If you want to feel depressed about the economy and the outlook for the investment markets, there are always pundits and media outlets to oblige you. I'm sure you're still seeing sober forecasts that the world is running out of oil and food, the U.S. economy was still mired in a painful hangover from the recession, that manufacturing jobs are fleeing America in droves, and the federal government is on a fast track to a Greece-like fiscal bankruptcy.
What sane person would invest in a world that is rapidly going to hell in a handbasket?
Before you buy your gun and cabin in the woods, before you stuff gold Krugerrands under the floorboards and a few years worth of canned food and bottled water in the pantry, you might consider some of the facts and figures that we aren't hearing about from the doomsayers.
Let's start with oil--specifically, the oft-quoted prediction that the world has experienced "peak oil," that we are using up our oil reserves, which will trigger a collapse of the global energy economy. Google "peak oil" and you can still read the doomsaying reports. But according to Wikipedia's latest entries, the OPEC countries actually have dramatically MORE reserves today than they did in 1980, and the numbers have been going up year-by-year. In 1980, Saudi Arabia reported 168 billion barrels of reserves, and the assumption was that most of its oil had been found and would be used up within 20 years. After 30 years of pumping oil and selling it to the world, Saudi Arabia is now estimated to have more than 264 billion barrels of oil in the ground. In 1980, Kuwait had an estimated 68 billion barrels of reserves. After thirty years of diligently pumping oil out of the ground, the country now has an estimated 101.5 billion barrels in the ground. Iraq's reserves have grown from 30 billion to 143 billion, the biggest jump of any OPEC nation except Venezuela, which had 19.5 billion barrels of proven reserves in the ground in 1980, and now is estimated to have more than 296 billion.
But the biggest oil and gas story in the world, by far, is the U.S. Fracking technology is controversial, but there is no controversy about its impact on the supply of oil and gas that is flowing into the U.S. economy at an ever-faster rate. In the ten years between 2001 and 2010, recoverable crude oil in the ground has risen from 144 billion barrels in the U.S. to 219 billion, and recoverable natural gas has risen from 1.28 trillion cubit feet to 2.54 trillion.
This impacts the economy in several ways. First, it provides American manufacturers and consumers with a steady supply of reliable, cheap energy. Second, it reduces imports of foreign oil, helping our economy balance its trade deficit. In fact, the U.S. has become one of the world's largest exporters of natural gas.
This leads to another gloom and doom issue: the alleged decline of America's manufacturing industry. One of the untold stories is that the combination of wage increases in China and elsewhere, plus the availability of cheap energy, has made it more attractive for American companies to bring their manufacturing plants back home--and for foreign-based companies to relocate their plants here, convenient to a huge market for the things they manufacture. Economists have even coined a new term for this trend. They call it "reshoring."
Some recent examples: General Electric moved the manufacturing of washing machines, refrigerators and heaters from a China factory to a Kentucky factory that had been rumored to be on the verge of closing. Apple has recently moved the production of its existing Macintosh lines from China to the U.S.
According to the Boston Consulting Group, December 2013 marked the 53rd consecutive month of expansion for U.S. manufacturers--a statistic you will never see in the newspapers. To find out what was going on, the organization surveyed decision makers at larger companies, and found that 48% were either strongly considering relocating manufacturing jobs back to the U.S or had actually done it.
So why is the U.S. still mired in a recessionary economy? Because it isn't. If you look at a graph of the monthly percent changes in the American gross domestic product, you see frightening declines in 2008 and 2009--a drop of 8.3% in the fourth quarter of 2008 alone, when (as you may remember) Wall Street nearly wrecked the global economy. From 2010 forward, however, growth has been steady quarter over quarter, with only a brief decline in 2011 when certain members of Congress decided it might be a good idea to default on America's debt obligations. Last year's growth rate was positive even though the two-week government shutdown cost the economy some $55 billion in lost productivity.
But what does all this matter if the government is on the fast track to bankruptcy?
This may be the most underreported story of all. According to the Congressional Budget Office, our nation's federal deficit shrank 37% in 2013, in part because revenues are up as the economy expands, in part because of the drawdown of U.S. military involvement in Afghanistan, in part because of the automatic spending cuts known as the sequester. Total U.S. government revenue exceeded spending by $53.2 billion last December, compared with a $1.19 trillion deficit in December 2012. In the past two fiscal years, government outlays have dropped from 22% of GDP to 20.8%, and some respected economists are now actually expressing concerns that the deficit is falling too quickly.
If you add all these trends up, our total economic picture is not nearly as gloomy as most people seem to believe. That doesn't, of course, mean that there are no challenges ahead; there are always challenges ahead. It doesn't mean that investments are going to go up; the short-term swings of the investment markets are largely determined by emotions, and few investors have access to the information that you have just read.
But the positive trends might give us hope that, despite all the negative reporting and self-serving forecasts of doom, the American economy is actually moving forward with some confidence. You might not need that refuge in the woods after all.
Sources:
http://en.wikipedia.org/wiki/Oil_reserves
http://oilindependents.org/oil-and-natural-gas-reserves-definitions-matter/
http://www.economist.com/news/special-report/21569570-growing-number-american-companies-are-moving-their-manufacturing-back-united
http://www.questia.com/library/journal/1G1-302110425/u-s-manufacturers-coming-home
http://www.telegraph.co.uk/technology/news/10092271/Forget-China-technology-manufacturing-is-coming-home.html
http://www.ft.com/cms/s/0/e14d6cae-249d-11e3-8905-00144feab7de.html#axzz2tJt3TE82
http://www.tradingeconomics.com/united-states/gdp-growth
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/10/30/congratulations-america-your-deficit-fell-37-percent-in-2013/
http://www.bloomberg.com/news/2014-01-16/shrinking-u-s-budget-deficit-is-credit-positive-moody-s-says.html
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
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Tuesday, February 18, 2014
Wednesday, February 12, 2014
A GUIDE TO 2014 TAX LAW CHANGES (& MORE)
While 2014 has not brought momentous changes to federal tax laws, there are many alterations and COLAs worth noting. In particular, the Affordable Care Act has prompted a few significant changes.
Additionally, a host of tax provisions created during the recession expired at the end of last year. Some were scheduled to sunset at the end of 2012, but were extended. Their reinstatement for 2014 is left to Congress.
The 2013 federal government shutdown affected the start of the 2014 tax season.
* On January 13, the IRS began accepting Form 1120/1120S, Form 1065, and payroll and excise tax returns (Form 720, Form 940, Form 941 and Form 2290) from corporations and partnerships.
* On January 31, the IRS will begin accepting Form 1040 and Form 1041 from individuals, unincorporated small businesses, and estates and trusts.1
A reminder: you should consult with a qualified tax or financial professional before making short-term or long-term changes to your tax or financial strategy.
Tax Changes Related to Health Care Reform
1. U.S. citizens & legal residents will face a tax penalty if they go without health insurance coverage for 2014 (with some exceptions).
This 2014 penalty is minor, and its impact will be felt in 2015.
This year, American citizens and legal U.S. residents who can afford health care coverage but elect not to buy it will be hit with a tax penalty called the individual shared responsibility payment. No one will have to make this payment until April 2015.2
For 2014, the penalty for uninsured adults is $95 per person or 1% of your yearly income, whichever is greater. The penalty for uninsured children in your household is $47.50. The total household penalty is capped at $285 in 2014 (or 300% of the individual adult penalty).2,3
Next year, the adult penalty rises to $325 per person or 2.0% of yearly income; it is supposed to max out at $695/2.5% in 2016.2,3
If you are a very wealthy individual who doesn’t buy health insurance in 2014, you get something of a break when it comes to the percentage-of-income penalty, which is calculated using your modified adjusted gross income (MAGI): the maximum individual penalty cannot surpass the national average annual premium for a bronze plan. That amount will be calculated this year, but will likely be in the vicinity of $4,500-5,000.3
How will the federal government know if you lack health care coverage? You will let them know as you file your federal taxes next year. The plan is for taxpayers to send in a supplemental form with their 1040s, indicating whether or not they were insured for 2014. If you weren’t insured for 2014, the IRS will deduct the penalty amount from your federal tax refund. If you don’t get a federal tax refund for TY 2014, then the IRS will reduce your TY 2015 refund by that amount, or your TY 2016 refund if you don’t get a TY 2015 refund, and so forth.2,3
At this juncture, it appears this is the only way the IRS can assess the penalty. It can’t put a lien on the money to collect payment.4
Could you be exempt from the penalty? To see if you are, visit healthcare.gov/exemptions. The list of exemptions is quite long.2
A reminder: if you are still uninsured and want to buy health insurance for 2014, you must do so before April. March 31 is the deadline for this year’s open enrollment period. If you miss that deadline, you will have to wait until October 7 for the chance to buy coverage.2,4
2. Some enrollees in qualified health plans offered through the Health Insurance Marketplace will get tax credits.
These rules apply to 2014 & subsequent tax years.
If you enroll in a qualified health plan through the federal health insurance exchange or a state health insurance exchange, you might be eligible for the Advance Premium Tax Credit – a credit that can be applied to reduce the cost of monthly health insurance premiums.
You can choose how much of the advance credit payments you want to apply to your premiums per month. If your advance payments for a year exceed the amount of the credit you are given for the year, you are looking at a refund. If they exceed the cost of the premiums, you will have to repay the excess payments made on your behalf when you file your 2014 federal taxes.5
Generally speaking, you qualify for a credit if your household income falls into one of these per-household-size ranges, which were 2013 estimates and may be adjusted slightly north this year:
$11,490-45,960 for individuals
$15,510-62,040 for a family of 2
$19,530-78,120 for a family of 3
$23,550-94,200 for a family of 4
$27,570-110,280 for a family of 5
$31,590-126,360 for a family of 6
$35,610-142,440 for a family of 7
$39,630-158,520 for a family of 8
Consumers learned whether or not they were eligible for a credit at the website of the health insurance exchange applicable to their state (or by speaking to its personnel via phone).5
By the way, if you have enrolled in a qualified health plan through a health insurance exchange, the reimbursement or direct payment of the plan premiums counts as a qualified benefit under a cafeteria plan in 2014 and years that follow.6
3 It is now possible to carry over some FSA funds to the next year.
An exception to the use-it-or-lose-it rule has been created.
If you participate in an employer-sponsored flexible spending account (FSA) plan, you know the drill: use the money in the FSA for qualifying medical expenses by the end of the plan year, because it will be gone next year.
IRS Notice 2013-71 creates a new wrinkle. Employers sponsoring FSA programs may now allow as much as $500 in unused FSA funds to be carried over to a subsequent year by a plan participant. Whatever amount is carried over doesn’t cut into the $2,500 contribution limit for the subsequent year.
Some FSA plans have allowed participants an extra 2½ months after the end of a plan year to spend their FSA money. The new carryover rule renders this “grace period” obsolete.7
4. Large-employer reporting & responsibility requirements of the Affordable Care Act will not take effect until January 1, 2015.
Big businesses & insurers get a 1-year reprieve from these mandates.
Much has been written about this already, but here’s a brief recap. Most large employers with at least 50 full-time employees would have been required to provide basic health care coverage to FTEs or pay penalties starting in 2014, but this requirement has been delayed until January 1, 2015.
There was also an information reporting mandate scheduled for 2014, by which these employers (and by extension, insurers) would have needed to supply details of the coverage to the IRS and individuals. This, too, has been delayed until January 1, 2015.
There was no 1-year postponement of the W-2 reporting requirements linked to the ACA; these are already in effect.7
5. A new excise tax is hitting insurers.
There will almost certainly be consumer impact.
