March 26, 2013

Household Spending Breakdown

Credit: jannoon028
One of the things I sometimes ask clients for is a breakdown of their living expenses for several months. Just like a tax return, you can actually tell a lot about someone based on their living expenses. Think about it - if someone had a few minutes with your checkbook or credit card statement, don’t you think they could develop a decent theory about your current income, paint a rough picture of how you typically spend your money, and maybe even infer a few things about your personality? Scary to think about, huh? (Don’t worry; I treat all client information with the highest degree of confidentiality.) Anyway, back to living expenses…

I usually ask clients for a breakdown of their living expenses for one of a few common reasons. Maybe I’m trying to figure out if they can retire, or why they’re finding it difficult to hit their saving goals. Perhaps they have a consistently negative cash flow (they are spending more than they are taking in) that is threatening their financial independence, or, sometimes, they simply have no idea where all their money is actually going. I don’t judge anyone’s expenses as I wouldn’t want anyone to judge mine, but it really can be eye-opening. I’ve had clients go through this exercise and realize they can retire if they pay off their mortgage and get rid of that fixed monthly expense, I’ve had clients realize to their horror they are spending more than five digits in a year at a particular discount retailer, and I’ve even had clients who appeared to actually spend more on drink than food. It’s their money, and I would never attempt to tell anyone how to spend their hard-earned money, but I’ve seen many people right before my very eyes become truly enlightened after we have taken the time to break down their household spending.

Rewind to the 2012 holiday season - sometime between Thanksgiving and Christmas: I harassed my very selective, very thrifty, and always-conscientiously-saving wife about how many “bargains” she acquired in a relatively short period of time. It wasn’t an accusation, and it didn’t lead to a “domestic difference of opinion,” but it did help motivate me to take the time to perform the very same analysis on our living expenses that I've done for so many others. I would later find out that I was dead wrong about my wife's spending and the magnitude of our joint discretionary spending relative to our living expenses. As a CPA and CFP, I didn’t even know my own household spending breakdown as well as I thought I did! As a friend of mine in college often used to say, “How embarrassing!”
I won’t bore you with all the details of the Presley Household Spending Breakdown, but I will share with you a few observations:
  • Gas and automotive expenses are considerable. When I was a kid, I remember when gas was $.79 a gallon… I must be getting old.
  • The costs of going out to eat can add up. I think I’ll ask my wife for a few more homemade dishes and cook a little more myself going forward. It’s probably healthier, too!
  • University of Georgia football expenses for tickets and tailgating should not be a separate category from discretionary (optional) spending. Anyone who knows me at all knows I’m a loyal alumni and a huge fan, but I realized that I was actually viewing UGA expenses separately from our discretionary spending, like a normal person would view utility bills. I bet I’m not alone in this twisted logic, as trying to convince some people I know that golfing, hunting, tennis, and seasonal clothes shopping are not required would be a “tough row to hoe.” I’m still trying to convince myself that I really don’t have to go to every home game, but it’s still a work in progress.
  • As many of you have probably picked up on from reading my other posts, I’m not a big advocate of debt. My wife and I work really hard and save really hard to try to put additional principal towards our mortgage whenever we can. This analysis actually showed me that we were putting unnecessary pressure on our cash flow and probably saying no to some opportunities that we should take advantage of as a relatively young couple. I still hate debt, and everyone should still have an emergency fund, but by closely examining our living expenses, I came to the somewhat obvious realization that taking a little more time to pay off our mortgage and having a full (and less financially stressful) life would probably be a better choice than paying off our mortgage as soon as absolutely possible and having a lot of spare time.
I hope you will take the time to look at the entries in your checkbook for the past few months, view those spending reports that are available online through many bank accounts and credit card accounts, or look at last year’s W-2 to see if you can figure out where all that money went. It can be helpful financially, but it can even be personally enlightening, too.
I still want to know what one client was feeding her cat. It had to be surf and turf!

March 19, 2013

Appreciating Appreciated Securities


Credit: David Castillo Dominici
If you have not started preparing your 2012 taxes, consider this your reminder. If you have already prepared your 2012 taxes, did you have any charitable deductions? If you did, I may have an idea for you to consider in 2013.

Giving cash or clothes to churches, charities, or other qualified organizations is a very admirable gesture in my book. You are sacrificing to help others who are less fortunate. In addition to the good feeling you will probably experience from your generous gifts of cash, clothes, shoes, or books, the U.S. Tax Code will also likely allow you to take a charitable deduction that could potentially lower your income tax bill. It seems like a win-win situation, but it could be even better; the U.S. Tax Code also offers tax benefits to those who gift stock, particularly appreciated stock (stock that has gone up since you bought it), to charitable organizations.

