This year, I decided to do my taxes on my own before we have a professional file them. I was hoping to develop a better grasp of the tax implications of my financial decisions while we are still in a learning phase. After this weekend, I’m glad I did.

This weekend I learned the importance of paying attention to the tax implications of your various accounts. I learned this that my wife’s “IRA” account will present us with a capital gains distribution of over $3000. What? Why are we being hit with capital gains? Shouldn’t they be rolled over into the account until retirement? Well, with a quick check, I learned that this account is not a tax-sheltered IRA like the one I opened last year.

This money was post-tax money that should have likely been placed in Roth IRA or the like. Currently it is just a fancy, very volatile savings account. Since it is not a tax sheltered account, we are responsible on paying taxes on the capital gains distribution. The irony of this is that these will likely be “paper gains” if the market continues its jittery fall this spring.

I found a good Morningstar article that does a better job explaining the reasons behind this but here is what I learned that we need to consider doing:

1. We need to consider switching this money to tax-managed funds Apparently these funds make an effort to realize some losses on holdings when they have to realize gains on others. With this tax consideration, these funds can come out ahead.

2. We need to consider switching to EFTs for this account. They apparently don’t have as many strategies available as the tax-managed funds but are a good second choice.

3. When switching out we need to be aware of funds that have had large returns over the past 3 years. These funds will have a huge tax bill regardless of whether we make any money or not because capital gains are based on gains that the fund realized and distributed to all shareholders equally regardless of their cost basis.

So if I go running to emerging markets right now, I could buy close to the top AND get hit with a large tax bill. Note to self, don’t do this.

For younger individuals such as myself, a little short term volatility will be averaged out over the next thirty years. Thus, the common financial advice is to keep yourself 80% or more in stocks to take advantage of those years of double digit gains in the equity markets.

This is good canned advice for the average person but it lacks the individuality that makes personal finance so personal. What if I am super risk adverse? What if I don’t ever want to see my portfolio or net worth go down? Do I ever have a chance of passing that magical $1,000,000 threshold in retirement?

I will say YES, you can still have a million dollar retirement without ever having to buy a single stock.

All you need is an upper middle class income, a savings account, and time.

If we were able to continue our family’s current average cash savings of $3000/month for the next 35 years and stuff this in a mattress we would have over $1,250,000 to sleep on at retirement.

That my friends is saving for retirement the hard way; the really hard way!

The biggest risk with this approach is the risk of inflation erroding the value of your savings

So, compared to the alternative, It looks like I will be sticking with stocks for my retirement. It’s a lot easier to save $3000/year invested in stocks than $3000/month invested in cash.

In years past when stocks, or real estate were zooming up, all I could do was watch and get a sick feeling in my stomach. It was the feeling you get when you are way behind and you feel like everyone else is just getting further ahead. All I could see were opportunities lost.

This time it is different and I think I know why… This time I am at least investing SOME money in the market.

To me this emphasizes the importance of just starting an IRA or 401K. Even though I have a large amount of debt, some of it at interest rates just over 8%, I have been able to have peace of mind by investing $200/month in my Roth IRA. That is not a lot by most standards and the majority of our savings have been used to start our Emergency fund, but it is enough for me to think that at least I am doing something.

Although I am missing out on maximizing my growth by not investing lump sum, I am also more comfortable that I will not have invested at a peak by investing over time.

So if you have that hollow feeling in your stomach when you watch the evening news, Just Start and I guarantee you will feel better in no time at all.

In a crunch, I did exactly what a large portion of Americans do: I took the easiest possible path and went to a financial planner. My situation is slightly different because I am lucky/unlucky enough to have an uncle who is a financial planner. Since this was a last minute investment and he had offered to help in the past I decided to write him the check and see what he could come up with for me.

