fill it out.  

The majority of people have simple tax returns and could fill out the forms themselves.  You could purchase software that helps you fill out the forms by interviewing you with questions such as, did you receive a W-2. If you answer yes, the software will then ask you to type the numbers from your W-2 into the program. The program will put the numbers on the correct tax forms. I will put a shameless plug in for the software I use at Happy Returns Tax Service. It cost $19.95 to $24.95  depending on if you use form1040EZ, 1040A or 1040.  It includes Federal, State and e-file.  It is a bargin compared to some of the software on the market and there are no hidden fees.   

Although many people find the tax software great, I find others who get frustrated with software and rather have someone else prepare their return.  There is a good article by John P Cummings, “How to Choose a Qualified Tax Preparer” on the IRS’s website.   

He does a good job of spelling out the qualifications of a Certified Public Account (CPA) and an Enrolled agent (EA).  A CPA can be very expensive even for a basic return.  In my opinion, many people who have a job and some basic investments like stocks, bonds and mutual funds do not need a CPA.  If you own a business, have multiple rental properties or are in complicated investment like; limited partnerships and stock options, then I would suggest you pay the price for a CPA.  

When choosing a professional to prepare your tax return ask for referrals. Avoid tax preparers that claim they can get you the biggest refunds.  I had clients ask me why there refund was larger the pervious year when prepared by another tax professional.  After reviewing the return, I would state that you gave more money to charity the previous year or you had work done to your home that qualified for an energy credit.  Their response is, “No I didn’t”.   Be careful you are still responsible for the return.  

If you are considered a low- and middle-income taxpayer age 60 or older you may qualify for help from the AARP Tax-Aide program.  It has nearly 32,000 volunteers staffing 8,500 sites across the United States. These IRS certified volunteers provide free tax counseling and preparation services. Visit their free AARP Tax-Aide site locator, where you can enter your zip code and receive location addresses, schedules, and other contact information.

Taxes are a frustrating task for many, but if you can find a true professional or good help it can make all the difference.  Happy tax season.   

Am I a Socialist

This may be my most controversial Blog yet or ever to come. I just finished the Book by Scott Burns and Laurence J. Kotlikoff, "Spend ‘til The End". Then I watched Michael Moore’s film "Sicko". I am not going to give my opinion of the book or the film, but both got me thinking about the American way of life. 

In short, Spend ‘til The End is an economist’s view of financial planning and suggestions of how to raise and "smooth" your living standard. Sicko is one man's view of the short comings of the United States health care system and a case for national health care. It is one sided and meant to build the case for national health care. 

The book points out how student loans can lower your standard of living for a very long time, possibly into your fifties and sixties. The book touches on planning for health care expenditures and long term care in retirement. Sicko suggests that we will all be better off with a health care system that is free and covers everyone. What if we did not need to worry about the cost of either education or health care? What if both were socialized? 

The more I thought about these questions the more of a case financially I could make that both should be provided as a right of citizenship. Yes taxes would go up, but they would be offset by the current cost of each. Currently I am spending about 6.3% of household income for medical expenses. My employer is spending about 8% of my salary for health care expenses. Would we need to raise corporate taxes and payroll taxes more than that to provide health care for everyone? I am not sure and it is a tough calculation to make. Part of the problem is that currently some of the uninsured are covered with the premiums of the insured. If an uninsured person goes to the emergency room and does not pay the bill, the cost is passed onto the insured. You would also have to factor in those who can not afford there medication and wind up in the hospital because of it. 

This has happened to a family member of mine. The hospital bill was over thirty thousand dollars back in the late nineties. That would have paid for about ten years of medication. This individual now has Medicare part D and has been getting the medication. 

Healthier employees are more productive employees and that would also have to be factored into the cost. Many people would retire earlier if they had health insurance and would be replaced with younger workers that can be paid less. People who do not get their annual check up because of the cost (even some with insurance do not go because of the co-pay) would get their check up and prevent or catch illnesses earlier which would lead to overall lower cost. 

What would happen if a college education was free? Companies and institutions would not have to pay their employees as much to make up the cost of college. If you are a doctor with a half million dollars in student loans, you need to make a certain income just to cover the loan payments. Some individuals may enter a field that pays less, like social work if they did not have to pay for student loans. Or maybe you know you want to do social work and have been accepted to an Ivy League school, but opt to go to a community college because of the cost. Would we have better educated individuals applying for lower paying jobs and possibly making a greater impact to those institutions? Not sure, but there are definitely students choosing their school on price. This is a wise thing to do. 

