Thinking Beyond Numbers

According to Mirriam-Websters.com, frugal means characterized by, or reflecting economy in the use of resources. Frugal comes from the Latin word frux, which interestingly enough can mean both fruits AND success, as in the fruits of my success. In fact, an old Latin phrase ad bonam frugem se recipere, means to improve oneself.  That sounds successful to me.

Creative Commons License photo credit: GViciano

So why the etymology lesson? Because I want to point out the connection between success (frux) and the economic resourcefulness of frugality. Most of us have just lost sight of the beauty of simple living. In fact, there is another Latin word from frux called frugalis, meaning virtuous. This is a philosophy the Puritans subscribed to, living a very simple life which would allow their focus to be more on spirituality, rather than materiality. Get the connection? So why aren’t more of us frugal? Quite simply it is because we’ve been taught to be consumers.

Prior to the 1950s, people understood the idea of frugality. In my short 13 years as a financial advisor I have run across a few frugal types. They may have a net worth of $2.7 million or more, but they look like you and me. The difference is they never bought into the idea of the consumption of “stuff”. (See Annie’s www.thestoryofstuff.com.) When the spending of the government brought the US out of the economic slump left over from the great depression, economists and government officials decided that spending was going to keep this country strong, even if it was at the expense of Americans’ savings. We were going to be a country of consumers.  The rub? The cost of retirement was getting too high. Companies and government got sick of footing the retirement bill for retirees who, with improving health care, were living too long. So what did they do? They shifted the retirement burden to us with 401k and other defined contribution plans. But they never taught us how to save. They’d only taught us how to spend. And the booming stock market of the 80’s and 90’s only hindered our need to save because of their stellar returns, capitulating in 1999 with the technology bubble.

So what do we need to do? We need to learn to save. For further reading on how much we should be saving, read my post How Much Should We Be Saving. In order to get your budget on track, avoid the major pitfalls of spending like constantly driving new cars and refinancing your home every few years. For further reading on car habits and mortgage habits, see Black Hole Car Habits and Mortgage Habits of Millionaires. We need to knuckle down on our spending habits. We can do this using sites like mint.com, wesabi.com, and geezeo.com to track your spending for free.

The good news is that there is some sign that Americans’ are learning to save as the personal savings rate is approaching almost respectable levels (see Bureau of Economic Analysis Personal Savings Rate). But we are far from the 15% to 20% needed to fund most retirements. In order to get there, we’ll need to change our habits from consumption to simple living with good old fashion frugality.

Creative Commons License photo credit: {Guerrilla Futures | Jason Tester}

A Roth IRA allows you to save tax deferred money like a regular IRA, and withdraw money tax free. The catch is that instead of paying taxes when you are retired and withdrawing money, you pay tax before you make your contribution.

Besides tax free withdrawals, one of the best features of a Roth IRA is that there is NO required minimum distribution (RMD) at age 70 ½. This works great for extending the life of your nest egg, which is crucial in down years like 2008, when many IRA owners age 70 ½ would rather let their portfolios recover. Lower IRA values after the 2008 recession is partially why Congress passed a law allowing retirees to skip their required minimum distribution last year.

Because of the benefits, Congress limits those who can have a Roth IRA. If your Modified Adjusted Gross Income (MAGI) is above $120,000 (single) or $176,000 (married), under most circumstances, you cannot benefit from a Roth. If your MAGI is below these figures you can make up to a $5,000 contribution to a Roth in 2010 ($6,000 if you are over age 50).

When does a Roth make sense?

1.    You don’t want to be forced to take required minimum distributions at 70 ½.
2.    You will be in a higher tax bracket during retirement
3.    You think tax rates will increase

There are other times a Roth IRA makes sense, but these are a few of the main reasons. Some other questions you may have are:

· If I make 401k contributions, can I still make Roth contributions? Yes. You can make Roth IRA AND 401k contributions as long as your MAGI is below the limits discussed above.