The federal government is now charging health insurance providers an aggregate flat fee each year. The fee – estimated to start at $8 billion for 2014, estimated to climb to $14.3 billion by 2018 – will be broken down per health care provider based on their premium trend. The Congressional Budget Office thinks the tariff will be “largely passed through to consumers in the form of higher premiums,” and larger deductibles may result as well.7,8
6. Owners of MSAs & HSAs should note new deductible and out-of-pocket expenses requirements for qualifying HDHPs.
The adjustments are small, but worth noting.
If you have a Health Savings Account (HSA) or Medical Savings Account (MSA), you must also be enrolled in a high deductible health plan (HDHP). You should be aware of the following requirements with regard to deductible limits on HDHPs this year.9
MSAs Annual Deductible Annual Limit, Out-of Pocket Expenses
Self-only coverage $2,200-$3,250 $4,350
Family coverage $4,350-$6,550 $8,000
HSAs Annual Deductible Annual Limit, Out-of Pocket Expenses
Self-only coverage $1,250 or greater $6,350
Family coverage $2,500 or greater $12,700
Tax Changes Affecting Businesses
7. Section 179 expensing is reduced; bonus depreciation is gone.
Here is why business owners bought more capital equipment before 2013 ended.
In 2014, the Section 179 expense deduction for equipment purchases is capped at just $25,000 of the initial $200,000 of business property put into service this year. The 50% bonus depreciation companies took advantage of in recent years is no more, and the accelerated deduction for qualified real property in the year of purchase is gone too.9,10
8. No more Work Opportunity Tax Credit.
This was an incentive for companies to hire.
The WOTC (and its variants) gave employers a credit for hiring veterans, recipients of supplemental Social Security benefits and Americans receiving select types of government aid. The credit varied per hire, but it was as large as 40% of allowable wages for an employee (25% of allowable wages for employees who had worked less than 400 hours for the business).10
9. Gratuities must now be treated as taxable wages.
Automatic tips may be history at many eateries.
When a large party eats at a restaurant, a gratuity is often built into the check. Prior to 2014, automatic gratuities were classified as tips. In 2012, IRS guidance let the service industry know that would soon change. Beginning this year, automatic gratuities are defined as service charges by the IRS, so they are taxable income. Practically speaking, this means a change for wait staff: instead of getting that money at the end of the night, they will get it as part of their paycheck. Darden Restaurants and Texas Roadhouse are among the players in the dining industry who have eliminated automatic gratuities this year, replacing them with suggested tip amounts on the bill.6,11
10. S-corporation relief has been extended.
The summer 2013 decision applies to many varieties of S corps.
In August, the IRS rolled out Revenue Procedure 2013-30, which unifies late-relief methods for many S-corp, ESBT, QSST, QSub and corporate classification elections. Starting this year, S-corps have up to 3 years and 75 days to request relief for eligible late elections after the intended start date of a late election.7
11. Mass transit & carpool allowances for employees have been roughly halved for 2014.
Other qualified transportation fringe benefit limits remain the same, however.
In 2013, employers could provide up to $245 a month to an employee to subsidize their commutes to work via carpools, vanpools or mass transit, and get a tax deduction as a result. In 2014, the maximum monthly subsidy is $130.
Employers may still offer employees up to $250 a month in qualified parking benefits, and reimburse workers up to $20 per month for qualified bicycle commuting.12
Tax Changes Affecting Individuals & Households
12. Two major mortgage-related tax breaks are gone.
Underwater homeowners could face major tax burdens if they sell.
The twice-extended Mortgage Forgiveness Debt Relief Act of 2007 expired at the end of 2013. It gave struggling homeowners the chance to exclude up to $2 million of forgiven home loan debt from their taxable incomes – a tax break that isn’t normally available for cancelled debts.
Mortgage debts incurred after Jan. 1, 2007 and not after Dec. 31, 2012 were eligible as long as they were secured by the taxpayer's principal residence. Debt reduced because of mortgage restructuring qualified along with forgiven debt from foreclosures and short sales. It was a great tax break, and many are calling for the MFDRA to be restored.10,13
Another housing tax break disappeared in 2014. In 2013, homeowners paying for private mortgage insurance (PMI) who chose to itemize their deductions could write off the cost of PMI premiums plus related interest and taxes. That isn’t possible now.10
13. No more above-the-line tuition & fees deduction.
Students & families lose a prime tax break.
For 2013, an eligible taxpayer could take an above-the-line deduction for qualified educational expenses paid during the tax year. That deduction ranged from $2,000-$4,000. The opportunity is gone in 2014, though the American Opportunity Credit and the Lifetime Learning Credit remain.10,14
14. No more educator expense deduction.
Classroom teachers will miss this one.
Last year, educators employed by eligible primary or secondary institutions could take an above-the-line tax deduction of up to $250 for unreimbursed expenses for school and classroom-related supplies. (The deduction limit was $500 for married taxpayers filing jointly.) In 2014, it is no longer around.10,14
15. Tax-free IRA distributions to 501(c)(3)s are no longer permitted.
Wealthy IRA owners, hospitals, universities & charities are already missing this one.
The IRA charitable rollover was initially set to disappear at the end of 2011, but it was brought back by Congress in both 2012 and 2013. Some legislators called for making it permanent. This year, it is absent. The move allowed IRA owners aged 70½ or older to avoid taxation on as much as $100,000 of their Required Minimum Distributions (RMDs) if the money was transferred directly from the IRA custodian to a qualified non-profit organization.10,14
16. Two major energy-efficient home improvement credits are gone.
One was designed for homeowners, another for contractors & builders.
In 2013, taxpayers who made certain energy-saving improvements to their residences could claim a tax credit of as much as $500 to offset the cost of the upgrades. Contractors could also claim a credit for building energy-efficient homes for their clients (up to $2,000 per home). Neither perk is around for 2014.10,14
17. The electric vehicle credit is now absent.
Will this dent electric & hybrid vehicle sales?
If you bought or leased a plug-in electric car in 2013, you likely knew about the tax credit of up to $7,500 for such vehicles. (The size of the credit depended on make, model and battery pack size.) Taxpayers won’t have this option in 2014.10
18. A big tax break on donated real estate has expired.
The Enhanced Easement Tax Incentive was a boon to conservationist groups.
During the years 2006-13, individual taxpayers that donated real capital gain property or property easements to a qualified conservationist organization could take a resulting deduction as large as 50% of their adjusted gross incomes. (Qualifying farmers and ranchers could deduct up to 100% of their incomes, and S-corps and C-corps could take advantage of the tax break as well.) In addition, donors of such real estate could keep taking the deduction for an additional 15 years, up to the fair market value of the property.
In 2014, the incentive to make such real property donations is less compelling: the deduction a donor can take reverts to 30% of their AGI in the year of the donation, and the carry-forward period reverts to 5 years in addition to the year of donation.10,15
19. Less favorable rules for small business stock gains.
The basic exclusion shrinks.
As a result of the American Taxpayer Relief Act of 2012, any taxpayer besides a corporation could exclude 100% of the gain from the sale or exchange of qualified small business stock acquired between September 27, 2010 and January 1, 2014 and held for more than 5 years. In 2014, the basic exclusion reverts back to 50%; it is 60% in empowerment zones. The gain that is eligible to be taken into account for purposes of this exclusion is limited to the greater of $10,000,000 or 10 times the taxpayer’s basis in the stock (see IRS Sec. 1202(b)(1)). The limitation is computed on a per-issuer basis, with lower limits ($5,000,000) applying to married individuals filing separately.16,22
20. Depreciation caps on “executive” vehicles have diminished.
Businesses with fleets are looking at less of a tax break.
In 2013, a business that put a car, truck or SUV into service could claim $11,160 in depreciation. But, as bonus depreciation is no longer allowed in 2014, the first-year depreciation cap allowed by IRC Section § 280F is now back to $3,160.17,18
21. The standard mileage rate has fallen to $0.56.
The decline is minimal, however.
In 2014, the optional mileage allowance for business use of owned or leased vehicles is $0.56 per mile, down half a cent from 2013.9
COLAs for 2014
22. Income tax brackets receive the usual minor adjustment.
These income thresholds define the 2014 federal income tax brackets.19
Bracket Single Filers Married Filing Jointly Married Filing Head of Household
or Qualifying Survivor Separately
10% Up to $9,075 Up to $18,150 Up to $9,075 Up to $12,950
15% $9,076-$36,900 $18,151-$73,800 $9,076-$36,900 $12,951-$49,400
25% $36,901-$89,350 $73,801-$148,850 $36,901-$74,425 $49,401-$127,550
28% $89,351-$186,350 $148,851-$226,850 $74,426-$113,425 $127,551-$206,600
33% $186,351-$405,100 $226,851-$405,100 $113,426-$202,550 $206,601-$405,100
35% $405,101-$406,750 $405,101-$457,600 $202,551-$228,800 $405,101-$432,200
39.6% $406,751 or more $457,601 or more $228,801 or more $432,201 or more
23. The individual estate tax exemption rises to $5.34 million.
It was $5.25 million in 2013. Any unused portion of the $5.34 million individual exemption may be transferred to a surviving spouse upon the death of the first deceased spouse through a timely filing of IRS Form 706.
In the big picture, the lifetime federal estate tax exemption and the lifetime federal gift tax exemption are unified, so an individual can also elect to use some or all of a $5.25 million individual exemption on gifts made during his or her lifetime (though that will lower the amount of his or her estate that may be excluded from inheritance taxes).
Incidentally, the annual gift tax exclusion amount remains at $14,000 this year.20
24. The standard deduction is slightly greater.
Here are the amounts for 2014.19
Single filers, married filing separately: $6,200 (up $100 from 2013)
Head of household: $9,100 (up $150 from 2013)
Married filing jointly/qualifying survivor: $12,400 (up $200 from 2013)
25. The personal exemption rises by $50.
In 2013, it was $3,900; in 2014, it is $3,950. Here are the 2014 phase-out ranges...19,21
Single filers, married filing separately: $254,200-$376,700
Head of household: $279,650-$402,150
Married filing jointly/qualifying survivor: $305,050-$427,550
26. The AMT exemption amount has risen for 2014.
As the Alternative Minimum Tax was at last indexed for inflation at the start of 2013, exemption amounts are set as follows:
Single filers: $52,800
Married filing separately: $41,050
Married filing jointly/qualifying survivor: $82,100
These amounts are a few hundred dollars higher than in 2013.19,21
27. Social Security’s taxable wage base is $3,300 higher in 2014.
This year, the FICA tax rate is 6.2% on the first $117,000 of wages paid to an employee. So an employee whose 2014 wages total $117,000 will pay $7,254 to Social Security's Old-Age, Survivors, and Disability Insurance (OASDI) program this year with the employer contributing an equivalent amount. (This tax rate is 12.4% for self-employed individuals).22
28. Phase-outs of itemized deductions get a COLA.
The Pease limitations returned in 2013 after a 2-year absence. These are thresholds that cut into the value of most itemized deductions above a certain AGI level. Here is where the Pease limitations are set for 2014.19,21
Single filers: $254,200
Head of household: $279,650
Married filing jointly/qualifying survivor: $305,050
29. Phase-out ranges for the above-the-line student loan interest deduction have been adjusted.
The deduction limit remains at $2,500 this year; the phase-out ranges are $5,000 north of where they were in 2013.17
Single filers, heads of household: $65,000-80,000
Married filing jointly/qualifying survivor: $130,000-160,000
30. Earned Income Tax Credit limits rise.
This tax break is designed to help low-wage filers. The credit varies based on a) your taxable income, b) the number of dependents you support. For 2014, you are eligible to receive it providing your earned income and your AGI each fall below the following limits:
$46,997 ($52,427 married filing jointly) with 3 or more qualifying children
$43,756 ($49,186 married filing jointly) with 2 qualifying children
$38,511 ($43,941 married filing jointly) with 1 qualifying child
$14,590 ($20,020 married filing jointly) with no qualifying children
The corresponding EITC for TY 2014:
$6,143 with 3 or more qualifying children
$5,460 with 2 qualifying children
$3,305 with 1 qualifying child
$496 with no qualifying children
If you have investment income exceeding $3,350 for 2014, you can’t qualify for the EITC.23
31. Some minor COLAs affect traditional & Roth IRA contributions.
While the amount you can contribute to a single traditional or Roth IRA or across multiple IRAs in 2014 is unchanged from last year – $5,500, $6,500 for those 50 and older – some other changes have occurred pertaining to the ability to contribute to a Roth or take a tax deduction from a “regular” IRA.
