Taxes are an unfortunate aspect to investing. These articles will help you understand some of the tax issues with investing.

• What are capital gains and capital losses?
• How to calculate capital gains and losses
• Taxable and non-taxable investment accounts
• Tax brackets and marginal tax rates
• Prepare taxes by hand or use software

One of the key steps to investing is deciding on your asset allocation.  What is an asset allocation you ask?  It’s the relative amounts of different asset classes in your portfolio which will determine how much risk your portfolio has.

Asset classes

An asset class is a grouping of similar investments whose prices tend to move together – in other words their price movements are at least partially correlated.  Asset classes can be defined on a very general level, such as stocks or on a more specific level, such as oil companies.  Since most oil companies make money based on similar variables such as the price of oil, it stands to reason that most oil company stock prices will frequently either go up together or go down together.

The concept of asset classes is important because one of the goals when building an investment portfolio is to use asset classes which are not correlated with each other.  The idea is that if one of your asset classes performs poorly (such as stocks in 2008), then your other asset classes (such as cash) will help make up for it.  This works the other way as well – if stocks do well, then your other asset classes will probably lower the overall return.  The reason for doing this is to lower the volatility of your portfolio – if you own all stocks then you could have years where you have -40% returns or +40% returns.  If you own a mix of stocks, bonds and cash then your best and worst years will be a lot less dramatic than the all-stock portfolio.

Some general asset classes:

• Stocks – This could be individual company stocks or shares of a stock mutual fund, etf or index fund.
• Fixed Income – Any type of bond, bond mutual fund or certificate of deposit.
• Cash – Usually money in a high interest savings account but could also include money carefully hidden under your mattress.

There are many different definitions for asset classes so it is important to learn the general asset classes (stocks, bonds, cash) and then learn about more specific classes only if they are applicable.

Now that we know about asset classes then let’s get on with some asset allocationing!

Asset allocation refers to how much of the various asset classes you have in your portfolio.  An older, more conservative investor might have a retirement asset allocation of mostly fixed income investments whereas a younger, more aggressive investor might have most of their investments in stocks.  The basic asset classes of stocks, fixed income and good old hard cash are the building blocks of an investment portfolio.

How to apply asset allocation strategies

Lots of people make the mistake of thinking you need to choose between all risky assets (stocks) or all safe investments (cash) but in actual fact you should pick a happy medium.  Riskier assets like stocks have a higher rate of expected return so if your time horizon is long enough, don’t avoid stocks completely just because they are more volatile than fixed income or cash.

Sample portfolio asset allocation

A retirement account with a long investment time horizon might have an 80/20 mix where 80% of the portfolio is invested in stocks and 20% is invested in bonds.  If this is too volatile for your stomach and you are having a hard time sleeping at night then instead of switching all the stocks to bonds or cash then just change your asset allocation to a less risky profile such as 60/40 where 60% is stocks and 40% is bonds.

Investment time horizon

The length of time until you need your investment is known as the investment time horizon.  Some asset classes such as cash are very safe.  If you have $5,000 in a savings account then you can sleep very well knowing that in 6 months you will still have at least $5,000 in that account.  If you put your $5,000 into a riskier asset class such as stocks (ie a stock mutual fund) then in 6 months your investment might be worth more than $5,000 or it could be worth less than $5,000 (possibly a lot less).

If you are investing money you don’t need for a long time (ie 20 years) then you might consider investing it in riskier investments such as a stock mutual fund.  If you need the money in a shorter time period (ie 6 months) then you should invest it in a very safe asset class such as cash (ie high interest savings account).  When evaluating risk its important to note that the idea is to try to maximize the likelyhood that your money will be there when you need it.  If you are saving for a house downpayment that you need in 1 year – the return you get in that year is not as important as the need for that downpayment to retain its value.

Another factor to consider is that for someone approaching retirement – they might want to start withdrawals from their investments in a few years but most of the money won’t be needed for many years after they start retirement.  Going to a 100% portfolio in that situation is probably too conservative.

Sleep at night factor

It is difficult for the average investor to watch their portfolio value take wild swings every time the markets jump up and down.  Lowering the amount of risk in your portfolio by increasing the safer investments (ie more bonds, less stocks) will help you sleep better at night if that is a problem.

Rebalancing

An important part of investing is to occasionally rebalance your investment portfolio.  Portfolio rebalancing is accomplished by occasionally resetting the proportions of each asset class back to their original percentage.

Let’s look at a rebalancing example

Susan has just won $50,000 in a lottery.  After doing some reading she decided that her portfolio asset allocation will be 60% stocks and 40% bonds.   One year later, Susan checks out the value of her portfolio and notices that the stocks make up 55% of the portfolio instead of the original 60% she wanted.  The bonds are now 45% of the portfolio instead of the original 40%.  Susan decides to rebalance her portfolio so the asset allocation is the same as when she started.

