Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Wednesday, January 25, 2017

Experience Civic Duty in a new way - Do your own taxes!

Executive summary:
  • Taxes are due 18 April 2017. Do them!
  • To start, gather ALL relevant financial documents.
  • Here are the only instructions you will need for doing your taxes: Read each line carefully. Fill it out appropriately and move to the next line. Repeat.
  • Online solutions can walk you through the process and you may be able to file for free!
Griping about taxes is a proud American ritual. It takes up more of our time than Super Bowl preparation, Fourth of July celebrating and comparing our state to neighboring states combined. It takes slightly less of our time than the presidential election season. We gripe about taxes for good reason - they are complicated to do. Even if you don't owe much, or anything, the process of doing your own taxes may seem daunting. Many people hand off this arduous task to a CPA or another tax preparer so that they don't have to deal with it.

While I encourage everyone to try their hand at doing their taxes by hand at least once, there are plenty of tools out there to help you through the process. If you don't want anything to do with the process, you can pay someone to do them for you. Just a quick note of caution when hiring someone else - there are no qualifications to be a tax preparer. While there are plenty of people who can do your taxes, there is no minimum qualification required by the IRS nor is there any regulation of the field. You are on your own here. My advice is to look to a reputable shop that is open year round (there are always plenty of fly by night places around this time of year) or turn to a CPA - a Certified Public Accountant. CPAs are highly qualified accountants who are best prepared for larger or more complicated returns. Bear in mind they will be more expensive, but worth it if you are not doing it yourself.

Step One is taking a couple of deep breaths. Doing your taxes is probably less complicated than you think. No pressure, but it is also your civic duty as an American.

Step Two to doing your taxes is gathering all of your documents. Any mail you have received that says "important tax documents enclosed" probably has something relevant to the process. You should expect to have a tax form for every financial account you have - bank accounts, brokerage accounts, retirement accounts, loans etc. You will also have a tax form from every source of income - jobs, freelance or contracted work. The most common, most important information is as follows:

  • Work/Income - how much did you earn? How much tax was paid on your behalf?
  • Bank accounts - how much interest did you earn?
  • Retirement accounts - how much did you contribute or withdraw?
  • Brokerage accounts  - did you realize any gains or losses this past year?
  • Mortgage and student loans - how much interest did you pay?
Also gather documents on rental income you received or businesses you own. There are a slew of income sources and deductible expenses that you can walk through and find.

You will also need to know if you are married or if you had any children in your possession last year. Generally speaking, if you possessed a child for more than half of the year (joint custody, kidnapping, etc) you get to claim them as a dependent.

Step Three is a good time to learn the lingo. If you have a regular job that has benefits and withholds taxes from your paycheck, you will have a W-2 from them. Your contract employers, banks and brokerage firms will send you a 1099. These both show types of income. The main filing form is called a 1040 and you report more details for that on your Schedule C, D, or E. Be careful though if you are self employed as you will need the 1040 Schedule SE. If you paid tuition last year or are claiming an education credit you will need to fill out form 8917 or 8863. If you have a low income and a large family you will want to check on Schedule EIC. If your household help considers you their employer check out Schedule H and if you paid taxes to a foreign government you might get that back on Form 1116.

All of these forms are available on and paper copies are available at local libraries, by request or through your own printer. The core filing is the Form 1040, all other forms and schedules come off of that.

Step Four - take another deep breath. Remember, the maintenance of the Republic is in your hands here.

Step Five - decide the best route for filing your taxes. If you don't have a lot of forms, maybe just a W-2 from work and a 1099 from your bank showing $11 in interest, you could do this easily yourself by hand. Online programs like TurboTax or H&R Block can walk you through the process fairly efficiently if you have all of your documents gathered. You typically get a free filing for simple returns at lower incomes. If you don't qualify for a free filing, these online tools can still help you figure out what you owe and what to put on a paper filing.

If you have more complicated taxes, particularly if you own a business, you may want to turn to a CPA. A CPA will typically not only provide the most accurate filing for you, but can also offer tax advice on how you can reduce your taxes with expenses you incurred in the previous year, or by maximizing contributions to a retirement account appropriate for your work situation.

Let's imagine that you are filing by hand for the rest of this article.

Step Six - start walking down the Form 1040. You will learn to love this form. Or not. Maybe you won't. If you truly love America, you probably will though.

