It is Year End Tax Planning Time

There is only one month left until the end of the year. It is now time to buy a copy of Turbotax or Taxcut and to work out how much you will owe in your taxes. I just downloaded my copy of Taxcut 2007 and have started to enter estimates into it to find out what my AGI and MAGI will be. This kind of tax estimation becomes important as your income gets close to $100,000 a year and it becomes even more important as your income hits $150,000 a year (all numbers I use are for married filing jointly).

Here are some important numbers to think about:

  • Above $100,000 you lose the ability to convert a normal IRA to a Roth IRA. If you have already done that this year you want to make sure your MAGI stays under $100,000, otherwise you will have to recharacterize the converted Roth IRA into a normal IRA.
  • Between $100,000 and $150,000 you start to lose the active rental real estate owner loss deduction. This is a big one if you own rental real estate, as depreciation charges will usually give you a taxable loss even if you are cash flow positive.
  • Above $150,000 you start to lose the ability to contribute to a Roth IRA
  • Above $150,000 if you have few itemized deductions and above $100,000 if you have many, you run the risk of getting hit with the AMT.

Tax planning should be year-round. I keep a spreadsheet for that purpose before the tax programs become available. But now is crunch time and it will soon be too late to adjust your income. The recent stock and bond market turmoil gives ample opportunity to harvest taxable losses. While you need to wait 31 days to buy back any sold stock you can buy a broad-market ETF to maintain your market exposure in the meantime. If what you sold was not a broad-market ETF you run almost no risk of the IRS questioning your actions.

If your income is too high this year and you own rental real estate you bought in the last couple years, you could choose to sell it off at a loss. The bad real estate market has already reduced the value of your holding so why not reap the tax benefits of a realized loss?

Disclosure: I am not an attorney or accountant or tax professional. These are just my opinions and not individualized advice. Please consult a CPA or tax attorney for tax advice.

Remember, Remember, to Tax-Loss Harvest in November

Tis the season to be jolly and to sell losing positions. Actually, it is always a good time to sell losing positions. But now is about as late as it can be for harvesting tax losses, waiting 31 days so as not to trigger the wash sale rule, and then re-purchasing the sold assets before the new year.

I followed my own advice, selling a number of stocks that I may buy back later. At the moment, my main goal is to reduce my taxable income for the year. I sold the Vanguard Value ETF [[VTV]] and bought the very similar iShares S&P 500 Value ETF [[ive]] to replace it. While the ETFs are similar, they are not ‘substantially identical’, and because of that buying one after selling the other does not trigger the wash sale rule. This is another reason why ETFs are great–there are hundreds of them out there that are similar yet not identical. So sell any in which you have large unrealized losses and replace them with similar ETFs. Assuming the similar ETF does not shoot up greatly in 31 days, sell it and buy back the original ETF. The result is realizing a taxable loss while keeping your equity exposure the same.

I also believe in doing a similar thing with stocks, and I just did that myself this morning. Sell those in which you have large unrealized losses and then just wait 31 days to buy them back. If you wish to maintain your equity exposure, you can buy an index fund or ETF in the meantime. On average any profit you lose from selling the stock will be more than outweighed by the lower taxes you will pay.

Now is the time to estimate your AGI for the year and plan what to do about it. If you are a landlord, watch out for the landlord loss deduction limits that phase in at an AGI over $100k. If you saved money in a Roth IRA, watch out for the limits that phase in at a similar income level. Remember, it is your duty as a productive citizen to minimize the taxes you pay!

Disclosure: I am not a tax lawyer or accountant. This is not to be construed as tax advice. Speak to a tax lawyer with at least 200 years’ experience and at least 50 years experience working as head of the IRS and the treasury department before implementing any tax strategy. Otherwise the IRS reserves the right to hunt you down and kill you like the scum that you are. Remember: it is not your money. It is the government’s money. Remember: it is not your life. It is the government’s life. War is peace. Freedom is slavery. Ignorance and cowardice are strength. Or something like that.

My Record so Far

Following is my record so far on all stocks I have disparaged or praised in this blog (not just the ones on which I made a good call):


American Realty Investors [[ARL]]: Down 1.4% since I pilloried this over-indebted real estate company.

Home Solutions of America [[hsoa]]: Down 49.4% since I discussed Andrew Left’s criticism of the company.

Document Security Solutions [[dmc]]: Down 33% since I criticized the company on August 21. While short the company at the time, I closed my short position at a loss to concentrate on other opportunities. Oops.

Remote MDX (OTC BB: RMDX): Up 96% since I criticized the company and its management. I was short at the time and I am short now. Ouch.

Sun-Cal Energy (OTC BB: SCEY): Down 82% since I slammed this stock back in mid-July.

Octillion (OTC BB: OCTL): Down 60% since I wrote about this horrid little penny stock. I was not short at that time but have since been able to sell short some shares.

Fox Petroleum (OTC BB: FXPE): Down 18% since I compared it negatively to Stormcat Energy [[scu]]. Going long Stormcat and shorting Fox would have resulted in a hedged profit of 8% since my article.

Continental Fuels (OTC BB: CFUL): Down 85% since I first pilloried this horrid little company. Down 65% since my second critical article was published October 12. I shorted this stock most of the way down, although I am no longer short. I do believe that the stock has quite a bit farther to fall, eventually to around $.01 per share or less.

H2Diesel (OTC BB: HTWO): Down 43% since I criticized it less than one month ago.


International Shipholding [[ish]]: Up 39% since I discussed the sell-off in this stock on August 8.

TSR Inc [[tsri]]: Up 10.3% since I praised this undervalued microcap with lots of cash.

Hastings [[hast]]: Up 23% since I noted its great earnings on August 21. I owned the stock at the time and I sold it off a couple weeks ago at $9.12 per share.

Stormcat Energy [[scu]]: Down 10% since I compared it favorably to Fox Petroleum (OTC BB: FXPE). Going long Stormcat and shorting Fox would have resulted in a hedged profit of 8% since my article.


Movie Star Inc. [[msi]]: Down 14% since I discussed it July 10. In that article I explained that I thought it was fully valued despite being a good company.

Regent Communications [[rgci]]: Down 24% since I discussed the company’s annoying management back on August 16. I sold out my stake at a loss since then, although with John Ahn of Riley Investment Management (an activist hedge fund) getting on the board, maybe the future will be brighter.

My Overall Record

I was perfect on stocks that I liked (if we consider Stormcat to be a pair trade with shorting Fox Petroleum). I was 8 out of 9 on stocks I disliked. Both the stocks on which I was neutral or uncertain went down.

So should you buy the stocks I like and short the ones I dislike? Buying the stocks I like might work, but I like few enough that it would not lead to a diversified portfolio. Avoiding the stocks I dislike would be a very good idea. My record on stocks I dislike reveals an excellent reason why shorting stocks is so risky (and why most people should avoid it): while 8 of 9 stocks I criticized dropped, often by a lot, the 9th stock almost doubled.

Disclosure: I am currently short Octillion (OTC BB: OCTL) and Remote MDX (OTC BB: RMDX). Ending prices used in the return calculations are as of November 2, 2007 when this article was written (one week before it was published). My disclosure policy is batting 1.000.

An ETF Asset Allocation Plan for Everyone

If I have not said it much before, I will certainly say it in the future: the best way to invest is with low-cost index mutual funds or low cost index ETFs. I like Vanguard, but it is even cheaper to get an account at and then invest in low-cost ETFs. They give you a certain number of free trades per month which is more than adequate for a long-term buy-and-hold investor. What I suggest below is not quite as simple as one of Vanguard’s excellent low-cost target date funds (see The Default Investment), but it will give you a portfolio that is more appropriate for your individual circumstances.

In the article on the default investment, I suggested talking to a financial planner if you wanted a tailor-made portfolio. However, the problem with financial planners is that they cost a lot of money relative to investable assets, particularly if you are not rich. A couple hundred dollars an hour or .5% of invested assets adds up quickly if you have a small portfolio. So for those with under a few hundred thousand dollars, it may be best to go it alone. You will need to first determine your risk tolerance. Buy Index Funds: The 12-Step Program for Active Investors; this book will help you think through how much risk you can handle. There are also 20 sample portfolios in the appendix for all different risk profiles. Those portfolios are designed for DFA mutual funds (which can only be accessed through a financial advisor). So I found suitable ETF substitutes for those funds and they are listed below along with their ticker and annual expense ratio. So buy the book, choose an appropriate portfolio for the amount of risk you can handle, get an account with Zecco, and then buy the following ETFs in the proportions recommended for your risk profile in the book. You will pay very few fees, your portfolios will be tax-efficient, and you will not have to think very much about your investments.

US Large Company: Vanguard Large Cap (VV), 0.07%
US Large Cap Value: Vanguard Value (VTV or VIVAX), 0.11%

US Microcap Index: iShares Russell Microcap Index (IWC), 0.60%
US Small Cap Value Index: Rydex S&P Smallcap 600 Pure Value (RZV), 0.35% or Vanguard Smallcap Value (VBR), 0.12%

Real Estate Index: Vanguard REIT ETF (VNQ), 0.12%

International Value Index: iShares MSCI EAFE Value Index (EFV), 0.40%
International Small Company Index: SPDR International Small Cap (GWX), 0.60%
International Small Value Index: WisdomTree Small Cap Dividend Fund (DLS), 0.58%