Phase-out ranges affecting the tax deduction for traditional IRA contributions (AGI).
Single or head of household, contributing to workplace retirement plan & traditional IRA: $60,000-70,000
Married couple both contributing to workplace retirement plan & traditional IRA: $96,000-116,000
Married individual contributing to traditional IRA, spouse in workplace retirement plan: $181,000-191,000
These phase-out ranges are $3,000 higher for investors who don't have a workplace retirement plan but are married to someone who does, and $1,000 higher for the others.24
Phase-out ranges affecting the chance to make a Roth IRA contribution (AGI).
Single or head of household: $114,000-129,000
Married couples: $181,000-191,000
These phase-out ranges have increased by $2,000 for single filers and by $3,000 for couples.24
32. New COLAs pertaining to SEPs, ESOPs, top-heavy plans & defined contribution plans.
Slight 2014 adjustments have been made to some thresholds for these plans.25
SEPs --- Maximum compensation of $260,000 (up $5,000 from 2013)
ESOPs --- 5-year distribution threshold of $1,050,000 (up $15,000 from 2013); Additional year threshold of $210,000 (up $5,000 from 2013)
Top-heavy plans --- $ limit defining key employee rises to $170,000 (up $5,000 from 2013)
415(c)(1)(a) plans --- Maximum annual benefit of $52,000 (up $1,000 from 2013) (defined contribution plans)
33. Saver’s credit thresholds are a bit higher.
The saver’s credit available to IRA and 401(k) account holders whose AGI falls underneath a certain limit, and millions of people claim it each year. It can be as large as $1,000 for single filers and as large as $2,000 for married couples. For 2014, the AGI limits for claiming the saver’s credit are:
Single filers: ≤ $30,000 (up $500 from 2013)
Head of household: ≤ $45,000 (up $750 from 2013)
Married filing jointly/qualifying survivor: ≤ $60,000 (up $1,000 from 2013)
Saver’s credits seldom approach the $1,000/$2,000 maximums, but they are certainly welcomed by low-income and moderate-income pre-retirees.24
34. The adoption tax credit has increased.
This very large credit is available to anyone who adopts a child under 18 years of age or a physically or mentally disabled child of any age. The child can be a U.S. citizen, a “resident alien,” or a “nonresident alien” as defined by the IRS. To claim the credit, you must demonstrate personal expenses as part of the adoption process (but see the exception below). The credit is commonly claimed by families in the year an adoption is finalized.
In 2014, the adoption tax credit is $13,190 per child, up from $12,970 last year. While the credit is subject to phase-outs (the MAGI phase-out range for 2014 is $197,880-237,880), any family that adopts a special needs child (as defined in the IRC) will qualify for the full amount of the credit even if no personal expenses are incurred in doing so.26
35. Retirement earnings test amounts for Social Security have risen.
If you receive Social Security benefits and you will be younger than full retirement age at the end of 2014, $1 of your benefits will be withheld for every $2 that you earn above $15,480 (a $360 increase from 2013).
If you receive Social Security benefits and reach full retirement age during 2014, $1 of your benefits will be withheld for every $3 that you earn above $41,400 – but that restriction applies only to earnings in the months prior to attaining full retirement age. (The applicable 2014 limit was $40,080.) There is no limit on earnings starting the month an individual attains full retirement age.
Will some of your Social Security income be taxable this year? That depends on your “combined income,” which Social Security calculates using this formula:
Adjusted gross income + non-taxable interest + 50% of Social Security benefits = combined income
If your combined income is between the following amounts, you may have to pay federal income tax on up to 50% of your benefits:
Single filers (“individuals”): $25,000-34,000
Joint filers: $32,000-44,000
If it exceeds the following amounts, you may have to pay federal income tax on up to 85% of your benefits:
Single filers (“individuals”): $34,000
Joint filers: $44,000
Marrieds who file separately will “probably” have their Social Security benefits taxed, according to the program’s website. The above dollar thresholds, incidentally, have never been inflation-indexed.27,28
What Hasn’t Changed in 2014
As annualized inflation has been tame, the IRS has left some yearly limits and thresholds unaltered for 2014. Here is a list of key unchanged items...9,19,24,29
Traditional/Roth IRA Contribution Limit --- $5,500 ($6,500 if 50 or older this year)
401(k), 403(b), TSP Contribution Limit* --- $17,500 ($23,000 if 50 or older this year)
SIMPLE Plan Contribution Limit --- $12,000 ($14,500 if 50 or older this year)
SEP Eligibility Threshold (minimum compensation amount) --- $550
FSA Contribution Limit ---$2,500
Maximum Federal Estate Tax Rate --- 40%
Federal Gift Tax Exclusion --- $14,000
“Kiddie” Tax Standard Deduction --- $1,000
“Kiddie” Tax Threshold (unearned income of a child) --- $2,000
hild Tax Credit Eligibility Threshold (earned income) --- $3,000
American Opportunity Tax Credit --- $2,500
Lifetime Learning Credit --- $2,000
Student Loan Interest Deduction* --- $2,500
Also applies to most 457 plans
**No longer limited to interest paid during first 60 months of repayment
Citations.
1 - irs.gov/uac/Newsroom/Starting-Jan.-13-2014-Business-Tax-Filers-Can-File-2013-Returns [1/9/14]
2 - healthcare.gov/exemptions/ [1/14/14]
3- kiplinger.com/article/insurance/T027-C001-S003-the-lowdown-on-the-health-insurance-penalty.html [11/22/13]
4 - washingtonpost.com/blogs/wonkblog/wp/2014/01/01/everything-you-need-to-know-about-life-under-obamacare-2/ [1/1/14]
5 - healthcare.gov/will-i-qualify-to-save-on-monthly-premiums/ [1/14/14]
6 - pselaw.com/2014/01/08/federal-income-tax-changes-in-2014/ [1/8/14]
7 - bkd.com/articles/2013/significant-tax-changes-for-2013-and-2014.htm [12/13]
8 - ahipcoverage.com/2013/11/26/irs-releases-final-rule-on-the-health-insurance-tax/ [11/26/13]
9 - tirereview.com/Article/122585/reviewing_2014_tax_changes.aspx [1/13/14]
10 - investopedia.com/articles/personal-finance/121913/major-tax-credits-expiring-2013.asp [12/19/13]
11 - news4jax.com/news/restaurants-changing-tip-procedure-due-to-new-tax-law/-/475880/23728894/-/10qlxejz/-/index.html [1/1/14]
12 - nctr.usf.edu/programs/clearinghouse/commutebenefits/ [1/2/13]
13 - recordnet.com/apps/pbcs.dll/article?AID=/20140110/A_BIZ0202/401100315/-1/a_biz [1/10/14]
14 - cbsnews.com/news/as-year-ends-congress-again-lets-55-tax-breaks-expire/ [12/31/13]
15 - landtrustalliance.org/policy/tax-matters/campaigns/incentive-faqs [1/15/14]
16 - jonesday.com/update_on_qualified/ [3/13]
17 - lindsayandbrownell.com/individuals/changes-for-20132014-tax-year.aspx [11/25/13]
18 - kfmr.com/tax-alerts/december2013/depreciation-limits-vehicles-2014 [12/13]
19 - forbes.com/sites/kellyphillipserb/2013/10/31/irs-announces-2014-tax-brackets-standard-deduction-amounts-and-more/ [10/31/13]
20 - bankrate.com/finance/taxes/estate-tax-and-gift-tax-amounts.aspx [1/6/14]
21 - taxfoundation.org/article/2014-tax-brackets [11/27/13]
22 - ssa.gov/OACT/cola/cbb.html [1/16/14]
23 - irs.gov/Individuals/Preview-of-2012-EITC-Income-Limits,-Maximum-Credit--Amounts-and-Tax-Law-Updates [12/30/13]
24 - money.usnews.com/money/retirement/articles/2013/11/04/modest-401k-and-ira-changes-coming-in-2014 [11/4/13]
25 - irs.gov/uac/IRS-Announces-2014-Pension-Plan-Limitations;-Taxpayers-May-Contribute-up-to-$17,500-to-their-401%28k%29-plans-in-2014 [11//4/13]
26 - washingtonadoptionattorney.com/adoption-tax-credit-for-2014/ [11/8/13]
27 - ssa.gov/OACT/cola/rtea.html [1/16/14]
28 - ssa.gov/planners/taxes.htm [1/16/14]
29 - irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-SIMPLE-IRA-Contribution-Limits [10/31/13]
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.
Additionally, a host of tax provisions created during the recession expired at the end of last year. Some were scheduled to sunset at the end of 2012, but were extended. Their reinstatement for 2014 is left to Congress.
_______________________________________________________________________
The 2013 federal government shutdown affected the start of the 2014 tax season.
* On January 13, the IRS began accepting Form 1120/1120S, Form 1065, and payroll and excise tax returns (Form 720, Form 940, Form 941 and Form 2290) from corporations and partnerships.
* On January 31, the IRS will begin accepting Form 1040 and Form 1041 from individuals, unincorporated small businesses, and estates and trusts.1
_______________________________________________________________________
A reminder: you should consult with a qualified tax or financial professional before making short-term or long-term changes to your tax or financial strategy.
Tax Changes Related to Health Care Reform
1. U.S. citizens & legal residents will face a tax penalty if they go without health insurance coverage for 2014 (with some exceptions).
This 2014 penalty is minor, and its impact will be felt in 2015.
This year, American citizens and legal U.S. residents who can afford health care coverage but elect not to buy it will be hit with a tax penalty called the individual shared responsibility payment. No one will have to make this payment until April 2015.2
For 2014, the penalty for uninsured adults is $95 per person or 1% of your yearly income, whichever is greater. The penalty for uninsured children in your household is $47.50. The total household penalty is capped at $285 in 2014 (or 300% of the individual adult penalty).2,3
Next year, the adult penalty rises to $325 per person or 2.0% of yearly income; it is supposed to max out at $695/2.5% in 2016.2,3
If you are a very wealthy individual who doesn’t buy health insurance in 2014, you get something of a break when it comes to the percentage-of-income penalty, which is calculated using your modified adjusted gross income (MAGI): the maximum individual penalty cannot surpass the national average annual premium for a bronze plan. That amount will be calculated this year, but will likely be in the vicinity of $4,500-5,000.3
How will the federal government know if you lack health care coverage? You will let them know as you file your federal taxes next year. The plan is for taxpayers to send in a supplemental form with their 1040s, indicating whether or not they were insured for 2014. If you weren’t insured for 2014, the IRS will deduct the penalty amount from your federal tax refund. If you don’t get a federal tax refund for TY 2014, then the IRS will reduce your TY 2015 refund by that amount, or your TY 2016 refund if you don’t get a TY 2015 refund, and so forth.2,3
At this juncture, it appears this is the only way the IRS can assess the penalty. It can’t put a lien on the money to collect payment.4
Could you be exempt from the penalty? To see if you are, visit healthcare.gov/exemptions. The list of exemptions is quite long.2
A reminder: if you are still uninsured and want to buy health insurance for 2014, you must do so before April. March 31 is the deadline for this year’s open enrollment period. If you miss that deadline, you will have to wait until October 7 for the chance to buy coverage.2,4
2. Some enrollees in qualified health plans offered through the Health Insurance Marketplace will get tax credits.
These rules apply to 2014 & subsequent tax years.
