The idea of a checklist isn’t new. It’s used by a number of professions, like engineers, pilots, and doctors, to prevent mistakes. There’s a reason every flight seems like a ritual. Both pilots and flight attendants go through a checklist before, during, and after each flight.

As a passenger it seems trivial, but they do it for a reason. It works. It makes sense too. Lives are on the line and anything that prevents errors and mistakes, inevitably saves lives. And all because of a simple checklist.

You can apply the same concept to your portfolio and investments.

An investing checklist forces you to stay in your comfort zone, stick to your guidelines, and make methodical thought out decisions. It becomes your process for investment selection – lists what you like and should avoid. It is your research process. It is a reminder of past mistakes to avoid. It keeps your portfolio inline with your long-term investment plan. It simplifies your investment process.

With money on the line, being thorough helps reduce risks, mistakes, and losses. It should keep you honest about investment ideas. In doing so, it should increase performance. Though, I won’t guarantee it. But if you’re using your checklist correctly, fewer mistakes lead to fewer losses and better performance. So you do the math.

Investment Checklists

Mistakes are a big reason investors fail. Which should be obvious. It’s how we learn from those mistakes that set us apart. The second biggest is not having a plan. You get around both with a solid checklist.

Here are two investment checklists to get you started. Understand these are generic templates for a number of reasons. But mainly, not knowing your strategy or selection process makes it hard to be specific. So please remove what you don’t need and add your own experiences, requirements, and strategy. It will only help your investing success in the long run.

Portfolio Checklist

Running through a portfolio checklist is a great way to make sure your investments stay aligned with your goals. It keeps your portfolio performing optimally and without extra risks. It’s perfect for quick quarterly checkups and complete annual reviews.

• Have your goals changed?
• Do your investments still meet your requirements?
• Do your investments align with your goals, risk aversion, and age?
• Is your asset allocation out of whack? Is it time to rebalance?
• Is it a diversified allocation?
• Is it a tax efficient allocation?
• Do the mutual funds live up to its stated investment goals?
• Do the index funds and ETFs perform up to the underlying benchmark?
• Have the fund expense ratios changed? More expensive? Less expensive?
• Is there an alternative lower cost fund available with a similar or better performance history and risk profile?
• Have economic changes affected your risk level?
• Has your investment time horizon changed?
• Do those economic changes call for an allocation adjustment?
• Have those changes provided a short-term opportunity?

Stock Checklist

Your stock checklist will solidify your predetermined requirements. It forces you to follow through on all the research. This way you don’t overreach for a stock because your neighbor recommends it and one metric looks convincing. When you build your list, it can be as simple as what makes a great stock or an extension of your favorite stock screen. Again, this checklist is far from complete. You’ll need to make changes and fill the rest.

Basic Info

• Is it a simple business – easy to understand?
• What is the business, products, services, and customer base?
• Is it a “one and done” product or repeat business?
• How does the business make money?

Management

• Does the business have consistently strong management?
• Is management short or long-term focused?
• How is management compensated?
• Is there a stock options plan? Is it diluting shareholder value?
• Is there a high insider ownership?
• Are insiders buying now?
• Is management honest or cagey on conference calls?

Competition

• Is the business a market leader?
• Is it increasing or decreasing market share?
• How does that increase or decrease affect cash flow?
• Who are the competitors?
• How are the competitors performing?
• How is this business different from its competition?
• Is there a competitive advantage?
• What are the barriers to entry?
• Is there brand loyalty?

Value/Pricing

• What is the intrinsic value?
• Based on what valuation method?
• Is the stock fairly priced? Under priced? Over priced?
• What is the margin of safety?
• Are revenues sustainable? Overstated? Understated?
• Are earnings sustainable? Overstated? Understated?
• Are cash flows sustainable? Overstated? Understated?
• What is the profit margin? Rising or falling over the past 5yrs? 10yrs?
• How is the company leveraged? Over? Under? Fairly?

Growth

• What does the company do with earnings? Reinvest? Acquisitions? Dividends? Buybacks?
• Have past acquisitions been successful?
• What are future growth expectations?
• What is driving growth?
• Is growth sustainable?
• Are there R&D or new product pipelines that could propel growth?