How could giving stock be better you ask? Let me give you an example of one of the best tax planning “tricks” in the book!

Example: Bob and his wife Susan want to give $10,000 to the Salvation Army. They have some extra cash laying around, their closets are overflowing with clothes and shoes, and they have a considerable amount of Home Depot stock in a brokerage account Bob has been adding to over the years. Bob knows he could write a check to the Salvation Army like he does every year, he and Susan have needed to go through their closets for longer than they’d like to admit, and Bob remembers his friend Steve talking about what a “great deal” he got by giving his church some stock last year, but what should Bob do?

Bob and Susan can obviously give anything they choose in any manner(s) they choose, but here are the likely results of their three different options:
  • Cash: This is probably the easiest and quickest way to give. Write a check, donate online, pay by credit card - whatever. You will help a charity and likely get a tax benefit. You will need to keep good records though (see “Records to Keep, Cash Contributions”).
  • Non-Cash Items: While this is a great way to clean out your house and instantly provide gently used items to those in need, it will require more effort both when you clean out your closet and when you file your taxes. The number of hoops you will have to jump through  (see “Records to Keep, Noncash Contributions”) in order to claim a charitable deduction grows as your non-cash donations increase from less than $250, to between $250 and $500, to between $500 and $5,000, and above $5,000, so please keep this in mind if you choose to donate non-cash items. I’m not saying this isn’t a good way to give charitably, and I’m certainly not giving you another excuse to neglect your overflowing closet, but I am saying that you might want to box up your stuff and give $500 or less of non-cash items per year so that you don’t have to remember the day you bought a sweater and how much you originally paid for it, pay your CPA more to fill out another very detailed tax form, or even have to consider bringing in an appraiser. 
  • Stock: As I mentioned earlier, Bob has a brokerage account with a lot of Home Depot stock in it. While he’s bought additional shares from time to time, he bought most of the shares on August 17, 2000, for $51.37 per share. Considering Home Depot closed at $71.37 per share on March 8, 2013, that means he has unrealized gains of $20 per share on most of his shares. If Bob and Susan want to give $10,000 to the Salvation Army, and Home Depot is at a price of $71.37 per share, Bob will need to transfer about 141 shares to the Salvation Army ($10,000 / $71.37 = 140.11 shares). Transferring these shares will likely require a call to his broker or financial advisor (and maybe even the Salvation Army) and some paperwork, so this is more complicated than just writing a check, but this is the strategy I would probably recommend for Bob, and here is why:
    • If Bob transfers 141 shares of Home Depot to the Salvation Army, he and Susan will probably be allowed to take a charitable deduction for the current fair market value of the stock at the time of the transfer ($71.37 per share in our example) of around $10,000. That’s just as good as giving cash!
    • If Bob transfers 141 shares of Home Depot to the Salvation Army, he and Susan will not have to worry about any of the long-term capital gain taxes they would have encountered had they sold 141 shares of Home Depot stock and then given the cash to the Salvation Army, or used the cash themselves. Assuming Bob and Susan would have faced the 15% long-term capital gain rates, by giving the stock directly they saved themselves around $423 in taxes [($71.37 fair market value price - $51.37 purchase price) x 141 shares x 15% tax rate]. If they were higher-income taxpayers and faced the new 23.8% long-term capital gain rates, they saved themselves around $671 in taxes [($71.37 fair market value price - $51.37 purchase price) x 141 shares x 23.8% tax rate]. Those tax savings make giving appreciated securities better than cash!
    • Now that Bob has $10,000 less of Home Depot stock than he might want, he can take $10,000 worth of his excess cash and purchase some new Home Depot shares. He would once again own around the same amount of Home Depot stock, and his new shares would have been purchased at around the current fair market value price of $71.37 per share. That means if Home Depot’s stock price continues to rise and he ever decides to sell the stock in the future, the gains on his new shares would only be based on stock price appreciation above his $71.37 purchase price - not the $51.37 purchase price of the shares he gave to the Salvation Army. Those potential, future tax savings could be worth something as well! (Of course, Bob could also decide not to use $10,000 of his excess cash to replace the Home Depot shares, and he could add those funds to his prudently diversified portfolio, but that’s for a different day…)

If you give charitably, I applaud you, and I hope you will keep on giving. If you currently don’t give charitably, please look after you and your family first, but I hope you will one day consider it. Either way, after today’s post, it is my goal that you now appreciate your appreciated securities a little bit more, and will consider the potential tax benefits of making stock gifting part of your charitable gifting strategy in 2013.


