How Buffett will Avoid the Buffett Rule, and You Can Too


Ask SmallIvy:  Please send investing questions to vtsioriginal@yahoo.com or leave in a comment.

Warren Buffet, the Sage of Omaha, has been complaining lately that his tax bill is not high enough.  He famously talked about how his cleaning lady (later changed to his secretary when the story is retold by others) pays a higher tax rate than him.  He has said that the wealthy should pay more in taxes.

As a result, the Obama administration has released what they call the Buffett Rule.  This is a new tax on those making more than a million dollars.  The trouble is that Warren Buffett did not make a million dollars last year.  In fact, he didn’t even pass the $200,000 threshold that President Obama has cited as “rich.”  He only made a salary of about $180,000.  So what gives?

The issue is that Mr. Buffett does not take a large salary.  Instead, most of his wealth is tied up in long-term capital gains in Berkshire Hathaway stock (the ones who bring you the talking gecko commercials).  This means that he pays no income taxes on his most of his wealth, despite being worth billions of dollars, since that is only a paper profit until he sells the shares.  So, unless there is a tax on wealth, he will continue to pay a lower tax rate than his cleaning lady.  (Note that the companies he owns stock in pay a fairly large 35% income tax, which affects his share prices.  He therefore is actually paying taxes on his wealth, as are all investors, which is the reason for the argument for lower capital gains taxes.  The point here is that the Buffet Rule will not cause Mr. Buffett to pay any more taxes).

But at least when he dies the wealth will be taxed as the money is inherited by his children right?  Not exactly.  You see, Mr. Buffett, like many billionaires, has created a foundation in his name and given a few billion to his foundation.  (Originally he was going to give most of his wealth to the foundation, but decided later to give the bulk to the Bill and Melinda Gates Foundation).  The foundation can then hire his children.  They can work in a big foundation-provided office, live in the foundation-provided houses, drive the foundation-provided cars, and take foundation-provided trips in foundation provided airplanes to perform “research” for the foundation.  He has been able to use his wealth to set his children, and probably his grandchildren up for life without ever paying a dime of tax on this wealth.

So, what can be learned besides the hypocrisy behind the Buffett Rule?  One can learn is that by buying stocks long-term and holding onto them, one can avoid personal income taxes almost indefinitely.  One can even avoid paying personal income taxes ever if the proceeds are given away to a qualified charity or, if wealthy enough, one sets up a foundation.  While it seems  exciting to trade stocks regularly, all you are doing is generating brokerage commissions and taxes.  To really use the tax-deferral properties of common stocks, invest for the long-term.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Make Money through Individual Stock Picking


Don’t forget – send your investing questions to vtsioriginal@yahoo.com or leave a comment.

Having discussed the factors that affect risk and the potential return in previous posts, I now lay out a
strategy for investing tied to life stage.  Note that this differs
somewhat from the standard advice that favors large amounts of
diversification from the very start regardless of age.   Some
advisers will even recommend against investing in common stocks
directly at all because they believe sufficient diversification
cannot be achieved without mutual funds.    For them one must be
invested in thousands of different stocks in every sector of the
market.

And yet thousands of people start their own business and succeed each year.  In that case
they are betting on one company – theirs.  This would be extremely
risky for an individual who is nearing retirement and needs to
succeed to eat.  When one is young and has a long time frame,
however, that time frame gives enough time to wait for businesses to
grow and succeed.  Likewise, that long time frame allows for one to
recover when things do not work out.  It therefore makes sense to use
less diversification and only buy the best companies while one has a
longer time frame.

The strategy therefore is to buy large interests in companies with good prospects for
substantial growth in the years ahead while one is young and has a
long time horizon.  One is acting like a silent partner in these
companies.  This is as opposed to trading stocks, where one is trying
to pick the stock whose price will go up soon, or simply buying the
market through a diversified set of mutual funds.

Because one will not have a large amount to invest at this stage of life, shares will be bought
over time, 100-200 at a time, until good-sized positions are held
(500-1000 shares) in a few companies.  Maybe you’ll have a growing
internet company, a retailer, a restaurant chain, a healthcare
company, and a software company in your portfolio after a few years
of saving and investing.  You’ll be buying only the best prospects –
there is no reason to select anything but your top pick in a sector
since, unlike the mutual fund manager, you don’t have enough money to
affect the prices of these companies.

The lack of diversification and the selection of younger growth companies will
cause large gyrations in your account balance from month to month.
While this would be foolish if you were only investing for a year,
the long time horizon allows for patience.  While short-term market
forces may cause the price of some stocks to languish, eventually the
growth of the business will lead to a growth in the price of the
stock.

Hopefully one will pick a few winners (there will certainly also be some losers).  As some of
these positions become large (say, $50,000 or more), one would sell
off some of the shares and use the proceeds to invest in other
companies.  The cardinal rule is again to never have more in one
position that you would be willing to lose.  This will lead to
natural diversification as your portfolio grows.

