MONEY 28 - GOLD/SILVER

Money readers take note +

THIS IS MY 28^TH POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money. When we talk about money and investments many people today are bringing up the topic of investing in gold and silver.  Both of these metals have been around forever and both are commodities. The well thought of investments in precious minerals and precious stones are platinum, gold, silver and diamonds. Let’s address gold and silver briefly.

You and I can buy gold and silver directly from various sources or invest in them though specialty index funds on the stock market.

First, how is gold measured?  Gold is considered pure investment grade at 99.9% pure or 24 karat.  We also see “karat” spelled “carat” or just the abbreviation which most people understand, ct, after the amount of gold in an item.  Fashion jewelry is many times 18 ct, or 14 ct, or 10 ct.  This is a measurement of the amount of gold in the item.  Let’s use 14 ct, which is very common.  So, the item you have is 14 parts gold and 10 parts of another alloy.  14 ct is more durable and stronger than 24 ct and less costly because it is a fraction of pure gold. The weight and price are important. Gold is valued in “troy ounces”.

How do I buy gold?  The two most common ways for investing in gold is either buying gold coins or buying gold bullion. As with most gold coins the value is not in the coin, but in the gold, with very few exceptions. You may want to look at the US Eagle gold coin.

Let’s go off the track a bit here.  You see fashion gold jewelry and you want to buy it because gold has gone up and so has gold fashion jewelry.  Now, the jeweler presents you with white gold, rose gold and regular colored gold.  What is the difference? Gold is yellow color. As we noted, fashion jewelry is not pure gold and has something else mixed in.  To make white gold there is either silver or nickel added in.  Rose gold is attained by adding copper.

Now, back on track with gold.  Gold has for centuries been a medium for trade as well as a precious commodity to hedge currency loss as well as thought to hold value in case of economic emergency, inflation or catastrophe. Gold is a commodity and can move up and down rapidly in price  As we learned in a previous blog the United States Government used gold to back the US dollar until August, 1971.  At that time gold was priced about $40/ounce.  Then, the US went off the gold standard, and the US went to a “fiat” currency.  Gold continued to rise from that point, and kept up with inflation or better.  It went through a period of about 20 years without much movement in price. Nothing huge happened with the appreciation of gold until about 2003 and the price was approximately $365/ounce.  By 2005 gold was priced about $445/ounce. Then, what happened in the world?  Well, first the US was involved in two very expensive wars, Iraq and Afghanistan. We had gone from a balanced US budget to running up incredible deficits.  At that point the European Union looked financially strong.  The US started printing more money, diluting the US dollar. Now, we are doing even more devaluing of the dollar (QE1, QE2 and now QE3). Financial weakness was creeping into the European countries. China, India and Russia started buying a lot of gold. Where are we now?  As of this writing (12/18/2012) spot gold price is about $1,700/ounce.

China is the number one acquirer of investment grade gold, India buys more gold, but for jewelry.  In India a sign of wealth is gold worn.

Let’s talk silver.  The last US silver coin was minted in 1970. The US Mint began making gold and silver coins in 1986 for investors, the weight and purity of content guaranteed. Silver is actually a byproduct or other mining such as gold, copper and lead. Silver is also measured in ounces. With silver fashion jewelry there should be a stamp on the item showing purity such as 925, meaning over 90% pure silver.

The high price of silver over recent history happened in 1980 when the Hunt brothers from Texas attempted to control the market of the commodity and the price went up to about $50/ounce.  Then, the price plummeted to about $4.50/ounce and remained in the $5 range from 1993 until 2004-5, the same time gold started taking off. Silver hit another high in May,  2011 of about $48/ounce.  Today, it is steady at about $32.50/ounce.

Is gold going up?  Answer is who knows.  Is it a limited commodity or will more reserves be found?  The world had predicted we’d have run out of oil by now, but with new technology many more billions of oil have been proven.  Perhaps the same will happen with gold reserves, and then enters supply and demand.   With both silver and gold you have low production costs.  The actual cost of producing one ounce of gold, and adding in all corporate expenses like administration, marketing, shipping, etc. the total cost is only about $550-680/ounce, and yet it is selling in the market at $1,700.  Silver is even less. Silver runs about $1.25/ounce in mining, low as it is a byproduct, plus administration costs.  What other products do you find that can sell for 300% or more profit margin?

What are drawbacks to these investments? 

1)    Volatile price

2)    Many scam artists in the business, and loose controls

3)    Lack of liquidity unless you purchase gold/silver stocks

4)    Storage expense. If you buy out of Switzerland storage may cost you a half of one percent annually or more. Buy out of Hong Kong about one third of one percent annually. Yes, you could put it in a bank safety deposit box, if large enough.

5)    Gold and silver do not earn any return until sold, and you hope for a higher price than what you bought it for.

How do I buy? In tons of places.  Go with a reputable source.  Reputable sources typically do not charge a commission, but work on a “spread”.  This means when they sell to you they sell at a higher price than if they were buying from you.  This is similar to buying foreign currencies when you travel.

How about gold or silver stock?

1)    The stock may not run parallel to the price of the commodity because of corporate failings.

2)    A benefit is that you have liquidity.  Call your stockbroker or investment advisor and you can buy or sell immediately.

3)    With an index mutual fund you are spreading your risk amongst several companies.

4)    When buying a gold/silver mining stock the stock may be priced significantly higher than the resources and assets of the company.

How much gold should I hold as an investment in my portfolio?  Again, gold is a hedge against disaster.  Many advisors recommend in the range of 10% of your total investment assets.

When should I buy?  As gold and silver are very price fluctuating I would recommend buying on dips in price and on a varying schedule, either quarterly or monthly when you have extra money to invest.

To end here, I hope you learned a bit about gold and silver. Another precious metal is platinum, and the price of that has historically been higher than gold, however with the run up in gold platinum is priced at $1,610/ounce. With gold and silver there is little utility today except for investments and fashion jewelry.  Substitute materials have taken over in commercial products and dentistry.