March 05, 2013

Last Call

Credit: Stuart Miles
Three years ago, my wife and I bought a townhome. And, by bought, I mean took out a mortgage for a townhome. At the time, our parents and friends were high-fiving us for the interest rate we got: 4.75%. It was amazing. I mean, there was no way interest rates could get any lower, could they?

Fast-forward to the present: interest rates have gotten lower. To be honest with you, my 4.75% was actually beginning to smell a little as I have casually been comparing it to the mortgage rates that many of my clients  have been sharing with me over the past few months. The rule of thumb is that you are usually wasting your time refinancing if the refinanced interest rate is not at least 1% less than your current rate, but just as I could have never envisioned in 2010, many current interest rates have fallen more than 1% when compared to my 4.75%. Thus, my wife and I are right in the middle of doing what I have advised many clients to consider doing over the past few years: refinancing.

So, why all the fuss this week? Why not another post on what you should do after you have a kid, why you should check your engine now, or how to make sure you can survive mayhem? Because I personally think interest rates have, to quote the musical Oklahoma!, “gone (down) about as far as they can go.” Think about your checking account interest rate – it’s pretty close to 0%. Chances are that, unless you have refinanced within the last three years, current refinancing interest rates are probably worth your looking into. And you should look into them soon because the housing market is beginning to pick up a little steam, and the Federal Reserve has recently started signaling that the Fed could be thinking about scaling back their bond-buying program (many economists believe the Federal Reserve’s bond-buying program has been artificially keeping interest rates low).

If you heed my advice and look into refinancing, let me share a few tips that I think you will find helpful:
  • Reach out to multiple lenders, including your current mortgage holder. The rates and fees will likely be very similar, but it’s worth talking to several lenders before you proceed as a sanity check just to make sure the particular lender you are considering is shooting straight with you. A crafty representative or two may try to pressure you by saying that “rates could change by the end of the day,” but don’t let that bother you; being thorough and comfortable is likely more important than one day’s worth of difference in rates and fees. Also, rates and fees aren’t necessarily going to get worse in 24 hours; they could improve, but not all loan representatives will mention that...
  • Your current lender could offer a smoother transition than someone new, but if there is a relative tie in rates and fees, I would lean towards whoever seems the most knowledgeable and responsive, and offers the best customer service.
  • Try to have some idea of what you are looking for before you call a lender. Are you looking to refinance into a 30-year mortgage? Are you looking to go from a 30-year mortgage to a 15-year mortgage? Are you planning on owning the property for the life of the loan? The more you can tell the potential lender upfront, the more specific and helpful information they will be able to quickly provide. Don’t worry though, because after you practice on potential lender #1, you will be much more comfortable when you reach out to potential lender #2!
  • If it were me, I’d ask lenders for three scenarios: their lowest interest rate possible (will likely require additional money from you at closing, but gives you the best interest rate), a no-closing cost scenario (don’t let the name fool you - there will be fees, but you will likely pay less at closing and your interest rate will only be a little higher than the lowest rate), and a lowest total dollar amount scenario (kind of a happy medium between the lowest interest rate and no-closing cost scenarios where you pay a little at closing and get an interest rate between the lowest rate and the no-closing cost rate). This will likely give you three, pretty-solid options to consider as you decide what is best for your particular financial situation.
  • Finally, know what you’re getting into. Refinancing can be a nuisance to the posterior, if you know what I mean, but going through the process can offer some real financial benefits. If you go forward with refinancing, you will have to provide tons of documentation, answer lots of seemingly ridiculous questions, and sign numerous forms relatively quickly. Don’t get overwhelmed, though. Take a deep breath, respond as quickly as you can, and by all means, carefully read what you are signing.

Sadly, Donna Summer’s Last Dance came to my mind as I started writing this post because I was thinking about the possibility that right now could be the last chance for many of us mortgage holders to benefit from these historically low interest rates. Have no fear though, since hearing from my soon-to-be new lender that my wife and I have been approved for a new mortgage (that’s even more favorable than the one we got in 2010), I’ve found myself humming Semisonic’s Closing Time.

What? Don’t judge. If you refinance, you might find yourself singing, too!