GET GOING! INVESTING FOR THE NEW YEAR (Bankrate.com)

10 top tips to beat investing inertia

Dr. Don Taylor, Ph.D., CFA, CFP, CASL

BANKRATE — 8:12 PM ET 12/24/14

This is my 16th year of writing a "Top 10" column to get you thinking about improving your finances in the upcoming year. May you benefit in 2015 from these investing tips.

1. Figure out what you're trying to reach

I encourage people to figure out what their goals are in life, and then work on a financial plan that will help them achieve those goals. However, goals that aren't well-defined -- like "I want a comfortable retirement" or "I want to save for my children's education" -- don't have numbers behind them, and that makes them harder to achieve.

I often see people financing goals they should have invested for, especially when it comes to their children's college education. With some exceptions, such as financing a mortgage, I'd rather see you earn a yield on your investments than pay a rate on a loan.

2. Insure, save, invest

Investing isn't the first step in providing for you and your family's future. Insurance is that first step. Between life insurance, health insurance, disability insurance, home, auto, liability insurance and long-term care insurance, evaluating and meeting your needs for insurance is an important first step before starting to save and invest for your future.

Financial professionals tend to differentiate between saving and investing. With saving, protecting principal is more important than increasing purchasing power. With investing, the emphasis is on building wealth and increasing purchasing power. An emergency fund, with its role of providing liquidity in times of financial need, is the place for savings. Retirement accounts, at least while you're still working, are the place to invest. Consumers with low risk tolerances tend to save money they would be better off investing.

3. Have an emergency fund

Too many people live paycheck to paycheck. They can't handle any financial setbacks in their lives. Some expect their credit cards to see them through the tough times, only to find themselves trying to dig out from under a mountain of credit card debt that may be growing at 23.99 percent interest.

As you start to build wealth in your investment portfolio, the portfolio can act as a financial backstop for at least part of the funds available in an emergency. Until then, it makes sense to have three to six months' worth of living expenses in a high-yield savings account or other liquid investment available to meet an unexpected financial need.

4. Know your income and outflow

Whether you want to do a forensic accounting of how you spent money in 2014 or decide to track spending with a financial app on your smartphone in 2015, the idea is to keep track of how you spend your income and figure out where the money goes.

While you're doing that, put together a spending plan and stick to it. I call it a spending plan instead of a budget, because like a diet, no one likes to be on a budget. Call it "planned spending" and it puts a positive spin on allocating your income to your need for current consumption, savings and investment. That's right; your spending plan should include line items for saving and investing.

I'm not a member of the "lose the latte" branch of financial planning. As long as you're not financing that latte by carrying credit card balances and you are meeting your savings and investment goals, enjoy your coffee. There's a lifestyle balance between current spending and saving for your future. All delayed gratification takes the fun out of today. Of course, if a cup of fancy coffee is the highlight of your day, you've got other things to work on besides your finances.

5. Invest in your health

What's health got to do with investing? Well, as my junior high school health teacher, Mr. Andrew Codispoti, always told his students, "health is wealth. All the money in the world can't buy health." OK, the poet Virgil said it first and better: "The greatest wealth is health." Invest in your health and the return on investment might amaze you.

6. Retirement income needs

Don't get confused into thinking that the 401(k) and IRA contribution limits, even with catch-up contributions for those 50 and older, were set by the government to ensure that you can retire comfortably. You're probably not saving enough.

Retirees wind up putting together a retirement income stream from retirement savings, Social Security and pension benefits. Pension benefits are getting rare in the private sector. Try to estimate your retirement income needs, and then work out a plan as to how you will meet those needs. Don't go ostrich on the topic; work with a financial professional if you need help coming up with a target for your retirement nest egg.

7. Maximize expected Social Security benefits

Too many seniors are in a rush to file for Social Security benefits. File before your full retirement age and there's a big reduction in benefits. For senior couples that can make it work, the higher wage earner can "file and suspend" at his or her full retirement age, earning delayed retirement credits up until age 70, while the lower wage earner files for a spousal benefit at his or her full retirement age.

When in doubt on the benefit claiming strategy that will maximize your Social Security benefits, hire a professional to review the different claiming strategies.

8. Maximize your employer's contributions to your retirement

If your employer matches any part of your contribution to their 401(k) or 403(b) plan, make sure you contribute up to the limits of the employer match. That's free money and you don't want to leave any free money on the table.

