by David John Marotta and Beth Anderson Nedelisky

Income-shifting is one of several tax planning tools families have used to lower their tax bill. Historically, parents could save a bundle by transferring highly appreciated investments to their children who are in lower tax brackets. However, this year, Congress has made income-shifting a dream of the past, trapping more kids in the dreaded "kiddie tax." Beginning January 1, 2008, children under 24 will owe taxes on unearned income at their parents' higher tax rates.

The "kiddie tax," or so it has been affectionately named, is a tax on children's unearned investment income or capital gains. Instead of taxing income and capital gains based on the child's tax bracket, the kiddie tax requires unearned income to be taxed at the parents' income and capital gains rates.

Before the expansion of the kiddie tax, parents turned to Uniform Transfer to Minors Accounts (UTMAs) or Uniform Gift to Minors Accounts (UGMAs) to move appreciated investments out of their estate. Once in the child's name, the assets were taxable at the child's - typically much lower - tax rates.

Shifting appreciated assets to a child could save a family 10% in capital gains taxes. Since most children earn little income, they usually fall into the lowest marginal tax brackets of 10% or 15%. Capital gains in these lowest two brackets are taxed at just 5%, compared to the typical 15% rate paid by many parents.

Savings could be even greater on short-term gains and investment income which are taxable at ordinary income tax rates. A child in the 10% bracket would pay 10% tax, instead of rates as high as 35% if mom and dad own the asset. 

A once-in-a-lifetime kiddie tax loophole made intergenerational transfers even more appealing. In 2008, 2009, and 2010, capital gains rates are set to drop from 5% to 0% for individuals in 10% and 15% tax brackets. In other words, before the recent changes to the kiddie tax law, children 18 and over in the lowest two tax brackets could expect to pay no capital gains taxes in the next three years.

The new kiddie tax rule closes this loophole forever. If you were waiting for the days of 0% capital gains tax, you can kiss that dream good-bye.

Through 2005, the kiddie tax was limited to kids under 14. Last year, Congress cast the tax net wider, requiring children under age 18 to pay the kiddie tax. And this year, with the passage of the Small Business and Work Opportunity Tax Act of 2007, children under 19, or full-time students up to 24, will be subject to the kiddie tax. The good news is the new kiddie tax law doesn't take effect until January 1, 2008. If your child is between the ages of 18 to 23 this year you can still realize gains at your child's lower rate, if you act now.

After January 1st, children under 19, or full-time students under 24 will be stuck paying income and capital gains at their parents' tax rates. The kiddie tax applies as follows: No tax on the first $850 of earnings. Income between $851 and $1,700 is taxed at your child's tax rate. Any unearned income over $1,700 is taxable at the parents' marginal tax rate. However, children who provide for more than half of their own support will not be subject to the new law.

The expanded kiddie tax law now makes UGMA and UTMA a poor choice for college savings. Instead, 529 college savings accounts provide tax-free growth on contributions, allowing families to reduce their exposure to income and capital gains taxes. Qualified expenses such as college tuition, books, room and board can be withdrawn tax-free. And unlike UGMA and UTMA accounts, the college savings accounts are owned by the parent.

For more information about year-end tax planning, you are invited to attend the November NAPFA Consumer Education Foundation presentation. John G. Bowen, CPA, CFP®, AIF®, of Bowen Financial Services, LLC, will be speaking on the topic of year-end tax planning.

The seminar will be held on Saturday, November 10th from 12:00pm to 1:30pm at the Northside Library in the Albemarle Square shopping center. For more information call (434) 244-0000, or send an email to Charlottesville at NAPFAfoundation.org.
To learn more about the NAPFA Foundation visit <a href="http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm" target=_blank>http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm</a>.

All presentations are free and open to the public. You are encouraged to attend and to bring your financial questions.

from http://www.emarotta.com/article.php?ID=254

IRAs Offer Big Tax Savings for Charitable Gifts (2007-10-22)

by David John Marotta and Beth Anderson Nedelisky

For a few more days this year, the tax law will allow you to give to charity directly from your IRA and count that gift toward your required minimum distribution. Giving to charity from your IRA will also provide you with additional tax savings.  But, to qualify, you must make your donations before 2008.

Unlike the typical deduction you may be taking to offset your charitable giving, the Pension Protection Act of 2006 offers you tax savings opportunities which a charitable contribution deduction will not.

The Pension Protection Act provisions allow you to make so called "qualified charitable distributions" from your IRA and to exclude the gift from your gross income. Furthermore, such gifts can be used to fulfill required minimum distributions. But you must give before 2008, when the provision sunsets.

If you are an IRA account owner over 70½, you are required to take withdrawals, known as "required minimum distributions" (RMDs), from your IRA account. You must take your RMD each year, regardless of whether you need the money or not. What's more, IRA withdrawals must be reported as income and are taxed at ordinary income rates. After all, Uncle Sam won't let your money go tax-free forever.

The Pension Protection Act offers a unique tax benefit with these so called, "qualified charitable distributions." Here's how: Gifts you make to charity from your IRA bypass your taxes altogether. Since your gift is not counted as income, it does not increase your adjusted gross income (AGI).

Your adjusted gross income determines your tax bracket and your eligibility for a number of other tax benefits. By reducing this number, you may avoid the phase-out rules which may limit your itemized deductions or personal exemption amounts. You may even be able to drop to a lower income tax bracket.

If your IRA contains both before-tax and after-tax dollars, you can save even more by giving. Qualified charitable distributions made from an IRA containing both before-tax and after-tax dollars are taken from the portion of untaxed dollars. This is a radical departure from the typical IRA model which requires you to withdraw the pre-tax and after-tax dollars proportionately. Under the Act, you'll be able to give away the dollars which carry the highest tax liability. At the end of the day, you'll have a higher percentage of after-tax dollars left in your IRA.

To be considered a "qualified charitable distribution," your donations must meet a few criteria. First, only IRA account holders age 70½ or older are eligible to participate.

Next, your donation must be made directly from your IRA to the charity. Contact your IRA trustee for more instructions on how to initiate the transfer. Any distribution made payable to you won't qualify.

Finally, be sure the receiving organization is a qualified public charity or private foundation which can receive donations. Contributions to donor advised funds aren't considered qualified charitable distributions. And, as with any gift to charity, don't forget to obtain a receipt acknowledging your gift.

Qualified charitable distributions will help to fulfill your annual required minimum distributions. But, your donation can be greater than your required minimum distribution amount. You can exclude up to $100,000 in qualified charitable gifts each year. A gift amount over $100,000 must be recognized as income and deducted according to the standard charitable deduction rules.

Above all, keep in mind that you cannot double-dip and take a deduction for your IRA qualified charitable contribution. No deduction is permitted for charitable distributions which are not recognized as income.

Finally, be sure you act soon. Only contributions made to charity before January 1, 2008 can be characterized as qualified charitable distributions.

Qualified charitable distributions are just one tax planning tool which may save you money. We advise our clients to meet with their tax professional in November or December to review their tax plan before year's end. Tax planning is complex and time consuming. So, make an appointment with your tax professional before the real tax season hits.

For more information about year-end tax planning, you are invited to attend the November NAPFA Consumer Education Foundation presentation. John G. Bowen, CPA, CFP®, AIF®, of Bowen Financial Services, LLC, will be speaking on year-end tax planning.

The seminar will be held on Saturday, November 10th from 12:00pm to 1:30pm at the Northside Library in the Albemarle Square shopping center. For more information call (434) 244-0000, or send an email to Charlottesville at napfafoundation.org. To learn more about the NAPFA Foundation visit <a href="http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm" target=_blank>http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm</a>.