If you enroll in a qualified health plan through the federal health insurance exchange or a state health insurance exchange, you might be eligible for the Advance Premium Tax Credit – a credit that can be applied to reduce the cost of monthly health insurance premiums.
You can choose how much of the advance credit payments you want to apply to your premiums per month. If your advance payments for a year exceed the amount of the credit you are given for the year, you are looking at a refund. If they exceed the cost of the premiums, you will have to repay the excess payments made on your behalf when you file your 2014 federal taxes.5
Generally speaking, you qualify for a credit if your household income falls into one of these per-household-size ranges, which were 2013 estimates and may be adjusted slightly north this year:
$11,490-45,960 for individuals
$15,510-62,040 for a family of 2
$19,530-78,120 for a family of 3
$23,550-94,200 for a family of 4
$27,570-110,280 for a family of 5
$31,590-126,360 for a family of 6
$35,610-142,440 for a family of 7
$39,630-158,520 for a family of 8
Consumers learned whether or not they were eligible for a credit at the website of the health insurance exchange applicable to their state (or by speaking to its personnel via phone).5
By the way, if you have enrolled in a qualified health plan through a health insurance exchange, the reimbursement or direct payment of the plan premiums counts as a qualified benefit under a cafeteria plan in 2014 and years that follow.6
3 It is now possible to carry over some FSA funds to the next year.
An exception to the use-it-or-lose-it rule has been created.
If you participate in an employer-sponsored flexible spending account (FSA) plan, you know the drill: use the money in the FSA for qualifying medical expenses by the end of the plan year, because it will be gone next year.
IRS Notice 2013-71 creates a new wrinkle. Employers sponsoring FSA programs may now allow as much as $500 in unused FSA funds to be carried over to a subsequent year by a plan participant. Whatever amount is carried over doesn’t cut into the $2,500 contribution limit for the subsequent year.
Some FSA plans have allowed participants an extra 2½ months after the end of a plan year to spend their FSA money. The new carryover rule renders this “grace period” obsolete.7
4. Large-employer reporting & responsibility requirements of the Affordable Care Act will not take effect until January 1, 2015.
Big businesses & insurers get a 1-year reprieve from these mandates.
Much has been written about this already, but here’s a brief recap. Most large employers with at least 50 full-time employees would have been required to provide basic health care coverage to FTEs or pay penalties starting in 2014, but this requirement has been delayed until January 1, 2015.
There was also an information reporting mandate scheduled for 2014, by which these employers (and by extension, insurers) would have needed to supply details of the coverage to the IRS and individuals. This, too, has been delayed until January 1, 2015.
There was no 1-year postponement of the W-2 reporting requirements linked to the ACA; these are already in effect.7
5. A new excise tax is hitting insurers.
There will almost certainly be consumer impact.
The federal government is now charging health insurance providers an aggregate flat fee each year. The fee – estimated to start at $8 billion for 2014, estimated to climb to $14.3 billion by 2018 – will be broken down per health care provider based on their premium trend. The Congressional Budget Office thinks the tariff will be “largely passed through to consumers in the form of higher premiums,” and larger deductibles may result as well.7,8
6. Owners of MSAs & HSAs should note new deductible and out-of-pocket expenses requirements for qualifying HDHPs.
The adjustments are small, but worth noting.
If you have a Health Savings Account (HSA) or Medical Savings Account (MSA), you must also be enrolled in a high deductible health plan (HDHP). You should be aware of the following requirements with regard to deductible limits on HDHPs this year.9
MSAs Annual Deductible Annual Limit, Out-of Pocket Expenses
Self-only coverage $2,200-$3,250 $4,350
Family coverage $4,350-$6,550 $8,000
HSAs Annual Deductible Annual Limit, Out-of Pocket Expenses
Self-only coverage $1,250 or greater $6,350
Family coverage $2,500 or greater $12,700
Tax Changes Affecting Businesses
7. Section 179 expensing is reduced; bonus depreciation is gone.
Here is why business owners bought more capital equipment before 2013 ended.
In 2014, the Section 179 expense deduction for equipment purchases is capped at just $25,000 of the initial $200,000 of business property put into service this year. The 50% bonus depreciation companies took advantage of in recent years is no more, and the accelerated deduction for qualified real property in the year of purchase is gone too.9,10
8. No more Work Opportunity Tax Credit.
This was an incentive for companies to hire.
The WOTC (and its variants) gave employers a credit for hiring veterans, recipients of supplemental Social Security benefits and Americans receiving select types of government aid. The credit varied per hire, but it was as large as 40% of allowable wages for an employee (25% of allowable wages for employees who had worked less than 400 hours for the business).10
9. Gratuities must now be treated as taxable wages.
Automatic tips may be history at many eateries.
When a large party eats at a restaurant, a gratuity is often built into the check. Prior to 2014, automatic gratuities were classified as tips. In 2012, IRS guidance let the service industry know that would soon change. Beginning this year, automatic gratuities are defined as service charges by the IRS, so they are taxable income. Practically speaking, this means a change for wait staff: instead of getting that money at the end of the night, they will get it as part of their paycheck. Darden Restaurants and Texas Roadhouse are among the players in the dining industry who have eliminated automatic gratuities this year, replacing them with suggested tip amounts on the bill.6,11
10. S-corporation relief has been extended.
The summer 2013 decision applies to many varieties of S corps.
In August, the IRS rolled out Revenue Procedure 2013-30, which unifies late-relief methods for many S-corp, ESBT, QSST, QSub and corporate classification elections. Starting this year, S-corps have up to 3 years and 75 days to request relief for eligible late elections after the intended start date of a late election.7
11. Mass transit & carpool allowances for employees have been roughly halved for 2014.
Other qualified transportation fringe benefit limits remain the same, however.
In 2013, employers could provide up to $245 a month to an employee to subsidize their commutes to work via carpools, vanpools or mass transit, and get a tax deduction as a result. In 2014, the maximum monthly subsidy is $130.
Employers may still offer employees up to $250 a month in qualified parking benefits, and reimburse workers up to $20 per month for qualified bicycle commuting.12
Tax Changes Affecting Individuals & Households
12. Two major mortgage-related tax breaks are gone.
Underwater homeowners could face major tax burdens if they sell.
The twice-extended Mortgage Forgiveness Debt Relief Act of 2007 expired at the end of 2013. It gave struggling homeowners the chance to exclude up to $2 million of forgiven home loan debt from their taxable incomes – a tax break that isn’t normally available for cancelled debts.
Mortgage debts incurred after Jan. 1, 2007 and not after Dec. 31, 2012 were eligible as long as they were secured by the taxpayer's principal residence. Debt reduced because of mortgage restructuring qualified along with forgiven debt from foreclosures and short sales. It was a great tax break, and many are calling for the MFDRA to be restored.10,13
Another housing tax break disappeared in 2014. In 2013, homeowners paying for private mortgage insurance (PMI) who chose to itemize their deductions could write off the cost of PMI premiums plus related interest and taxes. That isn’t possible now.10
13. No more above-the-line tuition & fees deduction.
Students & families lose a prime tax break.
For 2013, an eligible taxpayer could take an above-the-line deduction for qualified educational expenses paid during the tax year. That deduction ranged from $2,000-$4,000. The opportunity is gone in 2014, though the American Opportunity Credit and the Lifetime Learning Credit remain.10,14
14. No more educator expense deduction.
Classroom teachers will miss this one.
Last year, educators employed by eligible primary or secondary institutions could take an above-the-line tax deduction of up to $250 for unreimbursed expenses for school and classroom-related supplies. (The deduction limit was $500 for married taxpayers filing jointly.) In 2014, it is no longer around.10,14
15. Tax-free IRA distributions to 501(c)(3)s are no longer permitted.
Wealthy IRA owners, hospitals, universities & charities are already missing this one.
The IRA charitable rollover was initially set to disappear at the end of 2011, but it was brought back by Congress in both 2012 and 2013. Some legislators called for making it permanent. This year, it is absent. The move allowed IRA owners aged 70½ or older to avoid taxation on as much as $100,000 of their Required Minimum Distributions (RMDs) if the money was transferred directly from the IRA custodian to a qualified non-profit organization.10,14
16. Two major energy-efficient home improvement credits are gone.
One was designed for homeowners, another for contractors & builders.
In 2013, taxpayers who made certain energy-saving improvements to their residences could claim a tax credit of as much as $500 to offset the cost of the upgrades. Contractors could also claim a credit for building energy-efficient homes for their clients (up to $2,000 per home). Neither perk is around for 2014.10,14
17. The electric vehicle credit is now absent.
Will this dent electric & hybrid vehicle sales?
If you bought or leased a plug-in electric car in 2013, you likely knew about the tax credit of up to $7,500 for such vehicles. (The size of the credit depended on make, model and battery pack size.) Taxpayers won’t have this option in 2014.10
18. A big tax break on donated real estate has expired.
The Enhanced Easement Tax Incentive was a boon to conservationist groups.
During the years 2006-13, individual taxpayers that donated real capital gain property or property easements to a qualified conservationist organization could take a resulting deduction as large as 50% of their adjusted gross incomes. (Qualifying farmers and ranchers could deduct up to 100% of their incomes, and S-corps and C-corps could take advantage of the tax break as well.) In addition, donors of such real estate could keep taking the deduction for an additional 15 years, up to the fair market value of the property.
In 2014, the incentive to make such real property donations is less compelling: the deduction a donor can take reverts to 30% of their AGI in the year of the donation, and the carry-forward period reverts to 5 years in addition to the year of donation.10,15
19. Less favorable rules for small business stock gains.
The basic exclusion shrinks.
As a result of the American Taxpayer Relief Act of 2012, any taxpayer besides a corporation could exclude 100% of the gain from the sale or exchange of qualified small business stock acquired between September 27, 2010 and January 1, 2014 and held for more than 5 years. In 2014, the basic exclusion reverts back to 50%; it is 60% in empowerment zones. The gain that is eligible to be taken into account for purposes of this exclusion is limited to the greater of $10,000,000 or 10 times the taxpayer’s basis in the stock (see IRS Sec. 1202(b)(1)). The limitation is computed on a per-issuer basis, with lower limits ($5,000,000) applying to married individuals filing separately.16,22
20. Depreciation caps on “executive” vehicles have diminished.
Businesses with fleets are looking at less of a tax break.
In 2013, a business that put a car, truck or SUV into service could claim $11,160 in depreciation. But, as bonus depreciation is no longer allowed in 2014, the first-year depreciation cap allowed by IRC Section § 280F is now back to $3,160.17,18
21. The standard mileage rate has fallen to $0.56.
The decline is minimal, however.
In 2014, the optional mileage allowance for business use of owned or leased vehicles is $0.56 per mile, down half a cent from 2013.9
COLAs for 2014
22. Income tax brackets receive the usual minor adjustment.
These income thresholds define the 2014 federal income tax brackets.19
Bracket Single Filers Married Filing Jointly Married Filing Head of Household
or Qualifying Survivor Separately
10% Up to $9,075 Up to $18,150 Up to $9,075 Up to $12,950
15% $9,076-$36,900 $18,151-$73,800 $9,076-$36,900 $12,951-$49,400
25% $36,901-$89,350 $73,801-$148,850 $36,901-$74,425 $49,401-$127,550
28% $89,351-$186,350 $148,851-$226,850 $74,426-$113,425 $127,551-$206,600
33% $186,351-$405,100 $226,851-$405,100 $113,426-$202,550 $206,601-$405,100
35% $405,101-$406,750 $405,101-$457,600 $202,551-$228,800 $405,101-$432,200
39.6% $406,751 or more $457,601 or more $228,801 or more $432,201 or more
23. The individual estate tax exemption rises to $5.34 million.
It was $5.25 million in 2013. Any unused portion of the $5.34 million individual exemption may be transferred to a surviving spouse upon the death of the first deceased spouse through a timely filing of IRS Form 706.
