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.
What is a Mutual Fund?
Mutual funds are a unique kind of investment. They allow you to pool your money together alongside other investors. This allows you to purchase a portfolio of securities that would be difficult to put together on your own. They are also a great tool for average or even inexperienced investors who want to be cost-effective.
While there are plenty of investment options out there, mutual funds stand out for their lower bar of entry. If you are planning on putting savings in an investment of some kind so they do not sit around and go to waste, mutual funds are often recommended.
The main benefit of a mutual fund is that they have a professional manager regularly reviewing the investment portfolio. It’s certainly more cost-effective than hiring your own personal portfolio manager.
Types of Mutual Funds
While mutual funds are one of the most common ways in which Americans invest, there are several types of mutual funds to choose from. While mutual funds are simple for the investor, searching through the thousands of options would be quite challenging for someone new to the scene.
All mutual funds were designed to spread the risk while capturing wider market gains. There are still some key differences between the four main types of mutual funds.
Equity funds are mutual funds that are comprised of stocks of publicly traded companies. Equity funds make up a slight majority of all mutual funds. While equity funds offer you more growth potential, they also come with higher volatility than other types of mutual funds.
Because equity funds are comprised of publicly traded stocks, they can be further broken down into other categories. Equity funds will often focus on one specific industry, such as technology. Owning equity funds focusing on one specific industry are more vulnerable to volatility. Stocks in one sector often rise and fall together, so leaving all your eggs in the same basket is not always a great idea.
While this can potentially net you higher gains, diversifying your portfolio will help you mitigate your losses should anything go wrong. You could also opt for value funds, which focus the equity fund on stocks, which experts believe will yield higher-than-average returns.
Money Market Funds
Money Market funds are fixed-income mutual funds that invest in debt. They generally focus on the most high-quality, most short-term debts in government, banking or the corporate world.
These are considered to be the safest type of mutual funds, though they make up less than one-fifth of the market. One example of a money market fund asset is U.S. treasuries.
Bond funds are also fixed-income mutual funds, but they differ from money market funds in several critical ways. Investors in bond funds are paid a fixed amount based on their initial investment.
Bond funds do not invest in stocks either; instead, they invest in government and corporate debt. While bond funds are safer than equity funds, they offer less room for growth.
Balanced mutual funds invest in both equities and fixed-income bonds. They typically come with their own ratios for stocks versus bonds.
Who Needs a Mutual Fund?
Mutual funds are not meant for any particular type of person. Their main selling point is risk diversification, something that would benefit most amateur investors. As the investor, you can choose from a wide selection of options with different risk-reward characteristics. You can get a diverse portfolio that mitigates the risk of one particular stock going downhill. Of course, the main benefit of mutual funds is that they do not require you to have serious portfolio management skills, as that is someone else’s job.
Mutual funds are essentially professionally managed investment portfolios. While you could do the work of building your portfolio yourself, if you have a job and/or other serious commitments, you might not have the time for it. It takes a lot of reading to make sure you know what you’re doing, which is why mutual funds are so popular. You can simply get someone else to manage your portfolio at a small cost, and with less risk than other investments.
Unless you are unable to save up the money or you have the necessary skillset yourself, mutual funds could prove useful to you. As with all investments, there is an element of risk that cannot be ignored, but if you lack confidence in your ability to invest for any reason, mutual funds are a great first step.
The first step you will need to take is finding the mutual fund that is right for you. There are many mutual funds out there, so before you even start looking, you need to consider the following:
- How much money you are willing to put into a mutual fund. Different brokers have different minimum deposit requirements.
- How much time you are willing to spend on your fund. Some options are more hands-off than others.
- How long you want to wait before reaping the rewards of your investment.
You’ll want to sift through your options, but before you choose your broker, you will need to consider these options as well:
- The fees the broker charges. Some brokers simply charge more in fees, so you will want to know how much they will take from the start.
- Their educational resources. Some brokers might be a bad choice because they will not explain much to you. Because you are talking to them about investing your money, it stands to reason that they would educate you on your own investments.
- Their website. If their website is impossible to navigate and use, you are just going to have a bad time. Even if the broker is great, a good website will simply make your life easier.
What Kind of Return Should I Expect?
As with all investments, this will vary based on the specifics of the mutual fund. It is also dependent on the markets in general. The historical average annual return of the S&P 500 is 12%. The S&P 500 is an indicator of the performance of the 500 largest and most stable companies on the New York Stock Exchange, making it a great indicator of the larger stock market. While the historical average is 12%, the return changes massively year by year.
You likely won’t see a 12% annual return with mutual funds as a beginner, but the right professional can help you invest in the right mix of mutual funds. You should expect annual returns of well above 3% from any mutual fund worth investing in. According to The Quantitative Investment Decisions, LLC, the average annual mutual fund netted the investor 4.67% over the last 20 years.