It's Not Fun, but It Has to be Done Benjamin Franklin wrote a 1789 letter that states, “But in this world nothing can be said to be certain, except death and taxes.” Even at the United States’ early beginnings, federal taxes were a necessary evil to fund various public projects and administrative costs. Today, federal taxes serve much of the same purpose. While virtually no one likes to prepare and file their taxes, it is a necessity if you want to avoid fines and further hassle. It is no secret that preparing and filing your taxes is notoriously complicated. Many people lament that it should not be so difficult to pay the government. However, some of the complications allow people to save money if they discover specific tax benefits. Knowing how to file your own taxes may be a good option if your tax situation is relatively straightforward, or if you are willing to learn the process. Why Do You Need to File Your Taxes Every Year? The short answer is that federal law requires that most individuals file taxes annually. Income taxes are assessed every year based on your income earned during that period. You then pay a percentage of that income to the government, less any deductions, adjustments, or credits that you qualify to receive. If you do not file (and pay) your taxes, then you may be assessed penalties and interest. The Internal Revenue Service (IRS) can even go as far as garnishing your wages and repossessing your property if you do not file and pay as required. The Benefits of Filing Your Own Taxes If you are one of the 43% of Americans that are doing your own taxes, you are certainly not alone. Roughly 53 million people prepared and filed their own taxes in 2018. There are many benefits to filing your own taxes, including: Saving money: Hiring a tax professional is expensive, and many people can prepare and file their returns on their own, completely free of charge. Control: Some people like knowing the exact information that is included in their return and being able to control the data, and for some, knowing precisely how the numbers work out, is comforting. Gain helpful information: When you prepare your taxes, you can see what items saved you money this year or which issues you should address so you can save money next year. While filing your own taxes is complicated, it can be beneficial under the right circumstances. There are several programs online that walk you through the process to help ensure you are taking advantage of all of your available deductions and credits. The Drawbacks of Filing Your Own Taxes In addition to the benefits, there are also some disadvantages to filing your own taxes. These include: Time and effort: Preparing and filing your taxes takes time and work You have to sift through financial information and deal with concepts that you may not understand well. The process can be frustrating and take a considerable amount of time. Error risk: If you do not completely understand how your taxes work, you run the risk of making a mistake because of misconceptions. If that happens, it could lead to underpayment and audits down the road. Questions: Even if you use a tax preparation software, you may still have questions that will remain unanswered unless you do significant research or reach out to a tax professional. For some people, the risk of having a substantial error that triggers the IRS’s attention is enough to scare them away from preparing their own taxes. Preparing for Filing Your Taxes When you begin work on your taxes, you should have information gathered throughout the year. Some of the most common items that you will need include: Social Security numbers for you, your spouse, and any dependents Information about wages, such as W2s or 1099s Investment income information Documents that represent any other source of income Information regarding adjustments to income, such as student loan interest paid, IRA contributions, and health savings account contributions, just to name a few Information regarding potential credits, including, for example, child care expenses, education expenses, or retirement savings contributions Data about any tax payments that you may have made throughout the year Keeping good records will help make tax preparation easier at the beginning of the year. [youmaylike] The Basics About What You Can Claim When Filing You must pay income taxes on all your income earned throughout the year. However, that income is reduced by a few things. The further you can reduce your taxable income, the less you tax you will pay. There are three general categories of tax reduction methods: Standard or Itemized Deductions Everyone can claim either the standard or itemized deductions. Standard deductions are a set amount that is based on your filing status. Itemized deductions are based on actual expenses that you incurred throughout the year. You can choose to use the higher deduction. The higher the deduction, the less tax you will have to pay on your income because your income decreases on paper. Itemized deductions include things like medical expenses, state and local tax payments, and home mortgage interest deductions. Itemized deductions will only decrease your income by a certain percentage, or up to a specific point. Adjustments Some adjustments to your income may also be available. These include things like paying student loan interest or alimony. Adjustments are more valuable compared to deductions because they decrease your income dollar for dollar. Credits A credit decreases your taxable income as well. Some credits are refundable while others are not. For example, you get a child tax credit simply for having children that qualify for that credit, but that credit will not be paid out to you if you do not have any tax obligations. On the other hand, the Earned Income Credit, which is available for low-income filers, will be refunded to you even if you do not owe any taxes. There are a wide variety of deductions and credits available. Take a look at the federal forms and related schedules to determine whether you might qualify for any of these. How to File Your Own Taxes If You Live Overseas If you earned income in the United States as a U.S. citizen or resident alien, you likely need to pay taxes on that income. This is true even if you live overseas. You can still choose to e-file or mail your tax return to the IRS once you have it prepared, just as if you physically lived in the United States. In some cases, you will be taxed on the income that you earned throughout the world. However, you may be able to deduct a portion or all of the revenue that was not made in the United States in some circumstances. Filing Online The IRS offers an online filing option that is free for individuals that have an adjusted gross income below a specific threshold. Generally, your income must be below $66,000 to qualify for this service. You can also file online by using a commercial tax preparation software. Examples of this type of software include: H&R Block TurboTax TaxCut TaxSlayer There are many programs available that will file your taxes for you, often for a fee. Knowing how to file your own taxes can be a great way to save money, but it can be tricky as well. If you want to file your taxes yourself, be sure to read the form instructions thoroughly and get familiar with various tax saving opportunities before you begin preparing your return.
