On a plane back from New York, someone sitting next to me noticed I was writing my next blog, and asked me what my “10 Commandments of Investing” would be. A quick conversation led me to rapidly type my thoughts. So, consider this my extremely abbreviated summary of the things you should never forget when investing and planning your future.

Please be advised: these commandments are not listed in any order of priority, so don’t think of “number one” as being the most important. At some level, they are all very important.

Drum roll, please. Here they are, my 10 Commandments of Investing:

1. Stick with the indexes
Leave the individual stock picking to gamblers and speculators. Very few people really understand how to successfully pick individual stocks, and if they do, the news that drives markets today is totally unpredictable, making individual stock picking a highly risky venture. Reams and reams of statistics prove index investing almost always outperforms the financial advisors, money managers, and stockbrokers. Stick with the indicies and you’ll likely wind up far ahead of the game. Care to speculate a bit on some individual stocks? Do it with a small portion of your money, but certainly not the bulk of it.

________________________________________________________

2. Watch those fees
Wall Street loves investors that don’t watch their fees. For those investing in funds, check out www.personalfund.com. You might be shocked to find out the total cost your funds are charging you to own them year after year. Especially over the long haul, fees can destroy your returns.

Minimize fees as much as possible by investing in low-fee, highly diversified investments such as one of my personal favorites, Exchange-traded funds such as those offered by www.ishares.com

________________________________________________________

3. Create a bond ladder
For income, bond funds are the favorites among many advisors. They’re simple, quick, and unfortunately, sometimes loaded with fees. Consider laddering bonds instead. Why? Mutual funds containing bonds have no maturity dates. If the value of the fund goes down, good luck trying to guess when your principal will “come back.” With a laddered bond portfolio, as long as the bonds don’t default, you have a date when your money will be returned to you.

Creating a bond ladder is not as easy as choosing a few bonds funds; it usually requires the assistance of a skilled advisor. But the next time an advisor recommends bond funds for income, be sure to suggest this as an alternative. Some advisors don’t construct ladders, and if they have little or no experience doing so, I would suggest getting an opinion with someone else before leaping into the funds.

________________________________________________________

4. Diversify
You’ve heard it a thousand times, but it’s amazing how few people actually do it. Diversification saves lives and prevents disasters, especially when you don’t put too much money in one place. Also be certain to understand the concept of “rebalancing.”

That’s important stuff, and if you don’t understand it, go back and read a quick intro to the concept at Wikipedia. Rebalancing, together with diversification, will likely one day save your investment life.

________________________________________________________

5. Watch your money
No one else will ever keep track of your money like you will.

Don’t get lazy and stop paying attention.

Read your statements every month and monitor your progress and returns.

This is your hard earned money we’re talking about, and don’t ever forget that.

________________________________________________________

6. Don’t rush in
You’ve likely heard the saying “only fools rush in.” On every level, rushing into things can cause great harm. Whether it’s rushing in to get high returns, rushing out as a result of emotion, or rushing into a decision as to where to invest, before diving in pause, take a deep breath, sleep on it, and then make your decision. As a “subset” of this commandment, I would also include: Be careful when listening to others. What’s good for one person is terrible for another. The media does a great job of generalizing advice and investments, and I think that’s an awfully dangerous game to play.

Unless someone really understands your personal situation and goals, I firmly believe it’s nearly impossible to make conclusive and general statements as to “what’s good” and “what’s bad” for you. No good doctor could ever diagnose a problem without getting the answers to some basic questions. If they fail to do this, prescribing a pill can literally kill you. The same is true with investing. Only when a few key questions are answered could anyone really give prudent advice on “what’s good” or “what’s bad” for you. So the next time someone tells you to “stay away from this” or “you should invest in that” be careful. Educate yourself, assess the advantages and disadvantages of the advice you’re getting, pause, then make your decision. By doing so, chances are you’ll make the right one.

________________________________________________________

7. Don’t take the risk if you don’t need the return
Many people would do perfectly fine getting 7-10% returns on their money, yet their portfolios are invested in things that strive for well beyond that. Especially if you’re a retiree, if you doubled or tripled your money overnight, would you go out and buy a fancy new sports car? A mansion on the hill? Few of us would. And for that reason, always ebb towards the safer side of investing as much as you possibly can.