Here are the only instructions you will need for doing your taxes. Read each line carefully and ask yourself (or the instructions) if it applies to you. Fill it out appropriately and move to the next line. Repeat. If you want something more detailed than that, the IRS helpfully offers instructions for each of their forms. While they aren't always the easiest to read, they are broken out line by line, so just focus on the line at hand.

Lets start here:
This is what you see when you start looking at the form 1040.
This is the header - there shouldn't be any surprises here. If there are, we should probably talk about what it means to have a family. Knock this out and give yourself a pat on the back.

Start with your name. If you are married you will typically file jointly with your spouse. Times when you would not are if one spouse had lots of deductible expenses and a significantly lower income than the other spouse. You can figure out further down the line if this makes sense, but for most people, it will.

I like to tick the box indicating that $3 goes to the Presidential Election Campaign. While it is not abundantly clear to me that this has an impact, the general idea is that candidates that accept money from this fund are swearing off private donations. It is a hope, more so than an effective tool to keep private money out of politics. This is also pretty much the only time that you can directly choose where your tax dollars go, ironically, this makes it the least democratic and most anti-societal thing you can do on this form.

If you have children, you can put them in as dependents. If you don't, but have, for instance, kidnapped a child and held it hostage for more than half of the year, you can enter their name and social security number here. If you aren't sure if you have any children, lets just skip over this section because the questions get rather sensitive rather quickly.

That was easy want it? Take a deep breath if you like, but if you're fired up and ready to go, full steam ahead!

In this section of the 1040, you will list out ALL of your incomes from various sources.
Income. Simple concept, but this section belies how complex it actually is.

When I tell people that all there is to doing your taxes is walking down the 1040, this is a pretty good illustration of that. Read the first line (line 7). Wages, salaries and tips. Attach forms W-2. If you received any W-2s from any employers, this is where that information goes. Easy, they're just asking how much you made.

Banks and brokerages will send you information on interest and dividends (lines 8a-9b) and capital gains (line 13). Self employment income will go in line 12. Most of this stuff is fairly self explanatory - if you own a farm you will put income from that on line 18, for instance. This is where IRA income, pensions, rental property, social security benefits and more get reported.

Lets take a closer look at line 13. This will be relevant if you have investments in taxable accounts. One of the great things about capital gains is that you get to control when you realize them and losses can offset gains. You only pay taxes on the gains (difference between sale price and purchase price of the security). You can report more detailed information about these gains on Schedule D. Keeping track of your cost basis is very important. Before 2011 brokerages were not required to keep track of this vital information, so tracking it down for older investments can sometimes be a huge, time consuming hassle. The next time you hear someone gripe about millennials, remind them that at least nobody will have to waste their time tracking down our cost basis information.

If you get to line 22 and know that you haven't put some source of income down, go back and figure out where it goes. Otherwise, add everything up and pat yourself on the back.

Not so hard, huh? Recline a little more in your seat and take a well deserved deep breath and bite of chocolate.

Now that you have your TOTAL INCOME, it is time to adjust it.

In this section, you will find a few regular expenses which may lower your taxable income.
Adjusted Gross Income, or AGI, doesn't have to be an intimidating term. It is just a technical way of saying "this is my income after I account for a few things that I spent money on"

This is where you start reducing your income for tax purposes. You will end this section with an Adjusted Gross Income, or AGI. This is the basis for figuring out your taxes owed, but lets not get ahead of ourselves. Just go line by line and see if you can reduce your income with these common expenses.

Line 23 gives teachers the opportunity to deduct $250 of un-reimbursed classroom expenses. Why do teachers get their own line here? Well, we hardly pay them anything and they work long hours whilst being expressly exempt from overtime protections, we treat them as a punchline in a classic dumb joke about inability and berate them for our children's shortcomings, they raised and shaped every one of us and are the most vital defenders of the future of our nation, knocking a couple of dollars off of their taxes is quite literally the least we can do. If you want to take it a step further, buy a teacher some happy hour drinks.

If you contributed to a Health Savings Account or a personal retirement account this is where you put that information. If you are making less than $80,000 and are paying interest on student loans, you can deduct up to $2,500 of it here. Again, just take this section step by step and add everything up on line 36. Subtract that from your TOTAL INCOME on line 22 and you have arrived at your AGI.