Although I wrote the check back in April, until now that money has just been sitting in a money market fund while we worked around our schedules and time zones to get a chance to talk about what he suggested. His solution was this:

split the $4000 up into 4 different $1000 investments; each in a different class to diversify the investment. To do this he suggested class C shares in a World fund, Midcap fund, Large Cap Value fund and a Small Cap fund

This is a perfectly reasonable suggestion and likely the same one I would have gotten from any other financial planner. The problem I had was that I was not overly impressed with how he arrived at his suggestion.

• The first decision he made that caught my eye was the designation of Class C shares. In my limited investing experience I had never used or learned about the different classes of shares because I never thought that I would be investing through a broker. What I learned about class C shares made me question his decision to use Class C shares for my investmet.
  • I learned that class C shares carry the highest annual expenses in lieu of paying a front end or back end load and have a 1% penalty if you pull out within a year
  • they seem to be best if used for diversifying your money in the short term, allowing managers to chase yields without incurring loads as long as the money has been invested for 12 months.
  • Why then am I investing in class C shares when it will be at least 30+ years before I touch this money? The increased yearly expenses are sure to result in lower returns over this period. My impression is that he simply intends to chase yields every year or so without having to pay a load on either end.
• The way he picked which funds to invest in also seemed to be cookbook. He simply had a computer program which sorted out the funds that had the best 3,5,10 year yields in their respective categories. He didn’t seem to be making any long term decisions about which direction he thought the economy was headed, he just knew to split the money up and put it where people have been making money in the past 3, 5, 10 years.
• This form of diversity might not work anymore as we saw at the end of February when almost every asset class took a dip. Currently between my wife and I our retirement is 100% invested in stocks. With any hiccup in the global equity markets, we will likely see some significant loses.

For these reasons I question why we need to use financial planners. Your local financial planner is reading the same magazines, reading the same books, and might not have gone to school any longer that you and I. Should I be paying this guy X% of my assets each year. What value do they add to the equation or are they just yet another layer of middle men making a cut. We will see how he does. If his picks do well does this mean I should move the rest of my investments with him? Only time will tell. I will admit, he has more time than I do.

Some things are easier said than done and people continue to make a good living by reminding us to do the things we already know we should do.

Here is a quick summary of what I have relearned recently:

Smartmoney shows me how to double money in 5 years instead of the normal 10-15. Of course this means being aggressive. They do suggest some realistic steps. They don’t expect us to double our salary or win the Powerball but to instead:

1. Invest in a more aggressive version of the Modern portfolio theory. Use low cost ETF to split your risk between biotechnology, water technology, microchips, small companies and emerging markets.
2. Invest in rental real-estate, a simplified scheme of investing in something small you can manage yourself and take advantage of the preferential tax status of real estate
3. Start a business, not just any business but an Internet business/blog. With the Web’s omnipresence and falling prices the barriers to entry are low but the competition is high so focus on skills an knowledge that give you an edge.
4. Save more and spend less but instead of nickel and diming your way focus on big ticket items, think houses and cars where a 1% change can add up to a significant amount of money.
5. Live a healthy life and save money on doctor visits. There is a known health-wealth correlation some of which is due to the fact that healthy people tend to have better social networks for support and advancement in life.

Nothing earth-shaking but I was surprised to see a financial magazine mention real estate as good investment. It seems that most of the mainstream finance magazines are quick to point out the time and money you have to put into being a landlord and minimize the positives.

Currently for us, the quickest way for us to double our investments will be to keep our saving percentage high. We haven’t set any fixed goals for 2007, but instead make a meaningful effort to save as much of our salary as possible. After this year we should have a better idea of a realistic savings percentage and any changes in net worth we can expect.

I feel really guilty not making the deposit and I will be second guessing myself for quite some time on this decision. Fidelity has me convinced that by not making the investment I am passing up about $43,000 at retirement($86,000 for the both of us).