I know this Blog will be controversial, but I try to think outside the box. As Americans, are we truly happy with the current systems for providing education and health care to our citizens? Is there another way of doing things that would raise the living standard of every American? 

I believe that I am a capitalist, but one that can see the economic benefits of providing both health care and education to everyone. I do not believe that the systems would need to be run by the government and could still remain competitive. 

What do you think? 

Keeping Income Tax Records

This is the time of year where everyone needs to pay extra attention to there mail.  You will start to receive tax information from your employer, bank, investment companies, mortgage company, and others.  It is important to gather the documents and keep them together so when it is time to prepare your taxes, you have them. Missing one item on your return may subject you to an audit or cause you to pay a tax preparer to file an amended return. 

You need to keep good records for more than filing your taxes. With the federal deficit expected to be at an all time high, the IRS will be cracking down on tax cheats and possibly doing more audits.  If you happen to get audited you want to make sure you have all the documentation for your deductions and credits.  With lending standards tightening and banks requiring more documents to get a loan, having your records organized will make the process that much easier. If you are looking for either tax advice or financial advice providing a few years worth of tax returns will provide the advisor with an easy and quick view of your overall financial picture.  

Many people ask how long they should keep tax returns and records.   Publication 552  suggest that,

“You must keep your records as long as they may be

needed for the administration of any provision of the Internal

Revenue Code. Generally, this means you must keep

records that support items shown on your return until the

period of limitations for that return runs out.

The period of limitations is the period of time in which

you can amend your return to claim a credit or refund or the

IRS can assess additional tax…”

 

This means you should keep records for 3-7 years.  I would suggest you keep a copy of your return forever and dispose of some of the supporting documents after 3-7 years.  If you own property you will want to keep capital improvement records for as long as you own the property and 3-6 years after the property is sold. 

If you own a business, which has different requirements for record keeping you may want to keep records as long as you own a business.  If you want to sell your business the buyer will want to see many years of records.  

That being said, with electronic record keeping I see no reason why people should not keep their records forever.  You can buy a scanner for as little as $20 and scan all your records onto a drive.  Combo fax, scan and print machines are less than $200 and usually come with the software to store the documents electronically.  

The bottom line is that you never know when you will need a document from the past or for what.  Keeping your documents organized and for long periods of time is never a bad idea. 

Financial New Years Resolutions

It is that time of year again where one year is ending and another about to begin. We reflect on the past year and make resolutions for the New Year. With the economy in recession and reports that it may get worse in 2009 this is a good time to think about how you are going to get your financial house in order. Hear are some good financial resolutions you can consider.

Pay down debt
If you have debt on credit cards with high interest rates pay them off first. Consider transferring credit card debt to a home equity loan for a better rate. You will also get a fixed payment for a fixed period of time. This makes people fell better because they know when they will be out of debt.

Pay cash for purchases
If you clear your credit card balances by putting it on a home equity loan don’t charge it back up. Many people feel so good about clearing off the credit card that they go out and use it. Even if you do not transfer the balance, get in the habit of only paying cash for purchases. This will force you to save for what you want. If you don’t have the money, don’t buy it. That leads us to our next resolution.

Live within your means
When credit was so easily available you could increase your living standard buy going into debt. Now with credit tightening we are being force to live within our means. People need to consider what certain purchases do to their long term financial situation. Buying a more expensive car by spreading the payments over 7 years so you can afford it is an example of not living within your means.

Make savings automatic
Take advantage of payroll deduction in your employer’s retirement plan. Every investment company now should offer an automatic debit from you checking or saving account into their investments. Studies show those who make their savings plan automatic save more because they stick to the plan.

Buy income producing assets
One major point in Robert T. Kiyosaki’s book, "Rich Dad Poor Dad" is that we consider cars and boats as assets but they do not really increase our net worth over time. You want to buy asset that will increase your net worth and wealth. They are assets like stocks and real estate.

I could keep going, but I think this is where most individuals need to start. If you have already done the things above good for you and I will continue to write about how to get your financial house in order in future blogs.

Happy New Years!!

