In the midst of the constant headlines concerning government ‘bailout’ initiatives that have resulted from a credit crisis in the financial sector, one must stop to wonder whether the government is acting responsibly and what the likely results of these actions will be. (In truth, one doesn’t have to wonder that much … the government is acting with an almost complete lack of anything resembling financial responsibility.)

The core driver of this problem is that public agencies making market decisions will tend to make them based on political expediency instead of market effectiveness.  From the perspective of a politician, “long-term” thinking only lasts until the next election.  The reason is because most politicians are unconcerned what will happen after they are out of office and can no longer take credit for successes, and will not be subject to blame for problems.

Unfortunately, this decision making framework has spilled into the realm of government subsidies and bailouts.  This has amplified the scope of collective irresponsibility since public resources are not only used to sustain an out of control government, but have now been expanded to supporting businesses that are uncompetitive in the free market and depend on political support with taxpayer money for their success.  This has allowed many companies and executives that made destructive decision to stay in business because of public funds that were granted by government officials.

In a free market, companies that make critical errors would be re-structured in bankruptcy, or liquidated and sold off to new investors.  Unfortunately, the US government is choosing to drastically increase the amount of currency in circulation as a means to finance its spending, including bailouts to keep the failing companies afloat and stem the impact of a sharp reduction in credit availability.  (This process is also known as ‘printing money’)  This drastic increase in circulating dollars will eventually produce significant inflation.  This is caused by increasing the amount of currency in circulation, but keeping the amount of national output the same . . . more money chasing fewer goods MUST result in increased prices.

When inflation occurs, it de-values savings, home equity, and fixed-rate investments like CD’s and Bonds because those instruments tend to increase in value very slowly, and the purchasing power of the dollars they are denominated in consistently erodes.  Conversely, inflation rewards people who have taken out a large amount of fixed-rate debt by de-valuing the principal & interest payments.  Effectively, inflation punishes responsible behaviors like saving and paying down your mortgage while rewarding irresponsible behaviors like taking on large amounts of debt.

Ultimately, living with an irresponsible government means that you will be indirectly punished for acting responsibly.  By working hard to earn a high income, keeping lots of money in savings, and paying off your mortgage, you will be set-up for a tremendous double-whammy from taxes and inflation.  The massive government deficits make some form of future tax increases all but inevitable … much of this will be driven by inflation pushing up the nominal wages of individuals and corporations, driving “bracket creep” where people’s higher nominal income is taxed at higher marginal rates.  The second half of this pitfall comes from de-valued savings and home equity.  The people who have worked the hardest, sacrificed the most, and saved the most diligently will be punished by the inevitable inflation that is bound to stem from many decades of irresponsibility.

Fortunately, there is a way that regular people can profit from future inflation.  The prime strategy for beating inflation involves using long-term debt leverage to purchase investment assets that produce income and appreciation.  The most common way to do this is through rental real estate investments.  The way this works is that you purchase a rental property with a fixed-rate loan and lease it out to tenants.  When the inflation starts to hit, it will push up the home value & rents because the increased amount of dollars in circulation will be chasing after the same number of houses & rental units.  Since your investment is financed at a fixed interest rate, your expenses will stay relatively flat while your income inflates.

In the end, there is nothing that any one person can do to stem the tide of collective government irresponsibility that is overshadowing the entire global economy.  However, there are things that each individual person can do to protect themselves and their families from the effects of inflation.  Ultimately, our future is driven by the decisions that we make each and every day.  As you go throughout life, make sure that each decision you make is one that will help to create a brighter future.

 

It is one of life’s conundrums: If we hate paying taxes, then why do we consistently overpay them, collectively lending Uncle Sam some $300 billion year after year—interest free?

This year, as in previous ones, about 75% of individual taxpayers will receive federal income-tax refunds, with the average refund totaling around $3,000. From a purely economic standpoint, this makes no sense.

“All a tax refund is, is the government saying to you, ‘You’ve overpaid and here’s your change,’ ” explains Charles Enis, an accounting professor at Penn State University.

The rational thing to do, he says, is to pay just enough taxes throughout the year—via withholding and quarterly estimated payments—to avoid owing a penalty at tax time, and then pay any balance due when you file your return. (The minimum required payment is typically the lesser of 90% of the current year’s tax or 100% of the preceding year’s tax.) That way, you get an interest-free loan from Uncle Sam instead of Uncle Sam getting an interest-free loan from you.

But that is not what most of us do. Why not?

One possibility is that we are indeed acting rationally because, with interest rates so low, there’s not much opportunity cost to parking some money with the government for a while; it wouldn’t have earned any interest to speak of anyway. History shows, however, that we overpay our taxes in both high interest rate environments and low ones.

Another theory is that we find it too confusing or difficult to “zero out” our tax bills by, for example, decreasing the amount we have withheld from our paychecks. But at least one study has shown that even when taxpayers believe they could adjust their withholding relatively easily, they are still hesitant to do so.

No, it turns out we may actually prefer getting tax refunds. Why? Because they pay emotional dividends.

For one thing, they free us from worry and uncertainty, according to Donna Bobek Schmitt of the University of Central Florida, who has studied the issue. It is never pleasant to have to write a check at tax time, but it is especially unpleasant if the bill is unexpected or unexpectedly large—and even more so if we don’t have the cash to pay it. So, to avoid any unpleasant surprises, we err on the side of caution and overpay throughout the year, engaging in a form of forced savings.

Apparently, we don’t trust ourselves to set aside money in advance to pay our taxes—with good reason. In a survey for Capital One Financial, only one-quarter of respondents who owe taxes this year had set aside cash specifically to cover the cost.

Then there is the rush we feel from getting a refund, an experience akin to putting on your spring jacket for the first time in a year and finding a $20 bill in the pocket. We frame it as income. A windfall. (Same goes for owing less tax than expected; we frame it as a gain.)

In fact, research by Mr. Enis shows taxpayers are so addicted to this adrenaline rush that those who discover during tax filing season that their refunds will be smaller than hoped (or their tax bills higher) are more likely to open traditional, tax-deductible IRAs or add to existing ones to goose their refunds (or lower their tax bills). Is it any wonder why most IRA contributions are made between Jan. 1 and April 15?

And what of taxpayers whose refunds end up being larger than expected? They are more likely to open savings accounts or certificates of deposit or to buy U.S. savings bonds, according to an ongoing study of low- to moderate-income taxpayers by J. Michael Collins and Nilton Porto at the University of Wisconsin.

No matter what their size, refunds clearly pay big dividends in the way of spending enjoyment. It seems we view money differently if it comes in a big chunk like a tax refund than if it is dribbled out in smaller amounts, as is the case when you decrease your withholding to give yourself more take-home pay each week.

According to Ms. Schmitt, we enjoy getting a tax refund more than having the extra money in our paychecks because we are more likely to spend the refund on a vacation or a new TV (Yay!) but more likely to use the extra money each week to pay bills (BOR-ing.).

What will you do with your tax refund this year? Email me your plans and I’ll share them, along with some suggestions, in my next column.

—
investingbasics.wsj@gmail.com

Article source: Wall Street Journal

 

Do you pay your fair share in taxes?

Even as President Barack Obama pitches the “Buffett rule” to ensure that millionaires pay at least a 30% tax rate, some commentators are decrying the fact that about half of U.S. taxpayers don’t pay any federal income tax.

But our tax system is more complex than any sound bite or simplistic headline can illustrate.

Some multimillionaires do pay a lower effective income-tax rate than some middle-income taxpayers; receiving a chunk of your income via long-term capital gains rather than a paycheck is just one reason that happens. But the top 20% of income earners paid 70% of federal taxes in 2007, according to the most recent data available from the Congressional Budget Office.

That group also pulled in 60% of total pretax income, according to the CBO.

Meanwhile, 46% of taxpayers don’t pay any federal income tax, but they often pay a hefty portion of their income to levies at the federal, state and local level.

Those include payroll taxes for Social Security and Medicare; state and local sales taxes on groceries, clothing and other purchases; and federal and state excise taxes on things such as gas, cigarettes, alcohol and airline tickets.

The payroll tax for Medicare is paid by all workers, but the Social Security tax isn’t levied on income over $110,100 (in 2012). So people with bigger six-figure salaries pay a lower portion of their income to Social Security taxes than those earning less.

Maybe you “forgot” about that one deduction. So how long should tax cheats to assume they are not going to be caught?

Yet wealthy people bear a bigger share of corporate income taxes, which are ultimately borne by individuals. “All taxes have to be paid by somebody at some point,” says Steve Wamhoff, legislative director at Citizens for Tax Justice, the liberal lobbying arm of the Institute on Taxation and Economic Policy, a research group. “The corporate tax is paid by the owners of corporate stock and business assets.”

In 2011, federal corporate income taxes ate up an estimated 7.7% of income for the top 1% of income earners, compared with a 0.4% bite for taxpayers in the lowest fifth of the income ladder, according to the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution.

But partly because taxpayers earn money in different ways, the top 1% of earners saw a smaller share of their income go to payroll taxes.

Then there are state and local taxes to add in. People in the lowest 20% of income earners paid about 17% of their income to federal, state and local taxes in 2011, versus about a 30% effective rate for the top earners, according to an estimate from the Institute on Taxation and Economic Policy. But the share of total taxes paid roughly matches the share of total income for each of the income groups.

Sales taxes can have an outsize effect on lower-income people. “After they buy basic necessities, they typically won’t have a lot of money left over to save or invest,” says Mr. Wamhoff. A wealthier family is “more likely to have a portion of their income that they can put to savings or investments that will never be subject to sales taxes.”

What about those 46% who don’t pay federal income tax?

Roberton Williams, a senior fellow at the Tax Policy Center, says 23% of U.S. taxpayers don’t make enough money to owe that tax once they take their personal exemption and standard deduction. Another 23% qualify for tax breaks that bring their bill to zero or provide a refund.

“They start off with relatively low income to begin with,” Mr. Williams says, “and therefore have low tax liability before claiming any breaks.”

Wealthier people face a tax rate as high as 35% on earnings, “but they get the biggest tax breaks,” he says. “They start off with such a high tax that the biggest tax breaks don’t bring them down to zero. They’re benefiting hugely from tax breaks—much more than the poor people—but because they start off at the high level, their tax bills stay positive.”

That said, 1,470 millionaires were among those who paid no federal income tax in 2009.

Write to Andrea Coombes at andrea.coombes@dowjones.com

—Andrea Coombes is a personal-finance editor for MarketWatch. Read more at marketwatch.com.

Article source: Wall Street Journal

 

If history is a guide, many taxpayers will make a last-minute dash to the nearest post office late on Tuesday to file their federal income-tax returns ahead of the deadline.

If you are among the dawdlers, here are a few last-minute tips to consider:

Are you planning to claim the standard deduction, as nearly two-thirds of all returns filed last year did? If so, check to see whether it might be better for you to itemize your deductions. Itemizing means listing your deductions, such as charitable donations or interest expenses, on Schedule A of Form 1040.

Don’t send cash to the Internal Revenue Service. If you pay by check or a money order, make it out to the United States Treasury.

Did you work for two or more employers last year? If so, take a moment to see whether you had too much withheld from your pay in Social Security taxes.

The maximum amount of wages subject to Social Security tax for 2011 was $106,800. Thus, the maximum amount of Social Security tax that should have been withheld for 2011 was $4,485.60, or 4.2% of total wages, according to IRS Publication 17.

Here is an example offered by the IRS:

Suppose you’re married and file a joint return with your spouse who had no gross income. Last year, you earned $60,000 in wages from one employer. That employer withheld $2,520 in Social Security tax. You also worked for another employer who paid you $55,000 and withheld $2,310. Thus, your two employers withheld a total of $4,830. Subtract the Social Security tax limit of $4,485.60 for last year, and you have a credit of $344.40. Enter that amount on Form 1040, line 69—or on Form 1040A, line 41.

Most taxpayers zap their returns electronically to the IRS, rather than filing on paper. That is typically safer than the paper route, and it typically means you’ll get your refund more quickly.

If you’ve already filed and just discovered a mistake, you can fix it by “amending” your return using Form 1040X. It’s available on the IRS website (www.irs.gov). But it can’t be filed electronically under the IRS’s “e-file” system.

Write to Tom Herman at tom.herman@wsj.com

—Send your questions to us at askdowjones.sunday03@wsj.com and include your name, address and telephone number. Questions may be edited; we regret that we cannot answer every letter.

Article source: Wall Street Journal

 

What do you do if your child was put on the dreaded waitlist for the college of his or her choice?

Students only have a one in five chance of getting off of the waitlist, according to the Princeton Review.

While many of the students who are eventually accepted are handpicked to fill “holes” in an incoming freshman class (a college might be in need of a banjo player, for instance), there are ways for students to boost their chances of getting off the list.

The student should both call and write the admissions officer who handles applications from his or her region, says Elizabeth Heaton, senior director of educational consulting at College Coach, a provider of college advisers to high-school students and their parents, and a former regional admissions director at the University of Pennsylvania.

In the letter and phone conversation, the student should emphasize the specific reasons why the school is his or her first choice and mention any recent academic or extracurricular accomplishments. These can help give your child an edge, says Ms. Heaton.

Students should be gracious and avoid asking why they didn’t get accepted so that they don’t sound bitter, she says.

