Is Dividend Investing Overrated?

More and more I hear about the benefits to investing in dividend paying stocks. The idea is to invest in solid companies that pay a decent dividend. The more shares of the company you own, the more dividend income you will earn. For some, the goal is to have dividend income replace their work income so they can retire. For others, the goal is to use the dividend income now as a source of income while in retirement.

Investing

While this dividend investing strategy has its merits, there are some things you need to be aware of when going this route.

Why Are People Flocking to Dividend Investing Strategies?

The first question we need to ask is why the push to dividend investing? The answer is twofold. First, you have current retirees who use the income from stocks and bonds to live off of. Back when I was younger and my grandparents were alive, they mainly invested their money in bonds and the 5-6% yields on those bonds generated enough money to fund their retirement. For example, if you have $500,000 invested in bonds that pay 6% a year, you are looking at $30,000 a year in income. Add Social Security to this number and you can live a decent retirement.

But today, things are different. Bonds are yielding much less. In many cases, you are looking at best 2% for a yield. With $500,000 invested, that generates $10,000 in income per year. Even with Social Security, you are looking at a tougher retirement.

To overcome the low bond yields, many retirees have turned to dividend paying stocks. Here, they can invest in stocks that earn 3-4% in dividends, which comes out to $15,000 – $20,000 in income per year.

The second reason for the push to dividend stocks is that many investors are seeing the power of dividends. They realize that dividends are taxed at a lower tax rate if they are qualified and that these dividends can help to offset earned income. In other words, if you invest enough money in dividend paying stocks, you can eventually quit your job and live off of the income. When you get to this point, it is called financial independence.

The Potential Downfall of This Strategy

The major potential pitfall to the dividend investing strategy is that so many people are flocking to dividend paying stocks. As more and more people invest in these stocks, they push the prices higher and higher. What happens when interest rates start to rise?

Many of the retirees that are investing in dividend stocks solely for the higher yield will run to a lower risk investment, namely bonds. When they start leaving the market, stock prices will fall. We have seen evidence of this a few times when the Fed has signaled that it might soon raise rates. The stock market drops a couple hundred points.

Now, I cannot say how much the stock market will fall and I am not trying to incite fear in anyone reading this. As long as you have a long-term view of the stock market, you should be fine as prices will eventually come back. But, there will be the fear to sell and sit on the sidelines when stock prices fall. When you do this, the income you earned from the stocks will be offset by the money you lost in a lower share price.

What is a Good Strategy?

The best strategy is the same one that has been a good strategy in the past – hold a well diversified portfolio. If you have a nice mix of stocks and bonds and you have a long-term view of investing, you can weather any drop in the market and come out ahead in the future. The key though is staying invested.

Additionally, you want to make sure that your investments are set to have any dividends you earn reinvest to buy more shares. Why is this important? Over the past 90 years, dividends account for close to 40% of the total return of the stock market. What does that mean?

In a basic sense, if you did not reinvest the dividends you earned, you would have 40% less than you would have if you reinvested. That is a huge number.

Final Thoughts

The point is not to scare you out of investing. It was to talk about the potential pitfall of a popular investing strategy I see many investors taking a liking to. Always remember to look at both sides of the issue so that you know the risks as well as the rewards from anything you do.

If you are okay with the risks, then a dividend investment strategy could work wonders for you. But if the risks aren’t worth it to you, you might be better off sticking with a well-diversified portfolio.

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Brexit and Your Investments: What Should You Do?

If you’ve watched any financial news lately or opened up a newspaper, you know that the United Kingdom has voted to remove itself from the European Union, also known as Brexit. If you are like many people, you don’t fully grasp what this truly means. As a result, you rely on the news to provide you with the information. And judging by the news, there is blood in the financial and economic streets.

The US market dropped over 600 points last Friday and another 200 on Monday. Investors were scared. But should they be? What really does the UK leaving the European Union mean for your dollar? We will examine this to make things more clear for you so that you can stomach any future volatility in the stock market.

Brexit vote

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The Brexit: What You Need to Know

From a financial standpoint, all of the 28 (now 27 countries) in the European Union follow the same set of main guidelines when trading between each other. There are no tariffs between countries. A business in Germany can easily do business in any of the other EU countries.

Now that the UK is leaving the EU, they will have to come to agreements with the remaining countries in the EU. Will there be tariffs? What about other taxes on goods and services? No one knows this as of yet. But many people are forecasting that the UK will go into a recession because of the Brexit vote. Only time will tell if they actually do or do not.

Also related to the Brexit from a financial standpoint is immigration. As a citizen of a country in the EU, you can easily travel between countries and not just vacation, but also live and work very easily. You don’t need a visa like in many other countries. So now expats of the UK will have to follow a new set of rules if they are living and working in any EU country and the same holds true for anyone living or working in the UK who is a citizen of another EU country.

Brexit and Your Money

Most of the readers here are from the US, so the most direct impact you will have in terms of the Brexit is the stock market. As we now live in a global economy, what happens in other parts of the world will have an impact here. The question is, just how much of an impact?

