Beyond tax-favored savings accounts, there’s a whole universe of scholarships and fellowships that your children can apply for to cover the cost of college. I can’t possibly go through all of these here because there are thousands of them offered by a whole range of institutions. I’ve heard of one scholarship that you can get for being left-handed. Your employer might offer some scholarships to your children, their high school might offer some, and so will colleges. You can find all of the information you need about various scholarships and fellowships online, as there are at least a dozen free websites that let you search for scholarships. There are also many sources of need-based financial aid that you can access by filling out a Free Application for Federal Student Aid (FAFSA) and submitting it to the federal government, your state government, and the college your child will attend. Some private schools will also make you fill out a supplemental form to get their financial aid. You have to fill out a new FAFSA every year if you want to keep receiving financial aid. The federal government has a whole range of grants and subsidized loans for lower-income students, and even if you have plenty of money you should still try to apply for financial aid. The vast majority of students in both public and private colleges receive some form of aid, and it’s worth finding out if you’re eligible in order to save money on education. More than 80 percent of students attending private colleges, which are much more expensive than state schools, receive some kind of aid, so don’t be too proud to go looking for it. When I went to school thirty years ago, there were very few places to turn to for money. That’s no longer the case, yet I still hear plenty of people complaining that there isn’t enough money around to go to a good school. That’s nonsense, and that’s ignorance and laziness. Sorry to be blunt, but I am known as a guy who calls it as he sees it.
There are three really big tax benefits you can get from the government in order to cover the cost of college, but you can use only one of the three. Your choices are the Hope Credit, the Lifetime Learning Credit, and the Tuition and Fees Deduction. Anyone with a dependent who is a freshman or sophomore in college, or anyone who is a freshman or sophomore and is not claimed as a dependent on someone else’s taxes, can claim the Hope Credit, which is a credit of up to $1,650 on the first $2,200 of college tuition and fees as long as your modified adjusted gross income is less than $55,000 if you’re single, or $110,000 for a married couple filing a joint return. The credit becomes smaller if your income is over $45,000 if you’re single, or over $90,000 if you’re married and filing jointly. Remember, a tax credit is basically money in your pocket because your tax bill is reduced by a dollar for every dollar’s worth of tax credits you get. Then there’s a Lifetime Learning Credit, which applies to anyone taking college classes. You can claim this credit if you or a dependent is in college and you make less than $55,000 a year if you’re single, or $110,000 if you’re married and filing jointly. This is a credit of up to $2,000 on the first $10,000 of undergraduate or graduate school tuition and fees. If you’re not eligible for either of these credits, you can take the Tuition and Fees Deduction. This is technically an adjustment, which is a tax deduction that you’re eligible for even if you don’t itemize your deductions. (In any year, you’re allowed to take a standard deduction from your adjusted gross income, or you can itemize your deductions by looking at a list of available tax deductions. I suggest trying to itemize your deductions every year, and then taking whichever deduction, itemized or standard, is greater.) If you or a dependent is in college and you’re paying for it, you can deduct up to $4,000 that you’ve spent on tuition and fees in a given year. That means you don’t pay any taxes on the $4,000 of your income you deduct, which isn’t as good as a tax credit because a deduction of $4,000 will result in only $1,000 of savings if your effective tax rate is 25 percent. At any rate, the Tuition and Fees Deduction starts to phase out if you make more than $130,000, and disappears once you make more than $160,000 a year, as long as you’re married and filing your tax return jointly with your spouse.
Beyond these three big tax breaks, there’s also the student loan interest deduction, which is available to everyone with a modified adjusted gross income under $65,000, or below $135,000 if you’re married and filing jointly with your spouse. This deduction too can be claimed by either the student or someone claiming the student as a dependent, whoever took out and paid back the loan (this could be a parent or a child). This is a great deduction for anyone who’s recently gotten out of school and is still paying off student loans. You can deduct up to $2,500 of interest paid on student loans when you file your taxes.
There are other ways to save money on college. Going to a state school rather than a private school is obviously much less expensive. Going to a two-year junior college and then transferring to a four-year college will also save you money. That said, getting a great education is more important than getting an inexpensive education. If you have to pay a lot of money for your kid to go to a great school, trust me: he or she will earn it all back after graduation. If you’re paying for your kids to go to school, keep this fact in mind. I don’t think that parents should be obligated to pay for their children to go to college, but many parents want to pay, and if you’re one of them, you should know how to do it in the most cost-effective way possible.