Time for another deep breath and a bite of chocolate. Maybe take this opportunity to stretch your legs, get some fresh air, or call your senator about a pressing issue.

We have now made it to page 2.

This is where you figure out what you actually owe.
No need to fear - the second page is basically like the first page. Just take it line by line and you'll do fine.
This is a little misleading, the bulk of this section is more deductions and credits. A deduction reduces your income, but a credit reduces your taxes. Similar concept, just different calculations.

Line 38 is like the free square in Bingo - just write whatever you wrote on Line 37 to bring it to the back page. Fun, easy, relaxing.

If Line 39a is relevant to you, congratulations. You are either old or blind and you a higher deduction than standard. The handy explainer next to line 40 directs you to the instructions again, as do I. Most people will get the standard deduction, so just write that one on line 40. If you had large medical expenses, mortgage interest payments, charitable contributions or taxes paid (not including federal taxes) or a few other miscellaneous expenses, you may benefit from itemizing expenses. Check out Schedule A for more information. If these expenses add up to more than your standard deduction, itemize and send in the Schedule A along with your 1040.

41 is an easy math problem and 42 is also a fairly easy math problem on exemptions. Actually calculating your taxes is the trick of this whole sheet. If your income is simple, and only came from one or a few sources, you can probably use the tax table in the instructions. You simply put your finger on the number closest to your income, look slightly to the right of your finger, and put this number down on like 44.

There are some credits on lines 48-54 that can directly reduce the amount of tax you owe. If any of these apply add them up on line 55 and subtract that from line 47.

Don't take a break yet, the next section is still more of the same - you're in the groove, keep it rolling.

This section is basically like the last, just adds more taxes owed in that don't get credits taken out.
Annoyingly more of the same. The reason this section sits here is that these taxes are owed after credits have been taken out. Don't worry though, nothing too complicated here.

See if any of these apply to you. Critically, if you were self employed, this is where most of your taxes will come into play. You can see here that you should put that stuff on schedule SE to calculate tax owed there. There are some extra taxes that you might have owed here too.

Add everything up on line 63 and then have a BIG sigh. You just coast from here.

You've earned a drink here. Pour yourself a glass of water and stretch your back muscles out.

This is where you recount all of the times that taxes were already paid on your behalf last year.
Payments. If you have already paid taxes (on w-2 income or IRA withdrawals, for instance) note it here. This is the step before the grand reveal.
Payments should be fairly self explanatory. If you have paid taxes already or taxes have been paid on your behalf, you note that here. You will probably have this information on your W-2 or 1099's from work. There are a few last credits shoved in as well. Check this for all that you have already paid or might be owed back.

Add this all up on line 74 and queue up a drumroll in your head for the big reveal.

Do you owe more or get a refund? Find out here!
This is the moment of truth.
Line 75 has a revealing question for you. If you have been paying taxes all year (through quarterly payments or withholdings) this is where you find out if you were paying the right amount. Basically there is a number which is the taxes you owe on all of that income, and a number which you have already paid. If you owe more than you have already paid, you will move down to line 78; if you have paid more than you owe, you get to tell the IRS where to send your money back to.

The best way to get your refund is direct deposit. If you would rather split your refund up amongst several accounts, or buy a savings bond instead (weirdo) you can do that with form 8888.

Don't bother with line 77, you can pay those taxes when you get there.

If you owe taxes, pull out your checkbook or check out the fairly straightforward instructions on how to pay by phone or online.

Sign and date the form, write in your occupation and exhale.

See! That wasn't so hard.

Doing taxes yourself by hand is a useful exercise in civics. If you are just starting out in your career you will probably not have a hard time of it. The key is being organized with your documents on the front end and block out some quiet time to get things done. If that doesn't work, try an online tool or hire a professional.

Wednesday, January 11, 2017

The rich, they're not so different from you and me!

Executive Summary:
  • There are few differences between investors of different net worth, but where they vary, we can learn important lessons.
  • The very wealthy are more likely to work with advisors, are more willing to diversify investments internationally and take care to introduce their children to their advisors. 
  • In my opinion, the mass affluent can learn from this and be more financially secure.
The Rich understand that their advisors are looking out for them.

