Slideshow of the Fiscal Cliff Resolution
Eileen Jacobs
eileenjacobs


Fiscal Cliff Resolution's Impact on Taxes and Investing
Eileen Jacobs
eileenjacobs

Given the large US budget deficits of the past several years, tax increases were inevitable. No doubt, this will be a drag on economic growth going forward. For starters, those earning wages will experience an increase in payroll taxes. The withholding for Social Security taxes will revert back to 6.2%, the amount it was before the financial crisis.

The Bush-era tax cuts will remain in effect for those earning less than $400,000 per year with the top tax bracket being 39.6%. Long-term capital gains and dividends will remain at 15% for those earning less than the $400,000 threshold. The top rate for long-term capital gains and dividends has risen to 20%.

Most importantly, however, is the permanent patch to Alternative Minimum Tax (AMT). Previously, AMT had to be patched every single year, leaving an element of uncertainty for many filers. Had this not been resolved this year, many taxpayers would have been caught by surprise with a stiff tax increase.

Although this resolution will be a fairly minor drag on the economy, it will not be sufficient for solving our budget problems. Our budget deficits are too massive and spending cuts will still be needed to bring our budget to a reasonable level. Simply put, the government will still spend far more than it receives in taxes.

One of the buggest dangers is a sharp increase in interest payments for the national debt. Interest alone on the national debt is around $29 billion per month. A spike in inflation and interest rates could make this amount multiply. Currently rates on US government bonds are near zero with the 30 year bond being around 3%. This is why any increase will be huge. These rates are historically low and cannot get much lower. That being said, the risk involved does not favor US taxpayers. 

The Fiscal Cliff consisted of mostly media hype. The real problem involves the mushrooming amount of debt. If this is not dealt with, then we will experience a real crisis. According to Reinhart and Rogoff's This Time is Different, once debt-to-GDP rises to over 90%, it becomes a significant drag on the economy (We have already passed this level). In most cases cited by the authors, governments eventually default. Currency devaluations, resulting in inflation from printing money, are considered to be an indirect form of default. And is the most common method used by governments with fiat currencies. 

Slower Growth Impacts Equities

Currently, the stock market is priced with the assumption of GDP growing at the rate of its historical trend. This is roughly 3% per year. Since the Great Recession, we have not been anywhere near that. Corporate earnings for the majority of S&P 500 companies have been disappointing for the last 2 quarters. This suggests that earnings are near their peak for this business cycle. 


Medicare Taxes Set to Rise
Eileen Jacobs
eileenjacobs

Medicare surtaxes will be levied on high income earners. As it stands now, there will be 2 separate taxes for both earned income and unearned income.

The 3.8% Medicare surtax policy was passed in 2010 and is scheduled to take effect in 2013. This will affect those making over $200,000 per year ($250,000 if married). Currently, the top tax rate on dividends and capital gains is 15%. The surtax alone would increase this to 18.8%. Bear in mind that this does not take into account the expiring Bush tax cuts. That said, more increases for tax on investment income could be coming.

What effect will this have? It will make dividends worth less than what they are today. Because of the anticipation of higher dividends, many companies are currently paying special, lump sum dividends to avoid shareholders paying higher rates. Dividends you receive before the end of 2012 will still have a maximum tax rate of 15%.

The tax increase will have unintended consequences. If dividends are worth less in the future, companies will be more reluctant pay them. They will likely use other "tricks" like share repurchases. This increases earnings per share because it reduces the number of shares in the market.

Higher taxes for dividends will place downward pressure on stock prices. Because we are in a low yield environment, many investors have deployed more cash into dividend paying stocks. This is because interest rates are too low to provide a reasonable return.

If you plan on selling stocks in the near future, selling large gains before the end of 2012 will likely result in tax savings. This is especially true for high income earners.

The Medicare payroll tax will also increase for high income earners. An extra 0.9% will affect single filers with earned income over $200,000, married couples filing joint with income over $250,000, and married filing separate taxpayers with an income over $125,000. The top rate on Medicare overall will be a combined total of 2.35%.


Fiscal Cliff is Mostly Media Hype
Eileen Jacobs
eileenjacobs

Each time I turn on CNBC, there's a clock showing the countdown of the fiscal cliff (regardless of which show is on). This is merely a recurring theme: make you think the world is ending in dramatic fashion to keep you watching the news. CEO's like to come on the shows to tells us it's armageddon if we raise taxes. Isn't this just an attempt by them to avoid paying more taxes themselves?

The real truth is that the economy is already weak. Corporate profits have been below analysts' forecasts in the second half of 2012. In addition, we are interwoven in a global economy which includes a European recession and a slowing Chinese economy. Because the global economy is so interconnected, recessions elsewhere will have an impact.

Politicians also add drama. That is, they have an interest in "standing tough". If an agreement were reached right off the bat, it would appear as one side lost the battle or was not doing it's job. In other words, the longer they drag this out, the more it appears they are not letting the other party win.

