Want the Secrets About Money They Don’t Teach In School? « Richie Richer’s Guide To Everything Money (and more…)

Financial Planning, Meet Philosophy

Several years ago, I took an interesting philosophy course. The instructor suggested that in order to become “wise”, we needed to embrace some critical concepts. I’ll call this concepts “The Circles of Knowledge”. The main points go something like this:

• There are things you know you know- I know I know that the earth is round.

• There are things you know you don’t know- I know that I don’t know how to speak French.
• There are many more things you don’t know that you don’t know-I don’t know for example, that left handed people named Skip are five times more likely to have sleep disorders, nor did I know that there was was an organization looking into this phenomena (there isn’t really but you get the point).

• Paradigm Shifts- “There are facts, and people’s interpretation of facts”

What’s Your Money Paradigm?
To further illustrate, consider Steven Covey’s example of  a “Paradigm Shift” from his book “7 Habits of Highly Effective People”. Covey tells a story about an experience he had on a quiet Sunday morning New York subway ride. When a man and his children entered the subway car, the children became loud, rambunctious, and disturbing to everyone in the car. It was obvious that everyone in the car was disturbed by these children, and even more irritating that that the man didn’t seem to want to do anything to attempt to calm his children down. Covey explains to the man that his children were disturbing a lot of people and asked politely to try and control them. The man, seemingly oblivious to the situation replied “Oh, you’re right. I guess I should do something about it. We just came from the hospital where their mother died about an hour ago.”

The moral of this story is, one’s perception and opinion of facts are based on our own interpretation of events, coupled with our common sense, personal experiences, and knowledge of a particular subject (knowledge is a dangerous thing). Our opinion may not always lead us to the correct conclusion. This is the case with money too.

Why do People Make Dumb Mistakes? 

No matter how many times we experience volatility in the markets, people still run for the hills at the first sign of trouble. Even though “buy low, sell high” has been drilled into our heads at nausea, people are still human and will run for the exists when someone yells “fire”. This is human nature. There is an entire field of study in people’s reactions to money called “behavioral finance”. How about another example?

Ever held a stock that kept going down? Remember the Internet bubble? You held on to the stock because you thought it would come back right? The stock was originally $75/share, but now it trades at $10/share. You held on because you think that the real value is $75/share. That’s called “anchoring”. A popular example of this is the price marked on a car at the dealership. You determine how good of a deal you got by how much you were able to knock the salesman down, having never known what the “real value” of the car was. When it comes to the price of the stock, the “real” value is generally determined based on the fundamentals of the company, and comparable investments, not what the price of the stock was in the past. The fact is that the information changed. The price it is, or was, could have been an overreaction or not. The fact that the stock is a fraction of what it once was, likely has nothing to do with the current attractiveness or value of the investment.

So now you still have that stock in your portfolio right? Studies have shown that people have a tendency to hang on to “losers” (perhaps not just investments?) because they are biased toward inaction. If you sell and the stock goes back up, you have made a BAD decision. If you do nothing, your inaction feels less painful somehow even though the results are still just as bad.

Why I’m Here

There are things you think you think you know that you don’t. There are many more areas where you have absolutely no knowledge of something that is important and you never knew about the issue, or how important the issue was to you. I’m here to help educate you about money and understand what’s important from my perspective. Enjoy!

What is the Best Way to Reduce Your Federal Income Tax?

As a CERTIFIED FINANCIAL PLANNER™ , this is a subject that I get asked frequently. There is no one best answer to this question, however there are a number of places you can look to take advantage of tax breaks the government makes available. My first suggestion is “don’t let the tax dog wag the lifestyle tail”.

Before You Start:

• Review your “life plan”

Starting a business is one of the best ways to avoid (not evade) taxes if there is something that you have a genuine passion for. Starting a business is a major undertaking, however if you have interests in certain areas, think along the lines of how you could make a career of it . If you like photography, start a photography business. Fishing, how about a charter? Following your own interests will be your best guide as to the type of business you create.

As an individual, you might say that you earn money, pay taxes, and live on what’s left. A business earns money, takes deductions, then pays taxes on what’s left. Big distinction! The type of business (S corp, C corp, etc.) will dictate the specifics on business tax deductions.

In addition to deductions for running the business, you might be entitled to establish a retirement plan or pension plan for your business. Retirement plans are deducted from your income and are a deduction for the business. Depending on what type of plan you establish, contribution limits for retirement plans range from $44k to almost $200k per year! Deductions for retirement plan contributions could provide a major source of tax savings and be a good step toward securing a better retirement nest egg for yourself.

If starting a business isn’t your cup of tea,  home mortgage interest allows for a hefty deduction. Currently the government allows homeowners to deduct “qualified residence interest” of up to $1,000,000 of “acquisition debt” and up to $100,000 of home equity debt.

The Alternativee Minimum Tax (AMT) has been affecting average taxpayers more and more over the years.  The AMT can severely limit your ability to take certain kinds of deductions and it is important to work with a qualified tax professional or financial planner who can advise you on your individual situation before you implement a new strategy.

Opportunity abounds for people to save money on taxes. The right strategy will depend on your goals, opportunities, and stage of life.

When Will Realtors Start Using Google Earth?

I’m a big fan of Google Earth software. The program allows anyone to add information into the program to show any kind of data and display it within a geographic representation. In the case of Realtors, I think that it would be wonderful to have all of the homes on the Multiple Listing System (MLS)imported into Google Earth. Currently, when I look at homes on the MLS, it only tells me the town and school district that the property is located. As a buyer not familliar with a local area,  this information isn’t meaningful to me. If the property address were loaded into Google Earth, I would be able to see an aerial view of the neighborhood, proximity to highways, parks, or any other geographic feature that would be of interest as a buyer. In addition, a Realtor has the ability to link the placemark in Google Earth to their website, providing more information for a prospective buyer if they wanted it. I know it’s just a matter of time before this concept catches on, however in my opinion, the Realtors or developers who are the “early birds” on this opportunity could have a real technological and marketing lead on the competition.