Risks

• What are the possible failures?
• What factors, economic or otherwise, move the stock price positively? Negatively?
• Has the business/stock recently been in the news? Why?
• Any short-term catalysts that affected or could affect the stock price?

Reminder

The idea is to build an investment checklist that helps filter out mistakes, errors, and bad investments. This will increase your odds of success so you don’t lose money. In theory you track what works and what doesn’t. So when you come across an investment that performs better than the rest, you can use that as a filter to weed out the bad seeds later on.

As I said, the checklist works when you have experience to draw from. But if you are new, you’re unfiltered so to speak. Mistakes are part of the process. Investments fail. We lose money. Those mistakes become lessons that prevent future losses.

While you learn from your mistakes, take the time to learn from others too. The best investors are great because they learned from their mistakes. Thanks to their high-profile, the media thrives on covering those mistakes. Take advantage of that information. Do it often enough and you’ll build a working checklist.

As you progress, keep track of what works, what doesn’t, mistakes you’re susceptible to (everyone has them), how you avoided mistakes in the past, and what you learned from every investment. In the end, it all goes toward improving your investment checklist over time. Eventually, you’ll hone it into a solid, successful process.

Building An Investment Checklist is a post from: Novel Investor

©2013 Novel Investor. All Rights Reserved.

Low And Slow

The stock market is built for the overnight sensation. It’s wrought with short-term focus. Markets move by the nano second now. The average holding period for a stock is less than one year. Yet most people are investing for an event like retirement decades down the road.

There are many reasons for this. The internet certainly helped with easier access to your portfolio, the advent of the 401k, an increase in job hopping, the funds (mutual, index, and ETFs), and normal human behavior. That future income security is only a button click from being liquidated at the wrong time. How much of that has influenced and added to this new stock market environment.

Seth Godin covered this perfectly with the importance of low and slow. It’s not easy in this fast paced world. Easily overlooked, certainly, yet it’s become so important. When you invest long-term, it helps to slow down and think long-term. And know how not to react short-term (probably the hardest). Time is a great asset when we use it correctly.

Learning From Buffett

Bill Gates dropped a note on Linked In about what he’s learned from Warren Buffett. It certainly offers a few insights into how Buffett thinks and what the richest man in the world views as important now that he’s running one of the largest and more successful charitable foundations.

To give you an idea, one of the projects his foundation is working on is how to feed 9 billion people several decades from now. When you have a multi-billion dollar war chest, you can look that far into the future. What it also shows us is a glimpse of the potential investment landscape 20 or 30 years from now.

Last Call

• Charlie Munger’s 18 Biases That Cause You to Fool Yourself and Make Bad Decisions – great list.
• Possible versus Probable - understanding the difference is important.
• What You Don’t Know About Your Portfolio May Help You – goes great with low and slow.
• Wishing Upon A Star Manager Doesn’t Work – past performance metrics are just fund sales tactics.
• “Investing Is About Figuring Out What Somebody Is Doing Right And Paying Less” – interview with Joel Greenblatt for the Magic Formula investors.

Cheers

Thanks to Money, Life, & More, Money Soldiers, According to Athena, This That & the MBA, Master the Art of Saving, Reach Financial Independence, and See Debt Run for sharing.

Happy Hour: Low And Slow & Learning From Buffett is a post from: Novel Investor

©2013 Novel Investor. All Rights Reserved.

At the heart of this debate is earnings. Rather, what’s the best use of earnings for the shareholder. When a company earns money, it uses some of it to further grow and strengthen the company. What happens with the rest is up for debate.

The Theory

Speaking theoretically, earnings are used to increase shareholder value. By that I mean, as investors, we want the most efficient use of earnings because it provides the best return on our money. What the company does with earnings becomes very important.

In this theoretical utopia there are three things a company can do with earnings:

• keep it to grow and strengthen the company
• pay a dividend, or
• buyback stock

Between dividends and buybacks, the most efficient way to do this is buybacks. Every time a company repurchases shares, it increases a shareholders ownership percentage. Since ownership is a direct link to earnings, a stock buyback increases our piece of the earnings pie. If buybacks are consistent, that percentage increase in ownership will compound over time.

