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I Hate Paying Taxes


Photo credit: B Rosen

I can be something of an ideological nut job when it comes to avoiding income taxes. In my younger days, before my wife dragged me kicking and screaming into normal, civilized behavior, I was known to subsist on rice and beans for a month or two at a time in order to free up cash to max out my 401k plan, Roth IRA, HSA plan and any other tax-free savings vehicle I could get my hands on. Yes, it was Spartan. But it saved me a ton in taxes over the years, and I’m still enjoying those benefits more than a decade later.

Don’t worry, I’m not going to recommend you go to my ridiculous lengths. My pathological need to lower my tax bill is probably an unhealthy obsessive-compulsive disorder. But with the tax return deadline coming up on Monday, I figure a little advice on prioritizing is in order. It might be too late to put any of this into practice for your 2015 return. But you can absolutely make a dent in your 2016 tax bill. So, with no more ado, here are a few tips for lowering your tax bill this year.

It starts with the 401k. Before you invest a single red cent in anything else, you should come as close as you reasonably can to maxing out your 401k plan. In 2016, that maximum contribution level is $18,000. If you’re young, that might not be realistic goal. For some recent graduates, $18,000 might very well amount to nearly half their after-tax income. But if maxing out the 401k isn’t doable, then you should at least contribute enough to take full advantage of your employer’s matching, which usually amounts to 3%-5% of your income.

If I had an employee under me that didn’t contribute at least enough to get full employer matching, I would find an excuse to fire them. Employer matching is an instant, tax-free, 100% return. If you’re not smart enough to take advantage of instant 100% returns, you clearly don’t deserve your job.

Once you max out the 401k plan, look into contributing to a Roth IRA. (A Traditional IRA is usually not tax deductible if you’re already contributing to a 401k plan, so a Roth is going to make more sense.) A single taxpayer can contribute the $5,500 per year to a Roth IRA ($6,500 if 50 or older) so long as their income is no more than $117,000 per year. At higher income levels, the amount of money you can contribute to a Roth IRA starts to get phased out and goes to zero at an income of $132,000. For married couples filing jointly, your eligibility starts to be phased out at $184,000 and falls to zero at $194,000.

If you make too much money to contribute to a Roth IRA… well, congratulations! That’s a great problem to have. But it’s still a problem.

Luckily, there is a loophole. For those willing to do a little extra work, you can open a traditional IRA and then convert it into a Roth IRA.

Ok, let’s say you’ve maxed out all 401k and IRA options. What next?

If you have a high-deductible health insurance plan, consider using a Health Savings Account (“HSA”) as an “extra” IRA.

HSA accounts are intended to be used for health expenses. But no one ever said you have to spend the money. You can let the money sit in an HSA investment account until age 65, at which point you can withdraw it penalty free just as you could with IRA funds. Note: There are differences here. You can withdraw IRA funds penalty free at age 59 ½. With HSAs, you have to wait that additional 5 ½ years to age 65 in order to use the funds penalty-free for non-health-related reasons. Though you can withdraw the funds penalty-free and tax-free at any time so long as you use them for medical expenses.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.


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Finding Income Gems in a Bubbly Market


I follow income stocks pretty religiously, though I’ll admit it’s been a while since I’ve looked at tobacco stocks. I sold my last tobacco stock – Marlboro maker Altria (MO) — about a year ago when I took a long, hard look at the dividend yield (then about 4%) and decided it no longer made sense to own as an income stock. At that price, there was a lot of potential downside and very little upside.

Or so I thought…

It seems I sold too soon. Altria’s stock price has enjoyed a nice 20% bump since then, and the yield has shrunk to just 3.6%. The stock trades for 23 times earnings… which is slight premium to the broader market.

Now, I’m not the biggest fan of bubbly tech stocks like Facebook (FB) or Amazon (AMZN). But I can promise you this: I’d much rather pay the current multiple of 84 times earnings for Facebook or even 460 times earnings for Amazon… even though I consider those valuations to be wildly excessive… because I believe that there is at least a chance that the companies could grow into those valuations. It could happen. But tobacco stocks operate in an industry in terminal decline. Cigarette sales volumes fall with every passing year, and the regulatory noose just keeps getting tighter.

Now, there is nothing wrong with buying a stock in a declining industry, particularly if you’re playing it as a short-term trade. And even as a long-term holding, it can make sense so long as you’re buying them as deep-value stocks and realizing a decent current return via an outsized dividend. But there is no scenario under the sun in which tobacco stocks should trade at a premium to the broader market. None. Nada. Zip.

This is how desperate investors are for yield these days. They’re willing to accept a sub-4% yield on a no-growth company in a slowly dying industry because they can’t find a better yield elsewhere.

Well, the fact is, they’re not looking hard enough. As I wrote two weeks ago, prices in several corners of the income market are actually downright cheap. Yields of over 10% are common in mortgage REITs and business development companies. (Incidentally, I recommended one of my favorite mortgage REITs in the last issue of Boom & Bust.) These sectors are not without their risks, of course. But at least you’re being properly compensated for taking those risks at current prices and yields.

But while I like select mortgage REITs and business development companies, I see the very best opportunities in closed-end funds.

As a group, closed-end funds are trading at some of the deepest discounts to net asset value since the 2008 meltdown and its aftermath. It’s not unusual these days to find funds trading for 80 cents on the dollar. And some of the yields can be downright spectacular.