The American Dream
Enough about children, let’s talk about the American dream. Buying a home can be a great investment, but it’s important to realize that it’s not just an investment. Sure, owning your home is a great way to lower your tax bill, and generally speaking property values tend to go up over time, but you buy a home because you want to live there. Too many people treating homes as investments is a large part of what led to the housing bust from 2005 to 2007, when I’m writing this book. Speculators bought homes that they didn’t intend to live in. They were going to hold them for a brief period of time and then flip them to someone else at a higher price. But when the bottom fell out of the housing market, those speculators got crushed. Plus, there were all these extra houses that had been bought as investments, but the buyers dried up and the home builders, strapped for cash, kept pumping them out. They became their own worst enemies by increasing the supply. A lot of these people were acting as if real estate always went up, something I can’t blame them for because the only period of sustained declines in homes occurred during the Depression. Until now. Values started to decline in 2006 and continue to decline as I write these words in 2007. I’m not saying buying a home can’t be a great investment, but I am saying you can’t think that investments in real estate will always go higher. It’s not a law of physics. The great thing about a house is that even if it declines in value, you can still live there. The bad thing is that if you have to sell soon after you bought, either because you have lost your job or you need to move, you can no longer be assured that you will even break even, let alone have a gain.
That said, if you can’t pay your mortgage, you’re out on the street. Considering how many people were hurt recently by taking out mortgages they didn’t understand and couldn’t afford, it’s important that you take out the right kind of mortgage when you buy a home. For most people this is very simple: get a fixed-rate mortgage. Your monthly payments will stay the same until you pay off the mortgage. If interest rates decline and you can refinance at a lower rate, then do that. Don’t be tempted into getting an adjustable-rate mortgage, or ARM. If rates go up, your payments will go up and you might not be able to cover the cost. Right now, many people with ARMs are losing their home because they can’t make payments at those higher rates. This is your home; you don’t want to mess it up. For the same reason, you should stay away from any kind of exotic mortgage. The worst example of these is the mortgage that has a fixed low rate for the first two years, then swings to an adjustable rate that can go much higher over the next twenty-eight years. Many people got these loans thinking they could refinance after the first two years, but by then the housing market had fallen apart and credit had gotten tighter. These
people couldn’t refinance, and many of them lost their home. And never count on a piggyback loan, a home equity loan, to pay your actual mortgage. That’s a sucker’s game, although many of the mortgage companies, including some of the ones that went under, encouraged that. If you get a fixed-rate mortgage, none of these shenanigans will happen to you. You could still lose your home if you lose your job and can’t pay the same rate you’ve been paying, but as long as you keep earning the same amount of money, you should be fine.
As for tax savings, there are many different ways being a homeowner helps. If you sell your home and your profit is less than $250,000, or $500,000 if you’re married and file your taxes jointly, then you don’t have to pay tax on the sale. Keep in mind, this is just for qualified homes, meaning your main home or your second home. When you buy a home, the interest on your mortgage is tax-deductible, but again, this is true only for qualified homes. However, you can deduct all of your mortgage interest only if you have less than $1.1 million in the combined amount of your acquisition debt (which is the mortgage you used to buy, build, or improve your home) and your home equity debt (which is any kind of loan secured by the equity in your home that you used for other purposes, on the same qualified home). When you buy a home, you can deduct from your taxes what are called “fee points.” The mortgage lender will usually charge you a loan fee, which is often 1 percent of the value of the mortgage. One percent of the value of the mortgage is considered 1 point. So if you took out a $100,000 mortgage, you would pay a $1,000 loan fee to the lender. That $1,000 fee is tax-deductible. You can deduct part of the interest on a home equity loan. You can deduct the interest on a home improvement loan as long as you don’t use that loan for repairs. You can deduct the amount of money you pay in property tax from your income tax, and you can deduct water and sewer taxes too. And you can deduct any costs relating to selling your home.
Owning a home is a tax-deduction gold mine, which is why, despite all of the frightening talk about homes, they will always be a good investment if you buy them wisely. If you buy a home, you can get bountiful tax credits that aren’t available if you rent. For example, there’s a tax credit for energy-efficient home improvements. As long as you buy new, qualified energy-efficient equipment and keep it for five years, you can get a tax credit of 10 percent of the purchase price, up to $500. If you buy a solar panel—and I don’t know why you’d do that because those things are hideous—but if you do, you can get a tax credit for 30 percent of what you paid for the solar panel, up to $2,000.
There is a downside, though. If you sell your main residence at a loss, you can’t claim this as a capital loss and deduct the loss from your taxable income. With stocks, you can deduct your capital losses, and this can really help to lower your tax bill, although I don’t recommend making tax deductions a priority when you invest, because focusing on avoiding taxes rather than making money can compromise your ability to be a good investor.
There are many other important tax breaks out there related to getting what you want. They can help you start a family, buy a home, and send your children to college. As far as I’m concerned, these are some of the most important things in life, not just the most important financial aspects of your life. Saving money when you’re supporting someone you love or buying something you want more than anything else in the world is almost as good as making money. I regret that I didn’t say more on this subject in Real Money, but that book was meant for trading and investing your way into wealth. Stay Mad is about making and saving money every way you legally can.
