Dwayne K Dowell, MBA(Tax), CPA/PFS Blog

The IRS standard mileage rate for the final six months of 2011 was increased as a result of the recent increase in gasoline prices. The IRS usually only adjusts this rate annually in the fall.

The standard mileage rate was increased by 4.5 cents for business, medical and moving travel for the last six months of 2011. Charitable travel remained unchanged at 14 cents per mile as this rate is set by statue, not the IRS.

The standard mileage rate is used to compute the deductible costs of operating an automobile for business use in lieu of tracking actual costs. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage.

Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.

Mileage Rates for July 1, 2011 to December 31, 2011 are:

• Business: 55.5 cents per mile (Compared to first six months at 51 cents per mile).

• Medical: 23.5 cents per mile (Compared to first six months of 2011 at 19 cents per mile).

• Moving: 23.5 cents per mile (Compared to first six months of 2011 at 19 cents per mile).

• Charitable: Unchanged at 14 cents per mile.

The Best Financial Tool for Business Owners

If there were a tool that helped you create crystal-clear plans . . . that provided you with continual feedback on how well your plan was working . . . that told you exactly what's working and what isn't, allowing you to consistently make smart business decisions to keep your business on track for success - wouldn't you want to take advantage of it?

Well, there is such a tool. It's called the Budget vs. Actual report.

Clarifying Your Plan

Clarity is power. The clearer you are with your business goals, the more likely you are to achieve them.

Creating a budget forces you to drill down in to the details of your goals. It prods you to think about how one business decision affects all other aspects of the company's operations.

Example: Say you want to grow your sales by 15% this year. Does that mean you need to hire another salesperson? When will the business start to see new sales from this person? Do you need to set up an office for them? New phone line? Buy them a computer? Do you need to do more advertising? How much more will you spend? When will you see the return on your advertising expenditure?

You see, a budget is really a planning tool that makes you clarify your dreams. And planning is the first step in making your dreams real.

Navigating the Ship

Once you've clarified your goals, you start making business decisions to help you reach your desired outcome. Some of those decisions will be great and give you better than expected results. And some decisions will give you poor results.

This is where the Budget vs Actual shines.

When you compare your budgeted sales and expenses to your actual results, you see exactly how far you are off your plan. Sometimes you need to adjust your plan (budget) and sometimes you need to focus more attention to the areas of your business that are not performing as well as you planned.

Either way, you are gleaning valuable insights into your business.

It's like sailing a boat. You are off-course most of the time - but having a clear goal and making many adjustments helps you reach your destination.

Just Do It

Nike knows the power of the phrase "Just Do It." We often know what we need to do but don't take the necessary action.

It may seem like a huge hassle to create a budget and then create a Budget vs. Actual report every month. But as with any new skill, although it's hard at first, it does get easier.

Let us help you. We can guide you through the budgeting process. We can ask you questions that help you gain clarity.

You'll feel energized after it's done. You may even have fun.

So "just do it." Give us a call and we'll help you turn your dreams into reality.

When to Review Your Life Insurance Coverage

It makes good financial sense to periodically examine your life insurance coverage to make sure the coverage is still sufficient. After all, life insurance is often a family's most important financial and estate planning tool.

With today's frequent changes in financial circumstances and goals, it's a good idea to re-examine your life insurance coverage on the occurrence of any of the following:

• Marriage or divorce;
• Birth or adoption, or acquiring a financial dependent such as a parent;
• Children leaving for college;
• Children "leaving the nest";
• Purchase or sale of a home;
• Serious illness;
• Substantial growth or depletion of assets;
• Retirement; and
• Start-up of a business.

Tip: In addition to the amount of coverage, you may need to make a change relating to beneficiaries, policy ownership, or type of coverage.

Consult with me if you think it might be time to adjust your life insurance coverage. Please contact me at dkdowell@dkdcpa.com

Before getting into the specifics, however, we would like to stress the importance of proper documentation. Many taxpayers forgo worthwhile tax deductions because they have neglected to keep receipts or records. Keeping adequate records is required by the IRS for employee business expenses, deductible travel and entertainment expenses, and charitable gifts and travel. But don't do it just because the IRS says so-neglecting to track these deductions can lead to overlooking them. You also need to maintain records regarding your income. If your receive a large tax-free amount, such as a gift or inheritance, make certain to document the item so that the IRS does not later claim that you had unreported income.

To use the checklist, quickly scan the listed items. They are of general application only and should be tailored to your specific situation. If you think one of them fits your tax situation, discuss it with your tax adviser.

