Expiring Tax Provisions: How You Probably WON’T Be Affected

November 28, 2013 — Sam H. Fawaz

Happy Thanksgiving! I hope that your families and you have an enjoyable holiday and (hopefully) extended weekend.

You may have read that the last day of 2013 is scheduled to be the last day for an estimated 57 different tax deductions–unless the U.S. Congress turns its attention away from the next potential government shutdown and extends some or all of them.  All of these deductions will be available to the 2013 tax return that you file by April 15.  But as it stands now, they won’t be available next year, creating another potential stealth tax increase in 2014.
 
How will this impact you?  Only a few of the 57 are relevant to you at all, unless you qualify for the American Samoa Economic Development Credit, the “special expensing” rules for film and television production, the mine rescue team training credit or special three-year depreciation for your race horses that happen to be two years or younger.
 
You probably do, however, claim deductions for state and local taxes, which expire at the end of the year, and people with kids and/or grandkids in college might miss the above-the-line deduction for tuition and related educational expenses.  Many Americans will be at least slightly affected by the loss of the deduction for mortgage insurance premiums, and some retired Americans over age 70 1/2 will be distressed to learn that they can no longer make tax-free distributions of up to $100,000 from an IRA account to their favorite charity.  School teachers will lose their classroom expense deductions of up to (a whopping) $250 for un-reimbursed expenses.
 
And thousands of homeowners whose homes are listing below what they paid for them should realize that, at the end of December, they will lose a provision that lets them exclude from their taxable income any reduction in their mortgage obligation (through debt modification or a short sale) up to a maximum of $2 million.
 
Other expiring tax breaks that may affect some people reading this:
 
-Enhanced tax breaks for people who donate property (or easements on their property) to the Nature Conservancy or a local land trust.
 
-Tax credits for the purchase of 2- or 3-wheeled electric vehicles and a separate credit of $7,500 for those who buy certain 4-wheeled electric vehicles like the Ford Focus Electric and the Nissan Leaf.
 
-A maximum $500 tax credit for making certain energy-efficiency improvements in your home (like adding insulation), plus other credits for constructing new energy-efficient homes and a credit for energy-efficient appliances.
 
The biggest expiring corporate tax break is the research and development tax credit.  At the end of the year, companies will also lose the additional first-year depreciation for 50% of the basis of qualified property.
 
In the past, Congress has allowed tax provisions to expire and then, retroactively, extended them for another year or two–and many tax observers believe this will almost certainly happen with the state/local tax deduction and corporate R&D tax credits, and quite possibly for the tuition tax credit as well. 

So when you read about the 57 expiring provisions, and you are not in the biodiesel fuel business (four expiring credits) or planning to claim the electricity production credit for building a renewable power plant, or actively mining coal on Indian lands, you shouldn’t get too worried.  Chances are you aren’t going to get hammered on next year’s taxes–and Congress may even get around to extending the provisions that you really care about, at the very last minute of course.

Whether you’re looking for year-end tax planning, financial planning or money management help, please get in touch with us for unbiased, fiduciary advice that always puts your interests first.

I welcome your feedback, questions and comments. Have a great long weekend!

Source: https://www.jct.gov/publications.html?func=startdown&id=4499

 

My thanks to Bob Veres, publisher of Inside Information, for his help with this post

 

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2013 Year-End Tax Planning Tips

November 16, 2013 — Sam H. Fawaz

As we approach year-end, it’s again time to focus on last-minute moves you can make to save taxes—both on your 2013 return and in future years.

For most individuals, the ordinary federal income tax rates for 2013 will be the same as last year: 10%, 15%, 25%, 28%, 33%, and 35%. However, the fiscal cliff legislation, passed early this year, increased the maximum rate for higher-income individuals to 39.6% (up from 35%). This change affects taxpayers with taxable income above $400,000 for singles, $450,000 for married joint-filing couples, and $425,000 for heads of households. In addition, the new 0.9% Medicare tax and 3.8% Net Investment Income Tax (NIIT) potentially kick in when modified adjusted gross income (or earned income in the case of the Medicare tax) goes over $200,000 for unmarried, $250,000 for married joint-filing couples, which can result in a higher-than-advertised federal tax rate for 2013.

Despite these tax increases, the current federal income tax environment remains relatively favorable by historical standards. This article presents several tax-saving ideas to get you started. As always, you can call on us to help you sort through the options and implement strategies that make sense for you.

Ideas for Maximizing Non-business Deductions

One way to reduce your 2013 tax liability is to look for additional deductions. Here’s a list of suggestions to get you started:

Make Charitable Gifts of Appreciated Stock. If you have appreciated stock that you’ve held more than a year and you plan to make significant charitable contributions before year-end, keep your cash and donate the stock (or mutual fund shares) instead. You’ll avoid paying tax on the appreciation, but will still be able to deduct the donated property’s full value. If you want to maintain a position in the donated securities, you can immediately buy back a like number of shares. (This idea works especially well with no load mutual or exchange traded funds because there are no transaction fees involved.)

However, if the stock is now worth less than when you acquired it, sell the stock, take the loss, and then give the cash to the charity. If you give the stock to the charity, your charitable deduction will equal the stock’s current depressed value and no capital loss will be available. Also, if you sell the stock at a loss, you can’t immediately buy it back as this will trigger the wash sale rules. This means your loss won’t be deductible, but instead will be added to the basis in the new shares. You must wait more than 30 days to buy back shares sold at a loss to avoid the wash sale rules.

Don’t Lose a Charitable Deduction for Lack of Paperwork. Charitable contributions are only deductible if you have proper documentation. For cash contributions of less than $250, this means you must have either a bank record that supports the donation (such as a cancelled check or credit card receipt) or a written statement from the charity that meets tax-law requirements. For cash donations of $250 or more, a bank record is not enough. You must obtain, by the time your tax return is filed, a charity-provided statement that shows the amount of the donation and lists any significant goods or services received in return for the donation (other than intangible religious benefits) or specifically states that you received no goods or services from the charity.

Maximize the Benefit of the Standard Deduction. For 2013, the standard deduction is $12,200 for married taxpayers filing joint returns. For single taxpayers, the amount is $6,100. Currently, it looks like these amounts will be about the same for 2014. If your total itemized deductions are normally close to these amounts, you may be able to leverage the benefit of your deductions by bunching deductions in every other year. This allows you to time your itemized deductions so that they are high in one year and low in the next. You claim actual expenses in the year they are bunched and take the standard deduction in the intervening years.

For instance, you might consider moving charitable donations you normally would make in early 2014 to the end of 2013. If you’re temporarily short on cash, charge the contribution to a credit card—it is deductible in the year charged, not when payment is made on the card. You can also accelerate payments of your real estate taxes or state income taxes otherwise due in early 2014. But, watch out for the AMT, as these taxes are not deductible for AMT purposes.

Manage Your Adjusted Gross Income (AGI). Many tax breaks are only available to taxpayers with AGI below certain levels. Some common AGI-based tax breaks include the child tax credit (phase-out begins at $110,000 for married couples and $75,000 for heads-of-households), the $25,000 rental real estate passive loss allowance (phase-out range of $100,000–$150,000 for most taxpayers), and the exclusion of social security benefits ($32,000 threshold for married filers; $25,000 for other filers). In addition, for 2013 taxpayers with AGI over $300,000 for married filers, $250,000 for singles, and $275,000 for heads-of-households begin losing part of their personal exemptions and itemized deductions. Accordingly, strategies that lower your income or increase certain deductions might not only reduce your taxable income, but also help increase some of your other tax deductions and credits.

