Should I Invest in Facebook?

If you follow any news sources, you have definitely heard about the stock market debut of Facebook, the social networking giant.  Although I never give specific recommendations about individual stocks, the IPO of Facebook is a good opportunity to review some basic principles of sound investing.

Facebook became available for purchase to the average retail investor this morning after a long period as a privately held company.  The social networking site has over 900 million active members worldwide and is extremely well-known and broadly utilized.  For these reasons alone, many people assume that it would make a great investment.

Investing is using money or capital in order to gain profitable returns, such as interest, income, or appreciation in value.  How does a share of Facebook fit into this definition?  Facebook debuted on the NASDAQ exchange today with a market capitalization (share price x shares outstanding) of over $100 billion, representing approximately 100 times its profits from 2011.  Most publicly traded companies trade for 10 to 15 times their annual profits.  Facebook shares do not currently pay any income.  In order to achieve a profitable return, the share price would have to continue to increase.  Anything could happen in the short-run, but a long-term appreciation of Facebook shares is only possible with dramatic increases in revenue and profitability of the company.  This will require charges for services that are currently free, additional advertising that could drive away users or other new sources of revenue that don't currently exist.  Although I will never claim to predict the future, Facebook has a long ways to go until it pencils out as a sound investment in my view.

Prudent investing requires appropriate assessment of risk, diversification and discipline.  Invidividual stocks come with a risk that is too high for most common investors.  Diversification requires that an individual own many different types of investments in order to spread risks across various companies, sectors and economies.  Discipline is also required to achieve consistent, positive, long-term investment returns.  The unpredictability and short-term, emotional movements of individual stocks do not cater to the sound discipline of a prudent investor.

There are other investment considerations that I haven't discussed here, but my simple recommendation would be to use Facebook as the great social networking tool that it is and only use it as an investment in a broadly diversified portfolio.

Happy New Year!

Although the new year is just another date on the calendar, it does give us an opportunity to reflect on the past twelve months and how we might make the coming days better.  Many parts of our financial lives do reset with the beginning of the year, so I would like to offer some recommendations for improvement.

1)  Keep better records - This isn't just for the detailed personalities out there.  There is a lot of insight and power that can only come from accurate recordkeeping.  There are even simple solutions like Mint.com that will do most of the work for you.

2)  Accept the past and start fresh - Although real estate troubles or job changes might have changed your financial situation, you can reboot and develop a new financial plan for your current realities.

3)  Reduce clutter - This might include closing some unused accounts or consolidating some old investments.  Less clutter in the practical areas of our lives allows us to focus more on the things that matter most.

4)  Live life more efficiently - There are lots of small things that can be done here.  Reducing unnecessary shopping trips, replacing inefficient light bulbs or appliances and programming your thermastat are just a few.

5)  Insure the important things in life - You should not take insurable risks that could cause harm to your family in the event of an accident or disaster.

6)  Establish an estate plan - This can include a will, health care directives, and a trust.  The first step is to think about it.

7)  Think about your investments - This is an area that can be very costly when ignored for a long period of time.  Each investment involves risks and these should be carefully reconsidered periodically.

8)  Reduce unnecessary debts - There are good debts and bad debts.  Debts should be reviewed, prioritized and paid down in a smart way.  For example - pay down the debt with the highest interest rate first.

9)  Do some math - You might not enjoy numbers, but some basic arithmetic can help your financial security.  Basic assessments of income and outflows and projected future savings balances have to be done periodically to have a sense of realistic goals.

10)  Share what you have learned - Family and friends can benefit greatly from the financial lessons that you have learned through your experience.  Be a good example of healthy habits that will be observed by others.

I could list many more, but this should provide some ideas for many of you.  If this is seems overwhelming, contact a fiscally-minded friend, family member or financial professional.  They would be happy to help!

Are the Markets Making You Nervous?

Stock markets have been more volatile lately, largely due to U.S. and European debt problems.  Although these are significant problems in need of long-term, structural changes, I view investing as a long-term, disciplined process.  That being said, how does one invest for the future but also take advantage of short-term opportunities to strengthen ones financial situation.

As explained by Andrea Coombes in a MarketWatch article posted on September 23rd, there are five things that should be the foundation of any long-term investment portfolio:

Minimize Taxes - Although investment income and capital gains are taxable, there are ways to structure a portfolio to minimize or defer these taxable events.  Gains can also be offset by losses in certain instances.