Deferring the taxability of income makes sense for two reasons. Most individuals are in a higher tax bracket in their working years than during retirement. Deferring income until retirement may result in paying taxes on that income at a lower rate. Additionally, through the use of tax-deferred retirement accounts you can actually invest the money you would have otherwise paid in taxes to increase the amount of your retirement fund. Deferral can also work in the short term if you expect to be in a lower bracket in the following year or if you can take advantage of lower long-term capital gains rates by holding an asset a little longer.

Tip: You can achieve the same effect of deferring income by accelerating deductions-for example, paying a state estimated tax installment in December instead of at the following January due date.

Many employers offer plans where you can elect to defer a portion of your salary and contribute it to a tax-deferred retirement account. For most companies these are referred to as 401(k) plans. For many other employers, such as universities, a similar plan called a 403(b) is available. Check with your employer about the availability of such a plan and contribute as much as possible to defer income and accumulate retirement assets.

Tip: Some employers match a portion of employee contributions to such plans. If this is available, you should structure your contributions to receive the maximum employer matching contribution.

If you have your own business, consider setting up and contributing as much as possible to a retirement plan. These are allowed even for sideline or moonlighting businesses. Several types of plans are available which minimize the paperwork involved in establishing and administering such a plan.

Related Guide: For details on Keogh plans and other retirement plans benefiting self-employed owners, see the Financial Guide: EMPLOYEE BENEFITS: How To Handle Them.

If you have income from wages or self-employment income, you can build tax-sheltered investments by contributing to a traditional or a Roth IRA. You may also be able to contribute to a spousal IRA -even where the spouse has little or no earned income. All IRAs defer the taxation of IRA investment income and in some cases can be deductible or be withdrawn tax free.

Related Guide: For details on how Roth IRAs work and how they compare in other respects with traditional IRAs, please see the Financial Guide: ROTH IRAs: How They Work and How To Use Them.

Related Guide: For details on the Coverdell Education Savings Account (formerly the Education IRA) - special purpose vehicles for higher education - please see the Financial Guide: HIGHER EDUCATION COSTS: How To Get The Maximum Deduction.

Tip: To get the most from IRA contributions, fund the IRA as early as possible in the year. Also, pay the IRA trustee out of separate funds, not out of the amount in the IRA. Following these two rules will ensure that you get the most possible tax-deferred earnings from your money.

If you are due a bonus at year-end, you may be able to defer receipt of these funds until January. This can defer the payment of taxes (other than the portion withheld) for another year. If you're self employed, defer sending invoices or bills to clients or customers until after the new year begins. Here, too, you can defer some of the tax, subject to estimated tax requirements. This may even save taxes if you are in a lower tax bracket in the following year. Note, however, that the amount subject to social security or self-employment tax increases each year.

If you have investments on which you have an accumulated loss, it may be advantageous to sell it prior to year-end. Capital losses are deductible up to the amount of your capital gains plus $3,000. If you are planning on selling an investment on which you have an accumulated gain, it may be best to wait until after the end of the year to defer payment of the taxes for another year (subject to estimated tax requirements). For most capital assets held more than 12 months the maximum tax is reduced to 15% for sales after May 5, 2003 and before 2013. However, make sure to consider the investment potential of the asset. It may be wise to hold or sell the asset to maximize the economic gain or minimize the economic loss.

When your mutual fund manager sells stock at a gain, these gains pass through to you as realized taxable gains, even though you don't withdraw them. So you may prefer a fund with low turnover, assuming satisfactory investment management. Turnover isn't a tax consideration in tax-sheltered funds such as IRAs or 401(k)s. For growth stocks you invest in directly and hold for the long term, you pay no tax on the appreciation until you sell them. No capital gains tax is imposed on appreciation at your death.

Use the Gift-Tax Exclusion to Shift Income

You can give away $13,000 in 2011 ($26,000 if joined by a spouse) per donee, per year without paying federal gift tax. You can give $13,000 to as many donees as you like. The income on these transfers will then be taxed at the donee's tax rate, which is in many cases lower.

Note: Special rules apply to children under age 18. Also, if you directly pay the medical or educational expenses of the donee, such gifts will not be subject to gift tax.

Invest in Treasury Securities

For high-income taxpayers, who live in high-income-tax states, investing in Treasury bills, bonds, and notes can pay off in tax savings. The interest on Treasuries is exempt from state and local income tax. Also, investing in Treasury bills that mature in the next tax year results in a deferral of the tax until the next year.