To accomplish this she decides to sell some of the bonds and use the money to buy some stocks.  Another option for her would be to make any new contributions to the stock portion to try to get it back up to the original allocation.

What is the purpose of rebalancing?

• Potentially increase returns – By selling asset classes that have risen in value and buying other asset classes that have dropped you are selling high and buying low.
• Maintain original asset allocation – Susan had decided that she wanted a 60/40 allocation – if she never rebalanced then it is possible that her allocation (and investment risk) could change from her intended levels.

Summary

There you have it – determining the best asset allocation for your portfolio involves a combination of:

• Investment time horizon – when do you need the money?
• Risk profile – can you handle the ups and downs of the stock market?
• Rebalancing – this is something you should do once a year or so.

A tax sheltered annuity (TSA) is a tax-deferred plan for employees of public schools. This means that contributors can allocate a portion of their gross wages each year to the tax-sheltered fund. TSAs or 403(b) plans are open to employees of tax-exempt organizations such as 1-12 public schools, colleges, universities, libraries, charities and churches.

The money grows in the plan until it is withdrawn, likely at retirement, after 59 1/2 years or after losing a job, and is then taxed as ordinary income at the lower applicable tax rate. Contributions are made into funds or annuities offered by financial institutions chosen by the employer, the majority of them being high-fee insurance products.

The main problem with annuities is that many have stiff penalties for early withdrawals or transfers into other qualified plans. Holding periods for some annuities can be as long as 7-10 years. One way to avoid the surrender charges is to only transfer those amounts which have gone past the penalty date, and as new money passes the threshold, then transfer them to other qualified accounts. Be aware that transfers to other plans usually require a lot of paperwork.

Further, 2009 IRS changes, the first made in 50 years, have restricted the types of plans that transfers can be made to. The other catch is that your existing provider must allow transfers to be made. Check with your employer before making an out-of-plan transfer to a lower fee fund.

However, on the other hand, employees now have access to more transparent information regarding employer created plans. There is also a groundswell among teachers and other educational employees to lobby for better low-fee choices for your retirement money.

If you are changing employers, you can transfer to qualified plans offered by the new employer, on condition that the latter accepts transfers.

Short selling stocks is a method of betting against a stock. You borrow stocks from your broker and sell them a view to buying them back at a lower price. Short sellers hope to profit from market declines, or when a stock is hit with unexpected bad news leading to a tanking of the share price.

The mechanics are rather simple. You borrow the shares from your broker, for which you pay a financing fee, and return them when you them back at a lower price. For example, if you get news that stock XX is suffering from sharply lower customer orders and is currently trading at $50, you can sell 200 shares at $10,000. Two months later, you buy them back at $25.00 and pocket a gross profit of $$5,000, for a hefty 50% return.

Short selling is a short-term strategy that works best when the broader market is in decline. In 2008, any investor who shorted the banks would have done very well. However, this strategy requires monitoring prices closely so as not to be caught out by a reversal of trend. In an improving market, the headwinds are against short selling.

Your profits are limited to what you receive from the short sale, but the prospect for losses are pretty steep as a stock can fall to zero.

The SEC has in July 2009 permanently banned “naked” short selling where the investor looks to cover the stock only after the sale, to stop wild swings and market turbulence. Now the transaction broker has to promptly buy or borrow the stock. Stopping the abuse of short selling is a an announced SEC priority, and it is considering other rules including more public disclosure of short trades.

One of these is the Depression-era uptick rule which prevents short selling until the stock ticks at least 1 cent above the previous trading price.

A junk bond or high-yield bond is a bond rated at “speculative” grade or at “less than investment grade,” likely BB or lower. Its bond has to be markedly higher than a triple A bond to attract investors, and to make up for the additional risk of possible default. As a measure of comparison, the worst rating on a bond is C and a defaulted bond has a D rating.

Over the past twenty-five years, the yield differential between AAA and junk bonds has been between 3-9%, averaging around 6%. The high-yield papers sometimes come with a lock-up period where an investor cannot cash out for one or two years.

It is not that a junk bond is trash; just that the rating agencies are unable to give the kind of rating that can be safely bought by large institutional investors such as pension funds, which have to observe restrictions on the kinds of investments they can make.

Junk bonds are issued by companies which require a significant amount of financing such as utility companies. This form of debt is not new in US capital markets, and issuers in the early twentieth century include General Motors and US Steel.

Junk bonds have tended to outperform the higher rated bonds after a recession, and have been the preferred instrument for 2009, yielding a 43% return as at the end of November 2009, according to Morningstar. Opportunistic investors moved into junk bonds in late 2008 when, in the face of frozen credit, yields on junk bonds went up to more than 20% on the back of falling prices and to richly compensate investors for taking up the risk.