Making the Most of Year-end Securities Transactions

For most individuals, the 2013 federal tax rates on long-term capital gains from sales of investments held over a year are the same as last year: either 0% or 15%. However, the maximum rate for higher-income individuals is now 20% (up from 15% last year). This change affects taxpayers with taxable income above $400,000 for singles, $450,000 for married joint-filing couples, $425,000 for heads-of-households, and $225,000 for married individuals who file separate returns. Higher-income individuals can also get hit by the new 3.8% NIIT on net investment income, which can result in a maximum 23.8% federal income tax rate on 2013 long-term gains.

As you evaluate investments held in your taxable brokerage firm accounts, consider the tax impact of selling appreciated securities (currently worth more than you paid for them). For most taxpayers, the federal tax rate on long-term capital gains is still much lower than the rate on short-term gains. Therefore, it often makes sense to hold appreciated securities for at least a year and a day before selling to qualify for the lower long-term gain tax rate.

But be smart about this and don’t let the tax “tail” wag the investment “dog”; you don’t want hold the investment long term just to gain tax benefits at the cost of a possible loss of the accumulated gain.

Biting the bullet and selling some loser securities (currently worth less than you paid for them) before year-end can also be a tax-smart idea. The resulting capital losses will offset capital gains from other sales this year, including high-taxed short-term gains from securities owned for one year or less. For 2013, the maximum rate on short-term gains is 39.6%, and the 3.8% NIIT may apply too, which can result in an effective rate of up to 43.4%. However, you don’t need to worry about paying a high rate on short-term gains that can be sheltered with capital losses (you will pay 0% on gains that can be sheltered).

If capital losses for this year exceed capital gains, you will have a net capital loss for 2013. You can use that net capital loss to shelter up to $3,000 of this year’s high-taxed ordinary income ($1,500 if you’re married and file separately). Any excess net capital loss is carried forward to next year.

Selling enough loser securities to create a bigger net capital loss that exceeds what you can use this year might also make sense. You can carry forward the excess capital loss to 2014 and beyond and use it to shelter both short-term gains and long-term gains recognized in those years.

Identify the Securities You Sell. When selling stock or mutual fund shares, the general rule is that the shares you acquired first are the ones you sell first. However, if you choose, you can specifically identify the shares you’re selling when you sell less than your entire holding of a stock or mutual fund. By notifying your broker of the shares you want sold at the time of the sale, your gain or loss from the sale is based on the identified shares. This sales strategy gives you better control over the amount of your gain or loss and whether it’s long-term or short-term.

Secure a Deduction for Nearly Worthless Securities. If you own any securities that are all but worthless with little hope of recovery, you might consider selling them before the end of the year so you can capitalize on the loss this year. You can deduct a loss on worthless securities only if you can prove the investment is completely worthless. Thus, a deduction is not available, as long as you own the security and it has any value at all. Total worthlessness can be very difficult to establish with any certainty. To avoid the issue, it may be easier just to sell the security if it has any marketable value. As long as the sale is not to a family member, this allows you to claim a loss for the difference between your tax basis and the proceeds (subject to the normal rules for capital losses and the wash sale rules restricting the recognition of loss if the security is repurchased within 30 days before or after the sale).

Ideas for Seniors Age 701/2 Plus

Make Charitable Donations from Your IRA. IRA owners and beneficiaries who have reached age 701/2 are permitted to make cash donations totaling up to $100,000 to IRS-approved public charities directly out of their IRAs. These so-called Qualified Charitable Distributions, or QCDs, are federal-income-tax-free to you, but you get no itemized charitable write-off on your Form 1040. That’s okay because the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to worry about restrictions that can delay itemized charitable write-offs. QCDs have other tax advantages, too. Contact us if you want to hear about them.

Be careful—to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity. Also, this favorable provision will expire at the end of this year unless Congress extends it. So, this could be your last chance.

Take Your Required Retirement Distributions. The tax laws generally require individuals with retirement accounts to take withdrawals based on the size of their account and their age every year after they reach age 701/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. There’s good news for 2013 though—QCDs discussed above count as payouts for purposes of the required distribution rules. This means, you can donate all or part of your 2013 required distribution amount (up to the $100,000 limit on QCDs) and convert taxable required distributions into tax-free QCDs.

Also, if you turned age 701/2 in 2013, you can delay your 2013 required distribution to 2014, if you choose. However, waiting until 2014 will result in two distributions in 2014—the amount required for 2013 plus the amount required for 2014. While deferring income is normally a sound tax strategy, here it results in bunching income into 2014. Thus, think twice before delaying your 2013 distribution to 2014—bunching income into 2014 might throw you into a higher tax bracket or have a detrimental impact on your other tax deductions in 2014.

Ideas for the Office

Maximize Contributions to 401(k) Plans. If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the max for the match.

Take Advantage of Flexible Spending Accounts (FSAs). If your company has a healthcare and/or dependent care FSA, before year-end you must specify how much of your 2014 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying dependent care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts—you don’t want to set aside more than what you’ll likely have in qualifying expenses for the year.

Married couples who both have access to FSAs will also need to decide whose FSA to use. If one spouse’s salary is likely to be higher than what’s known as the FICA wage limit (which is $113,700 for this year and will likely be somewhat higher next year) and the other spouse’s will be less, the one with the smaller salary should fund as much of the couple’s FSA needs as possible. The reason is that the 6.2% social security tax levy for 2014 is set to stop at the FICA wage limit (and doesn’t apply at all to money put into an FSA). Thus, for example, if one spouse earns $120,000 and the other $40,000 and they want to collectively set aside $5,000 in their FSAs, they can save $310 (6.2% of $5,000) by having the full amount taken from the lower-paid spouse’s salary versus having 100% taken from the other one’s wages. Of course, either way, the couple will also save approximately $1,400 in income and Medicare taxes because of the FSAs.

If you currently have a healthcare FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. It’s not that hard to drum some things up: new glasses or contacts, dental work you’ve been putting off, or prescriptions that can be filled early.

Adjust Your Federal Income Tax Withholding. As stated at the beginning of this article, higher-income individuals will likely see their taxes go up this year. This makes it more important than ever to do the calculations to see where you stand before the end of the year. If it looks like you are going to owe income taxes for 2013, consider bumping up the federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will still have to pay any taxes due less the amount paid in. However, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your 2013 liability or, if smaller, 100% of your 2012 liability (110% if your 2012 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), penalties will be minimized, if not eliminated.

Watch Out for the Alternative Minimum Tax

Recent legislation slightly reduced the odds that you’ll owe the alternative minimum tax (AMT). Even so, it’s still critical to evaluate all tax planning strategies in light of the AMT rules before actually making any moves. Because the AMT rules are complicated, you may want our assistance.

Don’t Overlook Estate Planning

For 2013, the unified federal gift and estate tax exemption is a historically generous $5.25 million, and the federal estate tax rate is a historically reasonable 40%. Even if you already have an estate plan, it may need updating to reflect the current estate and gift tax rules. Also, you may need to make some changes for reasons that have nothing to do with taxes.

Ideas for Your Business

Take Advantage of Tax Breaks for Purchasing Equipment, Software, and Certain Real Property. If you have plans to buy a business computer, office furniture, equipment, vehicle, or other tangible business property or to make certain improvements to real property, you might consider doing so before year-end to capitalize on the following generous, but temporary tax breaks:

  • Bigger Section 179 Deduction. Your business may be able to take advantage of the temporarily increased Section 179 deduction. Under the Section 179 deduction privilege, an eligible business can often claim first-year depreciation write-offs for the entire cost of new and used equipment and software additions. (However, limits apply to the amount that can be deducted for most vehicles.) For tax years beginning in 2013, the maximum Section 179 deduction is $500,000. For tax years beginning in 2014, however, the maximum deduction is scheduled to drop to $25,000.
  • Section 179 Deduction for Real Estate. Real property costs are generally ineligible for the Section 179 deduction privilege. However, an exception applies to tax years beginning in 2013. Under the exception, your business can immediately deduct up to $250,000 of qualified costs for restaurant buildings and improvements to interiors of retail and leased nonresidential buildings. The $250,000 Section 179 allowance for these real estate expenditures is part of the overall $500,000 allowance. This temporary real estate break will not be available for tax years beginning after 2013 unless Congress extends it.