In the big picture, the lifetime federal estate tax exemption and the lifetime federal gift tax exemption are unified, so an individual can also elect to use some or all of a $5.25 million individual exemption on gifts made during his or her lifetime (though that will lower the amount of his or her estate that may be excluded from inheritance taxes).
Incidentally, the annual gift tax exclusion amount remains at $14,000 this year.20
24. The standard deduction is slightly greater.
Here are the amounts for 2014.19
Single filers, married filing separately: $6,200 (up $100 from 2013)
Head of household: $9,100 (up $150 from 2013)
Married filing jointly/qualifying survivor: $12,400 (up $200 from 2013)
25. The personal exemption rises by $50.
In 2013, it was $3,900; in 2014, it is $3,950. Here are the 2014 phase-out ranges...19,21
Single filers, married filing separately: $254,200-$376,700
Head of household: $279,650-$402,150
Married filing jointly/qualifying survivor: $305,050-$427,550
26. The AMT exemption amount has risen for 2014.
As the Alternative Minimum Tax was at last indexed for inflation at the start of 2013, exemption amounts are set as follows:
Single filers: $52,800
Married filing separately: $41,050
Married filing jointly/qualifying survivor: $82,100
These amounts are a few hundred dollars higher than in 2013.19,21
27. Social Security’s taxable wage base is $3,300 higher in 2014.
This year, the FICA tax rate is 6.2% on the first $117,000 of wages paid to an employee. So an employee whose 2014 wages total $117,000 will pay $7,254 to Social Security's Old-Age, Survivors, and Disability Insurance (OASDI) program this year with the employer contributing an equivalent amount. (This tax rate is 12.4% for self-employed individuals).22
28. Phase-outs of itemized deductions get a COLA.
The Pease limitations returned in 2013 after a 2-year absence. These are thresholds that cut into the value of most itemized deductions above a certain AGI level. Here is where the Pease limitations are set for 2014.19,21
Single filers: $254,200
Head of household: $279,650
Married filing jointly/qualifying survivor: $305,050
29. Phase-out ranges for the above-the-line student loan interest deduction have been adjusted.
The deduction limit remains at $2,500 this year; the phase-out ranges are $5,000 north of where they were in 2013.17
Single filers, heads of household: $65,000-80,000
Married filing jointly/qualifying survivor: $130,000-160,000
30. Earned Income Tax Credit limits rise.
This tax break is designed to help low-wage filers. The credit varies based on a) your taxable income, b) the number of dependents you support. For 2014, you are eligible to receive it providing your earned income and your AGI each fall below the following limits:
$46,997 ($52,427 married filing jointly) with 3 or more qualifying children
$43,756 ($49,186 married filing jointly) with 2 qualifying children
$38,511 ($43,941 married filing jointly) with 1 qualifying child
$14,590 ($20,020 married filing jointly) with no qualifying children
The corresponding EITC for TY 2014:
$6,143 with 3 or more qualifying children
$5,460 with 2 qualifying children
$3,305 with 1 qualifying child
$496 with no qualifying children
If you have investment income exceeding $3,350 for 2014, you can’t qualify for the EITC.23
31. Some minor COLAs affect traditional & Roth IRA contributions.
While the amount you can contribute to a single traditional or Roth IRA or across multiple IRAs in 2014 is unchanged from last year – $5,500, $6,500 for those 50 and older – some other changes have occurred pertaining to the ability to contribute to a Roth or take a tax deduction from a “regular” IRA.
Phase-out ranges affecting the tax deduction for traditional IRA contributions (AGI).
Single or head of household, contributing to workplace retirement plan & traditional IRA: $60,000-70,000
Married couple both contributing to workplace retirement plan & traditional IRA: $96,000-116,000
Married individual contributing to traditional IRA, spouse in workplace retirement plan: $181,000-191,000
These phase-out ranges are $3,000 higher for investors who don't have a workplace retirement plan but are married to someone who does, and $1,000 higher for the others.24
Phase-out ranges affecting the chance to make a Roth IRA contribution (AGI).
Single or head of household: $114,000-129,000
Married couples: $181,000-191,000
These phase-out ranges have increased by $2,000 for single filers and by $3,000 for couples.24
32. New COLAs pertaining to SEPs, ESOPs, top-heavy plans & defined contribution plans.
Slight 2014 adjustments have been made to some thresholds for these plans.25
SEPs --- Maximum compensation of $260,000 (up $5,000 from 2013)
ESOPs --- 5-year distribution threshold of $1,050,000 (up $15,000 from 2013); Additional year threshold of $210,000 (up $5,000 from 2013)
Top-heavy plans --- $ limit defining key employee rises to $170,000 (up $5,000 from 2013)
415(c)(1)(a) plans --- Maximum annual benefit of $52,000 (up $1,000 from 2013) (defined contribution plans)
33. Saver’s credit thresholds are a bit higher.
The saver’s credit available to IRA and 401(k) account holders whose AGI falls underneath a certain limit, and millions of people claim it each year. It can be as large as $1,000 for single filers and as large as $2,000 for married couples. For 2014, the AGI limits for claiming the saver’s credit are:
Single filers: ≤ $30,000 (up $500 from 2013)
Head of household: ≤ $45,000 (up $750 from 2013)
Married filing jointly/qualifying survivor: ≤ $60,000 (up $1,000 from 2013)
Saver’s credits seldom approach the $1,000/$2,000 maximums, but they are certainly welcomed by low-income and moderate-income pre-retirees.24
34. The adoption tax credit has increased.
This very large credit is available to anyone who adopts a child under 18 years of age or a physically or mentally disabled child of any age. The child can be a U.S. citizen, a “resident alien,” or a “nonresident alien” as defined by the IRS. To claim the credit, you must demonstrate personal expenses as part of the adoption process (but see the exception below). The credit is commonly claimed by families in the year an adoption is finalized.
In 2014, the adoption tax credit is $13,190 per child, up from $12,970 last year. While the credit is subject to phase-outs (the MAGI phase-out range for 2014 is $197,880-237,880), any family that adopts a special needs child (as defined in the IRC) will qualify for the full amount of the credit even if no personal expenses are incurred in doing so.26
35. Retirement earnings test amounts for Social Security have risen.
If you receive Social Security benefits and you will be younger than full retirement age at the end of 2014, $1 of your benefits will be withheld for every $2 that you earn above $15,480 (a $360 increase from 2013).
If you receive Social Security benefits and reach full retirement age during 2014, $1 of your benefits will be withheld for every $3 that you earn above $41,400 – but that restriction applies only to earnings in the months prior to attaining full retirement age. (The applicable 2014 limit was $40,080.) There is no limit on earnings starting the month an individual attains full retirement age.
Will some of your Social Security income be taxable this year? That depends on your “combined income,” which Social Security calculates using this formula:
Adjusted gross income + non-taxable interest + 50% of Social Security benefits = combined income
If your combined income is between the following amounts, you may have to pay federal income tax on up to 50% of your benefits:
Single filers (“individuals”): $25,000-34,000
Joint filers: $32,000-44,000
If it exceeds the following amounts, you may have to pay federal income tax on up to 85% of your benefits:
Single filers (“individuals”): $34,000
Joint filers: $44,000
Marrieds who file separately will “probably” have their Social Security benefits taxed, according to the program’s website. The above dollar thresholds, incidentally, have never been inflation-indexed.27,28
What Hasn’t Changed in 2014
As annualized inflation has been tame, the IRS has left some yearly limits and thresholds unaltered for 2014. Here is a list of key unchanged items...9,19,24,29
Traditional/Roth IRA Contribution Limit --- $5,500 ($6,500 if 50 or older this year)
401(k), 403(b), TSP Contribution Limit* --- $17,500 ($23,000 if 50 or older this year)
SIMPLE Plan Contribution Limit --- $12,000 ($14,500 if 50 or older this year)
SEP Eligibility Threshold (minimum compensation amount) --- $550
FSA Contribution Limit ---$2,500
Maximum Federal Estate Tax Rate --- 40%
Federal Gift Tax Exclusion --- $14,000
“Kiddie” Tax Standard Deduction --- $1,000
“Kiddie” Tax Threshold (unearned income of a child) --- $2,000
hild Tax Credit Eligibility Threshold (earned income) --- $3,000
American Opportunity Tax Credit --- $2,500
Lifetime Learning Credit --- $2,000
Student Loan Interest Deduction* --- $2,500
Also applies to most 457 plans
**No longer limited to interest paid during first 60 months of repayment
Citations.
1 - irs.gov/uac/Newsroom/Starting-Jan.-13-2014-Business-Tax-Filers-Can-File-2013-Returns [1/9/14]
2 - healthcare.gov/exemptions/ [1/14/14]
3- kiplinger.com/article/insurance/T027-C001-S003-the-lowdown-on-the-health-insurance-penalty.html [11/22/13]
4 - washingtonpost.com/blogs/wonkblog/wp/2014/01/01/everything-you-need-to-know-about-life-under-obamacare-2/ [1/1/14]
5 - healthcare.gov/will-i-qualify-to-save-on-monthly-premiums/ [1/14/14]
6 - pselaw.com/2014/01/08/federal-income-tax-changes-in-2014/ [1/8/14]
7 - bkd.com/articles/2013/significant-tax-changes-for-2013-and-2014.htm [12/13]
8 - ahipcoverage.com/2013/11/26/irs-releases-final-rule-on-the-health-insurance-tax/ [11/26/13]
9 - tirereview.com/Article/122585/reviewing_2014_tax_changes.aspx [1/13/14]
10 - investopedia.com/articles/personal-finance/121913/major-tax-credits-expiring-2013.asp [12/19/13]
11 - news4jax.com/news/restaurants-changing-tip-procedure-due-to-new-tax-law/-/475880/23728894/-/10qlxejz/-/index.html [1/1/14]
12 - nctr.usf.edu/programs/clearinghouse/commutebenefits/ [1/2/13]
13 - recordnet.com/apps/pbcs.dll/article?AID=/20140110/A_BIZ0202/401100315/-1/a_biz [1/10/14]
14 - cbsnews.com/news/as-year-ends-congress-again-lets-55-tax-breaks-expire/ [12/31/13]
15 - landtrustalliance.org/policy/tax-matters/campaigns/incentive-faqs [1/15/14]
16 - jonesday.com/update_on_qualified/ [3/13]
17 - lindsayandbrownell.com/individuals/changes-for-20132014-tax-year.aspx [11/25/13]
18 - kfmr.com/tax-alerts/december2013/depreciation-limits-vehicles-2014 [12/13]
19 - forbes.com/sites/kellyphillipserb/2013/10/31/irs-announces-2014-tax-brackets-standard-deduction-amounts-and-more/ [10/31/13]
20 - bankrate.com/finance/taxes/estate-tax-and-gift-tax-amounts.aspx [1/6/14]
21 - taxfoundation.org/article/2014-tax-brackets [11/27/13]
22 - ssa.gov/OACT/cola/cbb.html [1/16/14]
23 - irs.gov/Individuals/Preview-of-2012-EITC-Income-Limits,-Maximum-Credit--Amounts-and-Tax-Law-Updates [12/30/13]
24 - money.usnews.com/money/retirement/articles/2013/11/04/modest-401k-and-ira-changes-coming-in-2014 [11/4/13]
25 - irs.gov/uac/IRS-Announces-2014-Pension-Plan-Limitations;-Taxpayers-May-Contribute-up-to-$17,500-to-their-401%28k%29-plans-in-2014 [11//4/13]
26 - washingtonadoptionattorney.com/adoption-tax-credit-for-2014/ [11/8/13]
27 - ssa.gov/OACT/cola/rtea.html [1/16/14]
28 - ssa.gov/planners/taxes.htm [1/16/14]
29 - irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-SIMPLE-IRA-Contribution-Limits [10/31/13]
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.
