Tax Freedom Day Arrives on April 30, 2007 (2007-04-30)

Tax Freedom Day Arrives on April 30, 2007

(2007-04-30) by David John Marotta

This year's Tax Freedom Day arrives on Monday, April 30th. That's when we stop working for the government and start working for ourselves. For the average worker, all of his or her earnings for the first 119 days of the year go to pay federal, state, and local taxes. Starting May 1st, we are free -- at last -- to take care of our own family's needs.

The 2007 report, published this month by the non-partisan Tax Foundation based in Washington, D.C., measures the tax burden on Americans. According to the report, the 2007 federal tax freedom day comes twelve days later than it did in 2003.

Tax Freedom Day falls two days later than it did last year, even with the absence of tax increases. Gross Domestic Product has been strong, growing by at least 6.3% per year for the last three years. More wealth for Americans means an increase in Uncle Sam's share.

Due to our progressive tax system, Uncle Sam collects more taxes as inflation rises due to "bracket creep". As your income growth keeps up with inflation, your purchasing power remains unchanged. However, inflation drives you into a higher tax bracket and you pay higher taxes!

On average, taxes take nearly 33% of a worker's gross income – 22% for federal taxes and 11% for state and local taxes. For every eight-hour day we work, 2 hours and 35 minutes of our labor goes to paying taxes. Without taxes, you could leave work at 2:25 p.m.

Only since 1992 have Americans paid more for government programs than they spend on food, clothing, and medical care combined. For the amount of money we pay in taxes, government could already provide universal health coverage and feed and clothe us as well.

At the state level, tax freedom day varies from state to state. California has the 7th highest taxes with its Tax Freedom Day being delayed until May 7th. Virginia places 17th in the race for the highest tax state rate even though its Tax Freedom Day arrives on April 30th, exactly the national average.

The Virginia tax rate continues to climb higher each year despite claims of no new personal taxes because of both bracket creep and the significant increase in state business taxes. This has been a national trend. Business tax receipts have risen more than 20% over the past year.

Most non-economists vastly underestimate the negative impact of taxes on the U.S. economy. Taxes encourage every American to do things themselves, outside of the taxable economy, even if specializing and working together would have produced greater productivity. If you add the costs of complying with the complex web of regulations, our government costs Americans, collectively, over 50% of our wealth.

Imagine three builders who could build three houses if they worked separately. If they worked together and combined their specializations, they could build six houses instead. It may seem incredible that these builders would not take the opportunity to double their productivity, but with any tax rate higher than 50% they have no incentive to choose the more productive partnership. A 50% tax rate halves their productivity. Imagine the economic boom if the other half of worker's labor were set free!

Imagine a skilled surgeon whose marginal tax rate is over 50%. Everything she pays someone else to do costs her twice as much because she pays with after-tax dollars. It may be very inefficient to society for her to waste her time mowing her own lawn, changing her own oil or painting her own house, but specifically because she is in a high tax bracket, she can save more money than the average American by doing those chores herself. Another way to look at it is that without taxes, she could afford to pay those who provided her services twice as much.

Economist Arthur Laffer recognized that the law of diminishing returns applies to tax rates as well. According to Laffer, there comes a point beyond which increased taxation actually yields fewer tax dollars being collected. As we approach a 100% tax rate, we approach driving commerce into the ground and collecting nothing.

Many economists believe we are still beyond the point of diminishing returns. In other words, tax cuts would actually result in increased economic growth and more taxes being collected.

Presidents Kennedy and Reagan understood the Laffer Curve well. In 1964, Kennedy reduced the top tax rate from 91% to 70% and, to the surprise of many, tax revenues increased! Seventeen years later, the Reagan tax cuts reduced the top marginal rate from 70% to 50%. Revenues soared again. Between 1980 and 1997 the share of federal income taxes paid by the top 1% rose from 19% to 33%. The share of taxes paid by the top 25% increased from 73% to 82%.

The top 1% now pays 35% of the taxes in the United States. The top half pays almost 97% of income taxes. These two statistics have increased despite all the complaints that tax cuts have favored the rich.

Economists understand that the optimum rate of taxation is zero. The second most optimum rate of taxation is as low as possible. In contrast, many Americans seem to have the attitude that tax rates should be increasingly punitive.