However, a junk bond can be a useful diversification tool if you are intimately familiar with the company and its operations, and investing a small part of your portfolio in a high-yield bond fund might be a good strategy.

One of the age old debates about investment retirement accounts is whether it is better to have your money in an account where you contribute pre-tax money (ie 401k plan or Traditional Roth) or in post-tax accounts such as a Roth IRA. Unfortunately there is no one right answer so this post will cover some of the factors of both types of accounts.  Recent changes have made it possible for high income earners to convert their 401k and Traditional IRA accounts to a Roth IRA in 2010.  For more information check out how to convert to a Roth IRA in 2010.

When Should You Do A Roth Conversion

1. Conversion to Roth is advisable if you do not plan to make any withdrawals for a long time. For example, you are at the start of a new career and are 27 years old, you are gaining more than 30 years of tax-free earnings for paying upfront taxes now.
2. Even if you have retired, you could still benefit from conversion if you do not plan to tap into the Roth for another 10-20 years. Further, with a Roth, you do not have to deal with meeting minimum distributions or dealing with penalties for failing to withdraw from a traditional IRA on turning 70 ½,.
3. You plan to leave the money to your children or beneficiaries. Non-spousal beneficiaries who inherit an IRA have to pay taxes on the mandatory annual distributions; with a Roth, annual distributions are a must, but they are tax-free.
4. You have non-deductible IRAs. In the run-up to the changes in tax law, many people contributed to a non-deductible IRA to make the conversion. That option is still open, and it is like a back-door form of conversion – if you are a high income earner, tyou can contribute to a non-deductible IRA and then convert it to a Roth each year. There is a limit of $5,000 for individuals under 50, and $6,000 for those above 50.

When Should You Not Do A Roth Conversion

1. You cannot afford the upfront taxes. You must pay the taxes on your IRA on conversion. Do not use your IRA money to pay the tax bill as you will be hit with penalties and taxes on top of that – it like a double whammy. You can split the tax bill into two years, but watch out for proposed changes to tax rates, especially on the higher income brackets.
2. You are a baby boomer on the brink of retirement. When you retire and make withdrawals from your IRA, you will more likely be paying a lower tax rate, say around 15%. You do not want to pay 33% taxes on your withdrawals while you are still working, to avoid having to pay them at a lower rate.
3. You do not need the money and are leaving it to charity. The charity does not pay taxes, so conversion is pointless.

Consult your advisor or tax accountant if you have both pre-tax and post-tax contributions in your IRA and if your account is complicated by investment losses. There are easy ways to unravel the contributions.

Most of you are familiar with the 401K plan and the traditional IRA, but recent IRS changes have turned the spotlight on its lesser well-known cousin, the Roth IRA.  Recently there have been changes to allow high income earners to convert to a Roth IRA in 2010.

Before we figure out whether a Roth conversion is a good idea for you, let us first look at some basics.

What is a Roth IRA?

Like a 401K, a ROTH IRA is a vehicle for long-term savings, started in 1997. It is a tax-advantaged account, but unlike the traditional IRA or the 401K, you invest with the money you have left after paying your taxes.

Your money grows tax-free and you do not ever have to pay taxes on it again – yes, even gains and dividends in your Roth are tax free! ,

The main difference is when you pay your taxes. With a ROTH Ira, the tax is incurred upfront. In the traditional IRA or 401K, you have a tax advantage in each year of contribution, and you only pay your taxes on withdrawal when it is taxed like income.

Who is eligible for a Roth conversion?

Previously, you were eligible if you earned an adjusted gross annual income, singly or jointly, of not more than $100,000. That meant high-income earners or dual-income couples were not eligible.

However, the IRS has done away with the income limit, and top-income investors are now able to convert to the Roth. Many of them appear to be rapidly switching, creating a lot of business for their financial advisors and mutual fund companies

The wave of conversions is so strong that there is even an iPhone app to facilitate conversions! Recently published numbers in USA Today show that at the Vanguard Group, January 2010 Roth conversions were 7 times more than what they were in 2009!

What Happens on a Roth conversion?

To swap to a Roth, you need to pay upfront the taxes that were deferred on the income and subsequent investment gains in a 401K or a traditional IRA.

The IRS is making it easy for you by giving you a one-time chance to pay your tax bill over three years from 2010 till 2012.

Should You Convert to a Roth IRA?

There are many variables to consider. Some people are doing Roth conversionso because the depressed markets in the past few years have eroded gains in their 401K and the traditional IRAs, and they have therefore much less tax to pay, than if the markets had been booming then.

The question is:  Do you want to pay a big tax bill today or a bigger one tomorrow?

Secondly:  Can you afford to pay the bill, even if there is a three year window to do so?

