Ha! You Got (Tax) Shifted!

It’s what happens when state governments get real smart at taking your money away. Let’s say that you really don’t like taxes (that would probably be all of you). Well, because taxes are really unpopular politically, some state governments have engaged in long-practiced method of collecting needed revenue when times are tough (and sometimes when times aren’t so bad). Let’s call it… You Got (Tax) Shifted!

Here’s how it works.

You want low income taxes despite the fact that the cost of running the state/federal government gets more expensive? OK, lawmakers say. We won’t raise your income taxes. So they appeal to the federal government for “relief” (that means cash). However, people across the country don’t want that to happen either. Thus, local governments will increase their sales taxes. But then if that fails, what happens next? Something has to go to be cut, (or go up to bring in more revenue) So what will go up are...other things you don’t really get as upset about. Like:

- Bridge and Road Tolls
- Mass Transit Fares
- License Vehicle Registration/Tag Fees
- Monthly/Yearly Parking fees
- Parking Ticket fees/Speeding Ticket fees


And/or they start cutting back on services. Libraries and other public-service entities close earlier and shut off lights. Small businesses raise fees and cut back on hours as well. People work less. Here in NYC they are talking about eliminating entire lines of subway service and raising fares...again. These consumption fees are not “taxes” per se, but they still work in the same way by bringing in revenue to keep businesses are state-run services afloat. Of course, you can avoid many of these by not consuming these services, but it’s unlikely that you will stop driving, stop parking, flying, riding, etc. Otherwise, our economy, which depends on you spending money, will continue to tank.

How Much Does Your 401(k) Cost?

Investing in Your 401(k) is not free, but because you don't get a bill showing how many fees are withdrawn every quarter (or every year), many don't know they're paying or how much they're paying to invest in their Company's Plan.

And if you don't know, you should work to find out. Admittedly, I don't know exactly how much I pay but I have an idea. If your company allows you to see your 401(k) information online, chances are all you see is fund performance. You don't know that you're paying fees. Our company offers about 12 different funds, and I have 4 major funds in my account. Two are with Vanguard, one with Neuberger and one with American Century. I really had to dig to find out the fees associated with each, because they're not really all that apparent.

These management fees can eat into your returns if you're not careful. Consider the example below:

Fund A:

1-yr return: 5%

5-yr return: 10%

10-yr return: 11%

Management Fee: 2.0%

Fund B:

1-yr return: -5%

5-yr return: 13%

10-yr return: 10%

Management Fee: 0.35%

Fund C:

1-yr return: 33%

5-yr return: 13%

10-yr return: 7%

Management Fee: 0.75%

Think of the management fee as the "cost" of managing your money. Which fund would you choose if you were finding a place to put your money for a long time (5+ years)? Smart money would be in (B) of course. Some investors love to see those high returns in the 1-yr numbers, but it's unproven. Long term returns are what count. Note that although choice (A) may have a higher return, the management fee is deducted from the returns. Also note that your returns should be at or above the S&P 500 long-term average. One more thing: that fee is deducted from your account yearly regardless whether you make money or lose money.

So, if your 401(k) is accessible online with your employer, you should try to get access to the prospectus, which gives all the details on the fund you own. (Or, go to the fund's website) and download it from there. Inside you should look for the management fee section, which will give upfront cost (usually) of owning that fund. Some of the older funds may charge fees as high as 2-3% of your account balance, while others (like Vanguard) charge very low management fees.

J. Hogans: Mutual Funds

A proven track record, a fund you know, and the ability to take risks are just a few things you should know about Mutual Funds. Special Contributor Joseph Hogans returns to cover the basics.

My previous article focused on ways to build wealth through income-generating investments such as bonds, mortgage-backed securities (MBSs), and real estate investment trusts (REITs). While it is possible to put money directly into these investment vehicles, there are often high minimum investment amounts associated with these choices. Most mortgage-backed securities for example, require a minimum investment of $25,000. If you have that kind of money to put into one investment, consider yourself blessed. For the rest of us however, there is a way to get around these high investment minimums and increase the diversification of our portfolio at the same time. The solution lies in mutual funds.

A mutual fund is a pool of money from multiple investors that is used to invest in specific stocks, bonds, and other money-making securities. Instead of you needing $25,000 for a MBS, you and other investors can invest $1,000 each in a mutual fund that invests in MBSs. In this way, you can reap the benefits of a MBS investment without needing the large amount of money required to buy one directly.

The Basics

Mutual funds are denoted with a 5-letter ticker symbol (eg. ARGFX) and are run by a person, or group of people, known as a fund manager(s). The investments that these fund managers make will be guided by the fund objective, which is a statement defining the goal and types of investments that can be made. For example, a fund whose objective is “long-term capital appreciation” will only invest in securities that are expected to increase in value over the span of many years, as opposed to investing in securities to make a quick short-term buck. Therefore, it is important to review the fund objective and the history of the fund managers before you choose to invest in a mutual fund. Since the fund manager is the one who actually chooses how to invest your money, you need to make sure this person has a good history of choosing wise investments and sticking to the statements given in the fund objective.

Fees

After you have reviewed various fund objectives and managers and compiled a list of funds in which you may be interested in investing, it is time to look at the fees. Of course, the fund manager is not going to invest your money out of the kindness of his/her heart. They expect to be paid and also need some money to cover other necessary expenses (operating and administrative costs, private jet excursions to the Bahamas, Little Johny’s golf lessons, etc.). These costs are given by the fund’s expense ratio which represents the percentage of the fund’s net assets that are used to cover annual expenses. Though all funds have expenses, it is important to only invest in those whose expense ratios are low (~1.1% or less). However because you’re pretty smart, you know that with anything involving the movement of large sums of money, there are ways that people will try to hustle you. In the world of mutual funds, these hustles are known as “loads.”

No Load- A no load mutual fund is a fund that you can purchase without the fund manager charging a commission. If you invest $1,000 into the fund, $1,000 will added to the net assets of the fund.

Front-End Load- A front-end load mutual fund is a fund in which the manager takes a portion of your money before you even have a chance to invest it (he/she takes your money on the “front end”). Let’s examine the effect of a 5.0% front-end load fund. If you choose to invest $1,000, instead of the fund manager putting the entire $1,000 into the net assets of the fund, he/she will put $50 (5%) in their pocket and only put $950 into the net assets of the fund. This means that your investment has to have at least a 5% return for you to even break even. You’ve already lost money the moment you decided to invest in the fund.

Back-End Load- A back-end load, also known as a deferred load, fund is similar to a front-end load except your money is taken when you sell your shares (on the “back-end”). With a 5% back-end load, you will receive $950 when you sell $1,000 worth of shares. Once again, you’ve been hustled.

The Bottom Line

Mutual funds are a great way for the average person to become involved in the stock market. You are basically handing your money to someone who will invest it with specific goals and objectives in mind. Accordingly, it is important that you trust this someone (the fund manager) and you feel comfortable investing in the types of securities that your money will be used to buy (i.e comfortable with the fund objective). Once you have decided what your investment objectives are, do some research to find funds that match your objective. Analyze these funds to determine their previous returns over the long-term and decide what particular funds will be successful in the future given the objective, management, and fees. Most importantly, DO NOT invest in a mutual fund that charges a load. You are shooting yourself in the foot and making someone else rich when you do so.

If you have any questions feel free to e-mail me jwhogans[at]gatech[dot]edu.