The typical plan will match 50 cents to every dollar you contribute up to 6 percent of salary. That has your employer contributing 3 percent of salary. You've made 50 percent on your money before even deciding how you're going to invest it.

9. Review and rebalance your portfolio

Over time, you'll see your asset allocations change as the investments you own go up and down in value. Reviewing your portfolio holdings lets you see if you've gotten overweight or underweight in your target asset allocation.

Portfolio rebalancing has you buying and selling investments to get your asset allocations back to your target levels or ranges. Buying and selling in tax-advantaged retirement accounts typically won't have a tax impact, while buying and selling in taxable accounts does have an impact on your taxes.

If you're working with an investment professional, you should know his or her approach to rebalancing. If you're doing it yourself, weigh your investment horizon against your risk tolerance and whether you're adding new money to the portfolio to decide on the frequency or timing of your portfolio rebalancing.

10. Track investment fees and expenses

Knowing what you're paying for in fees and expenses when investing is an important move. Managing those fees and expenses is just as important. Whether your investments are in a tax-advantaged retirement account or a taxable brokerage account, by knowing what you're paying, you can make better decisions about how you're invested, reducing the drag on your investment returns net of fees. The Department of Labor's "A look at 401(k) Plan Fees" Web page is a good place to learn about fees in that type of retirement account.

If you're working with a financial services professional, you should know how they're paid. There are several different compensation models including hourly fees, assets under management, commission-based models or a flat fee for a specific financial plan or service.

Which is better, lump sum or pension (Fidelity)

Faced with mounting pension costs and greater volatility, companies are increasingly offering their current and former employees a critical choice: Take a lump sum now or hold on to their pension.

“Companies are offering these buyouts as a way to shrink the size of their pension plans, which ultimately reduces the impact of that pension plan on the company’s financials,” says John Beck, senior vice president for benefits consulting at Fidelity Investments. “From an employee’s perspective, the decision comes down to a trade-off between an income stream and a pile of money that’s made available to him or her today.”

Pension buyouts can be offered to any current or former employee of a firm. You may be already receiving benefits as a retiree with an accrued (vested) benefit, or you may have a vested benefit from a former employer, or your current company may be offering you a pension lump sum buyout long before you retire.

Whatever the case, here’s how a pension lump sum offer typically works: Your employer issues a notice that by a certain date, eligible employees must decide whether to exchange a monthly benefit payment in the future for a one-time lump sum. If you opt for the lump sum, you’ll receive a check from the company’s pension fund for that amount, and the company’s pension (or defined benefit) obligation to you will end. Alternatively, if you opt to keep your monthly benefits, nothing will change, except the option to take a lump sum will be removed.

Some employers are also considering buying annuities for those who do not opt for the lump sum offer. In this case, your benefits will not change, except that the insurance company’s name will be on the checks you receive in retirement, and the guaranteed income will be provided by the insurance company.1 (As with offering lump sums, companies that switch to an annuity provided by an insurance company can remove the pension liability from their books.)

The process is relatively simple, but the decision about which option to take can be complex. Here are the pros and cons of each option:

Keeping the monthly payment

Pension plans typically provide a payment of a set amount every month from your retirement date through the rest of your life. You may also choose to receive lifetime payments that continue to your spouse after you die.

These monthly payments do have drawbacks, however:

If you’re not working for the company making the offer, your benefit amount typically will not increase between now and your retirement date. During retirement, your life annuity payments typically do not come with inflation protection, so your monthly benefits are likely to lose purchasing power over time. An annual inflation rate of 3%, the average since 1926, will cut the value of your benefit in half in 24 years.
Taking your pension benefit as a life annuity means you may not have access to enough money to fund a large, unexpected expense.
Your ability to collect your payments depends in part on your company’s ability to make them. If your company retains the pension and can’t make the payments, a federal agency called the Pension Benefit Guaranty Corporation (PBGC) will pay a portion of them up to a legally defined limit. The maximum benefit guaranteed by the PBGC in 2014 is $4,943 per month for most people retiring at age 65. The monthly guarantee is lower for retirees before age 65 and larger for retirees age 65 or older. If responsibility for your payments shifts to an insurance company, it will be the insurance company and not the pension plan that is responsible for your guarantees.2

Taking the lump sum

A lump sum may seem attractive: You give up the right to receive future monthly benefit payments in exchange for a large cash payment now—typically, the actuarial net present value of your age-65 benefit, discounted to today. Taking the money up front gives you flexibility: You can invest it yourself, and if you have assets remaining at your death, you can leave them to your heirs.