All presentations are free and open to the public. You are encouraged to attend and to bring your financial questions.

from http://www.emarotta.com/article.php?ID=253

Employee Retirement Options - Part 2 (2007-10-15)

by David John Marotta

Most employees have all their retirement eggs in one basket --their employer's retirement plan. The plans usually offer less than two dozen fund choices to cover all your hopes of maintaining your lifestyle, independence, and dignity in your later years. As discussed in the previous article, the more baskets (and eggs) you have, the better. If most of your retirement assets are with your employer, here's how to make the most of what you've got.

First, there are some mistakes to avoid. Probably the most common mistake made by employees is to allocate an equal amount of money to each of the fund choices. Studies have shown that given ten choices, employees tend to put 10% in each choice. Given five choices they put 20% in each choice. If four of the choices represent one type of asset and the fifth is unique the asset allocation is split 80/20. If the funds happen to be the other way round then the asset allocation is 20/80.

The equal proportions methodology builds very poor portfolios. You can't afford to make these types of mistakes with your future livelihood. The only thing worse than the equal proportions strategy is allocating all of your money to just one fund. You need an investment philosophy that integrates all of your asset holdings. Only then can you evaluate which of your company's fund options are right and determine what percentage to allocate to each.

Many employer sponsored retirement plans are just mediocre. Neither the fund company nor plan provider has much incentive to fill your selections with stellar choices. Plan sponsors have a fiduciary responsibility, but few take that responsibility seriously. Procedures may or may not be in place even to meet minimum guidelines. Still, you should be able to find a few funds worth selecting in order to gain your employer's match.

Your own company or plan provider usually isn't the best place to turn for advice. After all, they are the ones that picked the options in the first place. You should get the outside opinion of a professional financial planner on where to invest.

Another common mistake is to invest in whatever funds have done the best over the past 1, 3, or 5-year period. None of these measures is long enough to produce a balanced asset allocation. Every financial disclaimer states that "past performance is no indication of future returns," and yet, past performance remains the primary selection criteria for many investors. Too many employees pick the asset category that has done the best over the past three years. However, these higher-than-average returns often represent a peak. Going forward, they are the fund choices most likely to under-perform for the next three years.

While three year average returns is a poor way to select a fund, thirty year average returns is a good way to select an asset category for including in your asset allocation. If small cap value is a good asset category to include for the long term, see if your plan includes any small value funds. Then judge them against other outside funds within their asset class and not against other funds within your plan.

You should be looking for funds which are the best funds within their asset class regardless of how well the asset class has done over the short term of just the last few years. Funds that are the best in their category can often be found through index funds that have very low expense ratios.

Remember also that you are looking for a team of funds and not just a few hot shots. Your retirement portfolio consists of more than just your employer's plan. Even if your employer's plan only has a couple of good choices, you can use your other investments to create a balanced asset allocation. While the choices in your employer's plan may be limited, investments in your IRA or taxable account will have an unlimited number of choices from which to craft a balanced allocation.

It is important to start with an over all asset allocation plan and then see what asset classes your employer's plan offers that would integrate well with your investment philosophy. Since your employer's plan usually has the most limited number of choices, pick the best it has to offer that fits with in your over all plan.

The NAPFA Consumer Education Foundation is holding a free seminar on how to build a well diversified retirement portfolio using your employer's retirement plan choices. I will be presenting how to build retirement portfolios using the choices available at the University of Virginia. The talk will be held on Saturday, October 20th from noon to 2pm at the Northside Library. For more information call (434) 244-0000, or send an email to <script language="JavaScript">eval(unescape('%64%6F%63%75%6D%65%6E%74%2E%77%72%69%74%65%28%27%3C%61%20%68%72%65%66%3D%22%6D%61%69%6C%74%6F%3A%63%68%61%72%6C%6F%74%74%65%73%76%69%6C%6C%65%40%6E%61%70%66%61%66%6F%75%6E%64%61%74%69%6F%6E%2E%6F%72%67%22%3E%63%68%61%72%6C%6F%74%74%65%73%76%69%6C%6C%65%40%6E%61%70%66%61%66%6F%75%6E%64%61%74%69%6F%6E%2E%6F%72%67%3C%2F%61%3E%27%29'))</script>. To learn more about the NAPFA Foundation visit <a href="http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm" target=_blank>http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm</a>.

from http://www.emarotta.com/article.php?ID=252

Employee Retirement Options - Part 1 (2007-10-08)

by David John Marotta

Putting all of your retirement eggs in one basket is easy to carry, but risky. Most workers are putting all their retirement assets in the basket of their employer's retirement plan. They are depending on one employer and two dozen eggs (funds) to hatch and maintain their lifestyle, independence and dignity in their later years. Don't trip.

Just one generation ago employers provided their employees with defined benefit plans for retirement. The employee could plan on a benefit that the employer had contractually promised. The employer was responsible to insure that a defined amount would be payable to each employee when they retired. Such security today is obsolete.

The new model moves the outcome responsibility from the employer to the employee through what are called defined contribution plans. The employer is helping with the input (the contribution), but no longer guaranteeing the output (the benefit).

An employee's retirement income is now contingent on four variables: how much the employee puts in, how much the employer matches, the performance of the underlying funds and of course, time.

In a typical defined contribution plan the employer will match dollar for dollar the first 3% of your salary, and fifty cents per dollar on the next 2% of your salary. That means if you contribute 5% of your salary, your employer will give you an additional 4% of your salary in retirement contributions.

Getting the maximum amount possible of this free money should be your first priority in saving for retirement. Even if your 401k or 403b defined contribution choices are not stellar, you still get an automatic 80% return on your money the very day you contribute. Strangely, many employees neglect to pick up this free money. The 80% automatic return is an offer you should not refuse.

After saving enough to get the full match from your employer, don't necessarily continue to use your employer's plan as your only retirement basket. After getting the full match, we recommend funding your Roth IRA, your spouse's Roth IRA and your taxable account. Only after adequately funding these individual account choices should you consider putting more money into your employer's plan than is necessary to get the full match.

Retirement plans through work are laden with fees and expenses that are not on individual investment accounts. The difference in fees is often 1% or more. The longer you leave your money in a defined contribution plan, the more the excessive fees will erode its value. There are plans so laden with fees that they are not even worth the match. Where the fee differential is 2%, after 30 years the fees will have eaten up the entire 80% match.

In other words, if you had the same amount of money in a traditional IRA account earning 2% more because of lower fees after 30 years you would have 81% more money in your account. For this reason alone, make sure that you don't leave money in an employer's retirement plan any longer than you have to. After terminating employment with one employer you should always roll that money into an individual IRA Rollover account where you can invest with lower fees and better choices.

It is a mistake to move money from a pervious employer's plan into your current employer's plan. This mistake, however, can often be undone. Money that has its source from another employer is usually allowed to be rolled out of an employer's plan and into an IRA Rollover account. If you are in this situation you should see if you can rescue some of your investments from the higher fees and limited choices of your current employer's plan.

There's another important tax reason not to put all of your retirement assets in your employer's plan. If you take a deduction while you are in a low tax bracket and in retirement when you are taking withdrawals you are in a higher tax bracket then your contributions work against you. You would have done better to have put your extra non-match retirement savings into a Roth or taxable account. Your tax rates are likely to be higher during your retirement. Currently, top marginal tax rates are only 35%. Before the Bush tax cuts the top marginal rate was 39.6%. Before the Regan tax cuts the top marginal rate was 70%. Before the Kennedy tax cuts the top marginal rate was 90%. Tax rates are at historic lows.

When you take the money out of an employer's plan or a traditional IRA account you will have to pay taxes at whatever tax rate is currently in effect. And after age 70 ½ you will have to start taking required minimum distributions in order for the government to ensure that they will get their tax. Historically speaking, the odds are your withdrawals during your retirement will be charged at a higher income tax rate than the deduction you received when you put the money in.

It may be better for you to pay your current tax rate and get your money into a Roth IRA where it won't be taxed again or a taxable investment account where the growth is only taxed at capital gains rates.

