Apartment Building Advisors Blog

In the wake of the financial crisis, almost all investors are looking for safety. As a result, financial firms are peddling a number of investments that promise protection of your principal, regular monthly payouts or guaranteed minimum returns.

But beware, many of these products aren't all they're cracked up to be. Some don't meet their goals, and many charge high fees.

"They may all be appropriate for some investors," says Harold Evensky, president of Evensky & Katz, a financial advisory firm in Coral Gables, Fla. "But to overplay their safety without risk would be irresponsible. If it all works, you're safe in protecting principal, but there is no guarantee. Some of these clearly have market risk. There is no guarantee managers will achieve their goal."

Among the products touting safety are principal-protected mutual funds and variable annuities.

Principal-protected funds

Principal-protected funds aim to do exactly what they're named: protect your principal. Some of these funds have maintained value by switching to bonds from stocks, which have plummeted 56 percent as measured by the Standard & Poor's 500 Index since October 2007.

Treasury and municipal bonds have performed much better during that period, but over the long term, stocks have outperformed bonds, so staying away from equities could be costly. That's especially the case because "the stock market's gains tend to come in spurts," says Evensky.

Moreover, a fund could be taking risk by holding bonds with long durations. "You want to be careful how far out the yield curve you go," says James Holtzman of Legend Financial Advisors in Pittsburgh. "Interest rates are pretty much at rock-bottom. The only place for them to go is up. The longer you hold the bond, the further the price falls unless you hold it to maturity.

In addition, "the idea of safety in fixed income is more of an issue given the turmoil and volatility of the past six to 12 months," says Michael Sheldon, chief market strategist for RDM Financial Group in Westport, Conn. He notes that even municipal bonds and investment-grade corporate bonds have suffered for extended periods.

Many principal-protected funds consist of structured notes, often called principal-protected notes, issued by financial institutions. For example, "one we were looking at paid the S&P 500 return over the next 13 months, excluding dividends, capped at say 30 percent," Evensky says. "What you get in exchange for that cap is a buffer on the downside, say 15 percent. So if the S&P 500 drops 15 percent, you're even. If it drops 20 percent, you're down only 5 percent. You give the upside away to protect the downside."

Many funds exclude dividends like that. But historically dividends have accounted for a substantial portion of return on stocks. Also, returns on these funds are taxed as ordinary income rather than capital gains or tax-advantaged dividends. "That can be a significant bite," Evensky says.

The issuers generally use derivatives to guarantee your returns and reduce their own risks. Much of the hefty fees go to fund those derivative positions. Derivative expenses can top 2 percent of fund assets, and those expenses, of course, are subtracted from fund values.

"If anyone is going to guarantee you something, it's going to cost," Evensky says. "The better the deal, the more suspicious you should be."

The principal-protected notes often work better for issuers than buyers, says Patti Houlihan, a financial adviser for Houlihan Financial Resource Group in Reston, Va.

"These kinds of things are a way for the underwriters to bring money in and hopefully share some of it with you," she says. "They have use of your money for whatever the period of the note is, and you have nothing but a structured product. There is nothing structured by any financial institution that doesn't give them the most opportunity for return and you the most opportunity for risk."

Issuer risk

Perhaps the biggest risk is that you're betting on the financial health of the institution issuing the notes.

"When I had principal-protected notes explained to me, the people representing the companies structuring them told me it's like buying zero-coupon Treasury bonds at 80 cents on the dollar and then putting the other 20 cents into puts and calls (options)," Houlihan says.

"That sounds good, but the rest of the story is that it's not U.S. Treasuries behind it. You're giving them your dollar, and they are the guarantor. If it was Lehman Brothers, (which was liquidated last fall), I wouldn't want them guaranteeing anything," she says.

Indeed, "many people got badly burned when they had structured products with Lehman," Sheldon says. "When Barclays Bank took over part of Lehman, I don't believe they honored the agreements. That put holders in a bad position."

And you don't know which company may become the next Lehman. "We do structured notes with JPMorgan Chase," Evensky says. "Two years ago, who would have thought there was any risk with them? Today, we put a limited amount with JPMorgan."

Variable annuities

As for variable annuities, they are a contract between you and an insurance company, under which the insurer agrees to make periodic payments to you. The value of your investment -- and the payouts -- will vary depending on the performance of the investment options you choose.

The investment options for a variable annuity typically include mutual funds that invest in stocks, bonds, money market instruments or some combination of the three.

"But fees can be quite high," says Holtzman. "Annuities usually sell with a 6 percent commission, and you're getting a huge surrender cost at the back end. Figuring out your return after expenses, it might not be worth it in light of other risks. If the issuer is Citigroup, you don't know whether it will be around next week, let alone for, say, the eight years of a variable annuity."

Marketers of variable annuities play to people's emotions, Houlihan says. "People want the highest return they can get without risk," she says. "That's an oxymoron."