Consider Tax-Exempt Municipals

Interest on state or local bonds ("municipals") is generally exempt from federal income tax and from tax by the issuing state or locality. For that reason, interest paid on such bonds is somewhat less than that paid on commercial bonds of comparable quality. However, for individuals in higher brackets, the interest from municipals will often be greater than from higher paying commercial bonds after reduction for taxes. Gain on sale of municipals is taxable and loss is deductible. Tax-exempt interest is sometimes an element in computation of other tax items. Interest on loans to buy or carry tax-exempts is non-deductible.

Give Appreciated Assets to Charity

If you're planning to make a charitable gift, it generally makes more sense to give appreciated long-term capital assets to the charity, instead of selling the assets and giving the charity the after-tax proceeds. Donating the assets instead of the cash prevents your having to pay capital gains tax on the sale, which can result in considerable savings, depending on your tax bracket and the amount of tax that would be due on the sale. Additionally you can obtain a tax deduction for the fair market value of the property.

Tip: Many taxpayers also give depreciated assets to charity. Deduction is for fair market value; no loss deduction is allowed for depreciation in value of a personal asset. Depending on the item donated, there may be strict valuation rules and deduction limits.

Keep Track of Mileage Driven for Business, Medical or Charitable Purposes

If you drive your car for business, medical or charitable purposes, you may be entitled to a deduction for miles driven. For 2011, it's 51 cents per mile for business, 19 cents for medical and moving purposes, and 14 cents for charitable. You need to keep detailed daily records of the mileage driven for these purposes to substantiate the deduction.

Take Advantage of Your Employee's Benefit Plans to Get an Effective Deduction for Items Such as Medical Expenses

Medical and dental expenses are generally only deductible to the extent they exceed 7.5% of your Adjusted Gross Income. For most individuals, particularly those with high income, this eliminates the possibility for a deduction. You can effectively get a deduction for these items if your employer offers a Flexible Spending Account, sometimes called a cafeteria plan. These plans permit you to redirect a portion of your salary to pay these types of expenses with pre-tax dollars. Another such arrangement is a Health Savings Account. Ask your employer if they provide either of these plans.

Check Out Separate Filing Status

Certain married couples may benefit from filing separately instead of jointly. Consider filing separately if you meet the following criteria:

• One spouse has large medical expenses, miscellaneous itemized deductions, or casualty losses.
• The spouses' incomes are about equal.

Separate filing may benefit such couples because the adjusted gross income "floors" for taking the listed deductions will be computed separately. On the other hand, some tax benefits are denied to couples filing separately. In some states, filing separately can also save a significant amount of state income taxes.

If Self-Employed, Take Advantage of Special Deductions

You may be able to expense up to $500,000 in 2011 for qualified equipment purchases for use in your business immediately instead of writing it off over many years. Additionally, self-employed individuals can deduct 100% of their health insurance premiums as business expenses. You may also be able to establish a Keogh, SEP or SIMPLE plan, or a Health Savings Account, as mentioned above.

Most consumer related interest expense, such as from car loans or credit cards, is not deductible. Interest on a home-equity loan, however, can be deductible. It may be advisable to take out a home-equity loan to pay off other nondeductible obligations.

Bunch Your Itemized Deductions

Certain itemized deductions, such as medical or employment related expenses, are only deductible if they exceed a certain amount. It may be advantageous to delay payments in one year and prepay them in the next year to bunch the expenses in one year. This way you stand a better chance of getting a deduction.

If you decide on a pass-through entity, which of the several do you choose? Here is a brief discussion of the rules applicable to each.

S Corporation

Limitation of liability gives S corps the edge-for business reasons-over general partnerships, sole proprietorships, limited partnerships (as to limited partners whose partnership activity might expose them to unlimited liability), and LLCs in states that don't allow single member LLCs.

Caution: Limited liability comes at a cost, however, since states may impose a tax on S corps not imposed on entities with unlimited liability.

S corps are subject to a number of significant rules and restrictions:

• All owners must agree to S corp status. This means that one co-owner can exact a price or impose conditions for his or her agreement.
• An S corp can have only one class of stock, which means that income, losses and other tax attributes are allotted among stockholders in proportion to stock ownership.
• The number of co-owners is limited (to 100, with qualifications, counting members of the same family as one stockholder).
• There are limitations as to who can be co-owners (for example, a nonresident alien cannot) and as to the kind of business that can qualify for as an S corp (for example, an insurance company cannot).

Caution: Failure to meet, or ceasing to meet, these requirements means loss of S status and conversion to C corp status-and C corp taxes.

These limits and restrictions will be contrasted, below, with the more liberal tax rules for partnerships and LLCs.

Note: S corps are often preferred because they are simple to operate. However, they are not suitable for many businesses. The much wider range of options for partnerships and LLCs introduces tax planning complexity which may be more than many or most small businesses can effectively use or understand.

