Understanding Taxes

It occurred to me last week that I had not filed my taxes (or even started) yet, and it was already April.  Luckily, I realized that I was somehow a full week ahead, and at that point, it was only the last week of March (which is when I usually file) but among homework assignments, shifts at work, and self-imposed obligations to friends, I couldn't find any time to take care of them.  Luckily, I had a later shift at one point this week and there is an H&R Block in the same shopping center as where I work, so I popped in with my tax information to see what would happen.

"I am coming in to start my taxes," I explained to the secretary when she asked me how they could help.  She asked me if I had an appointment, "nope."  To which she disappointingly said, "It's APRIL ... and you're coming in ... to START your taxes ... WITHOUT an appointment?"  "Yea, basically."  I already knew where this was headed, and it was the opposite of where it should be going.  "Well... *exasperated sigh* it just so happens that we had a cancellation."

This is why I often call myself "Mr. Lucky."

On one hand, it amazes me how much people don't know about the tax laws in our country.  On the other hand, it amazes me how complex the tax laws in our country are.  For both reasons, I have always gone to a tax professional to file my taxes.  It allows me to be lazy and laissez faire.  Also, I was once told very early in my career "H&R Block pays for itself."  It's true.  A few years ago, I owed some taxes (several hundred dollars were due) so we ran the numbers, and I could get a couple dollars back if I maxed out pre-tax contributions into my IRA.  I could have paid the government money and never seen it again, or I could have paid a little bit more to myself and keep it in my possession.  Of course, I did the latter.  But I never would have known it without H&R Block.

More importantly, I was employed for half of this past year and then under-/unemployed for the rest of the year, so I knew my 2011 tax situation would be unique.  Also, I was a student this year but I did not even consider that there would be significant tax breaks.  As it turned out, the tax deductions that I had in mind (and one that the average taxpayer would have used) would have reduced my taxes.  Conversely, there were some tax credits available for full-time students such as myself (I don't think of myself as a "full-time student," but I qualify as one) from which I could get a large refund.

If you don't know the difference between a tax credit and a tax deduction, then you probably need assistance from a professional.  You could pay taxes on your own and save the $100 fee from H&R Block, but you will risk missing out on potential "loopholes" to reduce those taxes.  For example, my taxes were 15% this year but what I paid (owed) was 1%.  I proudly felt like Bobby The Brain Heenan when I heard that fact.

Another sign you may need a tax professional is if you don't know that when I say "my taxes were 15%" that I mean, my last dollar earned was taxed at 15%.  The Internal Revenue Code uses a marginal tax rate, which means everyone is taxed the same way.  The first $9,000 we earn annually is not taxed ... at all ... for everyone.  The next $8,500 is taxed at 10%.  The next $8,500 is taxed at 15%.  Above that, it is taxed at 25% until you've earned $85,000 over that original amount (which I believe it $9,000, but I could be wrong), and then you reach the 28% tax bracket.

If you think your being in the 28% tax bracket meant every dollar you earned was taxed at 28%, then you're wrong (but you're in good company).

Another common misunderstanding is if you receive a bonus at work and the taxes are withheld at a higher percentage than on your ordinary income.  Many people are mistakenly under the impression that bonuses are TAXED at a higher rate.  This is untrue!  The increased withholding is to protect you from yourself.  You were not expecting the bonus (ideally) so withholding more of it means more of your taxes are paid by the end of the year than the remainder of your earned income.  Unfortunately, correcting people on either point is usually a fruitless endeavor, because (for whatever reasons) taxes are just misunderstood by the American public at large.

If you hear politicians push for "flat tax," this is the reason why.  Unfortunately, I think it's a bad idea.  Very bad idea.  I like the marginal (tiered) tax rates in this country myself.  Part of the reason it is a bad idea is that it would need an entire re-write of the entire Internal Revenue Code, and as confusing as it is now, at least enough people understand it.  If the entire book were rewritten, then it would be a crap-shoot whether it was written for better or worse.

Albeit, it would make filing taxes a lot easier.