If you are just starting out in your career you are probably in the lowest tax bracket you will ever be in. Therefore it is more important to carry your retirement savings in more than one basket. Fund your employer's plan with no more than is necessary to get the match and then fund your Roth IRA and build your taxable savings.

The NAPFA Consumer Education Foundation is holding a free seminar on how to build a well diversified retirement portfolio using your employer's retirement plan choices. I will be the speaker this month presenting how to build retirement portfolios using the choices available at the University of Virginia. The talk will be held on Saturday, October 20th from noon to 1:30pm at the Northside Library. For more information call (434) 244-0000, or send an email to Charlottesville@NAPFAFoundation.org. To learn more about the NAPFA Foundation visit <a href="http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm" target=_blank>http://www.napfafoundation.org/NAPFAfoundation_Charlottesville.htm</a>.

from http://www.emarotta.com/article.php?ID=251

by David John Marotta

Not all deductions are created equal. Some deductions are more valuable than others. What matters is whether or not the deduction is "above the line" or "below the line". The line in this case is your adjusted gross income (AGI).

Above the line deductions are subtracted from your gross income in order to compute your AGI. Therefore, above the line deductions reduce your AGI which also reduces your taxable income. Reducing your AGI can lower many subsequent calculations which will lower other taxes you may have to pay. As a result, above the line deductions are more advantageous than those taken below the line. They are like Dorothy's ruby slippers, once you have them on the Wicked Witch of Taxland can't touch you.

Below the line deductions are more uncertain. Like many items in the tax code the correct answer to "Will they reduce my taxes?" is: "It depends." They are like Dorothy's first encounter with the Wizard. He promises to grant her requests if she would only bring him the witch's broomstick and she never thinks to challenge the man behind the curtain.

AGI minus your personal exemptions and deductions equals your taxable income. You can claim a personal exemption for you, your spouse, and your dependents. In 2007, you can reduce your AGI by $3,400 for each exemption you claim. These exemptions are subject to phase outs above $234,600 for joint filers ($156,400 for singles).

Below the line deductions are subtracted from your AGI to compute your taxable income. You can either itemize your deductions or you can take a standard deduction, whichever is greater. In order to gain from itemizing, your itemized deductions must exceed your standard deduction. Nearly two out of three taxpayers do not gain and choose to take the standard deduction instead.

Your standard deduction is a fixed dollar amount based on your filing status plus some specific adjustments. For 2007, your standard deductions is $5,350 if you are single, $7,850 if you are the head of household, or $10,700 if you are married filing jointly. You can take an additional standard deduction of up to $1,050 if you are age 65 or older.

Home ownership is the most common way to boost your deductions above the standard deduction. The IRS allows home owners to deduct their interest payments each year. If your home mortgage is at 6% and your payments are mostly interest, then most of your mortgage is tax deductible. If your marginal tax rate is near one third, the government is paying 2% of your interest, and you are only paying 4% of your interest. For most middle class families that results in a huge tax savings.

The benefits of a mortgage are greater when the majority of your payment is interest, not principle. There is no tax deduction for payment of principle. Therefore, you want as many years of interest payments as possible. As a result, 30-year mortgages have much greater tax savings than 15-year mortgages.

When it comes to maximizing your deductions, home owners can also deduct real estate taxes and points paid down on the loan. The cost of the points can be deducted over the price of the loan. So, If you paid $3,600 in points for a 30 year mortgage you can write off $10 a month, or $120 each year. If 10 years into the loan you refinance again, all the remaining points that haven't yet been deducted are deductible in the year you refinance anew. In our example that would be $2,400.

If home ownership alone doesn't make itemizing worthwhile, your state and local taxes (including personal property taxes) along with any charitable deductions may push you over the top. Alternately, if you have high medical expenses which exceed 7.5% of your AGI, you can deduct them as well.

Once you have ensured that your itemized deductions are over your standard deduction there are several smaller deductions that can increase your tax savings.

Miscellaneous itemized expenses can be deducted only when their total exceeds 2% of your AGI. For most people, their deductions are too low or their AGI is too high. But, if your income drops for a year, or you retire, you may qualify.

Deducting miscellaneous expenses is difficult unless you keep good records throughout the year. Qualifying expenses may include work related expenses, legal or accounting fees related to tax preparation, investment advisory fees, estate planning and investment expenses including your safety deposit box, professional dues, and newspaper subscriptions.

Overall, keeping good records is vital to determining whether you can itemize your deductions come tax time. Itemizing your deductions may provide you with some additional tax savings. With an overflowing bucket of deductions and exemptions, your tax burden will soon be melting.

from http://www.emarotta.com/article.php?ID=250

Dorothy in Taxland - Tax on Marriage (2007-09-17)

by David John Marotta

Few Americans look forward to the idea of filing taxes. At best we feel like Dorothy being dropped into the Land of Oz. At worst, we feel like the Wicked Witch of the East having the house dropped on us.

As Glinda advises us, "It's always best to start at the beginning," and at the beginning of the tax return is determining your filing status. You would think that this is an easy and straight forward question. But since this is the beginning of dangerous journey on the yellow brick road, it is worth understanding the inequities that this section of the code causes.

Two different people with the exact same income and the exact same deductions can end up with very different amounts of tax owed, simply because of their filing status. Married couples -rich and poor alike- often bear the brunt of the inequities created by our current tax system

Every tax system does a certain amount of harm. The more progressive the tax system, the more devastating the unintended consequences. No marriage-neutral tax system can exist given a progressive taxation system.

Most people wrongly assume that the marriage tax penalty was eliminated by some of the tax changes that were enacted and gradually implemented over the past several years. The marriage tax penalty was eliminated in the 10% and 15% brackets by increasing the number of married couples who get special tax breaks.

Let's look at some examples.

Michael and James work in the same business. Each makes the same salary and takes the same deductions. The only difference is that Michael's wife stays home, while James's wife works at the firm.

In this case, the tax code gives Michael and his wife a tax break. Michael gets the benefit of claiming two personal exemptions (one for himself and one for his wife). The tax code favors these provider/dependent marriages like Michael's. They are better off filing jointly since Michael's wife - who is not earning any income - can't put her personal exemption to good use. But by filing jointly, Michael and his wife can use both personal exemptions, thus lowering the taxes on Michael's earnings.

However, James and his wife find themselves paying significantly more tax simply because they are married filing jointly.

If James and his wife are both low-income their filing status will dramatically change their tax status. A low income couple who marries and combines their income can forfeit other programs designed to help the truly needed. The most important of these programs is the Earned Income Tax Credit (EITC).

For 2007, a couple's income must be under $39,783 in order to qualify for EITC, while filing single or head of household must be under $37,783. Imagine a couple where each makes about $20,000 a year and you can see their dilemma.

EITC isn't small change either. In fact it is a much better way of targeting poor working families than raises to the minimum wage. For 2007, the maximum EITC credit is $4,716 which can make a huge difference in a struggling family.

The marriage penalty remains even if James and his wife are well-off. They are taxed as though they represent one very high income taxpayer and must pay more than they would if they were unmarried and just living together.

Most likely, neither Michael nor James will let the tax code determine if they should get married. But you can bet that Michael's wife and James's wife will let the tax code determine how much they are willing to work.

Because James and his wife are taxed at a combined rate, there is very little incentive for James's wife to continue working. Another way to think of it is a tax on families with two earners. In other words, it is a tax on married women whose husband's work, especially on women with high incomes.

James and his wife, by combining their incomes, have pushed each other into the top marginal tax bracket. That means for every dollar that James's wife earns, she is probably taxed at over 50%, including federal, state, and local taxes.

Now compare James's situation with Michael's. If Michael's wife can save a dollar by bargain shopping and preparing homemade meals, they are a dollar richer. James and his wife would have to earn at least two times as much to fare as well. Because of their combined income pushing them into the highest tax brackets, the government will take over half of everything they earn.