LLCs vs. S Corporations

LLCs and S corps share the same business advantage-limitation of liability. S corps are a bit better understood by the business community because LLCs are new and vary from state to state.

The tax advantages of LLCs, as compared to S corps, are the tax advantages of partnerships. All the points below where LLCs outscore S corps arise because LLCs can choose partnership tax status.

• LLC can to some degree allocate tax attributes, like income or certain kinds of income, depreciation deductions, etc., disproportionately among members to suit their individual tax situations (unlike S corps limited by the effect of the single-class-of-stock rule).

• S corp owners can deduct startup or operating losses up to their investment plus any debt that the S corp owes them. LLC members can do the same but can deduct further, up to their share of the debt the LLC owes others.

• Adding co-owners after the entity is formed is easier with LLCs. An outsider's transfer of appreciated property for an LLC membership interest is tax-free. A comparable transfer to an S corp is taxable unless the new co-owner-transferor (or group of transferors) owns more than 80% of the S corp after the transfer.

• Complex tax adjustments ("basis adjustments") can be made by the LLC when LLC interests change hands or LLC property is distributed. These adjustments, unavailable with S corps, can have the effect of reducing amounts taxable to certain LLC members.

• Distribution of appreciated LLC property to LLC members is not taxable to the LLC. Comparable S corp distributions to stockholders are taxable to the S corp.

Tip: Depending on circumstances, S corp status can be preferable to LLC status when the owners leave the business. The LLC is not taxed when appreciated property is distributed to its members, which is a standard form of business liquidation. But the members would be taxed on distributions exceeding the "basis" (broadly, the amount they invested) of their interests. S corp owners, on the other hand, can arrange a tax-free exit, via a corporate reorganization in which they transfer their S corp stock for stock in a corporate acquirer. (Later sale of stock in the acquirer would be taxable.)

Depending on state law, S corps and LLCs may be taxed at the entity level in states where they do business.

LLCs vs. Partnerships

LLCs, with their limited liability for all members, have the edge on general and limited partnerships from a business standpoint. While the federal tax treatment of partners and LLC members is basically the same, there are occasional special tax rules for limited partners (especially self-employment tax rules).

Note: It is not clear whether these special tax rules extend to non-manager LLC members.

Note: LLCs are more likely than partnerships to be subject to a state tax.

LLCs vs. Proprietorships

LLCs, with their limited liability, are preferable, where available, for sole proprietors from a business standpoint. Where the sole proprietor so elects, the LLC is ignored and the proprietor is taxed directly under federal tax rules as if no separate entity existed.

Note: Some states do-and some do not-ignore the LLC entity for state tax purposes.

FORT LAUDERDALE, Fla., April 25, 2011 /PRNewswire/ -- The Accounting and Finance Employee Confidence Index, a measure of overall confidence among U.S. accounting and finance workers, dropped 4.0 points to 52.1 in the first quarter of 2011, according to a recent survey of 3,654 U.S. adults among which 156 are employed in Accounting and Finance commissioned by The Mergis Group®, the professional placement division of SFN Group, Inc. The survey, conducted online by Harris Interactive®, shows that although workers gained confidence in the strength of the economy more workers believe to be fewer jobs available.

Results from the Accounting & Finance Employment Report:

• Nearly one-third (29 percent) of accounting and finance workers are confident in the strength of the economy, representing a four percentage point increase from the fourth quarter of 2010.
• More than half (55 percent) of accounting and finance workers believe there are fewer jobs available, up four percentage points from the previous quarter.
• Sixty-five percent of accounting and finance workers are confident in the future of their current employer as compared to 71 percent reported in the fourth quarter of 2010.
• Fewer workers believe it is not likely they will lose their jobs. Specifically, 69 percent believe so versus 78 percent last quarter.
• Thirty-six percent of accounting and finance workers are likely to make a job transition in the next 12 months, decreasing eight percentage points from the previous quarter.

"The financial landscape and job market remain relatively stable, despite the drop seen in this quarter's Accounting and Finance Confidence Index," stated Brendan Courtney, president of The Mergis Group. "While the Index took a dip over the past quarter, we direct our attention to the year-over-year trend which shows an upward movement of 1.5 points. This figure tends to be more stable and accounts for macroeconomic adjustments. It is also important to point out that as the economic recovery continues and productivity levels reach an all-time high, more accounting and finance workers are revealing the likelihood of making a job transition. In light of this, we recommend that companies who forego retention efforts all together over the past several years, pay close attention to them again as the economy improves and more workers keep their eyes open to potential opportunities."

