Benefits of Long-Term Investing

Imagine a cross-country car race that starts in downtown Houston during rush hour. One racer sees bicycle messengers speeding by in the stop-and-go traffic. Becoming impatient, he jumps out of his car, trading it for a bicycle. Once out of Houston, as other racers still in their cars pass him, he quickly realizes his short-term decision was unwise in light of his long-term goal of winning the race.

It may seem rather silly for this racer to trade in his car for a bike, yet investors do the same thing every day. They lose sight of the strategy that it will take to get their prize. Although many investors claim to understand the benefits of long-term investing, their actions often show a short-term focus.

So, what is long-term investing? And why is it a tenet of MTR Financial's investing philosophy?  Long-term investing is being committed to a sound investment plan—one that starts with a proper asset allocation appropriate to your risk tolerance—over a length of time, such as five to 20 years.  More importantly, though, long-term investing is a mindset that gives you perspective and discipline as you work toward your financial goals—and can keep you from making costly mistakes based on short-term perceptions.

Benefit 1: Maximize your wealth
The wealth you can accumulate over your lifetime is determined by three factors: (1) the amount you save and invest, (2) the return you earn on your investments, and (3) how long your money compounds, generating earnings from previous earnings. The long-term mindset is key to this last point: how long your money compounds from reinvesting your investment earnings. This is something most investors have direct control over. The earlier you start and maintain the long-term outlook, the more time compounding has to work its magic.

Benefit 2: Prevent costly mistakes
Losing sight of the long term and thinking you can time the market by exiting at the peak and re-entering the market at the trough over the short term is a big mistake. Timing market shifts correctly is nearly impossible, although making modest adjustments to your strategic allocation based on current market analysis can add value. However, we continue to see investors making wholesale market timing bets.

Why can market timing be so costly? Because returns are often concentrated in short periods. For example, in March 2009, US stocks were up 9%. Nearly 90% of the month's recovery came in just eight trading days following the low point of the stock market.

Portfolio studies have been performed to see what happens when you miss the top days in the market. The research, looking at returns from 1990-2009 shows that missing the market's top 10 days cut the return by nearly half on a portfolio of stocks, represented by the S&P 500 index.  Missing the top 20 days dropped the return below even Treasury bills (T-bills). And missing the top 40 days—that's 40 days out of 20 years, fewer than 1% of the trading days—produced a negative return. You can see how a small number of trading days can equate to large differences in return.

Benefit 3: Lower your risk
Having a long-term mindset and lengthening the time you hold investments can often reduce the probability of experiencing negative returns.  Studies have been done on the highest return, lowest return and average annual return of the S&P 500 over various holding periods from 1926. The findings show that as you move from a one-year holding period to a three-year, 10-year, and finally to a 20-year holding period, the number of negative returns experienced goes down. In fact, there's never been a 20-year period with a negative return.

Stay focused
How can you keep your long-term state of mind the next time you're tempted by a short-term decision?  Remember that keeping a long-term state of mind doesn't mean ignoring your portfolio. It means developing a plan based on long-term expectations, not short-term trends. Along the way there will undoubtedly be some fine-tuning. Investing for the long-term can help maximize wealth, prevent costly mistakes and lower the downside risk in your portfolio.

Or, to quote legendary investor Warren Buffet: "Someone is sitting in the shade today because someone planted a tree a long time ago."

Use The New Year To Establish Strong Financial Habits

“We are what we repeatedly do. Excellence, then, is not an act but a habit.” Aristotle. This quote has profound meaning for your financial life.  Even if your savings are up not to scratch or if your debt level is extremely high you can change the course of your financial future by changing your financial habits.

The secret is to start implementing small changes into your life and work them into your routine. Repetition will help to make them your new habits and you can then start reaping the rewards of healthy financial practices. Take a look at these 4 financial habits you should strive to adopt.

1. Start Budgeting Now

Creating a budget is not difficult. All you need to do is to identify your sources of income on one side and then list your fixed and variable expenses on the other. It is recommended to keep your fixed and variable expenses separate so it is easier to highlight possible areas for cutbacks. If you are not sure of where your money is spent you may need to do a little ground work to draw up your first budget. Start by making an effort to write down every time you spend money and start keeping your receipts. At the end of the month you can categorize your spending and then fill in your budget.

2. Use Goal Setting to Improve Your Financial Scorecard

Goal setting is important for improving your finances because this act gives saving direction and purpose and thereby makes it easier to part with your money now, for some reward in the future. For instance, it may feel like punishment to tuck away $1,000 a month just because it is important to save; but if you were to attach a goal to this figure it would become logical. So you might rationalize that you need to put $500 towards an emergency fund while $500 should go towards your next vacation. All of a sudden, putting away $1,000 is easier.