Note: Watch out if your business is already expected to have a tax loss for the year (or be close) before considering any Section 179 deduction, as you cannot claim a Section 179 write-off that would create or increase an overall business tax loss. Please contact us if you think this might be an issue for your operation.

  • 50% First-year Bonus Depreciation. Above and beyond the bumped-up Section 179 deduction, your business can also claim first-year bonus depreciation equal to 50% of the cost of most new (not used) equipment and software placed in service by December 31 of this year. For a new passenger auto or light truck that’s used for business and is subject to the luxury auto depreciation limitations, the 50% bonus depreciation break increases the maximum first-year depreciation deduction by $8,000 for vehicles placed in service this year. The 50% bonus depreciation break will expire at year-end unless Congress extends it.

Note: First-year bonus depreciation deductions can create or increase a Net Operating Loss (NOL) for your business’s 2013 tax year. You can then carry back a 2013 NOL to 2011 and 2012 and collect a refund of taxes paid in those years. Please contact us for details on the interaction between asset additions and NOLs.

Evaluate Inventory for Damaged or Obsolete Items. Inventory is normally valued for tax purposes at cost or the lower of cost or market value. Regardless of which of these methods is used, the end-of-the-year inventory should be reviewed to detect obsolete or damaged items. The carrying cost of any such items may be written down to their probable selling price (net of selling expenses). [This rule does not apply to businesses that use the Last in, First out (LIFO) method because LIFO does not distinguish between goods that have been written down and those that have not].

To claim a deduction for a write-down of obsolete inventory, you are not required to scrap the item. However, in a period ending not later than 30 days after the inventory date, the item must be actually offered for sale at the price to which the inventory is reduced.

Employ Your Child. If you are self-employed, don’t miss one last opportunity to employ your child before the end of the year. Doing so has tax benefits in that it shifts income (which is not subject to the Kiddie tax) from you to your child, who normally is in a lower tax bracket or may avoid tax entirely due to the standard deduction. There can also be payroll tax savings since wages paid by sole proprietors to their children age 17 and younger are exempt from both social security and unemployment taxes. Employing your children has the added benefit of providing them with earned income, which enables them to contribute to an IRA. Children with IRAs, particularly Roth IRAs, have a great start on retirement savings since the compounded growth of the funds can be significant.

Remember a couple of things when employing your child. First, the wages paid must be reasonable given the child’s age and work skills. Second, if the child is in college, or is entering soon, having too much earned income can have a detrimental impact on the student’s need-based financial aid eligibility.

Conclusion

Through careful planning, it’s possible your 2013 tax liability can still be significantly reduced, but don’t delay. The longer you wait, the less likely it is that you’ll be able to achieve a meaningful reduction. The ideas discussed in this article are a good way to get you started with year-end planning, but they’re no substitute for personalized professional assistance. Please don’t hesitate to contact us with questions or for additional strategies on reducing your tax bill. We’d be glad to set up a planning meeting or assist you in any other way that we can. You can find us at http://ydfs.com

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Possible Consequences of the Government Shutdown & Default

October 7, 2013 — Sam H. Fawaz

It’s possible that you’ve heard a news report or two about the government shutdown  that started October 1, and now a dispute over raising the U.S. debt ceiling and possibly defaulting on the government’s debt obligations as soon asOctober 17.  The question for an increasingly nervous investing public is: how will this affect the U.S. economy and (not to be too selfish here) my retirement portfolio?
 
Interestingly, it is starting to look like the government shutdown, if it runs for weeks instead of months, might have almost no effect on the economy at all.  Why?  The economic impact that had economists worried was the loss of income suffered by tens of thousands of federal employees.  But the Defense Department has continued paying all of its civilian personnel, simply by declaring all of them “essential employees.”  Not only were the leaders of the House of Representatives not inclined to argue; they have quietly passed legislation that would give back-pay to all federal workers who have been furloughed, just as soon as the stalemate ends.  The Senate and the President are likely to go along, giving the country the worst of all worlds: paying most government employees for staying home and not providing a wide variety of services to the public.
 
Ironically, the way the politics are working, one can almost guarantee that there will continue to be a stock market selloff before the shutdown ends.  For the Republican leaders in the House, there is little cost to holding their ground so long as there is not a public outcry and loss of voter confidence.  One of the sources of that pain would be a big drop on Wall Street.  Indeed, if you listen closely to the speeches by President Obama and the Democratic leadership, you hear dire warnings of a market drop as a result of the shutdown–which is their way of focusing the public’s attention on who to blame as it happens. 
 
What is interesting about that is that the markets often deliver corrections after long, accelerating uptrends like what we have experienced in the U.S. since March of 2009, and with the 20+% returns that Wall Street has delivered so far this year.  It wouldn’t have surprised anyone to see some kind of a quick downturn this Fall regardless of whether the government was operating at full capacity or at a standstill.  A week of small leaks in stock prices could lead to something larger as people realize they are sitting on nice gains and have no idea what Congress will or won’t do next.  The last time the government was shut down, stocks dropped almost 20%, the Republican leadership realized it wasn’t winning any popularity contests and the stalemate ended.  We’ve seen this script before.
 
A more consequential issue is the debt ceiling.  Congress must raise the total amount that the U.S. government can borrow (by selling Treasury bonds) to pay its various obligations, including, of course, interest on its current Treasury bonds.  Contrary to popular belief, raising the debt ceiling does not increase the federal debt; that debt exists whether or not Congress authorizes additional borrowing.
 
Failure to authorize the government to pay its legal obligations would create a self-induced fiscal crisis–ironic for a country whose representatives claim that they never want to become another Greece, and then talk about voluntarily defaulting on the nation’s debt obligations, which even Greece has avoided. 
 
One recent article suggested that a default on Treasuries would ripple through the global economy, among other things, causing anxious investors to demand higher interest rates and dramatically raise U.S. borrowing costs.  That, in turn, would raise rates on mortgages, credit cards and student loans, pushing the U.S. toward or into recession, and putting pressure on the stock market.  One report suggests that if the U.S. misses just one interest payment, the downward impact on stock prices would be greater than the Lehman Brothers bankruptcy.  In THAT aftermath, the stock market lost more than half its value.
 
Bigger picture, a default would undermine the role of the U.S. in the world economy.
 
As I previously wrote, the irony of the debt ceiling debate is that the gap between government spending and tax revenues has been closing rapidly on its own.  In July, the Congressional Budget Office reported that the deficit had fallen by 37.6%, the result of tax increases and sequester-related cuts in spending.  As a percentage of America’s GDP, the deficit has fallen from more than 10% at the end of 2009 to somewhere around of 4% currently.  Last June, the government actually posted a surplus of $117 billion, paying down the overall deficit, and the Congressional Budget Office has projected that September will also bring government surpluses.
 
Most observers seem to think that all of this will get worked out.  After all, what rational person–in Congress or elsewhere–wants to self-impose these problems when we have plenty of economic challenges already?  The stock market’s relatively calm trading days tell us that investors expect a compromise on the government shutdown in the near future.  Nonetheless, it may take a sharp day of selling to prod Congress off the dime.  Foreign investors are still lending to the U.S. government at astonishingly low interest rates (despite modest increases over the past week), which tells us they aren’t worried about a default.
 
The previous times we went through events similar to this, the stock market plunges proved to be buying opportunities for investors.  One of the great things about uncertainty and volatility is that it causes investments to periodically go on sale, and creates such anxiety that only disciplined (and perhaps brave) investors are able to take advantage.  There’s no reason to think this won’t be more of the same.

Sources:
 
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/10/06/maybe-the-government-shutdown-wont-clobber-the-economy-after-all/
 
http://www.cbsnews.com/8301-505123_162-57606253/debt-ceiling-understanding-whats-at-stake/
 
http://krugman.blogs.nytimes.com/2013/08/13/what-people-dont-know-about-the-deficit/
 
http://www.moneynews.com/newswidget/default-Catastrophe-lehman-demise/2013/10/07/id/529564?promo_code=125A8-1&utm_source=125A8Moneynews_Home&utm_medium=nmwidget&utm_campaign=widgetphase1

 

 

My thanks to Bob Veres of Inside Information for his help with this post

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Scary Headlines, Remarkable Returns-3rd 2013 Quarterly Financial Review

October 2, 2013 — Sam H. Fawaz

The threat of a government shutdown virtually guaranteed that the investment markets would close out the third quarter with a whimper rather than a bang.  The S&P 500 index lost 1.1% of its value in the final week of the quarter as the U.S. Congress seemed to be lurching toward a political standstill that would shut down the U.S. government.  All the uncertainty has tended to obscure the fact that most U.S. stock market investors have experienced significant gains so far this year.
 
And the recent quarter was no exception.  Despite the rocky final week, the Wilshire 5000–the broadest measure of U.S. stocks and bonds–rose 6.60% for the third quarter–and now stands at a 22.31% gain for the first nine months of the year.  The comparable Russell 3000 index gained 6.35% in the most recent three months, posting a 21.30% gain as we head into the final stretch of 2013.
 
Other U.S. market sectors experienced comparable gains.  Large cap stocks, represented by the Wilshire U.S. Large Cap index, gained 6.24% in the second quarter, and are up 20.77% so far for the year.  The Russell 1000 large-cap index returned 6.02% for the quarter, up 20.76% for the year, while the widely-quoted S&P 500 index of large company stocks gained 5.32% for the quarter and is up 18.62% since January 1.
 
The Wilshire U.S. Mid-Cap index index rose 9.02% in the latest three months of the year, and is up 26.19% as we enter the final quarter.  The Russell midcap index was up 7.70% for the third quarter, and now stands at a 24.34% gain so far this year.
 
Small company stocks, as measured by the Wilshire U.S. Small-Cap, gained 9.68% in the third quarter; the index is up 27.53% so far this year.  The comparable Russell 2000 small-cap index was up 10.21% in the second three months of the year, posting a 27.69% gain in the year’s first nine months.  The technology-heavy Nasdaq Composite Index was up 11.16% for the quarter, and has gained 25.24% for its investors so far this year.

Keep in mind that while a diversified portfolio of cash, stocks, bonds, real estate and other asset classes may not provide you with the full returns shown above, you are also not taking on the risk of a 100% equity portfolio. That’s just smart money and risk management.
 
In the first half of the year, any diversification into investments other than U.S. stocks were dragging down returns.  That was no longer the case in the 3rd quarter.  The broad-based EAFE index of larger foreign companies in developed economies rose 10.94% in dollar terms during the third quarter of the year, and is up 13.36% so far this year.  The biggest surprise is Europe: a basket of European stocks rose 13.16% over the past three months, which accounts for virtually all of their returns this year; the index is now up 13.17% for the year. 
 
Emerging markets stocks are climbing out of a deep hole that they fell into earlier in the year, returning 5.01% in the past three months, even though the EAFE Emerging Markets index is still down 6.42% for the year. 
 
Other investment categories are not faring so well.  Real estate, as measured by the Wilshire REIT index, fell 1.98% for the quarter, though it is still standing at a 3.84% gain for the year.  Commodities, as measured by the S&P GSCI index, reversed their recent slide and rose 5.44% this past quarter, taking them to nearly even, just down 0.27% so far in 2013.  Gold prices perked up on the uncertainty over the government shutdown, gaining 9.26% in the recent quarter, though gold investors have lost 20.48% on their holdings so far this year. 
 
Bonds have continued to provide disappointing returns both in terms of yield and total return.  The Barclay’s Global Aggregate bond index is down 2.24% so far this year, and the U.S. Aggregate index has lost 1.87% of its value in the same time period. 
 
In the Treasury markets, the year has seen a bifurcated market; declining yields in bonds with 12 month or lower maturities, while longer-term bonds have experienced rising yields and a corresponding decline in the value of the bonds held by investors.  In the past year, the yield on 10-year Treasuries have risen almost a percentage point, to 2.65%, and 30-year bonds are now yielding 3.73%, up 86 basis points over the past 12 months.    
 
Municipal bonds have seen comparable rate rises; a basket of state and local bonds with 30-year maturities are now yielding 4.32% a year; 10-year munis are returning an average of 2.56% a year.  The rises, of course, have caused losses in muni portfolios.
 
Perhaps the most interesting thing to notice about America’s 20+% stock market returns so far this year–extraordinary by any measure–is that they were accomplished at a time when investors seemed to be constantly skittish.  Just a few weeks ago, everybody seemed to be worried that the Federal Reserve would end its QE3 program and let interest rates find their natural balance in the economy.  One might wonder why this would be such a scary event, since it is the Fed’s economists way of telling us that the U.S. economy is finally getting back on its feet.
 
All eyes are still on Washington, but now they’ve moved from the Fed to the Capitol Building.  The question everybody has been asking in the final days of the quarter is: what would be the investment and economic impact of a government shutdown?  This question might be one to consider going forward, since the two parties seem to have a lot of fundamental disagreements over spending priorities, and budget battles could become quarterly events.
 
An article in the Los Angeles Times says that most economists and analysts seem to expect a partial two-week government shutdown.  The lost pay for hundreds of thousands of furloughed federal workers would cut 0.3 to 0.4 percentage points off of fourth quarter growth–the difference between weak 2% growth annual growth that the economy is currently experiencing and an anemic 1.6% growth rate that would be flirting with recession.  An estimate by Goldman Sachs puts the potential lost GDP at 0.9%.
 
A longer shutdown could cause disruptions in private-sector production and investments, and would almost certainly lead to stock market declines.  The L.A. Times article notes that stocks lost about 4% of their value during the December 1995-January 1996 shutdown.  Job growth stalled, and the GDP gained just 2.7% in that first quarter. Interestingly, in all cases of past government shutdowns, the stock market recovered all of the losses and then some. That could be why the market is holding up well right now, but a protracted shutdown creates uncertainty and the markets hate uncertainty.
 
Interestingly, Congress has quietly moved away from the issue that has triggered the last few budget stalemates, focusing this time on whether or not to fully fund President Obama’s health care legislation.  In the past, the issue was budget deficits, but it turns out that the budget deficit has come down dramatically over the past 12 months.  The U.S. government posted a $117 billion surplus in June, and the Congressional Budget Office expects to run a surplus again in September–the result of revenue gains as a result of tax hikes plus the growing economy, coupled with a 10% reduction in spending. 
 
What does all this mean for your investments in the final 2013 quarter?  Who knows?  Nobody could have predicted, at the start of the year, with all the hand-wringing over the fiscal cliff and new tax legislation, that we would be standing nine months into 2013 with significant investment gains in the U.S. markets and a resurgence in global investments led by, of all places, Europe.
 