· How can I get a Roth IRA if my MAGI is too high? In 2010 Congress is giving us a gift. They are allowing anyone with an IRA, regardless of income, to convert to a Roth IRAs. The catch is that you have to pay ordinary income tax on the converted money. Fortunately, the provisions in the law allows you to spread the tax due over your 2011 and 2012 tax bill. For some this may allow you to stay in the same tax bracket, assuming tax brackets aren’t raised.

Example: Jean has $100,000 in her IRA. She is in the 25% tax bracket, but expects to be in the 28% bracket when she retires in 10 years. She is planning on being retired for 30 years. My analysis shows that if she converts now, she’ll owe $25,000 in taxes, but will increase her total value of after tax distributions by $83,622.

This is an overly simplistic example, but it illustrates the point that Roth IRAs can save you money on tax in the long run depending on your situation. You may even be able to convert 401ks or 403bs with past employers to Roth IRAs as long as they are rolled into a traditional IRA and converted to a Roth before the end of the year. Also remember that this analysis is based on variables that may change over time. There is no guarantee you will benefit.

In summary, Roth IRAs are retirement accounts where you pay no income tax on withdrawals. This year, investors who were previously unable to get access to Roth IRAs, have the ability to convert their current IRA to a Roth regardless of income.

Money Shirt Creative Commons License photo credit: Rob Lee

This time of year can mean an influx of stuff and an outflow of dough. One way to counter this is to go through your closet and get rid of all your unwanted clothes. Every year I have a few shirts, sweaters, coats, and other things that I just don’t need anymore. Between my wife and I, this year we had six bags of clothes to donate.

How can you Give, Save, and Simplify your life? Follow these simple steps:

1. Clean Your Closet - Go through your clothes and get rid of the obvious things that you no longer wear. Then go over the things you are keeping for sentimental reasons and ask yourself, would someone else benefit more from this than me?

2. Catalog your items. I use an Excel spread sheet I created a couple years ago. This sheet catalogs your clothes and household items, and assigns them an estimated value based on tax valuations at bankrate.com. You can download your own FREE copy of this excel sheet here.

3. Take a Picture - I usually stack the items together and take a picture for reference. This is followed by good notes at the bottom of the excel sheet. 

4. Give - Give the items to your preferred charity. While I choose Volunteers of America because of how they indirectly helped a friend of mine, my neighbor finds it more convenient to donate to Good Will. You may prefer The Salvation Army. The important part is to find the charity that fits you, and start this new habit.

5. Take Documents to Your Accountant - Give the donations receipt, excel worksheet, and pictures to your accountant for your tax records. For non-cash donations greater than $500, you may need to fill out form 8283 along with your Schedule A. You can download that form from the IRS website at http://www.irs.gov/pub/irs-pdf/f8283.pdf.

It should be noted that in order to get the deduction, you need to itemize your taxes. But even if you don’t’ itemize and get the deductions, it still feels good to Give, and Simplify.

For more on donating items, visit the IRS website Publication 526.

Due to market conditions over the past 18 months, the IRS announced that required minimum distributions (RMD) for 2009 are waived for IRAs and other retirement plans, including Traditional IRAs, SEP, SIMPLE, Inherited IRAs, 401(k), and 403(b)(7).

As a result of the IRS waiver and its late announcement in 2008, the IRS recently issued new guidance for additional relief.  If you are an IRA owner, plan participant, and eligible beneficiary that has already taken a 2009 required minimum distributions, you now have the option to roll 2009 distributions back into the same account or into another tax-deferred retirement account.  You have until November 30, 2009, (already passed) or 60 days from the date the funds were received, whichever is later.  Only one RMD distribution roll-back is allowed.  2008 RMDs were not waived and may not be rolled back, under this new guidance.