Fortunately or unfortunately, depending how you look at it I can rationalize that either choice will be a good one. Here are my reasons for settling for 5% interest:

• I only recently put my finances back in order. Less than one year ago I had over $14,000 on my credit cards and was still learning the basics of financial management.
• The money in our savings is our emergency fund to help us in the event of an Emergency! By definition we will not be able to plan for it. If we didn’t have any savings we would risk falling back into credit card debt.
• The estimates that Fidelity gives are always too rosy. They don’t account for expenses, bear markets or other realistic events that I will likely have to face before I retire.
• If I were to pay off the remainder of my credit card debt before the 0% offer expires we wouldn’t have enough to max out the Roth’s anyway.

On can argue that the reasons to invest the money are just as good if not better:

• Time is my enemy right now. Barring any unforeseen changes in my career, I will only have about 4-5 more years to contribute to a Roth before my income exceeds the upper income threshold. A nice problem to have but to be ideally diversified between taxable and nontaxable accounts on the withdrawal end, I need to invest in a Roth while I can.
• With the favorable economic environment we have currently I should be able to earn at least twice the 5% I get from parking my cash in savings by placing it in a low cost index fund held in a Roth.
• This is money I shouldn’t need soon anyway so why not maximize its growth potential. Isn’t that what investing for the long term is about anyway. If there is an emergency I can just use the credit card again and play the rate game for a little longer.

Basically it comes down to risk tolerance and at this time with my finances just getting in order, my tolerance is low even though it should be high. You can thank people like me for keeping the markets from being too rational.

On the bright side, I did set up automatic deposits to maximize my Roth for 2007!

 The recent headlines about the “Dow hitting a six year high” and “Dow sets another record” makes great headlines and a great bottom line at the end of the month.  However,  I instinctively look for news or reports that could cause the economy to slip the other way.  Unfortunately you don’t have to look too far to find someone worried about inflation, oil, war, etc…..

I have definitely not been financial savvy in my life to date so I  don’t have any credibility in this realm, but my question is: How long will the bull run last. It seems like everyone and their brother made 15%+ last year in the stock market and with 2007 off to a good start, this run is starting to get pretty long in the tooth.

Its important for me to remember that even with the Dow at a new high, this doesn’t mean that it cannot go higher for two or more years. If the fundamentals are right then the market should keep on cruising.

Lets look at the supposedly positives driving this market:

• good earnings growth by companies, 2006 was one of the most profitable years
• real estate has not nationally tanked, demonstrating that it is more of a local phenomenon
• low unemployment, lots of low wage jobs out there
• the American consumer has made shopping a habit regardless of the financial’s behind it.
• interest rates are still historically low and there is still tremendous liquidity in the money supply.
• oil prices should gradually fall as more supply comes on-line and we get out of this crazy winter.

These all seem to add up to a pretty rosy picture for this year. As I read somewhere before, if you call bear enough years eventually you will be right but the bulls consistently outnumber the bears.

Why do I bring this up now? The main reason is that for the first time in years I actually have money to invest.  I plan to be more of a dollar cost averaging type of guy this year because the last time I invested in the market lump sum, it quickly turned south. 

Let us all hope that the good headlines keep on coming.  

I was taught that the money you lived on in retirement was the result of the money you saved during your working years. I actually started investing fairly early in life, putting a few thousand dollars from my summer job into a mutual fund in late 90′s. The thought was good but as with most things the devil is in the details.

You can guess the rest of the story, lost most of it with the burst of the dot-com bubble and was left with the $800 or so I have still invested. I have not added to this original investment nor have I managed it. It has sat in the same high expense, poorly managed “aggressive growth” fund that I originally invested in as a reminder of what happens when you don’t do your homework.

Retrospectively I was pretty much set up for failure:

• I was not diversified at all. 100% of my money was in stocks, in a single mutual fund classified as “aggressive growth” (read, lots of Dot-com stocks)

• My costs were too high. The mutual fund I was in had a high expense ratio and on top of that, shortly after the bubble burst I didn’t have enough money to meet the minimum balance so I was being charged a low balance fee.

I was fortunate to be young with only one summer lost and not on the verge of retirement with a lifetime of earnings on the line. I hope to build on this experience as I begin investing for my future once again. I am slightly concerned however because the stock market is again at an all time high. Lets hope history does not repeat itself.

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