MONEY 27 - ANNUITIES

THIS IS MY 27^TH POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  In the last blog we talked about insurance.  Let’s talk about investing in an insurance product, annuities.

Annuities have been around for years. These vehicles are managed by insurance companies and sold by bankers and insurance companies.  There are two main types: deferred and immediate.  The names describe the plans, you can defer payments to a certain future date or start payments immediately. 

A deferred payment, sometimes called a regular payment annuity, has a plan set up for periodic payment into the plan until a certain time or age you reach and then you get payments on a defined schedule, usually monthly to supplement social security, a pension plan or other retirement money.

An immediate payment plan, or single payment plan, involves you placing a certain amount of money into the plan. You may start taking out payments immediately, usually based upon a schedule.

Annuities can be either “fixed” (guaranteed) or “variable”. A fixed pay annuity is exactly that.  A fixed plan distributes money from the plan for a fixed period of years or until you die, or perhaps it is set up for payments to continue until your death and the beneficiary death.  This is many times used in a husband and wife relationship; a joint annuity.  If the plan has payments until both you and your beneficiary die, the payments will be less than if just established until your death. As with all insurance products this is worked out with actuarial studies.  A variable policy is associated to the investments made with the money such as bonds and stocks.  These markets fluctuate.

Annuities are set up to your estimated financial wants and needs, normally when a person retires.  These payments are paid to you from your original principal plus the money that has accumulated from being invested.

When there are payments made from the plan to you your original principal paid out from the annuity is tax free, however the amount of money that has grown in your plan from being invested will be taxable income.

The nice things about annuities are: 1) your principal grows tax deferred and 2) you can place any amount of money into an annuity unlike your IRA and other retirement plans where there are limits to the amount you can invest each year.

Just like other investments there are good points and weak points.  Let’s talk about the downside of annuities.

1)    Annuities are insurance products and many times have fairly high commissions paid to sales people, even up to 10%.

2)    There may be policy surrender charges the same as with life insurance if you need to alter the policy and take more money out than scheduled or withdraw all your money.  This could be anywhere from 5% to 20%.

3)    Administration and management fees can be substantial such as 1% to 1.75% of the money annually.

Today, everyone is trying to figure out what best to do with money and investments.  Managed money in annuities goes to the same trough, mainly bonds and stocks so returns have come down over the past 3-4 years. What are we looking at for returns, mainly on bonds where the money managers for insurance companies invest money?  We are down to about 1.6% for a 10 year US bond. An  A-AA mix of bonds reinvested may yield 2.5% now.

Bottom line, with annuities holding mostly bonds in their portfolios and high fees for purchase, management of money and very high penalties for yearly changes and withdrawals, you might be better off with other investments for the majority of your money.  Don’t forget that if and when interest rates go up the market value of bonds goes down. If you, or the money manager, sell bonds before maturity in a rising interest rate environment, you will most likely lose more money than you have made at today’s 1.65% to 2.5% yield rates.

When you look into investments you might run into the term “basis points”.  It may come across as “this” or “that” investment has changed 25 basis points.  What is this?  One hundred basis points equals one percent. Therefore, in the above illustration of 25 basis points, it means the investment has changed 1/4 of one percent.

As you most likely know, inflation (exclusive of food, oil and gas) is expected to remain low and interest rates are also predicted to remain quite low through mid-2013 and longer, so your returns on annuities will be similar.

Another positive point is that US debt is still very desirable in the world markets, and the US dollar should remain strong in relation to other currencies

MONEY 26 - INSURANCE

THIS IS MY 26^TH POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  Let’s talk about insurance.  Several years ago the trust company I worked for wanted me to have several national and state licenses more for knowledge, and not to necessarily sell products.  The reason for this being that I assisted the company in joining lawyers and other professionals on a regional lecturing platform.  Some of these licenses included  Life, Health and Disability licenses. That knowledge remains with me today as a useful tool for myself, and hopefully others who ask for advice.

As with all financial matters, please seek out professional advice from experts who are respected, full time people in the business.  Below is a personal example and perhaps can help you.

Let’s start with life insurance.  There are several types.  A friend recently told me he didn’t think he needed life insurance, and asked for my suggestions.  He is a divorced single man, with one child and has a successful business. Let’s look at this from different angles.  First, and foremost, he has a child to protect.  He can buy life insurance for himself at a relatively low cost as he is in his mid-thirties and hopefully insurable as he appears to be in good health.  Depending on the insurance company and amount of insurance he may need to have a complete physical exam for insurance underwriting.  If he buys insurance it is best not to name his estate as beneficiary because when he passes away the amount of insurance will increase his estate worth.  Name other beneficiaries, in this case perhaps his daughter. Today, inheritance tax exempts the first $5,120,000 million, however my friend’s business is worth more than that amount on an estimated value. Federal inheritance tax on an estate greater than $5,120,000 million starts at 35% and goes up from there.  Then, there could be state taxes involved.  Why waste money?

A second idea here may be to take a whole life or variable life policy out for his daughter and let the cash amount build for her financial security later in life, or to help pay for college education.

A third idea may be to protect his company’s assets, and the possible forced sale of the company to satisfy inheritance tax obligations when he dies.  A “key man” policy might be used, and paid for by the company and that would be a company expensed item.

There are three main types of life insurance, whole life, term and variable although in actuality there are many variations.  For instance, there are non-participating, participating, limited pay, single premium, interest rate changing policies and more.  With younger people insurance is inexpensive and whole life or variable life might make the most sense.  Your insurance professional will advise you and go over specifics.

Variable life insurance places the premiums into separate markets such as mutual funds or bond funds so that over time you may have a faster build up of money than with a set rate with whole life insurance.  With this insurance you, as owner, select where the policy money is to be invested.