3. Save for Retirement

Everyone needs to plan for their golden years. If you haven’t yet started up some form of retirement savings, there is no time like the present. You should also note that it is never too early to start. You can check how much you are allowed to save tax-free and at least make sure you are maximizing this amount. If your employer gives a match for retirement savings, always take advantage of this.  If you don’t, you are basically throwing away free money.

4. Keep Your Debt Under Control

If you have a problem with keeping your debt under control you should make this a priority. Start implementing measures to pay down outstanding debt, especially if that debt comes with extremely high interest rates. Allowing interest to accumulate even more interest is a sure-fire way to end up moving in the opposite direction of financial prosperity. To get a handle on your debt situation, make sure you have a strategic plan for pumping your available funds into making debt payments.

Bad habits form in good economies; and good habits form in bad economies. If you are wise, you will form good habits and keep them!  It is never too late to implement some good financial habits. All it takes is the desire to change and the dedication to stay the course.

Your Year-End Financial Checklist

As we approach the end of 2010, Santa should not be the only one making a list and checking it twice.  With all of the changes in income and estate taxes poised to take effect on January 1, 2011, it should come as no surprise that reviewing your family’s finances is even more critical this year-end.  Below is a small sample of items to consider.

In General 

• How is that Emergency Fund holding up?  The general rule of thumb is you should have three to six months of living expenses saved in a very liquid, easily accessible account.  Don’t have an emergency fund?  Start devising a savings plan to start building one right away.

• Plan a holiday spending budget to avoid overspending as we enter the holiday season.  Ideally, the spending budget you determine appropriate should be funded with cash rather than relying on credit cards.  The best holidays are those that don’t have statements showing up in your mailbox in January.

• Review your credit report for inaccuracies and accounts that should be closed but which remain open.  Everyone is entitled to one free report from the three major reporting agencies, Experian, Equifax, and TransUnion.   Schedule to pull one every four months, and you’ll provide year-round monitoring for your family.

Investments

• Be cautious about making additional investments in your non-retirement investment accounts, especially when dealing with mutual funds.  Funds are required to distribute capital gains and dividends to shareholders by the end of the year.  If you invest before the distribution date, you will receive your share of capital gains and dividends the fund recognized during all of 2010 – even if you only owned the fund for one day.  And that could wreak havoc on your income taxes.

• Required Minimum Distributions (RMDs) are back for 2010.  Failure to make your RMD results in a 50% penalty on any amount you did not take this year.  Not sure if you’re required to take a RMD?  Contact your tax advisor or MTR Financial Services for guidance.

Income Taxes

• As it stands right now, income tax rates are set to increase to the pre-Bush Tax Cuts rates.  Also increasing are the tax rates for capital gains and dividend income.  As odd as it may sound, it may benefit you to accelerate income in 2010, including selling investments with large gains.  Additionally, deferring certain itemized deductions such as charitable giving and real estate taxes into 2011 could result in a more efficient income tax scenario if the impending tax changes hold true.

• Check to see if you need to update your W-4 filing for 2011.  A change in marital status or a birth of a child in 2010 will normally result in the need to update your W-4.  Also, if you’re consistently getting large refunds with each tax filing, you may want to consider updating your W-4 as well.

Estate Issues

• Unless Congress acts before year-end, the estate tax will re-appear in 2011.  Each individual will have a $1 million exclusion, and the top tax rate on estates will go to 55%.  Those who haven’t had to worry about estate taxes in the past may find themselves subject to larger than anticipated estate taxes due to the decreased exemptions.  Consult with your estate planning attorney or MTR Financial Services for guidance on how to best address your potential need for new wills and estate documents.

• With the impending changes in the estate tax exclusion amounts for 2011, proper beneficiary designation for your retirement accounts and life insurance policies is critical.  Failure to review your current beneficiary designations could create additional tax for your heirs.

Insurance

• If you have a Flexible Spending Account (FSA) you need to be aware of a key change in benefits that will begin January 1, 2011.  Starting on this date, over-the-counter medication will only qualify for reimbursement if prescribed by a doctor.  The only exception is for insulin bought without a prescription.

We’ve all heard that a little planning can go a long ways.  With all the changes facing us in 2011, this adage certainly holds true.  Consider contacting MTR Financial Services for any guidance you may need in your overall financial plan.

Upcoming Tax Increases To Keep In Mind

Regardless of how the elections turn out tonight, and barring any legislation before the end of the year, changes to our personal income taxes will automatically occur.  I’m sure everyone is aware of the increasing marginal tax rates, as well as the increased capital gains tax rates.  