Based on what happened in the stock market the past few days, many would assume a large impact. But I disagree. In the days leading up to the Brexit vote, the US markets rallied assuming that UK citizens would vote to stay in the EU. When news broke that they voted to leave, the same investors who bought in now had to sell. This is what happened on Friday.

Over the weekend, everyone else read the news and digested the market drop on Friday and got scared. So come Monday, everyone else was ready to sell, thinking this was the end.

But it isn’t. It’s far from the end. The truth is, it will take at least two years for the UK to fully divest itself from the EU. What’s more, while the UK economy could go into recession, it is not as dominate of a player in the world economy as the US is.

For example, if you look back over the past few years, the US economy has been improving and the stock market has been doing well. The gains in the stock market are partially due to the Federal Reserve stepping in, but it is also because foreign investors are buying US stocks. These investors see the US economy as stronger than their home country, and as a result are buying US stocks in hopes of earning a higher return.

What Should You Do?

So what should you do with your investments? If you have time, meaning you don’t need the money in your accounts for 10 or more years, then doing nothing is your best option. You might even consider buying shares at this low point. The reason is because over the short term, there is going to be some volatility. We will see jumps and drops every now and then. But that is no reason to sell everything and prep for the end of the world.

If you do sell, like the average investor who moves in and out of the market based on short-term events, it will be the reason Why You Aren’t Earning What Your Mutual Fund Says You Are.

Don’t get caught up in the headlines trying to spook you into thinking this is it or the UK is the first domino to fall. You should take some time and realize that every so often, these doomsday predictions come about and they rarely ever pan out.

But what if you have less than 10 years until you need the money? In this case, I would take a hard look at your asset allocation and possibly speak to an advisor. You certainly don’t want everything you own in stocks since you could lose a decent amount in the short term. But at the same time, you don’t want zero exposure to stocks as bonds won’t be giving you the income or growth you may need.

One option could be to lower your exposure to international stocks. These would be non-US companies that do most of their business overseas. You still could get international exposure in large US based companies since so many do business overseas.

Final Thoughts

At the end of the day, understand that over the short term, the markets will be choppy and that on any given day, things could look really bad. But know that this is always the case short term. Long term, things will become clearer and much less volatile. If you are investing for the long term, you should take the steps to ride out the short term craziness in the markets and keep investing for your future.

If you are investing for the short term, then you might want to reassess your strategy and allocation so that you still have some exposure to take advantage of gains while at the same time protecting your assets until things settle down.

Are you invested for the long term? What are your thoughts on the Brexit vote?

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529 Plans versus UTMA Accounts

When I was growing up, my parents used an UTMA account to save money for my college expenses. Back then, it was really the only way to save for a child’s education. Nowadays, the 529 is a popular option. You may have heard about both types of accounts, but don’t know what the differences are between the two. Below I break down each account along with the benefits and drawbacks so that you can get a better idea of which account is right for your situation.

UTMA Account

An UTMA account, or Uniform Transfer to Minors Act account is a way for children to have ownership of assets. This is because minors are not legally allowed to own money or property, in a general sense. Because of this, each state has developed this type of account which allows for the child to have ownership of the assets. (A quick side note, UTMA and UGMA accounts are virtually the same except for the age at when the child has full ownership of the account. I’ll explain this in more detail below.)

What age does the child take full ownership? An UTMA or UGMA account is a custodial account. The account is the child’s, but the custodian, usually the parent, has a fiduciary responsibility to manage the account for the benefit of the child. The custodian acts on the account (making deposits and withdrawals) until the child reaches the age of majority for your given state. See the chart below for the most up to date list of majority age by state.

Here is where the difference in UGMA and UTMA accounts lies. For UGMA accounts, the child gains full access to the account when they turn 18 or 21, depending on the state they live in. UTMA accounts can be in the parents control until the child reaches 25 years old, depending on the state.

Income Tax Considerations

Any interest on the account is taxed to the child since the account has their Social Security number was used to open the account.

Benefits of UTMA Accounts

A nice advantage to an UTMA account is the reduced taxes. For 2016, the first $1,050 of unearned income (interest, dividends) is not taxed. The next $1,050 is taxed at the child’s tax rate. Anything above $2,100 in unearned income is taxed at the parent’s tax rate, when the kiddie tax kicks in. Of course, once you hit the $2,100 threshold, the benefit of an UTMA account in terms of tax savings goes away.

Drawbacks of UTMA Accounts

The main drawback of an UTMA account is that it counts against the child if the child is applying for financial aid for college. This is because the assets are in the child’s name and colleges look at the applicant’s (student’s) assets when determining financial need.

Another big drawback is the money in the account is the child’s when they reach majority age. While this may not seem like a big deal, the fact is once it is their money, they can do anything they want with it. So, if the account has a $50,000 balance when little Johnny or Susie reaches 18, they can buy a car with the money. Or travel with it. Or pay for college. It’s their call and you cannot do anything about it. While we all like to think that we are raising little angels, the truth is, that may not be the case.