Keep saving in your 401K

Many of the individuals that I have meet over the last month stopped saving into their employer sponsored plan.  The reason that they all gave, is that when they look at their account balance they have been losing their contributions.  That is not exactly the case but certainly looks that way.  What they are actually losing is past principal and earning.  If you have $10,000 in your account and make a $100 contribution and the losses in your stock funds are $350 for the contribution period, it looks like you lost your last contribution. What really is happening is you are now buying more shares for the same contribution.  If a $100 contribution bought you 10 shares of a stock fund, it now buys you about 20 shares. So when your stock fund goes back up $1, you make $20 on your last contribution.  This helps your account value come back much faster, but that is not the only reason why stopping contributions is a bad idea.

Let’s say you have two individuals, Sally Saver and Fred Freeloader (I was going to use Joe the Plumber).  Both 35 years old and saving $250 a month for retirement.  They both plan on retiring at the age of 65.  For simplicity sake we will assume they are both just starting to save. Because of the market they want safe investments earning 3.5% (not advisable but I want to make a point).  If Fred Freeloader waits 5 years to start making contributions he will have at age 65 $119,053 and Sally Saver would have $157,789, a difference of $38,736 more for Sally.   That is still not the whole story.  Sally would be paying less in federal income tax for five years all things being equal. This may be about another $3,500 in tax savings. The above example does not even take into account an employer match, which could have Sally's account balance much higher. 

Stopping contributions to your retirement plan is one of the worst things you can do.  If the losses in the stock market have you that upset, then ask the company that manages your plan if they have a guaranteed investment.  Be sure to ask if there are any strings attached with the guaranteed investment as there usually is.  This is the time to save more to make up for the losses, not give up on your retirement goals.  

The Difference Between Saving, Investing, and Gambling

Let’s take a look at the definition of each of the above words from dictionary.com.

Saving-
A Reduction or lessening of expenditure or outlay: a saving of 10 percent

Investing-
To commit (money or capital) in order to gain a financial return: investing their savings in stocks and bonds.

Gambling-
To stake or risk money, or anything of value, on the outcome of something involving chance: to gamble on a toss of the dice.

The above definitions shed some light on the differences of each word, but let me elaborate on them a little further.

In finance, saving would refer to setting aside money for the future. Forgoing consumption today to have more in the future. It does not mean buying shoes on sale. The major difference between saving and investing in my opinion, is that saving involves little or no chance of loss to the principle. Things like Money Markets, bank CDs and U.S. saving bonds. 

Investing on the other hand has both the potential for gain or loss. Because of the potential for gain or loss many people think of investing as gambling. They say things like, I lost money in the stock market before, and I rather take my chances at the casino. This is simply not true and I will explain why.

There are major differences between the two. Gambling involves either total gain or total loss. Also you can put up a small sum for a large payout, like the state lottery. Investing is more of a process in which you put up relatively a large sum of money compared with gambling, and it can take a long time for your investment to grow. Your money is placed into something, whether it is companies, real estate or a promissory note. You rarely lose all of your money when investing. With gambling one party wins and one party loses. With investing and saving many parties benefit from the transaction. For example, I put money into a saving account at the bank, the bank pays me interest and I make money. The bank loans the money to you for a new car, you get a car. The bank and the dealership make money. If the dealership deposits that money back into the banking system the process starts all over again.

My deposit- $20,000

Bank lends you my-$20,000

You give dealer $20,000 for a car

Dealer deposits same-$20,000

the bank lends the same $20,000 again and the process goes on and on. So my $20,000 deposit has provided $40,000 in loans or money into the financial system so far. This is an over simplified example of the multiplier effect to make a point. The bank has reserve requirements for safety and to meet withdrawals. A different process happens with stocks and bonds but has somewhat of the same effect. When investing, you are a contributor to the capital markets. Gambling may be fun but it is not the same as investing. As far as I can tell in the long run investors come out way ahead.

So which are you a saver, investor, or gambler, two of the three or all three?

Bernard L. Madoff and his Ponzi scheme

Bernard Madoff market maker and hedge fund manager was charged with securities fraud last week taking investors for as much as 50 billion dollars according to reports.  Investors in his fund use to state they do not know how he does it but his fund consistently returned 9-10% a year.  We now know how he did it, with a giant ponzi scheme. 

