There are a few yellow leaves on the trees. The mornings are cool.

“My son started school last week,” we told a neighbor yesterday.

“What? Seems awful early for public school.”

“They’ve been moving it forward. Back in the old days the kids helped on the farm with the harvest. School didn’t start around here until about the seventh or eighth of September. And we got to go back two weeks later because we lived on a farm.

“Now nobody does that anymore. I don’t know what young people do. Nothing, I guess. That’s why they start school earlier.”

Our youngest son, Edward, headed back to college on Sunday. He goes to school in New England and takes the train – the Vermonter – from Baltimore’s Union Station.

It seemed early to be sending him off too.

But Earth turns. The days grow shorter and cooler. And investors begin to feel the chill wind.

So far, only metaphorically. Later, they will feel the icy winds blowing around the corner of Wall Street in New York… or over their own hills and dales. And they will wonder…

…what’s a share in a company really worth? What’s a bond worth? Heck, what’s the dollar itself worth?

All of these questions will draw the same reply: It depends.

Hopes and Hallucinations

Among the things it depends on is the level of trust in society… in its leaders… in its capital structure… and in its future.

When the sun is shining it’s easy to have trust in a society. It’s when the chilly winds blow that the question marks begin to fly. You see them picked up like plastic bags by gusts of wind… floating around until they are snagged on some barren tree.

That’s when it gets interesting… when the hopes and hallucinations that undergirded the boom give way.

Markets are cyclical. Sooner or later, whether we like it or not, they change. And our guess is that investors are about to go back to school and learn that three major markets – debt, equities and gold – have changed direction recently. Gold is now headed back up. US stocks are completing a huge, rounded top. And bond prices have already begun to fall (and yields rise).

When Trust Fades

The Fed spoke like a climatologist last week. Maybe Earth will begin cooling off, it said. Then again, maybe it won’t.

It said it was still considering tapering off. But it also reminded us that it would only do so if and when it felt like it was kinda a good idea… which probably wouldn’t be any time soon.

US stock markets rose on Friday… barely. Gold got some exercise – up $25 an ounce to bring it within a few dollars of $1,400.

How about that gold? Just when you thought it was finished… it comes back strong.

What will it do when winter comes and the warm light of trust fades away?

To be continued…

Market Insight:

Dispelling the Dividend Tax Myth

From the desk of Jim Nelson

I got a lot of great feedback from Diary readers following last week’s debate with Bill about income investing. (If you missed it, you can catch up here, here and here.)

One of the most controversial issues was over how income from dividends is taxed versus income from capital gains. There seems to be a lot of confusion over this still. So today, I want to answer your questions… and try to clear up any remaining uncertainty.

First, a question from reader Mike R.:

Did I understand correctly that when you pull dividend income out of the “tax-advantaged” accounts that you will pay taxes equal to the capital gains/qualified dividend rates? That is wrong. I am a CPA; I recently wrote an article for a client’s magazine wherein I discussed the fact that “tax-deferred” accounts were actually conversion machines, turning capital gains and qualified dividends into ordinary income taxed at ordinary income rates. 

Thanks, Mike. You’re right. When you withdraw any money from a tax-advantaged account (your 401(k), IRA, etc.) you pay taxes based on your ordinary tax rates.

The point I wanted to make was that capital gains and dividends are taxed at the same rate when you withdraw from a tax-advantaged account. They’re both taxed as ordinary income.

A lot of people still believe that the dividend tax rate is higher than the rate on capital gains… even when used in a retirement account. But that’s not the case.

I want to get this straight for once and for all. In the case of retirement accounts – or any other tax-deferred account that allows stock investing – there’s NO tax advantage to buying non-dividend-paying companies over dividend-paying ones.

The same is true in taxable accounts to a large degree.

Reader Dave E. wrote, “Cap gain tax rates (at least presently) are more favorable than dividend rates.” Again, that’s a misconception. The qualified-dividend tax rate is identical at all income levels to the long-term capital gains tax rate. For the top bracket, both are taxed at 20%.

In other words, no matter where you hold your shares of a income-paying stock or fund, you are at no disadvantage in terms of taxes.

And there are plenty of overlooked tax advantages for certain classes of dividend stocks, as reader Mike J. points out:

I am a dividend-oriented investor, and have found that dividend-paying stocks generated most of my returns during the past 4 decades. Today, I invest in selected ETFs which pay tax-advantaged distributions monthly or quarterly. Most of these ETFs’ distributions are returns of capital, and less than 20% of the distributions are actually taxable as dividends.

This is a great point, Mike. I hope you were able to sign up for the free beta test of my new income investing advisory, Legacy Income. I’ll be talking a lot about this idea.

Certain types of income-generating stocks and funds – some ETFs, closed-end funds, REITs, MLPs and BDCs – have important tax advantages built in.

They don’t pay corporate income tax, which avoids the dreaded “double-taxation” problem. And often the IRS considers a portion of their distributions to be return of capital – which just means it is tax-deferred until you sell.

If you are investing in those types of ETFs and funds for their income, and you never sell, you may never have to pay taxes on that portion of your income.

Editor’s note: We got a huge response on Friday to our offer to Diary readers to sign-up, for free, to beta test two months of Jim’s new income investing service, Legacy Income. Jim reckons that’s all the time he needs to convince you of the power of recurring income to steadily build wealth.

We still have 68 beta-tester slots available. So, if you didn’t get a chance to sign-up already… and want to hear more from Jim about how to build long-term wealth through stock market income… go here now.