They will also have additional expenses as a result of working, and few, if any, of these expenses will reduce their income. Their business clothes, gas, and child care expenses may all have to get paid with after tax dollars making these expenses two times more costly than the income they may generate.

If all of this public policy debate makes your head swim, you are not alone. The bottom line is: The flatter the tax system, the less it matters whether couples combine their incomes or not. If every dollar of income were taxed the same and there were no deductions or credits, it would not matter if James and his wife combined their incomes. The same flat percentage of a combined amount is still the same flat percentage.

Practically speaking, many couples would be better off having either mom or dad stay at home. Having one family member who is working at reducing expenses and improving lifestyle can be the least expensive way to increase family wealth. Saving money by doing more things for yourself is worth two times the income earned by the spouse who winds up in the top brackets. And besides, "There's no place like home."

from http://www.emarotta.com/article.php?ID=249

Dorothy in Taxland: Above the Line Deductions (2007-09-10)

by David John Marotta

Those with wealth look ahead and adjust their affairs according to the tax code. But, most Americans look backward and only hope that Uncle Sam will return some of what they have already paid. Living in the moment and only looking backward is a recipe for paying the most tax at the worst time.

If you are like most Americans, you filed your tax return in mid-April and did not look at any of it during the last four months. The tax preparation which seemed so valuable at the time has faded like Dorothy's memories of Oz when she wakes up back in Kansas.

Many people who use tax computation software don't even understand the changing structure of our country's tax code. You fill in the blanks, press compute, pay the tax, and then forget about the torture until next year.

Into this dark forest of the tax code we throw college students and recent graduates. It is almost a rite of passage, better likened to a fraternity hazing than a step into adulthood. We smile a little when the trees grab the apples out of their hands.

The obfuscation of the tax code helps hide the details. Its Byzantine rules and regulations are carefully crafted to cover up just how much we pay each year. In other words, tax laws are stupid by design. While you are busy trying to translate word problems written in 'Taxglish' you don't realize they are asking all the wrong questions. Like Dorothy in the field of poppies, you can't seem to stay awake long enough to realize the danger.

Still, as long as you are so close to the Emerald City, it would be nice to have Glenda send a rain to help you get inside the city's gates. Similarly, a basic understanding of the specific contours of the stupidity of the tax code can help you avoid meaningless extra payments to the government and keep more of your income.

A professional tax expert can help you get the right deductions, but likely won't motivate you to keep the right records unless you understand the benefit for yourself.

There are three basic ways to reduce your tax burden: above the line deductions, below the line deductions, and credits. Each of these deductions is used in one of the three general formulas on the 1040 tax form. The first formula is: Gross income minus above the line deductions equals your adjusted gross income (AGI).

All deductions are not created equal. Some deductions are more valuable than others. What matters is whether or not the deduction is "above the line" or "below the line". The line in this case is your adjusted grow income (AGI).

Above the line deductions are subtracted from your gross income in order to compute your AGI. Therefore, above the line deductions reduce your AGI which also reduces your taxable income. A lot of calculations and limits are computed from your AGI. So, reducing your AGI can lower many subsequent calculations to lower other taxes you may have to pay. As a result, above the line deductions are more advantageous than those taken "below the line."

Above the line deductions will always lower your taxes. Above the line deductions are rare unless you are self-employed because they are mostly business related expenses. If you are self employed, you should have a lot of above the line deductions you are taking advantage of.

Above the line deductions include everything on Schedule C or F business deductions. If you are not a small business owner, you should consider performing some or all of your work under the umbrella of your own small business. If you run a successful business you will be paid twice what you are currently being paid and find yourself on the yellow brick road of accumulating real wealth. Even if you don't get any more pay, you may find more of your expenses are tax deductible and therefore you will pay less tax.

If you are not a small business owner there are still above the line deductions you can take such as: stock losses up to $3,000, IRA contributions, student loan interest, moving expenses, alimony and several other items.

Payments to your Health Savings Account (HSA) can also be deducted above the line. In 2007 the limit is $5,650 in tax free contributions. One out of every ten patients consumes 69 percent of health care costs. The other nine would benefit from an HSA.

With the savings on your insurance premiums, you should be able to accumulate a sizeable nest egg. And, unlike your traditional health care plan, your HSA funds are not subject to a "use it or lose it" policy. Anything you don't spend one year carries over to the next year. After all, it's your money.

In addition to doctor's visits, hospitalizations, lab tests and the like, an HSA can also pay for prescriptions and some over the counter drugs like aspirin with pre tax dollars. HSA accounts can even pay for vision and dental expenses such as contact solution and teeth cleanings.

Another above the line deduction is specifically designed for teachers. If you are a qualified educator you can deduct $250 for books, supplies and computer equipment you purchase. This deduction has been extended through 2007 as well.

These deductions are like Dorothy's ruby slippers, they are adjustments to your income and once adjusted nothing else in the tax code can touch them. Fund your retirement account, start a health savings account and go into business for yourself to take advantage of these incentives in the tax code.

from http://www.emarotta.com/article.php?ID=248

by David John Marotta

Last week we listed the ways university student are enticed into using credit cards. This week we will examine the economical impact of those initially small and convenient monthly payments.

If your credit card minimum payment was $10 and you repaid it every month for 15 1/2 years with an accruing interest of 15.9%, a $1,000 purchase would end up costing $2,250. Every time you use your credit card to pay for something you risk it being marked up two and a half times the normal sales price. Over time, that $10 T-shirt cost you $22.50!

Whenever you use your credit card, imagine that two and a half times the price of what you are buying will be deducted from your account over the next decade.

Students assume that they can run up a credit card bill because it will be easy to pay it off after they graduate when they get a high paying job. But the larger your debt the longer it takes to pay off that debt using minimum payments. The average student graduates with about $7,000 in credit card debt. They assume that $7,000 will be easily wiped away with their first high paying job.

Being burdened with $7,000 in credit card debt after graduation costs nearly $20,000 and can stretch nearly forty years to erase with minimum payments. Just when you should be saving and investing that $20,000, growing rich or buying your own home you are stuck with unfinished and unneeded college debt.

Whenever you casually reach for your credit card during college, visualize the choice between having the down payment on owning your own home or making that purchase.

Studies have linked accumulating credit card debt to psychological stress that increases the likelihood of dropping out of school and suicide. Students find themselves ill-equipped to handle the anxiety of mounting collection agencies alongside their course of studies.

Studies have also shown that a college degree is worth over a million dollars in increased lifetime earnings. Don't sacrifice the million dollar benefits of an education on the frivolous purchases of a credit card.

Every time you reach for a credit card image that credit card hanging on your wall instead of your diploma. It could cost you a million dollars to frame it.

The years after college and before children are the best time in your life to save. But you lose time and squander your resources if you enter the marketplace with credit card debt.

Your high school and college years are the prime years for funding your Roth IRA. If you use a credit card but don't fully fund your Roth IRA each year you have a credit card problem. Unlike a traditional IRA, you contribute to a Roth IRA after taxes, it grows tax free, and then in retirement you can make tax free withdrawals. Because the money is contributed after taxes, it is best to fund an IRA while you are a poor college student working summers and part time and still in a low tax bracket.

Contributing $2,000 a year to your Roth IRA during high school and college is better than starting to contribute during your first year after college and continuing for the remainder of your life.

Every seven years you wait to fund your Roth IRA you cut in half the standard of living you will have in your retirement. With normal market returns, after seven years of $2,000 a year contributions your Roth IRA will be appreciating at a rate of more than $2,000 a year, without any additional contributions. At normal market rates of return, that $14,000 contribution during high school and college will ultimately grow to more than $2 million dollars by age 67 and more than $4 million dollars by age 73.