She says one of her clients is very conservative and was told by the institution selling her an annuity that she was guaranteed a certain rate of return. "But 100 percent of the annuity was in aggressive mutual funds," hardly a guarantee of any rate of return.

Finding safety

So how do you achieve safety? "There is no such thing as a safe investment. You need a safe portfolio through balancing," Evensky says. Treasury Inflation Protected Securities, or TIPS, make sense now, he says.

TIPS are government securities whose interest rates are linked to inflation. When inflation rises, so do your interest payments. With the budget deficit exploding, inflation will probably rise, Evensky says. "The price of TIPS can be quite volatile, but they are paying about the same as Treasuries now, so their cost is low."

Evensky also recommends high-quality corporate bonds, perhaps in a laddered portfolio, where you have a range of different maturities.

Legend Financial has its clients in two Ginnie Mae bond funds. Those are the only mortgage bonds officially backed by the government. The firm also likes short-term bond funds.

"Normally, if you're uncertain, you would put your money in a money-market fund for safety and yield," Holtzman says. "The problem is that yields are basically nothing now. Using short-term bond funds, you're getting a better yield than money markets, and you can reinvest at higher yields if rates rise."

Chris Wheaton, managing partner of Litman/Gregory Asset Management in Larkspur, Calif., says diversification for his firm starts with stocks and bonds. As a temporary substitute for stocks, "we've got about a 15 percent allocation to high-yield bonds," he says.

You might not think those are safe, but "there's a lot more cushion on the downside because the price of high-yield bonds is so out of line (undervalued) in the aftermath of the financial collapse," Wheaton says. "And even if you get a capital loss from the asset going down, you have a high yield to offset the risk."

For more information about investing, and a glossary of terms, visit our Investing Guide.

Source: www.Bankrate.com

Taxes are like those holiday fruitcakes. They always seem to show up and just sit there. No one wants anything to do with them, except maybe to push them to the back of the buffet table. And the longer they sit, the harder they get.

Well, Bankrate can't make taxes (or fruitcakes) any more palatable. But we can help you move that unappetizing tax task off your desk. All it takes is breaking the chore down into digestible components.

Completing your tax return is a big job, but you don't have to tackle it all at once. By spreading out the task, you can save your sanity and maybe a little tax money, too, since you'll be better able to look for ways to cut your final bill.

Day 1: Gather data

Gather all your income data. It is, after all, called an income tax.

Find all your W-2 wage statements; any 1099-MISC forms, if you did independent contract work; and all the statements detailing just how much your savings and investments earned. If you sold a stock or other property, you'll need those data, too.

Did you win the lottery? You probably didn't win the big jackpot or you would've hired someone else to worry about this now! But any amounts you win are taxable.

And if you're enjoying your retirement, you may owe a part of those monthly pension checks to Uncle Sam.

Even if last year was a tough one financially, you may have some tax consequences. If you were out of work for a while and collected unemployment, those payments are taxable, and you should have received a Form 1099-G showing the amount.

Find all these income statements, clip them together and you're done for the day. See you tomorrow!

Day 2: Reduce taxable income

Welcome back. Day two probably will be the fullest of our tax-filing plan, but it's worth it. Today we start slashing your tax bill.

Pull together all your exemption, deduction and tax credit info. These items will help you whittle down your income to the actual amount that the Internal Revenue Service will tax.

You get to take $3,500 off the top for each person you claim as an exemption on your return. That's generally a pretty easy determination: you, your spouse and any dependents, which generally means your kids. But did you care for a parent, even one who didn't live in your home? You may be able to claim an exemption for that person, too.

Next, there are some expenses that any taxpayer can take without bothering with extra paperwork. These include certain IRA contributions, student loan interest, alimony payments or moving costs. Collect the backup for these nonitemizing expenses first.

Now check the standard deduction allowed for your filing status. Most taxpayers use this rather than bothering with tracking every expense to itemize. If the standard amount works for you, great! You may be through today in less than an hour.

But if you find itemizing will help cut your taxes, you have a bit more work to do.

If you're a homeowner, find the mortgage and property tax statement from your lender. In many cases, these amounts alone exceed the standard deduction. Don't forget that you can also deduct any state and local taxes, so you'll need the documentation of these payments.

Philanthropic filers get a break, too. Your qualified cash and property donations can reduce your tax bill. You now need substantiation of any monetary gift, regardless of amount. Acceptable records include a canceled check, a bank or credit union statement that shows the name of the charity and the date and amount paid, or a credit card statement indicating the charity and the transaction posting date. Make sure you have an official receipt for any charitable gifts that were $250 or more.

Next, pull out your medical records for last year to see if your costs total 7.5 percent of your income. If they do, you can use them. If not, don't waste any more time here.