529 Plan

A 529 Plan is a way for parents to save for their child’s college education. There are two main types of plans, a prepaid program and a savings account. Here, I am referring to savings accounts.

With a 529 plan, you make the contributions and the money grows tax free. When the money is withdrawn from the account, no taxes are paid assuming the money was used for qualified educational expenses. These expenses include tuition, fees, books, supplies and equipment, and reasonable costs of room and board (for those that are enrolled at least half-time).

You can contribute as much as you like to a 529. While this sounds great, any contributions that total more than $14,000 in a given year may be subject to the gift tax.

Benefits of 529 Plans

The main benefit is that the assets in the account are not the child’s, therefore they do not count against them at the child rate when applying for financial aid. This is because the child is a beneficiary of the plan, not the owner of the plan. If a parent is the account owner, the assets will be included as a parental asset (which is about 15% lower than the child rate). If a grandparent or another person is the account owner, the assets will be excluded from the calculations.

Another benefit is that you can change the beneficiary of the plan. Let’s say you have the account for little Johnny and he decides to not go to college. All you have to do is change the beneficiary from Johnny to Susie and she can use the money for college. You can even change the beneficiary to your niece or nephew if you want to.

You can choose whichever state plan you want. Each state has its own 529 plan. Contrary to popular belief, you can open up any state plan. So, if you live in Florida you don’t have to open up the Florida 529 Plan. Also, if you live in Florida and use the Florida 529 Plan, your child does not have to attend school in Florida. They can go to any college they would like.

Another benefit, just to emphasize the above, is that as long as the money being taken out of the account is for qualified educational purposes, no tax is paid.

Finally, some states allow you to deduct contributions to 529 plans on your state income tax.

Drawbacks of 529 Plans

If the money in a 529 is withdrawn for non-qualified educational expenses, it is taxed and is subject to a 10% penalty. There are some exceptions to this penalty. You can find the full list of them on the IRS website.

Each state has its own 529 Plan. Some are much better than others. This makes it confusing when trying to pick which state’s plan is the best. Personally, I like the Utah 529 Plan the most because it uses Vanguard funds and has very low fees associated with it.

Final Thoughts

If you are primarily saving for your child’s college education, a 529 Plan is a much better plan compared to an UTMA account for the reasons I laid out above. Of course, there are other plans for saving for college, so you will have to assess those as well to determine which one fits your needs and goals best.

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The Danger and Allure of Investing in Penny Stocks

We all want to become overnight millionaires. There are get rich quick infomercials on just about every late night television channel. Some people turn to the stock market in hopes of picking the next Apple or Google, but many times, this effort fails miserably.

Yet, the allure of a penny stock still draws in many investors. After all, where else other than Las Vegas can you put $5,000 down and walk away with double that in a short period of time? Here’s why you need to take extra precaution when investing in penny stocks.

penny stocks

What is a Penny Stock?

According to the SEC,

The term “penny stock” generally refers to a security issued by a very small company that trades at less than $5 per share…

Penny stocks may trade infrequently, which means that it may be difficult to sell penny stock shares once you own them. Moreover, because it may be difficult to find quotations for certain penny stocks, they may be difficult, or even impossible, to accurately price. For these, and other reasons, penny stocks are generally considered speculative investments.

The Risks Associated With Penny Stocks

The biggest risk when it comes to penny stocks is price manipulation. When you are talking about a stock that trades for $0.33 per share, simply having the price go up or down $0.02 makes a big impact. For example, if you invested $5,000 into this stock, you would own over 15,000 shares. If the price moved by $0.02 per share, you just made or lost $300. If the price moved by $0.20, you are looking at a gain or loss of $3,000!

Because of this, it is in the best interest of those invested in the stock to have the price increase. With penny stocks, making the price of the stock move is much easier than you would think. For example, you could easily go onto a stock trading message board and start talking about how great the company is and about a new product they are bringing to market. When others read these posts, they get excited and start to buy. This drives the price up, allows the first person to make some money, sell their holding and move on to another stock.

How does this work? While stocks are regulated, the companies behind penny stocks are so small and have such little (if any) revenue, they are not as high on everyone’s radar.

For example, most financial analysts are out researching other larger companies. They aren’t spending their time on the little fish. Therefore, you’ll have a hard time finding analyst research and recommendations on these stocks. This means that most of the information you hear is from people that might not have the best of intentions.

Even worse, in some cases, people will pay to get stories about certain penny stocks promoted. By doing this, they will pay a firm some money to publish reports that tout how great a company is and how they are poised to be a leader in the coming years. When you begin to do your research on the company, you see these reports that look legitimate to you, but they really are not.

How Do You Protect Yourself?

Other that not investing in penny stocks altogether, the only way to protect yourself is to do an incredible amount of research. For starters, you will want to make sure the information you are reading is honest or correct. The best way to make sure of this is to visit the company’s website or the SEC website. In both cases you will find reports that the company itself submitted talking about its business.

From there, you have to question everything you read. If you go on message boards, try to gain information from the poster. Do you see a pattern of them hyping the stock for a period of time? Maybe they hype for a few months, disappear, then come back hyping again. This could mean they buy low, hype the stock, sell high, and wait for the price to drop again.