If a person is older and trying to protect an individual, family or company assets a term insurance policy might be best. Term has no cash build up and is strictly a specific amount of insurance for a specified period of time with a set payment schedule.  After the time period expires there is no cash build up and no further insurance.  Term is the least expensive form of life insurance.

Because of life expectancies and insurance costs figured with actuarial tables, insurance of any type can be very expensive to buy later in life, even if health permits coverage.

Bottom line here is that I recommended that my friend see an insurance agent and most likely purchase insurance.  Almost everyone can use some life insurance if nothing more than to pay for burial costs, or legal costs to settle or administrate an estate until assets can be liquidated, which can take a long time.

MONEY 25 - TAXES/RETIREMENT ACCOUNTS

THIS IS MY 25^TH POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  This will be a short blog to get your mind going on upcoming tax changes.  I would render the advice to see your tax advisor or accountant on what appears to be coming down the pike.

For one, if you are selling real estate owned by you and have held it over 12 months you are currently eligible for long term Federal capital gains tax.  This rate has been 15% for some time, however the tax rate will go up. Rather than trading a piece of “like property”, for instance real estate for real estate under a 1031 Exchange you may be better off paying the tax at 15% rather than deferring taxation with a trade. Eventually you will be paying a higher tax rate.

If you have stocks held over one year and are thinking of selling, consult your broker or advisor in this area so you can take advantage of the 15%.

Another area of interest would be IRA’s and investments in them.  Consult your advisor to see if it may be wise to start a Roth IRA, or sell some assets out of your current IRA and place the money in a Roth IRA.  A Roth IRA is for money you have already paid taxes on. Any compounding in the Roth IRA is tax exempt, and then when you are eligible to take money from your Roth IRA it is tax free.

If you roll the money from one retirement custodial account to another it is advisable to do so directly versus taking a withdrawal as we all must place the money into a new account within 60 days.  If you miss the time permitted time period there is a penalty of 10% plus ordinary income taxes owed to the government.  There are two numbers you should remember, 59 1/2 and 70 1/2. You cannot take a withdrawal of this retirement money except in certain situations, such as for education, before the age of 59 1/2. And, you must take money out of your retirement account at age 70 1/2.

A quick story.  A friend of mine had about $850 in an IRA and was quitting their job.  Needing the money, they did not roll it into another retirement account thinking the government had “bigger fish to fry”.  Well, in this computerized world a few years after they did this, the government sent them a notice that they owed the 10% penalty, earned income taxes on the withdrawal and interest penalty…..ouch, there wasn’t much of the $850 remaining.

MONEY 24 - BANKING/LOANS

THIS IS MY 24^TH POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  We will continue from our last blog on banking and ideas. 

As we talked about banks are mainly in business to either deposit money into, or take money out, and I don’t mean in terms of robbing, instead borrowing money.  In line with savings accounts are “certificates of deposits” (CD’s) that the banks offer.  The interest rate you receive may vary according to the bank you use, the amount of money of the CD and the length of time the CD is for.  A CD is for a specific period of time and a defined dollar amount.  Early withdrawal will have a financial penalty.

In our wonderful world of financial technology you can go to websites like www.bankrate.com or www.money-rates.com and compare national rates for CD’s. These sites can also be used to search the lowest loan interest rates for cars and other things.  Make sure you check into the financial stability of the bank you are doing business with.

A bank savings account offers little interest these days, but you have liquidity of money, meaning you can take money out without penalty or tying your money up for a period of time as with the CD.

Let’s look at borrowing money.  Of course, this is one way banks make money.  They take in deposits and lend it out to customers.  The “spread” is profit for them.  Popular loans at banks are auto loans, home improvement and mortgage loans.  Banks love lending on collateralized items.  With this type of loan the bank will place a lien on your car or home, and file that document with the county clerk and recorder’s office so that it is of public record.

Banks offer safety deposit boxes to their customers to keep safe business documents, jewelry or any smaller item you may want to keep outside your home or office.  Some banks offer this as a free service although the free safety deposit boxes are small.  If you are using the depository for business this is a tax deductible item.  Some banks offer larger vaults, and there are private companies that offer large vault storage. You might want to store a collectable item in these private vaults that are temperature and humidity controlled.  Such items may be wood musical instruments, rare pieces of furniture or any items of value. Insurance is always recommended.

Another place you can check for rates and business similar to banking are credit unions.  Many times these institutions are better for serving the public than banks and they have been around since 1909. They are federally chartered by the US Government, however owned by individuals such as teacher’s unions. Credit unions are less for profit than banks. These chartered unions have the backing of an insurance fund and the US Government to $250,000 per account, similar to banks.

MONEY 23 - BANKING

THIS IS MY 23^RD POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  With these educational tutorials I am trying to bring into context practical, everyday and simple lessons about money.  Another friend of mine asked me questions very basic about banks, so I thought we could re-visit banking and delve into more parts.

What’s the purpose of a bank?  These days we all wonder, right?  Well, banks are around for two specific purposes, other than drive us crazy, these are to deposit money and to borrow money.  Some banks have more adjuncts like investment counselors as well so that you can buy and sell mutual funds, stocks and bonds; set up and manage trusts, life insurance, credit cards, etc.

We’ve covered much of this banking material in other blogs.  My friend wants to open a checking account.  First, is it going to be for personal use or business use?  Duplicate copies of each check is helpful at the end of the year accounting and for tax purposes. Yes, a lot of banking today is done “on-line” so we would need to call the bank or meet with them if there were  issues.  Getting down to even the most basics of a check. In the upper right hand we have the check number.  Most banks will start off with a three or four digit number, rather than “1”.

Next, we have several lines….date, who the check is to be made out to, the amount to be written in, the amount numerically written in and your “John Hancock” signature.  When writing in the amount I like to draw a short line prior to writing so someone else can’t add on, and a short line following the writing, again so someone can’t add on to the amount.  If you are writing a check for a small amount you might want to say as an example, “Only two and no/100”.  This way it deters someone dishonest person from adding a six or an eight in front of the two.