Survey Methodology

This survey was conducted online within the United States by Harris Interactive on behalf of Technisource from January 11-13, February 15-17, and March 16/18, 2011 among 3,654 adults ages 18 and older of which 156 are employed in Accounting and Finance. This online survey is not based on a probability sample and therefore no estimate of theoretical sampling error can be calculated. For complete survey methodology, including weighting variables, please contact CherylRhody@MergisGroup.com or 1-800-422-3819.

Demographic Results

Survey Background Information

About The Mergis Group

The Mergis Group is a leading professional placement firm that specializes in recruiting for positions in finance and accounting, engineering and manufacturing, sales and marketing, legal and human resources. The firm provides recruiting services to Fortune 500 and small and mid-sized companies through its network of 35 offices nationally.

The Mergis Group is a division of SFN Group, Inc. SFN operates a family of specialty businesses providing strategic workforce solutions in professional services and general staffing. To learn more, please visit www.mergisgroup.com.

SOURCE The Mergis Group

The "nanny tax" rules apply to you only if (1) you pay someone for household work and (2) that worker is your employee.

1. Household work is work done in or around your home by baby sitters, nannies, health aides, private nurses, maids, caretakers, yard workers, and similar domestic workers.
2. A household worker is your employee if you can control not only what work is done, but how it is done. If the worker is your employee, it does not matter whether the work is full time or part time, or that you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily, or weekly basis, or by the job. On the other hand, if only the worker can control how the work is done, the worker is not your employee, but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business. If an agency provides the worker and controls what work is done and how it is done, the worker is not your employee.

Example: You pay Betty to baby sit your child and do light housework four days a week in your home. Betty follows your specific instructions about household and child care duties. You provide the household equipment and supplies that Betty needs to do her work. Betty is your household employee.

Example: You pay John to care for your lawn. John also offers lawn care services to other homeowners in your neighborhood. He provides his own tools and supplies, and he hires and pays any helpers he needs. Neither John nor his helpers are your household employees.

Both you and your household employee may owe Social Security and Medicare taxes. The taxes for each of you are 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) of the employee's Social Security and Medicare wages.

You are responsible for payment of your employee's share of the taxes as well as your own. You can either withhold your employee's share from the employee's wages or pay it from your own funds.

Social Security And Medicare Wages

You figure Social Security and Medicare taxes on the Social Security and Medicare wages you pay. If you pay your household employee cash wages of $1,700 or more in 2010, (or 2009) all cash wages you pay to that employee in 2010 (regardless of when the wages were earned) are Social Security and Medicare wages. If you pay the employee less than $1,700 in cash wages in 2010 (or 2009), none of the wages you pay the employee are Social Security and Medicare wages, and neither you nor your employee will owe Social Security or Medicare tax.

Wages Not Counted

Do not count wages you pay to any of the following individuals as Social Security and Medicare wages:

1. Your spouse.
2. Your child who is under age 21.
3. Your parent.

   Note: However, you should count wages to your parent if both of the following apply: (a) your child lives with you and is either under age 18 or has a physical or mental condition that requires the personal care of an adult for at least 4 continuous weeks in a calendar quarter, and (b) you are divorced and have not remarried, or you are a widow or widower, or you are married to and living with a person whose physical or mental condition prevents him or her from caring for your child for at least 4 continuous weeks in a calendar quarter.

4. An employee who is under age 18 at any time during the year.

   Note: However, you should count these wages to an employee under 18 if providing household services is the employee's principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

Also, if your employee's Social Security and Medicare wages reach $106,800 in 2010 (Same in 2009), do not count any wages you pay that employee during the rest of the year as Social Security wages to figure Social Security tax. (But continue to count the employee's cash wages as Medicare wages to figure Medicare tax.)

You figure federal income tax withholding on both cash and non-cash wages (based on their value). However, do not count as wages any of the following items:

• Meals provided at your home for your convenience.
• Lodging provided at your home for your convenience and as a condition of employment.
• Up to $230 a month in 2010 for bus or train tokens (passes) that you give your employee or, in some cases, for cash reimbursement you make for the amount your employee pays to commute to your home by public transit.
• Up to $230 a month in 2010 to reimburse your employee for the cost of parking at or near your home or at or near a location from which your employee commutes to your home.

Withholding The Employee's Share

You should withhold the employee's share of Social Security and Medicare taxes if you expect to pay your household employee Social Security and Medicare wages of $1,700 or more in 2010. However, if you prefer to pay the employee's share yourself, see "Not Withholding the Employee's Share" in the next section.