Say a company with 10 outstanding shares wants to buyback 10% of those shares. So we’re left with 9 shares. If I owned 2 shares or 20% of the company before the buyback, afterward I would still own 2 shares but 22% of the company. Any other buybacks would only increase my ownership.

Dividends, however, aren’t as efficient. Thanks to taxes, we lose value every time the government takes its cut. Worst case, that leaves us with $0.80 for every dollar in dividends. So we lose 2o% of our buying power when reinvesting dividends. We’re left with a lower percent of ownership than if the company had purchased shares for us.

Rarely does theory play out perfectly in the real world.

The Reality

The real world likes to throw curve balls. Management makes mistakes. Shareholders think they know better (sometimes they’re right). Companies hold onto or distribute more earnings than it should. And sometimes the most efficient option is to put any distributions to work somewhere else.

There’s more but it leads to multiple reasons why neither buybacks or dividends are more efficient than other.

Case For Stock Buybacks

• Taxation favors buybacks – no capital gains tax unless shares are sold
• Buybacks increase percent of ownership
• Price matters – buybacks are best when repurchasing undervalued shares
• Management flexibility – not paying dividends provides management with more options
• False belief that the investor can reinvest dividends at a higher return than if the company did it for them
• Buybacks can be cancelled without much love loss

The most overused argument for stock buybacks is the tax treatment. The fact that every $1 in dividends isn’t really a dollar, it’s actually $0.80 to $0.85 after taxes.  (Okay, maybe not always. There are exceptions, if you’re in the lowest two tax brackets or using a tax advantaged account like an IRA or 401k. In other words, it’s the investors job to tax plan not management. In which case taxes are irrelevant.)

The reality is, buybacks are seen as an alternative to spending money or doing nothing. When a higher growth rate can’t be accomplished through other projects and the stock is undervalued, buybacks are the best use of earnings.

Of course, the best argument for buybacks is that investors simply don’t reinvest dividends. And when they do, it’s no more efficient than if the company did it for them.

Case For Dividends

• Immediate tangible results – you see dividend payments in your account
• Sign of confidence in future earnings
• Reinvestment increases share count and ownership
• Shareholder flexibility – dividend reinvestment is just one option
• Price matters – dividends are great when reinvested in undervalued shares
• Harder to measure valuation and impact of buybacks isn’t immediate
• Buybacks can mask employee stock options plan and management’s short-term greed
• Buybacks can be used to manipulate financial ratios
• Big negative for dividend cuts – forces management to keep a watchful eye on spending

The reality is, it’s easy to see the benefits of dividends. The immediate tangible results are a big selling point. The simple idea of getting paid from an investment is what drives many investors. You can’t deny the mental impact it creates. Being able to see consistent quarterly payments in your account offers a regular reassurance that your investments are working. Even if it’s not theoretically perfect or the most efficient it’s hard to argue with the psychology behind it.

The Best Case

Sadly, much of this debate can be chalked up to bad management that make imperfect decisions with earnings. If that’s the argument for one over the other, then why invest in a poorly managed company.

Personally, I prefer whichever gets me the best return for my dollar. Remember, dividends and buybacks are a result of the company earning more than its capable of wisely spending on growth, strengthening itself financially, and increasing its competitive advantage, not the other way around. That means the company is doing well and management is doing its job.

Should the shares be undervalued, by all means buyback stock (I view it as a special dividend with a lower tax bill). But only if it’s the best use of that capital. And I don’t need a dividend to know my investments are working. Again, if the company can reinvest that money at a higher rate than me, by all means keep it.

Sometimes the best argument for those earnings is neither. The key focus should be on acquisitions or projects and R&D for long-term organic growth. With those options exhausted, then the stock buybacks vs dividends debate can begin.

Digging Into The Stock Buybacks Vs Dividends Debate is a post from: Novel Investor

©2013 Novel Investor. All Rights Reserved.