This much we can predict: the recent uncertainties–the paralysis in Congress, worries about the direction of interest rates and whether the Fed is going to stop intervening in the markets–will give way to new worries, new uncertainties, which will make all of us feel in our guts like the world is going to hell in a handbasket. With that said, the bull market that started in March 2009 is getting long in the tooth and is overdue for a longer period of rest (10% or more correction, or even a bear market)
 
Nonetheless, the headlines obscure the fact that investment returns are created the hard way, by millions of people getting up in the morning and going to work and spending their day finding ways to improve American businesses, generate profits, create new products and new markets, day after day after day. 
 
Whatever ups and downs you experience–and you WILL experience them, perhaps in the next quarter or the next year–that underlying driver of business enterprises and stock value is constantly working on your behalf.  That will be true no matter what the headlines say, no matter how spooked you feel about whatever scary thing is going on in the world.  Nobody enjoys the investment ride the way children enjoy the thrills of a roller coaster, but both seem to ultimately deliver their riders to a semblance of safety in the end.

I hope you’re having a great week and I welcome your questions, feedback and comments. If you or someone you know is looking for a fee-only fiduciary advisor or money manager who puts your interests first, please don’t hesitate to get in touch with me.

 

Sources:
 
Wilshire index data: http://www.wilshire.com/Indexes/calculator/
 
Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp
 
S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf–p-us-l–
 
Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP
 
International indices:http://www.mscibarra.com/products/indices/international_equity_indices/performance.html
 
Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci
 
Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
 
Aggregate corporate bond rates: http://finance.yahoo.com/bonds/composite_bond_rates
 
Government shutdown impact:  http://www.latimes.com/business/la-fi-shutdown-economy-20131001,0,155302.story
 
Budget surpluses:  http://www.cnbc.com/id/100880536
 
http://www.cnbc.com/id/101030631
 
 
My thanks to Bob Veres, publisher of Inside Information for his help with this article.
 
 
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Fee-Only Financial Advisers Who Aren’t

September 21, 2013 — Sam H. Fawaz

Today’s (Saturday September 21, 2013) Wall Street Journal contains an article entitled ” ‘Fee-Only’ Financial Advisers Who Don’t Charge Fees Alone” written by award-winning writer Jason Zweig, better known as “The Intelligent Investor.” Jason acts as beacon to guide investors towards the better practices of saving and investing and warns them of the tricks and traps.

In this article, Jason points out that “You might think a “fee-only” financial adviser will never charge you commissions or other sales charges that could induce him to favor selling you something that is better for him than for you. Think again.”

Through his research, he found that many advisors who hold themselves out as “fee-only” indeed earn commissions, kickbacks, trails or other hidden compensation even though they might not sell you a product that generates one. He found that numerous advisors (661) that were Certified Financial Planners (TM) and worked for large Wall Street brokerage firms such as Morgan Stanley, UBS, RBC, Wells Fargo, J.P. Morgan Chase, Bank of America Merrill Lynch, Raymond James and Ameriprise Financial also listed themselves as fee-only advisors on the CFP (r) website. By definition, based on the nature of the firms that they work for, they cannot designate themselves as fee-only advisors or planners.

Many people also confuse fee-only with fee-based. They are definitely not the same. Fee-based means that the advisor can earn both fees for services as well as other commissions or kickbacks for selling investment, insurance or other financial products.

NAPFA, the National Association of Personal Financial Advisors (the de facto fee-only organization of planners and advisors found at napfa.org), the Financial Planning Association and the Certified Financial Planner board of standards are currently working on more clearly defining the “fee-only” standard and urging members to update their profiles and re-assert that they meet the more clearly-defined standard. I applaud this effort.

I wish to reassure our clients, prospects and friends that our firm, YDream Financial Services, takes a very serious and crystal clear stance on meeting the fee-only definition. Fee-only planners, like us, are compensated solely by fees paid by our clients and we do not accept commissions or compensation of any kind from any source. We also don’t earn any money or consideration from trails, referrals or markups. We have zero incentive to recommend any financial products and don’t accept anything (except perhaps trinkets from wholesalers or fund companies worth $5 or less handed out at conferences) that influences our recommendations. Our custodian, Charles Schwab does not reimburse or compensate us for any trade commissions or for the use of any particular financial products that they offer.

As a fiduciary, we take our responsibility to put your interests first and we endeavor do that in every recommendation or transaction that we initiate on your behalf. Finally, any conflicts of interest that our compensation approach might present are clearly discussed and disclosed with our clients and prospects prior to implementing the recommendation or moving forward with the engagement.

You can find the Wall Street Journal Article here http://goo.gl/23Oy3B. It’s worth the short read. If the link requires a log in or subscription to the Wall Street Journal Online, I suggest typing the title of the article above into your favorite search engine then click on the search hit that it finds.

Posted in Fee-only, General, investing, markets. Tags: , , , , . 1 Comment »

Your Returns Versus the Market

September 2, 2013 — Sam H. Fawaz

One of the most misleading statistics in the financial world is the return data we are routinely given by the financial media, telling us how much investors made in the markets and in individual stocks or mutual funds over some time period.  In fact, your returns are almost guaranteed to be different from whatever the markets and the funds you’ve invested in have gotten.

How is this possible?  Start with cash flows.  We are told that the S&P 500 has delivered a compounded return of about 7.8% from 1992 through 2011, which sounds pretty positive until you realize that this return would only be available to somebody who invested all his or her money at the beginning of 1992 and didn’t move that money around at all for the next twenty years.  If you invested systematically, the same amount every month, as most of us do, then you would have earned a 3.2% compounded return.  Why?  A lot of your money would have been exposed to the 2008 downturn, and not much of it would have enjoyed the dramatic run-up in stocks from 1992 to 2000.

In addition, there is the difference–only now getting attention from analysts–between investor returns and investment returns.  Human nature drives investors to sell their stocks and move to the sidelines after their portfolios have been hammered–which is often the worst possible time to sell.  And it drives people to start increasing their equity allocations toward the peak of bull markets when they perceive that everybody else is getting rich.  That means less of their money tends to be exposed to stocks when the market turns from bearish to bullish, and more is exposed when markets switch from bullish to bearish.

Understand also that owning a diversified portfolio means that only a portion of your investments are exposed to stocks. Assets such as cash, bonds, real estate, commodities and other non-stock investments all have returns that are inherently different than stocks, making overall portfolio return comparisons an “apples to oranges” one.

This would be bad enough, but people also switch their mutual fund and stock holdings.  When a great fund hits a rough patch, there’s a tendency to sell that dog and buy a fund that whose recent returns have been scorching hot.  Many times the underperforming fund will reverse course, while the hot fund will cool off.  The Morningstar organization now calculates, for every fund it follows, the difference between the returns of the mutual fund and the average returns of the investors in fund, and the differences can be astonishing.  Overall, according to Morningstar statistics and an annual report compiled by the Dalbar organization, investor returns have historically been about half of what the markets and funds are reporting.

And then there’s the tax bite.  Some mutual funds invest more tax-efficiently than others, and generate less ordinary income.  Beyond that, if a fund is sitting on significant losses when you invest, you get to ride out its gains without having the tax impact distributed to your 1040.  If the fund is sitting on large gains when you buy in, you could find yourself paying taxes on gains even if the fund loses money.

Sources:

http://www.forbes.com/sites/financialfinesse/2012/06/20/why-your-investment-returns-could-be-lower-than-you-think/

http://www.thesunsfinancialdiary.com/investing/understanding-ms-total-return-and-investor-return/

http://corporate.morningstar.com/cf/documents/MethodologyDocuments/FactSheets/InvestorReturns.pdf

My thanks to Inside Information publisher Bob Veres for his contribution to this post.

