Lesson 02: Investment Decision: Taxes, Market timing, and Short-Term Vehicles

“It’s not what you make, it’s what you keep that is important.”

Tax planning involves:

1) The desired profit/return after taxes.

2) Type of income received from investments

3) Timing of profit-taking and loss recognition

Short term investment also has the basics taxing like wages you earn
1) Federal: tax rates from 10% to 35%
2) State taxes

Types of Income for Individuals
1) Active Income: income from working (wages, salaries, pensions)

2)Portfolio Income: income from investments (interest, dividends, capital gains)

3) Passive Income: income from special investments (rents from real estate, royalties, limited partnerships)

Ordinary Income includes Active, portfolio and passive income. Taxed at progressive tax rates (rates go up as income goes up)

Tax bracket 2011

Marginal Tax Rate	Single	Jointly
10%	$0 – $8,350	$0 – $16,700
15%	$8,351– $33,950	$16,701 – $67,900
25%	$33,951 – $82,250	$67,901 – $137,050
28%	$82,251 – $171,550	$137,051 – $208,850
33%	$171,551 – $372,950	$208,851 – $372,950
35%	$372,951+	$372,951+

Capital Gain: amount by which the proceeds from the sale of a capital asset are more than its original purchase price

Capital Loss: amount by which the proceeds from the sale of a capital asset are less than its original purchase price

Taxation of Capital Gains

–        Capital assets held less than one year: ordinary income tax rates

–        Capital assets held more than one year: 15%
(or 5 %)

Taxation of Capital Losses

–        Capital losses can be used to offset capital gains

–        Up to $3,000 per year of capital losses can be used to offset ordinary income (such as wages)

Market Timing: process of identifying the current state of the economy/market and assessing the likelihood of its continuing on its present course

•         Three Conditions of the U.S. Economy

–        Recovery or expansion

•         Corporate profits are up, which helps stock prices

•         Growth-oriented and speculative stocks do well

–        Decline or recession

•         Values and returns on common stocks tend to fall

–        Change in the general direction of the economy’s movement

Figure 1.2  Different Stages of an Economic/Market Cycle

Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

1) Interest rates are the single most important variable in determining returns to investors for bonds and fixed-income securities.

2) Interest rates and bond prices move in opposite directions:

–        When interest rates go up, bond prices go down

–        When interest rates go down, bond prices go up

The Role of Short-Term Investment

•     Liquidity: the ability of an investment to be converted into cash quickly and with little or no lossin value

•    Primary use is for emergency cash reserve or to save for a specific short-term financial goal

Short-Term Vehicles

• Advantages: High liquidity and Low risks of default

• Disadvantages: Low levels of return and Loss of potential purchasing power from inflation

Next -> Lesson 3

Referance:

1) Gitman, Joehnk; Fundamentals Investing 10th Edition; 2008