Low taxes should not be a political issue that divides us. Every American should agree with the goal of keeping taxes as low as possible. In 2011, all of the federal tax cuts enacted since 2001 are scheduled to expire. In the words of John F. Kennedy, "An economy hampered by restrictive tax rates will never produce enough revenues to balance our budget - just as it will never produce enough jobs or profits."

from http://www.emarotta.com/article.php?ID=225

Buying a Car Without Breaking the Bank (2007-04-23)

Buying a Car Without Breaking the Bank

(2007-04-23) by David John Marotta

Purchasing a car is the second biggest spending decision we face as consumers next to buying a home. Unlike real estate or an investment portfolio which appreciates, cars are rapidly depreciating assets. In addition to the car's sticker price, operating expenses can drive the unsuspecting consumer into the poorhouse. And, if you choose to finance your car purchase, your losses will be compounded.

For most, owning a car is a necessity. And, aside from riding a bike, there are few ways to steer clear of the ongoing operating costs. But, you can strive to minimize them by applying a few common sense rules of thumb and by planning ahead for the next car purchase.

The day you purchase a new car it immediately loses much of its value. By the time you ultimately sell it, you will have lost most of your initial purchase expense. Add in the operation, maintenance, and repair bills, and the outlay becomes even larger. Not only do you pay a substantial amount to own a car, but you are forgoing the opportunity to save and invest this money in appreciating assets. Economists call the alternatives of what you could have done with your money your "opportunity costs." A single car purchase can cost you hundreds of thousands of dollars of opportunity costs.

Consider this simple example: You buy a car for $20,000 and keep it for five years. During that time, you fork over $5,000 for loan interest, $800 per year for insurance, $200 per month for gas, and $500 per year for maintenance. The operating costs alone will cost you $23,500. After five years - if you're lucky- your car has a resale value of $10,000 and you've spent $23,500 to keep the car running for a grand total of $33,500. But, that's still not your total cost for owning the car.

Had you invested your total cost of $33,500 in an asset that appreciated an average of 10% per year, at the end of five years you would have $53,950. So, not only did the $20,000 car have direct costs of $33,500 but you lost out on the potential to earn an additional $20,450 by investing that money instead. This brings your total opportunity cost for owning a $20,000 car for five years to a whopping $53,950 [$33,500 + $20,450]. Every new car you own depletes your retirement nest egg and delays a comfortable retirement by years.

It is possible to avoid driving a wreck without wrecking your finances. I've known couples with little to no retirement savings that justify buying $30,000 cars because they will get better gas mileage. To others, a car is not just a means of transportation, it is a lifestyle. You need to be more mature and consider the long-term effect on your finances.

When you buy a car, it's best to buy a used car that is two to four years old and has less than 50,000 miles on it. By this time the most rapid depreciation has already occurred, but it should still have enough useful years left to keep your annual maintenance costs low. Aim for the least expensive car that you can tolerate to drive.

Only buy a car you can pay for with cash. Shun easy credit. The only thing worse than buying a depreciating asset is buying a depreciating asset on credit. Paying interest on an asset that goes down in value is a ticket to the poorhouse.

Start saving for your next car immediately after you've purchased your current one. Put the money you are saving to buy a car into investments so that they can grow. Drive your current car as long as it is safe and reliable. The difference in your finances will be significant. Eventually you will have thousands of extra dollars allowing you to buy whatever car you desire from the annual investment return alone.

Leasing a car does not help very much. When you lease, you are essentially paying for the car's depreciation plus interest during your lease period. Unfortunately, you are still paying for the car's depreciating during the steepest drop in the car's value. There are some cases where you can take advantage of leasing as a business owner for tax purposes, but for the most part, leasing is a more expensive way to finance a car than paying all cash.

You can also minimize the cost of owning a car by reducing your insurance premiums. Get insurance quotes from at least four or five companies. You'll be surprised at how much premiums vary between providers. Also consider keeping a high deductible such as $500 or even $1,000 and dropping the collision and/or comprehensive portion of your coverage if your car is old and not worth more than a few thousand dollars.

On-line consumer resources such as www.edmunds.com and www.carfax.com can help guide you through the car-buying process. The more informed you are prior to entering into your purchase transaction, the more you will be able to stay within your established budget.

