Sunday, April 28, 2013

Motley Fool: Mutual Fund Pros Falter

This was publish in the Bee's business page today.  I've advocated investing in indexed funds for a long time.

I put $10,000 into the Vanguard S&P 500 index fund in July, 1996.  Today, that account is worth $32,465.63, after re-investing all the dividends.

When the tax law changed in 2000 allowing me to convert my IRA into a Roth, I did that.  And that account has grown by 58.01% in the 3 years, all invested in index funds, with about half of it in the Total Market Index Fund and the other half in the S&P 500 Index Fund.

My philosophy is to invest money I won't need for at least 10 years into index funds and just let it sit.  No one can time the market with consistent success.

If you change your investment strategy, however, beware of any potential tax consequence.

Fool’s School
Beware of the Experts

Some have accused professional mutual fund managers of being no better at picking stocks than a dart-throwing chimp. That’s insulting to chimps, though.

In any given year, the majority of professional fund managers underperform their benchmark index — a virtual certainty given a limited amount of return to capture and an unlimited amount of fees to charge.

For example, in 2011, 84 percent of U.S. stock fund managers underperformed the S&P 500 index, according to Standard & Poor’s. That’s bad enough, but dig deeper and it gets far worse. It turns out that the overwhelming majority of professional fund managers focused on the minority of stocks that underperformed the market. It takes skill to be that bad.

(Per S&P Capital IQ data, the average stock that rose more than 2.07 percent returned 20.4 percent, while the average stock below that threshold fell 16.6 percent.)

This isn’t rare, and it extends beyond fund managers to Wall Street analysts. According to Bloomberg, “The 50 stocks in the S&P 500 with the lowest analyst ratings at the end of 2011 posted an average return of 23 percent (in 2012), outperforming the index by 7 percentage points.”

Meanwhile, fees make the situation worse. In one report, IBM concluded that global money managers overcharge investors by $300 billion a year for failing to deliver returns above a benchmark index. Vanguard cites data by the Financial Research Corp. showing that the single best predictor of a fund’s future performance is its expense ratio (essentially an annual fee).

A common rebuttal is that, while money managers underperform an index, they are better at managing risk and lowering volatility. But studies have shown that the average mutual fund closely tracks the ups and downs of the overall market.

Some professional managers can beat the market and earn their fees. The majority can’t. If you don’t have the time or inclination to manage your own money, you’re likely to do best buying a passive, low-cost index fund.

Monday, April 15, 2013

Social Security: Many pay more in taxes than they'll get back


Up until now, Social Security has been a windfall for many retirees: They collected far more in benefits than they shelled out in taxes.

That's changing. Many of those retiring will have paid more into the coveted entitlement program than they will get back.

Here are the numbers:

A couple who each earned the average wage during their careers and retired in 1990 would have paid $316,000 in Social Security taxes, but collected $436,000 in benefits, according to data crunched by Eugene Steuerle, an economist at the Urban Institute.

Had that couple turned 65 in 2010, however, they would have paid $600,000 in taxes, but could expect to collect just $579,000. This is the first time in the program's history that taxes outweighed benefits for this group, a couple with average earnings.

The imbalance will get more pronounced for future generations of retirees. Couples now in their early 40s will have forked over $808,000 in Social Security taxes by the time they retire, but get back only $703,000 in benefits.

The Urban Institute included payroll taxes paid by both the employee and employer, but did not include the portion used for Social Security's disability insurance program. Since 2000, taxes for just the retirement program have totaled 10.6% -- 5.3% from the employee and the same from the employer. The levy is paid on income up to a certain threshold -- $113,700 for 2013. The institute said it adjusted its calculations for inflation plus 2%, about what a person could have traditionally realized in savings had they put the money in the bank.

So why is the shift happening now? It's because the first waves of recipients saw their promised benefits rise without sufficiently large tax increases to pay for them, Steuerle said. Rates rose significantly after the program was overhauled in 1983.

"Younger generations are paying much higher tax rates for the same benefits," he said.

Still, there are many folks who will collect more than they'll have paid. The typical American couple do not each earn the average wage during their careers since women often have lower incomes or take years off to raise children. In this scenario, the couple would receive more benefits than they pay in taxes because the wife's checks often will be based on her husband's earnings. Also, most lower-wage workers receive more in benefits than they pay in taxes.

To be clear, Social Security, created in 1935, doesn't operate like a savings account. Today's workers' taxes are funding the monthly checks being sent to today's retirees.

When it comes to Medicare, however, virtually all Americans are getting far more than they pay in taxes, which is 2.9% on all of one's income, not including the new 0.9% surtax on high earners. The couple turning 65 in 2010 paid a scant $122,000 in Medicare taxes, but can expect to get $427,000 in benefits.
And that pattern isn't reversing any time soon ... the spread actually widens for future generations.
Though many people are now putting more into Social Security than they will take out doesn't mean the entitlement program is on sound footing. A big part of the problem is that there are fewer workers to support the growing number of retirees.

The system is now paying out more in benefits than it collects in income, with the difference coming from the so-called trust fund, the result of surplus revenue previously paid into the system. But the trust fund is set to run out in 2033, after which the program will only be able to pay about three-quarters of promised benefits, according to the Social Security trustees.

"What we are paying into the system is paying for our parents' benefits," Steuerle said. "But it's not clear what that entitles us to get from our kids."

Monday, April 8, 2013

Pay your taxes electronically when you e-file your tax return

In my opinion, this is the best and safest way to pay taxes.  Doing so avoid checks getting lost or mis-used and data entry error by government personnel.   There is always a risk when one's social security number shows up on a check especially when banks these days routinely truncate the checks and store them electronically on their computers.

Friday, April 5, 2013

Proper Support for Charitable Contributions Critical

The IRS has been winning court cases where taxpayers do not follow all the requirements in supporting their charitable contributions.  Here are the IRS requirements:

David and Veronda Durden lost their $25,171 donation to their church because the acknowledgment from the church does not have the phrase, "no goods or services were provided in exchange" or "only intangible religious benefits were provided" even though they have all the cancelled checks.

A Sacramento couple lost an $18.5 million charitable contribution deduction because they did not attach a qualified appraisal to their tax returns: