Archives for January 2017

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Should I Prepare My Own Tax Return?

A reader writes in, asking:

“This is my first time having to file a tax return since getting a ‘real job’ and my head is spinning. Should I hire a CPA to do my taxes or is it better to use software for it myself? I’ve read that Turbotax guarantees the highest refund possible. Is it really better than hiring a CPA?”

Without a doubt, using a tax professional is the most reliable way to get the lowest tax bill. A key point here is that tax professionals use tax preparation software too, so using such software yourself does not provide you with any advantage over a professional.

That said, there are valid reasons for taking a DIY approach. Most obviously, you save on fees. Buying a download of TurboTax or other similar software certainly costs less than hiring a professional.

More importantly in my opinion though is that by preparing your own return for the first time, you’ll learn quite a bit about how income taxes work.

In my work, I frequently come across people who have been paying income taxes for decades, yet they don’t understand even the most basic income tax concepts (e.g., they misunderstand how tax brackets work, or they don’t know the difference between a deduction and a credit). Every year, they simply turn over all of their documents to somebody else who prepares their return, and so they go years without learning these things. Naturally, it’s impossible to make very good decisions about tax planning when you don’t understand the fundamental concepts.

In addition to allowing you to make smarter financial decisions, having a better understanding of income taxes allows you to be a more well-informed voter. It’s very common for politicians to propose various changes to our tax code (e.g., creating a new deduction or credit, or eliminating/changing an existing deduction or credit). If you don’t understand how the system works now, you can’t really understand the impact of proposed changes.

My point here isn’t that everybody should be preparing their own tax returns. It depends on your goals, and it depends on how complicated your return is. (If you’re already at the point where you have investments in taxable accounts, you itemize your deductions, and you have income from a rental property, then it’s going to be quite a challenge to prepare your own tax return if you’ve never prepared a return before.)

In summary, if you want to learn more about income taxes, you want to save on tax prep fees, and/or your return isn’t too complicated, those are all points in favor of preparing your own return. But it’s unlikely that your tax bill will be lower as a result of taking a DIY approach rather than hiring a professional. In most cases, the outcome that you’re hoping for with a DIY approach is that your return will turn out exactly the same as it would have if a professional had prepared it.


For More Information, See My Related Book:


Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions, exemptions, and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

A testimonial from a reader on Amazon:

"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"

Investing Blog Roundup: A Two-Dimensional Assessment of Risk Tolerance

When it comes to assessing how much risk you can handle with your portfolio, there are two things to consider: how much risk you can handle mentally, and how much risk you can handle financially. Many financial institutions attempt to provide one combined measurement of the two to get a sense of your overall risk tolerance. This week, Michael Kitces makes the case for assessing the two things separately, and allowing whichever aspect of risk tolerance is lower to control the decision:

Investing Articles

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Diversification Isn’t (Necessarily) Necessary for Fixed Income

A reader writes in, asking:

“What are your thoughts on bond diversification? Is it ok to just do something simple like a treasury bond ladder or is it necessary to diversify bonds like you do with stocks?”

No, I really don’t think that diversification is necessary for the bond portion of an investment portfolio.

Several years ago, prior to switching to a LifeStrategy fund, the bond portion of my portfolio included nothing but Treasury bonds (via a single bond fund). And that didn’t bother me at all.

The goal for the bond part of my portfolio was (and still is, for the most part) simply to act as something that is unlikely to go down (by much) during a stock market downturn. CDs or Treasury bonds (regardless of whether or not they’re held in a mutual fund, and provided they aren’t long-term bonds) achieve that goal very well without any need for additional fixed income holdings.

When Diversification *Is* Necessary for Fixed Income

Just to be clear on this point, when it comes to fixed-income investments other than FDIC-insured CDs and Treasury bonds, diversification is important. That is, if you’re putting a significant part of your portfolio into muni bonds, corporate bonds, or international bonds, yes, you definitely want to diversify those holdings.

Diversification Isn’t a Bad Idea

For many investors though, the goal of their bond holdings isn’t only to act as “something safe.” They also hope to achieve some degree of “free lunch” via diversification. The general thought process is that if something has a low enough correlation to the rest of your portfolio while providing an acceptable return, adding it to the portfolio can result in reduced risk without a correspondingly large reduction in return.

This is the argument, for instance, that Vanguard makes in favor of international bonds in their funds-of-funds.

That’s a thoroughly reasonable line of thinking. And if things go according to plan (i.e., correlations and returns behave the way you hope they will) it will improve your results.

However, it isn’t necessary. And it’s not entirely obvious that it’s a clear improvement over an all-CD or all-Treasuries fixed income portfolio, because:

  • CDs offer their own sort of free lunch sometimes, if you can find longer-term CDs (that have relatively high yields due to the long term) with low penalties for early redemption, and
  • Corporate bonds (i.e., the most likely candidate for adding to an otherwise-Treasury bond portfolio as a diversifier) often have higher correlation to stocks than Treasury bonds do, so it’s not a sure bet that they will have the desired result.

Investing Blog Roundup: T-Shares for Mutual Funds

In recent decades, investors have been putting considerable pressure on mutual fund companies to lower their costs. Morningstar’s John Rekenthaler argues that the same thing is beginning to happen with the cost of advisory services. The new “T” share class for advisor-sold mutual funds is one example of such pressures.

Investing Articles

Other Money-Related Articles

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The (un)Importance of Social Security Full Retirement Age

A reader writes in, asking:

“I read over and over that it’s ideal to wait until 70 to file for social security but that it’s important to wait until at least full retirement age. But what is special about full retirement age exactly? Am I wrong in thinking that it is not much better or worse than a year earlier or later?”

No, you are not wrong.

In terms of general Social Security rules, full retirement age is important because:

  • It’s the reference point around which your benefit is calculated (with a reduction for filing early and a bonus for filing later),
  • It’s the earliest date at which you can suspend benefits (though that’s much less frequently relevant these days after the changes made in 2015), and
  • It’s the point at which the earnings test is no longer applicable.

And full retirement age is often the best age at which to file for spousal or survivor benefits because:

  • It’s the point at which survivor benefits and spousal benefits stop growing (i.e., there’s no increase for waiting until 70), and
  • It’s the earliest date at which you can file a restricted application for spousal benefits (i.e., an application for just spousal benefits) for those who are still eligible to do so (i.e., anybody who was at least 62 years old as of 1/1/2016).

But, from the perspective of when to start receiving your own retirement benefits, full retirement age is nothing special. It’s just one of 96 possible months at which you can start taking benefits.

And in fact, of those 96 months, the first one and the last one (62 and 70) come up much more frequently than other months as the optimal time to start benefits.

If you could claim at any age (i.e., with delayed retirement credits earned for delaying beyond age 70 and with early claiming available prior to 62 — with an accompanying penalty), people in particularly good health would often want to wait well past age 70. And people in very poor health would often want to claim very early — perhaps in their 50s even.

But those aren’t options. So everybody who would be best served by claiming prior to 62 (if such were an option) will find “claim at 62” to be the best strategy. And everybody who would be best served by claiming later than 70 (if such were an option) will find “claim at 70” to be the best strategy.

In other words, yes, it is very uncommon that full retirement age happens to be the best answer for when to start receiving retirement benefits. (And for both spouses to start receiving retirement benefits at full retirement age is almost surely a mistake. In most cases, that would be a dominated strategy.)

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: Opening, Middle Game and Endgame of Retirement Planning

Retirement can last quite a long time. And, as Dirk Cotton points out this week, the risks facing you and strategies available to you are different from one stage of retirement to another. And it would be wise to explicitly account for such changes when crafting a retirement plan.

Investing Articles

Other Money-Related Articles

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