It’s important that parents not be the ones to contact the admissions officer, says Ms. Heaton, since doing so makes it look like the child’s interest isn’t genuine.

And neither the student nor the parents should show up on campus for an admitted-student tour this spring.

Article source: Wall Street Journal

 

An unexpected letter from the Internal Revenue Service can make your stomach drop, but you can take steps to reduce your audit risk.

Taxpayers overall face a low audit risk: The IRS audited 1.1% of all individual tax returns filed in 2010, or 1.6 million returns of 141 million filed.

The vast majority of those audits—1.2 million—were done by mail. Just 392,000 involved an in-person meeting with the IRS. That’s not necessarily good news. Taxpayers often are confused by IRS correspondence, and with such audits they don’t have the benefit of working with one single agent, the National Taxpayer Advocate says.

But the risk of an audit skyrockets for some. Fully 12.5% of taxpayers whose income topped $1 million faced an audit. And self-employed people who filed a Schedule C with gross receipts of $100,000 or more faced an audit rate of about 4%—four times higher than average taxpayers. Here are seven red flags:

Schedule C

Sole proprietors filing a Schedule C can reduce their audit risk by sticking to the facts—or at least making sure their expenses and income are not dramatically different from similar businesses.

For example, one Chicago-based hot-dog-stand owner said his cost of goods sold was 50% of gross receipts, says Robert McKenzie, a partner in the law firm Arnstein Lehr. “I know Chicago hot dogs are great, but he had a high cost.”

The IRS found the hot-dog salesman was reporting his expenses but only part of his revenue. He faced “a lot of tax and penalty,” Mr. McKenzie says.

Check out BizStats.com for an idea of whether your numbers are out of line; Mr. McKenzie says the IRS tells its agents to review that site for average business costs.

Over-the-Top Deductions

Taxpayers who claim large deductions attract attention. “Anything that is significantly above what persons in your income bracket might deduct is likely to be looked at,” says Mr. McKenzie.

“The mantra I preach to my clients is keep good records,” says Audrey L. Griffin, an enrolled agent in Centerville, Ga. “You’re going to get the best possible, honest, legal result and you have nothing to fear.”

Business or Hobby?

The IRS may decide your business is a hobby—especially if you have other income sources. For example, Mr. McKenzie says, the IRS disagreed with an executive who, in addition to his annual salary of $500,000, deducted expenses for his yacht, claiming it was a business charter operation.

In another case, a young man with annual trust-fund income of $300,000 decided to become a race-car driver. He wrote off his costs, including the car, maintenance and the like.

In both cases, the taxpayers settled with the IRS for a partial write-off, Mr. McKenzie says.

Rental Losses

If you show income from your job or business and claim rental-property losses, be wary. IRS rules limit deducting those losses in the current year, unless you prove you’re actively involved in managing the property.

“It’s a real hot item right now: Audit people who make significant income from their jobs and also claim rental losses,” Mr. McKenzie says.

In one case, the wife of a real-estate attorney—a stay-at-home mom with three young kids—managed the family’s rental properties, but the IRS said the couple couldn’t deduct rental losses in the current year. On appeal they won their case, Mr. McKenzie says.

“We were able to prove yes, he couldn’t have devoted 50% of his time [to the rentals] and made $600,000 a year, but she could,” he says.

Business Use of a Car

Ms. Griffin’s clients often insist that 100% of their driving is related to business and thus their costs are 100% deductible, but when she digs deeper she finds they often use that same car for non-business purposes.

“Then it’s not 100%, which is the reason the IRS requires you to keep mileage records,” she says.

Home-Office Deduction

You may be able to claim a deduction for expenses related to your home office, including home-insurance and utilities costs, but be prepared for the IRS’s attention.

“I would not discourage a client from taking that deduction if they qualify. I just try very hard to make sure they know the requirements and keep good records,” Ms. Griffin says.

But is it worth it? You would claim a deduction for a percentage of the housing expense related to the square feet of office space divided by the home’s total square footage. “It may be a very small percentage and it may not be worth raising this red flag,” Ms. Griffin says.

Earned-Income Tax Credit

Among people who claimed the EITC—a refundable credit worth up to $5,751 in 2011 for moderate-income taxpayers—2.2% of returns filed in 2010 were audited.

There’s a “high level of noncompliance,” Mr. McKenzie says, often because fraudsters exploit this benefit to line their own pockets. For instance, scammers will provide an extra Social Security number so taxpayers can claim an extra dependent—and increase their credit.

It’s a valid tax credit—just mind the scams and stick to the truth.

