Short Term vs Long Term Capital Gains

Posted on by Ryan

When you make money on an investment, it is called a capital gain.

Here in the U.S., we are taxed on capital gains.

It is worth noting, though, that you aren’t taxed on the gain until you actually realize it. That is, you aren’t taxed until you sell and the investment earnings are yours.

When you sell makes a difference in how you are taxed. There is a tax advantage to holding on to an investment for a longer period of time, since the tax rate on long term capital gains is usually lower than what you would find on short term capital gains.

Let’s look at the differences between short term vs long term capital gains.

Long Term Capital Gains Tax

Whether or not your investment gain is taxed as long term or short term depends on how long you have held it. In order to qualify as a long term investment, you need to hold the investment for more than one year. This means that you need to have the investment for at least one year and one day for it to qualify.

Your “tax bracket” for long term capital gains is based on your marginal tax bracket. Right now, the lowest tax rate on capital gains right now is 0%. This is a temporary situation for capital gains taxes. If you are in the 10% or 15% tax bracket (this is total income, including your capital gains), you don’t owe anything extra for capital gains taxes.

If you are higher than those tax brackets, you will owe 15% in capital gains taxes. Even though this tax rate was extended, it could expire if Congress doesn’t change things. But, for 2019, you can potentially avoid paying long term capital gains taxes.

However, even with a shift in the way long term capital gains are figured, the top rate is likely to be no more than 20% or 25% over time.

Short Term Capital Gains Tax

By contrast, there is no special tax rate for short term capital gains. If you hold an investment for a year or less, you will be taxed at your regular income rate. If income tax rates go up, or if your capital gains bump you into another tax bracket, you will pay whatever income tax is “normal” for you.

As you can see, if you are in a higher income tax bracket, it might make sense to hold on to your investments until they qualify as long term. That way, part of your income would be taxed at a lower rate.

Tax on Collectibles

You should be aware that there are different rules for collectible assets. While you might consider them investments, the IRS looks at them as a different class, “collectible assets.” If you hold collectibles for a year or less, and then sell, you are taxed at your marginal rate.

However, if you hold collectible assets for more than a year, you will be taxed at a 28% rate. For those in lower tax brackets, holding collectibles for a long time can actually be detrimental when it comes to tax liability.

Part of your investment planning should include considering the tax ramifications associated with when you sell your investments.

Financial Independence

Posted on by Ryan

Always Know Your Number

Financial independence and early retirement will vary depending on your situation, wants, and needs. If you have a family with a van load of kids, it’s probably more than if you are single and just need to take care of yourself. If you’re living in a big city like New York, Paris or Tokyo, you need more than those living in smaller cities and rural areas. The important thing is that you know your number. It should be one of your main goals in life. Because once you reach that number, you are financially free. Ask yourself, “How much do I need to live how I want for the rest of my life?” Everything beyond that is gravy. Personally, I like gravy. By the way, that was secret number one for wealth creation. – Always know your number. Few great things are accomplished without a well-defined goal.

My Path to Financial Independence and Early Retirement

Growing up my dad would always say “You have two choices! You can work for your money, or you can have your money work for you!”. That stuck with me, so when I turned 18 I started contributing to my 401k plan. Over the next three years my contributions averaged $100 a month, which at the time was making around $20k a year. After I turned 21, I got a job at HP starting at $26k. Now that I had an extra $500 a month in my pocket, I felt “rich”. I decided I would add half to my 401k and the other half I could spend. This put my annual contributions at $4,200, plus HP’s match of 4% ($1,040), which meant I was adding $5,240 a year to my portfolio.

How long will your retirement and savings accounts last? Click here to find out!

I knew that I wanted to buy a house, so at the age of 22 I created a budget that would allow me to have enough for a down payment when I was 23 years old. I finally had enough saved up for the down payment and purchase my first house at the age of 23. I lucked out and bought it towards the bottom of the market. Over the next few years as my salary began increasing I made to continue to increase my savings. Now, I’m 29 and my portfolio is just over $158k. Looking back I would of never imagined that by 27 I’d have over $100k in my portfolio.

