Wise Money Decisions

A few weeks ago I wrote about the historical behavior of the stock market during recessions.  The bottom line is that you shouldn’t alter your investing strategy when the financial press starts bellowing that a recession is near. 

A few days ago I came across a recent article by Larry Swedroe on Seeking Alpha that adds some depth to the analysis. 

According to Swedroe there have been 11 recessions lasting an average of 11 months since World War II.  The CNN tool that I pointed to in my earlier article shows 9 recessions.  The discrepancy may be due to covering slightly different time periods (the CNN tool starts at 1950 and Swedroe starts at the end of WW2) or using different definitions for recession.

During the worst of the 11 recessions, the S&P500 lost 17.9%.  During the best recession (or least worst recession) the S&P500 gained 27.6%!  I’d love more recessions like that.

The average S&P500 return during the 11 recessions was 7.1%.  Let’s see, a return of 7.1% over an average 11 month period - hardly something to be afraid of.

Swedroe rightly points out that you wouldn’t want to exit the market even if you could perfectly time the beginning and end of the recession.  After all, what would you invest in during the recession that would beat 7.1%?  Not treasury bills, which averaged 5.1% over the 11 recessions.

Conclusion

By the time a recession begins, the stock market has already priced in the recession.  You would have to exit the market sufficiently ahead of the recession, before the market has priced it in.  And that, my friend, is impossible.  It is already impossible to determine that a recession has begun at a given point in time, but it is even more impossible to make the determination a few weeks or months in advance of the recession!

The Tax Foundation keeps track of how much the average American spends on taxes such as federal and state income taxes, social security, medicare, sales and excise taxes, and property taxes.  Comparing the sum of these various taxes with the average American’s income results in some surprising conclusions.

According to the Tax Foundation the average American will spend 30.8% of his/her income on taxes in 2008.  Yikes. 

To put this in perspective, if you dedicated all of your income starting on January 1 to pay your annual tax burden, you wouldn’t be finished until 113 days later on April 23^rd - “Tax Freedom Day.”  Only after that would you start to make money for yourself. 

There is perhaps some irony that Tax Freedom Day falls so close to April 15^th, the day personal income tax returns are due.

Which Tax is the Largest Culprit?

Income taxes are the largest culprit by far.  Of the 113 days the average American works to pay taxes, income taxes are responsible for 42.  The rest break down as follows:

Federal, state, and local income taxes … 42 days

Social Security and Medicare … 28 days

Sales and excise taxes … 16 days

Corporate income taxes … 13 days

Property taxes … 12 days

Taxes Are More Expensive Than Food, Clothing, and Housing

The Tax Foundation also calculates the number of days the average American works to pay for basic livings costs:

Food … 35 days

Clothing … 13 days

Housing … 60 days

Health and medical care  … 50 days

Notice that taxes cost more than food, clothing, and housing combined.

It’s a Hypothetical Average

Now of course we don’t work the first 113 days of each year to pay taxes.  Instead we pay them a little bit at a time.  But Tax Freedom Day is a useful visualization to help us understand the extent of the tax burden Americans face. 

Tax Freedom Day is calculated using the tax burden of the average American.  Some taxpayers pay a greater percentage of their income and some pay less.  Tax burdens differ because of progressive tax rates, different tax rates for different types of income, and the various deductions and credits that disproportionately affect a taxpayer’s tax burden depending on his circumstances.

The tax laws do not treat all types of income equally.  No matter how much you pay in taxes, it makes a lot of sense to be aware of how different types of income are taxed.  For example, income earned from labor generally is taxed more heavily than income earned from capital.

Conclusion

It’s sobering to realize how many hours I work to pay my taxes each year. 

I can’t control how the government writes the tax laws, but I can utilize those laws to reduce my tax burden as much as possible.  It’s important to take advantage of things like tax-advantaged retirement accounts, tax-favored health insurance, deductions and credits, and the lower tax rate on capital gains. 

To quote the well-known judge Learned Hand in a federal tax case from 1934 (Helvering v. Gregory):

“Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands: Taxes are enforced exactions, not voluntary contributions.”

Yesterday I pointed out that I normally wait to do my taxes until late March or early April in case my stock broker sends me updated information. 

My stock broker must have read my blog because today I opened up the mail and what did I find?  (drum roll…)  An updated statement from my stock broker! 

Once again, I’m glad I waited to do my taxes.  It just goes to show that sometimes it’s better to put off until tomorrow what you can do today.

I love numbers.  I love to tinker with anything that has numbers.  That’s why I can’t wait to start my taxes.  It’s the most wonderful time of the year. 

Most years I would have started by now.  This year I’ve waited a little longer than usual.  Here are the top five reasons I haven’t started my taxes:

REASON #1:  I owe money.  Financially it is advantageous to defer the payment as long as possible.  The latest I can pay without running the risk of penalties or interest is April 15^th - so that’s the day I pay. 

I don’t always wait until April 15^th.  Sometimes I go to the post office on April 14^th to beat the rush.