Monday, February 3, 2014
ORGANIZING YOUR PAPERWORK FOR TAX SEASON
If you haven't done it, now's the time.
How prepared are you to prepare your 1040? The earlier you compile and organize the relevant paperwork, the easier things may be for you (or the tax preparer working for you) this winter. Here are some tips to help you get ready:
As a first step, look at your 2012 return. Unless your job, living situation or financial situation has changed notably since you last filed your taxes, chances are you will need the same set of forms, schedules and receipts this year as you did last year. So open that manila folder (or online vault) and make or print a list of the items that accompanied your 2012 return. You should receive the tax year 2013 versions of everything you need by early February at the latest.
How much documentation is needed? If you don't freelance or own a business, your list may be short: W-2(s), 1099-INT(s), perhaps 1099-DIVs or 1099-Bs, a Form 1098 if you pay a mortgage, and maybe not much more. Independent contractors need their 1099-MISCs, and the self-employed need to compile every bit of documentation related to business expenses they can find: store and restaurant receipts, mileage records, utility bills, and so on.1
In totaling receipts, don't forget charitable donations. The IRS wants all of them to be documented. A taxpayer who donates $250 or more to a qualified charity needs a written acknowledgment of such a donation. If your own documentation is sufficiently detailed, you may deduct $0.14 for each mile driven on behalf of a volunteer effort for a qualified charity.1
Or medical expenses & out-of-pocket expenses. Collect receipts for any expense for which your employer doesn't reimburse you, and any medical bills that came your way last year.
If you're turning to a tax preparer, stand out by being considerate. If you present clean, neat and well-organized documentation to a preparer, that diligence and orderliness will matter. You might get better and speedier service as a result: you are telegraphing that you are a step removed from the clients with missing or inadequate paperwork.
Make sure you give your preparer your federal tax I.D. number (TIN), and remember that joint filers must supply TINs for each spouse. If you claim anyone as a dependent, you will need to supply your preparer with that person's federal tax I.D. number. Any dependent you claim has to have a TIN, and that goes for newborns, infants and children as well. So if your kids don't have Social Security numbers yet, apply for them now using Form SS-5 (available online or at your Social Security office). If you claim the Child & Dependent Care Tax Credit, you will need to show the TIN for the person or business that takes care of your kids while you work.1,3
While we're on the subject of taxes, some other questions are worth examining...
How long should you keep tax returns? The IRS statute of limitations for refunds is 3 years, but if you underreport taxable income, fail to file a return or file a claim for a loss from worthless securities or bad debt deduction, it wants you to keep them longer. You may have heard that keeping your returns for 7 years is wise; some CPAs and tax advisors will tell you to keep them for life. If the tax records are linked to assets, you will want to retain them for when you figure out the depreciation, amortization, or depletion deduction and the gain or loss. Insurers and creditors may want you to keep federal tax returns indefinitely.2
Can you use electronic files as records in audits? Yes. In fact, early in the audit process, the IRS may request accounting software backup files via Form 4564 (the Information Document Request). Form 4564 asks the taxpayer/preparer to supply the file to the IRS on a flash drive, CD or DVD, plus the necessary administrator username and password. Nothing is emailed. The IRS has the ability to read most tax prep software files. For more, search online for "Electronic Accounting Software Records FAQs." The IRS page should be the top result.4
How do you calculate cost basis for an investment? A whole article could be written about this, and there are many potential variables in the calculation. At the most basic level with regards to stock, the cost basis is original purchase price + any commission on the purchase.
So in simple terms, if you buy 200 shares of the Little Emerging Company @ $20 a share with a $100 commission, your cost basis = $4,100, or $20.50 per share. If you sell all 200 shares for $4,000 and incur another $100 commission linked to the sale, you lose $200 - the $3,900 you wind up with falls $200 short of your $4,100 cost basis.5
Numerous factors affect cost basis: stock splits, dividend reinvestment, how shares of a security are bought or gifted. Cost basis may also be "stepped up" when an asset is inherited. Since 2011, brokerages have been required to keep track of cost basis for stocks and mutual fund shares, and to report cost basis to investors (and the IRS) when such securities are sold.5
P.S.: This tax season is off to a late start. Business filers were able to send in federal tax returns starting January 13, but the start date for processing 1040 and 1041 forms was pushed back to January 31. Per federal law, the April 15 deadline for federal tax returns remains in place, as does the 6-month extension available for those who file IRS Form 4868.6,7
Citations.
1 - bankrate.com/finance/taxes/7-ways-to-get-organized-for-the-tax-year-1.aspx [1/6/14]
2 - irs.gov/Businesses/Small-Businesses-&-Self-Employed/How-long-should-I-keep-records [8/8/13]
3 - irs.gov/Individuals/International-Taxpayers/Taxpayer-Identification-Numbers-%28TIN%29 [1/17/14]
4 - irs.gov/Businesses/Small-Businesses-&-Self-Employed/Use-of-Electronic-Accounting-Software-Records;-Frequently-Asked-Questions-and-Answers [5/22/13]
5 - turbotax.intuit.com/tax-tools/tax-tips/Rental-Property/Cost-Basis--Tracking-Your-Tax-Basis/INF12037.html [1/23/14]
6 - irs.gov/uac/Newsroom/Starting-Jan.-13-2014-Business-Tax-Filers-Can-File-2013-Returns [1/9/14]
7 - irs.gov/taxtopics/tc301.html [1/22/14]
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.
Monday, January 27, 2014
HAS A CORRECTION STARTED? DOES IT MATTER?
Last Monday, the U.S. markets dropped roughly 1% of their value, and Europe and Asia were down by similar amounts the following day. The market (the S&P 500) then fell 2.1% on Friday in a sickening lurch. This combination was enough to cause pundits and investors to ask whether we are now in the early stages of a bear market or, indeed, if the past almost-five years should be considered an interim market rally inside of a longer-term bear market.
The answer, of course, is that nobody knows--not the brainiac Fed economists, not the fund managers and certainly not the pundits. A Wall Street Journal article noted that most of the sellers on Friday were short-term investors who were involved in program trading, selling baskets of stocks to protect themselves from short-term losses. Roughly translated, that means that a bunch of professional traders panicked when they learned that Chinese economic growth is slowing down on top of worries that the Fed is buying bonds at a somewhat less furious rate ($75 billion a month vs. $85 billion) than it was last year.
What we DO know is that it is often a mistake to sell into market downturns, which happen more frequently than most of us realize. A lot of people might be surprised to know that in the Summer of 2011, the markets had pulled back by almost 20%--twice the traditional definition of a market correction--only to come roaring back and reward patient investors. There were corrections in the Spring of 2010 (16%) and the Spring of 2012 (10%), but almost nobody remembers these sizable bumps on the way to new market highs. Indeed, most of us look back fondly at the time since March of 2009 as one long largely-uninterrupted bull market.
Bigger picture, since 1945, the market has experienced 27 corrections of 10% or more, and 12 bear markets where U.S. equities lost at least 20% of their value. The average decline was 13.3% over the course of 71 trading days. Perhaps the only statistic that really matters is that after every one of these pullbacks, the markets returned to record new highs. The turnarounds were always an unexpected surprise to most investors.
We may get a full 10% correction or even a full bearish period out of these negative trading days, and we may not. But the history lesson suggests an important lesson: if we DO get a correction or a bear market, we may not remember it a few years later if the markets recover as they always have in the past. The people who lose money in the long term are not those who endure a painful market downturn, but the people who panic and sell when the market turns down.
Sources:
http://finance.yahoo.com/blogs/the-exchange/stocks-plunge-in-u-s---dow-sinks-more-than-280-points-205935575.html
http://www.bloomberg.com/news/2014-01-16/crashes-corrections-and-monday-s-bear-market-.html
http://www.bloomberg.com/news/2014-01-23/the-bull-market-ends-or-is-it-just-a-correction-.html
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
The answer, of course, is that nobody knows--not the brainiac Fed economists, not the fund managers and certainly not the pundits. A Wall Street Journal article noted that most of the sellers on Friday were short-term investors who were involved in program trading, selling baskets of stocks to protect themselves from short-term losses. Roughly translated, that means that a bunch of professional traders panicked when they learned that Chinese economic growth is slowing down on top of worries that the Fed is buying bonds at a somewhat less furious rate ($75 billion a month vs. $85 billion) than it was last year.
What we DO know is that it is often a mistake to sell into market downturns, which happen more frequently than most of us realize. A lot of people might be surprised to know that in the Summer of 2011, the markets had pulled back by almost 20%--twice the traditional definition of a market correction--only to come roaring back and reward patient investors. There were corrections in the Spring of 2010 (16%) and the Spring of 2012 (10%), but almost nobody remembers these sizable bumps on the way to new market highs. Indeed, most of us look back fondly at the time since March of 2009 as one long largely-uninterrupted bull market.
Bigger picture, since 1945, the market has experienced 27 corrections of 10% or more, and 12 bear markets where U.S. equities lost at least 20% of their value. The average decline was 13.3% over the course of 71 trading days. Perhaps the only statistic that really matters is that after every one of these pullbacks, the markets returned to record new highs. The turnarounds were always an unexpected surprise to most investors.
We may get a full 10% correction or even a full bearish period out of these negative trading days, and we may not. But the history lesson suggests an important lesson: if we DO get a correction or a bear market, we may not remember it a few years later if the markets recover as they always have in the past. The people who lose money in the long term are not those who endure a painful market downturn, but the people who panic and sell when the market turns down.
Sources:
http://finance.yahoo.com/blogs/the-exchange/stocks-plunge-in-u-s---dow-sinks-more-than-280-points-205935575.html
http://www.bloomberg.com/news/2014-01-16/crashes-corrections-and-monday-s-bear-market-.html
http://www.bloomberg.com/news/2014-01-23/the-bull-market-ends-or-is-it-just-a-correction-.html
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Monday, January 20, 2014
BOGUS EFFECT
This time of year, we often find ourselves reading about the "January Effect," which is sometimes described as a predictable way to forecast returns, and sometimes as a way to know whether this is, or is not, a good year to invest and make some money.
Unfortunately, most of this reporting is nonsense.
Let's start with the predictable part. Wouldn't it be nice if, even for just one month of the year, we could know whether the market is going to go up or down? That's what market pundits are implying in their January Effect reporting: that markets have a strong tendency to rise in January. Why? The explanation, first offered in 1942, is twofold:
1) Stock investors tend to harvest their tax losses at the very end of the year, selling any stocks that happen to be below the price they paid for them, and, of course, claiming the loss on their tax returns. This selling activity depresses the prices of stocks generally in late December (Why do we not hear about a negative "December Effect?"), but when those investors buy back into the market in January, the additional buying demand pushes up prices.
2) Mutual funds, who are the biggest stock investors, have to report their holdings as of the end of the year. If they made an embarrassing mistake and purchased a stock which subsequently dropped like a stone, the portfolio manager engages in an exercise known as "window dressing:" she conveniently sells that stock right before December 31, and then reports a portfolio that doesn't include the losing investment. This is a great way to prevent reporters from asking pointed questions about what they might have seen in that dog stock when they purchased it in the first place. And it makes it look like, despite what might have been poor performance throughout the year, the fund is strangely only invested in stocks that went up.
Of course, the cash position is only temporary; the fund will put the money to use in January. Just like the tax harvesting activity, these sales in December and purchases in January, we are told, have a wind-at-the-back impact on share prices in the first month of the year.