They Crumpled In An Emotional Heap

More than once I saw one of neighbors crumble into an emotional heap when their careers stalled and their money train slowed to a crawl. They were shocked to find that they had little to nothing in reserve. It wasn’t like their business managers were ripping them off like you see on television or in the movies. Their business managers sent them monthly reports, informed their clients of all the major decisions and in most cases even had them sign documents authorizing their actions for their client’s money. Their clients just didn’t read the reports or understand the ramifications of their investments or finances. They were lazy or at least distracted by life like many of us.

It’s easy to shove your finances off to an accountant or business managers, after all they are trained in finance. They know what to do with my money… right? Train wrecks rarely happen because of technical failure. They happen because someone is not paying attention. Take responsibility for your own finances. Cash your own pay checks. Pay your own bills. Invest your own money. It’s really not as hard as it look–plus it’s good for you. Nobody will watch your money like you.

Two Secrets to Financial Independence & Wealth Creation

Now I am going to give you the next two secrets for wealth creation… Always do the math and avoid complexity. Don’t leave the math to someone else. Do it yourself. It is really not that hard. Most investments can be calculated on the back of a napkin. And if they cannot be calculated on the back of a napkin, then run away really, really fast and don’t look back!

If you cannot understand how an investment works, then don’t invest in it! There… I just saved you a million dollars. I hope you’re happy.

But seriously, complexity kills investments. The more complex a deal, the more likely it will fail. The main component to the financial crisis of 2008 was the failure of derivatives and guess what…almost nobody without a doctorate in mathematical analysis can really explain what derivatives do and how they function. The calculation of how a derivative works and when they “kick-in” is very complex. The failure of the derivatives caused a chain reaction that almost completely destroy the financial system of the United States and caused giant financial waves throughout the world.

So, let’s recap…

Always Know Your Number
Take Responsibility for Your Finances
Do the Math Yourself
Avoid Complexity

How to Calculate What You Need

Now you are saying “Hey, the title of this article promised to help me figure out how much money I need. So, what gives?” You right. I won’t cop out and I won’t be lazy. Here is the math.

You need to figure out how much you will spend each month once you are financially independent. That number is probably different from what you are currently spending. Here are a couple of reasons why.

What Not to Include

Once you have achieved financial independence, you do not need to spend money each month to invest or save for retirement. That is not to say that you don’t invest. You just don’t need to include it as part of your monthly nut. Also, do you plan on having a mortgage or car payments while you’re becoming financially independent? Most of you will not. Do you need as much life insurance? Probably not. Will you have credit card payments? I sure hope not. What are you going to do with all your free time? Travel? That costs extra. How about hobbies? (I always wanted to build a fully equipped woodworking shop with every kind of lathe, saw and gig that I could possibly want to use.) If you don’t have a mortgage, then you won’t have that big tax write-off. Better budget for it (Try our Budget Calculator). You get the point.

You will usually need to spend less on a monthly basis after you reach financial independence, even with the extras. So, do the math and find the number.

For this example, let’s say that you have paid off your house, car and credit cards, plus you are a travel bug that likes to go on a nice cruise twice a year to someplace sunny. Your number is $20,000 per month or $240,000 per year not counting inflation (we will get to that in a moment.) That’s a big number for some, not so big for others. The important thing is that you find your number.

What to Deduct

Wait a minute…we can deduct some things because you probably have some future income already secured. How about Social Security? (Yeah, it will probably still be around even with all the politics). Do you have a retirement account? How about a life insurance annuity? Do you have rental income from real estate? What about dividends from a stock or bond portfolio? I get quarterly royalty payments from the movies I made. That counts! All steady future income lowers that annual $240,000 number. So, let’s say after you count all your future income, you lower the number to $160,000.

Investable Assets and Inflation

Now, how much money would you need in investable assets to generate $160,000 per year? Also, how do we take into account inflation? I believe a properly diversified investment portfolio can generate about 8% per year without taking too much risk. So, to generate $160,000 per year you would need about $2,000,000 in investable assets.

But wait… we need to take into account inflation. This is where it gets a bit tricky, because some of your future income like real estate, social security and stocks may have inflation compensation mechanisms or increases, while others like some pensions and bonds may not. Again, it is important that you do the math and figure it out now, so you don’t end up short.

So, let say we have calculated that one third of future income is covered by inflation increases and the other two thirds is not. I like the number 3% for inflation. It’s probably conservative and closer to 2%, but hey, that’s where the dart landed when I threw it at the inflation index dart board. Besides, 3% gives us a little cushion in case you live a longer than you planned. So, we need to make an extra 3% per year to cover the inflation on the $160,000 and an extra 1% on top of that to cover the loss due to inflation on some of our future income. That just cut our 8% interest in half and therefore doubled the amount of investable to about $4,000,000.