What are all those numbers at the bottom of the check.  Going from left to right is the routing number for your bank and processing.  The next numbers is your checking account number. You will notice the last four digits is your check number on a particular check.

When you endorse another person’s check on the back, I like to write in where the check is to be deposited to avoid screw-ups.  For instance, write in “Only for deposit into checking account 1234567 (your account number) and then sign below that.

When opening this checking account you will be asked to sign a “signature card”.  I like to sign my checks differently from the exact name on the left top of the check.  For instance, if my name was John H. Doe on the check I might sign J. Doe, so that check forgers or people who have stolen checks have a harder time cashing the check, as your name is different than at the top of the check.

It may be a good idea to do something similar with credit cards.  A friend of mine with his credit cards writes in “Ask for photo/personal ID” where the credit card is to be signed on the backside.

Ask the bank if you can have “overdraft protection” on your checking account.  This is a line of credit, a reserve account, like a credit card so if you don’t have adequate money in your checking account you will automatically have money transferred into your checking account so that your check does not “bounce”. If you don’t have this and a check does not have sufficient funds it is returned to the party you wrote the check to, and this can get expensive with a bank transaction fee of $35-50.  The interest charged on a “overdraft protection” account is high, approximately 20% in most cases.

When selecting a bank for a checking account ask about all fees.  There are many banks that have free checking.

We will cover more in banking and practical information in our future blogs.

MONEY 22 - INVESTMENT CALCULATIONS

THIS IS MY 22^ND POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money.  In the last post we covered simple interest, compound interest and rates of return.

 Let’s talk about quick ways to figure out how an investment might look without a lot of figuring.  There is a rule of 7 and 10.  That means that you are going to be close in figuring compound interest using these two numbers if you want to make 7% or 10% on your money.  If I make an investment at 7% it will take me 10 years to double my money.  If I make an investment at 10% it will take me 7 years to double my investment.

What if you want to get an approximate return on investment other than 7% or 10%?  Some people use the rule of 72 to figure how long it takes to double money.  In this case, divide the percent you are receiving into 72.  An example is an investment at 9% and you want to know how long it will take to double your money?  Divide 9 into 72, and the answer is 8 years.  72 is most commonly used, as many numbers can be divided into it without decimal places.  It is a quick estimate,  The more accurate number to use is 69.3, or even 70, a whole number.

Have you heard of APR?  Annual percentage rate may be different from the interest rate quoted to you at time of purchase of a home or car.  There are essentially two types of APR.  Nominal APR is the same as simple interest on a loan, as we have discussed.  Compound APR, or effective rate, takes the simple interest on a loan and then adds in extra charges to the loan, this may include service fees, loan origination fees, transportation and set up fees on cars.  On mortgages the big ones are appraisal fees, loan origination fees and perhaps PMI or private mortgage insurance.

Here is an illustration:

Nominal APR: $100 for one year and cost of money is $5.  Therefore divide $100 into $5 and you will get .05. Move the decimal point two places to the right and you get 5%.

Now, let’s assume the same $5 in cost of money and the same $100 loan for one year under compound APR. We need to add in all costs for the loan.  Let’s assume $.50 for loan origination, another $.50 for service fees, and $1. for filing fees with public recorder’s office.  The extra charges on the loan are $2. thus we have $7 instead of $5.  Now, divide $100 principal amount of loan into $7 and you will get .07.  Again, move the decimal point two places to the right and you will see your loan interest rate is not 5%, but in actuality 7%. These additional costs are normally paid up front, however they are amortized over the length of the loan.

You’ve probably heard the terms “future value” of money and “present value” of money. 

Future Value: Future value of money is the value of money at a certain time in the future that would be equal to today’s value.  This is similar to interest rate returns we have talked about to date.  As an example, if inflation is running at 3% in the USA, after a year what amount of money would I need to have the same purchasing power as I do today if I held $100?  The answer is $103.

Present Value: This is the opposite of future value.  You take a figure in the future and bring the amount back to the current value, based upon facts or assumptions like inflation rate. In other words you are discounting the value of money back to today.

MONEY 21 - INTEREST CALCULATIONS

THIS IS MY 21^ST POST ON UNDERSTANDING MONEY TOOLS

Money, Money, Money. A friend from Flagstaff, AZ, recently asked me to post a tutorial on various types of interest and returns on investment, so here goes. Even though he is an accomplished businessman he told me he lacks knowledge in this area.  We will cover only a couple types and give simple examples.

Simple Interest: What is my return on investment over a one year time period assuming I can have the total return of my capital investment back?  So you loan me $100 for exactly one year, and I give you $105 back what is your return as measured in “simple interest” terms? 5%.  I determined this by calculating the difference between $100 and $105 which is $5.  Then, take the original capital amount, or principal amount, $100, and divide it into $5. The result is .05. To make .05 a percentage move the decimal point two places to the right….5%.  For us lesser brained individuals it helps to remember to divide the larger number into the smaller number!

Compound Interest: You can figure this amount with a calculator that has the symbol for compound interest, or do it on paper like we will here. Let’s assume we have $100 again and you lend it to me for a three year period again at 5%. How much will I return to you after three years? 

Year one: $100 X 5% equals $5, then add that on the next year’s principal.

Year two: $105 X 5% equals $5.25. Now, I owe you $110.25 the end of year two. Add that onto your principal.

Year three: $110.25 X 5% equals $5.52 (rounded up to the next penny).  Therefore, at the end of year three I will pay you $115.77 for the money I borrowed for three years.  The interest for each year is calculated on the principal amount adding in each prior year’s interest, thus the term compounding of interest.