Cash For Gold

Natural beauty in investing may happen very rarely.  Despite all I have learned, there is a lot more in investing that I do not know.  However, I know what my expectations are and I know what my limits are, so when it comes to managing my money, those are the most important things to know.  Beyond that, my opinion has very little influence in the overall marketplace.  Regardless, it is beautiful when I learn people I respect share my same opinions.

My favorite television show is "South Park," and tonight was the second episode of their sixteenth season.  It was entitled "Cash 4 Gold," and as soon as I learned that much about it, I was immediately excited to see it.  I knew they would have fun poking fun at the Cash For Gold places, but as the episode played out, it brought to life my personal opinion on investing in gold, which made my heart smile.

My former-roommate (who's currently a highly successful investment banker) told me a couple years ago that the biggest use of gold today is for making jewelry in India.  If that's the source "demand" of gold, then the rest of the marketplace's "demand" is bunk!  It does not surprise me that the American investors have gone from high-tech stocks (which was a natural bubble) to the rest estate market (which was a bubble that got inflated by a lot of hot air), and now Pat Boone's "Gold IRAs" have taken the advertising time and space previously held to hock REITs.  For the record, there is no Gold IRA anymore than there is a Green IRA or a Red IRA.  The marketing ploy of that commercial alone is absurd.

In no uncertain terms, the "South Park" episode drew correlation between the elderly population buying items on Home Shopping Network and the excessive supply of "jewelers" who are ready and able to purchase gold.  Although the episode pinpointed how unbalanced the supply and demand for gold are in this country, it opted against targeting those individuals who are encouraging people to invest their IRA and other retirement accounts with gold.  Perhaps the average person is not exposed to those ads as often as I am, or (unfortunately) they aren't smart enough to understand that a spoof is not a good method for investing, and that episode may insire another several thousand wannabe-Cartmans to move their money to gold.

I sold a gold ring for my best friend a couple weeks ago, which I absolutely HATED to do, but I went to a jeweler who had been buying gold for as long as I have been living in my current location (over 13 years now), so I felt as though she got a good deal.  Immediately after the sale, I started kicking myself because I wish I had thought to "shop" it around to a few of these nefarious "Cash For Gold" places, and see how their offers stood up against this place.  According to "South Park," we would likely have been offered a high of $8.75 or a low of a seven-layer Taco Bell burrito.

In reality, gold is at a pretty big high right now, so it's a SELLERS market.  I am so weary of the metals market right now that I told my friend to NOT sell gold at first, and then I realized that this was the best time to SELL gold since she was interested, so I convinced her to sell and she got $50 for an otherwise worthless piece of jewelry.

Although, I hate to think how much her mother paid to give it as a gift however many years ago.

Financial IQ Score

There is one important (critical, even) element of your financial lifestyle that I have neglected to mention previously in this blog, and that is your Credit Score.  Not only have I failed to mention it in this blog, but honestly, and I should be ashamed to admit it, I have neglected my own credit score for the past 10 years, which was the age by which my mother required us to be financially self-sufficient.

In terms of finance, your credit score is a far better measure of intelligence than your IQ.  Sadly, I didn't even know what mine was.  All I knew is that it had to be decent because, when I bought my convertible in 2007, the salesman confided that, after his bosses saw my credit score, he wasn't allowed to let me leave without a sale.

Fortunately, this week I took that sizable step of getting my credit report from all three bureaus.  Honestly, I was planning to approach each of the three bureaus independently and find out the score myself instead of paying someone else to do it, but that's usually because the expense is $100+/yr from most of the companies offering the service.

However, the last time I was at my bank (Wells Fargo), I saw a whiteboard offering to provide your credit report for $1.  I didn't think much about it since the purpose of my visit was only to withdraw money to pay my mortgage at the bank across the street.  But a couple months passed since then, and as I went to the bank, I was ready to inquire about it.  Unfortunately, their whiteboard was now reading another advertisement, so when the teller asked if there was anything else they could do, I proactively inquired if the offer was still valid.  He said it was, and shortly thereafter, sat me down with a personal banker.