Posted in General, investing, markets, retirement. Tags: , , , , . 1 Comment »

Handle Asset Location With Care

August 18, 2013 — Sam H. Fawaz

An old question has become new again.  You have tax-deferred accounts like IRAs and Roth IRAs, and you have accounts that pay taxes every year on the income they receive.  Where do you put different types of assets? 

The answer is that you want to put the most tax-inefficient investments inside the tax-deferred accounts.  The most notoriously tax-inefficient investments, historically, have been bond funds, commodities futures funds and real estate investment trusts (REITs), which all generate ordinary income that can be taxed at 39.6% plus the 3.8% Medicare tax for higher-income taxpayers.  The Roth IRA, which shelters all future returns from taxes of any sort, can be a great place for mutual funds that invest in small cap stocks, since they tend to have high turnover and historically have provided the highest gains.  

In taxable accounts, you might put growth stocks which, if you hold them for more than a year, will have their price appreciation taxed at a maximum rate of 20% (or 23.8% with the Medicare surtax).  Of course, you can choose to hold individual securities for much longer periods, which gives you tax deferral on its own–and, if the stocks are held until death, the heirs get a step-up in basis, which basically means any rise in value is never taxed.  Municipal bonds which qualify for an exemption from federal taxes are also good candidates for the taxable portion of your investment accounts. 

What makes this debate new again?   Higher ordinary income tax rates, and potentially higher capital gains tax rates (up from 15% to 23.8% for tax filers who have to pay the new Medicare surtax) have introduced some gray areas, as have the historically low rates on bonds.  When bonds were delivering upwards of 10% on the investment dollar, putting them in an IRA was a no-brainer.  But what if you’re cautious about rising rates, and you’ve shortened maturities in a yield-starved market, so your return is closer to 1%?   Suddenly, these funds are no longer a huge tax concern. 

At the same time, REITs offer tax benefits like depreciation, which becomes more valuable at higher ordinary income rates.  And persons in retirement may see their tax rates fall from above 39% down to 15%, which decreases the benefits of astute asset location, and might raise the value of rebalancing each year across all accounts. 

Another consideration for retirees is the mandatory withdrawals they have to take from their IRA account after they reach age 70 1/2.  If the IRA is holding all the income-generating investments, then systematically liquidating those holdings means creating a higher exposure to stocks and a generally more volatile portfolio as you age–which may be the opposite of what is desired.

Saving taxes through asset location strategies is one of those rare opportunities to get additional dollars without taking additional risk–but a mindless focus on taxes without looking at the bigger picture can result in unintended consequences.  The rules of thumb need to be informed by your tax bracket and other aspects of your individual circumstances–with an eye on the ever-changing tax and interest rates that Congress and the markets throw at us. 

Source:

http://www.financial-planning.com/fp_issues/43_8/asset-allocation-rules-2685905-1.html?zkPrintable=1&nopagination=1

 

 

 Many thanks to Bob Veres, publisher of Inside Information for his help writing this blog post.

 

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The Rollercoaster Effect

June 23, 2013 — Sam H. Fawaz

There are two kinds of investor in this world.  One type pays close attention to the daily (and sometimes hourly) flood of information, looking for a reason (any reason) to jump in or out of the markets.  The other kind of investor is in for the long haul, and recognizes that the markets are going to experience dips and turns.  If these people are particularly wise, they know that the dips and turns are the best friend of the steady, long-term investor, because as you put money into the markets, as you re-balance your portfolio, you gain a little extra return from the occasional opportunities to buy at bargain prices.

Last week, the investment markets made an unusually sharp turn on the roller coaster, and showed us once again the sometimes-comical fallacy of quick trading.  See if you can follow the logic of the events that led to last week’s selloff.  Federal Reserve Board Chairman Ben Bernanke and the Federal Open Market Committee issued a statement saying that the U.S. economy is improving faster than the Fed’s economists expected.  Therefore (the statement went on to say) if there was continued improvement, the Fed would scale back its QE3 (quantitative easing) program of buying Treasury and mortgage-backed securities on the open market, and ease back on stimulating the economy and keeping interest rates low.

Everybody knows that the Fed will eventually have to phase out its QE3 market interventions, and that this would be based on the strength of the economy, so this announcement should not have stunned the investing public.  Nothing in the statement suggested that the Fed had any immediate plans to stop buying altogether; only ease it back as it became less necessary.  The statement said that this hypothetical easing might possibly take place as early as this Fall, and only if the unemployment rate falls faster than expected.  At the same time, the Fed’s economists issued an economic forecast that was more optimistic than the previous one.

The result?  There was panic in the streets–or, at least, on Wall Street, where this bullish economic report seems to have caused the S&P 500 to lose 1.4% of its valueon Wednesday and another 2.5% on Thursday.

In addition–and here’s where it gets a little weird–stocks also fell sharply in Shanghai and across Europe, and oil futures fell dramatically.  How, exactly, are these investments impacted by QE3?

The only explanation for last week’s panic selloff is that thousands of media junkie investors must have listened to “we plan to ease back on QE3 when we believe the economy is back on its feet again,” and heard: “the Fed is about to end its QE3 stimulus!”

It’s possible that the investors who sold everything they owned on Wednesday  throughFriday will pile back in this week, but it’s just as likely that the panic will feed on itself for a while until sanity is restored.  If stocks were valued daily based on pure logic, on the real underlying value of the enterprises they represent, then the trajectory of the markets would be a long smooth upward slope for decades, as businesses, in aggregate, expanded, moved into new markets, and slowly, over time, boosted sales and profits.  The roller-coaster effect that we actually experience is created by the emotions of the market participants, who value their stocks at one price on Wednesday, and very different prices on Thursday and Friday.

The long-term investor has to ask: did any individual company in my investment portfolio become suddenly less valuable in two days?  Did ALL of their enterprise values in aggregate become less valuable within 48 hours–and at the same time, did Chinese and European stocks and oil also suddenly become less valuable?  Phrased this way, the only possible answer is: no.  And if that’s your answer, then you have to assume that eventually, people will eventually be willing to pay the real underlying value of the stocks in the market, and the last couple of days will be just one more exciting example of meaningless white noise.

With all that said, it’s prudent to be cautious about going “all in” on this pullback in the market and to perhaps take some hard-earned partial profits on positions you’ve been holding. In our clients’ portfolios, we’ve upped our hedges and taken partial profits on short-term positions, but are still holding the majority of our equities and bonds.

With the action in the markets last week, we officially have the beginnings of a downtrend, but that can be very short-lived in this QE environment, so we remain on our toes. Be sure to consult with your advisor if you’re uncomfortable with your holdings or have trouble sleeping at night because of your positions. Nothing in this message should be construed as investment advice or suggestions to buy or sell any security.

If you have any questions or comments, please don’t hesitate to contact us or post them here. We are a fee-only fiduciary financial planning and investment advisory firm that always puts your interests first.

Have a great week!

Sam

Sam H. Fawaz CFP™, CPA
Registered Investment Adivsor Representative
NAPFA Registered Fee-only Advisor
Financial Planning Asssociation Member
(734) 447-5305
(615) 395-2010
http://www.ydfs.com

TheMoneyGeek thanks Bob Veres, publisher of Inside Information for his help with writing this guest post.

Posted in General, investing, markets, retirement. Tags: , , . Leave a Comment »

The Value of Education

May 19, 2013 — Sam H. Fawaz

Now that college graduation exercises are upon us, you are no doubt hearing reports that young people matriculating from this or that prestigious alma mater are having trouble finding jobs.  The easy conclusion seems to be that a college degree doesn’t matter very much anymore in the new economy.  But that, of course, is a short-term view; younger people have fewer job-related skills than people who have been employed for a few years, so they generally have trouble getting that first job no matter what their education level.