Emerging Markets Index: Vanguard Emerging Markets Index (VWO), 0.30%
Emerging Markets Value Index: WisdomTree Emerging Markets High-Yielding Equity (DEM), 0.63%
Emerging Markets Small-Cap Index: WisdomTree Emerging Markets Small-Cap Dividend Fund (DGS), 0.63%

One-Year Fixed Income Index: (see below)
Two-Year Global Fixed Income Index:
Five-Year Government Income Index:
Five-Year Global Fixed Income Index:

There are no funds that are very close to the above, but you can use different weights on Vanguard’s bond funds to approximate the average duration of the mix of the above funds. Vanguard Short-Term Bond Index (BSV), 0.11%, has an average maturity of 2.7 years, while Vanguard Intermediate-Term Bond Index (BIV), 0.11%, has an average maturity of 5.7 years. Both are invested primarily in Treasury and government agency securities. For very-short term bonds (or just buying government bonds of any maturity), you could enroll in Treasury Direct and buy 1-year treasuries direct from the US Government. If you hold them to maturity you pay no fees.

I see no great need to invest in foreign bonds, considering the safety of the Vanguard funds. While more diversification is good, there is a limit to how safe something can get–and it doesn’t get much safer than one to five year government and AAA-rated bonds. So if Index Funds says that you should have 10% in each of the four bond categories, your weighted-average maturity would be 3.3 years. So you could put 10% of your investable assets in 1-year bonds through Treasury Direct, 15% in the Vanguard Short-Term Bond Index, and 15% in the Vanguard Intermediate-Term Bond Index. This gives you an average maturity of 3.4 years.

When investing in these ETFs, you should rebalance every year. You could also choose to put a portion of your funds in one or more of Vanguard’s target date funds and then just add on the extra funds (value, small-cap) to the main target date fund. Then you would not have to rebalance as often.

If you follow the above plan, you should expect to outperform 80% of other investors, because they will incur more taxes and more fees. You will also end up with investments tailored to your unique circumstances. And you will only have to think about your investments once a year. This sounds like a good deal to me.

The Value of Sloth

Are you worried that you aren’t doing enough to increase your investment performance? Perhaps all you need to do is go on a 2.5 year vacation. According to Mark Hulbert, the best performing investment newsletter over the last 5 years has not been published in the last 2.5 years. So by doing absolutely nothing it has garnered great profits. Surprisingly, this is not an isolated instance–mutual funds and individual investors who trade less often make more money. Partly because they reduce their costs and commissions, but also because the urge to always do something often leads to stupid mistakes.

Another good example of the benefits of sloth comes from investing in the S&P 500. As shown by a recent research article, you would have done better holding the original 500 companies in the S&P 500 and doing NOTHING rather than investing in the actual S&P 500 index (which adds or drops about 20 stocks each year). So even a 50 year vacation can be beneficial! And remember that the less frequently you trade, the fewer taxes you pay (because you are compounding pre-tax money–if you sell each year you compound after-tax money).

Disclosure: it has been far too long since I took a vacation!

Why Inexperienced Investors Do Not Learn

Why Inexperienced Investors Do Not Learn: They Don’t Know Their Past Portfolio Performance

Glaser and Weber just released a paper with the above title on SSRN. I urge you to download and read it. They examine the performance of 215 online investors over the past 4 years and find that the investors have no clue whatsoever as to how much money they made or lost. At the extreme, one investor who thought he had lost 50% per year had actually gained 2% per year. Another who thought she had gained 120% per year had lost 3% per year.

There was literally no correlation between the returns investors thought they had made and the returns they actually made. There was a tendency for those with better performance to be more accurate in assessing their past performance (they were better calibrated). This is a logical outcome–those investors who know how they did were more likely to allocate money to strategies that worked. So if they knew that they tended to lose money speculating in tech stocks, they would know to switch to something safer (index funds or blue chip stocks). That is why you should know your performance.

I am the poster boy for the importance of tracking performance. Since I started seriously investing in 2005 I have done all sorts of things–day trading, options, shorting stocks, speculating in gold, quantitative investing, value investing, and raw speculation. I know after tracking my performance in detail on Icarra that most of these things were not worthwhile. While I made a lot of money in gold I did not know what I was doing, so it made sense to get out. I lost money in day trading and got out with minuscule losses after only a week. I have made money shorting stocks. I have broken even on my options trading, mostly because I have gotten fairly good at shorting stocks and I used puts on a few stocks this summer that I could not borrow the shares to short. I have lost a lot of money in various stock speculation. When I have focused on finding and understanding good value stocks I have on the whole made money, doing slightly better than the market. My quantitative investing performance has been pretty darn spectacular.

So now that I know how I have performed, what will I do about it? I have forbidden myself from rank speculation in stocks or options. I have increased my short activity. I have limited the number of individual stock positions I pick for my value investing portfolio, increasing the size of each position, so that I can focus on better understanding each company. I have also drastically increased the portion of my portfolio that I allocate to quantitative strategies, both long and short.