So why is this nonsense? Back in 1942, and for some years afterwards, it might have made sense to do all your tax loss harvesting once a year as the holiday decorations were being taken down at the malls. Today, with modern software tools, professional investors can check daily to see if there are portfolio losses they can harvest, so the buying and selling is spread out through the year. Also, today's mutual funds report the contents of their portfolios quarterly, rather than annually, so the window dressing activity (which still goes on), happens each fiscal quarter, rather than all at once at the end of the year.
Moreover, a quick glance at history suggests that returns in the month of January have been pretty random for this century's investors. The S&P 500, in the calendar month of January since January 2000, has delivered returns of -4.18%, +6.45%, -2.12%, -5.87%, +2.04%, -1.73%, +0.89%, +1.53%, -4.74%, -11.37%, -5.22%, +1.12%, +2.77%, +2.44% and -0.77% last January. If you can see a pattern there worth betting on, chances are you're also a genius at the racetrack.
The other January Effect says that if stocks rise in January, they will be up for the year, and if they fall in January, then the market will deliver losses through December. Of course, any time you give the market a head start in either direction, there will be a slight tendency for the rest of the year to follow suit--similar to if you saw an Olympic sprinter break out of the blocks ahead or behind the pack, you would notice a tendency to finish ahead or behind. Not a guarantee, you understand, but a tendency.
Looking at the historical record, when stocks finish the first month down, they finish the year down 58% of the time--almost exactly what you would expect within the statistical probabilities of randomness. Researchers have actually determined that--probably also due to random factors--the returns in September have historically been the best predictor of returns for the year as a whole.
The truth is, none of us have a way to predict even a week, much less a month, much less a year of market returns. Whenever we read about the Super Bowl winner predicting the market, or the month of January or September or the winning party in the Presidential election, we should recognize that the article is being written purely for entertainment, giving us a chance to fantasize that, somehow, we can, for a moment, know the unknowable future and maybe even profit from it.
Sources:
http://moneymorning.com/2013/12/26/january-effect-exist/
http://blogs.wsj.com/moneybeat/2014/01/15/so-much-for-the-january-effect-sp-500-back-in-record-territory/
http://blogs.barrons.com/stockstowatchtoday/2014/01/14/after-the-drop-as-january-goes-so-goes-the-year/
http://www.businessweek.com/articles/2014-01-07/investors-looking-for-a-january-effect-should-wait-a-few-months
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Unfortunately, most of this reporting is nonsense.
Let's start with the predictable part. Wouldn't it be nice if, even for just one month of the year, we could know whether the market is going to go up or down? That's what market pundits are implying in their January Effect reporting: that markets have a strong tendency to rise in January. Why? The explanation, first offered in 1942, is twofold:
1) Stock investors tend to harvest their tax losses at the very end of the year, selling any stocks that happen to be below the price they paid for them, and, of course, claiming the loss on their tax returns. This selling activity depresses the prices of stocks generally in late December (Why do we not hear about a negative "December Effect?"), but when those investors buy back into the market in January, the additional buying demand pushes up prices.
2) Mutual funds, who are the biggest stock investors, have to report their holdings as of the end of the year. If they made an embarrassing mistake and purchased a stock which subsequently dropped like a stone, the portfolio manager engages in an exercise known as "window dressing:" she conveniently sells that stock right before December 31, and then reports a portfolio that doesn't include the losing investment. This is a great way to prevent reporters from asking pointed questions about what they might have seen in that dog stock when they purchased it in the first place. And it makes it look like, despite what might have been poor performance throughout the year, the fund is strangely only invested in stocks that went up.
Of course, the cash position is only temporary; the fund will put the money to use in January. Just like the tax harvesting activity, these sales in December and purchases in January, we are told, have a wind-at-the-back impact on share prices in the first month of the year.
So why is this nonsense? Back in 1942, and for some years afterwards, it might have made sense to do all your tax loss harvesting once a year as the holiday decorations were being taken down at the malls. Today, with modern software tools, professional investors can check daily to see if there are portfolio losses they can harvest, so the buying and selling is spread out through the year. Also, today's mutual funds report the contents of their portfolios quarterly, rather than annually, so the window dressing activity (which still goes on), happens each fiscal quarter, rather than all at once at the end of the year.
Moreover, a quick glance at history suggests that returns in the month of January have been pretty random for this century's investors. The S&P 500, in the calendar month of January since January 2000, has delivered returns of -4.18%, +6.45%, -2.12%, -5.87%, +2.04%, -1.73%, +0.89%, +1.53%, -4.74%, -11.37%, -5.22%, +1.12%, +2.77%, +2.44% and -0.77% last January. If you can see a pattern there worth betting on, chances are you're also a genius at the racetrack.
The other January Effect says that if stocks rise in January, they will be up for the year, and if they fall in January, then the market will deliver losses through December. Of course, any time you give the market a head start in either direction, there will be a slight tendency for the rest of the year to follow suit--similar to if you saw an Olympic sprinter break out of the blocks ahead or behind the pack, you would notice a tendency to finish ahead or behind. Not a guarantee, you understand, but a tendency.
Looking at the historical record, when stocks finish the first month down, they finish the year down 58% of the time--almost exactly what you would expect within the statistical probabilities of randomness. Researchers have actually determined that--probably also due to random factors--the returns in September have historically been the best predictor of returns for the year as a whole.
The truth is, none of us have a way to predict even a week, much less a month, much less a year of market returns. Whenever we read about the Super Bowl winner predicting the market, or the month of January or September or the winning party in the Presidential election, we should recognize that the article is being written purely for entertainment, giving us a chance to fantasize that, somehow, we can, for a moment, know the unknowable future and maybe even profit from it.
Sources:
http://moneymorning.com/2013/12/26/january-effect-exist/
http://blogs.wsj.com/moneybeat/2014/01/15/so-much-for-the-january-effect-sp-500-back-in-record-territory/
http://blogs.barrons.com/stockstowatchtoday/2014/01/14/after-the-drop-as-january-goes-so-goes-the-year/
http://www.businessweek.com/articles/2014-01-07/investors-looking-for-a-january-effect-should-wait-a-few-months
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Monday, January 13, 2014
BEHAVIORAL FINANCE AND "NANNY" PROVISIONS
One of the most interesting areas of financial research these past ten years has come, oddly, not from economists or investment researchers, but psychologists, who are pioneering a branch of study known as "behavioral finance." This has led to one of the strangest sights in the history of Nobel prizes: the 2002 prize in economics handed out to psychologist Daniel Kahneman for (according to the Nobelprize.org website) "having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty."
The behavioral finance research tells us that most people take mental shortcuts to arrive at decisions, and some of them lead to odd conclusions. Around the time you make your New Year's resolution to lose weight, do you buy a $500 annual membership to a gym or opt for a $10 per visit pay-as-you-go fee? Most people who choose the former end up actually going to the gym less than once a month; the flat fee is only a bargain when you assume that the bold post-resolution intention will actually happen, but it's often a terrible deal when a person's actual behavior is taken into account.
How do you decide whether to be an organ donor when you face the option on your driver's license application? In countries where the default option is yes (you consent to be an organ donor), 90% of individuals happen to be registered organ donors. In countries where the default option is no, the percentage ranges from 10% to 30%.
This research is now finding its way into the hands of policy makers, who are pioneering a new governmental role of protecting you against the dangers of your own mental shortcuts. One recent example is automatic enrollment in a company retirement plan. Research shows that if people are required to affirmatively opt-into having a portion of their paycheck sent to their 401(k) retirement plan, they will do so at a lower rate (67%) than if they are enrolled by default and have to affirmatively opt-out (77%). The U.S. government has been encouraging auto-enrollment policies at American corporations, on the theory that workers will be better off if more of them are making regular 401(k) plan contributions.
Another example in Britain came when the government offered tax incentives for people to insulate their attics, reducing energy consumption and the associated pollution from energy production. But so few people showed an interest in the incentives that the UK government finally had to switch tactics. It offered the same tax break, but added a loft clearance service that would help people clean out their attic and give them assistance in disposing of (sell or throw away) unwanted items. The new service tripled insulation participation rates.
When the city of Copenhagen painted green footprints on the sidewalks leading to litter bins, littering decreased by 46%.
The idea of applying behavioral economics to political and social initiatives sounds a lot like manipulation to its critics, who worry that we are moving toward a "nanny state" where the government feels compelled to protect us from our own behavioral biases. Reducing litter on the streets of Copenhagen is relatively noncontroversial, but what about initiatives that try to influence buyers to select more energy-efficient cars? Or government policies that discourage the consumption of certain foods or beverages? The New York City ordinance against large soda containers was based on the assumption that people were unable to recognize, on their own, the health risks of soda consumption.
Interestingly, at least one of these behavioral initiatives is now showing evidence of backfiring. The Center for Retirement Research at Boston College found that companies that have switched to automatic enrollment in their 401(k) plans have been paying for the additional cost by giving their employees smaller employer matches--3.2%, compared with an average 3.5% for plans without automatic enrollment. At the same time, the Boston College researchers and the Vanguard organization have found that for some workers, the automatic savings rate offered in the default is lower than what many workers would have chosen if they had made an affirmative decision to participate. Worse, the automated mix of investments (typically target date funds) that is the default option has underperformed the investment mixes that workers have tended to select on their own. For some workers, at least, the government's behavioral finance nudge will cost them real money.
Sources: http://www.politico.com/magazine/story/2013/12/obamas-nanny-state-100848.html
http://swampland.time.com/2013/08/09/nudge-back-in-fashion-at-white-house/
http://money.usnews.com/money/retirement/articles/2013/11/18/the-downside-of-401k-automatic-enrollment
http://www.401khelpcenter.com/cw/cw_auto_enroll.html#.UqYzl2RDuAc
http://www.inudgeyou.com/green-nudge-nudging-litter-into-the-bin/
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
The behavioral finance research tells us that most people take mental shortcuts to arrive at decisions, and some of them lead to odd conclusions. Around the time you make your New Year's resolution to lose weight, do you buy a $500 annual membership to a gym or opt for a $10 per visit pay-as-you-go fee? Most people who choose the former end up actually going to the gym less than once a month; the flat fee is only a bargain when you assume that the bold post-resolution intention will actually happen, but it's often a terrible deal when a person's actual behavior is taken into account.
How do you decide whether to be an organ donor when you face the option on your driver's license application? In countries where the default option is yes (you consent to be an organ donor), 90% of individuals happen to be registered organ donors. In countries where the default option is no, the percentage ranges from 10% to 30%.
This research is now finding its way into the hands of policy makers, who are pioneering a new governmental role of protecting you against the dangers of your own mental shortcuts. One recent example is automatic enrollment in a company retirement plan. Research shows that if people are required to affirmatively opt-into having a portion of their paycheck sent to their 401(k) retirement plan, they will do so at a lower rate (67%) than if they are enrolled by default and have to affirmatively opt-out (77%). The U.S. government has been encouraging auto-enrollment policies at American corporations, on the theory that workers will be better off if more of them are making regular 401(k) plan contributions.
Another example in Britain came when the government offered tax incentives for people to insulate their attics, reducing energy consumption and the associated pollution from energy production. But so few people showed an interest in the incentives that the UK government finally had to switch tactics. It offered the same tax break, but added a loft clearance service that would help people clean out their attic and give them assistance in disposing of (sell or throw away) unwanted items. The new service tripled insulation participation rates.
When the city of Copenhagen painted green footprints on the sidewalks leading to litter bins, littering decreased by 46%.
The idea of applying behavioral economics to political and social initiatives sounds a lot like manipulation to its critics, who worry that we are moving toward a "nanny state" where the government feels compelled to protect us from our own behavioral biases. Reducing litter on the streets of Copenhagen is relatively noncontroversial, but what about initiatives that try to influence buyers to select more energy-efficient cars? Or government policies that discourage the consumption of certain foods or beverages? The New York City ordinance against large soda containers was based on the assumption that people were unable to recognize, on their own, the health risks of soda consumption.
