4 Lessons I Didn't Learn From a Certified Financial Planner

AND NEITHER WILL YOU.

What can a Certified Financial Planner do for you that you can't do yourself?

A Certified Financial Planner will help you invest your money in such a way so as to minimize the risk of you losing your money, while at the same time helping you grow your money so that it doesn't lose value as a result of inflation.  

Because stocks, bonds, real estate and commodities (which are referred to as asset classes) don't all go up in value or down in value at the same time,  a Certified Financial Planner will help you invest your money across all these asset classes.

The idea is that even if one asset class goes down, others will maintain their value or increase in value.

As a result, your investment account will remain on the plus side overall.

For managing your investment account or providing investment advice, a Certified Financial Planner will charge you either a flat fee, a percentage of assets under management, or earn money directly from the commissions on the stocks and bonds he or she invests your money in.

What a Certified Financial Planner can't do

Every once in a way, comes a system shock that a Certified Financial Planner won't be able to protect you from. The stock and real estate bubbles of the last decade are an example.

When a big system shock happens, and it has happened several times through history (you should read about the South Sea bubble and Tulip Mania when you have the time), the value of most or all capital assets will plunge.

Most will recover over time.  How long a period of time will depend on the magnitude and length of the run-up.

But some investments will go to $0.

These will include companies that were a good idea on paper but had no revenue. Like the many dot.bombs of the turn of the century.

But they could also include solid companies which made the wrong decisions at the wrong time and couldn't extricate themselves successfully. 

Lehman Brothers is a classic example.  A Wall Street stalwart, it nevertheless collapsed in the CDO debacle of this decade and its stock became worthless in 2008.  Ouch!

So what's an investor to do?

Ask about Index Funds  -- which are baskets of stocks or bonds. They offer far more safety than individual stocks and bonds.

While Index Funds do not protect you from market risk or macroeconomic risk, they will protect you from individual stock risk. Your money cannot go to $0 as in the Lehman example above.

Not surprisingly, professional investors like Warren Buffett of Berkshire Hathaway and Jack Bogle of the investment management company Vanguard advise investors who don't have time to pay attention to their investments to stick with Index Funds.

Most of us fall in this category.

But back to sharing with you the 4 lessons I didn't learn from a Certified Financial Planner.

These lessons are intended to save you from some of the mistakes I made as a new immigrant to the US. 

The information will also apply to anyone who is just out of college and starting their financial life.

Feel free to pass it on to whoever you think might benefit from it.

Members of community associations like Kannada Koota of Northern California, Northern California Mangalorean Association and other such community associations come to mind. New immigrants to the Bay Area might be expected to join these associations.

Moving on to Lesson No.1 that I didn't learn from a Certified Financial Planner...

Fill your W4 incorrectly and it could be a ticking time bomb

When you go to work for a company, the payroll  department gives you a form to fill called a W4.

The W4  is published by the IRS and it is used to determine how much federal and state tax should be taken out of your fortnightly or monthly paycheck.

If you fill this incorrectly, it will explode on you come tax time.

How so?

Simply, you may put too many deductions on it for your income, your tax bracket and your tax status.

If you do that, the payroll department will deduct less tax from your paycheck than required.

And you will underpay your taxes throughout the year.

Then when April 15 rolls around, your tax return will indicate you owe the IRS a chunk of money - with penalties. Ouch.

It happened to me.

In my fresh-off-the-plane-from-India days, I found myself owing $4000 to the IRS at tax-time because of an improperly filled W4.

So how does one go about understanding how to fill the W4 correctly?

I would advise you to spend some time understanding the tax code through J K Lasser's books or Fairmark.com.

You can also ask someone you trust.

But one way or another, get your W4 right.....to avoid any nasty surprises come April 15.

On to Lesson No. 2  learned through the school of hard knocks rather than from a Certified Financial Planner...

When you owe back-taxes to the IRS, the IRS installment plan may not be the smartest decision

If you have no liquid cash, your first instinct might be to use the IRS installment plan to pay your back taxes.