Control Costs  - Any investment has a cost associated with it, but these costs can be controlled by evaluating management fees and consolidating assets to reduce fees.  Costs can often be hidden or difficult to quantify, so an independent investment professional can assist in evaluating the true costs of various investments.

Diversify - This is as simple as "Don't put all your eggs in one basket."  Investments should be across various asset classes, company sizes and economies.  A large amount of an investor's portfolio in one specific investment, concentrates too much risk in one area, unless that investment is broadly diversified itself.

Rebalance - Different asset classes will perform differently in a portfolio.  Outperformance of one asset class should be realized and then reinvested in an underperforming asset class.  This rebalancing can contribute significantly to the aggregate performance of a portfolio over time.

Be Proactive, But Patient - A plan should first be developed before investing significant amounts of capital.  This plan should include goals and the amount of risk that you are comfortable with.  Portfolio performance should be monitored versus this plan over time and changes can made, if needed.  Accomplishing long-term financial goals is a patient process, though, and no rash changes should be made based on emotions.

Although the news headlines will always affect our emotional well-being, a long-term investment plan with a strong foundation provides a stable backdrop to the ups and downs of our daily lives.

A Tribute to Steve Jobs

Considering that the world lost an icon this week in Steve Jobs, I thought I could offer a small tribute of my own.

Ever since my family purchased an Apple II computer in the early 80s, I've appreciated the products that were influenced by Steve Jobs and his way of thinking.  Technology really is just a tool people use to communicate, create, appreciate other's creations and just get things done.  I've always been excited by the way I could more elegantly and efficiently accomplish things in my life with techology, while also enjoying the process.  This has always been the case when I've interacted with something Steve Jobs influenced.

Considering that this blog is about investing, I also wanted to share some thoughts about Steve Jobs and the business world.  I recently came across this quote from the well-known management consultant, Peter Drucker:
 
"Because the purpose of business is to create a customer, the business enterprise has two--and only two--basic functions: marketing and innovation.  Marketing and innovation produce results; all the rest are costs."

This is something that Steve Jobs understood at an amazingly high level.  From the time he returned to Apple in 1997 until the present, Apple's stock price increased 9,000%.  This was the effect of his focus on marketing and innovation.  As we strive to improve the American economy, we need to think of new and better ways to do things and share this message with the world.  Investing in this innovation will lead to positive returns because of the increased value that is created.  I hope that we can all get to work and be a part in making the world a better place.

Should You Save for Your Childrens' College?

Many parents of young children consider putting aside money for their children's college education a top priority.  As a parent of young children myself, I feel like the current and future education of my children is of critical importance.  That being said, everything has a cost and paying for your children's college is something that you need to be able to afford.  A popular online columnist, Emily Lambert, recently wrote about reasons that you might not want to save for college.  As a financial planner, I consistently discuss the cost of a college education with my clients and how to view this expense like an investment instead of an obligation.  I'm continually surprised when I meet parents who are willing to put up to six figures into private school tuition without any sort of idea about what this "investment" might lead to.

I recently attended a presentation by nationally-known parenting experts, Richard and Linda Eyre about entitlement.  They shared the maxim that "ownership is the antidote of entitlement and also the prerequisite of responsibility."  I feel like we should help our children own their education and future career.  As a result, they are much less likely to feel entitled and more likely to suceed.  Part of this ownership might require them to invest in their college education through savings, scholarships or part-time work during college.  Parents have many responsibilities in rearing their children.  These responsiblities often require financial outlays, but I encourage parents to evaluate their spending regarding their children in order to make sure it is leading to ownership instead of entitlement.

Do you have control of your finances?

As I talk to family, friends and prospective clients, I often hear about financial challenges. Most people have financial challenges. If not, they would almost always like to be in a better place when it comes to their financial well-being. I try to remind people that the challenges aren't always the problem. The problem is often the fact that people don't have a clear picture of their financial situation. Many people aren't even aware of what parts of their financial lives they are in control of. I'd like to review a few areas and offer some suggestions.

A good starting point is a net worth statement and a income statement. In plain English, a net worth statement is a listing off all positive and negative account balances in order to come up with the net positive or negative "net worth." An income statement is a listing of all income and expenses over a chosen period of time. Once you have pulled together a basic summary of where you are, you can start to look at what you can control to improve your financial situation.