In the last issue of Peak Income, Rodney recommended a solid municipal bond fund paying a fat 6.7% yield… tax free. If you’re in the highest tax bracket, that amounts to a tax-equivalent yield of over 11%.

Now, getting these kinds of yields involves taking a modest amount of risk. The fund employs a little leverage and owns a small amount of bonds issued by some shaky issuers like Illinois and Puerto Rico. But the vast majority of the fund is invested the bonds of at least semi-responsible state and local governments that can reliably be expected to service their debts. And believe me, I consider a fund like this a lot safer than an Altria trading at today’s prices.

Next week, I’ll be adding a new recommendation to the portfolio: A solid REIT fund offering an 8% dividend and backed by some of the biggest, safest names in the business.

This piece first appeared on Economy & Markets.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.

Photo credit: GotCredit

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Dividend Investing: How Many Years of Dividend Growth is Enough?


I gave my thoughts on dividend investing to CNBC’s Constance Gustke. You can read the full article here, and an excerpt is below:


Does the length of years a stock has been paying dividends, and maybe increasing them, matter in selecting a dividend investment?

Reliability of cash flow and dividends over a number of years is essential, but how many years, exactly? This could be the most important question when it comes to choosing a dividend ETF, specifically.

Sizemore said S&P Dividend Aristocrats Index is 25 years, the basis for the PowerShares NOBL ETF, and only includes stocks with a 25-year history of raising dividends. While that means the dividends are “close to bulletproof,” the downside is, you don’t get the tech-sector names like Apple or even Microsoft, which have emerged as some of the fastest-growing dividend payers.

“You’re getting a core of old consumer staples and old industrials that have been around forever,” Sizemore said. “It’s not bad, but those stocks are kind of expensive.” In his view, with the stock market in the latter stages of a bull market run, sectors like consumer staples aren’t trading at prices that Sizemore sees as being a good entry point. “I don’t want to overload on these sectors,” he added. “They won’t have to cut dividends, but the problem is, the stock prices aren’t that compelling.”

Overall, “10 years is a nice round number,” Sizemore said. “As an investor, you can figure that in any 10-year window, the companies have seen at least one recession. Clearly, it takes a high-quality company with substantial staying power and cash flow to generate and grow a dividend over 25 years, but what an investor also might miss out on is emerging dividend players.”

Photo credit: Simon Cunningham

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Musing on Prospect Capital’s Earnings Release

Decent earnings report by Prospect Capital $PSEC. Mild decline in NAV due mostly to mark-to-market losses.

— Charles Sizemore (@CharlesSizemore) Feb. 9 at 04:20 PM

$PSEC‘s dividend unchanged for the next three months…and language in the press release seemed to imply a special dividend was possible.

— Charles Sizemore (@CharlesSizemore) Feb. 9 at 04:21 PM

At current prices (including after hours trading), $PSEC yields 18% and trades for 59% of book value.

— Charles Sizemore (@CharlesSizemore) Feb. 9 at 04:23 PM

It’s a bear market, and value doesn’t seem to matter much now. But $PSEC seems like a nice low-risk, high-return buy here.

— Charles Sizemore (@CharlesSizemore) Feb. 9 at 04:24 PM

$PSEC‘s concentration in energy 3.2%, including first lien senior secured loans where third parties bear first loss capital risk.

— Charles Sizemore (@CharlesSizemore) Feb. 9 at 04:26 PM

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Is Apple the Next Altria?

It’s nice to see some level-headed analysis of…well…just about anything these days. Apple (AAPL) has taken its lumps over the past six months as investors fret that the company is now “post-growth.”

I don’t believe that Apple is finished growing. But even if it is, I would argue that the stock is cheap at current prices. Even utility stocks — which really are close to zero-growth companies — trade at higher valuations than Apple does today. (See Revisiting Icahn’s Apple Call After the Correction.)

Barron’s Tiernan Ray made some very sensible comment’s in Saturday’s issue:

Jim Cramer coached his viewers to adopt a certain resignation. What if, he mused, Apple were just an enormously valuable company that might never grow again, like Pfizer (PFE), whose sales have declined four years in a row? Seen in that light, the iPhone is an important but declining asset, akin to Pfizer’s Lipitor, he suggested.

As if the comparison to a cholesterol drug wasn’t hilarious enough, CNBC also brought on a noted New York University business professor, Aswath Damodaran, who suggested, with a bit of a twinkle in his eye, that we think of Apple as we do of Altria (MO), which makes Marlboro cigarettes. Like Altria, Apple can afford to pay out billions in dividends and buybacks for decades to come, whether it grows or not. And anyway, he concluded, people seem as addicted to their iPhone as they are to cigarettes.

Altria (formerly Philip Morris) was the best-performing stock in the Standard & Poor’s 500 from 1957 to 2014, according to Howard Silverblatt with S&P/Dow Jones Indices, so perhaps this point of view has a certain logic to it.

I made the comment years ago that Big Tech is the “New Big Tobacco,” and the metaphor still holds. I also commented about a year ago that Apple had enough cash on its book to continue paying its dividend at current levels for the next ten years… without earning a single dime of additional profit… and this takes into account the taxes Apple would have to pay to repatriate the cash at current tax rates. Yes, Apple could be a break-even company… not earning a single penny in profit… and still maintain its dividend for the next decade.

Apple is one of the best — and safest — bargains I’ve seen in my lifetime at these prices.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. He is currently long AAPL.

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