He printed the scores for me, which were very, very good thankfully, and then segued into offering a separate credit card through the bank.  He prefaced the fact that the card would have 0% interest for nine months, and unbeknownst to him, I am about six months away from starting a new career in law, so (ideally) I could use this card for the next six months and then start paying it down over the last three.  The card was ideal for my current situation (especially since I am having trouble paying off my current credit card each month).  I agreed, and we scheduled a follow-up meeting, and then I went across the street to the next bank to pay my mortgage.

At that bank, I was approached by a Personal Banker upon entering the door.  He asked why I was there (politely) and then offered to help me.  I don't know whether he knew the paperwork in my hands were my stellar credit report or not, but we paid my mortgage and then he went on a high pressure push for moving my assets over to the bank.

Now, the reason I pulled my accounts from this bank (where I had banked for over 13 years) last year was when I was quitting my job and going back to school, their checking account would have come with a monthly fee of $25.  Initially I opened up a new bank account with them where the balance to avoid the fee was significantly lower, but then Wells Fargo blew them out of the water with their checking account, so I closed that new bank account at a different branch through the same bank.  As it turned out, there was a $25 fee to close the new account and they had signed me up for the credit card that I declined when presented with the offer.

Cut back to current day, and their new sales pitch is that if I bring over one of my retirement accounts, then I would qualify for free banking across the board, and also (and this was the huge no-no of any aspiring salesmen) their retirement plans were superior to mine.  As we know through this blog, my account is self-managed.  While the comment was supposed to be directed at Vanguard, it was more of a personal attack on my own ability to manage my account.  Albeit, it was a blind attack since the blabbermouth clearly didn't know what he was saying would be interpreted so differently, but nonetheless, I left slightly insulted and very disgusted.

The entire conversation with Wells Fargo rep had nothing to do with my retirement accounts, even though my balances there are way higher and the interest rates at Wells Fargo are way higher.  Therefore, I have decided to move a larger amount of my savings account to Wells Fargo this month.  Not my investment accounts, mind you, but my savings account.  As we know from Vanguard's Investment Philosophy, saving is for the short-term, and investing is for the long-term.

Regardless, it was an eye-opening morning to see how competitive the financial corporations, especially for high balance account holders with high credit scores.

The Full Motley: 1Q, 2012 (supplement)

I have never done an entry like this one before, but I wanted to do it because I noticed today that my 401(k) balance has tripled since February 2009, and I haven't even contributed to it since last April.

Last week I made my first quarterly rebalance of 2012, and I noted that the benefit of anchoring your portfolio around your asset allocation and rebalacing to your target allocation at predetermined intervals is that it takes the guess work out of investing, and then, (A) you don't have to hire a professional, and (B) you won't react emotionally, and you'll make wiser moves in the long-run by focusing on the long term.

Therefore, you never want to reassess your moves after one week since it just increases the temptation of reacting emotionally, but if you have the self-discipline to check your portfolio's performance frequently while holding true to your allocation & intervals, then there isn't much harm in checking in more often.

That was the case today when I heard that the markets were up, but I was curious how the recent string of increases had affected my portfolio.  Out of curiosity, I checked the price per share from last week when my reallocation took affect to the most recent price per share in the market.

• 24 = $79.16 < $81.03 (higher)
• 29 = $5.85 = 5.85 (even)
• 59 = $66.31 < $67.20 (higher)
• 84 = $11.03 > $11.02 (lower)
• 85 = $32.55 < $33.01 (higher)
• 113 = $28.72 < $29.20 (higher)

Four of my six funds have gone higher (including BOTH of the funds that I moved out of) and the total decline in the other two funds was only $.01.

There are two ways to analyze this information.  On the one hand, I could have been better off staying in the two funds highlighted in red for another week (which indicate the funds where I pulled money out yesterday).  On the other hand, the money I took from those funds has already been made back so the higher performing funds are already returning higher and the "profits" taken from there are holding stable or increasing in their own rights.