Additionally, see what else the poster writes about. Maybe they are touting various penny stocks with the same message just reworded. Unfortunately, not only does this take time on your part, but the people good at hyping a stock will be sure to have various usernames and aliases making it nearly impossible to find a pattern. At the end of the day, you are left with trying to figure out why this person is telling you the information. Does it benefit them in any way? Most likely the answer is yes.

Final Thoughts

The allure of striking it rich overnight will always be there for many of us. If you decide to take the penny stock route, I urge you to be cautious. Read only reports released by the company, since the majority of other reports cannot be trusted. In addition, invest only with money you are comfortable losing. The odds are much greater that you will lose it all rather than double it.

Would you invest in penny stocks?

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Why You Shouldn’t Focus on Income to Grow Your Wealth

After I wrote how to calculate your net worth, I was out with a friend and we were talking about growing our wealth. Throughout the conversation, he continued to focus on growing his income. I had to explain to him that his approach to growing his wealth was flawed.

Why was his approach flawed? Why shouldn’t you focus on income to grow your wealth? What should you focus on?

net worth

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Overview of Net Worth

When it comes to growing our net worth, there are two sides to the equation: assets and liabilities. The best way to grow net worth is to make sure we eliminate, or limit liabilities as much as possible and increase our assets as much as possible.

When it comes to liabilities, this means avoiding debt as much as possible. Now, I realize we can’t avoid debt altogether. I personally would never own a home if I didn’t take out a mortgage. So some debt is expected. Do you know What Percentage of Assets and Liabilities are in Your Home?

But when you do have debt, make sure you are taking the steps to pay it off on time or even sooner. For every dollar you decrease your debt, you are increasing your net worth.

Don’t Focus Solely on Income to Grow Your Net Worth

When it comes to assets, the strategy gets a little more involved. Many people like my friend will put all of their energy into growing their incomes. They will work 80 hour weeks to generate a large paycheck.

This isn’t a bad thing, but you also have to make sure you are saving and investing as much of that money as possible. When you do this, you can earn interest, dividends, capital gains and enjoy appreciation as well.

The earnings on your investments will help you grow your net worth more quickly than you can possibly grow your income. After all, you will eventually get capped out on your earning potential. All jobs have a pay floor and ceiling and once you hit that ceiling, you are done. Your only option is to see if another company is paying more for a similar job or move higher up the corporate ladder by taking on another role with more responsibilities.

There is no ceiling to earning dividends and income from your savings and investments. They continue to generate more and more income, year after year as long as you continue saving and investing.

Focus on Savings to Make Your Money Work For You

You should be focusing most of your attention on saving and investing the money you earn. The reason for this is simple: let’s say you put all of your energy into earning $150,000 a year but don’t focus on saving it. When can you retire? The answer is never because you have to keep working so that you have money. You are working for your money.

If on the other hand you save as much as you can and invest it, you can retire at some point. This is because your savings will be generating income and you can also use the savings as income. In this case, your money is working for you.

Which scenario sounds better? Personally, I will take the option of retiring over having to work forever. If you feel the same, then you need to make sure you are not ignoring the saving part of growing your net worth.

I am not saying you should completely ignore earning as much as you can. After all, the more you earn, the more you can potentially save, which means you can retire even sooner than you thought. What I am saying is that you need to focus on both parts of the asset side of your net worth statement. When you can do this, you will start to see positive results.

Final Thoughts

If you want to be financially free, you have to calculate your net worth. It is a great tool to keep you motivated to grow your wealth and improve your finances. When you do track it, make sure you are not forgetting about growing your assets by saving and investing as much money as possible. Doing this will allow you to grow your net worth much faster than if you simply focused on growing your income alone.

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Avoid These Pitfalls of Taking out a 401k Loan

A popular way to borrow money recently has been to take a loan from your 401k plan. The thought is this type of loan is OK since you are both the borrower and lender and therefore, you reap the rewards of the interest. While technically this is true, there are some pitfalls to avoid when taking out a 401k loan and some issues to consider before you sign on the dotted line. Let’s review them so you can make the best decision for you and your future.

401k loan

(Photo Credit: Stuart Miles/FreeDigitalPhotos.net)

How Does a 401k Loan Work?

Here is a brief background for how a 401k loan works. You fill out the necessary paperwork with your employer and you get a check for the loan amount. You then repay the loan back to your 401k plan along with a stated interest rate. For most loans from a 401k plan, the interest rate is usually 1-2% higher than the prime rate.

As of this writing the prime rate is 3.5% so you would be looking at an interest rate of 4.5% or 5.5% if you took out a loan today. Again, you pay yourself the interest.

Other things to consider:

  • The loan must be repaid in 5 years but can be longer if the money is used for the purchase of a new home
  • You can borrow up to 50% of your 401k plan balance or a maximum of $50,000
  • In many cases, you have to pay fees to take out this loan
  • You cannot change the monthly amount you have to repay
  • The interest you pay is not tax deductible

The Pitfalls of 401k Loans

On the surface, this sounds like a win-win situation. You borrow money and pay yourself and not some greedy bank the interest. But here are a few things you need to understand.