You can see this in the first chart below; older workers, who have presumably more experience in the workplace, tend to have lower unemployment rates than their younger competition.  A recession like 2008-2009 simply reinforced a long-term pattern; it made the jobs situation worse for everybody.  Today’s difficult job market continues to allow employers to put a premium on experience.

Longer-term, however, a college degree does seem to confer huge advantages for getting employment.  Consider the most recent jobless statistics, broken down by education level:

Jobless rate for persons who have not earned a high school degree:  11.6%

Jobless rate for high school graduates with no college training: 7.4%

Jobless rate for persons with some college training or an associate degree: 6.4%

Jobless rate for persons who have earned a bachelor’s degree or higher: 3.9%

Longer-term, as you can see from the second chart below, people who are educated at every level tend to be less likely to be unemployed than those with lower educational attainment.  The better-educated also tend to earn higher incomes over their lifetimes–the most recent statistics compiled by the Pew Research Center suggests that the average high school graduate with no further education will earn about $770,000 over a 40-year worklife, compared with $1.4 million for a worker with a bachelor’s degree.

Image

Parents reading this article, and graduates who are paying off enormous student loans, are no doubt wondering whether Pew was able to factor in the upfront costs of getting the college degree, plus the opportunity cost of four years (or more) spent on campus rather than in the workforce.  Even when these considerable costs are factored in, the net gain for a student who graduated from an in-state four-year public university is about $550,000 over a person’s worklife.  The third chart shows the various disparities in yearly earnings at different ages; you can see that at age 25, the differences are not huge, but over time, college education begins to create significant income separation.

Image

Bottom line?  Ignore the gloomy reports of college graduates having trouble finding work. This has always been a problem, admittedly made worse by today’s weak job market, but not an indictment of the value of a college education.  Education, as George Washington Carver once remarked, is still the golden key that unlocks the doors of opportunity.

Sources:

http://www.pewresearch.org/daily-number/the-monetary-value-of-a-college-education/

http://www.pewsocialtrends.org/2011/05/15/is-college-worth-it/6/#chapter-5-the-monetary-value-of-a-college-education?src=prc-number

TheMoneyGeek thanks Bob Veres, publisher of Inside Information for this guest post.

Posted in College Planning, General. Tags: , , . Leave a Comment »

Hey Windows 8, Where Do I Start?

September 30, 2012 — Sam H. Fawaz

For as long as I can remember, Microsoft’s releases of operating systems (OS) have been primarily designed around the personal computer environment.  Shortly after release, Microsoft then “shoe-horns” the OS into other devices such as smart phones, earlier versions of tablet PC’s and personal digital assistants.  As a result, users’ biggest complaints in the past have been slow or sluggish responsiveness, poor user interface design and incompatibility of the OS with small devices and screens.

Now with Windows 8 scheduled for an official release date of October 26 2012, about three years after the release of Windows 7, Microsoft (MS) has turned the “one size fits all” OS paradigm into the “lowest common denominator” paradigm.  That is to say, it’s almost as if MS has taken the interface, first introduced in the failed Zune music player, then refined for the Windows Smart Phone 7, and has scaled it up for the PC and modern tablet environment.

In this article, I’ll give you the highlights of my experience working with the new OS over the past couple of month and my thoughts on them.  In many respects, Windows 8 builds on Windows 7 with a few user interface changes, feature enhancements and under the hood upgrades.  In addition, I found that compatibility of hardware devices and software with Windows 7 carried over to Windows 8 with few exceptions.

Installation & Initial Impressions

The release to manufacture (RTM) version of Windows 8, a 3.5 GB DVD ISO image, downloaded to my Lenovo ThinkPad W500 notebook without any issues. After burning the image to an installation DVD, I was ready for the install.

The Windows 8 install routine follows the same script as Windows 7.  The installation wizard asked very few questions and proceeded to install Windows 7 without a hitch.  In fact, the only real choice to make during installation is whether to upgrade the existing operating system (assuming one exists) or to perform a fresh install.

In my case, the laptop I was using had two hard drives installed; one with Windows 7 running on it and another empty hard drive. In the majority of cases, I highly recommend backing up your computer and data, testing the backup, and then doing a fresh install (which reformats the hard drive and overwrites the old operating system).  This process, while more time consuming and labor intensive, ensures that your install goes more smoothly and your computer won’t be slowed down with old remnants and “trash” files, hidden malware, and a bloated registry from your previous Windows installation.  Obviously this means reinstalling all of your applications, finding your software keys, and re-registering the applications, so be ready for that.

For a fresh install, the entire process took about 20 minutes, even on my older hardware.  If the installation fails on your hardware, it’s more than likely a hardware or driver compatibility issue. Sometimes merely re-starting the install process after failure gets it to work.

After the installation and reboot were complete, and since I still had Windows 7 installed on the secondary drive, a Windows dual-boot menu came up allowing me to choose Windows 7 or Windows 8. If you do a fresh install over your existing operating system, you won’t have this choice. I chose Windows 8.

One of the new features of Windows 8 is a universal “network” login. While in the past each PC user had a local account to log onto each PC he or she owned, MS now understands that users have multiple devices (laptop, desktop, tablet, smart-phone) and would prefer not to have to create separate logins, internet favorites, desktop settings, etc. for each device.  This is akin to having a “network” or domain controller at the office monitoring and granting access to employee PC’s.  While this is optional, I highly recommend it since it also integrates your social networking accounts and Microsoft store access with the operating system.

By having users create a Microsoft “cloud” user account, using either a Hotmail or MSN e-mail address (or your own primary 3rd party e-mail address), Microsoft can store these settings in the cloud for use with any device you log into with that e-mail address.  That way, every device you log into will look, work and feel the same no matter where you are.  Of course, that means Microsoft can sell you apps and other devices in their digital “ecosystem”, not unlike Apple’s approach to locking you into their digital ecosystem.  It also means that you get 7 GB of online SkyDrive storage free for use to store and share documents and other files.  SkyDrive aware applications can conveniently take advantage of this storage (e.g., Office 2013)

Once you set up your user account, first-time setup asks you which WiFi network you want to connect to (assuming one is nearby) and what settings you want to use for Microsoft updates (i.e., automatic, ask, download then ask.)  New in Windows 8, you can choose your color scheme and background “tattoo” for your working environment (which of course can be changed anytime).  After a few seconds, the new Windows 8 “Metro” interface appears with a background picture of the infamous Seattle space needle. This is where the fun starts!

Before I continue describing my experience, I should mention that at one point shortly after installing Windows 8 (and a few applications), the system inexplicably crashed badly and couldn’t be recovered. Even the repair facility on the Windows 8 install disc was unable to recover the system. Worse, the Windows 7 partition would not boot up either, even though the data contained therein was intact. Only a full installation, this time without the Windows 7 drive in place (my choice), would get me up and running again.  Perhaps this was a hardware issue or an issue with this RTM version; I may never know. But suffice to say, in the future, I will not attempt another dual boot install of Windows 8 with another computer, lest it render both OS’s unusable (thankfully my data was still safe, but I still have to reinstall Windows 7 to get that partition running again).

User Unfriendly Interface?

Even though Windows 8 is not officially released, the new Metro interface (start screen) has already generated a considerable amount of controversy and, let’s just say, outright hatred.  Booting up to the start screen brings you to a tablet or smart-phone style interface with live “tiles” for pre-installed applications (apps) like maps, internet explorer, mail, games, store, music, camera, video, etc.  These apps update the desktop automatically (think gadgets) with information like the weather, incoming mail, social network updates, etc.  Double clicking one of the tiles launches the full-screen app.  Install an application of your own and a launch tile is created for you on the desktop.  But gone in Metro are the comfy and familiar task bar and Start button we’re all accustomed to.  In my opinion, the graphical interface is far inferior to that found in Apple’s OS and seemed a bit like child’s play.  The tiles themselves seemed to be low resolution and quite plain.