________________________________________________________

8. Get out if something isn’t working
The greatest investors I’ve ever known are the ones who don’t get emotional about their money. I’m not talking about the Warren Buffets of the world. I’m talking about highly successful investors I’ve met who were schoolteachers, electricians, and small business owners. Some of the best investors I’ve met are those who understand that becoming emotional about an investment often leads to disasters. Easier said than done, I know, but this one is very important: Don’t ever fall in love with an investment. It doesn’t love you as much as you love it. So if it isn’t working, cut it off before you really regret it.

________________________________________________________

9. Understand tax consequences
I’d place this right alongside number two above. Over time, the tax ramifications of your investments can really help or hurt you. It’s been said that “It’s not what you earn, it’s what you keep.” Amen. You absolutely, positively need to understand the very basics of what happens with your taxes when you move money around, especially if you are investing in mutual funds that often create taxable events beyond your control.

________________________________________________________

10. Keep it simple
Only one more commandment? That’s too bad. I can think of so many more favorites — start saving as early as possible, take advantage of compounding, max out your qualified plans, etc. But if I had to pick only one more point to complete this quick “off the top of my head” list, it would have to be to keep it simple.

I once met a very successful investor who did quite well for himself over many years. His entire portfolio consisted of literally three positions: a Standard & Poor’s (S&P) 500 index fund, a low-cost bond fund and a low-cost international stock fund. Other than some cash sitting on the sidelines, that’s it, and not surprisingly, he did better than most investors I’ve met with phone books of investments that re difficult, if not impossible, to keep track of. While I certainly don’t endorse keeping your entire portfolio in three positions (given that I don’t know your personal situation), I can say that keeping it simple is a universal lesson of life itself, and in the world of investing, it allows you to do one very important thing: keep track of what you have and how it’s doing. The more complicated things get, the more room there is for disaster. It really is as simple as that.

IN CONCLUSION

It’s a bit tricky narrowing down an entire investing universe to ten points. Perhaps if I was flying from Los Angeles to Florida instead of New York to Florida I’d have more time to think about this. I’m sure as soon as this is posted I’ll regret not including some other things that will come to mind. So, consider the above a random sampling of my mind that in the matter of a few minutes, conjured up the above over two small bags of Delta’s Roasted Peanuts and a Diet Coke (that just spilled all over my Sports Illustrated magazine. What a bummer).

Stay tuned for my next post on the lessons Star Wars teaches us about investing. I’m having fun with that one.

If you enjoyed this post, don’t forget to subscribe to my RSS feed!

3 little ideas that can mean big things for investors

Although there’s plenty of bad press and dark clouds over the housing market these days, it’s hard to argue that real estate will remain a foundation of many people’s wealth for a long time to come.

Building wealth with real estate can be as simple as buying a house, living in it for many years and eventually selling it for a profit. Building wealth with real estate can also be as “simple” as investing in a commercial property such as a shopping center and collecting an income from it while it presumably appreciates in value.

That said, the purpose of this article is not to address the more familiar scenarios above, rather, to summarize three often overlooked concepts that could be helpful to quite a few people:

• 1031 Exchanges
• Tenants In Common programs
• Using IRA money to buy real estate

Let’s take a closer look at each…

1031 Exchanges

In its simplest form, a 1031exchange provides a real estate investor with the opportunity to defer payment of capital gains tax when selling one property for another. By deferring taxes owed on a sale of a property, an investor basically has more money available to purchase a new property, essentially receiving a “tax free loan” from Uncle Sam on the amount of money that would have ordinarily been lost to taxes.

Although 1031 exchanges are relatively simple to implement, there are a handful of important points to understand:

• 1031 exchanges do not apply to primary residences. Only property held for investment or business purposes can qualify.

• The property being bought and sold must be of “like kind.” Generally, “like kind” simply means exchanging one investment or business property for another. Although the definitions of “like kind” is generally liberal, state laws could differ so be sure to take a closer look at the state(s) in which the property(s) are being bought and sold.

• The property being purchased must be of equal or greater value than the one being sold. In addition, the equity and/or debt of the new property must be equal to or greater than the equity and/or debt of the property being sold as well.

• For a qualified exchange to take place, one must identify the new property within 45 days and the transaction must be complete within 180 days.

• The exchange must be conducted through a Qualified Intermediary; the real estate investor cannot take possession of the proceeds from the sale nor can they maintain any control of them. If any of these important criteria are not met, the exchange does not qualify as a 1031.