You may withhold the employee's share of the taxes even if you are not sure your employee's Social Security and Medicare wages will be $1,700 or more in 2010. If you withhold the taxes but then actually pay the employee less than $1,700 in Social Security and Medicare wages for the year, you should repay the employee.

You pay withheld taxes as part of your regular income tax obligation. You don't deposit them periodically-subject to an exception for business owners. See "Payment Options for Business Employers" below.

Withhold 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) from each payment of Social Security and Medicare wages. Instead of paying this amount to your employee, you will pay it to the IRS with a matching amount for your share of the taxes.

If you make an error by withholding too little, you should withhold additional taxes from a later payment. If you withhold too much, you should repay the employee.

Example: You hire a household employee (who is an unrelated individual over age 18) to care for your child and agree to pay cash wages of $100 every Friday. You expect to pay your employee $1,600 or more for the year. You should withhold $7.65 from each $100 wage payment and pay your employee the remaining $92.35. The $7.65 is the sum of $6.20 ($100 x 6.2%) for your employee's share of Social Security tax and $1.45 ($100 x 1.45%) for your employee's share of Medicare tax. You will match the $7.65 you withhold with $7.65 from your own funds when you pay the taxes.

Not Withholding The Employee's Share

If you prefer to pay your employee's Social Security and Medicare taxes from your own funds, you do not have to withhold them from your employee's wages. The Social Security and Medicare taxes you pay to cover your employee's share must be included in the employee's wages for income tax purposes. However, they are not counted as Social Security and Medicare wages or as federal unemployment (FUTA) wages.

Example: You hire a household employee (who is an unrelated individual over age 18) to care for your child and agree to pay cash wages of $100 every Friday. You expect to pay your employee $1,600 or more for the year. You decide to pay your employee's share of Social Security and Medicare taxes from your own funds. You pay your employee $100 every Friday without withholding any Social Security or Medicare taxes. For each wage payment you will pay $15.30 when you pay the taxes. This is $7.65 ($6.20 for Social Security tax plus $1.45 for Medicare tax) to cover your employee's share plus a matching $7.65 for your share. For income tax purposes, your employee's wages each payday are $107.65 ($100 plus the $7.65 that you will pay to cover your employee's share of Social Security and Medicare taxes).

Once you've identified your financial and investment goals and assessed your investing personality, you'll need to create an investment portfolio that fits your needs and understand what's involved in managing that portfolio on an ongoing basis.

Entire books--actually shelves full of books--have been written about ways to design and manage a portfolio, so this discussion obviously can only serve as a basic introduction to the process. However, it can help you understand the challenges involved and decide just how much assistance you might need, as well as how involved you want to be in managing your portfolio on an ongoing basis.

Designing an investment portfolio generally involves figuring out how to integrate all your various financial and investment goals. Generally, this involves some form of asset allocation (the process of deciding how to divide your assets among different types of investments, such as stocks, bonds, cash alternatives, and other investments). It may also include specific tax planning strategies to minimize your tax burden.

Some people choose to look at each investment goal separately. Each goal might have its own asset allocation designed specifically for that goal, taking into account such factors as time horizon, risk tolerance, and liquidity needs.

One example of this is what's sometimes known as the "bucket" approach. A retiree might have one "bucket" of assets invested exclusively in short-term investments that will be used to pay living expenses for the next 1-3 years. A second bucket might hold mostly bonds and preferred stock designed to produce income that is used to replenish the short-term bucket. A third bucket might include a growth component designed to help the overall portfolio keep pace with inflation over the long term. And another bucket might be invested to provide for a grandchild's education in five years.

Example(s): Bob prefers to think of his investments as silos. He has an annuity that will provide him with a lifetime income (subject to the claims-paying ability of the issuer) that is sufficient to cover the cost of food, clothing, and housing. He has a portfolio of individual bonds that collectively pay him enough to eat out and travel occasionally. And he owns a group of stocks that he plans to either sell one day to pay for his grandchildren's education or leave to them after he's gone.

Such goal-based investing allows you to match specific assets to a specific time horizon, which can be particularly useful for large, long-term goals or if your assets are relatively modest. However, it also can lead to inefficiency and inadvertent overlap between multiple portfolios. In some cases, it also might not be the most effective way to manage your tax liability.

Others find it beneficial to establish a single asset allocation that takes into account all or most of their combined investment assets and is aimed at achieving an overall average rate of return for the entire portfolio. This can promote tax efficiency (for example, by facilitating strategic harvesting of tax losses across multiple assets or accounts). It also gives you a broader perspective on your overall financial situation and can mean greater flexibility to shift your overall asset allocation if necessary.