Because of the time value of money and the power of compounding, you should think of all of your major purchases in terms of your total opportunity costs. This is a good way to avoid overspending. The less you spend on depreciating assets, the more you can save and invest in assets that should grow in value and help you meet your long-term financial goals. Secure your financial security before you secure your dream car. And analyze all your major purchases within the context of a comprehensive plan for saving and investing.

from http://www.emarotta.com/article.php?ID=228

Familiarity Breeds Concentration (2007-04-16)

Familiarity Breeds Concentration

(2007-04-16) by David John Marotta

Investors have been told, "Invest in what you know." While this may have been a good adage for avoiding investing in companies with no business models, it is a poor rule of thumb to use when building diversified portfolios.

Familiarity bias causes New Jersey Investors to buy construction companies based in New Jersey simply because they feel like they know these companies better than financial services companies in Singapore. Similarly, investors in the San Francisco Bay area are more likely to be heavily concentrated in high tech companies. These are cases where limited experience can cause an investor to build a portfolio that is not the best mix of assets to help him or her meet important financial goals and objectives.

Investors who are comfortable with CDs or bonds often fail to allocate enough of their assets to the equities that will provide the important appreciation needed to help them meet their long-term goals. Because they lack the personal familiarity, most American investors are under-invested in foreign investments and even more are under-invested in the emerging market countries.

Because of a familiarity bias, most investors have over-weighted large cap stocks whose names they recognize and whose products they use. This large cap bias occurs despite the fact that mid cap, small cap, and foreign stocks, on average, provide a higher rate of return over time.

Even in the realm of large cap stocks, investors most often invest in companies that are well-respected and considered to be the best in their field. This happens despite the fact that studies have shown that these industry leaders, on average, under-perform companies whose stock prices are temporarily depressed because the companies are having trouble.

A distressed company can move its stock price more by laying off a few hundred workers than a solid company can move its stock price by meeting its 30% revenue growth projection. The solid company is known for being a great company and the expected future growth has already been factored into the stock price. If the company reports 25% growth instead of 30% growth, investors will reevaluate the company's value and the stock price will drop accordingly.

By the time the average person sees a trend and recognizes a company's value, the pattern is just as likely to revert to the norm or go the other way.

Because investors concentrate their investments in what they are familiar with, they often don't even know that they are concentrated. We have seen investors who thought they were diversified because they were invested in several mutual funds with different names while each funds held similar underlying investments.

Studies have shown that when investors are given several choices, they tend to put an equal portion in each investment. Since many 401k plans don't have the same number of funds representing each asset class, naïve investors often build very unbalanced portfolios.

Measuring a client's asset allocation and diversification is not difficult. The critical step is crafting an asset allocation that best meets a client's financial goals.

Investors can avoid the familiarity bias that can cause an undesirable increase in portfolio volatility while also lowering returns either by broadening their investment knowledge or by seeking out trusted advisors who have that knowledge and experience.

To broaden your knowledge, I would recommend reading the revised edition of The Intelligent Investor by Benjamin Graham with updated commentary by Jason Zweig. Alternatively, the NAPFA Consumer Education Foundation talk this Saturday is entitled "Protecting Your Portfolio by Investing Globally" and is being presented by my financial mentor and father, George Marotta, CFP® who has just finished teaching a discussion on global finance during the winter term at Stanford University. His presentation will be held on Saturday, April 21, in the Northside Library Meeting Room in the Albemarle Square Shopping Center in Charlottesville, Virginia from 12:00pm to 1:30pm. The presentation is free and open to the public.

If you have questions about the NAPFA Consumer Education Foundation or would like a schedule of upcoming NAPFA Foundation presentations, send an email to Charlottesville at NAPFAFoundation dor org or visit http://www.napfa.org/consumer/NCEFCharlottesville.asp

from http://www.emarotta.com/article.php?ID=227

Breaking Spaghetti: A Seven-Year Financial History (2007-04-09)

Breaking Spaghetti: A Seven-Year Financial History

(2007-04-09) by David John Marotta

For the past seven years US markets have experienced the ripple effects of the tech sector's correction in 2000. The latest waves have been in the slow decline of the housing market and, now, in the weakening of the commercial real estate market. While economists can't always explain the timing of these ripple effects, the corrections in the market are much like the physics of spaghetti.