Rate of Return (ROR):  We covered this in a real estate blog, but let’s go over it again. This is similar to simple interest. Let’s say we invest or buy something for $100 and sell it one year later for $105.  $105 minus $100 is $5.  The original principal or invested amount $100 divided into $5 is .05.  Again, the larger number into the smaller number!  Move the decimal point two places to the right and you have 5%.  Conversely, to work mathematically from a percentage move the decimal point two places to the left, thus back to .05.

Internal Rate of Return (IRR):  This is a bit tricky, but is commonly used in investments such as oil and gas and real estate.  Oil and gas wells are depleting assets, and hopefully the other, real estate, is an appreciating asset. This takes into consideration a different ending principal amount, or a principal/invested amount, that may differ from the original (the effective rate of return).  It is used in capital budgeting and analyzing investments.  It can also be referred to as “discounted cash flow”.  In oil and gas, wells are a depleting commodity, therefore are worth less over a given period of time or perhaps not worth anything at the end of a period of time. This needs to be factored into your investment decision and return on investment.  In theory let’s assume you and others invest $100 each in a partnership for oil and gas drilling. The well may produce a return of 50% the first year, 30% the second year and 25% the third year, and on and on for a few years until the well is depleted or waters out.  At that time, excluding equipment, the well is essentially worthless and you need to figure out over a period of time what your returns are.

Another case for IRR is real estate.  Real estate is made up of commodities, like materials that can fluctuate and many times go up in value over time. In this circumstance, let’s say we take our $100 and invest in a real estate partnership (perhaps a REIT on the New York Stock Exchange). The partnership may pay out 6% the first year, 5% the second year and 8% the third year.  At the end of 3 years the partnership, or your interest in it, is sold for $112 because of appreciation in value of the asset or assets.  Now, you need to figure out the internal rate of your return.  The formula is fairly complex and we won’t cover this, but this is the theory.

In the next blog we will continue from here on this topic into annual percentage rates, present values and future values of money.

MONEY 20 - TAXES

THIS IS MY 20TH POST ON UNDERSTANDING MONEY TOOLS

We are back to Money, Money, Money on this tutorial blog.  Let’s discuss taxation.

No doubt about it the wealthy pay less a percentage in taxes, although the total amount paid is quite great.  Today, the wealthy have moved their total assets owned in the US from about 14% ownership 15 years ago to about 50% today.  No wonder the dollar amount has gone up! They also have the ability to do this legally as they hire the best law and accounting firms for tax planning and asset preservation.  God bless the wealthy, however the middle class cannot afford these financial services and the poor have no money, perhaps they are the luckiest!

I will have to admit that I am not the smartest individual, so unlike other blogs I have written I needed to look up current income tax percentages to relay them to you.  Hope you find this of interest and help.

First, let’s talk about tax avoidance for long term and off shore accounts which has been common for a long time, however in recent years there has been attention drawn to the usage.  In my varied history I was involved with a very wealthy family and our law firm had the following scenario to minimize taxation and then shuffle money to various currencies.  In the US we invested in mortgages via a partnership. These mortgage packages had lives of over 12 months to take advantage of long-term capital gains.  As previously discussed the long term Federal capital gains tax rate is 15%. Then, state tax is paid depending on which state you reside in.  Several states do not have state income taxes, like Texas, Nevada and Florida. 

When we established this partnership we structured a corporation in the Cayman Islands that owned the partnership, thus as income came into the partnership we paid taxes on that entity and then the money was transferred to an offshore account. All legal.  Large US corporations are doing similar today.  They have offshore accounts, book the income and assets here however keep the money outside the US to avoid taxation.  I don’t see this changing much even if out corporate tax rate is decreased. Most large corporations are already paying very low rates and not 35-39% at the high end.  There are many world wide tax havens including the Isle of Mann and Isle of Jersey off England.

How are partnerships taxed?  The income is a pass-through to each individual’s income tax rate and reported on their Form 1040 and Schedule E.  The partnership itself needs to file a Form 1065 to inform the IRS that the partners are reporting the proper amount on their tax returns.  The partnership supplies each partner with a Schedule K-1.

Let’s address Federal tax percentages for individuals, head of household, for 2012.  In October the IRS looks at inflation rates and may adjust the tax rate accordingly for the following year.

If you make up to:     Tax rate:

-$12,400.                      10%

-$47,350.                      15%

-$122,300.                    25%

-$388,350.                    33%

-more than $388,351,   35%

If you are filing as single, (not head of household) or married filing separately the rates will differ from above. The income level can be adjusted by some personal expenses and giving, including donations to non-profit organizations like churches and charities.  Also, contributions to ERISA plans like 401-K’s and IRA’s.  Best to talk with your human resource director or accountant for planning.

Now, let’s look at FICA.  If you are an employee of a corporation the employer pays a portion and you pay a portion.  If you are an independent contractor, as is common today, you pay all of the FICA.  FICA is broken into two parts, 1) Medical/Hospital Insurance and, 2) Old Age, Survivors and Disability Insurance.

Through December 31, 2012 employees pay 4.2% (a 2% Holiday temporary cut) and the employer pays 6.2% to the Old Age, Survivors and Disability Insurance portion of FICA.  Both the employee and the employer contributes 1.45% to the Medical portion. Self employed individuals pay 10.4% to “OSASD” and 2.9% to the Medical part. In 2012 at $110,100 of income contributions are not required. The max is adjusted on an annual basis by the government and is indexed.

Let’s look at corporate income taxation.

If the corporation made up to or between:       Tax rate:

-Up to $25,000.                                          15%

-Between $100,000-$335,000.                   39%

-Between $335,000-10 million                   34%

-Between  $10-15 million                           35%

-Between $15-18,333,333.                          38%

Is this percentage weird, or what?  To account for the differences there has to be more companies falling into different adjusted income ranges to vary percentages paid.

These income levels are after expense adjustment, and again this is where  good tax law firms and accounting firms add great value.

