Take the "Ouch" Out of Next Year's Tax Bite

Question of the week:I'm dreading April 15th already. I know I'm going to owe--is there anything I should be doing now to lower my taxes? --Philly76

Dear Philly76,

We feel your pain. The economy is down and its future is uncertain, but we still have to pay the tax man. When we recently asked members of the Armchair Millionaire community about what they're doing to cut their taxes, we heard a few grumbles and some good suggestions:

"I'm going to sell one index fund that I've had forever that is down 30 percent overall, and then use the money to buy shares in another index fund. I'll get a nice capital loss to write off, plus get somewhat better diversification than I had before." --MBL

"I'm paying all my property taxes before the end of year, increasing my 401(k), and taking capital losses, but my taxes will be still be high this year ..." --SM

My suggestion is that you step back and take a good look at your overall financial picture. Ask yourself: Can I save more in tax-deferred accounts? How much can I afford to give away? How can I adjust my investments to reduce my tax liability? My checklist will guide you on some of the specific moves you can make.

The Armchair Millionaire Checklist of Tax-Busting Moves

• Give to a good cause. It's no coincidence that you receive most of your charitable solicitations at this time of the year. Haul out your checkbook and donate to those less fortunate than yourself and get a tax deduction at the same time. And don't overlook non-cash donations. That old clunker sitting in your driveway, for example, might be worth more as a write-off when you donate it to a local charity than it would be if you sold it to your 16-year-old nephew.

• Harvest your capital losses. There is one advantage to selling when the market is down: You can use up to $3,000 of capital losses to offset any capital gains or "ordinary" income, like your salary. (If you have any capital gains this year, by the way, I congratulate you.) If you have more than $3,000 in losses, you can carry them over to future years. To not truly "lock-in" your losses, I suggest selling one investment and immediately reinvesting your proceeds in another investment that is similar enough to fit in with your overall investment goals.

• Max out your 401(k). Every buck you stash away for retirement is a buck that won't be taxed. The maximum most people can contribute this year is $11,000, a figure that will go up by $1,000 every year until it hits $15,000 in 2006. If you're over 50, take advantage of the new "catch-up" provision, which lets you contribute even more: $12,000 this year, going up to a sweet $20,000 by 2006. See your HR folks for details.

• Take advantage of flexible spending accounts. Many employers these days offer these accounts (also called "cafeteria plans") that allow you to have a set amount of money withheld from your paycheck that you can use later for medical expenses or childcare. Your contributions come out pre-tax, so you get to save a few bucks on these basic expenses. Fall is often the time when employers let their employees begin or change their contributions, so check with your HR department.

THE BOTTOM LINE: There are plenty of ways to lower your taxable income, and you'll find that many of them will not just cut you tax bill, but improve your overall financial picture, to boot.

Ripped Off!

Question of the week:I just found out the closing costs I paid when I refinanced my mortgage were much higher than average. I had no way of realizing this before it was too late-what should I do in the future to make sure I know what I'm getting into when I deal with banks, brokers, etc.? --AB in Colorado Springs

Dear AB,

FROM ARMCHAIR MILLIONAIRE.COM Start Your Financial Future Today Name: Email:

As financial services have proliferated into every aspect of our lives, so too have the chances for us to pay too much for, or to get talked into buying financial services that we don't really need at all. When it comes to getting hit with unexpected financial services costs, you have plenty of company in your frustration. When we asked Armchair Millionaire community members about the surprise charges that get their goat, we got an earful. Here are a few examples:

ATM fees. "When I can't get to my bank and have to use another ATM machine, I have to pay that machine, plus pay my bank for the privilege of getting my own money." --Theresa

Mutual fund loads. "Fund loads don't improve fund performance, and have little bearing upon a fund manager's results." --Vito Z.

Biweekly mortgage payment programs. "Paying a bunch of money to have your mortgage payments put on a biweekly plan so you can pay it off sooner is crazy. Just make an extra payment yourself every year." --Kimmy

Some of the fees you pay are compensation for honest work by financial services providers, but others are hidden fees that simply pad their bottom line. My checklist will help you separate the reasonable from the outrageous.

The Armchair Millionaire Guide to Not Getting Fleeced

• Look closely at underlying costs. You will always pay some kind of fee or commission for every single financial service or product you ever buy, but often it will not be clearly spelled out for you. No load mutual funds can still carry significant costs, for example. Just because you can't easily see it doesn't mean it isn't there, so don't hesitate to ask about the fees that you will be paying.

• Take your time. People spend more time deciding which video to rent than they do hunting for the best deals on financing or insurance, even though careful shopping could save them thousands of dollars. Shop around and make sure you understand what you're getting in to. If you're feeling pressured, or if you're not getting the answers you need, delay your decision to another day.

• If you don't need it, don't buy it. More does not equal better. Children--and others without dependents or mortgages--probably don't need life insurance, plain and simple, no matter what your insurance salesman tells you. Don't buy credit card insurance when you pay your balance off every month. Likewise, don't buy insurance that will pay off your mortgage if you die when you already have life insurance.

• Understand how your financial services providers are paid. How much will your insurance salesperson make from selling life insurance to you? What about your broker? Are they paid a commission every time they make a change in your portfolio, or do you pay them a percentage of the assets they manage? Paying for advice is fair. Overpaying for advice isn't. Make sure you are comfortable with the price you're paying and what you are getting in return.

• Negotiate fees. Everything from "dealer prep charges" when you buy a car to "mortgage broker fees" when you finance a house may be negotiable. Understand them and ask for them to be lowered or removed. If the fees are not satisfactory to you, be prepared to take your business elsewhere.