You Decide to Quit

Let’s say you take out a 401k loan and 6 months later you find your dream job. What happens to your loan? It is due in full within 30 or 60 days (depends on your 401k plan guidelines) of you leaving your employer. So, if you took out a $25,000 loan, and there is a $22,000 balance outstanding, you have to pay this $22,000 in full in 60 days. Odds are you don’t have $22,000 lying around otherwise you wouldn’t have needed the loan.

So what happens? The IRS makes you pay taxes on the amount outstanding plus an early withdrawal penalty (the penalty only applies if you are under 59 ½ years old).

The penalty is 10%. So, if you are in the 25% tax bracket and you have the $22,000 outstanding balance, you would owe $7,700 ($22,000 x 0.25) + ($22,000 x .10) in taxes. That’s not fun.

You Hurt Your Future Self: Stopping Contributions

Most people don’t save enough for retirement to begin with. When you take money from your 401k plan, you increase the risk of waking up when you are 60 and realizing you can never retire.

Yes you will pay yourself back the money (hopefully you will, but there is a chance you won’t) but as life happens and expenses arise, you may cut back or stop your retirement savings.

Additionally, many people stop their regular contributions to the plan when they have a loan to repay. The thinking is that since you are paying yourself, you aren’t negatively hurting yourself. But doing this will hurt you greatly as we will see in the point below.

Ideally you just want to leave retirement money be. It is for retirement after all and was never intended to be a short term loan.

You Hurt Your Future Self: Missing Stock Market Growth

Paying yourself sounds great, but you are really hurting your retirement dreams. This is because of compound interest. If you were to leave the money alone to grow in the stock market, it would most likely average 8% annually (the historical average of the stock market).

By taking the loan, you are at best paying yourself 5.5% interest. That is a difference of 2.5%. I know it doesn’t sound like much, but thanks to compound interest, it is.

Let’s look at a quick example. You have $50,000 saved for retirement and that money will grow for 30 years. In scenario 1, you leave the money invested in the stock market and never add any more to it. In scenario 2, you take a $25,000 loan out and pay back with 5.5% interest. What do you end up with in 30 years?

  • Scenario 1 (left money invested): $503,132
  • Scenario 2 (took the loan): $470,432

That 2.5% difference in interest turns out to be a costly one. You have $30,000 less because you took out that loan.

The kicker here is that it is a simplified example. Most likely you are adding more money each month to your retirement plan so the difference is going to be much greater.

Final Thoughts

You need to really think long and hard before taking out a 401k loan. It sounds great – you pay yourself back the interest, but you earn a lower return and that lower return can cost you in the future.

I’m not saying you should never consider taking out this type of loan, but rather make it a second or third option. In many cases, people use this loan when buying a house. They need the cash for a down payment.

Try to find ways to save money for the down payment as opposed to raiding your retirement account. It’s not the end of the world if you have to put off the dream of home ownership a year or two so you can save for a down payment.

Taking on a house purchase is a big step and it has lots of unexpected expenses related to it. Make sure you are on solid financial ground, which includes a healthy retirement balance so you don’t jeopardize your future dreams.

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5 Ways to Reduce Your Taxes as an Investor

I recently had my tax appointment with my accountant and realized just how much of a tax savings I had because of the smart things I did with my investments. The great thing here is that the things I did to help keep my tax bill low weren’t difficult to do.

Ways to Reduce Taxes through Investing

Here are some tips to reduce taxes through investing for you to take advantage of before the tax deadline.

reduce taxes through investing

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Put Money Aside for Retirement

I know, we’ve all heard this one, but you hear it because it works. For me, it works especially well since I’m self employed and contribute to a solo 401k. This allows me to not only put away the typical $18,000 limit as an employee, but I can contribute more as an employer.

In the couple years I’ve been working for myself, I never have been able to contribute the absolute max to this plan, but I sock away as much as I can.  If you are in the 25% tax bracket and contribute $4,000 to your 401k at work, you just saved yourself $1,000 in potential taxes. To me this is no-brainer. You save for retirement and you save on taxes.

Read More: Can You Have a 401k and an IRA at the Same Time?

Pick Smart Investments

Mutual funds are a good option for many investors. You invest with a little bit of money and get professional management and are diversified from the start. But mutual funds don’t allow you to control capital gains.

Even if you don’t sell any of your holdings during a given year, chances are you still will have capital gains. It might look nice to get a couple hundred dollars when a mutual fund distributes a capital gain, but the downside is that you are taxed on that money.

To avoid this, you should look into exchange traded funds (ETFs). Many of these don’t pay out capital gains, only dividends. This will help you to keep your tax bill in check at the end of the year.

Now, don’t go run out and change all of your investments. You should slowly transition over to ETFs because if you sell your holdings in a taxable account, you will owe taxes on any gains you have.

This doesn’t apply to investments held in retirement accounts, since any income you earn from investments is tax deferred until you begin to withdraw the money.