Obviously, making another change today would be foolish based on the small balance in my portfolio, but if you wanted to invest in an allocation that rebalanced frequently (such as daily), then the best fund for you is a "fund of funds" or a balanced fund which sets an allocation closely matching your preference.

Incidentally, the Target Retirement funds are a perfect example of that philosophy.  They have an allocation, and their investment managers seek to maintain that allocation daily, regardless of market performance.  While they miss out on having a large stake in the funds as asset classes that are rising, they also avoid giving their earnings back when those asset classes retreat.  As I've noted often in this blog, all investments fall much faster than they rise.

In my opinion, it is not worth the investment risk.  And, without question, it isn't worth the time investment to track your investments daily over the 30+ years.  If anyone had that much "spare" time, then I'd strongly recommend volunteering somewhere.  Life is about more than just money (although, understanding investments is invaluable knowledge).

The Full Motley: 1Q, 2012

It has been a long time since I have talked about my personal accounts on here, but the lack of updates does not reflect a lack of knowledge.  After erroneously rebalancing a month ahead of schedule on July 10, 2011, I furthered the "error" by rebalancing again on October 10, 2011 (a month ahead of schedule) since I felt the markets retracted more in September and it would be corrected by November.  That thinking is exactly what asset allocations are created to avoid.  Normally, the schedule should be what you do and speculation should be on what you are not doing.  Unfortunately, for my purposes, I cannot say that my early moves were a bad thing for my portfolio.  But I will say that they did not pay off much either.

This month I intentionally got back on schedule, and I was very pleased with how well my portfolio has performed since October 10th.  The funds that I discuss on these entries are in my 401(k) and in the past, I had been adding money into the funds at all times.  I left my job in April, so no money has gone into that account since then, and the balance is now higher than it was when I left, which is encouraging.  In my last entry, I noted that I expected the 2012 markets to raise higher than 10% as measured by the Dow, so I expect another summer slump, but I have another rebalance on May 10, 2012, which should be before the market retracts.

As for today's moves, here is my chart:

Fund # - Real / Current / Target
Fund 24 - 26% / +1% / 25%
Fund 29 - 5% / 0% / 5%
Fund 59 - 25% / 0% / 25%
Fund 84 - 9% / -1% / 10%
Fund 85 - 25% / 0% / 25%
Fund 113 - 10% / 0% / 10%

In the interest of full disclosure, although this blog should never be used as the primary tool for financial planning on any account except the one listed, there were additional moves made in which money was taken from two stronger-performing funds and placed into four lagging funds to preserve the target allocation, which is the point of rebalancing quarterly.

I only mention this caveat to note how pleased I was to see how well those two funds had performed since October.  The trickiest part about asset allocation is the actions in contrast to urges and expectations.  I mentioned how I failed twice last year by rebalancing a month ahead of schedule, but it is equally important to note that this move takes money out of stronger performing funds and put them in funds that are performing not as well.

Every financial analyst knows the reason for that move would be to "buy low, sell high," but the problem outside of rebalancing is, when you sell, you have to put the money somewhere.  If a fund earns 25% over a quarter, and you want to "sell high," where is it going to go?  If you need it, then that's an option but it does not allow for further growth.  If you sell for the sake of selling high, then you probably know it is going to a stable value fund or a lesser performing fund.  But if you analyze the move, then there is a strong likelihood you will decide to hold the excess where it is.

This quarter reminds me how much rebalancing simplifies this struggle.  It is like cleaning house in a way.  Each fund has its set place, and if one fund gets moved over to one side or another, then you just move it back where it belongs without thinking about it as taking money from a "winning" fund and putting it into one that lags.  When those choices start getting the better of your mind, then reconsider the allocation.  But, as I've noted previously, when you adjust your allocation, then the new allocation should be decided upon about six months before the first action is made on the account.

I'm sure future entries will discuss this concept further, even though I am very comfortable with my current target asset allocation.