Bank Accounts - Are you paying unnecessary fees or missing out on earning interest? Do you have adequate savings?

Investments - Are you taking inappropriate risks considering your stage in life? Do you know what you are investing in and why you are doing it? Are your investments diversified? Have you had a professional assessment of your investments?

Real Estate - Do you have the lowest rate available on your mortgage? Is your mortgage balance appropriate? Are you maintaining your home and only spending money on it in "smart" ways?

Credit Cards - Do you pay more interest and fees than is necessary? Do you even need to use credit cards to begin with? Can you reduce the balances that are incurring interest?

Other Loans - Borrowing money for purchases should be well thought out and should not be a frequent behavior.

Salary - Are you living up to your potential at work? Have you evaluated your career path and what type of spending that supports over the long run?

Monthly Expenses - Which of these are necessities and which of these are luxuries? Can you really afford all the luxuries?

Taxes - Do you take advantage of all available deductions? Do you consider the tax impact of your large financial decisions?

The Bottom Line - Are you living within your means? Is more coming in than is going out?

Gaining control of your finances takes work, just like keeping your body healthy, keeping your marriage strong and teaching your children correct principles. Like all of these things, increased financial control will expand your options in life and lead to greater peace of mind. We are all faced with challenges we can't control, but we also have the ability to take charge and chart the path we want to follow in life.

Balance & Compromise

As I read the news headlines and follow happenings in the U.S. and around the world, I realize that many of our problems would be solved with more willingness to keep things in balance. We are seeing battles in Congress between taxing and spending. We see disputes between those preferring economic development versus those who want to preserve the environment. We also see fights in families and governments that can lead to heartache and sometimes even violence or wars. As I ponder the problems around me, I wish that more people could consider both sides of the story and compromise to solve problems and move forward.

When I work with individuals to develop a financial plan or manage an investment portfolio, it often comes down to the ideas of balance and compromise also. There are often choices to be made between short-term spending and long-term savings. There is balancing that needs to be done between asset classes in an investment portfolio. Compromises also have to be made between spouses about financial goals. Finally, a compromise is needed in determining how much risk can be tolerated and how much potential reward that might lead to.

A basic understanding of financial principles is something that all Americans could use. As we work to solve some of our state and national economic problems, we could all benefit by taking a look at our individual lives to see how we can bring things into better balance. A more realistic view of finances on the individual level would have significant benefits in solving some of the more significant problems in our country and around the world.

The Efficient Market Hypothesis

So what is the "Efficient Market Hypothesis" and how does it apply to investing? This theory states that it is impossible to "beat the market" because the "efficiency" of the stock market causes existing share prices to always incorporate and reflect all relevant information. If this theory is true, it is nearly impossible to outperform the overall market, and higher returns can only be obtained by buying riskier investments.

A common perception about investment managers and "Wall Street" is that there are some super-smart people out there that know how to make money from investing in ways that no one else does. History has proven that the vast majority of "active" (those who use expert stock selection or market timing) managers do not outperform the markets as a whole. In most cases, the higher than market returns are obtained by taking on additional risk. Many on "Wall Street" also become wealthy by charging unnecessarily high fees for their advice.

If this hypothesis is correct, then what is the best approach to investing? For most people, index funds, exchange-traded funds, or low-cost mutual funds are the answer. Diversification, portfolio rebalancing and reducing costs are the three factors that can best increase portfolio values over time without taking on more risk than the individual would normally be comfortable taking. Like most fields, there are some true principles of investing, and I believe that the "Efficient Market Hypothesis" is one of these principles. I recommend that you look at this article and video for more discussion and advice on this topic.

The True Principles of Investing

There are numerous sources of investment information in the world, many claiming to have something that will provide an above average return or provide access to exclusive, profitable information. Although I'm open to new sources of investment information, I often view these sources somewhat skeptically until I understand the source of the information and how tried and tested it is.

Although things are changing in the world every day, there are some principles of investing that are as close to truth as it gets in the financial world. First of all, markets work. Various types of investments provide an expected return based on the risk of the investment and markets price these securities commensurate to the risk and expected return.

Second, and related to the first principle, is that investors are rewarded in proportion to the risk they take. This may not seem true in the short run, but over longer periods of time, this is almost always the case.