Read More: Do You Know the Difference Between an ETF and a Mutual Fund?

Pay Attention To Asset Allocation

Asset allocation is making sure your portfolio is well diversified and working at the best it can to grow for you over time. One area that is sometimes overlooked by investors is what investments are where. This is important because it can have a large impact on your taxes.

In general, you should have assets that are the least tax efficient in retirement accounts and those that are most tax efficient in non-retirement accounts. So what does this mean?

If you invest in a bond portfolio that doesn’t hold government or municipal bonds, you want to make sure this is held in a retirement account. This is because bond funds pay off interest each month and that income is treated as ordinary income. So if you are in the 25% tax bracket, the monthly distribution the bond fund pays is taxed at 25% as well if you don’t have it in a retirement account.

Furthermore, you want to keep high turnover holdings in a retirement account too. These funds tend to throw off lots of capital gains, which you owe taxes on. You can find out what you fund turnover is by looking at a site like Morningstar.

Read More: What is a Backdoor Roth IRA?

Sell Some Losers

Another way to save on taxes through investing is to sell some holdings that declined in value when you have any realized gains. You are allowed to use the losses to “cover” the gains. In other words, when you add the loss to the gain, it will result in a lower ending number. This lower ending number is what you owe taxes on.

The nice thing is that you can use these losses to offset other income too, but only to an extent. The IRS allows you to offset $3,000 of ordinary income each year with capital losses.

So let’s say you have a capital gain of $5,000 and a capital loss of $10,000. You can use $5,000 of that loss to offset the $5,000 gain, bringing it to zero. You can then take another $3,000 of your capital loss to offset your ordinary income. This leaves you with a loss of $2,000 which you are allowed to carryover into future years. You can either use it on capital gains next year or against ordinary income.

Read More: 3 Benefits of Tax Loss Harvesting

Donate Investments

One final option for investors to reduce taxes through investing is to donate securities. In this option, you can donate your holdings to a donor advised fund. With this option, you simply transfer holdings over to a donor advised fund. Once the assets are in this fund, you can instruct how you want the money to be divided up or what charity or charities you want it to go towards.

The reason this is a smart option is because you don’t have to realize any gains you earned when you donate. For example, let’s say you want to donate $10,000 to a charity. You have an investment that you bought for $2,000 and it is now worth $10,000. If you donate that $10,000 investment from your portfolio, you get to write off the $10,000 as a charitable deduction.

If you were to sell the holding and then make the donation, you would still get to deduct the $10,000 charitable donation, but you would also have to pay taxes on the $8,000 gain you realized when you sold the investment.

Read More: What to Do With Your Required Minimum Distribution

Final Thoughts

When it comes to taxes, there are many ways you can reduce your taxes through investing. Not all of these options will apply to everyone, but you should be able to use a couple of them to your advantage. Make sure you are doing all you can to keep your taxes low. The less you pay in taxes, the more money you keep in your pocket.

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What to Do With Your Required Minimum Distribution

Read any magazine or newspaper or watch any financial television show and you will learn about the importance of saving for retirement, how much you should save, and what type of account to save your money in. But you don’t hear much about what to do when you are required to make a distribution from your retirement account. What are your options with the money?

In most cases, you will need the money and use it to pay for your daily living expenses. But what if you are in a situation where you really don’t need the money to get by financially? Or what if you only need a portion of it? Sadly the IRS doesn’t care and still requires that you take a minimum amount of money each year.

I am going to walk you through some options for what to do with your required minimum distribution.

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What is a Required Minimum Distribution?

Before we get into the options you have with this money, let’s first make sure that we all are on the same page when it comes to what a required minimum distribution is.

A required minimum distribution is an amount of money the IRS requires you to withdraw from your retirement plan every year once you turn 70 ½ years old. Read How to Calculate RMDs to help you to determine how much you need to withdraw each year and when you have to take your first and subsequent distributions based on your birthday. Be sure to understand the rules about delaying your first distribution since it can push you into a higher tax bracket.

You need to understand that most retirement plans do require a minimum distribution. These include traditional IRAs, SEP and SIMPLE IRAs, 401k, 403b and profit sharing plans. Excluded from the list is the Roth IRA. You do not need to make a required distribution from a Roth IRA. The only time one is required is if the owner passes away. The person who inherits the Roth IRA will be required to make minimum distributions each year.

What happens if you fail to take the required distribution? The IRS hits you with a penalty – a 50% penalty on the amount you didn’t take. So, if you were required to take $25,000 and only took $5,000, the IRS is going to hit you with a $10,000 penalty. This is why it is important to take your required distribution each year.

What to Do With Your Distribution

Now we get to the good part – what to do with your distribution assuming you don’t need all of it. Here are some great options for you:

Invest the money: You can’t put the money back into a retirement account, but you can certainly invest the money into a taxable account. This will allow for the money to keep growing at a decent rate of return each year until you do need the money.

Donate the money: Another option is to make a donation to a charity of your choice. You will not only be helping those in need, but you will help yourself as well. By making a charitable contribution, you will get to write off a portion of the donation on your taxes, saving you money. Some brokers even allow you to put the money into a charitable trust so that you can donate it over a few years if you would like.