Americans are saving more money. The budget deficit will eventually give way to spending cuts or higher taxes; ergo, we need to prepare for a higher tax environment. Below are twelve ways to save money on taxes during a recession:

1. Tax Loss Harvesting – Unfortunately, because of the market decline, we had a lot of losses last year. Fortunately, we captured those losses so that you could use them to offset ordinary income up to $3,000.
2. Pay off Debt – You do not have to pay tax on your savings if you use it to pay down debt. If you save it in CDs or mutual funds you pay tax on gains and interest.
3. Low Turnover - Invest in funds with low turnover and dividends. Exchange traded index funds have extremely low turnover, meaning that they don’t buy and sell within the fund creating capital gains and dividends. Dividend investing may loose its moxy if we see tax rates increase.
4. Take Advantage of Tax Deferral – Use the tax deferral feature of retirement accounts to defer interest on your fixed income or bond investments. By allocating the bond portion of your overall investment plan to your IRAs and 401ks, you defer that interest until retirement.
5. Save in Retirement Accounts – By adding money to your retirement accounts, be it IRA or 401k accounts, you defer income tax on that money until retirement.
6. Use Municipal Money Markets – Sometimes you can’t avoid having some money market positions in a taxable account. If you have large amounts of money in a money market position, like for an emergency fund, put that in a municipal money market to avoid paying state and/or federal income tax on the interest.
7. Take Advantage of Tax Credits – If you are planning on putting savings to good use, add them to your home. Tax credits are available at 30% of the cost up to $1,500 in 2009 and 2010 for existing homes.
8. Review Legal Structure of Your Business – With business evaluations down, this could be a good time to convert to a C-Corp to an S-Corp with low built in gain tax impact. You could also maximize the impact of loss generating businesses. Sole proprietors may wish to change structure for asset protection.
9. Itemize Deductions Every Other Year – For those of you close to the increasing standard deduction, or who don’t have enough to itemize your deductions every year for one reason or another, you can try to double up some payments in some years. For example, pay your winter property taxes a little late (Jan), and make double charity donations in the same year (Jan and Dec) to increase your itemized deductions every other year.
10. Convert IRAs to Roth IRAs – This could lower your overall income tax burden during distribution and reduce your estate tax.
11. Gift at Lower Values – Right now we can transfer funds to our heirs at lower values than we could have in 2007. If these values increase, they increase at your heir’s tax rates, not yours.
12. Have Kids! – This $1,000 credit may not be feasible for all of you, but I thought I’d bring it up because, with a little luck, my wife and I will qualify for this credit before year end. Our next child is due December 26th.

How Much Should You Be Stuffing in the Little Piggy? Creative Commons License photo credit: annia316

Do you ever wonder how much of your income you should be saving? Having recently listened to a Vanguard podcast on “Can thrift make a comeback” and revisiting the classic “The Millionaire Next Door” it occurred to me that many people don’t know how much to save. This is very apparent when we start to look at the Personal Savings Rate in the US.

Prior to the recession, as the market was starting to rise, in 2005 the savings rate actually was negative at one point. This was pretty bad according to the MSNBC.com article U.S. Savings Rte Hits Lowest Level Since 1933. It isn’t until recently that the savings rate has started to rise. Now some ecomonist are saying that the recession recovery might take longer because we are saving too much money! This is odd because the savings rate is only about 5%, which isn’t even close to the amount Thomas J. Stanley and William Danko of The Millionaire Next Door say most affluent households save.

Dr. Stanley says that most millionaires save 15 % to 20% of their income. How do they do it? They play great defense. To put it another way, they are frugal. It all boils down to living below your means. In order to live below your means, you might need to know what your means is to start. That is as simple as grabbing your last tax return. Look at line 22 or total income, and multiply that number by 0.2% or 0.15%. That is how much you should be savings. If you total income is $100,000, you should be savings $15,000 to $20,000.

Creative Commons License photo credit: Jayel Aheram

It is the start of football season. If you are a fan like me, Sundays on the couch with my son and a bowl of chips is just about heaven,.. even if you’re a Detroit Lions fan. This is my rookie year in a Fantasy Football. My league is called TDs and Beers. Not my call. Eight teams, two divisions, sixteen games, and a lot of cyber trash talk.

Immediately prior to our live draft starting, while trash talking about giving my toddler a bath, I couldn’t help noticing the similarities of Fantasy Football and Stock Picking. Allow me to expound.