The last time there was an increase in the contribution limit was 2007.  Well, the index was finally high enough to make adjustments to some, but not all the 2012 IRA contribution limits.  Most important was the bump in the maximum contribution.

2013 Maximum IRA Contribution Limits

Starting in 2013, you can add a little more to your retirement savings.  Both the traditional and Roth IRA saw an increase in the maximum contribution amount.  Which will max out at $5,500.  If you are 50 years or older, you can add a $1,000 catch up contribution.

Which IRA is best for you will depend on your MAGI or modified adjusted gross income, whether you meet the income requirements or if a deduction is more helpful.  You can also split the difference and divide the maximum $5,500 between a traditional and Roth IRA if you qualify for both.

2013 Roth IRA Contribution Limits

Not everyone can use a Roth IRA. Actually, the less you make the better, since there is a limit based on your income. That said, the Roth IRA income limits were raised slightly for 2013.

If you only qualify for a partial contribution, we included a breakdown of the Roth IRA partial contribution phaseout by income in the tables at the end of this post. It should be enough to tell you whether a Roth is a good idea for your situation.

Before you contribute to a Roth IRA, check if you qualify for a traditional IRA deduction too.  The extra tax savings might be worth it.

2013 Traditional IRA Deduction Limits

Unlike the Roth IRA, the traditional IRA doesn’t have income limits preventing you from contributing.  Instead, if you meet the income requirements, you can deduct some or all of those contributions.  So you can get extra tax savings now just for adding to your retirement savings.

If your MAGI qualifies as a partial deduction, we included a breakdown of the traditional IRA partial deduction phaseout by income in the tables at the end of this post. It should give you a good idea of a deduction amount come tax time.

Don’t forget, even if you don’t qualify for a deduction, you can still make the maximum contribution allowed for a traditional IRA.

No Retirement Plan Through Work?

If your work doesn’t offer a retirement plan, your traditional IRA deduction limits might be different depending on your situation:

• Single or Head of Household – any MAGI amount can take the full deduction.
• Married, filing jointly or separately with a spouse not covered by a plan at work – any MAGI amount can take the full deduction.
• Married filing jointly with a spouse covered by a plan at work – if your MAGI is up to $178,000, you can take the full deduction.  If your MAGI is more than $178,000 but less than $188,000, you can take a partial deduction.  If your MAGI is $188,000 or more, you can not take a deduction.
• Married filing separately with a spouse covered by a plan at work – If your MAGI is less than $10,000, you can take a partial deduction.  If your MAGI is $10,000 or more, you can not take a deduction.

Get Started

The best way to take advantage of the 2013 IRA contribution limits increase is to get started now. You can set up and open a new IRA in just a few minutes or add to an existing one before the deadline.  Make sure you mark the correct tax year when making your contribution.  Don’t wait till the last minute.

IRA Phase Out Tables

The tables below are for the Roth IRA phase out and Traditional IRA phase out for the single, head of household, and married filing jointly tax filers only. If your MAGI falls in between the income levels shown, you’ll have to do some math to find your exact amount. The tables should give you a good sense of where you stand at tax time.

Roth IRA Partial Contribution Phase Out

Traditional IRA Partial Deduction Phase Out

You can find the full IRS announcement here.

Updated to include phase out tables, originally posted Oct 23,’12.

2013 IRA Contribution Limits Increased is a post from: Novel Investor

©2013 Novel Investor. All Rights Reserved.

Tuesday Streak

The biggest streak to impact returns ended this week. For twenty Tuesdays in a row the Dow closed positive until this week. It seems those positive Tuesdays had a big impact on performance so far this year. The Disciplined Investor has a great chart showing just how much Tuesday’s account for the Dow and S&P 500 this year.

Now, had you only invested for the Tuesday effect, by that I mean buying Monday and selling on Tuesday, you’d still underperform the benchmark. But can anyone complain about a 12% return in 5 months by only investing one day a week.

When Guru’s Attack

When you think of brawls, social media doesn’t come to mind. Yet, Twitter seems to be built for online fighting. With a 140 character limit, you need to make it count. And its fast becoming an annual event. Last year it was Suze Orman, this year…Dave Ramsey.