Example(s): When Betty retired, her advisor designed her portfolio to provide an average annual return of 4 percent, which she uses to pay all of her living expenses that aren't covered by Social Security. The portfolio includes a growth component designed to ensure that the portfolio keeps pace with inflation. It also is structured so that in Betty's later years, she will begin to draw down the principal itself.

Monte Carlo simulations can project a portfolio's performance based on how its asset allocation would have performed in the past. Such a simulation can give you an idea of the range of returns, including best-case and worst-case scenarios, that you might reasonably expect from a given portfolio. (However, remember that past performance is no guarantee of future results and any projections are only as good as the assumptions that go into the computer model that creates them.)

One fundamental decision you'll want to consider in your portfolio design is whether you want to pursue a strategic investment strategy or be more tactical. If you prefer a strategic, long-term approach to asset allocation, which takes into account your risk tolerance, time horizon, and historic returns for various asset classes, you'll probably gravitate to more of a buy-and-hold approach (see below). By contrast, a tactical approach tends to be more opportunistic and take advantage of changing market conditions by investing a greater percentage in asset classes that are expected to outperform in the immediate future, or that may reduce risk.

A compromise between the two methods is a so-called core-and-satellite approach. To pursue it, you would establish a core strategic asset allocation that is kept relatively constant and is based on your strategic goals, and practice tactical asset allocation with a smaller percentage of the portfolio. For example, you might shift some of the tactical portion of your portfolio into small-cap stocks if you felt they were poised to do well, and then move out of them if your thesis proves wrong or another type of investment presents a better opportunity later.

Designing a portfolio is only the first step. Once your general approach and asset allocation strategy are established, you'll need to select specific investments and decide on the timing of any purchases and sales. In other words, your portfolio will need to be managed on an ongoing basis. This is never an easy task (just ask any professional investor). Some of the factors that can affect portfolio performance include socioeconomic and political conflict, higher or lower interest rates, changes in laws or governmental regulations, and tax legislation, to name only a few of the many things that professionals keep an eye on when managing money.

Here is a brief list of some of the tasks and decisions you'll face:

One of the most challenging tasks of portfolio management is selecting specific securities from the thousands available. Typically you and/or your financial professional would establish screening criteria to develop a list of likely prospects for purchase, then do more detailed research to determine precisely what and when to buy.

One of the choices you'll face is the decision whether to invest directly in individual stocks and bonds, or use a vehicle such as a mutual fund to invest in them. Each has its advantages. Individual securities allow greater flexibility in timing a trade, better management of potential tax liability, lower costs (in some cases), and potentially higher returns if you select a stock that takes off. However, diversification requires a higher minimum investment, and though diversification doesn't ensure a profit or protect against potential loss, you could lose your entire investment if you select the wrong security. Mutual funds offer professional management (particularly actively managed funds) and you can generally achieve greater diversification at a lower cost. However, your fellow investors in a fund can affect your returns, and you have less control over when capital gains are realized. Exchange-traded funds (ETFs) also have become popular investment vehicles in recent years. Like a mutual fund, ETFs invest in multiple securities. However, they are traded throughout the day as a stock is and can have tax advantages.

Many investors use both individual securities and funds to take advantage of what each offers. Before investing in a fund, carefully consider its investment objectives, risks, charges, and expenses, which are contained in the prospectus available from the fund. Read it carefully before investing.

Benchmarking measures the performance of your investment portfolio against certain models. Although you can use something like the latest 10-year Treasury bond, for instance, as a benchmark for all bonds, the term usually refers to comparisons with standardized indexes. The best-known and most reliable indexes include the Standard & Poor's 500, the NYSE Composite Index, the Nasdaq Composite Index, Dow Jones 30 Industrials, the Wilshire 5000, the Russell 2000, and Nasdaq 100. Benchmarking can help you determine whether the investments in your portfolio are matching comparable investments, exceeding them, or underperforming. However, it's important to be sure you've selected appropriate benchmarks. And although benchmarking has proved highly effective, past performance as reflected by the various indexes does not necessarily predict future performance.

If you plan to rely on your portfolio for income, you'll need to determine how much you need and how the portfolio will produce it. For example, will you withdraw a portion of the principal, or withdraw only the income? Do you need to be certain about the precise amount of each payment or withdrawal, or is there room for flexibility? Even if you're not using any income the portfolio produces, you'll need to understand how factors such as changing interest rates can affect the income your investments will produce.

Some of these decisions will be made in designing the portfolio, but you may also have to reexamine them as your circumstances and the financial markets change.