Account Aggrigation- Quicken, Yodlee, or other?

Technology canbe a wonderful thing. There are more and more ways of aggregating your consumer online billing accounts together, but which one?

I tried Yodlee through Yahoo Finance a while back. I found the program to be quite quirky and not robust enough for my needs. I recall that many of the businesses that I was a customer of were not on their list.

For my personal use, I use Quicken. I think it has more functions and is more widely utilized by financial institutions. As a customer, I like the ability to download their “QFX” file and have it open directly into the Quicken software. In addition, Quicken integrates directly with Turbo Tax making end of year tax preparation easier. While Quicken in my view is far ahead of Yodlee’s capabilities, it takes a significant amount of time to master the capabilities of the program. As a CERTIFIED FINANCIAL PLANNER™, I understand all of the financial concepts in Quicken, but I feel like I need a “Certificate in Quicken Planning” in order to use the thing.

Learning From Warren Buffett-Good For the Heart, Good For The Tax Return

 The Associated Press recently reported that Warren Buffett Wants Charities to Use His Fortune Within 10 Years After His Estate Is Closed.

Warren Buffett is arguably one of the greatest investors of all time. We should all be so fortunate to be in his position. Warren Buffett is not only a smart investor and generous philanthropist, he no doubt has achieved significant tax benefits from his donations.

If I were in his shoes, I would want to create a lasting charitable legacy that carried on after my death. I find no greater satisfaction in knowing that my money went to worthy causes and helped in contributing to make the world a better place.

I’m sure most people who had Warren Buffett’s money would answer the same way. The fact is, people who have significant wealth over the current Unified Credit Amount (for gift and estate tax purposes) are subject to onerous estate taxes (45% Federal, plus any applicable state death taxes) at the time of their death. People in this position who take the time to plan their estates properly, can realize significant tax deductions by making charitable contributions. Vehicles like Charitable Remainder Trusts can provide a tax deduction for the charitable contribution, remove assets from one’s estate so that they are not subject to estate taxes, and provide the donor with an income stream in return for the contribution. In my opinion, these kinds of trusts are particularly useful when one has highly appreciated assets (like real estate or low basis stock positions) which would be subject to capital gains tax if sold outside the protection of a trust of this type. In some cases, the donor can actually wind up with MORE, by actually gifting the asset away! This should not be construed as legal advice (I’m not an attorney and not qualified to give legal advice), but a wake up call to people that if done properly, people can have their cake and eat it too in many cases. When considering a charitable gift of this nature, I would say that it is helpful to determine how much money one needs in order to live the lifestyle they desire, how much estate taxes they could potentially be subject to, what steps could be taken to reduce their taxable estate, and what legacy objectives could be realized as part of this process.

Warren Buffett’s desire to have the charitable organizations spend his assets within 10 years of his death reflect a trend among large donors called “Strategic Philanthropy” where donors want to have more control of what happens to the money that they donate. Realizing that in some cases, only a very small percentage of a donor’s contribution goes to the actual cause intended, many wealthy individuals have opted to create their own private foundations instead. This can allow the donor to take a salary (within limits) from the foundation, employ family members for pay (within limits) and create a lasting legacy that carries on after the donor’s death. People are advised to speak to a qualified estate attorney for legal advice.

In my opinion, the bottom line is that while many people know “giving to charity is good” they don’t know about the financial benefits that can come from “doing good”. I’ll bet Warren knows…

What is your take on the current real estate market? Is it a good time to buy REIT, builders, personal housing, etc?

I think it’s important to preface by saying that there are a number of ways to buy into these kinds of investments. In recent years, more and more investment firms have developed investment products to allow investors to invest in specific sectors of the economy (including the ones mentioned). Some of these include mutual funds, index funds, and exchange traded funds (ETF’s). My answer to you would depend on how you are intending to invest in these areas.

The sectors mentioned have been very hot for some time now. While the Federal Reserve has stopped raising rates (and there is now a strong indication that they may cut rates in the spring), a significant inventory of unsold homes that were purchased by Real Estate speculators could cause the price of homes to continue to decline. On the flip-side, while the Fed has raised rates, prices of home mortgages have been trending down for several months now. While it is difficult to say whether this will continue, I see this trend as a factor that will help to stabilize the housing market. When money becomes cheaper to borrow, this makes homes more affordable. You will find many people who agree that the fevered housing market of the last several years was fueled by falling mortgage rates. In my own opinion, I would not be surprised to see home prices stabilize in 2007 or early 2008. If the scenario were to unfold in this way, one could argue that we were approaching a bottom. It’s also interesting to see that home-builders like Toll Brothers and (symbol TOL) and D.R. Horton (DHI) have seen their stock prices rise as the rates on the 10 year treasury bond have fallen (this is what many mortgages are tied to). This could be another indication that much of the housing bubble has been priced into securities of home-builders.

As mentioned, there a many ways to invest in this area. You could go out and buy a single stock (like a Toll Brothers) or a publicly traded REIT. When investing in in individual stocks, your results are tied not only to the success of the underlying trend, but also to the results of that company. This obviously introduces more risk into the picture. An alternative to buying individual stocks would be to buy a basket of these kinds of companies through a mutual fund, index fund or ETF’s. ETF’s are becoming the rage on wall street due to their tax efficiency, low cost, and liquidity (not all ETF’s are liquid).

Ishares , Powershares, and Wisdomtree  are some of the companies that offer ETF’s in various sectors.