Real estate is something that will always be there. It is the ground we live on or the structure we work and live in. For this reason, it is something of value. The population of the earth isn't decreasing and the prime places to live and work aren't increasing. This seems like an obvious formula for success as an investment. Many people have made fortunes investing in real estate, but the average investor doesn't always have this experience. Why is this and what has recent history taught us about investing in real estate?
Many Americans are homeowners and, as a result, they became aware of the significant increases in home prices of recent years. This seemed to be a ride that many people were taking to easy prosperity. No one wanted to be left behind so more and more people jumped on for the ride. Like any speculative bubble, the residential real estate market has come crashing down and many novice investors have suffered with the crash. Many people are now avoiding real estate of any form and regretting their decision to invest in this market. Is this the best thing to do?
Your home is often your most valuable asset. Not only does it provide a place to live, but it allows for tax breaks and a forced savings plan (through paying down a mortgage and building equity over time). As a result, buying a home within ones means is not a bad decision. The idea of your home as the primary means to build wealth does not always make sense, though. Over the past twenty years (which included the housing bubble) home prices have averaged gains of just 3.6% a year. Stocks, on the other hand, have averaged gains of 8.4% per year (including the recent downtown in the stock market).
I'm not saying there isn't a place for real estate in a diversified investment portfolio. There are professional real estate managers and ways to invest in commercial real estate in a prudent, diversified manner. My experience and history have taught me that a home should be primarily a home and investing in real estate beyond that should be done carefully, prudently and with a long-term, diversified approach, just like the rest of the investment portfolio.
Tuesday, June 30, 2009
Friday, June 19, 2009
Tax Consequences of Investing
The tax code is complex and constantly changing, but the tax consequences of building and maintaining a diversified investment portfolio are fairly straightforward. I will provide an overview of taxes and investments in this post and then delve into more details regarding specific investments at another time.
The federal tax system classifies taxable income in two ways. Income is considered ordinary income or capital gain income. The capital gain classification is then broken down into short-term or long-term capital gains. Ordinary income is taxed on a sliding scale in a progressive manner. This means that the higher your income, the higher percentage you typically pay in tax. Short-term capital gain income is taxed at your ordinary income tax rate. Long-term capital gain income is typically taxed at a flat 15% income tax rate.
Investment assets (stocks, bonds, mutual funds, CDs, etc.) are taxed in two ways. The first is the income that these assets produce on an ongoing basis. This income is taxed as ordinary income, except when it is qualified income and it is taxed at a 15% rate. The gain or loss realized from selling these investments, after holding them for a short-term (one year or less) period or long-term (greater than one year) period, is taxed at the capital gain tax rate described above.
As this basic introduction to investment taxability illustrates, the tax code is complex and convoluted. Despite being a Certified Public Accountant (CPA), I wish that Congress would enact a simple, straightforward tax system, as opposed to playing political games with our money. In the meantime, we are required to spend a lot of time learning how our tax system works or having professionals do this work for us.
The federal tax system classifies taxable income in two ways. Income is considered ordinary income or capital gain income. The capital gain classification is then broken down into short-term or long-term capital gains. Ordinary income is taxed on a sliding scale in a progressive manner. This means that the higher your income, the higher percentage you typically pay in tax. Short-term capital gain income is taxed at your ordinary income tax rate. Long-term capital gain income is typically taxed at a flat 15% income tax rate.
Investment assets (stocks, bonds, mutual funds, CDs, etc.) are taxed in two ways. The first is the income that these assets produce on an ongoing basis. This income is taxed as ordinary income, except when it is qualified income and it is taxed at a 15% rate. The gain or loss realized from selling these investments, after holding them for a short-term (one year or less) period or long-term (greater than one year) period, is taxed at the capital gain tax rate described above.
As this basic introduction to investment taxability illustrates, the tax code is complex and convoluted. Despite being a Certified Public Accountant (CPA), I wish that Congress would enact a simple, straightforward tax system, as opposed to playing political games with our money. In the meantime, we are required to spend a lot of time learning how our tax system works or having professionals do this work for us.
Friday, June 12, 2009
Finances & Children
Being a father of four children, I'm becoming more experienced in this topic. My wife and I were also raised in large families and have discussed the various financial lessons we did or didn't learn as we were growing up. As my children get older, I want to make sure I'm doing what I can to pass on some sensible financial management skills, even if none of my children follow in my footsteps professionally.
The most critical thing a parent can do is to set an example of sound financial management. Even though we are all unique and born with different personalities, we tend to model some of the parental behavior we saw as children. Although I understand financial principles and could "justify" certain financial decisions, I try to consider the message I'm sending to my children. I can already sense the natural approaches my children might take to money by the way they manage their piggy banks, but I will never regret the positive influence I may have on their future financial decisions.
Example aside, what are some other things we can do as parents to teach our children sound money management skills? I suggest giving them financial responsibility at a relatively young age. This can be done by providing an allowance with expectations or helping them participate in entrepreneurial activities. Handing children money with no expectations doesn't encourage much learning, but adding some responsibility to meet obligations can encourage simple prioritizing or budgeting at a young age. Many children also like to participate in childhood businesses like lemonade stands, recycling, yard care, or babysitting. These activities teach important business skills at a young age before the decisions become more critical and life altering. These skills can also be taught through games like Monopoly or computer games like Lemonade or Zoo Tycoon. I try to make learning these skills fun for my children at this age so they are prepared for the time when money isn't always so much fun anymore.
The most critical thing a parent can do is to set an example of sound financial management. Even though we are all unique and born with different personalities, we tend to model some of the parental behavior we saw as children. Although I understand financial principles and could "justify" certain financial decisions, I try to consider the message I'm sending to my children. I can already sense the natural approaches my children might take to money by the way they manage their piggy banks, but I will never regret the positive influence I may have on their future financial decisions.
Example aside, what are some other things we can do as parents to teach our children sound money management skills? I suggest giving them financial responsibility at a relatively young age. This can be done by providing an allowance with expectations or helping them participate in entrepreneurial activities. Handing children money with no expectations doesn't encourage much learning, but adding some responsibility to meet obligations can encourage simple prioritizing or budgeting at a young age. Many children also like to participate in childhood businesses like lemonade stands, recycling, yard care, or babysitting. These activities teach important business skills at a young age before the decisions become more critical and life altering. These skills can also be taught through games like Monopoly or computer games like Lemonade or Zoo Tycoon. I try to make learning these skills fun for my children at this age so they are prepared for the time when money isn't always so much fun anymore.
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