Gift the money: Maybe you have a grandchild that is getting ready for college or just graduated. You can give them a gift by giving them the money to pay for college or buy their first house. You could even set the money up in a trust so that they can get the money at a later date.

Pay off your mortgage: If you still have a mortgage, you can consider making a large principal payment on the loan to help you pay it off faster.

Be an angel investor: Ever want to help an entrepreneur succeed? This could be your chance. If you find someone with a great idea, you can invest in the business or idea.

There are even some small angel investing networks around the country that team up to invest in new startups all of the time. A quick online search will help you find any in your area. Make sure you talk with a lawyer first to be sure you aren’t just throwing money away.

Start your own business: Of course, you could skip the part about being someone else’s angel investor and be your own by investing in an idea you have. Just be sure to set some ground rules so that you are smart with how much money you put into the business or idea and when to call it quits.

Final Thoughts

In the end, having to take a required minimum distribution isn’t the end the world. As long as you get creative with how to use the money (assuming you don’t need it to live off of), you can help others or even help yourself.

Take the time to understand what is most important to you and see how a small windfall can help a cause or another person to be better off down the road.

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Are You Making These 3 Excuses to Avoid Saving for Retirement?

Many people put off saving for retirement just because it is so far away. They think they will have time to start saving in 5 or 10 years. After all, 30 years into the future is long time away. Others put off saving for retirement because they are in debt. They have been told that debt is bad and they need to get out of it as quickly as possible. While this is true, saving for retirement today is still important. What excuses are you making to avoid saving for retirement? Here are some common excuses and why you need to save for retirement.

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Excuse: You’re In Debt

Let me be clear, getting out of debt is important to your financial health. But you have to be smart about digging yourself out of it. Many times we find we dig out of debt just to be right back in a mountain of it a few years later. I know because I was one of those people.

Figure out why you are in debt. The problem is that the debt cycle repeats itself because we never get to the root issue. For me, I thought I just had a spending problem and would go in spurts. Pay off debt, get back into it. It wasn’t until I looked within myself and admitted I was lacking in self-esteem and I was depressed. Buying things made me feel good. When that “high” wore off, I bought more to feel good again. When I confronted these issues, I was finally able to overcome my debt.

Save enough to get the company match. If you are in debt, chances are you will struggle like I did until you are able and willing to look within to see what the real problem is. This could take a few years. During this time you can easily save money for retirement. In fact, you can get away with just saving a small amount – enough to get your company match – and still be making progress.

The match your employer gives you is essentially your money. You get it when you save. If you don’t save, you are missing out on free money. It boggles my mind why so many people skip free money. If you tell me you’ll give me $20 if I save $100, you bet I’m taking that deal. And you should too.

Excuse: You Only Have a Few Dollars

I know a few bucks here and there appear as though they won’t make a difference. But they do. Even if you only save $1,000 a year for 30 years and earn 6%, you end up having over $80,000 saved. I know it isn’t a million bucks but would you rather have $80,000 or nothing? I’ll take the $80,000 any day of the week.

Every dollar adds up. I encourage you to save something, anything to your 401k plan. Any money you save for retirement is money you otherwise wouldn’t have to live off of come retirement.

Excuse: The Stock Market is Too Volatile

Another issue I see many face is the fact that they give into the short-term movements of the stock market. They see the market drop, get scared and run. Some build up the courage to invest again, most times after the market has turned the corner and has been rising for a while. Others remain too scared and simply avoid the stock market.

You can make money investing. When you invest, you have to take a long-term outlook. Over the short-term, the market will jump around, rising and falling. But over the long-term, the market moves higher. Look at any chart as proof and you will see that as time passes, the market moves higher.

Stay invested for the long term. Now, I realize that looking at the long-term is easier said than done. But you have to take the steps to keep this in mind so that you don’t sell and hide when the market drops. You need to stay invested for the long-term and find ways to handle stock market volatility.

If you had stayed invested after the crash in 2008, you would have made your money back and then some. When the next crash comes, and it will at some point, you need to stay invested again and in time, you will earn your money back and then some again.

Learn and understand how the market works and stay invested. If you can do these things, you will be better off financially.

Final Thoughts

Regardless of your financial situation, you have to start saving for retirement today. Every little bit helps and it is more than you otherwise wouldn’t have had you not saved it in the first place. I know how easy it is to fall into the trap of telling yourself you will start saving tomorrow. But you can’t fall into this trap. You know how fast time flies, how it is suddenly fall already or how fast the holidays sneak up on us.

Before you know it, you will be staring down retirement with nothing saved and will have little hope to build any size of nest egg. Start saving today so that you don’t have to face this reality in the future. Do yourself a favor and avoid the stress and worry about what your life will be like financially when you are older by saving something, anything, today.

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Low Cost Investing Options to Avoid Unreasonable Fees

When it comes to investing, there are all sorts of options to invest your money. You could go with mutual funds or stocks or exchange traded funds. From there you have countless online discount brokers, full-service brokers, and even automated investing services.