From here, things get a little nebulous.  Click on an app tile and it’s quite unclear what you need to do to close the app, launch another one, bring up the app menu, or simply get back to the start screen. I really hope that Microsoft ships the OS with a start-up tutorial for new Windows 8 users to demonstrate how to navigate the OS.  Without something like that, you’re just plain lost.  The first time I rebooted the computer, I had my desktop bitmap background displayed with no clue how to bring up the log in screen (hint: press any key!)

In Microsoft’s effort to create a single operating system intended for use with a keyboard and mouse as well as with finger swipes, they have created needless complexity and confusion for the user.  While I pride myself on digging deep under the hood in every operating system I unwrap, I felt somewhat lost and dumbfounded with my non-touch laptop screen when trying to navigate the OS.  Click up, right-click, click down, click right, click left, double-click, triple click; I tried everything to try and learn how to navigate the interface. Frustrated doesn’t begin to describe how I felt until I figured things out.

The fact is, without some help from the web, I wouldn’t have figured out how to navigate the interface.  By accident, I discovered that pressing the Windows key brought up the traditional Window 7 like task bar and interface (but still no Start button.) Pressing it again takes you back to the Metro interface.  Talk about feeling dumb.

To save you some time and frustration, here’s a little cheat sheet: The upper and lower edges of your screen are reserved for application menus and functionality.  The right and left edges of your screen are reserved for the operating system functionality. You move your mouse (or finger on a tablet) to the screen edges to bring up and use the selections that appear.

Moving your cursor to the upper left-hand corner brings up the thumbnails of all the running applications and a thumbnail of the start desktop.  Moving your cursor to the upper right-hand corner brings up the Windows 8 palate of buttons (called charms): search, share, start, devices and settings.  I won’t take the time to describe them since their name and clicking on each of them makes their functionality obvious.

Launch a traditional (non-Metro) application like MS-Word and you find yourself in the familiar desktop world, a la Windows 7. Launch a Windows 8 compatible application and you’re in the Metro world. At times, it felt like each of these two types of apps were on separate islands, if not like being on a dual boot system with two disparate operating systems. Figuring out how to get from one app to another took some guessing. Fortunately, the Alt-Tab and Windows-Tab key combinations still work. Nonetheless, it definitely takes some getting used to.

Though I didn’t have a touch-screen system to test it, Windows 8 is optimized for touch-screen PCs and tablets.  With the success of the iPhone and other tablet devices, having these capabilities built-in will make the user experience much more pleasant and interactive. Microsoft has made great strides in this area.

New Features and Enhancements

Like all previous iterations of Windows, Microsoft touts the security, performance and resource enhancements brought about by a new “architecture” in Windows 8.  Each version seems to always promise to use less memory, employ processors more efficiently, and need less disk space.  The disk space claims had better be true since solid-state drives (which I don’t have except on my iPad) are somewhat space constrained and quite expensive in the short term.  In addition, to be a truly mobile operating system, it would have to be truly memory and processor efficient. The new trusted boot is supposed to prevent malware from loading before the operating system, thereby making it more secure.

Windows 8 touts much faster start-up time. Is it faster than Windows 7? Yes it is. Is it much faster? No, not in my opinion, at least not on my laptop.

Windows 8 also claims to have longer battery life and faster graphics and text rendering. In my limited testing, I wasn’t able to validate these claims (especially since I don’t have a test work bench). I can however attest to the fact that I was able to connect and reconnect to Wi-Fi networks faster.

Windows 8 comes with the new Internet Explorer 10 as a Metro type application.  The menu and URL bar are moved to the bottom and Microsoft claims that it’s not only faster than previous versions, it has far better support for HTML5 standards.  Using IE 10 is like having a “clean full sheet” view, something that took some getting used to. But I found that I really liked how it looked and felt.  Nonetheless, the first application I installed on Windows 8 was Firefox (and of course my favorite app, RoboForm).

For some reason I’m unable to explain, I was not able to fully test the multi-monitor support touted in Windows 8.  Among Windows 8’s features for handling multiple monitors is the new ability to adjust and set the location of the task bar.  In my case, Windows 8 simply refused to recognize my 30” monitor (perhaps an incompatible driver). But if you’re using multiple monitors, setting the location of the task bar is a nice and long overdue enhancement.

As mentioned above, many apps ship pre-installed on Windows 8 with access to thousands more in the Microsoft app store.  If you’ve ever used a tablet PC or smart phone, you know exactly what I’m talking about.  One annoying aspect of apps are their minimalist approach to giving help and user options.  You often waste time hunting for a button, a menu, something to help you do what you need to do.  Sometimes too little of a good thing (options) is just as bad as too much of it.

My Experience, Comments & Editions

In day-to-day use, there was not much about Windows 8 that struck me as being radically different than Windows 7.  The speed and performance were similar as were the application and hardware compatibilities.  Most hardware manufacturers won’t have to rush out new compatible Windows 8 drivers, but some will.  Since the old Windows registry unfortunately lives on with Windows 8, backwards compatibility is assured, but so are the legacy issues, performance and problems inherent with it.

One important decision you’ll have to make is whether to trust your PC security (anti-virus, malware, firewall, spam, etc.) to Microsoft’s built-in capabilities and forgo a third party security suite or ante up for one. There’s no guarantee that your existing Windows 7 security suite will be compatible with Windows 8, so you may have to upgrade to a newer version. My decision is easy: let the security experts take care of my PC security, so I’ll spring for a third party compatible application.

As for my overall impression, Windows 8 strikes me as the next trouble spot for Microsoft a la Windows Vista.  The Metro interface will be discussed ad nausea and I suspect will continue to be bashed in the media.  In general, while I am happy with the Windows 8 upgrade, I don’t feel compelled, as I did with Windows 7, to rush out and upgrade my Windows 7 PC’s. However, if you’re ordering a new PC soon, then I highly recommend one with a touch screen. For that, Windows 8 is a must have.

As of this writing, Microsoft has announced four editions of Windows 8 with varying feature sets (e.g., Windows 8, Pro, Enterprise, and RT) with pricing from $14.99 (for Windows 7 computers purchased after June 1, 2012) to $39.99. For more details on the various editions, feature comparisons and upgrade paths, check out http://en.wikipedia.org/wiki/Windows_8_editions.

Windows 8 runs on any hardware that can run Windows 7. It will also be able to run any programs that run under Windows 7, unless you opt for a Windows RT tablet, which will only run new-style (Metro) Windows 8 apps.

After using Windows 8 for a period of time, it became readily apparent why Windows 8 upgrade pricing is so inexpensive: Microsoft expects users to make a lot of purchases from the Microsoft store. Towards that end, the store is somewhat “in your face” more often than you might like.

Like Windows 7, I once again expect a very slow and cautious corporate approach to upgrading to Windows 8, with many companies waiting until the first service pack is released before committing to deployment.  While the operating system is more secure, I don’t see many compelling corporate features to cause many companies to rush into upgrading.  Windows 7 is simply good enough.

Because of the learning curve involved, and because there is currently no option to disable the Metro interface, I suspect that many IT departments will shelve this upgrade until Microsoft is pressured enough to make the Metro interface optional and bring back the Start button and traditional Win 7 interface as the default. I’m not sure that’ll happen, but a slow corporate OS upgrade cycle might convince Microsoft to do so.

If you’ve been playing with the consumer preview or RTM versions of Windows 8, I would love to hear your feedback or questions.

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