THE BOTTOM LINE: Financial services pitfalls are so commonplace now that there is no way to even know about all of them. Your best route is to go slow with any decision, be skeptical of all fees and insist on completely understanding any product or service before you buy.

Wheeling and Dealing

Question of the week:I'm very tempted to by all the zero percent financing offers to go ahead and get a new car. What's your opinion about those deals?
--LT from Texas

Dear LT,

You have a lot of company these days, as these deals have been in large part responsible for the substantial boost in car sales this year. We asked members of the Armchair Millionaire community your question, and heard strong opinions both for and against. Here are a couple of examples:

Stay away. "It seems like they offer you zero percent and then jack up the retail price, so I'm not really sure it's that great of a deal." --M. Tyger

Go for it. "You can't beat these deals. I got zero percent financing on a Chrysler Sebring and saved $4,000 by not buying a car with interest payments." --John L.

In my own view, zero percent financing is a great marketing tool for the dealers, but usually not such a great deal for consumers. Here are the main reasons I steer away from them:

• You're likely to pay a higher price for the car in order to get the zero percent deal.
• You can generally only get the zero percent deals if you have perfect credit. (In fact, one study showed that less than 10 percent of all car buyers who financed at their dealership received the zero percent rate.)
• The deals only apply to certain models (often the most popular ones) and only new cars.
• Many zero interest deals apply only to shorter term loans--like 24 or 36 months--making the monthly payment too high for some.

If you decide you simply must go after the zero percent offer, I suggest that you love the car, negotiate hard on the price, and walk away if they tell you that you won't qualify. And if you decide the deal isn't right for you, my checklist will guide you through your alternatives.

The Armchair Millionaire Checklist of Car Buying Options

• Pay cash. Imagine that! Yes, people do actually still put down cold hard cash for cars. Pros: You'll have your very own zero percent deal, and no debt monkey on your back. Cons: You'll have to do some serious planning ahead and saving to have the cash on hand when you want to make the buy.

• Get a loan from your bank or credit union. Pros: You can already have your financing in hand when you hit the dealership, giving you an edge in the negotiations. Cons: Your interest is not tax deductible.

• Get a home equity loan. Pros: You'll probably get a good interest rate, plus be able to deduct the interest you pay. Cons: You'll erode the equity you have in your home, and may have to pay some closing fees.

THE BOTTOM LINE: There are no hard and fast rules in the best deals for car financing. You have to sit down with your calculator and run the numbers on each one, figuring in your down payment, the term and interest rate of the loan, and the price of the car.

Making a Buck on Real Estate

Question of the week:My money is primarily in the stock market right now, but I'm interested in diversifying by trying my hand at real estate investing. What's your take on that? --MM

Dear MM,

While making money in real estate is easy if you believe the late-night TV hucksters touting instant profits with no money down, the reality is quite different. Yes, it certainly is very possible to get better returns in real estate than in the stock market. But it requires a lot more work and a bit of luck.

When we recently asked members of the Armchair Millionaire community about investing in real estate, we heard about some good and not so good experiences:

"I first opted to try investing in real estate several years ago when moving out of state for new employment. Instead of selling my house, I contracted with a local property management company to rent it out and take care of it for me. This was one of the best moves I've ever made. This property has not only appreciated to near double what I owe on it, it also generates some monthly passive income. Since then, I have acquired other properties and am using the income they generate to purchase more." --Kevin

"My parents invested in a commercial real estate deal to build student apartments in a small town a few miles from a state university, but they lost money on it. It did sound like a project with good potential, but the person in charge went bankrupt during the building phase and all the investors lost their money." --Simplicity Key

When considering the pros and cons of investing in real estate versus the stock market, consider these fundamental differences between the two:

When you invest in stocks--especially if you do so through an index fund--you can build a hugely diversified portfolio of stocks from around the country and the world. But when you invest directly in real estate, you're usually restricting yourself to one property (or type of property) in one geographic location. This leaves you vulnerable to shifts in that market.

On the upside, real estate prices in general over the years have tended to be much more stable when contrasted with the volatility of the stock market.

If you're determined to dabble in real estate, my checklist will get you started in the right direction.

The Armchair Millionaire Checklist for Investing in Real Estate

• Understand what it takes. You'll have to devote a nice chunk of your time to your new enterprise. Also, be advised that you could expose yourself to financial and legal difficulties, and may have to deal with tenant and maintenance issues--all with no guarantee of a profit. If you don't have the right temperament for all this, stick with stocks.

• Choose your specialty. Your could buy property with the intention of selling and turning a quick profit within days, or purchase a property, rent it out, and then wait years for it to increase in value. You might invest in single family homes, apartment buildings or commercial property. You could focus on run-down neighborhoods or glitzy shopping malls. Each of these is a very different game, so understand the advantages and disadvantages of each and then pick one to excel in.

• Start slow. Don't take on too much too soon. Deal with one property and then, if it works out, go on to another. The learning curve is steep, so don't over commit your money while you're learning the ins and outs.

• Get professional help. Positively have an attorney and CPA on your side, preferably ones who specialize in real estate transactions.

• Consider REITs. Real Estate Investment Trusts (REITs) invest in publicly traded real estate companies but you buy and sell them like a mutual fund. With REITs you get diversification into real estate without the headaches of being a landlord.

THE BOTTOM LINE: As with all investments, when you're looking for higher returns in real estate you'll have to take on higher risks. Before you make the leap, closely scrutinize whether it's the best course for you, and then create a clear strategy for making it work.