By ANDREA COOMBES

Article source: Wall Street Journal

 

An Article recently published by the International Business Times explored the potential for problems associated with aggregate student loan debt.  Since the total student loan debt outstanding exceeds $1 Trillion dollars, the scope of the problem seems immense.  When complicated by the 30% of student loans that are 30 or more days overdue, there appears to be a crisis brewing.

The concern expressed by many is that the burden of student loan debt will suppress people’s future disposable income.  To many, this presents a dire scenario where future consumption spending cannot keep growing due to the crushing burden of student loans.  It is complicated by the high rate of unemployment among recent college graduates, and has led many to believe that government action is required to “fix” the problem.

The Solution that Isn’t a Solution

When college students gather in protest rallies, they frequently hold up signs demanding that their student loan debt be forgiven.  Since the overwhelming majority of student loans are underwritten by the US government, all that this would accomplish (besides delivering a free ride to people who acted irresponsibly) is to turn $1 Trillion of private debt into $1 Trillion of public debt.  This sounds great for people that are either looking for a handout or looking to buy votes by giving away a handout with government money, but it does nothing to solve the underlying problem.

By accelerating the government debt problem, it accelerates the extent to which drastic action must be taken.  Many (mistakenly) think that the pile of student loan debt can be dissipated with additional taxes on the wealthy.  Unfortunately, this strategy has two main deficiencies.  The first is that there aren’t enough wealthy people to pay the taxes.  The second is that most wealthy people hire lawyers and accountants to reduce their tax burden with (legal) income sheltering strategies.  The ultimate result is that the government is unable to tax away its debt and will need to inflate the currency.  Since inflation disproportionately impacts the poor and middle class, it will ultimately end up coming back to bite the people who were holding the signs demanding that the government wipe away their student loans.

The Real Problem

A paper recently published by Georgetown University breaks down the average earnings and unemployment rates for college graduates based on the level of education and course of study.  It comes as no surprise that subjects such as education, business, and engineering all have relatively low rates of unemployment associated with them and respectable earnings.  However, studies in subjects such as social sciences and the liberal arts have very high rates of unemployment and relatively low earnings.

Thus, the real problem is not that people carry so much student loan debt, but that people have chosen to take out large amounts of debt to finance an education that does not have a significant market value.  Another way of stating the situation is that people who study subjects like engineering and business do not have a student loan problem.  The reason is because their education prepares them for a career that allows them to generate an income so that their debts can be paid off.

The Real Solution

Understanding the real problem is the first step toward a real solution.  The only way for this lingering problem to be solved is for the people who are under all of this debt to become gainfully employed so that they can pay their debt back.  However, attaining gainful employment requires that better decisions be made in regard to the course of study that one pursues in their path of higher education.  This is the only method of dealing with this problem that will not result in a simple transfer of the burden to somebody else.

The truth is that all choices involve cost.  The decision to attend college is frequently very wise.  However, it is highly important to choose a course of study that is consistent with your long-term career interests.  Studying the arts is fine if you are content with living the life of an artist.  However, if you desire to climb the income ladder, then you must acquire skills that will allow you to generate value for an employer that are sufficient to justify a favorable level of compensation.

Student loan debt is not fundamentally different from any other kind of debt.  It is not good or bad in and of itself … student loans taken out to acquire skills that allow you to earn a good income to support your family are a very wise decisions.  Loans taken out to finance four years of partying a degree that offers no employment prospects are much more suspicious.  All debt is fundamentally neutral in nature.  It only becomes good or bad when paired with an investment that is good or bad.

Thus, the answer is for more people to make better decisions regarding what they study.  In the larger context, the investments of time, money, and education we make are what will define whether any resources we borrow to make those investments were wisely deployed.  Instead of demanding that other people bail us out after making bad decisions, we should take the opportunity to make better decisions in the future.  Each day is a new chance for us to learn.  We should seize those learning opportunities to make each successive day more prosperous than the last.

 

Sooner or later, the markets always punish investors who do the right thing for the wrong reason.

Some investors in dividend-oriented stock funds might end up learning that lesson the hard way.

So far this year, $9 billion has gone into mutual funds and exchange-traded funds that focus on U.S. stocks that pay stable, high or rising dividends, estimates EPFR Global, which tracks where investors are moving their money.

All other U.S. stock funds combined have had a net outflow of $7.3 billion.

Many of the investors joining the dividend stampede appear to be motivated by the low interest rates mandated by the Federal Reserve, which have led to a yield famine among traditional income investments like bonds, certificates of deposit and money-market funds.

