‘Do not expect the fund’s quoted past performance to continue in the future. Studies show that mutual funds that have outperformed their peers in the past generally do not outperform them in the future.  Strong past performance is often a matter of chance.’

Key components Empirical Study PDF (Key pages selected)

Investors are constantly bombarded with information and news about what investments are ‘hot’ and the best strategies for ‘the new environment’ we’re in.  Unfortunately many investors fall prey to the hype and fail to understand tax implications, Government implications, and pure economics.  Deciding to torment myself, I sat down to watch Fox News and the investment show “Cashin’ In”.  What then unfolded was purely beyond my wildest imagination.

One guest suggested that everyone move to ‘Good Dividend stocks’—and frankly, why not?  Good ones are much to be preferred over ‘Bad’ ones! (a slight hint of sarcasm)

So here are a few simplistic, quick facts concerning dividend paying stocks so all of you can understand what a dividend paying stock is and what it means:

1.    Companies disburse their profits over the year through a dividend to the shareholders of the company.
2.    Companies without profits do not pay a dividend.
3.    Some companies choose not to pay a dividend because they instead re-invest the money into the company via expansion.
4.    In tough economic times (such as 2008), many banks and companies slashed their dividends since there were no profits.
5.    Just because a company may pay a 3 or 4 or 5% dividend each year doesn’t mean that the stock can’t go down 10, 20, 30% or more—thus eliminating any temporary pleasure that came from the dividend.

How About Taxes on ‘Good Dividend Stocks’?

Tax Issue #1:
Beginning in January of 2011, the favorable 15% tax on dividends will expire and the rate returns to previous ‘ordinary income’ taxation.  So what?  Well, if you earn more than $66,000 that means an additional taxation of 13% (28% total).  Now I can hear you say……”but the tax bracket is 25% Bryan.”  Not so fast!  In 2011 we revert to year 2001 tax codes. Remember also that the top bracket goes from 35% to 39.6%.

Tax Issue #2:
Come 2011, the Government has initiated a limitation in deductions and deductibility based on an individual’s income.  This will basically add an additional tax of 1.2% to most families.

Tax Issue #3:
In 2013 we get the fantastic new health care tax on investment income which will add an additional 3.8%.

In final calculations, we could expect to see on the high side a total tax on dividends of nearly 44%.  So how will such a tax complicate dividend paying stocks?  You tell me.  But with 44% higher cost of doing business, I figure many investors will be ‘less inclined’ to purchase a 5% yielding stock when in reality it will mean 2.8% after taxes.  Supply and demand then dictate a potential drop in the price of such stocks.

Does this mean I throw dividend paying stocks down the drain?  Absolutely not.  They should be a part of any investment plan as a whole. For example, if you own an index fund, you will own many companies that are paying dividends.  To have one single stocks for dividend payments only, however, is rather risky and extremely irrational (in my humble opinion).

So What Should I do?

Go back to basics and develop an investment strategy not based on the ‘pick of the day’ or the ‘fund of the week’ but instead focuses on these primary factors:
1.    What are you attempting to accomplish?
2.    How much risk are you comfortable with?
3.    Understand that 90%+ of your return will come from Asset Classes (Large US, Small US, Commodity, US Small, Int. Small, Emerging, etc) and not from mutual fund manager brilliance or skill.
4.    Learn the total cost of your investments and question “what am I getting for this?”
5.    Rebalance, Rebalance, Rebalance.

Lastly, order the 7 Deadly Investor Traps CD and learn the traps that easily wound and kill many investors.

The crazy thing is if you look at major news outlets all the titles are of doom and gloom–Proving once again we have no idea what markets or stocks will do but we can have faith in the long term success of investing across various asset classes while managing our risk.