And don't overlook miscellaneous deductions. This amount has to total 2 percent of your income, but there are a lot of expenses you can include here -- unreimbursed employee business expenses, investment costs, even tax preparation fees.

If you're self-employed, track down all receipts and documentation for any number of business-related expenses. This includes the mileage records you kept when using your car for business, the office equipment and supplies you bought, and the utility bills you paid to keep the home-office lights on.

Now to the credits. These breaks can help cut your tax bill dollar for dollar.

If you didn't make much, you may be eligible for the earned income tax credit, or EIC. The break could be even larger if you have kids.

Even if you don't qualify for the EIC, you may be eligible to take $1,000 per child off your tax bill. If you paid a nursery school to watch them while you worked, part of that cost may cut your taxes. Pull child care records for the exact amount you spent.

Credits also are available for some educational costs -- yours and your children's. You'll need these details. And there's even a credit to cover some adoption expenses.

Once you've found all this material, stack it next to your income info. You're finally through for the day.

Day 3: Find your forms

Now that you know what you made and how you can reduce it to a more tolerable taxable level, find the forms you'll need to file.

The IRS offers three individual tax return forms: the 1040EZ, 1040A and 1040. Each has specific requirements you have to meet to use it.

It may be tempting to use the simplest form, the 1040EZ, if you're eligible. But you should look at the other two anyway. Generally, the longer versions offer more opportunities for tax breaks. For example, the deduction for up to $2,500 in student loan interest can't be claimed by EZ filers.

Once you've made your choice, take a few minutes to read over the form. Here you'll see exactly where you'll put the information you gathered on days one and two, and where the deductions and credits are subtracted. (But don't enter anything yet. We have to have something to look forward to!)

In addition to your main tax form, you'll get an idea of any additional forms you may need. Where an attachment is required, it will be noted on the individual tax return you file.

For example, if you opted for the long 1040 return, you'll likely need Schedule A (referenced on line 40 of the 1040) to itemize your deductions. You also might want Schedule B (asked for on the 1040, line 8 and line 9) if you have a lot of interest or dividend income to report. Self-employed taxpayers will see mention of Schedule C or Schedule C-EZ (line 12 of the 1040), along with the accompanying Schedule SE to pay self-employment taxes (the 1040's line 27 as an adjustment and line 57 as a payment).

For most taxpayers, encountering unfamiliar paperwork is a big aggravation. But by examining the forms beforehand, you'll have a heads-up about what to expect when it comes time -- tomorrow -- to start filling them out.

Day 4: Fill out your forms

Now the real fun begins. Today we put pencil to paper to complete your return.

Actually, this should be a piece of cake (and one that's preferable to that aging fruit-filled holiday concoction) because you already have your income, deduction, exemption and credit information at your fingertips.

You can either work your way through income and deduction data stacks, entering the information at the appropriate tax return lines, or you can start at the beginning of your chosen 1040 and work your way down the return. It's a matter of personal preference, but if you're not overly comfortable in filing your taxes, you're probably better off going with the line-by-line approach.

A tip for entering information: Have the instruction book for your return handy. The 1040 and additional forms are pretty skeletal. The instructions help flesh out your entries, provide work sheets you might need and, in some cases, even let you know that a certain line doesn't apply to your filing situation.

Plus the instructions are where you'll find the tax tables. You'll need these to see just what your tax bill is.

Day 5: Take a break

Ignore your taxes.

You've made it past the filing halfway mark. You deserve a break!

Take today's tax hour and read a book, take a walk or luxuriate in a bubble bath. Tomorrow and taxes will be here soon enough.

Day 6: Check your work

OK, back to the filing grindstone. Today, with a fresh eye, double-check your tax form entries.

When people inspect their returns right after they've filled them out, they tend to see what they know should be entered rather than what is actually on the form.But thanks to yesterday's break, your review today will give you a new perspective.

Simple entry errors, text and mathematical, are the most common tax-filing mistakes. Make sure you haven't overlooked a deduction or a transposed dollar amount.

Don't forget the obvious. Check names -- yours, your spouse's, your children's and any other dependents'. Make sure you've entered the Social Security number for each and that the numbers are correct.

Finally, if you're not using computer software or an online program to make your calculations, plug in the adding machine and check your addition and subtraction again.

Day 7: Sign, seal and deliver

We're in the home stretch.

Confident that you've counted all your income, taken all the deductions you can and entered your information correctly and completely, it's time to wrap up your annual tax filing.

Make one final check of your return to guarantee that all is in order. Then sign it, make yourself a copy and send it on its way, either via the post office (make sure you've put enough stamps on the envelope) or by hitting the "enter" button on your computer keyboard.

And what to do with the rest of today's tax-filing hour?

Pour yourself a cold one, kick back and congratulate yourself on conquering your taxes in one relatively hassle-free week!

For more tax-filing information and tips, check out Bankrate's Tax Guide.

Source: www.Bankrate.com