Others might just be chasing past performance. The 100 highest-yielding stocks in the Standard Poor’s 500-stock index outperformed the overall market by an average of eight percentage points last year, according to Birinyi Associates.

Think twice before you jump on the bandwagon. While dividend-oriented funds are a perfectly legitimate way to invest in stocks, you shouldn’t mistake them for bonds.

Nor, popular belief to the contrary, are they much safer than the stock market as a whole. And they could suddenly go from being tax-friendly to painfully taxable.

When you buy a Treasury, you collect interest and get your money back (not counting inflation) when the bond matures. When you buy a dividend-paying stock, you collect a quarterly payment—but that certainly doesn’t mean the stock price will be stable.

In the fourth quarter of 2008, the SP 500 fell 21.9%; dividend-oriented mutual funds lost 20.2%, according to investment researcher Morningstar

. In other words, the average dividend fund fell nearly as much as the overall stock market. Bonds, meanwhile, performed beautifully: Over the same period, the Barclays Capital U.S. Treasury index returned 8.75%.

And from the stock market’s peak in the fourth quarter of 2007 through its bottom in the first quarter of 2009, the Dow Jones U.S. Select Dividend index lost 53.8%, versus a 50.2% loss for the SP 500, according to Fran Kinniry, an investment strategist at Vanguard Group.

In the long run, dividend-paying stocks are slightly less risky—and more rewarding—than the equity market as a whole. In the short run, however, they can expose you to the risk of being in the wrong place at the wrong time.

In 2007, 29% of the SP 500′s dividend income came from banks and other financial stocks, according to Howard Silverblatt, senior index analyst at Standard Poor’s.

That didn’t end well. Many banks that had been paying steady income to shareholders suspended their dividends—or even went bust. Their investors suffered.

Today, financials account for only 13% of the SP’s dividends, with consumer staples (15%) and technology (14%) contributing the biggest share. Apple’s

recent declaration of a dividend might prod more tech companies into distributing cash to shareholders. Some dividend funds could thus end up concentrated in technology stocks, much as they once were in financials, says Steve Condon, investment director at Truepoint, a financial-advisory firm in Cincinnati.

Another point: Since 2003, dividends have generally been taxed at just 15%, much lower than most bonds, whose interest payments are taxed at ordinary-income rates. Unless Congress and the White House take action, the dividend rate will leap to 43.4% next year for investors in the top federal tax bracket—the same rate that would apply to most bonds. You can avoid this problem in a tax-sheltered 401(k) or individual retirement account.

Robert Gordon, a tax expert at Twenty-First Securities in New York, thinks “there’s a good possibility” that politicians can work out a deal to keep dividends taxed at today’s lower rate, but there isn’t any assurance of that.

The right reason to own one of these funds, says Daniel Peris, author of “The Strategic Dividend Investor” and co-manager of the Federated Strategic Value Dividend

fund, is that stocks with growing cash distributions tend to be solid businesses that earn greater returns in the long run than stocks as a whole.

“I would like to think that every client who’s buying a fund is buying for the right reason, but that would be naive,” he says. “I acknowledge that some people, based on last year’s strong returns, may be chasing past performance.”

Any memory more than three years old is ancient history on Wall Street. But investors on Main Street should hark back to 2008. That year, many dividend funds provided at least 3% in income—but their average total return was minus-35%.

There aren’t any easy ways to get income when the bond market is this stingy. Expecting the stock market to be generous certainly isn’t one of them.

—
intelligentinvestor@wsj.com; twitter.com/jasonzweigwsj

A version of this article appeared April 7, 2012, on page B1 in some U.S. editions of The Wall Street Journal, with the headline: The Dividend-Fund Dilemma.

Article source: Wall Street Journal

 

Most of us would like to change something about ourselves or our lives. We eat too much. We smoke. We don’t exercise. We’re stuck in the wrong job. We spend too much and save too little. We look for love in the wrong places.

Some of us have a few things we’d like to change. Some people want to transform their entire lives.

But can we? And if so, how?

Charles Duhigg may have found the key.

Duhigg, a reporter at the New York Times, spent three years interviewing researchers, marketing mavens and neuroscientists to understand better how our brains work, and how we can use that knowledge in our daily lives.

He’s published the results in a new book, The Power of Habit.

The bottom line: We’re running on autopilot most of the time, and we don’t really know it. We are controlled to a remarkable degree by our habits, not just by our conscious choices.

“A habit is a choice that we deliberately make at some point, and then stop thinking about, but continue doing, often every day,” he writes.