Whenever you look at prices in a store or restaurant, imagine taking the decimal out in front of the cents. That is how much tax free income you are losing in retirement by not contributing to your Roth IRA. And by age 85 you could add another zero. The $8.50 lunch costs you $850 at age 63 and $8,500 by age 85.

If you don't think you have any problems with your use of credit cards, but you haven't been saving and fully funding your Roth IRA, you have a problem with your use of credit cards.

Every time you go to use your credit card ask yourself if you've fully funded your Roth IRA for the year. If you haven't, put the credit card right back in your wallet.

All debt is not equal. Credit card debt is bad debt. Student loans are good debt. Good debt is anything that last longer than it does to pay the loan back. Good debt is investing in things that will pay you more money than the debt costs. An education is good debt because it will increase your income, satisfaction in life, and longevity.

Credit card debt is bad debt. Bad debt is anything that you can wear, eat or drink. Always pay cash for these items. If you do, what you wear, eat and drink will be healthier and less expensive. The next time you pull out your credit card for any of these items imagine wearing, eating or drinking $20 dollar bills.

Use these visualization techniques to stem your excessive use of credit. Alternately, just leave your credit card locked in your dorm room. Life's too short to let it get sucked dry by credit cards.

from http://www.emarotta.com/article.php?ID=247

by David John Marotta

Every University student knows they should have a credit card. You have to have a second form of ID on many financial transactions. You have to have one to establish good credit. And, the more you use them, the more you will accrue bonus points toward cash, mileage credits and various "free gifts".  P.T. Barnum said, "There's a sucker born every minute." But it doesn't have to be you.

About half of first year University students have at least one credit card. By the second year they nearly all do. About 60% of them pay off their balance each month. Even the most responsible of these students is succumbing to developing the worst mental rules of thumb on how to think about their finances.

They need to have rules of thumb that are not influenced by Madison Avenue. They need visual images to help them understand what the use of credit does even if they think they are using their credit card responsibly. They need to understand the credit card company's goal of ensnaring them into perpetual servitude.

In most states, eighteen year-olds are eligible for a credit card without parental consent or personal employment. The next generation can't learn to live within their means if parents keep supplementing their means. We don't do our children any favors by intervening and ruining life's lessons.

Emulate the best frugality in your parents. If your dad was the frugal parent, then whenever you go to use that credit card ask, "Would dad think this is a great idea?" If your mom was the frugal parent, then whenever you go to use that credit card ask, "Would mom think this is a great idea?"

Your parents had to learn the lessons of income, debt and savings in order to send you to school. Each generation must learn the lessons of life in the same way that the previous generation did - on their own. Students have to develop their own financial compass.

Targeting university students is a strategic decision for credit card companies. They know students are more likely to exceed their credit limit, make minimum payments and remain loyal to the company that issues them their first card.

Credit card companies attract students with loud music, flashy giveaways and free food. The most typical give away is a free T-shirt. There are at least nine ways that T-shirt could cost you thousands of dollars.

True story. A friend's son filled out a credit card application at a booth outside the stadium at one of the University of Virginia's home games. He was promised a T-shirt in the mail for completing a form. Instead they used all of his credit information to steal his identity and have the credit card sent to another address. Thousands of dollars later he was still trying to clear his name.

When you see those T-shirt offers, imagine they read, "I had my identity stolen and all I got was this lousy T-shirt." But you probably won't get the T-shirt.

Studies have shown that when people use a credit card, they are willing to spend twice as much money as when they use cash. Those same studies show that the biggest savings are enjoyed by a refusal to make small everyday unnecessary purchases. Put those two studies together and you will double your spending and cut your savings in half simply by using a credit card.

That means that you have to imagine that everything you purchase with a credit card costs twice as much. Only if it costs twice as much would you be as hesitant to purchase it as if you had to pay cash.

Although 60% of college student's pay off their balance each month, that leaves 40% who do not. It is relatively easy for a bill to be lost, misplaced or forgotten in the hectic lifestyle of college activities.

If you lack the money to pay cash the credit card is very convenient. The smaller minimum payments are easier to pay than the accrued balance. As a result, it is very easy to get suckered into the pattern of just paying the minimum each month instead of the balance.

Next week we will examine the economics of how students are impacted by these convenient monthly payments.

from http://www.emarotta.com/article.php?ID=246

The Business of Being an Artist - Part 2 (2007-08-20)

by David John Marotta

For those working in the arts, financial planning is artistic freedom. You can be an artist and also eat well if you don't avoid the subject of financial planning all together. After you have your cash flow and career planning in place, you also need to address your insurance and legal concerns.

First, shop smart for health insurance. Consider opening a Health Savings Account. One of the worries when you are self employed is health care, especially the worry of a medical emergency that will swamp your family's finances. If you are in relatively good health and you don't smoke and you don't abuse alcohol or drugs you should lean toward covering your own medical expenses out of pocket and having a very high deductible health insurance in case of an emergency. This is exactly what a Health Savings Account was designed for.

To protect you against catastrophic medical expenses, Health Savings Accounts are coupled with a High Deductible Health Plan (HDHP). However, to qualify as a HDHP, insurance deductibles must be a minimum of $1,050 for individuals and $2,100 for families.

The good news is HSA-eligible HDHP premiums are only a fraction of the cost of a traditional medical insurance plan. A study by the Galen Institute found that the majority of HSA-eligible plan participants pay premiums of less than $100 per month. Try comparing that to the premiums for most insurance plans which average $335 for individuals and $906 for families - per month.

Qualified expenses may also include items which may or may not count toward your deductible. This means that you may be able to use pre-tax money to pay for vision and dental costs like contact solution and teeth cleanings.

The higher your deductible the less expensive the insurance will cost. I recommend you get as high a deductible as you can, probably in excess of $5,000, and put your savings toward building up the balance of your health savings account until it is larger than your deductible. Anything you don't spend one year carries over to the next year. You need medical coverage to protect you and your family in an emergency, and a Health Savings Account is the first place to look.

The next step is to get your documents in order. There are five very important documents to make sure that you have readily accessible. First you need a will so that your partner and children are taken care of in the event of your death. Second, you need a living will so that someone else can make decisions about your life if you can't. Third, you need a power of attorney that authorizes some one to manage your finances if you are sick or disabled. Fourth, you need to compile a directory of basic information for anyone who needs to take over handling your finances in an emergency. And fifth, you need an annual collection of financial statements both for yourself and also for those helping you with financial planning. This collection of documents will help you track your finances.

These yearly financial statements should include a net worth statement, an asset allocation analysis, the cost basis for all taxable investments, the past year's performance, your current income and a copy of the first two pages of your tax return. Pulling these documents together is difficult the first time, but updating them every year thereafter is much easier and will help you visualize your progress.

Also, if you have children you should have some life insurance. Don't hesitate to buy the minimum life insurance you need. I recommend that you buy low cost term life insurance and invest the difference. You should also look at disability insurance and an umbrella policy.

You will need to know some tax basics. You also have to understand when taxes and tax reporting is due. If you have income you must make estimated quarterly tax payments. Our tax code is ridiculous, burdensome, and stupid beyond measure. But it doesn't need to make sense and they will still send you to jail and take away your house for not understanding it.

The IRS also doesn't care if you send them too much money, so you need to understand how to take every possible deduction. Good record keeping is the key, and potentially your weakness.

The artist can take a number of unique tax deductions. Expenses that are tax deductible are those that are 1) incurred in connection with your trade, business, or profession 2) ordinary and necessary and 3) not lavish or extravagant under the circumstances.

You cannot know what qualifies simply from that description. Only by looking at the actual IRS legal cases can you determine what qualifies and what does not. You need a supportive CPA to help you through this process. More than just helping you fill out the forms, they should be proactive in their tax planning and advice.