I hope you enjoyed this informational blog and found the stats of interest.

MONEY 19 - REAL ESTATE

THIS IS MY 19^TH POST ON UNDERSTANDING MONEY TOOLS

Homes: Renovation, to buy new, resale.

In this blog we’ll discuss briefly the benefits of keeping your home and renovating parts of the home, or to buy new or resale in today’s market. These are thoughts to go through before making important decisions.

The first question is what is my motivation, emotional or rational? If you renovate your current home you need to ask, “how long do I intend to live in this house”? With most renovations you won’t get your money back in full.  This varies according to where you live in the US, and what you decide to renovate and to what degree.

If your mind has decided a new home, this is probably one of the best times to do so, pending that the economy of the country can move forward.  The reason for this is that many of the large home builders are still buying developed lots and land from banks that are in bankruptcy.  There are exceptions to this as in Boston, NYC, Washington D.C., parts of southern California, North Dakota and Wyoming where prices have held up.

The builder is starting with a developed lot that he has purchased from a distressed seller at $.20 on the dollar and then material costs are down from the highs of 6-9 years ago. You can’t do better than that!  The homes come with new warranties, build times of 4-12 months and you get to select the options you desire.

The insulation and energy factors are so much better today, including radiant barrier roof sheathing to reflect heat, blown in insulation, insulation wrapped vents, energy efficient windows, etc.  Your maintenance costs will be lower on a new home. 

Many builders offer built-in pest control systems like “Taexx” tubing which is installed in the exterior walls and a pesticide company can service the port on the outside of the home with the pesticide passing through the wood studs on a regularly scheduled basis.  Many builders offer “hot water loops” so that you have quicker hot water no matter where in the house.

When looking at costs for a new home don’t forget that most people will select options for the home that add on 12-20%.  On top of that new home builders normally don’t include exterior landscaping, or in warm areas the swimming pools are at your expense.

If you renovate your current home, select which rooms and how far you want to go with the renovation remembering you may not get all of this money back.  Normally, when the work is completed you will only see 60-85% back as a financial improvement to the home. 

House “flippers” normally do the minimum amount of work to make a house appear clean and improved so they can sell it; this is different.  The house “flipper” will improve the yard and landscaping for “street appeal”.  Inside the house they will paint and re-carpet, but that is pretty much all, unless they are certain the market will dictate getting their cost back plus a profit.

Many people start with the kitchens and bathrooms.  Kitchen cabinets and appliances are expensive.  Does a person want to update the plumbing, electrical, replace windows, carpet, tile, scratched doors, etc.  Where does one draw the line?  How about more insulation in the attic?  How about the basement and finishing that area into part of the house?  In many areas a finished basement is not included in the square foot livable as of record.  If this is the situation you will get a minimum return on investment.

Many people who renovate love the area they live in and their neighbors and don’t want to give that up.

MONEY 18 - LAND DEVELOPMENT #6

THIS IS MY 18^TH POST ON UNDERSTANDING MONEY TOOLS

Land Development Part 6

Now, we’ll take a brief look at Parcels 3 and 4.  Again, if it is convenient please go to my website: www.premierewisconsinland.com.

Parcel 3 totals 10 acres.  The water ditch that flows through Parcel 2 extends through this section and eventually the water flows to the Rock River to the north.  This ditch divides off two acres on the eastern side of the parcel.  Prior to construction of the highway there was considerable slope to the east.  Here our strategy was to use extra clean dirt that the DOT wanted to truck off, and fill this sloping area.  Again, similar to the other parcels we first removed existing topsoil.  After completing perc tests in case a septic type of sewage system needed to be used we isolated enough land (100’X400’) and did not compress this area with heavy equipment.  This would be adequate for 15-20 condos or apartments.  Single family homes would not be an issue.  We brought in about 25,000 cubic yards of clean dirt and replaced the topsoil for farming purposes until the real estate market returns.  On the southern border we took advantage of the DOT’s highway demolition work and received crushed concrete to create berms.

The best usage for this acreage would be single family homes or low multi-family, probably nice apartments.  With permission by the DNR we would like to create a walking bridge across the water ditch and make a park out of 2 acres for the residents of this area.  In conjunction with the DOT we placed commercial weight and size culverts for entry to the land.

On Parcel 4 we did very little work. This is a beautiful 84 acre parcel, treed with varying topography and views.  It adjoins a State nature conservancy on the northwest side. It would be prime land for a few expensive homes on sites of 5 acres or more.  A septic system or alternative septic system could be used.  Water is not an issue.  Good, clean potable water can be obtained from wells, which is common to the area. We placed commercial weight culverts for entrances to the property.

MONEY 17 - LAND DEVELOPMENT #5

THIS IS MY 17^TH POST ON UNDERSTANDING MONEY TOOLS

Land Development Part 5

Let’s touch briefly upon some of the costs involved in land development. We have discussed work completed on Parcels 1 and 2.  Here are a few approximate costs involved. 

When the State Department of Transportation purchased land for the highway and interchange project a new survey needed to be completed.  Make sure you have a well-respected engineering firm complete this as errors cannot be afforded down the road.  The cost for a new survey was $10,000. Then, as previously mentioned, we brought in 130,000 cubic yards of clean dirt fill onto Parcel 1 and 10,000 cubic yards on Parcel 2.  This dirt delivered, graded out level after removing and storing topsoil and replacing at least 9-12” of topsoil ran about $15-20 per cubic yard.  That tallies up to about $2 million or more for Parcel 1 and about $175,000 for Parcel 2.

Let’s look at some figures to keep in mind when developing property. One acre is 43,560 sq. ft.  To raise one acre of land one foot higher to get the amount of fill you might need, divide 43,560 by 27 to convert square feet to cubic yards, and you get about 1,613 cubic yards. To bring in all utilities, pave site for parking, curbs, gutters, water, sewer (or an alternate to city sewer), fiber optics, etc. it is going to run about $200,000. for nice residential; this including soft and hard costs.  Then, add in original cost of land, financing charges and I hope you want to make a profit!