When it comes to investments, stocks get all the attention. In fact, I’d be willing to bet many of the people reading this have 100% of their retirement savings in the stock market.
There are a few issues with this strategy, however. A portfolio only consisting of stocks is vulnerable to the whims of the stock market. This means that if stocks head lower, your portfolio will do poorly as well. When you’re younger and have time to recover, this isn’t so bad. But it really hurts as you start to approach retirement age.
Standard, low risk bonds are a natural choice to protect yourself during the next financial crisis, or if you are investing as a senior. There’s just one problem: with interest rates so low, the average bond doesn’t yield much. This means the asset class doesn’t offer much more than protection, which isn’t very exciting. You want to at least be paid to wait.
Let’s take a closer look at high-yield bonds, a special kind of bond that offers some protection while also paying generous yields.
What’s a High-Yield Bond?
First off, let’s talk about what a high-yield bond is and how it differs from a regular bond.
A bond is a special debt security created when a company borrows money from investors. Some bonds are secured by specific assets on a company’s balance sheet, but most are just borrowed against the general credit worthiness of the firm. The firm must make interest payments back to investors — these usually happen twice a year — and the bond will have a maturity date where the full amount borrowed (face value) must be paid back. A corporation will either have enough cash in the bank to do so or, more commonly, they will issue a new bond to pay off the old one.
What interest rate a company pays on this loan depends on its credit rating. Companies with good balance sheets and bright futures get the best interest rates. These safer bonds are called investment grade bonds. Organizations that struggle to be profitable or who aren’t growing must pay higher rates. It’s these so-called "junk" bonds that make up the heart of the high-yield debt market.
Ultimately, the interest rate on a bond is directly related to a company’s likelihood of paying back its debt. High-yield bonds have a greater chance of default, so they pay a higher interest rate.
Two Types of High-Yield Bonds
One thing you might not know about bonds is there’s a bond market, a place where bondholders can trade their assets, just like stocks. But unlike the stock market, which has one central trading area, the bond market is less organized. Trading happens between market participants on an over-the-counter basis, facilitated by various brokers.
The first type of high-yield bond is one issued by a company with a poor credit rating. Everyone knows the bond is risky, and the interest rate is higher to compensate for that risk. This type of debt is very straightforward.
The bond market makes the other kind of high-yield bond a little trickier. Say a company issues a 10-year bond. Everything is all good for the first four years, and then the company’s earnings fall off a cliff. To accurately price in this new risk, the price of the bond goes down. This increases the potential total return to compensate for the risk.
Let’s look at a quick example. A bond might go from 100 to 90 while paying a 4% interest rate. Someone who buys the bond at 90 with five years remaining on the debt will get 4% annually from the interest and an extra 10% in five years when the debt is fully paid off. That translates into a 6% annual return, which is much better than the 4% interest rate offered at the beginning.
How You Can Buy High-Yield Bonds
Every online broker has a section where you can buy individual bonds. It’s as simple as finding the individual bond you want, placing an order, and you’ll end up owning it.
However, I’d recommend most DIY investors not touch individual bonds, for a few reasons. Firstly, bonds are complicated. There are a lot of variables that go into pricing a bond, and there are thousands of smart minds trying to pick up the best deals in the bond market. Chances are these folks have an edge you don’t.
Secondly, it’s hard for retail investors to build a diverse bond portfolio. You want as many bonds in your account as possible, especially if you’re buying riskier high-yield bonds. That’s hard to do with just a portion of an already small portfolio.
Retail investors also don’t get very good deals when buying individual bonds. Brokerages would much rather deal with big investors; therefore, they get better pricing, while regular folks get ripped off.
It’s not all bad news, however. There is one simple way a retail investor like you or me can get access to the high-yield bond market, instantly getting a diverse portfolio filled with hundreds of different bonds: we can buy a high-yield bond ETF. Learn more about ETF investing.
The biggest one is the Barclay’s High Yield Bond ETF (NYSE:JNK), an exchange traded fund that holds stakes in 910 different bonds and has a market cap of $11.4 billion. It only charges a 0.4% management fee, which is a very reasonable price to pay for that much diversification in one place.
The best part of this investment is the yield. JNK currently pays a distribution of 5.4%. Compare that to investment grade bond ETFs, which have yields in the 2.5–2.75% range.
There’s another kind of junk bond fund, one that offers much higher yields. These products will pool investors money — plus a certain amount it borrows — into a high-yield bond portfolio. These products are obviously riskier than straight high-yield bond funds, but they pay yields in the 7–8% range.
The Bottom Line
There’s a reason high-yield bonds offer a better interest rate. They’re riskier than investment grade bonds on two fronts: they’re more likely to default, and the price of the underlying bond tends to fall when the economy falters. This makes these bonds a relatively poor choice if you’re looking for a product to insulate you from stock market dips.
For investors with a long-term view, temporary setbacks aren’t a big deal. For them, high-yield bonds are a good choice for a portfolio. They deliver big yields and diverse ETFs minimize default risk.
They’re an excellent buy-and-hold choice for the average portfolio. Just don’t be surprised when your high-yield bond fund falls 20% the next time there’s a recession.