Financial Frontlines®

There is a credit card scam going around where an email indicates that the writer is with the VA prescription drug group. This scam is phishing for credit card numbers. There is no such VA effort taking place. The VA hopes to get a press release out about this scam this afternoon.

The IRS extended the First-Time Homebuyers Credit from last year and improved upon it. For homes purchased under the 2008 program, the credit was worth up to $7500 and it was actually an interest-free loan. The $7500 had to be paid back over the next 15 years.

For homes purchased under the 2009 program, the credit is worth up to $8000. Unlike last year, this credit does not require repayment unless the home ceases to be your main home within 36 months of purchase. The credit amount varies. You can claim the smaller amount of 10% of the purchase price OR $8000.

The program applies to:

• First-time home buyers. “First-time” home buyers are people who did not own any other main home during a 3-year period prior to your home purchase.
• Home purchases in the U.S. between April 9, 2008 and before December 1, 2009.

A “main home” is one where you live most of the time. It can include single family homes, townhouses, condos, houseboats, house trailer, or other types of residences.

The credit does have restrictions. The credit is phased out with income on line 38 of your Form 1040 of $95,000 for single filers or for married filing jointly, $170,000. See the IRS web site for more information and disqualifying rules; http://www.irs.gov/newsroom/article/0,,id=204671,00.html.

Wow, this program has caused quite a state of confusion and for good reason.

The tax withholding reduction (up to $400 for individuals or up to $800 for couples) applies to “earned income”–people still earning a paycheck with an employer.  They will have their payroll taxes reduced and at the end of the year receive a tax credit for the reduced amount.  So you pay fewer taxes now (more pocket money) and won’t owe the tax later.  Each wage earner in the family may have this reduction applied to them by their employer.  However, the dual income family can apply only one tax credit at the end of the year for up to $800 per joint tax filing. 

Retiree checks are not eligible for this program.  However, retiree checks use the same tax withholding tables as paychecks.  So our retiree checks will reflect the tax withholding decrease.  That means you either increase your withholding to compensate for the withholding reduction or be ready to possibly owe more taxes when you file your 2009 income tax returns.

If you also receive Social Security and/or VA Compensation, you will receive a one-time lump sum amount of $250 in one of your monthly checks in the next few months.  If you also work and receive either VA or SS checks, that means you receive the payroll tax withholding reduction AND the $250 lump-sum HOWEVER the $250 will be subtracted from your payroll tax withholding credit. 

IRS site: http://www.irs.gov/newsroom/article/0,,id=204447,00.html

DFAS My Pay site for tax withholding changes: https://mypay.dfas.mil/mypay.aspx

Hope this helps.

The Fair Credit Reporting Act allows military members away from their normal duty station to place an “active duty alert” on their credit report.  This program is designed to minimize the risk of identity theft while you are deployed.  It works by forcing a business or credit agency to verify your identity before any credit can be issued in your name.  The alert is good for one year and can be cut short or lengthened if need be.  For details on the program and how to establish your alert, check out this Federal Trade Commission web site:  http://www.ftc.gov/bcp/edu/pubs/consumer/alerts/alt147.shtm. 

So you’ve heard it a hundred times.  Only invest in stocks if you have a long term horizon.  Here we are in this economic downturn and some of you nearing retirement are wondering, “What is long term?  I have 5, 10, 15 years to go.  Is that long term?”  I have to share a little information to lead up to the answer.

Start with the fact that our economy goes through up and down cycles as a normal course of events.  The cycle goes up when demand for goods and services goes up and the supply system kicks in to meet demand.  Demand decreases and the cycle heads down because the need for goods and services decreases.  We are currently suffering from exaggerated demand fed by easy credit and the lack of personal savings—the rally cry was spend, spend, spend!  The economy overheated; AKA “the bubble.”  This resulted in an overextended supply system as it worked to meet artificially high demand.   We are feeling the pain as the supply system readjust to a normal state.  Retail sells down, lower production, loss of jobs, higher savings, tighter credit…  How long can it last?

“How long can it last?” and “What is long term?” are related.  We are talking about economic ups and downs.  The Gross Domestic Product (GDP) is a measurement of the state of our economy; economic growth or not.  Consumer and business spending are significant parts of the GDP along with government spending and exports-imports.  Typically the GDP increases 2.5 to 3% a year.  So growth is the norm.  That’s a good thing and indicates your investments are up more than they are down most of the time.

Here’s a chart of our GDP from 1930 to 2007 (I’m using 2007 because I have a full year’s data through that year):

Lots of positive and little negative.  But when negative hits, and depending on the timing of when it hits in your life plans, it can be painful.  The average GDP downturn, or recession, lasted 10 months.  We are in the 14^th recession since 1930.

Let’s compare the GDP chart with what happened during the same time period in the stock market as measured by the Dow Jones Industrial Average.

Because the stock market is driven by company earnings, the rather consistent nature of positive GDP growth drives nice growth in the stock market.

Come on Shane, what’s the answer!  Well, of course it depends on several factors.  Nothing is cut and dry.  Are you still working?  How long have you been working?  How much have you saved?  What is your allocation in your investment portfolios (401k/IRAs) between stocks and bonds?  How many more years until retirement?  Are you still contributing to your portfolios?

If you are still working and contributing to your portfolios, you will regain your “losses” quicker by having a majority stock portfolio and through consistent purchases during the down period.  Your rebound time averages approximately one year for younger workers (< 10 years on the job) and approximately 2 years for more senior workers (> 10 years on the job).  Buying while the stock market is low decreases the share price of your holdings by increasing the number of shares bought and owned at cheap prices.  When the market rebounds, you don’t have to wait until the market returns to its pre-recession levels because you have lowered the bar, so to speak, with a lower average share price in your portfolio.  What?  If you buy a shirt for $30, your average shirt cost is $30.  If you buy two more shirts at $10 each, your average shirt costs is now $16.60.  If this was the stock market instead of shirts, to be back at even, the market would only have to climb back to $16.60 and not $30 to make you whole.

If you aren’t working and/or not contributing, your wait is longer.  This is assuming you remain invested in stocks.  Let’s look at this a couple of different ways.

First look. If you start the clock right now at your current account values, then, approximately 80% of the time you’ll be in positive territory after a 5-year period.  You’ll have a 95% chance of a positive return over a 10 year period.  And over 15 years you are virtually assured a positive return.

Second look.  You want to know when you will be back to whole based on your October 2007 account value.  No one knows the answer to this.  Historically, it has taken up to 20 years after the Great Depression but usually it is less.  If this is your objective, to be made whole the quickest way possible, you’ll need an outstanding stock picker–not probable.

For the future, all you workers must understand the economic cycles and how they affect your portfolio.  If you are 10 years or less from retirement, note if we are rising or falling in the cycle.

If we are rising, start pulling profits off the table on the way up to lock in your gains.  Don’t get greedy and ride the wave all the way up before you pull the profits.  You’ll get caught as the cycle goes over the top and you will lose value fast.

If the cycle is falling, buy like there is no tomorrow.  Decrease your average share costs and prepare for the rebound.

We’ve had two bubbles burst since 2000.  We should have learned our lessons by now and know how to react.  There are so many variables in this discussion that we can only hope that things go according to the norm.  Then we somewhat know what to expect.  Best wishes everyone.

Thanks to data and reports from the Dow Jones, Washington Post, Employee Benefit Research Institute, Department of Commerce, Bureau of Labor Statistics, U.S. Bureau of Economic Analysis, and American Funds.