Portfolio managers generally fall into one of two camps (or maybe somewhere in between). Active managers believe that the best way to produce above-average investment returns is through careful selection of individual securities and trading them at opportune times to take advantage of ups and downs in the financial markets. Another camp believes that trying to beat the market averages is not worth the cost and risks involved and is extremely difficult even for professionals. They argue that buying and holding investments for an extended period--typically years--is more cost-effective. Buy-and-hold is an example of a passive management investing style, which is often practiced through indexing: designing a portfolio to match a specific index to try to replicate its performance.

If you prefer active management, you should either be prepared to devote the time and research necessary to make wise trades, or have someone with more experience handle it for you by investing in actively managed mutual funds or working with a professional money manager.

Some investors feel comfortable selecting an investment, but less certain about when it makes sense to sell an investment. Aside from factors that are unique to a specific investment or your own circumstances, you might consider selling an investment when:

• The investment has performed poorly, well below your expectations
• The investment has performed well and exceeded your expectations
• You feel another investment might perform even better
• It is beneficial from a tax standpoint

Caution: A wise investor will understand the importance of properly timing the sale of an investment, as well as any tax consequences.

The rewards of controlling investment-related expenses are twofold: (1) you pay no more than is necessary, and (2) you pay enough to ensure that your portfolio provides strong returns.

A cost-effective implementation of your investment plan begins with an understanding of the charges associated with managing a portfolio. Some of the most common include:

• Investment professional's and money manager's fees: These fees vary widely, depending on the size of your portfolio and the services rendered. Firms and individuals who are registered with the Securities and Exchange Commission are required to publish a fee schedule. Some states permit performance-based fees. Under these arrangements, the fee is higher if the portfolio performs better than expected (a benchmark is predetermined for this purpose).
• Trading costs: Whenever securities are bought or sold, commissions and execution costs are incurred. The commission fee is generally calculated as a function of the number of shares traded, price per share, and degree of trading difficulty, among other things. The execution cost (also referred to as the spread) is the difference between what you pay for a security (the ask price) and what the dealer pays for the security (the bid price).
• Custodial charges: A custodian serves as the keeper or guardian of the investment and actually holds the securities. This custodian (typically a brokerage firm or trust company) is the intermediary between you and the investment professional. Generally, an annual fee is charged for each account held by the custodian.

Tip: Any management costs and expenses should be adequately disclosed. An above-the-line expense (e.g., administrative expenses) appears on your invoice as a separate line item. Below-the-line expenses (e.g., trading costs) are netted out of the performance of the portfolio.

Even if you pursue a buy-and-hold approach to managing your portfolio, buy and hold doesn't mean buy and forget. Your portfolio's performance will still need to be monitored so that it can be adjusted to changes in your circumstances and/or the financial markets, or simply to ensure that you're getting the performance you expect from it. From time to time, you may need to either rebalance or redesign a portfolio.

Rebalancing simply involves restoring your original asset allocation by shifting your funds among investment categories to regain the ratios you decided on when the portfolio was first designed. For example, if one asset class has done well and now represents more of your portfolio than you originally intended, you might sell some and use the proceeds to invest in another asset class that is now underrepresented.

Tip: Many investment advisors recommend using shifts of 5 percent or more as a trigger for rebalancing. Others recommend that it be done every year. Tax time or year-end are natural times to think about rebalancing.

Caution: You should consider the transaction costs and/or tax consequences that might result from rebalancing. For example, selling an investment might trigger capital gains tax and/or (in the case of a mutual fund) redemption fees.

Rebalancing is less drastic than redesigning your portfolio, which may involve setting an entirely new asset allocation and/or replacing your existing investments with fresh ones. You may want to consider redesigning your portfolio when you are faced with major life changes, such as retirement, or if your investment goals have changed.

As even this brief discussion shows, designing and managing a portfolio requires at least some understanding and experience with the financial markets and investment planning, plus the time and dedication needed to supervise all the myriad aspects of properly supervising a portfolio on a day-to-day basis.

If you aren't sure you have the time and/or expertise involved, a financial professional can be involved to the extent you feel is appropriate. That role can be all-encompassing or limited to certain tasks. Either way, the duties can be broken into four major categories:

• Managing all or part of your portfolio: Typically, an investment professional will employ and oversee money managers who evaluate and implement investment options and strategies. You may also employ money managers directly to implement your own investment decisions.
• Reviewing your portfolio's performance: This entails measuring the overall performance of your portfolio, as well as the performance of asset classes and individual investments within the portfolio.
• Reporting to you: Reports on your portfolio should provide you with information about its performance, compliance with your investment policy, your progress toward your financial goals, and the effects on cash flow and taxes.
• Recommending changes to your investment plan as the need arises: In general, there should be guidelines for any changes and any periodic rebalancing.