Third, diversification is a critical investment tool. It allows investors to capture risks that generate expected return but reduce risks that do not. The common phrase for diversification is "Don't put all your eggs in one basket."

Fourth, the appropriate risk or asset allocation is unique to each investor. The various rules of thumb do not apply to every investor. A customized approach considering the risk the investor can tolerate is best.

Finally, costs are variable and should be considered. Although two similar investments may provide similar returns, two investors could end up with vastly different sums of money because of the costs related to accessing these two similar investments. As consumers, we should be aware of the various costs of investing and comfortable with their appropriateness to our situation.

I seek for true principles in any area of my life that help me make more informed, reliable decisions. The investing world has been analyzed and researched for many years in order to uncover what things work when it comes to capital markets. I welcome feedback and discussion as I continue to seek and implement the true principles of investing in my profession.

Risk & Diversification

The headlines have been dominated recently by the BP oil disaster in the Gulf of Mexico. This story and the dramatic effect it has had on the value of BP stock are yet another example of the risks inherent in investing. Considering these risks, why do people invest and how can one invest without exposing oneself to too many of these risks?

Many people consider large, established companies to be good investments. There are several reasons that this is true, but putting too much of ones investment portfolio into the stock or bonds of a single or small number of companies is still a risky proposition. BP and GM are dramatic, recent examples.

So how does one reduce the risks of investing in the "wrong" company? The simple answer is diversification. The common phrase used to define this term is "Don't Put All Your Eggs in One Basket." By owning stocks and bonds from a variety of companies, large and small, domestic and international, the risk of losing large amounts of wealth is reduced.

Some people have questioned the value of diversification because nearly every type of investment lost value during 2008. While this is true, a 40-year study that was presented at a recent financial planning conference showed that a year like 2008 was truly an anomaly. Diversification has provided significant protection in 38 of the last 40 years. Although disasters and market shifts will continue to pose risks for companies of all types, diversification is one way to have exposure to the upside of investing, without taking on too much risk.

New Opportunities

As someone who is interested in the automobile industry, I took special interest in the announcement today of a partnership between Tesla and Toyota. Tesla is a young, Silicon Valley start-up electric automobile manufacturer and Toyota is the large global auto giant that has gotten a bit of bad press recently. So what does this announcement have to do with investing?

Tesla has been producing a very expensive electric roadster that has sold well to those who can pay over $100,000 for a car. Tesla's next product is an electric sedan that should be affordable to more buyers at about $50,000. Toyota (along with most auto manufacturers) has experienced a slowdown the past couple years and recently closed a large auto factory in the San Francisco Bay Area, which was formerly a joint venture with General Motors.

Today's announcement was that Tesla would buy the closed factory from Toyota to manufacture its future products and learn from Toyota's expertise in manufacturing. Toyota announced that it would invest $50 million in Tesla to learn from some of its young, venture-like thinking and methodologies and jointly produce electric vehicles in the future.

In my opinion, this announcement is a great example of the transitions that happen in a free-market economy and the opportunities that news ways of thinking and doing things can provide. Tesla is focused on the future of automobiles, without being restricted by oil or labor unions. Toyota is looking to improve its image and rekindle some energy that large organizations tend to lose over time. A well structured investment portfolio can be designed to take advantage of these transitions and the opportunities they provide. Although an economic downturn causes a lot of pain and upheaval, it also opens new doors and allows new ways of thinking. As an investor, I like to look forward for the growth and changes that might be just around the corner.

Risk & Volatility

Anyone who follows the news headlines heard about the dramatic drop in the stock market yesterday. Although it was followed by a significant recovery, there was a point yesterday where the Dow Jones Industrial Average was down almost 1,000 points. What caused this to happen and what does it mean about the risk of investing in the stock market?

There is speculation about the exact cause of yesterday's volatility, but it was most likely caused by a combination of global economic uncertainty, computerized trading programs and human trading actions. All of these factors confirm that investing in equities does carry risk and this risk becomes more apparent when uncertainty exists. Our world economy has become more volatile and uncertain in recent times and the changes in the market show this.

Despite the volatility, developing a well-diversified, long-term investment portfolio is still the way to achieve returns that stay ahead of inflation and to build real wealth over a long period of time. Recent events confirm the need to have a well-thought-out financial plan and appropriate investments which support the risk this financial plan allows. Having a plan like this in place allows the short-term emotion of the markets to be viewed as "noise" and the long-term goals remain the primary concern.