As one grows older and has more capital to protect, some of the money would be put into more
stable companies and placed into mutual funds.  More diversification
is also favored to help protect against events at any one company
resulting in a large loss.  A percentage of the portfolio would
remain in your best-of-the-best picks, but this percentage would
decline with time as you shift from asset growth to asset protection.
This allows one to hold onto gains that have been made while still
allowing for some growth.

Note that a small gain in a large portfolio will provide the same dollar return as a large gain
in a small account.  Ironically the dollar amount held in the young
growth companies may remain about the same with time.  It will just
become a smaller percentage of the account since the account will get
bigger.

Having outlined the strategy, I’ll now describe the life stages with more detail.  Before
one ever starts investing, however, one need to put his financial
house in order.  To start investing while deep in debt will only
result in disaster.  One will never be able to overcome the 18% rates
charged by credit cards.  Likewise, not having cash on hand to handle
life’s little calamities will result in needing to sell stocks and
pay capital gain and commissions each time a car breaks down or the
furnace goes.  Investing in individual stocks without putting away
other funds for retirement is also not wise.  Here are the things
that must be done before you ever buy your first shares of stock:

  1. Save up an emergency fund of 3-6 months worth of expenses.  This will allow you to fix
    the car without needing to sell stocks or pull out the credit card.

  2. Pay off all credit cards and cut them up.  Really.  Start paying extra on the smallest
    balance and then as each is paid, roll the extra money saved from
    not having payments into the next largest debt.

  3. Pay off student loans and pay off or sell cars with large balances and buy less
    expensive ones for cash.

  4. Fund your retirement accounts with 15% of your take-home pay in growth stock mutual funds
    in tax protected accounts.  This will ensure you have funds for
    retirements even if you have terrible luck in stock picking.

  5. If you have a home loan, refinance into a 15 year fixed rate loan.  This will mean that
    your house will actually be paid off in 15 years.

Once you have accomplished the above, you are ready to start investing and growing
wealth.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Getting Rich Requires You Work Together


Money and money fights are leading causes of divorce.  Often it is actually the burden of debt that drives people apart, but certainly it is very difficult to grow wealthy unless both partners are aboard with the plan.  Just as you’ll only go in circles if one person is paddling a canoe on one side with more force than the other is putting in on the other side – no matter how hard the stronger person strokes – it is impossible for one person to out-earn the spending and poor financial management of the other.

An issue with many couples is that they never really come together with their finances.  Despite the preacher declaring them “one,” there is a still a sense of her money and my money, his debt and my debt, her earnings and my earnings.  In a two earner household it doesn’t matter who earns more money.  Likewise, in a one earner family where one parent is raising the children it doesn’t matter who is doing the important work and who is working the 9-5 job.  It is still “our” money, and “our” debt.  It also needs to be “our” plan.

The first step in working together is developing and agreeing to a budget.  More than just a plan on spending and saving money, the budget is an agreement on what to do as a couple.  Because most important decisions involve money, this has the side benefit of opening up communications about goals and needs.  There should be no asking permission to make purchases – purchases should be agreed upon in the budget and then the budget executed without further questions.

Before the month begins there needs to be agreement on how money will be spent, saved, and invested.  The best approach is to have one person construct the budget and then have a meeting to discuss it and agree on a final form.  It is very important that both people have an equal vote – no running one spouse over or just giving the cop-out “whatever you want to do.”  This only builds resentment.

Once the budget is constructed and agreed upon, it must be binding on both individuals.  If something comes up, try to resolve it within the budget.  If it absolutely can’t be resolved, get back together and determine how the budget must be adjusted.  In doing so, the impact of the decision is seen.  “We can buy that new TV, but it will reduce investments by $500 this month.  Is this really what we want to do?”  Note that a small amount of money each month, say $100, should be given to each individual to spend any way they wish, no questions asked.

 A second consideration is to primarily have only joint accounts.  There should be no “my account” and “your account.”  There should be no hiding of money or spending.  If you trust the person enough to sleep beside them you should trust them enough to have access to your money.  (A special exception would be if one person had an addiction to gambling or  substances, but this is a special case).

The exception to having only joint accounts is that in the event of a sudden death of one spouse, assets in a joint account might be encumbered, depending on the laws of the state.  It is a good idea to ask this question of an attorney when doing a will (which everyone should have).  If access to money might be an issue, having separate accounts with a few month’s worth of expenses would be wise.  These accounts should be primarily dormant – all spending and income should go into the joint accounts.

So, before saying “I do,” be ready to merge everything, including accounts and debt.  A strong marriage is built around working together.  Remember also, one of the primary factors millionaires site in gaining their wealth is a supportive spouse.

If you have investing questions, please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.