Don’t let emotions drive your investment decisions

Remember August 8, 2011?

That’s the day the Dow Jones Industrial Average fell more than 600 points after the first-ever Standard & Poor’s downgrade of U.S. debt. The Dow’s one-day drop was its biggest point loss in a single day since December 1, 2008, and the sixth biggest point drop in its history. On that day the Dow closed down 634 points (5.6%) to 10,810. That single day’s decline in stock values wiped out about $2.3 trillion in investor wealth in the U.S. What happened to investors who panicked and sold their stocks or stock mutual funds that day? By letting emotions control their investing decisions, they locked in their losses.

According to studies in the field of behavioral finance, various biases tend to drive our investment decisions. For example, many people succumb to “anchoring” bias. That’s the irrational decision to hold on to something — a stock, a car, a piece of information — just because you already own it. Or you might fall prey to “recency” bias, the assumption that events in the recent past are a reliable predictor of the future. The stock market’s been going up, up, up. So you jump on the bandwagon, assuming that the next twelve months will mirror the prior year. Don’t count on it. When emotions rule the day, investment portfolios suffer.

To curb emotional investment decisions, consider the following two time-tested strategies:

  • Dollar-cost averaging. This is a strategy in which equal dollar amounts are invested at regular predetermined intervals. Percentage contributions from your biweekly paycheck to a 401(k) account are a good example of this type of investing. When the market’s falling, you buy more shares in a stock mutual fund because the price of those shares is falling. Conversely, when the market’s climbing, you enjoy the appreciation of your existing shares and buy fewer shares at premium prices.
  • Diversification. Because markets seldom move completely in unison, the strategy of investing in different industries, different countries, and different types of investments (stocks, bonds, and real estate, for example) can help reduce risk without substantially diminishing overall returns.

Above all, be honest with yourself. Sometimes a trusted advisor can provide an objective set of eyes to steer you away from poor investment decisions. You might also want to keep a journal to help you slow down, analyze your investment decisions, and allow your emotions time to cool off.

How important is location to business success?

How important is location to business success?

For years, real estate developers have recited the mantra of “location, location, location,” and start-up businesses do well to take heed. Location is often the single most important determinant of a company’s success or failure. Place your brick-and-mortar building in a prime locale and, other things being equal, the firm will have a greater chance of accomplishing its objectives. Set it down in the wrong place, and the business may struggle for years.

What factors should you consider when deciding where to locate your fledgling business?

  • Type of company. If you’re starting a roofing business that plans to provide services at clients’ homes, location may not be as important as, say, a barbershop that takes walk-in customers. The same might be true of a company that deals mainly with suppliers and vendors (a wholesaler, for example) versus a firm that generates revenue from drive-by traffic.
  • Demographics. A careful study of your customer base should factor into the location decision. A child care service that caters to busy professionals will need a location that makes drop-off and pick-up easy and secure. A store that sells geriatric supplies to senior citizens may want to make easy access a priority. If your customers are mostly teenagers, a mall setting may fit the bill.
  • Competitors. Ever notice how fast-food restaurants are often clustered along the same highways or near the same malls? Hotels and motels often locate near each other as well, in close proximity to airports and freeways. It may seem counter-intuitive, but placing your storefront close to your competition is often a wise choice. You can take advantage of your competitor’s marketing, and customer traffic they’ve generated may spill over to your store. If Home Depot doesn’t stock that widget, your specialty hardware store is just around the corner.
  • Affordability. Be realistic and find a location you can afford. A spot in an upscale mall might be great for snagging boutique customers, but if those clients don’t bring in substantial revenue, rental costs may eat your business alive. You might be better off locating on a busy street near your target demographic. By renting a more affordable space, you’ll ensure that more of your income stays in the company.

Above all, remember: There’s no substitute for doing your homework — before you put down roots.

Late filing IRS penalties

Late filing penalties

Sometimes smart people forget to do smart things — and when taxes are involved, a lapse of memory may be costly. For example, two penalties can apply if you forget the federal income tax filing deadline.

  1. The failure-to-file penalty is assessed each month or part of a month from the due date until you submit your return. The penalty is calculated on the net amount of tax you owe — so no tax due means no penalty.
  2. The failure-to-pay penalty comes into play when you owe tax but fail to pay it by the due date of your return. This is true even if you received an extension of time to file the return.

When both situations apply — that is, you did not file a return and you would have owed tax if you had — the penalties can be combined.

The failure-to-file and failure-to-pay penalties may be abated when you have good reason for forgetting to send in your return and/or your payment. What’s a good reason? One example is when paying the tax would cause undue hardship, such as a situation where you are forced to sell property at a sacrifice price.

An extended period of unemployment may also qualify you for relief. As an illustration, you could request a one-time extension to pay your 2011 income tax if you were unemployed for 30 consecutive days during the fifteen months prior to April 17, 2012. The extension may also be available if your 2011 business income dropped by 25% or more due to economic conditions.

Give us a call if you haven’t yet filed your return or paid your income tax for 2011 or an earlier year. We can help you find a payment option that will keep the penalties to a minimum.

Gambling income is taxable

Gambling income is taxable

Think it’s a good bet that Internet gambling will soon be legal in your state? One thing is sure: A payoff from that wager, or any other, is taxable income. So are prizes from bingo, lotteries, raffles, and radio station contests.

Those winnings, and others, are taxable whether or not you receive Form W-2G, “Certain Gambling Winnings,” from the sponsor of the wager or contest. It doesn’t matter how much you win either. On your federal income tax return, all your lucky bets are ordinary income, taxable at your regular rate.

What about unlucky bets? Gambling losses are deductible — as long as you itemize. That means you’re not allowed to subtract your total losses from your total winnings and report the net amount on Line 21 of your federal Form 1040.

Instead, you claim some of your losses as an “other miscellaneous deduction” on Schedule A, Itemized Deductions. Why only some losses? Because the rules limit the amount you can deduct to the total of the winnings you report.

A minor consolation: Gambling losses are not subject to the two-percent-of-AGI haircut, so the only limitation is the amount of your winnings. Of course, you’ll also need to be able to support your total claimed losses with records such as the actual vouchers or a log book.

Give us a call before you cash that winning  ticket. In addition to helping you sort out the tax reporting, we have planning suggestions so you can keep more of your windfall.