However, keep in mind the following cautionary factors:

You are responsible for making the funds last throughout your retirement.
Your investments may be subject to market fluctuation, which could increase or reduce the value of your assets and the income you can generate from them.
If you don’t roll the proceeds directly into an IRA or an employer qualified plan like a 401(k) or an 403(b), the distribution will be taxed as ordinary income and may push you into a higher tax bracket. If you take the distribution before age 59½, you may also owe a 10% early withdrawal tax penalty.
You can use some or all of the lump sum to purchase annuity—typically, an immediate
annuity—which could provide a monthly income stream as well as inflation protection or other features. But as an individual buyer, you may not be able to negotiate as good a deal with the insurance provider as the benefit you would have received by taking the pension plan annuity, so the annuity may or may not replicate the monthly pension payment you would have received from your employer. You also need to select your annuity provider carefully, paying special attention to a company's credit ratings, and make sure you read and understand the terms and conditions of the annuity.

Making your choice

Whether it’s best to take a lump sum or keep your pension depends on your personal circumstances. You’ll need to assess a number of factors, including those mentioned above and the following:

Your retirement income and essential expenses. Guaranteed income, like Social Security, a pension, and fixed annuities, simply means something you can count on every month or year and that doesn’t vary with market and investment returns. If your guaranteed retirement income (including your income from the pension plan) and your essential expenses, such as food, housing, and health insurance, are roughly equivalent, the best choice may be to keep the monthly payments, because they play a critical role in meeting your essential retirement income needs. If your guaranteed income exceeds your essential expenses, you might consider taking the lump sum: You can use a portion of it to cover your monthly expenses, and invest the rest for growth.

These comparisons may be relatively easy if you’re already retired, but developing an accurate picture of your retirement income and expenses can be difficult if you’re still working. Beware of the temptation to use the lump sum to pay down credit card debt or handle other current expenses—and not just because of the large tax bill you’re likely to face. “Lump sum distributions come from a pool of money that is developed specifically for retirement,” explains Beck. “To access those funds for another reason puts the quality of your retirement at risk.”
Longevity. Both your monthly benefits payment and the lump sum amount were calculated using actuarial calculations that take into account your current age, mortality tables, and interest rates set forth by the IRS. But these estimates don’t take into account your personal health history or the longevity of your parents, grandparents, or siblings. If you expect to have an above-average life span, you may want the predictability of regular payments. Having a payment stream that is guaranteed to last throughout your lifetime can be comforting. However, if you expect to have a shorter-than-average life span because of personal reasons or your family medical history, the lump sum could be more beneficial.
Wealth transfer plans. After you’ve considered retirement income and expenses, and have planned an adequate cushion for inflation, longevity, and investment risk, it’s appropriate to take wealth transfer plans into consideration. With pension plans, you often don’t have the ability to transfer the benefit to children or grandchildren. If wealth transfer is an important factor, a lump sum may be a better option.

Moving forward

A pension buyout should be evaluated within the context of your overal retirement picture. If you are presented with this option, consult an expert who can give you unbiased advice about your choices. Finally, be aware that more corporations continue to consider discharging their pension obligations, so it’s a good idea to stay in touch with old employers. “If you’ve left a pension behind at a former employer, sometime in the coming years you’re very likely to be offered a lump sum,” says Beck. “Keep your former employer’s administrator up to date on your current address, because you can miss this opportunity if your employer can’t find you.”

Next steps

First and foremost, make sure you know whether you have any pension benefit at your current or former employers, and keep your contact information with those companies up to date. You cannot even consider an offer if you don’t know it exists.
Second, make sure you have a plan for retirement. If you understand your needs, you will be better prepared to understand which option is right for you if you do receive a lump sum offer. Because these offers usually have a limited window for election, it will be more difficult to make an educated and informed decision without knowing, in advance, your total retirement financial picture. Using Fidelity Income Strategy Evaluator® (login required) and Retirement Income Planner can get you started.
If you decide to take a lump sum in lieu of monthly pension payments, you may want to consider rolling it over to an IRA. A direct rollover from your employer's plan to your IRA provider (trustee to trustee) will not be subject to immediate taxation and may be the best way to preserve the tax-deferred status of this money. You should consult your tax adviser.