Ramsey is most known for helping people get out of debt and does it well. It’s his investment claims that get him in trouble. Ramsey likes to throw around 12% returns and an 8% withdrawal rate for retirement planning. Both are higher than any rational CFP would assume.

There’s good reason for it. It’s nearly impossible (this post does a great job showing the flaws).

That post also makes another great point. Ramsey’s 12% claim just one ups everyone else. Its workout video marketing at its best. How do you beat the 30 minute workout video in sales? Release a shorter one.

While all the sane financial planners are showing clients conservative 6% growth numbers, Ramsey’s out there swinging 12% around. Well, 12% gets you noticed even though his math is wrong (which seems to be a constant with him).

People like guarantees. While Ramsey sells people on getting into financial shape, his 12 minute retirement workout almost always fails. Yet, backing off his claims now would impact his sales, certainly his image and credibility, and his network of so-called advisers selling poor investment products. So he’s forced to defend himself by doing what all gurus do best, mudslinging. It’s a tried and true move, attack your opponents and avoid backing your claims at all costs.

All things considered it’s probably the only move in his case. The only way his 12% return and 8% withdrawal rate works is when the money out lives you. Unless the key to your retirement plan involves a premature end, I suggest you get retirement advice from someone more credible.

Last Call

• How Warren Buffett Made His Fortune  - brief history on Buffett and his willingness to adapt.
• Avoiding the Easy Trap of Buying High – hard to do but a great reminder.
• Easy-Money Addiction Could Hurt Performance – with all the concerns out there deflation might be the one of the biggest.
• How Chasing Yield Affects Expected Returns - great summary why high yield isn’t the best choice now.
• Bill Black: How Elite Economic Hucksters Drive America’s Biggest Fraud Epidemics - a look at financial crises from the S&L crisis to today.

Cheers

Thanks to Budgeting in the Fun Stuff, Planting Our Pennies, Happy Homeowner, Master the Art of Saving, and Money Soldiers for sharing.

Happy Hour: Tuesday Streak And When Gurus Attack is a post from: Novel Investor

©2013 Novel Investor. All Rights Reserved.

To confuse things the IRS made several cost basis reporting changes. It revamped stock basis reporting in 2011, followed by changes in mutual fund, ETF and DRIPs (Dividend Reinvestment Plans) in 2012.

Some say it makes the process easier. Which it does. Really, it enforces accuracy so nobody fudges their numbers. Good or bad, the changes force you to make cost basis accounting decisions at the time of sale. This is easy enough when you sell all the shares of a stock.

But it doesn’t always work out that way. Maybe you want to sell half your shares. Then there are reinvested dividends to account for now. And the intricacies of mutual fund shares, reinvested distributions, and return of capital. Or you just want to rebalancing your portfolio. In other words, it’s complicated.

Yet, how you report cost basis directly affects your tax bill. Which is the point of this guide. It’s also a big piece to a tax efficient investment strategy. And that is where you can save money.

Calculating Cost Basis

Basis

When we talk investments (stocks, ETFs, mutual funds etc.), basis is the cost at the time of purchase plus any transaction costs or commissions. There are exceptions like gifts and inheritance, which we’ll cover later.

When you buy 1,000 shares of Ford at $14 and your broker charges you a $10 commission, your cost basis is $14,010 for those shares. That transaction is given a unique  tax lot ID so you and the IRS can track those shares separately from other Ford stock you might buy later.

The process is the same for mutual funds, ETFs, and reinvested dividends.

Capital Gain

Anytime you sell shares for a profit, it’s known as a capital gain. The IRS has two classifications of capital gains:

• Short Term Capital Gain – realized gain from assets sold inside of one year of the purchase date
• Long Term Capital Gain – realized gain from assets sold one year or beyond the purchase date

This is important. The tax rate for each capital gain is different and there are rules on how each gain is offset by a capital loss.

Capital Loss

Anytime you sell shares for a loss, it’s known as a capital loss. Again, the IRS has two classifications of capital losses:

• Short Term Capital Loss – realized loss from assets sold inside of one year of the purchase date
• Long Term Capital Loss – realized loss from assets sold one year or beyond the purchase date

A capital loss offsets a capital gain or your income which lowers your tax burden. The IRS has rules in place on what gets first priority.