Many people expect that taxes have to rise especially since the Government has been borrowing billions to rescue the economy.  Due to this, a growing and ballooning deficit has taken its place. With the implications of this growing deficit obvious to everyone, those who govern will be looking at all areas to reduce this indebtedness. Raising revenues ’should’ be high on the Government’s agenda especially with impending expenditures of Social Security & Medicare as baby boomers retire.  Because of these factors either programs have to be cut or  taxes will have to rise.

Monday’s WSJ article titled “To Fix Deficit Tax Man Must Knock on Many Doors’ looked at three scenarios for taxes:

1) Proportionally raise all rates

2) Proportionally raise rates on the top three categories

3) Proportionally raise rates on the top 2 categories. (Note: this is an Obama pledge – to not raise taxes on those making less than $200K. So the first two options violate that pledge).

Under scenario 1, The Tax Policy Center found that Washington would have to raise taxes by almost 40 percent to reduce – not eliminate, just reduce — the deficit to 3 percent of our GDP, the 2015 goal the Obama administration set in its 2011 budget. That tax boost would mean the lowest income tax rate may jump from 10 to nearly 14 percent, and the top rate from 35% to 48% percent.

Under scenario 2, the top three rates would jump from 28% to 52.6%, 33% to 61.9% and 35% to 65.7%. It should be noted the Tax Policy Center looked at two other scenarios: 1) eliminate itemized deductions or limit the value of said deductions to 15%. They found that neither one would generate enough revenue to meet the deficit.

Under scenario 3, the top two tax brackets would increase from 33% and 35% to 72.4% and 76.8%, respectively.

WSJ TAX MAN COMETH ARTICLE

While many  find it inconceivable that we will end up under scenario 3, let us not forget that until JFK’s tax cut in the early 60’s, top tax rates were over 90%.  JFK’s tax cut brought it down to 70%.  Reagan’s cuts then brought it down to 50% and eventually 35% in 1986.  I would expect some combination of higher income tax rates, especially on high income earners combined with a Value Added Tax (VAT tax). VAT taxes have been used by many countries for many years so we can expect them here to help battle the deficit, entitlement spending and runaway social programs.

An interesting calculation I just saw  is by Steve Dudenhoeffer and it shows each individual citizens share of the deficit.  But wait!  This is different because it shows  how this measures out based on WHO actually pays taxes.  Remember, only about 1/2 of all Americans pay taxes.
http://politicalponderer.blogspot.com/2009/10/how-much-do-you-owe.html

So what would I recommend if  someone  made me in charge of the government?  Here’s The Financial Coach’s approach.
1.  Cut Corporate tax levels to 10% but  only if the company employs a certain percentage of their employee’s in the US.  This would return jobs to America that have left our nation due to higher labor costs, legal costs, Gov. Regulation costs and taxes.

2.  Establish a national Flat Tax along with a National Sales Tax and cut capital gains taxes to 10%.  By simplifying the tax code more revenue will be collected and overall productivity will increase since taxpayers will not be ’stressed’ with trying to fill out tax forms, maintain records and etc.  A NST would provide additional revenue and a lowering of the capital gains rate will INCREASE new businesses, development, and investment.  This means jobs and wealth creation.  Obstacle: Government and Tax Professionals that depend on taxes for a living.

3.  Decrease Government regulation on businesses.  Big Business is actually ‘dependent’ on Big Government to help drive COMPETITORS out of business.  A large company can absorb the cost of legal teams and regulation while smaller companies are stymied and driven out.  Let the Free Market Rule and Reign.

4.  Change Entitlement Programs:  Maintain current promised benefits for retiree’s and future retiree’s 54 and older.   Increase the retirement age for anyone under 53 to age 70 for full retirement benefits from Social Security.  Eliminate early retirement benefits except in the case of medical or health conditions.  OBSTACLE: You name it.  Win support from retiree’s by keeping benefits in tact and win support from younger people by making SS private investment accounts.

5.  Begin a new education policy that creates a system in which anyone that drops out of school or fails miserably can never be eligible for housing assistance, medicaid or other government programs.  End the cycle of dropping out only to be on the welfare roll for life.