June 29, 2010

What amount constitutes a person's "fair share" of taxes?

There's an endless debate about what constitutes a person's "fair share" of taxes, especially when it comes to "rich people."

Of course, it depends greatly on what you define as "rich," and whether or not you fall into that group.

You can judge for yourself. Here are the official numbers on who pays the Federal income tax collected in the U.S.

Percentiles Ranked by AGI	*AGI Threshold on Percentiles**	Percentage of Federal Personal Income Tax Paid
Top 1%	$410,096	40.42
Top 5%	$160,041	60.63
Top 10%	$113,018	71.22
Top 25%	$66,532	86.59
Top 50%	$32,879	97.11
Bottom 50%	<$32,879	2.89
* AGI is Adjusted Gross Income Source: Internal Revenue Service (2007 tax return data) Also, according to the Tax Foundation (based on 2006 data), 41% of the U.S. population were "out of the tax system" in 2006 (includes non-filing households and filing households with zero liability).

June 28, 2010

Why free ETF trades may not be such a great deal

Schwab, Fidelity, and Vanguard have all recently rolled out free ETF trades of one variety or another.

Schwab & Vanguard let their account holders buy and sell their respective ETFs free of charge while Fidelity offers a number of ishares at zero transaction cost to their customers.

Is this a good deal? Well, free is certainly a good price. However, you can trade ETFs at many other firms for as low as $4 and typically not higher than $10. So unless you are using ETFs to dollar cost average into funds frequently in small transaction amounts, the difference might not be that material.

More importantly, there are many reasons to consider or reject a particular ETF that rank much higher on the list than free trades. Such reasons include the index the particular fund tracks, the liquidity of the fund itself as well as the underlying securities it holds, the typical bid/ask spread of the fund, and the fund's propensity to trade near or away from its net asset value, among others.

Lastly, there is much to be said about the brokerage firm trading platform you use. Fidelity, Schwab, and Vanguard (and almost all other brokerage firms) still use a cumbersome, "old school" share-based, individual security trading system which requires great effort and is prone to human error when executing an investment strategy.

My advice is not to choose your ETFs based on zero transaction fees, but instead select your funds based on the more important criteria mentioned above.

And do yourself a favor and check out Folio Investing. Under their basic pricing plan, most investors pay between $50 and $150 a year to effect a sound, long-term buy and hold investment strategy. A small price given their superior investing platform.

Note: I receive no compensation from and am in no way affiliated with Folio Investing. I'm just a big fan of their technology platform and brokerage services.

Time diversification: Does time decrease the riskiness of stocks?

Investing in stocks is risky. But does equity risk decrease as your timeframe increases?

Yes. or No. Depending on how you define risk.

"In the end, the time diversification debate can be restated as a debate over opposing views of risk. Supporters of the time diversification perspective perceive risk as the chance that an equity portfolio will underperform a low-risk portfoli
The historic record suggests that such risk declines with time. Critics of time diversification perceive risk as variations in the final wealth value of a portfolio and uncertainty about the returns investors will experience during specific time periods.
The historic record suggests that the range of such outcomes, from best to worse, widens with time."

Read the entire Vanguard article, Equity risk and time: A survey of U.S. investors.

The bottom line is that investors need to view equity risk in light of both of the above definitions. An appropriately balanced portfolio that includes stocks, bonds, and cash is the most sensible way to protect against both market volatility (or "sequence risk"), and inflation.

June 9, 2010

At least it's not 1966 (as far as we know)

1966 was an infamous year in investment history.

For any retirement period duration from ten to fourty-four years commencing that year, 1966 produced the dubious distinction of the worst possible retirement year in recorded market history (going back to 1926).

Worse even than any year prior to, or during, the great depression.

The combination of brutally high inflation throughout the entire decade of the 1970's and early 1980's and an abysmal bear market during 1973 and 1974 (with a subsequent excruciatingly slow recovery) produced the ultimate portfolio stress test.

Two takeaways, one fairly obvious, and one more subtle:

1) If you want a historical "worst case" scenario to stress test a portfolio, start with 1966. Sure, the future could hold something worse, but if your portfolio can sustain you to a ripe old age under the worst that history has served up (so far anyway), you're probably in a pretty good place.

2) Think back to the environment on the eve of 1966. The country had begun to heal from losing President Kennedy to an assassin's bullet. The Cuban Missile Crisis had been averted and the backyard bomb shelter building craze had come to an end.

The United States' ground participation in the Vietnam war had begun only nine months earlier and had not yet turned into the quagmire it would eventually become (public opinion hit its high point in support of the war in March of 1966).

The stock market was coming off of three consecutive double-digit gain years.

Inflation had run under 2% for the prior eight years. Interest rates had been at historical lows for nearly a decade.

In short, there was nothing that might have indicated that 1966 would commence such a bad retirement investment climate. To the contrary, things looked pretty good.