Getting to a Real Number

Now don’t panic. Yeah, that is a big number. But it is a real number. And now that you know your number, you can make a plan to achieve that number. Believe me… it’s doable. Most of us will never be able to save our way to that kind of number. However, I never liked making 2% on my money. I believe in high-yields of 10%-14% on my invested money. I know they are achievable. So, enough for today. Go get started on achieving financial independence! Follow my blog in the coming months, and with a little patience, a little math and some thoughtful consideration, I will show you how to make your number.

How Do Mutual Funds Work

Posted on by Ryan

So how do mutual funds work? Well, mutual funds are a type of communal investment that gathers money together from numerous different investors to purchase stocks, bonds, and other securities on a larger scale than what an individual investor could afford independently.

When you contribute money to a mutual fund, you get a stake in all of the fund’s investments, and your portfolio becomes more diverse and potentially more profitable.

You also get an investment professional who actively manages the fund; a real plus if you don’t have the market experience or wisdom necessary to make accurate investment decisions.

Mutual Fund Shares

One of the first questions you might ask is, “Since mutual funds are a collection of securities instead of a single company, who determines the cost of each mutual fund share?”

The net asset value (NAV) determines the price per share of a mutual fund. The NAV is calculated by taking the total value of securities that the fund owns and dividing it by the number of outstanding shares.

If a mutual fund’s total value is $50 million and there are 2 million shares, then the NAV would be $25. So if you wanted to invest $3,000 into a mutual fund with a NAV of $25, you would own 120 shares of that mutual fund.

Benefits of Mutual Funds

A Diverse Portfolio – Many financial experts will tell you that a person needs at least $100,000 to adequately diversify their portfolio with individual stock purchases. But what if you only have a few thousand dollars to start with?

Investing in a mutual fund is a great way to have a well-diversified stock portfolio with a minimum initial investment because mutual funds are already diverse and they have a low minimum requirement.

You need diversification to limit your potential risk of losing money. A decline in the value of a particular security within a mutual fund is often offset by the strength or increasing value of other securities within that fund.

Managed by Investment Professionals – Mutual funds are managed and supervised by professional investment administrators. The goals of the fund managers are directly related to the investors’ success because the managers are paid based on the performance of the mutual fund.

The fund manager uses his or her market experience, wisdom, and expertise to decide when to buy and sell securities. Because the manager is making decisions for the mutual benefit of the fund, the individual investor doesn’t have the difficult job of trying to time the market.

The resources and research expertise of mutual fund managers far exceed those of the average investor.

Mutual Fund Risk and Diversity

There are always risks associated with every type of investing, and mutual funds are not immune. Mutual funds also have management fees (although minimal) that don’t normally accompany individual stock purchases.

Instead of labeling these items as disadvantages, think of them as necessary information needed to make wise and accurate investment decisions.

Mutual funds can add diversity, stability, convenience, and high quality purchases to any investment portfolio, no matter if you want to spend $1,000 or $1,000,000.

Financial Risk Tolerance vs. Emotional Risk Tolerance

Posted on by Ryan

One of the terms that you might have heard when you are getting ready to invest is “risk tolerance.” As you might imagine, this term refers to the amount of risk you can handle when you invest. As you evaluate potential investments, it’s a good idea to take some time to review your risk tolerance. For the most part, risk tolerance can be divided into two parts: financial and emotional. Before you make an investing decision, it helps to understand your own risk tolerance; you will make better decisions if you know your own limits.

Financial Risk Tolerance

First, consider your financial risk tolerance. This is represented by how your finances can handle different risks. The old rule is to avoid investing money that you can’t afford to lose. Your first consideration is to figure out, financially, what makes sense for your investment portfolio.

If you are struggling financially, risking a large portion of your paycheck might not be the best plan. You probably need that money for other purposes; you can’t afford to lose it on a risky investment that has the potential to go bad.

In such cases, it might make sense to put a little aside , and take advantage of dollar cost averaging to help you prepare for the future, without sacrificing today.

On the other hand, if you have extra money, you might think it fun to do a little day trading, and take bigger risks. As long as you won’t miss the money if you lose it, it shouldn’t be a problem.