If you do receive an offer, review it with a trusted financial adviser. Everyone’s circumstances are different. What is right for your friend, neighbor, coworker, or relative may not be right for you.

The Top 5 Regrets (National Underwriter Life & Health Magazine)

Top five regrets of the dying

OCT 29, 2014 | BY PAUL WILSON

There are some very important reasons why we need to get over our fear of death and illness.

One of the biggest hurdles faced by advisors in the life and health sector is the fact that people hate to talk about illness, aging and death. And on some level, who can blame them? It's scary. But as I've written before, there are some very important reasons why we need to get over our fear, or at least learn to handle it like grown ups.

One of the first steps in this process is simply becoming more comfortable talking about aging and death so we can properly prepare and begin to learn from the wisdom and perspective of those who have faced it before us.

Bronnie Ware is an Australian nurse who spent years working in palliative care and caring for patients in the final weeks of their lives. She recorded their most common regrets and collected them in a blog and later a book titled "The Top Five Regrets of the Dying: A Life Transformed by the Dearly Departing."

"When questioned about any regrets they had or anything they would do differently," Ware said, "common themes surfaced again and again." These themes provide invaluable insight into what really matters about our lives when we look back on them.

Here are the top five regrets of the dying, with accompanying thoughts from Ware.

5. I wish that I had let myself be happier.

"This is a surprisingly common one. Many did not realize until the end that happiness is a choice. They had stayed stuck in old patterns and habits. The so-called 'comfort' of familiarity overflowed into their emotions, as well as their physical lives. Fear of change had them pretending to others, and to their selves, that they were content, when deep within, they longed to laugh properly and have silliness in their life again."

4. I wish I had stayed in touch with my friends.

"Often they would not truly realize the full benefits of old friends until their dying weeks and it was not always possible to track them down. Many had become so caught up in their own lives that they had let golden friendships slip by over the years. There were many deep regrets about not giving friendships the time and effort that they deserved. Everyone misses their friends when they are dying."

3. I wish I'd had the courage to express my feelings.

"Many people suppressed their feelings in order to keep peace with others. As a result, they settled for a mediocre existence and never became who they were truly capable of becoming. Many developed illnesses relating to the bitterness and resentment they carried as a result."

2. I wish I hadn't worked so hard.

"This came from every male patient that I nursed. They missed their children's youth and their partner's companionship. Women also spoke of this regret, but as most were from an older generation, many of the female patients had not been breadwinners. All of the men I nursed deeply regretted spending so much of their lives on the treadmill of a work existence."

1. I wish I'd had the courage to live a life true to myself, not the life others expected of me.

"This was the most common regret of all. When people realize that their life is almost over and look back clearly on it, it is easy to see how many dreams have gone unfulfilled. Most people had not honored even half of their dreams and had to die knowing that it was due to choices they had made, or not made. Health brings a freedom very few realize, until they no longer have it."

Successful Investing: Best Tips from the Pros (ZeroHedge)

Published on Zero Hedge (http://www.zerohedge.com)

10 Legendary Investment Rules From Legendary Investors

By Tyler Durden

Created 12/11/2014 - 19:00

[1]

Submitted by Tyler Durden [1] on 12/11/2014 19:00 -0500

Bridgewater [2]

Fail [3]

Gambling [4]

George Soros [5]

Gundlach [6]

Howard Marks [7]

James Montier [8]

Jeremy Grantham [9]

Livermore [10]

Oaktree [11]

Ray Dalio [12]

Reality [13]

Risk Management [14]

Seth Klarman [15]

Wall Street Journal [16]

Submitted by Lance Roberts of STA Wealth Management [17],

I live in Houston, which has been a huge economic beneficiary of the sustained increases in oil prices, drilling, refining and related processes. As such, the amount of wealth created in energy-related investments has been enormous and, not surprisingly, a vast majority of individuals have overweighted portfolios in energy with the expectations that "oil prices can only go up." Of course, this sentiment is certainly understandable when you look at the performance of the energy sector versus the S&P 500 since the turn of the century. (Annualized return, capital appreciation only: S&P 500 3.24% vs Energy 17.71%)