Hold a piece of dry spaghetti by the ends. Now, bend it slowly until it breaks. What you'll notice is it almost never breaks neatly in half. Instead, it shatters into three or four fragments. Only recently have physicists studied why this occurs. When a bent strand of spaghetti is broken, a series of waves travels down the length of the pasta fragmenting additional pieces. When the bent rod of pasta is suddenly set free by an initial break, it releases energy waves which cause breaks in other areas.

The physics is fascinating, but it also helps us understand the trickle down effects of the tech bubble bursting. The stress released by the technology correction has resulting in delayed releases in other parts of the economy. In the markets, this ripple effect happens over years - even decades - rather than milliseconds, but the concepts involved are similar.

Although the tech bubble was isolated to a small portion of the overall market, this relatively small break created ripple effects which explain some of today's market conditions. The initial break in the tech sector contributed to the correction we are experiencing in the housing and commercial real estate today.

Officially, the top of the bull market was the first quarter of 2000, when the Dow reached 11,722, the S&P 500 drifted over 1,500 and the NASDAQ climbed to over 5,000.

The bubble was limited to large cap growth technology stocks. In 2000, investors with a large concentration of tech stocks watched as their portfolios were eventually reduced to pennies on the dollar in 2000. Large cap growth stocks lost 33.5% of their value. But that same year, small cap value stocks actually appreciated 18.7%. Growth stocks were down, but core and value stocks were still up.

In 2001, large cap growth stocks lost an additional 29.1%. Growth stocks were down and investor sentiment pulled all of the large cap stocks down as well. But small cap value stocks were still going up and earned an additional 18.6%.

By 2002, investor sentiment finally pulled down large and small cap stocks - both growth and value. This drop, however, was not evenly shared by all stocks. Large cap growth stocks lost a whopping 33.2% while small cap value was down only 8.2%.

From 2000-2002, if you were invested in only the large cap growth stocks you lost about 68.5% of your net worth. However, during that same time, if you were invested in small cap value stocks, your investments appreciated 29.2%!

As a result of the recession, the Federal Reserve lowered interest rates to help stimulate the economy. This caused financial services to do well because lower interest rates created an unprecedented increase in lending activity - everything from refinancing for mortgage equity withdrawals to commercial real estate loans.

Lower interest rates increased available credit and the speed at which money was moving through our economy, in essence, expanding our money supply. The increases in the money supply devalued the dollar. As the dollar dropped in value, foreign investments (stocks and bonds) began to yield higher returns. Likewise, companies that owned oil, natural gas, copper, gold, or silver found that as the dollar decreased in value, they could get more dollars for the hard assets they were producing.

The ripple effects continued to work their way through the economy. Lower interest rates for mortgages also drove housing prices up. As interest rates hit historic lows, home buyers could afford houses previously above their price range that their income could not support at the higher rates. For example, in March of 2000, a family with a 30-year fixed rate mortgage at 8.4% could afford to borrow $131,000 with a $1,000 monthly payment. By the time that the interest rates had dropped to 5.4% in June of 2003, that $1,000 monthly payment would service a $178,000 mortgage.

Housing prices soon skyrocketed in absolute dollars, but they were not rising as much in terms of monthly payments. Lower mortgage rates, along with a devaluation of the dollar and resulting higher prices for all hard assets, explain the rise in housing prices over the past seven years.

The rising real estate market boosted consumer spending in three ways. First, homeowners - due to rising home values - enjoyed a higher net worth and therefore spent more money. Second, low rates encouraged a high turnover of houses resulting in high levels of consumer spending as homes and rentals were being refurnished and remodeled. And finally, homeowners refinanced their homes, or set up lines of credit, turning their houses into virtual ATM machines.

As a result of Americans using their homes to finance bigger spending habits, their home equity began to dwindle. Many mortgages grew to exceed 80% of the home's value. Then, the Federal Reserve started to raise rates.

Many homeowners with adjustable rate mortgages have seen their monthly payments increase 50%, due to the higher rates. With the sudden jump in monthly mortgage payments, many are finding they can no longer afford to stay in their homes. The rate of late payments and foreclosures has continued to rise leaving many lenders on the brink of bankruptcy themselves.

Studies suggest that for every 1% drop in housing prices, gross domestic product (GDP) could drop by 0.2%. Looking forward, if falling home prices continue with a slowing economy, it could result in a recession. Dropping prices in housing would have a direct relation to company earnings and thus stock prices. If the real estate market does decline, the effect will be another shock of breaking spaghetti in the economy.