This may not be the smartest decision.

Because the IRS will charge you interest on the unpaid taxes.

Whereas if you can open a 0% APR credit card, you can pay off the IRS balance effectively avoiding these interest charges.

So if you are good with managing credit, check your mail for 0% credit card offers if you are ever in the situation of owing the IRS and don't have the cash to pay it off.

On to Lesson No 3....

"No Credit" is worse than "Bad Credit"

This was a real shocker for me.

Here I was, paying everything with cash or a debit card in my first couple of years in the US and feeling quite superior as a result of it - only to pay the price of being declined by every single company for an auto loan when I needed to buy a car.

Here's why.

Companies that provide auto loans need to run a credit check to approve you for an auto loan.

Since I hadn't made purchases of any kind with credit and in fact, didn't possess a credit card, I had no credit history for them to go on.

And so I was DECLINED. With a capital D.

I can't tell you how mad that made me.

Especially when the memory was still warm in my mind of being  back in India and being invited by Diners Club to take out one of their credit cards -which, in those days had the exclusivity of  receiving an invitation for the American Express Black.

Anyhow, long story short, I had to take out a secured credit card for a year to build up a credit history.

And then only did I become eligible for an unsecured credit card and for the car loan.

A humiliating, but educative experience.

Bottomline - "No Credit" is worse than "Bad credit".

So build up your credit history without delay.  Make some purchases on credit.

Then you won't be denied an auto loan or a housing loan - when you need it.

And my final lesson for you today is....

Watch out for taxes on "phantom income" with ESPP sales

Yes, strange as it sounds, this can happen with ESPP sales.

You could buy shares under your company's Employee Stock Purchase Plan and sell the shares for a loss. 

And then have to pay taxes on the "phantom income" generated by the sale.

Ouch. How could that be?

Your company would have granted you the shares at a discount to market price.  A 15% discount is typical.

It is this 15%  discount that becomes taxable if you sell the shares before 2 years have elapsed.

Like your salary, bonus and time-off which are all considered part of your income, so too the espp discount.

Keep this in mind when you make an ESPP sale.

So you are not taken aback by the "phantom income" from the discount that shows up on your W2. Like I was the first time it happened.

Note - you will need to separately report the loss on Schedule D of your tax return based on the 1099-B you receive from the broker who executed the sale.

Sounds confusing? Don't worry - there's a wealth of information available online on ESPP sales.

Visit Fairmark.com, Investopedia, Motley Fool, Turbo Tax or your broker's website and you will find this information.

These are 4 money lessons I learned the hard way.

But hopefully you will never have to.

Especially if you have a good memory for what you read and hear like my friend Sharon does.

Wishing you a Happy and Successful 2011.

Lower Your Tax & Tax Filing Expense - 4 easy ways I do this each year

1. I use Turbo Tax to file my taxes instead of a tax preparer like H & R Block or Liberty Tax Service or Jackson Hewitt.  I estimate that I have saved $150 per year since 2004 by doing my taxes myself instead of using a tax service.  Indeed, I wish I had learned to do my taxes and switched to Turbo Tax earlier. Since learning how to do my taxes myself, I have taught 5 friends to do their taxes themselves with Turbo Tax and I should be able to teach you as well.  Or I can point you to places where you can learn.  In the meantime, here's the guidance on who should consider using Turbo Tax:

*If you are a salaried person with a fixed income,or indeed anyone with a fixed income and you usually take the standard deduction instead of itemizing (I will explain this in a future post for those who need the information if I get any requests), you should definitely go with e-filing your taxes. If your income falls within $57,000 a year, you may in fact be able to file your taxes for free on the IRS website itself- check out if you are eligible.  If you are not eligible to file for free, you should still definitely go with using Turbo Tax (which I use) or Tax Act.  I use the online version of Turbo Tax, but you can also pick up the boxed software version from Costco or any bookstore like Barnes & Nobles or Borders.  