What a Difference a Year Makes!

Although unemployment remains high and the media may continue to focus on the negatives of the past couple years, things have turned around dramatically in the stock markets. For example:

S&P 500 (Large U.S. Companies)

Down 38.49% in 2008

Up 23.45% in 2009

EAFE Index (Large International Companies)

Down 45.09% in 2008

Up 27.75% in 2009

MSCI Emerging Markets Index (International Companies from Developing Nations)

Down 54.48% in 2008

Up 74.50% in 2009

The trend is quite similar for many other stock indices in 2008 and 2009 and the positive returns are even more dramatic from the point the markets bottomed on March 9, 2009.

Pessimists might say that although we have seen positive returns in the markets of late, we still aren't back to the 2007 peak and we don't know where we're going from here. Both of these points are valid, but a more positive view would be that we've made great progress in coming back and the markets (which typically forecast 6-9 months forward in the economy) are forecasting significant economic improvements.

A couple conclusions from this short analysis would be that markets are volatile (2008-09 were an extremely dramatic example) and that investing is a long-term proposition with bumps along the road. This recent period once again confirms the need to have a realistic, diversified investment plan and to stay disciplined through the ups and downs.

The Costs of Investing

Much has been said recently about a new sense of frugality in our economy. Down markets and higher levels of unemployment have a nasty way of forcing people to be more frugal. Whether this frugality continues is yet to be determined, but one thing is certain--consumers are more price conscious in today's environment.

So what is the price of investing? When I say price, I'm referring to the transactional or management cost of investments. The risk associated with stocks and bonds and the potential cost due to realized losses is another topic and a separate discussion. There can also be tax costs associated with investments which I won't address in this post.

The do-it-yourself investor will need to set up an online trading account and will typically pay a trading commission of $8-20 each time they buy or sell a stock. There might also be an annual maintenance fee. Mutual fund trades can have transaction fees, or might be "no-load," which means there isn't an initial cost to purchase the shares of the fund. Mutual funds also have ongoing management and trading costs, which can be quite significant. These costs are disclosed, but not easily obtainable or comparable for the individual investor. Mutual funds can also have front end (purchase) or back end (sales) charges.

The investor working with a professional financial advisor will typically pay on a transaction or ongoing management basis. Some advisors will also consult on an hourly basis. The transaction cost is often a commission or front end charge that is passed on to the advisor. Mutual fund management fees are also shared with advisors at times and surrender charges cost the investor for selling out of an investment before a specified period of time has passed. An ongoing management fee is typically charged based on the value of an investment portfolio.

The myriad of costs, fees, loads and commissions are often complex, confusing, and at times, unnecessary. They tend to enrich the advisor at the cost of the client or investor. Although any professional investment advisor needs to be compensated to make a living, I recommend three things to keep in mind with regard to investment costs.

1) Costs should be fully and completely disclosed. Financial advisors are more likely to hide their fees if they are unnecessary or unreasonable.

2) Costs should not be charged at multiple layers, if possible. Investing can be done in an efficient, institutional manner where costs aren't charged at many layers without any corresponding benefit.

3) The financial advisor's compensation should be fully aligned with the client's best interest. An advisor shouldn't be paid solely for a "sale" without any ongoing accountability for client success and service. Commission-based salespeople are motivated to convince you that their solution is the best because that is how they are paid.

Investing significant financial assets in an appropriate manner can be critical to a prosperous and flexible financial future, but careful attention should be given to the price of investing before moving forward with an approach.

Will America Still be No. 1?

The recent economic times have caused some to question whether America will continue to be the economic superpower it has been in the past. The World Economic Forum recently ranked the United States number two behind Switzerland amongst the world's most competitive economies. While I'm a strong believer in a free-market economy and the uniqueness of America rooted in the ideals of our founding fathers, no one can say how the American economy will compare to other world economies several generations into the future.

As an investor, what should you do to adjust to this potential new reality? It really comes back to one of the basic principles of investing - diversification. Any well-designed investment portfolio should take a world view and include more than just U.S. stocks and bonds. Developed and emerging international markets should also be considered. European and other developed economies, along with emerging markets like China and India, can diversify the risk of a portfolio while potentially increasing the return.