However, be careful when trading on margin. While you could magnify your gains, you will also need to make sure you have a high enough financial risk tolerance to handle magnified losses.

Emotional Risk Tolerance

Determining your financial risk tolerance is fairly straightforward: You just need to run the numbers. Emotional risk tolerance, though, is another matter. Emotional risk tolerance is all about what you can handle emotionally, and has only a little to do with money (although your money situation can contribute to how you emotionally handle risk).

Before you invest, consider your emotional state relative to risk. Some people have a high emotional risk tolerance. They enjoy the thrill of the “game.” Investing in volatile markets, or taking a chance to make it big, holds a great deal of appeal. (Incidentally, you have to be careful if you have a high emotional risk tolerance but a low financial risk tolerance — it can be easy to get carried away and ruin yourself.)

If you have a high emotional risk tolerance, you can mentally handle risks that others have problems with.

A low emotional risk tolerance, though, can mean problems in high risk situations. Constant worry about what will happen next will eventually take its toll on your own health and on your relationships. While you shouldn’t avoid investing altogether, it is a good idea to stick with “safer” investments, such as solid value/dividend stocks, index funds, and stable bonds.

You will need to overcome your risk aversion to some degree, though, since a very high emotional risk tolerance (leading you only to cash products or low yielding bonds) can cripple your ability to build wealth.

Bottom Line

The first rule of just about anything is “know thyself.” Carefully consider the financial and emotional aspects of your risk tolerance so that you can make investing decisions that work better for you.

Quick & Painless Ways to Start Saving Money Regardless of Income Level

Posted on by Ryan

Learning to save money is not easy for everyone. Let’s face it; we’re not all hardwired to love saving money. In a society that is mostly consumer driven, it doesn’t make sense to a lot of people that they need to save money when they really want the latest and greatest new HDTV.

People are taking vacations and buying new cars when they can barely afford to pay their electric bills. It just doesn’t make sense logically, but when you look at it from the way that parents are training their kids it only makes sense. The fact is that we all need to be saving money no matter what our income level is.

Even if you only make $25,000 a year, you need to be living below your means enough to be able to put that money in an emergency fund. Most experts recommend that you have at least a 6 to 9 month emergency fund in place in case life happens. But how do you save when you feel like your income is barely enough to cover your current expenses?

Take Care of Debt First

The first thing that you have to do is start to kill off any debt that you have. You may have to start doing some things on the side to
pay your debt down faster.

When you have bills hanging over your head, you’re never going to be able to save enough money to matter. Living with debt is one surefire way of experiencing “life” in the least enjoyable way.

In order to knock off your debt quickly, think of doing things like having a garage sale or selling items in an online auction. Even doing small things like this from time to time will help you knock some of your debt off so that you can start putting more money toward savings.

You might want to also speak with some of your credit card companies to see if you can settle on some of your credit card debt. If you owe $10,000 on a credit card, but you only make $20,000 a year then it’s obvious you’re never going to pay their credit card off.

Some creditors might be willing to make a deal with you, especially if you find yourself getting behind.

Savings Goals to Give You Direction

You also need to set some goals for your savings plan. What are you saving for exactly? Perhaps you’re saving for the down payment on your first home or for a vacation. Figure out how much you need to put back each week or month to meet your goals.

However, don’t just save for things that are tangible. Make sure that you’re saving for your future, your retirement, your kid’s college funds, etc.

Give yourself a time-frame in which you would like to make your financial goals. The best way to do that is set some short-term goals along with a long-term one. This will allow you to have some attainable goals along the way so that you’re not discouraged.

Think about how much you need to save out of each paycheck so that you can meet these goals. A good way to figure out how much are spending is to keep track of all your daily expenses. Write down how much you spend on gas, eating out, car payments, your cable bill, utilities, entertainment, etc.

Often, when people see how much money they’re throwing away on unimportant things, it makes it very easy to start saving.

Final Thoughts on Saving

No matter what income level you’re at right now, you can learn how to save money for your goals. It may be a matter of trimming your expenses, but you have to decide what your priorities are and what’s most important to you.

If you want to purchase a home, it might not be quite as important to you to go clothes shopping all the time or get your hair done on a regular basis. If you make the sacrifices now, your savings account will thank you for it.