*If you are a salaried person with stock investments and espp and option sales but with no deductions to itemize, then you should still go with using Turbo Tax.  I fall into this category.  There have been some unusual years when I had to report a Traditional to Roth conversion and when I had to report contributions to an HSA account (which is a tax-sheltered account for medical expenses which can be opened in conjunction with a IRS approved high-deductible HSA health plan), but I was able to input these into Turbo Tax without any heartburn.

*If you itemize, you should still visit the Turbo Tax website and explore the different versions.  There are 5 versions in all - Free, Deluxe, Premier, Home & Business and Business and you can try any of them for free.  You only pay when you actually file.  Isn't that cool?  In fact, I have a friend who runs her own business and uses a tax preparer but models her taxes in Turbo Tax every year before going to the tax preparer, which I thought was pretty smart.

I find it so convenient to use Turbo Tax for several reasons.  For one thing, page by page you are guided by questions so  you do not miss any income, any deductions, any exemptions and any credits. Also, as you enter the information, your tax refund (positive or negative) updates in real time in the top right hand corner. Also, the program advises you on how you might be able to lower your taxes by taking advantage of tax sheltered accounts, lets you know if you are at risk of  incurring the dreaded AMT or Alternative Minimum Tax and tells you where you fall statistically among the nation's tax payers.  You can file both your federal and your state taxes on Turbo Tax.  I understand all the tax preparers now have an online DIY version in the style of Turbo Tax but I have not explored or used them and I would be interested to know how they compare with Turbo Tax.

Moving on to other ways to lower your tax every year following my lead:

2.   I do some tax-loss selling every year.  As I said, some of my savings are in stocks.  Besides investing in mutual funds through tax-sheltered accounts such as a 401K, IRA, HSA and 529 (which I hope you are familiar with and contribute to), I have been investing directly in stocks since late 2003.  No one wants a stock to turn out to be a dud, but when a stock does turn out to be a lemon (and they frequently do) and loses a significant amount of value and has no hope of recovery soon, you can sell the stock and take a loss.  As blue as taking a loss might make you feel, there is a silver lining to this cloud - you are allowed to offset the loss against gains from sales of stock that you made in the year and even against your regular income.  You are allowed to offset up to $3000 a year.  I have taken advantage of this in some years.  If you want to learn more about Tax-Loss Selling,  this Investopedia  link provides you with more information.  Investopedia  is a veritable encyclopedia for investment information.  If you like your information in a fun, entertaining and easy to read way, then you can also check out Motley Fool  on which you can find all kinds of information related to stock investments and individual stocks written in layman's language.

Moving on...

3. I invest in mutual funds only in tax-sheltered accounts.  The reason I do this is because mutual funds have something known as a capital gains distribution.  You can find the definition by clicking on this Investopedia link.  When I was new to mutual funds investing, discovering that you could incur a taxable capital gains distribution even on a fund that had lost value was one of the nasty surprises.  There are all sorts of mutual funds and not all of them will have taxable capital gains distributions, but I decided to make my life simpler by investing in mutual funds only in tax-sheltered accounts such as 401Ks, IRAs, 529s and HSAs.

4. Lastly I try to manage my IRS tax withholding, so that there are no big shocks come tax time. For this you have to learn how to correctly fill the W4 that you submit to your company's payroll manager.  The IRS website offers information on this and has a handy W4 calculator, but the general rule is that the fewer deductions you put on the W4, for instance if you put 0 or 1, then the more tax is withheld from your paycheck. And conversely, the more deductions you put, for instance if you put 6 or 7 or 12, then much less tax is withheld from your paycheck.  It is not a good idea to have less tax withheld from your paycheck than you owe, because you will owe this plus penalties to the IRS when tax time comes around.  If you have too much tax withheld on the other hand, then it amounts to you giving the IRS an interest-free loan - which of course you will get back as a refund at tax-time.  After experiencing the first situation - where I owed a huge chunk of money, I prefer to err in favor of giving the IRS a tax-free loan and getting back a refund, so that's been the way to go for me.

Hope you enjoyed this article - check back for more articles like this - with actionable ideas for your job, money, investments, health and peace of mind