The only problem is that many times when you invest, you have to pay a commission or trading fee.

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(Photo Credit: worradmu)

Low Cost Investing Options to Choose From

Here are some low cost investing options to get around these fees so that you can invest more of your money.

Free Investment Options

Mutual Funds: This investment is the easiest one to invest in for free. In fact, there is no reason, none, why you should pay a fee to invest in a mutual fund. There are thousands of no cost funds out there and they are just as good and in most cases better, than any fund you pay to invest in.

The easiest options are to go directly to the fund company. Places like Vanguard and T Rowe Price allow you to invest in their mutual funds for free.

Discount brokers like Fidelity and Schwab allow you to invest in their own mutual funds for free and thousands of other providers as well.

Other discount brokers, like Scottrade and E*Trade allow you also to invest in other mutual funds for free as well. All of these discount brokers have lists of the funds you can invest in for free, so make sure you look over that list first.

Exchange Traded Funds: In many cases, ETFs are just as easy to invest in for free. While you cannot go to the iShares website and invest directly with them, you can do so at Fidelity for free. Fidelity even offers a handful more ETFs that don’t have a commission fee.

With Schwab, the same is true as well. You can invest in Schwab ETFs for free or many other providers ETFs for free. Some other discount brokers have free ETFs as well. The only word of caution is to do your research first. Not all brokers offer the same free ETFs to trade. If the ETF isn’t free, you are looking at paying a commission in line with buying stocks, which is between $7 and $10 per trade.

Stocks: This is the most difficult option when it comes to trading for free. Some brokers will give you free trades if you open an account with a certain dollar amount. Others will give you free trades if you place a crazy amount of trades each month. Don’t fall for this trap. You don’t make money with short-term trading. These companies want you to get in the habit of trading so that when the free trades are used up, you are in the habit of trading and will start racking up the fees.

As of this writing, the only truly free stock trading options are two new companies, Robinhood and Loyal3. I personally don’t have experience with them, but have heard good things about them. Note that you cannot invest in any stock for free at Loyal3. They have a small (but growing) list of companies you can invest in for free. As of this writing, some of the companies include:

  • Nike
  • Microsoft
  • Amazon
  • Coca-Cola
  • Apple
  • Berkshire Hathaway
  • Disney
  • Intel

As you can see, the list has some nice names on it. If any readers have used the Loyal3 service or know of another way to trade stocks for free, leave a comment below.

Low Cost (And Free) Brokers

With the competition for your money at an all-time high, online brokers are doing everything to get your money. Most don’t charge a fee to have an account and most don’t even have inactivity fees, which were standard some years ago.

Options like Fidelity and Schwab are great places to start as they offer free mutual funds and ETFs to invest in and charge an acceptable price for stock investing. A firm like Vanguard is just as good, with free investing in their own mutual funds and ETFs, the only difference is their mutual funds have a minimum of $3,000. Both Fidelity and Schwab have much lower minimums.

Another new option out there is a firm called Motif. There you can either invest in an already created motif or create one yourself. A motif is essentially a “fund” you create that is made up of stocks or ETFs. You can have up to 30 investments in a motif and the fee to trade a motif is just $9.95. This is a deal if you are investing in 10 stocks because at most other brokers, you are looking at a fee of $99.50 (10 x $9.95) to make these trades. As with Loyal3 above, I have no experience with this firm either, but think the concept is great. However, Madison opened an account at Motif to take advantage of the Motif Investing $150 Sign Up Bonus.

The last option for brokers are the robo-advisors. The two big ones are Betterment and Wealthfront. These companies work by investing your money into a set portfolio of low cost ETFs. You open an account and set up an automatic investment and you are done. They will invest your money each month for you. They are a great option for those who are scared of the stock market because they take the emotion out of the equation. You are investing each month, regardless of what the market is doing.

I personally use Betterment and love it. While there is no fee for your monthly investments, they do charge a management fee. With Betterment, the fee starts out at 0.35% and goes down to 0.15% as your balance grows.

In addition to investing your money, they also rebalance and tax loss harvest for you, allowing for better returns.

Why You Need To Understand The Commission You Pay

For some, you might wonder why paying a $7 commission on a stock trade is a big deal in the first place. The reason is simple: it is a lot of money! While $7 might not sound like much, if you are investing $100, then that $7 is a 7% fee! You have to invest at least $500 to get that fee down to just 1% and you could argue that is still a large amount of money. After all, most investors refuse to use a financial advisor that charges a 1% annual fee to manage their money. When you invest yourself and pay the commission, you are still losing out on your money. Therefore, you have to pay attention to fees.

If you only have a small amount of money to invest each month, then look at free mutual funds or ETFs as opposed to stocks. Otherwise, your best bet is to keep saving your money until you have $1,000 or so to buy a stock (remember each stock you buy has the commission) so that your fee is reasonable in amount.

Final Thoughts

Remember, fees and commissions eat away at your money. Take the time to research the cheapest investment options for your situation so that you can keep more of your money. Find a low cost investing option that works for you.

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