The rule of thumb is – capital losses first offset gains of the same type, then gains of the other type, and lastly, your income.

So, if you have a big short-term capital loss, it will first offset any short-term gains. Anything left, will offset any long-term capital gains. The rest will offset other income up to $3,000 per year. Any loss beyond that is rolled forward to future years.

Carryover Loss

When a loss exceeds the $3,000 deduction limit, it can be carried over to future tax years. The same rule of thumb applies for carryover losses. It offsets capital gains first, then income, and the rest is carryover for the next tax year until there is no loss left.

Say you sell several stocks for a net $4,000 capital loss this year. You can write off $3,000 of that loss against your income for the current tax year. Then you can use the remaining $1,000 loss to offset any capital gains or income next year.

Cost Basis Method

None of this matters if you use the wrong cost basis method. You remember the lot ID mentioned earlier? When you sell shares, you need to decide which lot ID those shares correspond too. If, like the Ford example earlier, you only bought 1,000 shares of Ford, there is only one lot ID to choose.

But what if you bought 1,000 shares of Ford, three separate times, each at a different share price. Now choosing a lot ID is important. To do this, you’ll need to specify one of these cost basis methods at the time of sale:

• Average Cost – an average of the total purchase cost divided by the total shares held. This is only available for funds.
• LIFO - or Last In, First Out sells shares in the most recent lot ID first.
• FIFO - or First In, First Out sells shares in the oldest lot ID first.
• Highest Cost – sells shares in the lot ID with the highest cost basis.
• Lowest Cost – sells shares in the lot ID with the lowest cost basis.
• Specific Lot – sells shares in the lot ID of your choice.

Every broker and fund company sets a default basis method. If you’re not sure which one is used, contact your broker and find out. Their default method makes tracking your gains and losses easier for them. It is not setup to give you the best tax results.

When you sell all the shares of a stock, you have the full capital gain or loss. But when you only sell some of your shares, you can pick those with the basis and holding period that gives you the best tax results.

By the way, there isn’t a right cost basis method per se. It all depends on your existing capital gain/loss, how a lot ID sale changes that capital gain/loss, the potential for future capital gain/loss on remaining unsold shares, and your tax rate.

I always use the specific lot method because it offers flexibility. In the end you need to weigh the trade-off between your current tax bill and possible future taxes.

To do this, you’ll need to keep track of everything. Now, I know that brokers and fund companies do it for you. It’s always a good idea to have your own records. So, to get you started, we included a free cost basis spreadsheet template at the bottom of this post. Plus, if you ever switch brokers, inherit stock, or just need to double-check, you’ll have the records.

Stock Cost Basis

You calculate the cost basis for stock you’ve purchased by taking the cost of the shares plus the commission your broker charges. Lets use the Ford example from earlier: 1,000 shares at $14/share with a $10 commission. Your cost basis is $14,010, per share it’s $14.01.

What if you sell those 1,000 share of Ford for $12? Your broker charges another $10 commission for the sale and your proceeds are $11,990. Don’t forget to subtract the commission from the sale. You get a capital loss of $2,020 ($14,010 cost basis – $11,990 sale).

Stock Splits

If a company declares a stock split, the cost basis of your old shares is evenly split between the old and new shares. Say, you own 1,000 shares with a cost basis of $20/share ($20,000 basis). The company does a two for one stock split. Now, that $20,000 basis is split between 2,000 shares with a $10/share basis.

ETF Cost Basis

When calculating cost basis for ETFs, just use the same process we went through for stocks. Thanks to the low costs of ETFs, it’s easy to see someone owning the same ETF for years, regularly buying new shares each month and reinvesting dividends. Not unlike a mutual fund.

Every one of those events is a new lot ID to track with a different holding period and basis. Do that over several years and there is your excuse to have accurate records for tax purposes.