In Wisconsin it costs about $30 a linear foot to bring in sewer lines to the property.  The depth for sewer lines is about 8 feet. This will vary according to where your development is because of frost lines and other requirements. In this case we planned two scenarios for sewage.  One was to work with the City sewer and be accepted into a filing district, and work with the State and DNR to run lines under the highway. If permitted, running lines under the highway would run about $200 a linear foot.  Another solution is an alternative sewer system.   Siemans Corp. has a very good system, although not inexpensive.

As a back up plan we ran soil perc tests for septic and isolated certain areas on the project for this.  These ground sites cannot be compacted by heavy equipment.

Out West it is common to require archaeological studies to be completed.  If bones or artifacts are found from the land studies, these locations will be isolated and kept from development until removal of historical artifacts has been completed.

Also, in the Western states where you have dry conditions with “washes” these washes are natural and cannot normally be disturbed except with special permission by the Army Corp of Engineers and the Department of Natural Resources. Sometimes it can be of benefit to the development to re-contour the water flow and washes, but it may be quite expensive and is under the control of the government agencies to grant permission.

Check with the county or city/town you are working with to see if a “dust permit” is required.  Most places where it is dry like in the Western states a dust permit is required whether you are grading out a lot for a house or many acres for a development.  If it is a city lot it may be as easy as asking a neighbor if you could periodically use some water from a hose to keep the dust down.  On larger developments you will need to bring in water trucks.

To keep taxation to a minimum, what I like to do is form a Limited Liability Corporation that will give some legal protection for the acquisition of the land, the needed studies (soft costs) and the basic land improvement. The land would normally be in a lower real estate tax standing being designated agricultural 1 or 2.  Then, when it is time to build on the land another corporation will be formed and you can sell or transfer the land to that entity.  This enables a person or company to pay long term capital gains tax on the from the LLC you initially set up.  Current Federal Tax on long term capital gains with a hold over 12 months is 15%.  Once you start operating and building on the land normal corporate taxes will apply.

Also, leave the land as agriculture zoning or conditional zoning until everything is final with all parties as taxes will increase substantially once construction starts.

Studies, permit fees, etc. will vary depending on parts of the country and if you are only dealing with state and county regulations or have to meet town and city requirements.

MONEY 16 - LAND DEVELOPMENT #4

THIS IS MY 16^TH POST ON UNDERSTANDING MONEY TOOLS

Land Development Part 4

Now, we will go to Parcel 2 of the development we are analyzing. Again, go to www.premierewisconsinland.com and/or follow my dialogue.

This parcel is about 10 acres and quite narrow (about 250 feet).  It is situated between the road that is the entrance to the highway overpass and another road/street.  Because there is commercial on two sides of this site, the highest and best use is determined to be commercial/retail. The State purchased 2.5 acres for a park and ride near the west end, however politics with the town has entered the picture and the town doesn’t want to maintain the park and ride that the State will pay for thus preventing it to be completed at this time.   Again, be prepared for politics affecting your work! 

There is a possibility with the park and ride location to be incorporated into the development package and provide more parking to satisfy the State’s requirements, and a win, win situation.

Another obstacle on the parcel is 60,000 sq. ft. designated isolated wetlands through mandated testing. What can we do?

With the “isolated” wetland situation the DNR and State actually takes that land away from your control.  There is a possibility to work with the State and DNR to purchase other land and give/dedicate that to the State in lieu of your land holding, usually on a 2 or 3 to 1 ratio in their favor. This is referred to as “mitigation”. Sounds peculiar, but the owner has lost control of his land.  If this can be accomplished, we can go ahead and incorporate this land into the building package as parking sites, not suitable to build upon.  Proper engineering and drains will need to be incorporated to drain this location under the road that is access to the highway and to the north into another small wetland area.

Normal strip centers are long and run 50-55 feet or more in width.  Walkways, parking and shipping transportation drops in the back of the stores will be planned for and laid out.  Deliveryshipping access in the rear of the building needs to be about 24 feet or wider.

On the eastern part of Parcel 2 we brought in clean fill after removing topsoil; approximately 10,000 cubic yards was delivered and graded out as that area was low, and then replaced with topsoil for farming usage until the market demand for retail and building returns.

Closer to the west end of this strip of land is a ditch for water run off that flows north under the highway and eventually to the Rock River, a larger Wisconsin river.  When the time comes for complete grade work and building our engineers will work with the DNR on alternatives for this.  It is not only the ditch that is important when planning out development, but the setbacks the government requires.

As obstacles arise work with people and find solutions for the best of all concerned, and avoid lengthy legal entanglements.

MONEY 15 - LAND DEVELOPMENT #3

THIS IS MY 15^TH POST ON UNDERSTANDING MONEY TOOLS

Land Development Part 3

In this segment we will take the basics of a development from the purchase to finish of land work to turn to a builder/developer using my development in Wisconsin as an example. Again, my blogs are meant to be educational and touch upon the business basics, not in detailed depth.  Please go to: www.premierewisconsinland.com

Or follow along as I describe the land and now it’s 4 parcels.

Two of the most important ingredients of land development are lots of luck and timing!

This aspect will be broken apart so each blog is not too long.

This project is a major interchange in Oconomowoc, Wis. about 30 miles west of Milwaukee near I-94 and combines two state highways. The land was purchased in the 1990s, and was chosen as one of three possible sites for a large interchange including 4 land highway and over pass; one of the largest projects in Wisconsin. The State Department of Transportation

(DOT) selected this land over the other two sites.  Over a year of work with the Department of Transportation was completed coordinating my land work with the State engineers, and then the project was postponed because of funding.  This is where staying power is necessary, as the unexpected seems to always occur. 