Life's many and varied financial responsibilities put a lot of stress on all of us, but they are easier for the analytic to address than the artist. Hopefully this two part series has given you some practical advice to begin to manage the financial challenges you are facing. Remember, if you need help, ask. The National Association of Personal Financial Advisors  at <a href="http://www.napfa.org" target=_blank>www.napfa.org</a> is one of many helpful sources of competent fee-only financial advisors.

from http://www.emarotta.com/article.php?ID=245

The Business of Being an Artist - Part 1 (2007-08-13)

by David John Marotta

The image of the starving artist has prevailed too long. At the July 24-29 San Diego Comic-Con there were tens of thousands of people working in the arts. Of the 650 hours of events and presentations, only one hour was devoted to financial planning for artists. Here are the financial essentials that artists avoid at their peril.

Financial planning is simply doing what it takes to give you the where-with-all to do what you want. The first time that financial planning keeps you from making a big mistake, it will have paid for itself ten times over. It is that important. The poorer you are the more you need financial planning. You don't have any margin for mistakes.

Complicating the topic, the artistic temperament tends to avoid the analytical activities required for financial planning. This leads them to make one of these mistakes: avoiding the subject all together, trusting people they shouldn't, or trying to do it themselves. You can be an artist and also eat well. But first you must admit you need help, and find someone trustworthy who will.

For each area you need help, identify who will accomplish the task. When you are just starting out you may have to do some of the financial planning yourself. Family members can also be very helpful. As your artistic time becomes more valuable, it will pay to outsource some of these functions to trustworthy and competent professionals.

Members of the National Association of Personal Financial Advisors (NAPFA) are truly comprehensive and strictly fee only. They sign a fiduciary oath and accept no commissions which helps eliminate many potential conflicts of interest. You can visit www.napfa.org to find a fee-only advisor in your area. A comprehensive financial planner can help you with everything without trying to sell you anything.

This column will describe what you need to do regarding cash flow and career planning. Next week we will describe what you need to do about insurance and legal concerns.

The first step is to keep track of what you spend each year and where the money actually goes. As many artists know, an artist's freedom often lies in being extremely frugal. Some of your expenses will be weekly or monthly, others will be once or twice a year, and some will be tied to a specific artistic project. Plan with a 12 month perspective, handling each of these three categories separately. Job related expenses should be packaged under a corporation and associated with a job budget.

Your day to day financial spending should be approximately 65% of your take home pay. The other 35% should be set aside for longer term savings. Living off 65% of your income may seem extreme, but it allows a family to stay out of debt and spend their money more deliberately to meet the financial goals they value most. Failing to account for the 35% is the greatest cause of financial trouble. Here is where the 35% you don't spend each month will go.

Those who are artistic are sometimes generous to a fault. Until you are running a surplus, just set aside 10% for charities. Another 10% percent should be put toward retirement savings even if the entire amount cannot be tax deferred. This amount should be deducted before you even see your paycheck. This represents 20% of the 35% we are setting aside.

How should your 10% retirement dollars be allocated? Assuming you don't work for a company that matches your 401k contributions, maximize your contributions to a Roth IRA first. Next look at a SEP or Simple IRA for additional retirement savings as part of being self-employed. You can consider an individual 401k if your financial success warrants it.

Next, put at least 5% of everything you make into a taxable savings account. You can make this higher if you can live off less than 65% of your income. Retirement savings is all well and good, but if you are between patrons, you will need some cash to buy food. Taxable savings can serve as an emergency fund, provide a down payment on a home, or be used to expand your current business or get a new venture started.

Of the initial 35%, there is now 10% left. Save this 10% for large unexpected expenses. Families who go into debt usually do so because of unexpected spending on their car, home, or emergency medical bills. The smartest way to go forward financially is to avoid going backwards.

As your business grows, you should probably start a corporation, perhaps more than one. It actually isn't that hard, and there are many more opportunities for financial planning and tax management if you have a corporation. Putting income and artistic expenses under a corporation can allow you to take more deductions and pay less tax.

To progress to the next level, you need to have a plan for maximizing your art making money. Many artists view this as a crass compromise with the prevailing culture when in fact their art is counter-culture, edgy and avant-garde. It doesn't matter. Edgy art can be just as lucrative as pabulum for the masses. You don't necessarily need to change your art; you need to have someone who can make money from whatever your style of art is.

Assuming that you are going to have a career in the arts, you need to have a reasonable and realistic career plan and know what the next step is toward reaching your goals. If you are in the performing arts or in an art that requires a collaborative effort, it is more important to plan the next step of your career. Try contacting people who are doing what you would like to be doing and ask them what intermediate work led them to where they are. If you are producing art, it may be more important to determine the next step in marketing and selling your product. In this case you may find it important to have a business partner whose sole job is selling whatever you produce.

Like all endeavors, the first 20% of the time you can spend on a career path or business plan will reap 80% of the benefits. My advice is not to miss the 80% benefits because you neglected to invest the 20% effort of getting started. If your work at creating one piece of art can be multiplied by using that art on lots of different products the time and effort may well be worth it. To stay productive, update your career or business plan once a year on a weekend retreat.

As your art becomes more successful you need to focus on saving and investing. Artistic windfalls should not be spent on short term increases in your standard of living. A sound savings plan will begin to work for you, providing interest, dividends and capital gains that can make permanent increases in your standard of living. Patience and perseverance with your 5% taxable account and 10% retirement account will reap a lifetime of rewards.

Want to know how to be a financially independent in just 20 years? Save $1,100 a month and invest it in the stock market averaging 11.5%. You'll have a million dollars that could spin off enough income to allow you to do whatever, and eat well. Behind the magic of compound interest though is first and foremost a financial plan that lives off less than you make. The 65/35 formula is a good place to start.

The real lifestyles of rich artists would get very low television ratings. They are frugal to the point of being miserly, but they are also willing to take risks by investing their wealth in the markets, their businesses, and themselves.

Financial stress does not usually enhance creativity in the arts. It is essential for artists who want to gain the freedom to pursue art as their livelihood that they follow the advice in this article. Financially successful artists do what they're good at, follow the 65/35 rule, and secure the analytical help of other financial types to help them along the way.

from http://www.emarotta.com/article.php?ID=244

With Great Characters Come Great Stock Returns (2007-08-06)

by David John Marotta

Last week I attended the San Diego International Comic-Con. The four day event has grown from covering comic books to all things associated with popular culture. But comic books are still at the heart of the convention, and Marvel Comics is still the industry leader.

I've been a Marvel fan since growing up reading the very early years of Spider-man. My earliest issue is The Amazing Spider-man #5 featuring the villain of Doctor Doom. Since then the comic industry has evolved and changed as the average age of fans has gotten steadily older and the stories have gotten steadily more sophisticated. Today the average age of a comic book reader is late thirties and it is the exception, not the rule, for a comic publisher to gear a line of comics toward younger readers.

The Comic-Con boasted over 130,000 in attendance and more than 350 hours of presentations as well as miles of vendors and booths in the convention hall. Imagine putting more than the entire population of Albemarle County into a convention hall.

Stan Lee, the co-creator of most of Marvel's most notable characters, was at the Comic-Con speaking and signing. Stan Lee was Marvel's editor-in-chief from 1941 to 1972 during which time he co-created The Fantastic Four, Spiderman, the Incredible Hulk, Iron Man, Thor, Doctor Strange, Daredevil, the Silver Surfer, and the X-Men. Today, comic fans and non-comic fans alike recognize Stan Lee's face and voice as the embodiment of the comic book super hero.

Currently Marvel Comics has 44% of the comic book market share. DC Comics (Superman, Wonder Woman, and Batman) comes in second with 27%. Dark Horse Comics (Buffy, Hellboy and Star Wars) comes in a distant third with 6.7%. And Image Comics which includes Todd McFarlane Productions (Spawn) and Top Cow Productions have 4.4%.