So take a look at your performance. If it is okay, you may want to allocate more money to those strategies that are more profitable and less to those that are less profitable. If your performance is dismal, you may want to just stick all your investments in index funds. Remember, if you index, you can expect to outperform 80% of all investors, while spending a lot less time thinking about your investments.

Depreciation made easy

Okay, call me a glutton for punishment, but what I did this last Saturday night was type up a variety of the most useful depreciation schedules. The schedules are set up for real estate investors, but anyone who in the course of a small business needs to depreciate real or personal property might find these worksheets useful.

Excel Depreciation Schedule
Open Office Depreciation Schedule

Feel like timing the market?

It may not be such a good idea. A perfect market timer could have, over the last 80 years, turned $1 into $670 million. A perfectly inept market timer would have turned $100 million into $1,000. A market timer would have to be right about 70% of the time just to equal the return of a buy and hold index fund. Do you think you are that good? See the study here

Uncorrelated assets now correlated

One of the reasons for recommending diversification of asset classes (stocks, bonds, real estate, commodities, etc) is that since different asset classes are imperfectly correlated this will reduce volatility and risk. A recent report from Merrill Lynch shows that the correlation between different asset classes have increased over the last year. Your best bet for diversification? Short-term bonds with maturities of a 2 to 5 years. My bet is on treasuries, particularly TIPS. For my personal portfolio, I lend money on the P2P lending site and I expect to earn an 8.5% annual return with little effort.

Article here (PDF):

Asset Allocation for Dummies

I will tell you now, and I will repeat myself as necessary: I am not an expert on asset allocation. That being said, I doubt that anyone else is, either. It is impossible to describe any investing philosophy without touching on asset allocation, so following is my philosophy.

Total up all the assets of significant value you have. That includes your car, house, savings and checking accounts, expensive objects (any object worth over $1,000 is worth counting), bonds, and mutual funds and stocks.

The first key to asset allocation is that you should eliminate any high-rate debt you have. If you have bonds or mutual funds that are not in a retirement account, then you should sell them off to pay off credit card debt. It is very hard to get better returns on your stocks than the credit companies get from you. Look at paying off credit cards as a safe, easy, guaranteed investment that will yield 18%.

Now, it is my firm belief that you should always have at least six months worth of living expenses in cash-type accounts (checking accounts, savings accounts, and money market accounts). A portion of this money can be in a higher yielding short-term CD, though. Some would say this is high. At the very least, you should have two months’ worth of expenses saved. Otherwise, if an emergency comes up, you will be forced to rely upon credit card debt or to liquidate your stocks.

After you have taken care of the basics, stick the first $10,000 of your money destined for stocks into a low cost index mutual fund. I recommend Vanguard funds. This is for a few reasons. First, it ensures that even if you do something really stupid and lose the rest of your stock money, you will still be exposed to possible gains in the stock market. Second, your individual stocks may be quite volatile, and having some of your stock in an index fund will probably help you sleep at night.

Now for the rest of the money. The traditional two investments are stocks and bonds. How should you allocate how much you have in bonds versus how much you have in stocks (including your mutual fund)? Ben Graham recommended that as a value investor, you should be most highly invested in stocks when the stock market is at a low (in the depths of a bear market), and least invested in stocks when the market is at a peak (and when the future seems rosiest). How do you time when the worst of a bear market will hit, or when the peak of the bull market will come?

You don’t. All you do is gradually sell more stocks as the stock market rises, and buy more as it declines. Any cash you generate from selling you put into bonds, and when you are buying stocks, you are selling bonds. You never want to hold all stocks or all bonds, in case you are wrong and the one outperforms the other for a period of time. You do not have to perfectly time the market to do quite well using this method.

Another view on asset allocation is that it should vary with your age. The thinking is that if you are older, you will need your money sooner, and should not have as much money in stocks, which could do poorly for years. Ben Graham thought this idea was bunk, and I would agree, to some extent. While stocks as a whole may underperform bonds for a period of years, if you are doing a good job as a value investor, then the stocks you buy will tend to do okay even in bear markets. When they go down, they will tend to come back up within a period of a couple years.

Thus, I recommend a hybrid approach. As you get very old, put some money in bonds. But if you are a successful stock investor, keep investing in stocks. Also, over time, stocks have generally outperformed bonds (though this is not certain in the future). Therefore, except at the heights of a bull market, keep the majority of your investable assets in stocks.

That being said, the stock market as a whole is not cheap right now, and neither is the bond market, so an allocation of 50% stocks, 40% bonds, and 10% cash in a money market account sounds reasonable.

If even this is too much thinking (and worrying) for you, I suggest investing your retirement money in Vanguard’s excellent target-date retirement funds, which have low fees and choose your asset allocation for you.