Ask the Fool

Bear Market, Defined

Q: I hear the stock market entered a “bear market” — how is that determined? — C.M., Cincinnati

A: It’s all a matter of degree. When the stock market’s overall value drops (from its high point) by 10%, that’s considered a “correction,” suggesting that the market had gotten ahead of itself and has self-corrected. When the overall value falls by 20% or more, that’s a bear market.

Bear markets can last from weeks to years, so money you’ll need within a few years shouldn’t be held in stocks. As a long-term investor, you can wait for the recovery that (historically speaking) always follows. You might even buy more stock while prices are low.

Q: If I’m in the 22% tax bracket, I’m not paying 22% on all my income, am I? — P.Z., online

A: Not at all. That’s your “marginal” tax bracket, meaning that your next dollar of income will be taxed at that rate. Federal tax brackets change over time, but for the 2019 and 2020 tax years, there are seven; they tax income at 10%, 12%, 22%, 24%, 32%, 35% and 37%.

So if you’re single and your taxable income for 2019 is $55,000, you’d pay 10% on your first $9,700 of income (that’s $970), 12% on your income from $9,701 to $39,475 ($3,573), and 22% on your income from $39,476 to $55,000 ($3,415). (That 22% bracket covers income up to $84,200, by the way.) Add those three sums, and they come to a total tax of $7,958. Divide that by your taxable income of $55,000, and you’ll see that you paid 14.5% of your income in federal taxes. That’s your effective tax rate, reflecting your total taxation, and it’s more meaningful than your marginal rate.

Fool’s School

Meet the Taxpayer Bill of Rights

When April rolls around each year — or July, this year — you might feel like it’s just you, alone, against the massive Internal Revenue Service, and that you’re powerless if you have any problems or grievances. Not so — you have the Taxpayer Bill of Rights!

As the IRS explains: “Each and every taxpayer has a set of fundamental rights they should be aware of when dealing with the IRS. Explore your rights and our obligations to protect them.” Here are the 10 rights you have, with a few excerpts from explanations:

≤ The right to be informed: “Taxpayers … are entitled to clear explanations of the laws and IRS procedures in all tax forms, instructions, publications, notices and correspondence.”

≤ The right to quality service: “Taxpayers have the right to receive prompt, courteous and professional assistance in their dealings with the IRS, to be spoken to in a way they can easily understand, to receive clear and easily understandable communications …”

≤ The right to pay no more than the correct amount of tax.

≤ The right to challenge the IRS’ position and be heard.

≤ The right to appeal an IRS decision in an independent forum.

≤ The right to finality: “Taxpayers have the right to know the maximum amount of time they have to challenge the IRS’ position as well as the maximum amount of time the IRS has to audit a particular tax year or collect a tax debt.”

≤ The right to privacy.

≤ The right to confidentiality.

≤ The right to retain representation.

≤ The right to a fair and just tax system: “Taxpayers have the right to expect the tax system to consider facts and circumstances that might affect their underlying liabilities, ability to pay or ability to provide information (in a) timely (manner). Taxpayers have the right to receive assistance from the Taxpayer Advocate Service if they are experiencing financial difficulty or if the IRS has not resolved their tax issues properly …”

Know your rights!

My Dumbest Investment

Get a Load of This

My dumbest investment was when I got talked into buying shares of a mutual fund with a 5% load and a 1.25% annual fee. I did the math after few years, comparing the large-cap mutual fund to a simple index fund based on the S&P 500, and learned that I’d given away thousands of dollars.

I’m glad I learned those lessons in my mid-20s. Now I don’t trust anyone trying to sell me anything. — C.B., online

The Fool responds: Over long periods, most actively managed mutual funds (those with highly paid professionals choosing what to buy and sell, and when) underperform the overall market. It makes more sense for most of us to just stick with index funds, which tend to perform better for lower fees.

Whatever kind of mutual fund you buy into, it’s also best to avoid those charging a “load,” which is a sales fee that can be front-loaded (you pay it when buying shares), back-loaded (you pay when you sell) or even ongoing (you pay each year). Loads can be as high as 8.5%. If you plunk $3,000 into a fund with a 5% front-end load, $150 will be lopped off in fees, with only $2,850 going into the fund on your behalf.

There are lots of good no-load funds, so give them preference. And look for low annual fees, too — ideally well under 1%. Many index funds charge less than 0.2%.