1. There are rookies and there are veterans.

Obviously I’m a rookie to fantasy football. Picking from my heart and less from my head, I picked 3 Detroit Lions on my team. Conversely, my best friend Joe, who is in over 12 different leagues (8 that his wife knows about), knew everything about every team. He knew the bye weeks, the starters and backups for the Jacksonville Jaguars. Joe had drafting strategies depending on the order that the computer picked him to draft. Wide receiver, wide receiver, running back, quarter back, etc.

Similarly, when investing, you have experts and rookies and strategies based on where you are in your life. You have technical analysis, fundamental analysis, top down analysis, bottom up analysis, sector funds, asset classes, international, domestic, and even socially responsible funds. Maybe football should have a socially responsible team?

2. There are sure bets, and risky bets.

Adrian Petersen is supposed to be the cream of the crop. He led the league last year in rushing yards. If you’re not a football fan that means he’s a good runner. The best pic. “He had one game with over 57 points last year” Joe explains as we talk football over dinner. Adrian Petersen is a sure bet.

In the stock world we also have what some consider sure bets. This reminds me of the Cisco Kid back in the heyday of the internet bubble. Cisco Systems could do no wrong. They were making 100% every day, or so it seemed!  Cisco was a sure bet.

But just like Cisco not being a sure bet after the internet bubble burst, in Fantasy Football there are sure bets that burst. In 2008, Tom Brady, quarterback for the New England Patriots, and 3 time Superbowl champion, went down in the first game with a season ending knee injury. That was one sure bet that crashed and burned. This reminds me of another rule with stocks: Past performance is not indicative of future performance. There are no guarantees when investing in FANTASY FOOTBALLS PLAYERS or THE STOCK MARKET.

3. There is plenty of noise.

No matter where you turn you always have plenty of opinions of who is the best fantasy football picks. MLive, my Lions football watering hole, posts a top 5 fantasy picks weekly it seems. ESPN has internet galaxies devoted to finding the almighty greek gods football champions, complete with up-to-date, play by play, minute to minute stats on ALL the players. We know when Ocho Cinco tweets while catching a ball with one hand and a shoe only half laced up. Seriously, can you get enough sensationalism?

This is exactly like watching Jim Cramer on CNBC. They guy is a entertainer if I’ve every seen one. Jim says buy and millions of investors jump. This is what Carl at the Behavior Gap calls financial pornography coming out our ears. Unfortunately, everybody is a fantasy football expert much like Jim Cramer is an investing guru. (Insert sarcasm here.) So it is hard to tell which source is reliable, and which source is less than reliable. I haven’t found anywhere too reliable in fantasy football.

But investing does have something that fantasy football doesn’t have: Index Funds. Investing in an index fund would be much like picking the whole National Football League as your fantasy team. You may not win the big one with a concentrated holding of the best quarterback, runners and wide receivers, but you are guaranteed to have those top players within your overall portfolio. Just a little something to think about the next time you are playing fantasy football or picking an investment. Go Detroit Lions

Many of us are well aware of the income limitations on Roth IRAs being lifted in 2010. But are you aware that the Exemptions income phase out is also being lifted?

A personal exemption is the amount excluded from taxable income, given to any taxpayer who cannot be claimed by another taxpayer. The Personal Exemptions was initially used to help make sure the poor paid little income taxes. With inflation and increasing incomes, the initial $3,000 exemption, now $3,650, has become less of a player in the tax world. This became even more evident when in 1990, policy makers began phasing out the personal exemption for higher income earners. In 2010, that income limit is being removed entirely, only to return in 2011. What can high income earners do to take advantage of this opportunity?

Have your tax planner run a tax estimate for 2010 to determine how much taxes your are projected to pay. You may pay less if your income is higher, and you have a large family with say, 3 or 4 children to claim. Knowing that your estimates may be less, you can use extra estimate payments towards Roth conversion tax, or lower your estimates on purpose to increase cash flow now.