Ponzi schemes work by creating the illusion of profits by taking the funds of new investors and putting them into the accounts of current investors. Eventually new money stops coming in and original investors start asking for their money back and the whole things collapses.  People will want to assign blame for this whole thing. Clearly Madoff himself is to blame. He has been around Wall Street for 50 years and with his connections and reputation he did not need to defraud investors to make a living.  He got greedy and I hope he spends the rest of his days on this planet in a jail cell. 

I do not think we should over look the investors in Madoff’s fund. His list of investors is a who’s who of the world's rich. These were not your average 401K type of investors.  They were people with millions and billions to invest and should have known better.    The fund seemed to defy logic and Madoff gave very little explanation of how he made his returns.  Investors also got greedy and took an attitude of as long as I keep making money whatever he is doing is ok with me.  Investors long for the ideology that a money manager can continue to make money in equities no matter what the market is doing.  The investors in Madoff’s fund broke a fundamental rule; if it sounds too good to be true it probably is. 

The regulators are to blame also, but remember hedge funds have fought regulation and won time and time again.  They have basically operated outside the regulator environment.  So I will not blame the regulator as much as those in congress who fought against the regulation of hedge funds. 

No matter who we blame it will not get back the 50 billion dollars of losses for investors.  I just hope some investors will learn from this. There are certain principals of investing that no fund manager can get around.  One of those principals is that there will be periods of loss and if your fund never losses money be suspicious and get your money out while you can. 

Social Security; When to Collect

A major decision facing individuals turning age 62 is; should they take Social Security benefits early or delay until full retirement age or even later. You will get different answers among financial professionals depending on who you talk to. If a financial service person goes right into; take Social Security and invest the money into XYZ, you should be suspicious. They are more than likely thinking of a sale, than what is really best for you. Because your decision to take Social Security early depends on your life expectancy and future returns of investments, an absolute answer to the question is not possible. What is possible is to inform you what to consider when making the decision.

According to an example on SSA.gov a 62 year old would receive $1018 a month. At age 67, which would be full retirement age, the monthly benefit is 1476, and at age 70 the benefit is $1840 monthly.

Let’s say you collect your benefit at age 62 and invest 100% of the after tax amount into an investment that earns 6% per year for 5 years. Let us assume you are married, file a joint tax return, and have a combined income of $42,000. About $76 of each check will go toward income taxes. That leaves $942 to invest each month. Invested for five years at 6% you would have $65,744. If you invest in an immediate annuity for you and your spouse, you would get about $390 (Joint life annuity) a month according to immediateannuity.com. This is short of the increase in monthly benefits of $458 from Social Security for delaying payments until age 67. The increase in your SS benefit comes with a cost of living adjustment (COLA) and more favorable tax treatment. A single life annuity would produce about $465 monthly. This may be more than the increase in your SS benefit, but with  one or two COLA adjustments you should have a greater benefit from SS in a few years.

The other way to look at it is; how long it takes to accumulate $65,744 (cost of delaying benefit) if you invested the $458 a month (the increase in benefit). You would break even in 9 years and 1 month using a 6% rate of return. Which means if you live past the age of 76, it was worth the delay in benefits. Most articles now state the probability of a 67 year old living to age 76, this misses the point. You need to make your decision at age 62. The probability of a 62 year old male living to age 76 is 75%, and a female 80% according to The Vanguard Group’s life expectancy calculator.

Some other things to consider are:

If you still plan on working before your normal retirement age, $1 in benefits will be deducted for each $2 you earn above the annual limit. In 2008 the limit is $13,560.

Your health, you may want to take SS benefits as soon as you can, for obvious reasons. If you take the early benefits, remember it may impact your spouses’ benefits.


Whose record will your spouse collect under? If your spouse will be collecting SS under your record, then an increase in benefits to you will mean an increase in benefits to your spouse if he/she outlives you.

Can you afford not to take it? Sometimes retirement is not by choice, and people need to figure out how to make ends meet. Collecting SS early may be a necessity.

Individuals considering taking early SS benefits should think about other sources of income to sustain themselves for as long as possible. Social Security is the one benefit backed by the taxing power of the federal government; which makes it one of the most secure lifetime benefits in the world today. As noted above it also has a COLA and favorable tax treatment. There is not another product available today by financial service companies that can match the value of your SS benefits.