Much of Marvel's ascension over DC Comics stems from Stan Lee's development of the personal side of super heroes during the 60s and early 70s. Fans felt like they were catching up with old friends and looked forward as much to the soap opera of their comic private lives as the battles of their super powered persona. This paved the way for Marvel to become much more than just a comic book publisher.

Marvel Entertainment, like the Comic-Con, has expanded to include much more than just comics. In fact, Marvel only gets 31% of its revenue from publishing comic books and trade paperbacks, including related advertising revenues. Another 33% is gained from toys and action figures. Marvel's toy line is currently sold exclusively through Hasbro which has benefited that company immensely. Hasbro (HAS) stock is up 77% over the year ending June 30, 2007.

A full 36% of Marvel's revenue is gained from licensing their characters on other products, feature films, television programs and theme parks. This last category of licensing brings in the most revenue and has much less cost associated with it. This is the elusive prize that is gained by developing characters and stories so popular as to develop into a franchise.

Marvel Comics owns over 5,000 characters and franchises them in licensing, entertainment, publishing and toys. They emphasize feature films, DVD/home video, consumer products, video games, action figures and role-playing toys, television and promotions. On the first day of the convention the US Postal Service released their line of Marvel Comics stamps.

Movies based on Marvel characters this year include "Spider-man 3" and "The Fantastic Four: Rise of the Silver Surfer". Planned for 2008 are "Iron Man" and "The Incredible Hulk".

I also met Joe Quesada at the Comic-Con. He is the current editor-in-chief of Marvel. Quesada gained this position in 2000 and took Marvel from its bankruptcy and reorganization in the late 1990s to a revival of the comics of its primary characters. His focus on hiring quality writers and artists helped boost sales that were relying too much on past glories. His leadership must have done something right. Marvel Entertainment (MVL) stock is up 44.6% over the year ending June 30, 2007, and has averaged a 40.2% annual growth rate over the past five years.

Marvel's latest Annual Report has a section entitled "Risk Factors" that highlight the need every artistic endeavor has for a savvy financial, marketing, production and legal team behind them. For example, historically Marvel has not controlled the decision to proceed with the production of films and television programs based on characters that they license to studios, and they have not controlled the timing of the release of those films and programs. As a result, delays and cancellations of movie releases can greatly affect the sale of merchandise related to those characters.

To offset this lack of control Marvel is taking the risk of self producing the next two movies under their own Marvel Studios. Producing their own movies allows them to both control the timing of their release and retain the full benefit from any revenue stream but has the potential to effect the quality of the final product. These decisions are amazingly risky and incredibly important. But then, "With great risk often comes great returns."

from http://www.emarotta.com/article.php?ID=243

Keeping Expenses Low While Building Your Portfolio (2007-07-30)

by David John Marotta

Q: I enjoyed reading about your "Rocks and Sand" technique to keep expense ratios low. I own iShares EAFE (EFA) for my foreign rock. What no-transaction fee foreign mutual fund that tracks the EAFE index do you recommend for monthly deposits until I purchase another "rock?" - Steve

A: The "Rocks and Sand" technique comes from the following analogy: Imaging you have several buckets that represent different asset classes you want to invest in.  Purchasing large rocks costs money (transaction cost), but they have a lower expense ratio after you have purchased them. Since rocks cost money to be broken up, they aren't as cost-efficient when you need to move funds from one bucket to another. Buckets can be filled in with sand with a higher expense ratio, but it doesn't cost any money to move sand from one bucket to another.

The transaction cost of building a portfolio of ETF "Rocks" is more than compensated by the fact that ETFs have lower expense ratios. IShares MSCI EAFE (EFA) is the most popular ETF for foreign stock investing. Its expense ratio is only 0.35%, an entire percentage less than the typical foreign stock funds. Lower expense ratios are saved every year, while transaction costs are only incurred in the year the investment is purchased or sold.

To reap the benefits of monthly additional investments and lower expense ratios, we use a combination of ETFs and no-transaction fee mutual funds. We invest large amounts in ETF shares that provide the rough asset allocation "Rocks" we are seeking to save on expense costs. These positions aren't bought and sold to take advantage of lower expense ratios without incurring transaction costs. Smaller monthly amounts are invested in no-transaction fee no-load mutual funds on a regular basis, like "sand" filling in around the "Rocks". These funds have slightly higher expense ratios, but the amounts are small compared to ETFs, so the overall portfolio expenses remain small.

Then, when a significant amount of "sand" dollars collect in the mutual fund of one asset class, that fund is sold and a lower expenses ratio ETF "Rock" is purchased in its place. Conversely, if an asset class needs to be reduced, some of the ETF is sold and the smaller portion of the proceeds is reinvested in a similar mutual fund.

The lowest cost method for keeping an asset allocation model balanced is to buy mostly rocks for each of the buckets of a diversified portfolio, and then add the sand of a no-transaction-fee mutual fund into the bucket that needs rebalancing. Whenever too much sand has accumulated in one of our 6 buckets, we sell the sand and replace it with another rock. If the weight of the rock(s) in one bucket gets to be too much, we sell a piece of rock and replace it with some sand which can be easily moved into one of the other buckets.

This "rocks and sand" technique can enhance your portfolio returns by as much as a full percent each year. This is especially true for portfolios between $500,000 and $1 million. There are even more powerful techniques that can be used for amounts in excess of $1 million. For large accounts, engaging a Fee-Only financial planner often pays for itself in lower expense ratios alone.

An analysis of efficient markets suggests that even a random collection of individual stocks can provide an adequate approximation of an index. If a random collection of stock can approximate the index, then stocks in a mutual fund can do the same. For our sand and in small accounts we will sometimes use the following funds: Artisan International Value (ARTKX) up 23.77% over the last year, Artisan International (ARTIX) up 26.75%, Artisan International Small Cap (ARTJX) up 37.13%, and Excelsior Emerging (UMEMX) up 40.54%.

Some of the funds we use may be closed to the average investor and available only to institutional investors. But you should be able to substitute other funds with good characteristic for the sand in your portfolio.

While the EAFE index returned 27.00%, the iShares EAFE exchanged traded fund returned 26.85%. Some years the actively managed funds we use as sand will beat the index funds and some years they will fall short. So long as you evaluate the funds you use carefully I would not worry if they are index funds or actively managed. The amounts you are investing in sand are small compared to the amount you have invested in the rocks of index funds. So long as your sand is in the ball park, they can provide a good holding place until you get enough assets to justify purchasing a larger rock.

Sand also doesn't need to be in exactly the same index as your rock. Sand can also be used to further diversify your portfolio. Perhaps you are only purchasing rocks in the EAFE Index. You can use the sand of a no-transaction fee index or actively managed fund to add emerging markets, foreign value or foreign small cap to increase your diversification and boost your returns while waiting to buy another rock. So you can be less concerned about finding no-transaction fee mutual funds that exactly track you exchange traded funds and focus instead on selecting the best funds in the general category.

from http://www.emarotta.com/article.php?ID=242

Blending Index Funds to Achieve Higher Returns (2007-07-23)

by David John Marotta

If you have been following my investment advice closely, you can probably guess that I don't favor stock-picking as the best way to meet your financial goals. But even if you favor index funds, as I do, that doesn't mean you have to use them exclusively.

You have probably heard the statistic that most actively managed funds fail to beat their indexes. Here's why. Most mutual funds are laden with loads, fees and expenses. It is nearly impossible to recover from the drag of high expenses. This is why most mutual funds have to be sold by mutual fund salesman. They could never compete when there are funds that are just as good with half the expenses. Most funds have no hope to beat their indexes because they are gouging their investors. But be aware, there are even index funds with high fees.