Interestingly, at least one of these behavioral initiatives is now showing evidence of backfiring. The Center for Retirement Research at Boston College found that companies that have switched to automatic enrollment in their 401(k) plans have been paying for the additional cost by giving their employees smaller employer matches--3.2%, compared with an average 3.5% for plans without automatic enrollment. At the same time, the Boston College researchers and the Vanguard organization have found that for some workers, the automatic savings rate offered in the default is lower than what many workers would have chosen if they had made an affirmative decision to participate. Worse, the automated mix of investments (typically target date funds) that is the default option has underperformed the investment mixes that workers have tended to select on their own. For some workers, at least, the government's behavioral finance nudge will cost them real money.
Sources: http://www.politico.com/magazine/story/2013/12/obamas-nanny-state-100848.html
http://swampland.time.com/2013/08/09/nudge-back-in-fashion-at-white-house/
http://money.usnews.com/money/retirement/articles/2013/11/18/the-downside-of-401k-automatic-enrollment
http://www.401khelpcenter.com/cw/cw_auto_enroll.html#.UqYzl2RDuAc
http://www.inudgeyou.com/green-nudge-nudging-litter-into-the-bin/
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Monday, January 6, 2014
HOW TO BEAT THE MARKET
Chances are, you've read articles saying that it is impossible to beat the market--that is, to consistently earn higher returns than the stock market averages. At a recent conference for industry professionals in Dallas, the distinguished economist Dr. Horace Brock offered a deep dive into economic theory, and told the audience that there are actually multiple ways to beat the market.
The first and most obvious way is cheating. If you have inside knowledge about a stock that nobody else possesses, then you can make more astute trades than everyone else. The Securities and Exchange Commission has managed to catch a number of these criminals. You may have heard of Ivan Boesky, or Martha Stewart's famous phone call to her friend the founder of ImClone. Quest Communications chief Joseph Nacchio dumped more than $50 million of company stock in 2005 before his company went into decline. More recently, police are pursuing a massive insider trading case against a French doctor and FrontPoint Partners, who are accused of netting $30 million while trading on nonpublic knowledge.
Until they were caught, these "investors" (and Galleon Group hedge fund manager Raj Rajaratnam, Charles and Sam Wyly and certain Bear Stearns hedge funds) were making a lot more money in the markets than you and I ever will.
If you're not especially good at cheating, then you can rely on the second way to beat the market: luck. Don't laugh; there's evidence that most of the mutual funds that outperform the overall market in any given year just happen to be lucky. Their luck tends to lead to bad luck for investors, however. Investors have a tendency to assume that the fund managers who had great performance this year are brilliantly astute, move their money out of less-lucky funds, and then lose money when the managers' luck runs out and their funds underperform by roughly what they were outperforming before. Net-net, these managers had exactly as much bad luck as good luck, but many more investors were exposed to the bad luck period than the good luck period. Ouch!
You can also win the lottery, and some people are lucky enough to do so. Their "investment" return on that lottery ticket is astronomical; nobody can deny that.
Brock offered three other ways to beat the market, all of which rest on sounder footing. By way of background, he cited very complicated research by Mordecai Kurtz at Stanford which showed that almost 95% of the short-term market movements can be explained by two things: news and expectations. The news is pretty simple; suppose Intel beats the consensus estimate of its earnings next quarter by two cents a share. This can either send the stock price soaring or tumbling, depending on whether most investors expected the stock to miss its earnings estimate (therefore, the news is better-than-expected and the stock rises), or to beat its earnings estimate by more than two cents (bad news, the stock plunges). Bigger picture, the news might be that Greece has tumbled into default, causing a short-term plunge in stocks around the world.
But longer-term price movements depend on how the world changes more gradually, based on trends that are not obvious and seldom in the news. To take some of the more obvious examples: China abandons communism and gradually becomes the second-largest economy in the world. The Internet is born, and creates entirely new market dynamics. Europe adopts a new common currency, which sets in motion a lot of other changes for good or ill.
So how do you beat the market? If you are slightly more astute about understanding the business implications of these trends than the average person, Brock told his audience, then it is possible, over the long-term, to position your assets more advantageously. Your secret sauce is thinking and reading--or investing with very thoughtful money managers who take a long-term view of gaining returns.
You can also beat the market by not following the herd. Brock said that new mathematical models of market bubbles and busts allow for what he called "the uneven distribution of mistakes," a world where most investors can be wrong about their expectations or evaluations, all in the same direction. Remember how people were flipping houses in 2007 and Wall Street firms were betting the world that housing prices would never go down? Remember the technology mania leading up to the 2000 Tech Wreck?
You can beat the market by holding a diversified portfolio (which will keep pace with the market) and systematically rebalance your investments regardless of what fearful or euphoric cries other investors are screaming outside your window. That way, when the distribution of mistakes is nearly 100% on the side of euphoria, you will be holding fewer stocks than the average investor and participating less in the inevitable bust. And when the distribution of mistakes is on the side of fear and nobody wants to own stocks, you're participating in the market and benefiting from the inevitable recovery.
These last two methods of beating the market are not nearly as exciting as cheating or winning the lottery. So if you want excitement, you can turn to the last way that Brock said markets can be beaten. Every Wall Street firm has active traders who stare at six or eight computer screens all day long, with their finger hovered over a buy or sell button. They house their trading servers in the same building as the mainframe servers that process orders for the New York Stock Exchange and Nasdaq, so their buy and sell commands will arrive milliseconds ahead of the competition. They study expectations, and then, as soon as news arrives, that instant, they make a trade that will be thousandths of a second ahead of other quick-twitch traders--and, probably, a few days ahead of the trade that you and I would eventually be tempted to make.
This quick-twitch trading arrangement doesn't always work out exactly as planned, however, which greatly adds to the excitement. Bruno Iskil, otherwise dubbed "The London Whale," managed to trade away more than $6.2 billion (with a "b") of the assets of JPMorgan in 2012, while Brian Hunter's quick reflexes on the keyboard ultimately cost hedge fund investors in Amaranth Advisors a total of $6.4 billion in 2006. Baring Brothers Bank collapsed in 1995 thanks to the fast and furious futures and options trading activities of Nick Leeson. Yasuo Hamanaka at Sumitomo Bank ($2.6 billion in losses), Jerome Kerviel at Societe Generale Bank ($6 billion), Toshihide Iguchi at Daiwa Bank ($1.1 billion) and Kweku Adoboli at UBS ($2 billion) all generated their share of excitement for the institutions that employed them.
The good news here is that it appears, based on sound theoretical evidence, that people CAN beat the market in a variety of ways. Some of them are legal, but only a few are safe. The safest methods also happen to be pretty boring--and, alas, they don't come with guarantees.
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
The first and most obvious way is cheating. If you have inside knowledge about a stock that nobody else possesses, then you can make more astute trades than everyone else. The Securities and Exchange Commission has managed to catch a number of these criminals. You may have heard of Ivan Boesky, or Martha Stewart's famous phone call to her friend the founder of ImClone. Quest Communications chief Joseph Nacchio dumped more than $50 million of company stock in 2005 before his company went into decline. More recently, police are pursuing a massive insider trading case against a French doctor and FrontPoint Partners, who are accused of netting $30 million while trading on nonpublic knowledge.
Until they were caught, these "investors" (and Galleon Group hedge fund manager Raj Rajaratnam, Charles and Sam Wyly and certain Bear Stearns hedge funds) were making a lot more money in the markets than you and I ever will.
If you're not especially good at cheating, then you can rely on the second way to beat the market: luck. Don't laugh; there's evidence that most of the mutual funds that outperform the overall market in any given year just happen to be lucky. Their luck tends to lead to bad luck for investors, however. Investors have a tendency to assume that the fund managers who had great performance this year are brilliantly astute, move their money out of less-lucky funds, and then lose money when the managers' luck runs out and their funds underperform by roughly what they were outperforming before. Net-net, these managers had exactly as much bad luck as good luck, but many more investors were exposed to the bad luck period than the good luck period. Ouch!
You can also win the lottery, and some people are lucky enough to do so. Their "investment" return on that lottery ticket is astronomical; nobody can deny that.
Brock offered three other ways to beat the market, all of which rest on sounder footing. By way of background, he cited very complicated research by Mordecai Kurtz at Stanford which showed that almost 95% of the short-term market movements can be explained by two things: news and expectations. The news is pretty simple; suppose Intel beats the consensus estimate of its earnings next quarter by two cents a share. This can either send the stock price soaring or tumbling, depending on whether most investors expected the stock to miss its earnings estimate (therefore, the news is better-than-expected and the stock rises), or to beat its earnings estimate by more than two cents (bad news, the stock plunges). Bigger picture, the news might be that Greece has tumbled into default, causing a short-term plunge in stocks around the world.
But longer-term price movements depend on how the world changes more gradually, based on trends that are not obvious and seldom in the news. To take some of the more obvious examples: China abandons communism and gradually becomes the second-largest economy in the world. The Internet is born, and creates entirely new market dynamics. Europe adopts a new common currency, which sets in motion a lot of other changes for good or ill.
So how do you beat the market? If you are slightly more astute about understanding the business implications of these trends than the average person, Brock told his audience, then it is possible, over the long-term, to position your assets more advantageously. Your secret sauce is thinking and reading--or investing with very thoughtful money managers who take a long-term view of gaining returns.
You can also beat the market by not following the herd. Brock said that new mathematical models of market bubbles and busts allow for what he called "the uneven distribution of mistakes," a world where most investors can be wrong about their expectations or evaluations, all in the same direction. Remember how people were flipping houses in 2007 and Wall Street firms were betting the world that housing prices would never go down? Remember the technology mania leading up to the 2000 Tech Wreck?
You can beat the market by holding a diversified portfolio (which will keep pace with the market) and systematically rebalance your investments regardless of what fearful or euphoric cries other investors are screaming outside your window. That way, when the distribution of mistakes is nearly 100% on the side of euphoria, you will be holding fewer stocks than the average investor and participating less in the inevitable bust. And when the distribution of mistakes is on the side of fear and nobody wants to own stocks, you're participating in the market and benefiting from the inevitable recovery.
These last two methods of beating the market are not nearly as exciting as cheating or winning the lottery. So if you want excitement, you can turn to the last way that Brock said markets can be beaten. Every Wall Street firm has active traders who stare at six or eight computer screens all day long, with their finger hovered over a buy or sell button. They house their trading servers in the same building as the mainframe servers that process orders for the New York Stock Exchange and Nasdaq, so their buy and sell commands will arrive milliseconds ahead of the competition. They study expectations, and then, as soon as news arrives, that instant, they make a trade that will be thousandths of a second ahead of other quick-twitch traders--and, probably, a few days ahead of the trade that you and I would eventually be tempted to make.
This quick-twitch trading arrangement doesn't always work out exactly as planned, however, which greatly adds to the excitement. Bruno Iskil, otherwise dubbed "The London Whale," managed to trade away more than $6.2 billion (with a "b") of the assets of JPMorgan in 2012, while Brian Hunter's quick reflexes on the keyboard ultimately cost hedge fund investors in Amaranth Advisors a total of $6.4 billion in 2006. Baring Brothers Bank collapsed in 1995 thanks to the fast and furious futures and options trading activities of Nick Leeson. Yasuo Hamanaka at Sumitomo Bank ($2.6 billion in losses), Jerome Kerviel at Societe Generale Bank ($6 billion), Toshihide Iguchi at Daiwa Bank ($1.1 billion) and Kweku Adoboli at UBS ($2 billion) all generated their share of excitement for the institutions that employed them.
The good news here is that it appears, based on sound theoretical evidence, that people CAN beat the market in a variety of ways. Some of them are legal, but only a few are safe. The safest methods also happen to be pretty boring--and, alas, they don't come with guarantees.
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
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