Remember that the exemption income limitation phase out lift is only in effect for 2010. Once you have run these calculations, you will have a better idea as to what you can expect for your tax bill.

Exemption Source: http://www.taxpolicycenter.org/briefing-book/key-elements/family/exemptions.cfm

Paid For Since 2003.

“A horse is a horse of course of course, unless it’s Mr. Ed.”

Those of us that are old enough to remember Mr. Ed might recall that horses use to be the primary means of transportation. Okay, so maybe I’m not that old. But I do remember watching all those westerns. So what do horses have to do with cars? Not much except somewhere along the way, maybe it was when “horse power” was sexy, cars went from being a means of transportation, to a means of ego gratification. For those of you who are car fanatics, like most of my family are here in Michigan, I’ll tread lightly.

I heard once that the average Joe spends 18% of his entire life’s earning on cars. Between oil, gas, maintenance and repairs, insurance, the actual car’s cost, and interest on the loan used to purchase the car, we’re talking big bucks. If the average Joe makes $62,500 and lives to age 78, that means that from age 16 to 78, Joe is going to spend $697,500 on cars over the course of his lifetime. So how does Joe prevent this net worth black hole from happening?

It has nothing to do with antimatter Dr. Hawking, and something to do with anti-materialism and/or anti-consumerism. This re-appearing money trick requires making cars a means of transportation again, and not ego gratification.

What are some of the things we can do?

1. Buy, don’t lease. Leasing is like renting. A friend of mine from high school is always sporting a new Jeep every 2 or 3 years. Twenty years later and he’s still got a payment of a couple hundred dollars a month. Conversely I know another person not unlike myself that hasn’t had a car payment for over 5 years now. This frees up cash flow and makes it much easier to save money, not unlike the $500 a month I am currently saving. This leads me to point #2:
2. Pay cash, don’t borrow. Most of the millionaire next door types that I run into have no debt. They pay cash for everything. Well they pay credit, collect points, travel extensively, and pay the bill when they return. When the time comes, I’ll pay cash for my next car, unless of course I get 0% financing.
3. Keep your car for as long as the wheels turn. In 1997 Bob Sikorsky said that a family car can last 1.5 million miles, or a lifetime, if maintained properly. The other day my dad said his Buick went haywire. The lights started flashing and he had to pull over. Turns out he turned 250,000 miles.

Follow these three golden rules and what car you buy shouldn’t matter too much. But if you want to be a real type “A” person about it,  there are a couple other things you can do:

1. Perform a cost comparison. Research the real cost to own one car versus another, and compare the life-cycles costs. Pick the car that has good fuel efficiency and low insurance rates. My dad actually chose his car based on how much it was going to cost to insure it.
2. Buy gently used. Because depreciation can accounts for 46% of the cost of a car, buy your car used with up to 35,000 miles on it.
   
3. Negotiate! Not everyone is as savvy as you are about buying cars. They have to have the next best thing and are willing to dump theirs at major losses to get out of their payments.

As a parting thought, do you know what the number one car driven by millionaires is, according to Dr. Thomas Stanley in The Millionaire Next Door? The Ford F150! Not a Cadillac, that was second. Not a Mercedes like I saw so many of in Italy. Not a BMW, nor a Audi. The number one car driven by millionaires was the Ford F150.

The most successful millionaires’ next door that I’ve ran into in my 12 year career as a financial planner have one thing in common with their vehicles. They are paid for.

UK Puts A Stop To Commissions!

The United Kingdom is banning commissions for financial advisors at what will no doubt be one of many ripples felt from the mismanagement of the financial industry around the globe over the past 18 months.  Here are some of my favorite parts:

• Industry professionals say the regulations will help clean up an industry plagued by bribery and corruption for years, the Financial Times reported.
• Financial advisors will have to tell their clients upfront how much the advice will cost, and give them the choice of paying for advice as a fee or having it deducted from their investments.
• “Crucially, the amount the adviser receives for recommending a product will be negotiated with the investor, and not determined by the product provider,” according to the newspaper.

Check out this great read at Financial Planning Magazine.