• Multiple properties can be included in a 1031 exchange. For example, one can exchange several smaller properties for a single property and vice-versa.

• Cost basis is carried-forward from the property being sold to the one being purchased. The newly purchased property does not take on its own cost basis.

• Any taxable gain from depreciation recapture is deferred as well.

There are many other important issues that need to be addressed before any transaction takes place, but hopefully the above summary demonstrates that a 1031 exchange can certainly be a worthy benefit to consider before someone sells an investment property.

_________________________________________________________

Tennant In Common Programs

One of the main problems I’ve come across with 1031 exchanges has nothing to do with the process itself. Rather, a common problem I’ve seen is simply not being able to identify a property worthy of purchase after the original property is sold.

In such a case, one might consider one of the many Tenant-In-Common programs available in the country. Otherwise known as a “TICs,” “fractional-ownerships” or “co-ownerships,” these programs provide real estate investors with the opportunity to purchase a partial, or proportionate interest in an existing property instead of owning the entire property itself.

Although a 1031 exchange can take place when “rolling” the proceeds of the sold property into a TIC, some investors shy away from these programs given the lack of controlling interest. Conversely, some investors might actually prefer a TIC program given the management of the property is off-loaded to a third party, obviously at a cost.

 

That said, when a 1031 is desired and a property cannot be identified, one might consider a TIC program in order to defer paying the capital gains. (IMPORTANT NOTE: TICs are a complex procedure. Be sure to consult with a qualified CPA or tax advisor before any actions are taken).

_________________________________________________________

Using IRA money to invest in Real Estate

When it comes to building wealth with real estate, this is without a doubt one of the biggest surprises out there…. Unbeknownst to many, it is entirely legal to purchase real estate using IRA funds, but there are a handful of restrictions and important details to consider before doing so.

Technically speaking, IRAs cannot invest in things such as artwork, rugs, antiques, metals, gems, stamps, coins, beverages, stock in an S corporation, life insurance, and other tangible personal property. Other than these items, everything else is generally fair game, including real estate such as land, commercial property, residential property, real estate options and real estate loans.

Although using IRA funds to purchase real estate is generally simple to implement, there are a few restrictions and important details to consider such as:

• The custodian of the property: most IRA custodians will not allow real estate to be purchased within their accounts. Only a select few custodians in the country specialize in these types of arrangements.

• The purchase of real estate can be for investment only. Real estate such as a primary residence cannot be purchased using IRA funds.

• The IRA cannot buy real estate from a “disqualified person.” A disqualified person is defined as the IRA owner itself, a spouse, a direct descendant or ascendant (for example: a daughter, son, mother or father). To simply this important point, it is completely legal to use IRA funds to buy real estate from a stranger or parties generally outside the family bloodline.

• An investor cannot personally guarantee a loan when IRA money is being used to purchase a financed property. For those asked to personally guarantee a loan when using IRA money to purchase a property, various banks do specialize in loaning money to IRAs to help finance such a purchase. However, when financing is necessary, a simpler way to buy real estate using IRA funds might be to purchase the property in partnership with money held outside the IRA, with a third party or even as part of an LLC which is completely legal as well.

• An investor using IRA funds to purchase real estate could incur Unrelated Debt Financed Income. UDFI is the income and/or capital gains tax attributable to the financed portion of the property. UDFI must be paid by funds within the IRA and for various reasons not addressed here, taxes incurred by using IRA funds to purchase a financed property are typically greater than taxes incurred from a property purchased with funds outside an IRA.

• If at all possible, when using IRA funds to purchase real estate, it’s ideal to buy property that does not require financing. If financing is required, one should consider purchasing the property in partnership with third parties (as stated above, third parties such as money held outside the IRA or as part of an LLC). In the arrangement where no financing is required when buying the property, the major benefit is that no UDFI would likely be incurred.

Needless to say, the above covers only the general concepts of using IRA funds to purchase real estate. But when it comes to building wealth from investing in real estate, if there is one concept many investors are not aware of, hands-down, I’d say this one is it.

As with all concepts mentioned above, before taking any action, be sure to review your unique personal situation with a qualified tax advisor. After all, when it comes to investing, taxes and just about everything else, it’s the details that always count the most.

Alan Haft offers securities through Workman Securities Corp., Eden Prairie , MN . Member FINRA/SIPC. This investment is offered to Accredited Investors only. Consult your financial representative for more information about qualifying as an Accredited Investor.