In the end, the US government will be forced to deal with its budget problems. Because of the massive gap between tax revenue and its expenditures, there will be no options left except higher taxes and reduced benefits. Whether a consensus is reached in the short term or not, the huge deficit will be a drag on the economy for years to come.


How I Estimate My Taxes Without Preparing the Whole Return
Eileen Jacobs
eileenjacobs

You may have a ballpark idea of how much income you have. Or, how much money you will make next year. Perhaps you need to just get an idea of what your tax situation is likely to be quickly and easily. Taxes PhD Tax Estimator will accurately calculate Form 1040 components without all the clutter of standard income tax software.

The aim: to understand your tax situation in as few steps as possible and see how changes will affect you going forward. This productivity tool will aid in:

  • Predicting a refund or balance due amount
  • Calculating accurate estimated tax payments
  • Revealing the impact of deductions and credits
  • Adjusting withholding amounts

Taxesphdestimatorscreenshot
Taxes PhD is also available on Android smartphones.


On Time and Money
Eileen Jacobs
eileenjacobs

Simply put, we are a nation of instant gratification. That said, it may not be such a bad thing. We should spend the bulk of our time doing what we're best at. Just because you can do something doesn't always mean that you should.

If you're putting in long hours at work, it's more feasible to get a sandwich from Subway than to cook at home (going to McDonalds is a different story). Convenience goods generally cost more. Like getting a gallon of milk from 7-Eleven.

Many people are do-it-yourselfers. I'm not one of them. Why go through the trouble of learning how to fix something that you'll likely deal with just once?

Changing you own oil for your car is the perfect example. Why do this yourself when you can take to a shop, and get it done within minutes? The cost for this service is low. In addition, you don't need to worry about getting dirty and disposing the oil when you're done.

Doing a task in which you're not good at is a misallocation of resources. If your time is worth more in your primary business, you should seek to outsource tasks that are not your core business. These generally include tasks that are redundant in which you can write a simple to-do list for. These tasks require little or no creative thought. If you cannot completely outsource them or automate them, you may need to hire an employee to perform them.

Ultimately, the value of your time and specific situation will dictate what things you spend your time on. When I was younger, my time was worth less than it is now. So, it was a rational decision to carry out a few of the tasks that I wouldn't do today. Back then, I have more time and less money. Thankfully, things have changed now.

We have limited room for how many tasks we can handle. We can't focus on a long laundry list of high priority tasks. Therefore, reality eventually forces us to prioritize. Knowing where your critical path lies and staying on it are critical elements of being successful.


Everything Can Always be Made Better
Eileen Jacobs
eileenjacobs

Innovation doesn't stop once we become experts. Becoming an expert can have serious consequences if you're not careful. When you rely on your expertise, it's easy to become complacent. And resistant to change.

No matter what level you achieve you should always be questioning yourself. Is the way you've always done something still the best? Often times. the ultimate solution for continued success lies on something far outside our circle of competence. For example, industries become outdated. A better typewriter, for example, will not achieve anything when the world is shifting to computers. The same can now be said for traditional desktop PC's because the market is shifting to laptops and mobile.

Indeed, it's important to continuously be studying your closest competitors. That said, disruptive technologies can affect your business even when they're outside your industry. This is how Apple became a dominant force in the music industry. Samsung, being a large conglomerate, has become a leader in mobile computing through manufacturing Android phones. Traditional computer manufacturers including Dell and HP could have been big players in mobile.

A disruptive technology is generally a breakthrough that causes a revolution within an industry. This causes many new entrants to strike it rich while many established businesses go bankrupt. As stated earlier, this breakthrough often comes from companies that were outside of the industry being disrupted. Or, they had not traditionally been a direct competitor.


Like Europe We Have Our Own Problems
Eileen Jacobs
eileenjacobs

Lately, the media has been extensively covering the bad financial news coming out of Europe. Meanwhile, the financial problems here in the U.S. have persisted. This is not intended to downplay the importance of Europe to our economy and the global financial system. On the other hand, we have our own critical economic headwinds to be concerned with.

For starters, we have many states and localities that are nearly bankrupt. This is somewhat comparable to the members of the European Union. States, like European Union countries, cannot control their own money supply. Therefore, they have to raise taxes and cut benefits. One key difference, however, is that states don't have the option to leave the union unlike the members of the EU.

The federal deficit is one of the biggest problems we currently face. The aging demographics only compounds the problem. Medicare especially will add strain to our government's financial problems. The mushrooming costs of Medicare are simply not sustainable. In the future, our health care system will have to adapt and become more cost efficient. Health care costs have been rising much faster than incomes and inflation.

Our national debt has reached a level in which it will be a drag on the economy. According to Carmen Reinhart and Kenneth Rogoff's This Time is Different, large federal deficits are a drag on economic growth. In this type of situation, government spending crowds out private investment. In addition, government spending has a slightly negative multiplier on the economy. This is the opposite of private investment.

The odds of government debt default are very high once a nation's debt to GDP (Gross Domestic Product) ratio gets to be over 90%. That said, the term 'default' is much broader than simply failing to make the payments. The most common form of default is through inflation. In this situation, the decrease in value of a country's currency reduces its debt burden. This is a form of cheating creditors because they are being repaid with money that's less valuable compared to the principal that was originally lent.