CNNFN: Dow at 4-year high, Nasdaq hits 11-year high

NEW YORK (CNNMoney) -- U.S. stocks rallied Friday, as investors cheered a much stronger-than-expected jobs report.

The Dow Jones industrial average gained 157 points, or 1.2%, the S&P 500 added 19 points, or 1.5%, and the Nasdaq composite increased 46 points, or 1.6%.

The rally pushed pushed the Dow, up more than 5% in 2012, to its highest level since May 2008. The Nasdaq, up more than 11% for the year, climbed to its highest level since December 2000. The S&P 500 has gained almost 7% this year, and finished at a six-month high.

The rally was sparked by the Labor Department's monthly jobs report, which showed that the U.S. economy added 243,000 jobs in January, far exceeding expectations. The unemployment rate dropped to 8.3%, the lowest since February 2009.

Economists surveyed by CNNMoney had expected the government to report an increase of just 130,000 jobs in January. The unemployment rate was expected to rise to 8.6%.

Economists had expected a slowdown in post-holiday hiring, considering that about 40,000 temporary couriers were hired for the holidays alone.

"The jobs data blew away market expectations," noted Marc Chandler, global head of currency strategy at Brown Brothers Harriman, calling it a "monster" jobs report. "This coupled with other recent reports for January, show the year has begun off on a firm note," he added.

Meanwhile, investors were also on the lookout for an official agreement on a debt-reduction plan and a second bailout for Greece. The deal is expected to be near, but negotiations are likely to continue thorough the weekend.

U.S. stocks ended mixed Thursday as investors digested a cautious economic outlook from the chairman of the Federal Reserve.

The Full Motley: 2012 Preview

On December 31, 2011, the market closed the year at 12,217.56, which was approximately 6% up for the year (opening at 11,577.51).  This news made me happy because all year, I had said that the 2011 markets would be up <10%.  Believe me, there were times when I thought I would be off.  More often than not, I expected that the markets would close higher than 10% but a surprisingly slow fourth quarter dashed those higher expectation.  Interestingly, the second and third quarters had most analysts forecasting a down year but, as often the case when taking current news and projecting it too far into the future, their predictions were short-sighted.  The best success is when projecting far into the future, at least a year.  That said, those expectations will not always prove to be true, but they remove emotion from investing, which is often the most common pitfall to trip up investors.

Case in point, my predictions last year were that the stock market would be up less than 10% (as measured by the Dow) and that bonds and gold would suffer great falls.  Additionally, I added an actively managed fund to my portfolio to hedge against the perceived lag of indexing.  As already noted, I was right about the markets going up between 0-10%, but my other expectations were incorrect.

The 12-month return in the Vanguard Total Stock Market Index (Investor Shares) was 0.96% whereas the returns for the PRIMECAP Fund retreated by -1.84%.  This is a testament to the strength of indexing since PRIMECAP is one of the most highly regarded actively managed funds Vanguard has to offer.  Additionally, the Vanguard Total Bond Market Index (Investor Shares) returned 7.56% in the year that I expected bonds to fall significantly.

The following are the 2011 returns for funds in which I am invested or in which I have been invested in the past five years listed from highest (bonds) to lowest return (international):

• GNMA Fund Inv 7.69%
• Total Bond Mkt Index Inv 7.56% (Adm 7.69%)
• High-Yield Corp Fund Inv 7.13
• 500 Index Fund Inv 1.97
• Total Stock Mkt Idx Inv 0.96% (Adm 1.08%)
• STAR Fund 0.77%
• Prime Money Mkt Fund 0.05%
• PRIMECAP Fund Inv -1.84%
• Explorer Fund Inv -1.89%
• Total Intl Stock Ix Inv -14.56%

At this point in the year is when I like to set my strategy for the coming year.  While the Presidential Election adds a great degree of uncertainty to American investors, I recently read that the market is usually positive during election years.  As a result, I am not going to make any changes to my current allocation and maintain my current investment strategy.

As for the market itself, I expect that the Dow will be up over 10% and close above 13,439.32 in 2012.