Which countries should be invested in and in what ratio? More emphasis should be put on developed economies because of a longer track record and stronger government regulation and controls. Emerging markets offer enticing potential returns, but they bring increased volatility and the added risk of unstable governments or unethical practices. Limited emerging market investments are appropriate for most investors. The world economic landscape is always changing, but these changes create opportunities to adjust a portfolio to capitalize on the new economic realities.

Is it different this time?

The significant economic events of the past year have caused many to proclaim that traditional buy and hold investing is no longer valid. Supposed experts have also proclaimed that modern portfolio theory is dead. I've also read that the efficient market hypothesis no longer works. Have things changed in the U.S. or world economies so much that the tested, proven and researched tenets of modern investing no longer hold?

I would argue that things haven't changed and the modern ideas of investing are still correct. History has changed. Although history tends to repeat itself and what we've seen recently has happened before, many of us are seeing economic events occur that have not happened in our lifetimes. The reaction to these recent events by individuals and our government has been somewhat unprecedented, but that is a political discussion I don't want to get into at this point.

The efficient market hypothesis states that markets are efficient and asset prices reflect all known information or instantly change to reflect new information. The enormous amount of market volatility that we've seen recently has been due to the enormous amount of economic uncertainty. Once the uncertainty starts to recede, the market will react, as we've seen with some of the positive information being reported recently and the corresponding positive move in the markets.

The efficient market hypothesis is the best working model of how world markets function. The best way to invest in markets is to develop a diversified portfolio (Modern Portfolio Theory) with the appropriate amount of risk exposure. As opposed to markets "failing," much of recent economic history has been due to investors reassessing their level of risk and making appropriate adjustments. Despite the economic pain that has been inflicted on many, recent events have been an opportunity to really experience market risk and why the return premiums from holding equities (stocks and mutual funds) exist. Can we learn valuable lessons from this or are we bound to repeat these cycles again some time in the future?

Watch this eight minute video to hear Eugene Fama, the father of the efficient market hypothesis, share his views.

Is Real Estate Investing a Good Idea?

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.

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.

Investing is a Way of Life

I have been thinking about purchasing a new car recently and this whole process has reminded me how many of life's decisions are better made when they are looked at as an investment. This also includes non-financial decisions, since just about all decisions we make involve a time, energy or emotional commitment. Some people might think I'm a little over-the-top to think this way, but this view on life can pay for itself many times over, just as a good financial investment can.

My current automobile has proven to be a worse investment than I would like to admit. This might have something to do with the fact that I suppressed a few of my governing principles when I made the initial purchase. I have since become a bit wiser and committed to not make the same mistake again. I am considering the total cost of ownership with the potential new purchase, including value, reliability, warranties, resale value, practicality and so forth. This is how any major purchase or decision should be viewed. Hindsight is 20/20, so we will never make all our decisions perfectly, but investing time up front and considering the total cost of ownership of an investment approach or financial advisor relationship is crucial.

In regards to the auto purchasing, there are many great values available right now, along with tax incentives. If you happen to be in the market for a new car (remember total cost of ownership) I have a link here on my blog to TRUECAR, a great new site that helps you discover what people are "really" paying for their cars. Cars are a neglected side interest that I have, so maybe I will blog more about the auto industry in another post later on.

Long-Term Thinking

Many trusted, well-grounded professionals in various fields will agree that true success rarely comes without discipline and a long-term perspective. Due to the amazing advances in technology and the pace of change in the world today, one might think that success can easily be achieved overnight. This does happen on occasion, but it is more the exception than the rule.

There are also great risks in approaching things with a short-term perspective. One need not look any further than Wall Street and the recent meltdown to see what happens to companies, financial markets and entire economies in this case, when too much emphasis is put on growth or profits in the short-term. The changes in the U.S. real estate market are also an example of how emphasis on short-term profits from "flipping" homes has wreaked havoc on many Americans, well beyond the guilty profiteers.

A recent analysis I did on the returns of a well-diversified portfolio showed that the typical average returns of various investment assets have not held up in more recent history. On the other hand, these returns do occur when the investment time horizon is extended to a generation or longer. This analysis, along with personal experience throughout my lifetime, confirms that achieving exceptional returns from the implementation of proven investing principles is a disciplined, long-term process.