Even people in crisis can use this knowledge to turn their lives around.

We can’t unlearn bad habits. The way to defeat them is to learn new, better ones.

The book begins with the case of “Lisa Allen,” a young woman who did precisely that. She began as an overweight, heavy-drinking smoker with debts and no job. Her husband had just left her. A few years she was fit, clean, gainfully employed and in charge of her life. She ran marathons, bought a house, got engaged, and began a master’s program.

And her turnaround began when she took the decision to change one “keystone” habit, and quit smoking. That change led to other changes, and so on.

Habits are a neurological reality, Duhigg reports. Neurologists studying scans of Lisa Allen’s brain found that “one set of neurological patterns her old habits had been overridden by new patterns. They could still see the neural activity of her old behaviors, but those impulses were crowded out by new urges. As Lisa’ habits changed, so had her brain.”

But how do you change a bad habit?

According to Duhigg, researchers at the Massachusetts Institute of Technology believe all habits break down into three steps: The cue, the habit (which he calls ‘the routine’) and the reward.

The cue is what triggers the habit in the first place walking past the pastry shop, having a coffee, and so on. The reward is the craving the habit is really designed to satisfy.

The trick to changing is to identify those three elements, and then to divert them into something more productive.

He illustrates with an example from his own life. Duhigg says he was putting on weight. How did he change?

1.Find the bad habit.

Duhigg noticed he had put on weight. Why? What had changed? He realized he had started taking a break from work each afternoon, walking to the New York Times cafeteria, and eating a big chocolate chip cookie.

2. Find the reward.

What is the real reward, or payoff, you are seeking? In other words, in Duhigg’s case, what was the payoff that got him started on this habit in the first place? What craving was he trying to satisfy?

You might think that was obvious. Surely you eat a cookie to eat a cookie, right?

Well, not really. Was it a need for food? To relieve the mid-afternoon boredom? An excuse to stretch his legs? A chance to chat to co-workers in the cafeteria?

The amazing thing is Duhigg didn’t really know and research suggests that’s true for most of us.

“We’re often not conscious of the cravings that drive our behaviors,” he reports. “Most cravings [are] obvious in retrospect, but incredibly hard to see when we are under their sway.” Turns out there’s a big difference between the habit and the real reward, or the real craving, that drives it.

How do you find the reward? Duhigg recommends a simple three-step technique: Experiment, write, wait.

First, experiment: Try out different alternative habits to see if you feel the same reward.

Was his cookie habit just an excuse to stretch his legs? Duhigg tried going for a walk instead.

Was it a craving for food? He tried having an apple at his desk instead.

Second, after each experiment, try isolating by writing down the first three things that come to mind “emotions, random thoughts, reflections on how you’re feeling, or just the first three words that pop into your head.”

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Why? Habit researchers found that the act of writing down is incredibly powerful. (This is also true of cognitive behavioral therapists). “It forces a momentary awareness of what you are thinking or feeling,” writes Duhigg, and will help you later recall those emotions later.

Third, after doing that, he waited for fifteen minutes. He set an alarm. When it went off, he asked himself: Do you still feel the urge for that cookie?

That fifteen minutes is key, says Duhigg. If, fifteen minutes after, say, eating an apple, or going for a walk, you still feel the urge to go to the cafeteria, then you haven’t found the real reward.

After a lot of experimentation, and reviewing your notes, you should be able to identify the real reward your habit is designed around.

3. Find the cue.

Typically, something sets us off. You light a cigarette when you have a cup of coffee. You reach for the ice-cream after dinner. And so on. To break the bad habit we need to find the cue.

Scientists have found that these typically fall into five categories: Location, time, emotional state, other people, or an immediately preceding action.

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What was Duhigg’s cue? To find out, he waited until the craving struck and then noted down five things: Where am I? What time is it? What’s my emotional state? Who else is around? And what action immediately preceded the urge?

After a few days he was able to isolate his cue: Time.

At around 3:30 pm every afternoon, he felt the need for a distraction from work, the kind, he notes, that came from gossiping with a friend.

Not everyone is in Lisa Allen’s old shoes. But I’ll bet everyone has some habits they could do without.

Article source: Wall Street Journal

 

It long has been one of the most tightly held secrets in the financial-services world: what your insurance agent is paid.

That might be about to change, thanks to a new regulation in New York.

Agents and brokers in the state now are required to alert clients, in writing, how they are being compensated, and to provide specific details to clients on request. In March, the rule—which originally took effect in January 2011—survived an appellate-court challenge by an agents’ group.

Associated Press

TIAA-CREF is often recommended by experts.