Another important factor is your age, and how many more years of tax-free earnings you can expect before you need to make withdrawals.

If you are 30 years of age with another 30 years of investment gains, you are more likely to make a different decision from your neighbor who is now 62 and is planning to withdraw his gains to go sailing around the world in the next year.

How to convert to a Roth Ira

High-income earners still cannot directly invest in a Roth Ira. They have first to open a traditional IRA and then convert it to a Roth. The first thing to remember is that you do not have to convert all of your IRAs in one year , you can do it in tranches.

The mechanics of conversion may be a little less simple, especially if you have a few IRA accounts. You cannot pick and choose the accounts you wish to convert.

Here is an example. You have 2 IRA accounts, one worth $60,000 has non-deductible contributions (contributions made from after-tax money) of $20,000, and the other a rollover IRA of $100,000.

You cannot transfer just the non-deductible amount of $20,000 into the Roth. You have to observe the pro-rata rule. Altogether, you have $160,000, and the non-deductible portion accounts for 1/8. If you decide to convert $50,000 into the Roth, the portion that would be tax free is 1/8 of $50,000 or $6,250.00.

One of the issues of conversion is how to pay the taxes due on the amount you convert, and that is going to influence how much and when you are going to convert. It is advisable not to take money out of your IRA to pay the taxes as you are hit with taxes and possibly penalties.

Bear in mind you have two options:

1. Pay the full tax bill when filing 2010 tax returns
2. Defer it over 2011 and 2012.

For many, it is best to convert as early as possible to leverage the amount of time you have for tax-free investment gains.

There is some Roth conversion paperwork to do, but your mutual fund or the financial institution holding your account will have all the information you require.

You will need to let them know if you want the taxes withheld from your IRA or if you plan to pay the taxes yourself. You will also want to name to the beneficiary to your Roth.

There are also couple of words you need to add to your investment vocabulary – recharacterization and reconversion.

Recharacterization of Roth conversion

It is often overlooked that you can undo your Roth conversion. This is a move called recharacterization which is permissible under tax laws. If you convert $10,000 to a Roth IRA and the market tanks after the conversion, you can have a do-over back to a traditional IRA. You will not get your losses back, but you can claim the full amount of $10,000 to calculate your deductions against your taxes.

You can have a re-do up to October of the year following your conversion; if you have already paid taxes on your Roth conversion, you can file an amended return for a refund.

Roth Reconversion

Further, you can reconvert back to a Roth, yet again, but you have to wait either for 30 days after your recharacterization or the next calendar year, whichever is the later. You are also allowed partial recharacterizations or reconversions.

If you plan multiple Roth conversions, you might consider separate accounts to simplify any future recharacterizations.

Should I do the Roth IRA conversion?

Check out this article which covers reasons for and against doing a Roth conversion.

Technical analysis trading is when investors attempt to predict future price trends by relying on historic data. They use statistics that reflect investor behavior such as prices, volume, open interest, moving averages and other trading variables to make investment decisions. These data are plotted onto charts.

This sort of investing is not suitable for beginning investors but it is important to know that this field of stock “study” exists.

Technical analysis is applied to the broader markets, single stocks or a group of stock such as pharmaceuticals. It ignores stock fundamentals and studies only the impact of previous stock movements on future trends, whereas fundamental analysis studies the causes that can affect a stock price.

There are a few basic principles behind technical analysis trading

• Pattern of price movements can be mathematically modeled onto charts. The probability is that an already identified price pattern will repeat itself.
• It is only concerned with the price and volume action in the market, not the reasons for the moves
• Investor behavior is predictable and trading psychology does not change – trading patterns identified decades ago are still valid today.

Trading Analysis indicators

The indicators used are either lagging or leading indicators. A typical lagging indicator is the MACD or moving average convergence divergence which shows the relationship between two moving averages of prices. If the MACD break above a signal line, it is a bullish indicator, and conversely, it may be time to sell if it falls below.

One of the more famous examples of technical analysis is the “sell in May and go away” investing strategy which looks at the fact that historically the stock market hasn’t done all that well between May and October (when you are supposed to buy again).

A commonly used leading indicator is the relative strength index (RSI) which measures the relative outperformance of a stock against another, or against a market index such as the S&P 500. Some technical analysts believe that the higher the relative performance, the more likely the uptrend will continue. Others believe a high RSI could mean an overbought stock, suggesting that it is about to fall.

Technical analysts also use numbers theories such as the Fibonacci sequence and the Elliot wave theory, the latter suggesting a stock trades on repetitive wave patterns.

As you can see, technical analysis is not necessarily cut-and-dry and various interpretations can be attached to the same set of indicators. I personally give no weight to technical analysis but I think it is important to understand the philosophy behind it.