The land combined two farms. I took advantage of the DOT’s delays to take down all the barns, out buildings and one old farmhouse, leaving one farmhouse remaining.  The States will pay more for a house and residential lot than farmland, so best to leave something remaining on the land. The Department of Natural Resources (DNR) becomes involved from the onset if you do work on anything over one acre of land, or do major changes to land. With demolishing of buildings comply with State and local permits and standards.  I had to have the acidity of the concrete tested before burying the foundations!

In 2000 the State’s budget was met for the project and the engineering plans once again began.  I had a great law firm working on my behalf and in May, 2004, the State purchased the needed land of 60 acres with a mutually agreed upon price, rather than push the State into eminent domain, where they can take private land for the betterment of the public.

Now, you want to do several things at once:

-Hire a top civil engineering firm.

-Contract with a good public relations firm.

-Hire a market study to be completed that will help confirm optimum usage for land.

-Hire a top architectural firm for conceptual layout.

-Contract for soils tests including wetland studies.

-Contact Departments of Natural Resources and Army Corps of Engineers.

-Contact all utility departments including water, sewer, telephone, and cable companies for fiber optics.

-Stay in close contact and meetings with the State engineering department.

-Meet with the contracting company that wins the bid for the construction of the highway for the State.  You want a close relationship with this contracting firm.

Large projects take time.  This one took 3 years to finish the highway once ground was broken.  I coordinated a lot of land work at the same time.  Normally contractors for the State will have extra soil or fill that can be used for your own development. This may include crushed concrete for berms and other subsurface layers.

Parcel 1 work:  This is approximately 35 acres and best suited for retail/commercial.  Nice residential lies to the east.  Neighborhoods are close-knit communities. As soon as construction starts the people may be up in arms; noise, development, dust, changes to the area. This is where a good public relations firm comes in.  Parcel 1 sloped to the north dropping about 6 feet from one end to the other.  After wetland studies were completed we were losing a few acres to wetlands, and these acres cannot be touched.  Sometimes this can be subtle, and not necessarily wet areas.  The DNR will look for wetland cabbage, cattails, or do acidity tests on the soil to make determinations. 

If you lose acreage because of wetland designation to the State, you can use it as a natural green belt as a certain amount of acreage will need to be dedicated for green belt. 

We eventually brought in 130,000 cubic yards of clean fill to this parcel after removing the topsoil and then graded  it to a 0-1% grade.  Then, replaced 9-12” of topsoil as mandated by the DNR. We want to hold this in agricultural zoning until the economy returns or until the land can be sold to a builder. Farming the land can keep your taxes low. Prematurely rezoning can be devastating from a real estate tax and cost standpoint.

We will continue from here with the next blog.

MONEY 14 - LAND DEVELOPMENT #2

THIS IS MY 14^TH POST ON UNDERSTANDING MONEY TOOLS

Land Development Part Two

Let’s take a simple subdivision of land.  Assume you have two acres zoned residential, the land has no water and sewer to site, but does have electrical, gas, and telephone.  The first step would be to meet with the city planning department if it is in a city, then the county planning office. From past experience my recommendation is to get all approvals in writing. As a case in point, a friend had a home in a town on over two acres with one acre minimum zoning.  In a meeting with the town planner they told him there was no problem dividing off one acre that would permit salability, and that also held true with the county.  After a division of the land, a new survey and the county approval, the town would not acknowledge the division and the lot became worthless. Get it in writing!

Continuing on, select and employ a civil engineer.  They can tell you the needed steps and assist.  You will need at a minimum a new survey that will be needed for the county and town or city. In addition, you may have to do soil studies, wetland studies and studies for the Environmental Protection Agency. Soil studies would be needed for approval of a septic system or alternative waste system.  You will also need to talk with any utility companies involved and perhaps the Department of Natural Resources when involving land in excess of one acre.

Some states have different regulatory laws.  In Arizona where I have developed land the Arizona Department of Real Estate requires a “Public Report” to be given to every buyer of a subdivision of 6 or more lots prior to contract with the buyer.  A potential buyer may “reserve” a lot, however he cannot go to contract without the Public Report.  Essentially, the Report presents all facts about the subdivision and has been filed with the Real Estate Commission.  Any change to a material fact requires the Report to be amended.

There are few large parcels of land being developed now because of the economy.  Even large developer/builders are looking for the bank owned developed lots and not developing land.  Builders also want to limit risk so they are buying small developments where they can get in and get out within a couple of years, unlike 7-10 years ago.

Let’s look at the basics of developing a larger amount of land. This can take 8-10 years and longer to get final approvals so you probably will have to work and budget through economic downturns or at least one recession. Another hurdle that you have no control over is politics, both from government sector and private sector.  A mayoral term is many times 4 years. You may be in favor with one mayor and set of commissioners, and then with a change in local government you run into new people to work with. They may be an obstacle to get final approvals for your subdivision, either halting it or slowing it down substantially.

For a large development procedures are the same to start as the small development except more people are going to be added to the “party”.  The subject property is contracted for sale with contingencies based upon what you want to accomplish and time frames. Most sellers will want additional non-refundable earnest money, or payments at certain periods as they are taking the property off the market.  A person starts with a market study and discussing the proposal with the city/town and county.  You, or a public relations firm, can start on the private sector feedback to see how welcome the project will be. To start, you will have a design/architectural firm who is familiar with this kind of project do a work up including layout, architectural design proposals and most likely a three dimensional plan that the layman can visually understand.  The better they can see the intent and the resultant taxes and benefits to the county/city the more likely you will get a nod toward approvals.

Typically, cities are more restrictive than counties.  If everything looks like a go you will need a good real estate law firm, accounting, civil engineering, public relations and real estate brokerage firms and more.  With good advice from these professional groups they should be guiding you as to what is needed to succeed in that particular environment.

With everything looking good, the property is purchased with financing in place.

Next, we will continue with the development of the land.