A report from Spectrum Group examining the differences between investors based on their net worth level had some interesting points. They surveyed investors ranging from Mass Affluent - those worth $100,000 - $1 Million, Millionaires - those worth $1 - 5 Million and Ultra High Net Worth - those worth over $5 Million. Amongst them, the Ultra High Net Worth were more likely to use an advisor. As an investment advisor, I could take that as great news. The clients with more money are the ones who want to work with me, right? But that likely has more to do with their very busy and complex lifestyles. They probably also have plenty of other hired "staff" to take care of details that they cannot be bothered with. In other words, having an advisor, for the UHNW crowd, is a product of their money, not the other way around.

I kept digging as the report still had some things to reveal about investor behavior.

One stereotype of the very wealthy is that they have a lot of their net worth tied up in their business. Think of Warren Buffett, Donald Trump, the Waltons and the Koch Brothers. They are fantastically wealthy and much of that wealth is tied up in businesses (some publicly traded, some private). According to the survey, about 4% of the net worth of the UHNW crowd was tied up in private business. This was the same amount as the Mass Affluent had! Maybe the UHNW folks had already sold their businesses, but maybe they were just like the rest of us (except with more money and an advisor). The big story about their net worth is that they had much more money available for liquid investments and less money tied up in their home.

Of those investable assets, people have three options, manage it themselves, hire someone to manage it, or pick somewhere in between. Reinforcing the likelihood of the very wealthy to have an advisor, they were much more likely to have someone else manage their money. 53% of the Ultra High Net Worth individuals had an advisor either manage or consult on how to manage their wealth, compared with only 41% of the Mass Affluent.

This again gets back to the UHNW needing to have someone handle some of their affairs, but there is something else here. Many less affluent investors either wrongly believe that they do not need or cannot afford professional help with their assets. This is just wrong. While any given asset manager may not be able to outperform any given benchmark, many advisors do add real value to their clients' financial lives. Our value is not in getting a few basis points over the S&P 500, but in the tens of thousands of dollars we generate for clients by optimizing pension and social security withdrawals, the details of asset location to save on taxes and the peace of mind knowing someone else is figuring out the details for them. Bad decisions and mistakes can be very costly to any investor, whether in returns never realized or actual money misspent. If all your advisor does it reduce those mistakes, they are worth something to you.

The Ultra High Net Worth investors understand the value of an advisor, and maybe that is something that the Mass Affluent could benefit from!

Amongst their top worries, the wealthy and the merely affluent are much the same. They worry about government gridlock, political environment and stock performance in broadly the same high amounts. Notable departures, however, are that the UHNW do not have to worry about inflation, as the cost of a lifestyle is not as big of an issue. They are insulated from the rising cost of basic goods and services to some extent. Additionally, they do not worry as much about interest rates that they earn on savings. When you have much more of your assets invested, the interest you earn does not have a very notable role on your income statement.

When it comes to foreign investments, the very wealthy are much more comfortable investing outside of the United States. The survey in 2016 repeated an earlier survey in 2012, and everyone has gotten a little more skittish on foreign investing. But while 50% of the very wealthy are comfortable with foreign investments, 72% of the mass affluent are adamantly opposed to it. Domestic or "home" investment bias is a big issue. While US stock returns have always been the core of US investor portfolios, they could benefit from foreign exposure. Diversification into foreign markets lowers the overall risk of portfolios and can increase returns over the long term. While foreign stock returns can be more volatile than US returns when economic and currency swings go hand in hand, investments abroad are useful sources of return when US returns are sluggish.

Foreign diversification is certainly something that most investors could probably benefit from. This is a lesson the Mass Affluent may want to pick up form the Ultra High Net Worth investors.

Lastly, Ultra High Net Worth investors are looking to future generations. They are much more likely to be active in making sure that their wealth is well-managed when they are gone. 62% of the very wealthy would introduce their children or grandchildren to their advisors versus 39% of the Mass Affluent. This is important, not just in letting your own wealth continue to have an impact but by simply getting future generations started on the right foot. While children of clients may not have large accounts themselves, as an advisor, I want everyone to be financially fit and am happy to work with people who understand the importance of an advisor. The Mass Affluent can make their next generations better off by starting those conversations and making introductions. Even if their legacy does not include a huge inheritance, it can still include financial security.

Overall, the Ultra High Net Worth appeared to be very similar to the Mass Affluent. After all, we are all just humans with the same wants and needs. The UHNW were just wealthier. There were a few significant ways in which they differ, though, and therein lie some important lessons for the Mass Affluent.