At this point, you know enough about personal finance to get rich and stay rich, but all of that can take you only so far. If you really want to try to get rich, you need to know not just that you should invest, not just what kind of tax-favored accounts to use as an investor, but also what you should actually invest in, and how you can become a better investor. I’ve already written a great deal about the specifics of being a great investor in my previous books, but now I’ll teach you things you’ve never learned before, and I’ll reveal my favorite stocks and mutual funds for long-term investors. That way you can put away as much money as you can and grow that money far beyond what you ever dreamed possible. In an era when houses are no longer a sure thing, that’s the real American dream.
6
TWENTY NEW RULES FOR INVESTING
For twenty years, I managed money professionally, taking the funds of rich people and trying to make them richer. I was in a performance business; I got to keep 20 percent of the gains, even if they were only on paper. There are two kinds of gains in the business: realized and unrealized. When you sell a stock for profit, that profit is a realized gain. When you own a stock that’s up from where you bought it, that’s an unrealized gain. At the fund I took 20 percent of both realized and unrealized gains. I also received 1 percent of the assets as a management fee. I initially reported to my investors once a quarter, but increasingly they asked for monthly, then weekly, and ultimately daily performance figures. As my assets grew and my performance fluctuated by the hour—I needed to make $430,000 a day just to continue my yearly returns—some clients asked for my numbers hourly.
With that kind of pressure, I began to focus entirely on short-term returns. If I could have a good day, I could satisfy the investors who checked in by 4 p.m. A good morning, and I didn’t dread the hourly calls. In my last two years I installed software that flickered reds and greens along with down and up arrows every tenth of a second, all the better to see whether I was making or losing money at that very moment.
Needless to say, I felt like was on a daily treadmill from 4 a.m. until 4 p.m. as I traded early morning in Europe and then the U.S. markets right until the closing bell. Thank heaven my investors didn’t demand nightly returns. I used to trade from 4 a.m. until 11 p.m., breaking only for a quick dinner before Tokyo opened. I was able to stop that insanity only after Tokyo peaked in 1989, and I never looked back.
I give you all of this information because I could not wait to retire from such an insurmountable minute-to-minute challenge. Although I have had a love of stocks my whole life, I do not have a love of report cards, and I was being graded with every tick of the symbols in my portfolio.
And I wanted to resume another passion I had, journalism—this time not just print, but Internet and television journalism. I wanted to stay in the game, but I couldn’t be a legitimate journalist and a serious investor of my own money at the same time. To be a journalist I had to agree to provisions in my contract that wouldn’t let me profit from any securities. That led to a wholesale sell-off of every stock I had, a retreat from all hedge funds, and a charge into real estate and cash.
And you know what? I was miserable. Just miserable. My beloved stock market was marching on without me and I wanted to get back into the band!
I struggled mightily for a formula that wouldn’t let me profit but that would let me show others how the game is played, and I came up with a charitable trust model. I would put money into a trust that would distribute the profits to charities of my choosing at year-end. None of the gains could accrue to me.
Very quickly, through mention on TheStreet.com and CNBC, people wanted to know what I was doing with the trust and whether they could follow along. So I created a website and an electronic newsletter, ActionAlertsPlus.com, which you have no doubt heard of if you watch Mad Money or read TheStreet.com’s RealMoney.com section, where my blog appears. For a fee, I would show you how I would manage my personal stock portfolio. In order not to profit, lest the product become a big success—which it has, the largest paid subscription e-newsletter anywhere—I let you buy the stocks ahead of me and sell them ahead of me. Unfortunately that has skewed performance down for me, but it doesn’t matter because it skews it up for those who subscribe to the newsletter.
The business of running money personally, not being in the hedge fund world, has been incredibly eye-opening for a number of reasons. First, I am, at last, able to think longer-term, which is incr
edibly liberating and refreshing for me. In fact, I’m forced to think longer-term because of a whole variety of restrictions on the charitable trust that prevent me from trading stocks in the short term. I love the idea of being able to buy something and let it work over time, which is good because that’s all the charitable trust lets me do. I try to have a six-to eighteen-month time frame for all my buys, which gives them a chance to truly percolate and blossom. As you will soon see, when I don’t let them do so, I don’t make as much money at best and perform quite poorly at worst.
Second, I think I have become a much better investor. That’s because when I was at my hedge fund, we were in a very different world, an unregulated world where the big boys—including me—could always outperform small investors. We were able to call managements any time up until one month before the quarter—the so-called quiet period when they knew approximately the results of the quarter and weren’t allowed to give them away—and ask how things were going. That allowed us to have a better idea than anyone else whether a given company was going to beat the estimates, meaning it would report a better-than-expected quarter or a worse-than-expected quarter. Given that the biggest determinant of a company’s stock, besides its sector, is whether or not it will beat the estimates, these calls were money in the bank.
Jim Cramer's Stay Mad for Life Page 17