In the end, large and growing federal deficits lead to subpar economic growth. Recovery from large deficits can be long and painful. At best, we will go through a muddle through period. This is a period similar to the environment we are currently in. Yes, GDP is growing. On the other hand, the growth rate is slow with unemployment persistently high. To many, this feels as if the last recession never ended. This has all happened despite the fact that the government has been on a spending binge.

The largest spending binges occur after financial crises according to the research done by Reinhart and Rogoff. The financial crisis of 2008 was no exception. In the long run, however, the extra spending will only add to the problem.


Three Headwinds that Today's College Students Face
Eileen Jacobs
eileenjacobs

You should always treat your education like it's an investment. That said, when the cost of any investment rises beyond that point at which a reasonable return can be made, it's time to look at different options. This may include not making a decision at all. It is also important to note that by doing nothing, you are still taking a position. In fact, we see this in investing all the time. For instance, by deciding not to be in the stock market, you are taking a position in either cash or an alternative investment.

In recent years, tuition prices have risen to unbelievable levels. Despite this, young students are advised they should go to college regardless of the cost. This can be bad advice. There are three major problems that students are dealing with today. Obviously, the high tuition fees result in high student loan balances. The average borrower in his or her 30's today has a student loan debt balance of $28,500.

The second major headwind is the fact that the job market has been weak since the 2008-09 recession. This economic recovery has been unusually weak. Indeed, the unemployment rate for those who have degrees is generally lower. However, companies are reluctant to hire unexperienced workers and invest a large amount of capital to train them. This only makes the debt woes worse. Coupled with a high balance, new graduates are unable to make their loan payments. If they get behind on these payments, penalties and interest raise the loan balance. Student loan debt is also difficult to get rid of through bankruptcy. This is because most debt is issued or guaranteed by the federal government. Similar to that of income taxes, it's much more difficult to default on government debt than private debt.

The third headwind college students face today is globalization and technology. Many mid-level professional jobs have been eliminated through automation and outsourcing. Being able to obtain a steady career with long-term employment is becoming rare. Since the economic recovery, retail and food service have been the fastest growing job sectors. This shows that there is a mismatch between what the market demands and what colleges are preparing students for.

The media, especially the financial news, likes to talk about the value of human capital. With the price of robotics falling and the productivity improvements of software, companies can get more done with less people. Where the jobs will come from in the future is unclear. This does not ensure that the future will be grim. Productivity gains lead to lower prices which is a great benefit for consumers. Lower prices can, in the end, lead to new industries and new innovation. If consumers can get more for less, history shows they willingly spend more. 


How We Make Financial Decisions
Eileen Jacobs
eileenjacobs

Financial decision making is simply more tricky than it seems. When we make our decisions, they always seem rational at the time. In addition, economists mistakenly have looked for ways to justify our decisions as being rational. Obviously, this cannot be the case.

We often buy things on emotion. Economists would rationalize this by saying that the item we bought gave us the most utility at the time. In reality, the thing we bought could have been a snickers bar or a soda. Something with no real value, in other words. But it gave us a feeling of satisfaction. Does this qualify as a rational decision? I think not.

Many irrational decisions people make involve those that provide the most pleasure or the least pain. This casuses even the most disciplined of people to slip every once in a while. For instance, a motivated health guru doesn't eat healthy 100% of the time.

Another decision making problem we have lies with our illusion of being able to predict the future. We are hardwired to look for patterns. Then, we take those patterns and expect trends to continue indefinitely. Obviously, very few trends continue indefinitely. Most of these trends are nearly random and regress to the mean over time.

Bull markets start once everyone has given up on a particular asset class. This makes it undervalued. Anything that's undervalued will begin attracting savvy investors. A new trend is born. When a new asset establishes a track record of rising prices, it attracts more investors. The trend strengthens and becomes psychologically reinforcing. Usually, the asset is at or above its intrinsic value at this point.

When prices get unreasonably past their fair values, a bubble is born. A crash becomes inevitable. But its difficult to stop and cash in. This is because it's impossible to know when prices peak. A rational investor could stand to miss a big portion of the upside because a bubble could persist for longer than one would reasonably assume.

Governments also play a big role in bubbles. In fact, they will do anything to keep the party going. Keeping interest rates low is the perfect example. Lax lending standards and rising debt levels are a red flag that a bubble exists. Examples of this include buying stocks on margin and leveraging real estate.

The nature of bubbles reflects that most investors buy near the top. If an upward trend doesn't exist for an asset, no one talks about it. Out of sight, out of mind. Gold simply wasn't discussed in the 1990's. The law of large numbers would show that the asset pool was too small at the beginning of the bull market in order for the majority to have owned it. If the masses were holding any particular thing, the prices would have been higher. And no new trend could get any traction.

We make our decisions based on what others are doing. In order to achieve long term success, try looking for the assets no one else is buying or discussing.


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