Cost Basis For Reinvested Dividends

The basis calculation for reinvested dividends is the same as those used for ETFs and stocks. But is easily overlooked with DRIPs. Dividend Reinvestment Plans automatically buy shares when dividends are paid out. It’s no different from having the dividends paid in cash, then you immediately turn around and buy new shares. So you get a new lot ID for each reinvestment.

Over several years, the number of shares can quickly add up. So will the number of lot IDs to choose from when you finally start selling shares. This is why tracking everything is important.

Cost Basis For Mutual Funds

Mutual funds have been very popular over the past two decades. They usually come in two forms: load and no load mutual funds.

You calculate cost basis for mutual funds the same as stocks: purchase price plus transaction cost or commission. Purchase price will be the net asset value (NAV) on the day shares were purchased.

A mutual fund with a 5% load, would have a cost basis of NAV plus a 5% commission. So 100 shares bought at an NAV of $10/share ($1,000 + 5%($1,000)) would have a $1,050 cost basis with a basis of $10.50/share.

The average cost method is one method allowed by the IRS when you sell mutual fund shares. You figure out average cost by adding up all the money invested into the fund, including reinvested dividends and divide by the number of shares you own. Then you assume the sold shares are a long-term capital gain/loss.

It’s the easiest method to use for long-held funds, but it probably won’t offer the best tax savings. Once you choose the average cost method, the rest of the shares in that fund must use it too.  It’s worth weighing before you lock shares into the average cost method.

Cost Basis Of Inherited Stock

When you inherit stock your cost basis is calculated based on the date of the previous owners death. Even if the previous owner bought those shares years or decades ago at a lower cost basis, you won’t get hit by the tax burden. Instead your cost basis is updated to a current valuation.

For stock, your cost basis per share is the share price on the date of death. It’s the same for ETFs, mutual funds, and any asset where basis plays a role in taxes.

The one exception is if the estate of the previous owner was subject to estate tax. In that case, an alternative valuation date six months after the previous owners death can be used by the executor to value the shares. The executor decides on the date used to calculate basis.

Cost Basis Of Gifted Stock

Unfortunately, gifts don’t get the same privileges as an inheritance. When a family or friend is generous enough to gift you shares of a stock or fund, your basis stays the same as when it was purchased.

There is one exception. When you sell those shares for a loss, the basis is the lesser of – the previous owner’s basis or the value when you received the shares. You can’t benefit from the previous owner’s cost basis.

If you do get a gift, make sure you find out all the cost basis information from the previous owner and the value on the day you received them.

Find Old Cost Basis Information

When you inherit or receive stock as a gift, the last thing anyone thinks about is the original cost basis. Or maybe it was overlooked when you switched brokers years ago. Either way, its information you’ll need when you sell the stock.

When dealing with stocks, this process gets difficult the further back you go. Capital changes, things like spinoffs, stock splits, or issued dividend shares, become more likely. It can make a big difference on the original cost basis.

This can be difficult if you don’t know the date it was bought. In which case, you can ask the prior owner or their old broker for past transaction statements.

But if you do know the date, you can use historical stock quotes to find the information. Just take the average of the high and low price on the date in question. Yahoo Finance is a good place to start and adjusts all historical prices for stock dividends and splits.

Return Of Capital

You might run into a few special situations where you have to adjust basis. Return of capital is the most common found. I’ve covered it with REIT tax rules, but you see it with mutual funds and MLPs too.

When a fund, REIT, or MLP sells an asset, it can reinvest the money or pay it out to shareholders. If the money is paid out to shareholders as a return of capital. It’s not taxed as ordinary income. Instead, it lowers or adjusts the cost basis of the shares by the amount paid out. Eventually the adjusted basis will be taxed as a capital gain when you sell the shares. Unless, the share price drops and it becomes a capital loss.

Say you have 1,000 shares with a $20/share cost basis. You get a 1099-DIV showing a $2/share return on capital. Your new cost basis for the those shares become $18 ($20 -$2). It’s fairly simple but gets complicated the more lot IDs you track and have to adjust.

Cost Basis Spreadsheet

The best way to track your cost basis is with a simple spreadsheet. It’s an easy way to know exactly where you stand before any transaction and throughout the year. When it’s time to finally do your taxes, it makes calculating cost basis that much easier.