But, if most actively managed funds fail to beat their index, nearly all 100% of index funds fail to beat their index. Even if an index fund tracks their index perfectly, they too have expenses and even if their expenses are as low as 0.2% then they will still under-perform the index by 0.2%.

Even if you are a die-hard believer in the efficient market hypothesis, that doesn't mean you have to invest only in index funds. If the efficient market hypothesis is correct, then you won't do any worse (on average) with a random collection of stocks within an index than you will by holding the index. If stock picking doesn't matter, then you are free to pick any collection of stocks within the index that vaguely represents the index.

Some index funds perform poorly against the index not because they have high fees, but because they are trying to track the index too closely. When a stock is added to S&P 500, millions of dollars invested in S&P 500 Index funds must all buy that stock in order to track the index exactly. Stocks added to the S&P 500 do very poorly the year after this surge of automated buying. Funds that delay purchasing these stocks can perform better than those who purchase them immediately and pay a premium. Similarly, stocks that are being removed from the S&P 500 will out perform the index over the next year because all the index funds dumping the stock drive the price down needlessly. Delaying the sale of this stock until it has had a chance to recover produces superior returns.

In fairness, there are a few index funds which use these actively managed techniques to purposefully not track the index as closely as they could in order to try to beat their index. Vanguard 500 Index Fund (VFINX) uses some of these trading techniques and has beaten the S&P 500 Index over the past 3, 5, and 10 years. This past year, though, they under-performed the S&P 500 Index by 0.18%, which it just so happens is exactly their expense ratio.

Even if you believe in the efficient market hypothesis and investing in indexes, you have to ask the question "Which index?" Take for example the allocation you invest in foreign stocks. The EAFE Index is a cap-weighted index of a collection of countries that are in Europe, Australia, and the Far East, hence the initials EAFE. EAFE had a return of 27.00% over the year July 2006 through June 2007. The EAFE Index is split into EAFE Value and EAFE Growth. On average Value produces higher returns than growth, so you may want to buy some EAFE Value to provide this emphasis. Over the past year EAFE Value had a return of 28.65% vs. 27.00% for EAFE. EAFE Growth only returned 25.29% over this same time.

If you want to tilt your EAFE investment toward value, you would still want to invest the majority of your investments in the index and then add a portion in value specifically rather than just buying more EAFE Value than EAFE Growth.

The iShares EAFE (EFA) has an expense ratio of only 0.35%, while iShares EAFE Value (EFV) or Growth (EFG) have expense ratios of 0.40%. So you can reduce your expenses ratios by investing the bulk in iShares EAFE (EFA) and a portion in iShares EAFE Value (EFV) in order to keep expense ratios lower and still tilt toward value in order to boost your returns on average.

EAFE, however, does not include Canada. Many investors forget or don't know this, so they only invest in the United States and EAFE. A more sophisticated investor would add an appropriate share of Canada, such as iShares Canada (EWC). Canada is a good investment to include in your portfolio. Canada, not China, is America's biggest trading partner. Rich in natural resources, Canada's oil reserves are second only to Saudi Arabia's. In fact, Canada is the largest foreign supplier of energy to the US. Canada's returns over the past year were 28.3% vs. 27.00% for EAFE.

You may also want to invest in the emerging market countries. These are 26 countries of the developing nations that are not part of the EAFE Index but are part of the emerging market EMU Index. This past year the EMU Index had returns of 36.63% vs. 27.00% for EAFE. The iShares has Emerging Market Index exchange traded fund (EEM) provides an easy way to invest in this index. In addition to EAFE, EMU and Canada, those countries with the most economic freedom produce superior returns. We just finished our analysis and found this collection of a dozen countries produced an average return of 34.02% over the last year vs. 27.00% for EAFE. This technique requires another dozen country specific indexes most of which can be purchased through iShares exchange traded funds.

Just as Value indexes do better than Growth indexes, so also Small Cap indexes do better than Large Cap indexes. There currently isn't an iShares for small cap foreign, though this would also boost your returns, if it existed.

So far I have mentioned several indexes you should be investing in to provide the right mix just for your foreign investments. Even if you use all index funds, we recommend blending dozens of them in an asset allocation aimed at reducing risk and increasing returns to best meet your specific financial goals.

Rather than judging a fund solely on whether it is an index fund or not, funds should be judged by a whole set of criteria. Look for funds with low expenses, a broad collection of stocks, superior execution and low turnover.

And also, judge a fund by what index is follows most closely, does it drift outside that index, and what correlation that particular index has with other investments in your portfolio.

Building an asset allocation which is a blend of dozen indexes based on their expected risk, return, and correlation to other investments in the portfolio is what comprises the analytic analysis even for those who believe in mostly efficient markets.

from http://www.emarotta.com/article.php?ID=241

Managing Your Biggest Asset: Your Career (2007-07-16)

by David John Marotta

Your career is your biggest financial asset. Most people determine the value of their work by the dollar amount on their paycheck. However, judging your career based solely on your take-home pay is a short sighted evaluation. Learning to manage the full value of your career will translate into a higher quality of life and a higher net worth.

Two aspects of a career should be evaluated. One is the obvious quantitative measurement of salary and employee benefits. The second is a set of qualitative measurements which are even more important. As you will see, focusing on the qualitative measures is the surest way to maximize your bottom line in the long run.

The quantitative measurements are the easiest to assess but still involve much more than just comparing the base salaries of different career options.

A career's financial value can be determined by computing the net present value of wages and benefits minus the financial cost of the career, which will be explained in a moment. Don't overlook the value of your employee benefits. Employer matching contributions made to a 401k can be considered as valuable as a salary. Other benefits should be evaluated based on their value to you, not simply their cost to your employer.

If you are married with children, and both you and your spouse work, then be sure to account for the added cost of having both parents working. After subtracting child care, work clothes, transportation, prepared foods, and taxes, many two-career families would do just as well without the second career. Reducing household expenses and starting a part-time home business may be a better way to increase the family's bottom line.

The qualitative measurements of a career, although they are more difficult to assess, are even more important in the evaluation.

A job should be evaluated in relation to the new skills you learn and master as part of your employment. One job may pay you more because you are already a master of those skills, but a lesser-paying job may be better for your long-term career because of the skills you will gain.

It is your future skill set that will determine your future compensation. With the increase of project-based employment, longevity and seniority no longer have as much capital. Those who are the most successful at managing their careers are able to work at different jobs to gain the skills needed for each progressive step of their career.

In doing this, they treat their career as their own asset, not that of their employer. By taking ownership of their employment, they accept the fact that they are captains of their own fate. Those who follow this strategy often end up as top executives of large companies or start a business of their own.

A second important consideration is the social connections you will make on the job. Careers are as much about who you know as they are about what you know. No successful person in business functions alone. It is important to respect the value of building and maintaining relationships with other talented professionals as part of your career.

You don't need to be part of the "good ol' boys" club to benefit from a network. Simply knowing who can get a job done properly is a valuable commodity that will pay you back many times over. Every mom with a list of reliable babysitters or competent electricians knows the value of such a network. Just as you would evaluate how much money the company is going to put in your 401k, you should try to determine how much social capital the company will help you build.

Finally, make sure that your job is in harmony with the rest of your life and goals. It does not make any sense to spend the best decades of your life chasing after money so that you can finally do what you really enjoy in retirement. The strange truth is that people who do what they love often make more money that those who are simply after a big paycheck. And if you really love what you do, you'll find you'll never have to "work" a day in your life.

Fitting work into your life often begins by analyzing family constraints. Raising your children isn't worth missing. No matter how much time you spend with them, you blink twice and they are grown. If you are lucky, you will get another chance with your grandchildren, but it's better to not miss a moment with your children the first time around.

Learning to manage your career is every bit as important as learning to manage your money. Doing so will mean you will get to do what you love. And in the long run that should pay big dividends.

from http://www.emarotta.com/article.php?ID=240