By the way, if you receive a tax refund you should adjust your withholding.  There is no reason to make an interest-free loan to the federal government.  Same with your state withholding.  Learning how withholding works is a wise money decision.

REASON #2:  I need to contribute the full amount to both my and my wife’s IRA.  I need to round up some money and move it between accounts.  That takes time.

I could file my taxes before I contribute the money.  You are allowed to file your taxes before making the IRA contribution.  As long as you make your IRA contribution by April 15^th, then the IRS doesn’t complain. 

However, if you file your taxes and later decide not to contribute to your IRA, you will need to file an amended return.  Rather than risk an amended return in case I change my mind, I wait to file my return until I’ve done the IRA contribution.

REASON #3:  Last year I did my taxes in January.  Several days later I received a 1099 for a brokerage account that showed numbers different than what I expected.  I had to redo my return. 

Two weeks later I received an amended 1099 showing different numbers.  I had to re-redo my return. 

Even though I love doing my taxes, I wasn’t crazy about doing them three times in one year.  I decided from then on I would wait until March to do my taxes.

You may wonder why the broker was sending me amended 1099 statements after the January 31 deadline.  I found out later it wasn’t anything to do with the broker, but instead was a result of holding some foreign investments.  Foreign companies and funds don’t always follow IRS rules about reporting tax information on a timely basis. 

The last few years I received several amended statements, but I haven’t received any this year.

REASON #4:  I started this blog a few weeks ago.  It takes a tremendous amount of time.  Time I otherwise could spend doing my taxes. 

I think it’s safe to say I’m the only blogger in the world that wishes he could spend a little less time blogging in order to spend a little more time doing taxes.

REASON #5:  Doing my taxes is like a week in Hawaii.  The anticipation is wonderful.  The trip is wonderful.  But it’s a little disappointing after it’s over.  There’s nothing to look forward to until next time.

By waiting to do my taxes, I extend the excitement of the anticipation and defer the disappointment of the aftermath.

Conclusion

There are several reasons I have waited to do my taxes.  Deferral is the main reason.  I defer the payment of any tax as much and as often as I can. 

Deferral only makes sense if you invest the money in the meantime.  If you put the money in a checking account instead of investing it, then there would be very little benefit of deferral.

If you don’t like doing your taxes, then I hope for your sake you finish them quickly (or better yet you’re already done). 

But if you’re crazy like me and you love doing your taxes, I hope you haven’t started yet so you have the whole wonderful process to enjoy.  Have a great couple of weeks before April 15^th!

Back in the good ol’ days I always locked my checked luggage.  I liked knowing my luggage would not be opened without my permission. 

It’s been several years since the rule was changed.  It’s been so long I have no idea where my little Samsonite keys are.

A couple days ago I found out you are allowed to lock your checked luggage as long as you use certain locks approved by the TSA.  I am aware of two companies that make approved locks: Travel Sentry and Safe Skies.  Here is the Travel Sentry mark:

TSA personnel have codes or tools to unlock the locks.  The idea is they see the mark, realize they can open it without breaking it, do their inspection, and lock it back up. 

Has anybody used one of these locks?  Did it work as advertised?

Last week I visited Stockton, California.  I met with a residential broker who covers certain Stockton neighborhoods.  He showed me a map of his areas with each foreclosure indicated by a little circle.  I couldn’t see street names or other features on the map because there were so many circles. 

According to this article from September 2007, Stockton was the foreclosure capital of the country with nearly 4% of homes in foreclosure.  Since then I have heard that Detroit has overtaken Stockton but Stockton remains in a close second place.

More Foreclosures Than Buyers

There are so many foreclosures in some areas around the country that banks can’t find buyers.  According to this article, many foreclosed properties are simply abandoned by the banks.  Apparently the property has lost so much value that it’s more cost effective for the bank to abandon it rather than incur carrying costs and the expense of finding a buyer or auctioning it off.  Amazing.

Foreclosures Are More Than Just a Financial Problem

When a property is abandoned it can create opportunities for drugs, crime, or other problems.  The city is forced to board up or demolish the abandoned properties.  There’s not much worse for a neighborhood’s property values than six boarded up homes on every block.

In Syracuse, New York, vacant homes were sold for $1.  Yes, you read that right - one dollar.  You can either buy a hot dog at the movies or 5 homes in Syracuse.

In Cleveland the mortgage companies are dumping properties through the internet.  Prices are so low that investors are buying anywhere from 15 to 100 at a time.

All told the U.S. homeowner vacancy rate is 2.8%, or about 1 million vacant homes.  Wow.

Know Your Finances

The record number of foreclosures has affected a record number of families.  I hope the affected families will land on their feet and make wise money decisions to be in a position to become homeowners again. 

I suspect that many of the foreclosed owners chose a house based on a broker’s assurance that they could afford a certain monthly mortgage payment.  Then it turned out the broker was too optimistic.  It is unfortunate that some brokers had no qualms about taking advantage of an unsophisticated buyer.