I thought I would summarize some of the key changes that will automatically occur come January 1^st:

• Personal income tax rates will rise.  The top income tax rate will rise from 35% to 39.6%.  The lowest rate will rise from 10% to 15%.  The full list of marginal tax rate hikes is:

o   10% bracket rises to an expanded 15% bracket

o   25% bracket rises to 28%

o   28% bracket rises to 31%

o   33% bracket rises to 36%

o   35% bracket rises to 39.6%

• The “marriage penalty” (reflected in standard deductions and tax brackets for married couples that are less than double the single amounts) will return.  This change will cause many two-earner couples to owe more tax and may discourage couples from marrying.

• The capital gains tax will rise from 15% (0% for taxpayers in the current 10% and 15% tax rate brackets) this year to 20% in 2011.  

• The dividends tax will rise from 15% this year to potentially 39.6% in 2011 – dividends will be taxed at ordinary income tax rates.

• Itemized deductions and personal exemptions will again be phased out (no phase out limits for 2010), which has the same mathematical effect as higher marginal tax rates.

• The child tax credit will be cut in half from $1,000 per child to $500 per child.

• The dependent care credit will be calculated on $2,400 of expenditures (rather than $3,000) for one dependent and $4,800 (rather than $6,000) for two or more eligible dependents.

• Stepped up basis on inherited property returns along with a $1MM personal exemption and a top estate tax rate of 55% for estates over the $1MM level.

• The increased alternative minimum tax (AMT) exemption will expire, causing millions more taxpayers to owe AMT.

• The $250,000 immediate expensing of business equipment provision will be reduced to $25,000, and 50% bonus depreciation will expire.

The best plan is a proactive plan, so if any of the changes listed above could adversely affect you it’s best to address the issues now rather than trying to be reactive come January 1.  Any questions at all, just send me a message!

They're Baaaack......

In response to the drastic stock market decline in 2008, Congress (as part of the Worker, Retiree, and Employer Recovery Act of 2008) suspended required minimum distributions (RMDs) from IRAs and defined contribution employer plans for the 2009 calendar year.  As a result, individuals could avoid having to deplete retirement assets while the value of those assets was suddenly depressed.  But RMDs are back as of January 1, 2010.  If you’re out of practice – or making a required distribution from your IRA for the first time – here’s what you need to know:

When Do RMDs Have To Be Taken?

According to IRS regulations, people aged 70 ½ and older must take their distributions by December 31 of each year, or when they separate from the employer sponsoring their retirement plan, whichever is later.  There is one exception – if you turned 70 ½ in 2010 (and you are retired) you can wait until April 1, 2011 to take your first RMD.  It is important to note, though, that the RMD taken is for the 2010 calendar year – you will still have to take the RMD for 2011 by December 31, 2011, thus creating two distributions for 2011.

How Much Do You Have To Take?

Distributions are calculated by IRS rules, so you have to adhere to a very specific formula.  Your 2010 distribution will be based on your retirement account’s value on December 31, 2009 and one of three IRS tables found in Appendix C of IRS Publication 590.  Essentially, you are dividing your IRA balance by what the IRS has determined your life expectancy to be, depending on which table you are using.    If an individual has several IRAs, they can generally add the balances together and take the required distribution from just one account.  This is not true for 401(k) and 403(b) plans.  If an individual has money in several plans from previous employers, distributions must be taken from each plan – a good reason to combine them into a single IRA.  If you are unsure which table applies to your situation please contact your tax professional or MTR Financial Services for guidance.  It is important to remember that these calculations only determine your required distribution – you can always take more than the required distribution if you wish.

Consider The Taxation of Distributions

The money taken from your retirement account is taxed as ordinary income in the year taken because you received a tax deduction when you contributed to it.  With income tax rates widely expected to increase in 2011, the timing and amount of distributions you take need to be closely monitored.  If you did turn 70 ½ in 2010, it may make sense to take your first RMD in 2010 rather than deferring it to April 1 of next year.

Who Else Is Required To Take Distributions?

If you inherit an IRA (either a traditional or Roth) or employer-plan account from someone other than your spouse, you must begin taking RMDs over your life expectancy, starting with the year following the year of the account owner’s death.  (Spousal beneficiaries can simply roll the inherited account into their own IRA, and will not be required to take distributions until age 70 ½.)  Therefore, if you inherit an IRA from a parent, for example, and you are only 50 years old, you will be required to take annual distributions from that account each year for as long as you live.

Still Not Sure?

If you are still not sure if you have to make a required distribution by December 31, 2010 please consult your tax professional or MTR Financial Services for clarification.  The penalties for not taking the required minimum distribution, or any distribution at all, are severe.  You will be taxed 50% of the amount that you should have taken but did not.  That is a pretty stiff penalty that you will want to avoid!