The organization, the Independent Insurance Agents and Brokers of New York, says it won’t appeal and will focus on helping agents comply with the rule, known as Regulation 194.

Other states have been monitoring developments and may craft similar disclosure rules, some experts say. In the meantime, you can take the initiative and ask the agent to disclose his commission—and if he doesn’t give you an answer, consider shopping elsewhere.

Agents’ commissions can be steep, but they aren’t readily apparent because they are paid by the insurer. They matter to consumers because an insurer paying a low commission generally will have more room to be generous with consumers in annual interest or other product features.

For many popular types of annuities, commissions run from 5% to 7% of the invested amount, and some insurers pay 8% or more to agents. The disclosure could be a starting point for a conversation about whether a lower-commission version of the product, or a different product, might offer greater value, consumer advocates say.

Richard Poppa, president of the New York agents’ group, calls the rule a “solution in search of a problem.” He maintains that it is burdensome to agents and brokers because of the record-keeping it entails, while “only a minuscule number of consumers have asked their agents for compensation information.”

Guardlian Life Insurance Company

Guardian Life Insurance Co. of America is often recommended by experts.

The rule already has had an effect nationally. Officials at the National Association of Insurance and Financial Advisors say New York’s effort prompted the trade group to change its own policies regarding disclosure of commissions. Now, it encourages all of the 45,000 agents who belong to its state and local associations to fully disclose all commission amounts if a consumer asks, for both insurance and securities products, whatever state they are in, says NAIFA President Robert Miller.

Previously, the group gave members no guidance on whether they should disclose their compensation, but generally opposed government requirements that agents do so for life insurance and annuities.

Agents, for their part, say their upfront commissions for products like annuities aren’t outsize when viewed in terms of the years over which a product is owned. The commission can turn out to be less on a per-year basis than what many people pay their financial advisers annually, about 1% of the account balance, to oversee a portfolio of stock and bond mutual funds.

Here’s what you need to know about commissions before talking to an agent.

Life insurance. The selling agent, and others in the sales structure, often receive upfront commissions and other compensation totaling more than half of the first-year premium. This can amount to hundreds of dollars in the case of “term” life insurance, which provides a death benefit for a specified number of years, or thousands of dollars for “permanent” life, which combines a lifetime insurance policy with a tax-advantaged savings component.

The commission is more important with permanent life. To see the impact, look at the “illustration” provided by the agent of the projected cash-surrender value over time. In large part due to the commission, there may be little cash-surrender value in the first year.

There also are annual charges for the death benefit and administrative costs. The Consumer Federation of America says a smart option is buying from TIAA-CREF, a highly rated insurer that sells policies through staff employees and has low overall costs.

Another option: a “blended” permanent-life policy, which incorporates ample amounts of term-life insurance as a way to hold down the cost. Because agents receive smaller commissions for these versions, though, they may not readily pitch them.

Peter Katt, a fee-only life-insurance adviser in Mattawan, Mich., says it is also important to focus on insurers with track records of delivering long-term value, including through dividend payments. Among his favorites: Guardian Life Insurance Co. of America, Massachusetts Mutual Life Insurance and Northwestern Mutual Life Insurance.

Annuities. These are tax-advantaged savings and retirement-income policies. One hot product is the “indexed” annuity, in which the annual interest is tied to market benchmarks. The contracts are aimed at yielding more than bank certificates of deposit, with guarantees against loss of principal. Commissions currently average 6.3% of the principal payment, says Sheryl Moore, founder of AnnuitySpecs, a market-research firm.

“Variable” annuities are a tax-advantaged way of investing in stock and bond funds. Upfront commissions recently have run 4% to 7% or so of the invested amount, paid by the insurer. As with permanent-life insurance, they also carry annual fees. Fees in versions with generous guarantees of lifetime income can top 3.5% a year of the account balance, which is a serious drag on your funds’ returns.

Another downside: Annuities typically come with financial penalties on principal withdrawals in excess of a specified amount. Penalty periods can stretch 10 years, and in general, the higher the commission, the higher the penalty.

Auto insurance. Independent agents, who can provide quotes from multiple insurers, earn about 15% to 20% of the annual premium, or $150 to $200 for a policy with a $1,000 annual premium, says Kevin Delaney, director of insurance at First Niagara Risk Management.

The Consumer Federation recommends consumers shop around to get quotes from insurers that don’t use agents, such as Amica Mutual Insurance and USAA (for families with military ties), and then ask an agent to beat the best price.

By LESLIE SCISM

Article source: Wall Street Journal