You can download our free cost basis spreadsheet template below.

 It’s available in Excel and Google Docs:

• Excel Cost Basis Spreadsheet
• Google Docs Cost Basis Spreadsheet

If you choose the Google Docs version, you’ll need to make a copy. Just go to File and select Make A Copy like in the image below.

That will copy the spreadsheet to your Google Drive folder and label it ”Copy of Cost Basis Spreadsheet Template”. Feel free to make changes, improve it, and share it.

Review

Every time you buy a stock or fund you start a paper trail that will directly impact your future taxes. But when it comes time to sell those shares, calculating cost basis and good records will decide your tax burden. The hard part is deciding which lot ID to sell.

Of course, the work around to all this is just keep good records going forward. The better discount brokers, like TD Ameritrade, let you download your transaction statements complete with all your cost basis information. Keeping your own separate records is a good idea too.

If your records are accurate and up to date, you only have to choose those shares with the basis and holding period that give you the best tax results now and in the future.

Guide To Calculating Cost Basis For Tax Savings is a post from: Novel Investor

©2013 Novel Investor. All Rights Reserved.

Buying on Margin

Margin trading is a great way to boost profits, it’s also the only way to lose more than 100% of your investment. Buying on margin is using credit to buy securities with the hopes of increasing your profits. The downside is the potential to lose everything and still owe your broker for interest and other fees.

When it comes time to pay, it’s not like a credit card where you send in a minimum payment. With a margin account, if you’re too far in the red, the broker doesn’t need your approval to sell your securities to cover the difference. Your just out of luck and money, wishing you never opened a margin account.

Avoiding Taxes

Nobody likes paying taxes. As a whole you should try to pay as little in taxes as possible. There are a couple of ways of looking at this. The first being the old money in a mattress view. That you’re purposely avoiding any investment or savings account that pays an interest or dividend so you don’t have higher taxes. If that’s the case you should get your head examined.

The other side is purposely not selling a security for a profit to avoid paying taxes. This is more a problem of a glass half empty view on things. Look on the bright side, you made money, put a portion aside to cover taxes, and reinvest the rest. You risk too many things by avoiding the sale. Losing any profit you had, and tax code changes to name a few.

Market Orders

Market orders may not seem that bad. Imagine if the grocery store was set up like the stock market. Would you use a market order with food prices changing by the second?  Would you buy your food at the next available price or would want to set some limits?

That’s why limit orders are the best. You specify the exact price you’re willing to pay and the limit order protects you from big price swings. If your price isn’t hit you can reevaluate your price point or the investment’s value. The bottom line, investing requires discipline and limit orders push that objective.

Gambling

Call it chasing returns, looking for a sure thing, or just greed, if you want to gamble with your money go to Vegas. You’re sure to have a great time doing it, may even have your room comped, but the odds are against you as far as making money.

Investments should be made after thorough research. If you somehow need excitement to keep you interested, that’s okay. Use a small portion of your portfolio, no more than five or ten percent, as a trading account. Research a few speculative positions and pick a few you think will pay off. If it doesn’t pan out the losses are just a small part of your portfolio. Of course, the better option is let your investments stay investments and keep the gambling at the casinos.

Impatience

Impatience is costly. Your portfolio isn’t growing fast enough so you make changes. That stock you bought isn’t rising in value so you sell it. You start second guessing yourself and you move your money into something else.

How costly is impatience? Go back and look over your transactions in the past couple years. How often you make changes to your portfolio? How often did you buy something only to turn around and sell it a few weeks later? Where is the price now, if you had held onto it? Most importantly, how much did you pay for every transaction? Those trade commissions add up and eat away at your profits.

We’re too used to the immediacy of things and it tends to cross over into investing. That’s why it’s good to take a step back, watch from a distance, and see how things play out. When it comes to your investments, bad habits can be harmful to your money. Catching them early will go a long way toward reaching your financial goals.

5 Bad Investing Habits To Avoid is a post from: Novel Investor

©2013 Novel Investor. All Rights Reserved.