Time to take a tax strategy

Unfortunately with unprecedented spending by the new administration, there will be a point when the bill will come due. You can agree or disagree that it is the right thing to do, but one thing remains un-questionable, we will be taxed more heavily. Now, many individuals have taken solace in the fact that the president has said that the increases will only impact people with income over $250K, but this is simply not true. As with all taxes, even those intended for the rich, will find their way down to all incomes. All one has to do is look at the AMT, once a tax to ensure that high income earners “pay their fair share” now impacts people making as low as $50K per year. In NY, the millionaire’s tax now applies to people making nowhere near a million dollars. Finally, add inflation into the mix and individuals will really start to push the limits on the phase outs and policies intended for the wealthy.

So how can you minimize your taxes and keep more of your hard earned cash?

Maximize your 401K holdings

This is probably the simplest way to put money to work for you tax free. The current limits are $16,500 for individuals or $22,000 for anyone over the age of 50. The money goes in tax free and reduces your taxable income in the current year. As your money grows, you do not pay taxes until you retire. At that point the money is taxed as income, but you will have had many years of tax free growth.

Open a Roth IRA

While you do not get an immediate benefit from a Roth IRA, you will over the long term since gains are not taxed and when you retire you earnings will be available tax and penalty free. Unfortunately, if your combined income is over $166,000 you begin to phase out your eligibility and at $176,000 you can not contribute to a Roth IRA.

Don’t worry, if you hit the income levels you can open a Non-deductable IRA. Normally an IRA works similar to a 401K. You put money into the plan and you get an immediate tax savings on your income. In a non-deductable IRA you don’t get the up front tax break, but you do get years of growth tax free. At the end you will be taxed as ordinary income.

(As a side note, democrats do not care for Roth IRAs due to the tax free earnings at retirement. While there has not be any proposed legislation regarding them, it would not be surprising if they are shelved or modified in the next few years given that the democrats control the house and senate. You may have a limited opportunity to open one. Even if you can only spare a minor amount to open one, you will get you in the door and preserve your rights in future years to contribute when your finances change.)

Invest in tax free bonds and funds

Depending on your income, these can have substantially better returns then the market or other options. There are many good funds out there. The key is to find solid funds that have a good track record of returns. Many financial sites can help guide you in your selections.

Offset gains with losses

Unless you are perfect in your stock selections, you will have losses. This is probably one of the most important and hardest strategies to use. The reason being is it is almost always an emotional decision. If you can set aside your pride or feelings of hope, you can take a rational approach that can save you taxes. For example, say you were invested in Pepsi Co. and it is down 20% as the end of the year approaches. If Pepsi is down because of market forces then odds are Coke will also be down. If you sell your position in Pepsi and buy a position in Coke, you will now have a loss to use against any gains plus still be invested in an industry you feel will rebound. It does not always have to be a like industry, remember you are taking strategic loses by moving money into other stocks you feel will give you returns. Also remember don’t sell just to sell. Strategy is key.

Subscribe to this blog's RSS feed

For those that have been following the market, we have had some nice gains. It started me thinking that I have been lucky over the last 10-years to not experience a down year and it might be nice to share 10 Fundamentals that started me out. I believe these tips built a solid foundation for my own trading strategies and hopefully they will help you as well.

1. Only invest what you are willing and to lose!

If you only follow one rule, let it be this one. I hold solid to this one. I have talked to people that have taken out lines of credit on their homes only to lose it in the market. Why do this? Sure, if you are successful you can make enough return to pay the interest, but if you are wrong you not only have lost money, but you have a loan to pay back with interest. It does not matter if it is $3,000 or $100,000, only invest what you are willing and can afford to lose. If you follow this rule, any amount you lose will not send you to the mental institution.

Keep in mind this amount does grow if you investments grow. If you start with $10,000 and are lucky enough to turn it into $20,000, you can now afford to lose $20,000 because you are really only risking your initial $10,000. It is kind of like playing with house money when you strike it big in Vegas. You may choose to pull out you $10,000 and only play with the house’s money or you may keep in your initial investment to double your buying power.

2. Keep you emotions out.

Play with emotions and you will be guaranteed to lose money. This rule only works if you follow rule #1. Emotions are great for love and relationships, but it clouds judgments on investments. Sometimes a stock my be down 10% and it is time to let go because of new fundamentals or market sentiment, but if you are attached to the stock like your attached to your home football team you may just keep riding the boat down. Investing needs to be objective and emotion free in order to see the truths about stocks.

3. If you don’t have time to do research, then buy mutual funds.

Mutual funds are a great way to have some one else manage your risk. There are great funds out there and you can go to any major news site to find listings of the lowest cost and best performing funds. I personally use sites like Schwab.com and Morningstar.com.

4. Do not use margin.

I know it is tempting, especially when you have some winners in your portfolio. Unless you are very well seasoned with investing and know how to effectively use margin, stay away. Improperly using margin can quickly take you portfolio to zero as opposed to solid mutual funds or stocks which rarely go to zero.

5. Don’t count on the big win!

Don’t go in looking for the big score. When you begin investing you should look for solid performing stocks and mutual funds. This is not going to double you money over night, but it will keep your risk down and if done correctly start to grow your portfolio. The more you grow the more risk you can start to take. I typically allow 5-10% of my funds for risky investments (after much testing of my strategies), however, when I first ventured into strategies, I never invested more than 2%.

6. Eliminate should of, could of, only if, bought to soon, and sold to late from your vocabulary.

You can not dwell on your past actions. It is fine to learn why you made the mistake and incorporate controls into you next strategy, but once you know why don’t harp on yourself. If you do, then your judgment will be clouded on your next trade because you will start to second guess your strategy.

7. Don’t ride waves!

By the time you see the wave it is probably too late and you will likely get crushed to the bottom. Remember, there are many firms and investors that monitor changes 24-hours a day that influence the markets. When waves are rolling, you can be sure they will exit about the time you enter.

8. Set goals!

If you buy stocks and want to eliminate emotions from your stock trading, you have to set goals and strategies for each trade. If you stick to your strategy you have more control. Yeah, sometimes you might lose out on some big gain, but it goes both ways. If a stock far surpasses your goal because of some news and you think there is more room, then you can always sell a portion of you position and hedge your risk, but other than that when you goal is reached you should take your action.

9. It is not profit until you sell.

So many times I here people talking about huge gains and how well they are doing in the market only to find out several months later they have huge losses. Mainly because they were lucky enough to be on the ground when a wave started and elected to hold their position instead of selling at the peak. This is why it is important to have realistic goals and sell your positions when they are reached. If you are not a buy/sell person then stick to mutual funds and let the mangers do the work.

10. Buy on down days in the market.

Why buy when the market is up 100 points. Just wait, at some point there will be a down day to buy.

Please share your successful strategies!