It is a good reminder for all of us to exercise control and responsibility over our finances.  I feel bad for foreclosed homeowners.  At the same time I recognize it was irresponsible to outsource the task of calculating how much house they could afford.  Especially to a broker whose commission was linked to the amount of the mortgage.

The better approach is to determine how much house you can afford, and then talk to the broker. 

I’ve been keeping an eye on mortgage rates to see if I should refinance.  Despite the higher conforming loan limits for Fannie Mae and Freddie Mac, the rates don’t seem to have come down. 

My understanding is that it will take some time before Fannie Mae and Freddie Mac begin to buy mortgage loans with the higher amounts.  If you are planning to refinance a home that falls under the higher threshold, you may wish to wait a few more weeks or months. 

In the meantime keep watching rates.  It makes it easier if you can find a good, easy way to check rates every few weeks. 

A Good Way to Check Rates Without Bothering a Live Person

If you’re like me, you don’t like the idea of constantly bothering a mortgage broker to ask about rates.  So I found another way that doesn’t involve a live person.  I regularly check rates at amerisave.com.  Amerisave is an online mortgage broker.  I used Amerisave when I bought my current home.  For reasons I won’t go into here, Amerisave is different than other mortgage brokers.  Sometime soon I’ll put up a post about the advantages of using Amerisave to obtain a mortgage when buying a home.

I haven’t used Amerisave for a refinance.  I find some parts of the site confusing when looking for refinances, but it’s still a great place to check rates and prices.

Ben Stein writes a column for Yahoo Finance.  I don’t always agree with his advice, but I do like his commitment to low-cost index funds and long-term investing.

In this article on CNN Money, Mr. Stein makes some great points.  When the interviewer asks him about the consequences of an impending recession, Ben says:

“I’m worried that my wife smokes and that I eat too much. I’m worried about al Qaeda and unethical behavior on Wall Street but not about the economy. If there’s a recession, I’d buy stocks. That’s when you make money: when markets are spooked. In fact, I’m buying now.”

Then the interviewer asks him what he’s buying:

“Index funds. Exchange-traded funds, all based on broad domestic and foreign indexes. Trying to pick individual stocks is a trap. I can’t do it. Warren Buffett can, but hardly anyone else can beat the indexes over a long period of time.”

The interviewer asks Ben why he invests if Wall Street manipulates the market:

“Traders can cause short-term volatility. In the long run, the market must revert to a sensible price/earnings multiple.”

Conclusion

Ben’s advice is good.  Buying low expense exchange-traded funds, especially when the market is down, is a solid strategy for most investors. 

By the way, if you don’t know Ben Stein you need to go to Amazon and buy Ferris Bueller’s Day Off (link is to the “Bueller…Bueller…Special Collector’s Edition”). 

Jeremy Siegel is the author of one of my favorite investing books, “Stocks for the Long Run.”  In this 18 minute video he discusses the recent rate cuts, his concern that the Fed isn’t sufficiently concerned about inflation, and the Bear Stearns acquisition. 

If you’re not interested in macroeconomics then the only interesting part will be the Bear Stearns discussion.

The part I found most interesting is the comparison of Bear Stearns and Long Term Capital Management at about the 7 minute point.  Talking about mortgage-backed securities, Siegel says that Bear Stearns:

“Thought this stuff was great, they were buying it all the way down, with leverage…. It looked like a double down strategy on the part of Bear Stearns….

The truth is, had they had the liquidity to hold on, the Bear Stearns positions might have turned out to be very profitable. 

Just like Long Term Capital Management ten years ago, had they been able to hold on, those positions became profitable.” 

For those unfamiliar with the story of Long Term Capital Management, you can read about it here. 

The lesson that I take from both Bear Stearns and Long Term Capital Management is that you need to retain enough liquidity to withstand a temporary drop in your portfolio.  It doesn’t help to be right in the long run if you have to liquidate before you get there. 

Or as the famous quote says, “The market can stay irrational longer than you can stay solvent.”

After the post about the checked baggage limits the question came up whether the proper spelling is ”traveling” with one L or “travelling” with two L’s. 

My spell checker gives two thumbs up to one L and doesn’t like two L’s.  Apparently it comes down to U.S. English vs. rest-of-the-world English. 

From a comment on wordreference.com that I have no reason to doubt:

In American English, in a multisyllabic word with a final consonant directly preceded by a single vowel, that consonant does not get doubled if the stress does not fall on the last syllable.

travel –> traveling (stress falls on the first syllable)
marvel –> marveling (ditto)
transfer –> transfering (ditto)

forbid –> forbidding (doubled because the stress falls on the last syllable)
concur –> concurring (ditto)
defer –> deferring (ditto)

Possible exception:

The spelling “kidnapping” is becoming more and more common even though, according to the rules above, it should technically be “kidnaping.” The reason there is hesitance about this spelling is that it causes a confusion about the pronunciation of the “a” as a long vowel.

When I plugged the above quote into Microsoft Word, Word liked each of the given examples with one exception.  It autocorrects “transfering” to “transferring” with two R’s. 

Ah, beloved English, what would I do without your exceptions to every rule?