As with the physics of spaghetti, one break in the economy usually leads to multiple breaks elsewhere. And while short-term trends are difficult to accurately predict, there are long-term trends that you can still profit from with foresight and a sound investment approach. Diversifying your portfolio across non-correlated asset classes is the best way to earn steady long-term returns while managing risk.

from http://www.emarotta.com/article.php?ID=226

Financial Planning for the Second Half of Marriage (2007-04-02)

Financial Planning for the Second Half of Marriage

(2007-04-02) by David John Marotta

My wife and I are celebrating our twenty-fifth wedding anniversary this month. Our oldest child is now a freshman in college and our youngest is a sophomore in high school. The financial planning issues that were important during the first half of our marriage become critical as a couple enters the second half.

The second half of marriage can either be the best time of life or the time when a marriage breaks up. The transition can catch unsuspecting couples off guard.

A survey from the book "The Second Half of Marriage" surveyed couples' responses to the question: "What are the areas that cause the greatest stress in your marriage?" In every decade of life, the number one answer was "finances." Budgeting, retirement planning, and other money issues can easily ruin what might otherwise be a time of remembering why you got married in the first place.

Times of transition are particularly hard on marriages. As the work of raising a family wanes, couples often look to each other for help in redefining their calling in life. Mothers who have devoted years to caring for children may want to fulfill one of the dreams they postponed decades ago. They may want to go back to school, take on a new career, or be more involved in charitable causes. Husbands, on the other hand, may find they are ready to scale back their careers.

While having a close friendship and spiritual commitment are the most important ingredients of a fulfilling relationship, financial troubles are usually the primary point of contention. Fulfillment in the second half of marriage will require reconnecting with our spouses. Part of that process will mean proactively working on your finances, together.

If you and your spouse are approaching this season of transition, take this opportunity to check-up on your retirement money, your marriage, and your mission.

First, get your retirement plan together. A retirement plan, like a spending plan, helps a couple limit their disagreements to only those issues outside the plan.

It is at this point that a little advance planning can make a world of difference. If you have to choose between funding your retirement and paying for your children's education, your desire to fund your kids' college education may not be the best choice. The government will loan you money for college but not retirement. You can also drastically reduce the costs of college but not so with retirement. If necessary, your children can borrow for their college education. If they do, they still have a long time horizon in which to repay those loans and to build wealth.

For most couples, expenses drop significantly after their children finish college. Although saving in the early years of marriage is ideal, when the kids are finally off on their own, couples get one last chance to save for retirement.

These years before retirement are critical in determining whether you have sufficient assets to retire. During this time, it is important that your investments are not invested too aggressively or too conservatively. Between age 45 and 65, the size of your portfolio should at least double and then double again. By the first day of retirement, you should plan on having about 23 times your annual income.

Next, reestablish opportunities for communication with your spouse. The period just before the children leave home is often the most difficult on the marriage relationship. After a quarter century, the communication focus of most couples is their children. Creating new channels of communication that are spouse-centered are critical during this time of transition.

The natural course of relationships is to drift apart. So, don't be down on yourself if you and your spouse are 'working' on your marriage. The fact is, if you aren't working on your marriage, it is probably headed in the wrong direction.

Finally, find your mission for this new phase of your life. It is easy when you are young to think you have all the time in the world for all the good things in life. First your job, then the kids rightfully occupied much of your time. But, as these responsibilities begin to ease, revisit the bigger life questions which are critically important, even if they aren't immediately urgent.

George Kinder in his book "The The Seven Stages of Money Maturity" uses three questions to help people understand these life questions. Take the time to write out your answers honestly and thoughtfully, and then share your thoughts with your spouse.

1. If you knew you would have all the money that you needed, now and in the future, from this moment forward, how will you live your life?

2. If the doctor told you that you would die suddenly and without symptoms in five to ten years, how would you change your life for the time that remains?

3. If the doctor told you that you would be dead within twenty-four hours, what feelings, regrets, longings, and unfulfilled dreams would haunt you?

Nothing is more meaningful than structuring your life around lasting values. Sometimes the vague nebulous answers that we live by are not ultimately satisfying. Reevaluating our purpose can give renewed meaning to our lives and relationships, especially in this season of change.

from http://www.emarotta.com/article.php?ID=224