[18]
Not surprisingly, the recent plunge in oil prices, and related energy stocks, has sent investors scurrying for cover. Previous "complacency" has turned to outright "panic" as portfolios, and retirement plans, have been crushed by plunging asset prices.
Strongly rising asset prices, and in this case commodity prices, have driven investor exuberance in the sector leading many to ignore deteriorating fundamentals, excessive leverage, and other financial diseases. However, when prices deteriorate rapidly, investment mistakes are quickly revealed.
It is important to remember that we are not investors. We are speculators placing bets on the direction of the price of an electronic share. More importantly, we are speculating, more commonly known as gambling, with our "savings." We are told by Wall Street that we "must" invest into the financial markets to keep those hard-earned savings adjusted for inflation over time. Unfortunately, due to repeated investment mistakes, the average individual has failed in achieving this goal.
With this in mind, this is an excellent time to review 10 legendary investment lessons from legendary investors. These time-tested rules about"risk" are what have repeatedly separated successful investors from everyone else. (Quote Source: 25iQ) [19]

1) Jeffrey Gundlach, DoubleLine

"The trick is to take risks and be paid for taking those risks, but to take a diversified basket of risks in a portfolio."

This is a common theme that you will see throughout this post. Great investors focus on "risk management" because "risk" is not a function of how much money you will make, but how much you will lose when you are wrong. In investing, or gambling, you can only play as long as you have capital. If you lose too much capital but taking on excessive risk, you can no longer play the game.
Be greedy when others are fearful and fearful when others are greedy. One of the best times to invest is when uncertainty is the greatest and fear is the highest.

2) Ray Dalio, Bridgewater Associates

“The biggest mistake investors make is to believe that what happened in the recent past is likely to persist. They assume that something that was a good investment in the recent past is still a good investment. Typically, high past returns simply imply that an asset has become more expensive and is a poorer, not better, investment.”

Nothing good or bad goes on forever. The mistake that investors repeatedly make is thining "this time is different." The reality is that despite Central Bank interventions, or other artificial inputs, business and economic cycles cannot be repealed. Ultimately, what goes up, must and will come down.
WallStreet wants you to be fully invested "all the time" because that is how they generate fees. However, as an investor, it is crucially important to remember that "price is what you pay and value is what you get." Eventually, great companies will trade at an attractive price. Until then, wait.

3) Seth Klarman, Baupost

“Most investors are primarily oriented toward return, how much they can make and pay little attention to risk, how much they can lose.”

Investor behavior, driven by cognitive biases, [20] is the biggest risk in investing. "Greed and fear" dominate the investment cycle of investors which leads ultimately to "buying high and selling low."

[21]

4) Jeremy Grantham, GMO

“You don’t get rewarded for taking risk; you get rewarded for buying cheap assets. And if the assets you bought got pushed up in price simply because they were risky, then you are not going to be rewarded for taking a risk; you are going to be punished for it.”

Successful investors avoid "risk" at all costs, even it means underperforming in the short-term. The reason is that while the media and WallStreet have you focused on chasing market returns in the short-term, ultimately the excess "risk" built into your portfolio will lead to extremely poor long-term returns. Like Wyle E. Coyote, chasing financial markets higher will eventually lead you over the edge of the cliff.

5) Jesse Livermore, Speculator

“The speculator’s deadly enemies are: ignorance, greed, fear and hope. All the statute books in the world and all the rule books on all the Exchanges of the earth cannot eliminate these from the human animal….”

Allowing emotions to rule your investment strategy is, and always has been, a recipe for disaster. All great investors follow a strict diet of discipline, strategy, and risk management.

6) Howard Marks, Oaktree Capital Management

“Rule No. 1: Most things will prove to be cyclical. – Rule No. 2: Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.”

As with Ray Dalio, the realization that nothing lasts forever is critically important to long term investing. In order to "buy low," one must have first"sold high." Understanding that all things are cyclical suggests that after long price increases, investments become more prone to declines than further advances.

7) James Montier, GMO

"There is a simple, although not easy alternative [to forecasting]... Buy when an asset is cheap, and sell when an asset gets expensive.... Valuation is the primary determinant of long-term returns, and the closest thing we have to a law of gravity in finance."

"Cheap" is when an asset is selling for less than its intrinsic value. "Cheap" is not a low price per share. Most of the time when a stock has a very low price, it is priced there for a reason. However, a very high priced stock CAN be cheap. Price per share is only part of the valuation determination, not the measure of value itself.

8) George Soros, Soros Capital Management

“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

Back to risk management, being right and making money is great when markets are rising. However, rising markets tend to mask investment risk that is quickly revealed during market declines. If you fail to manage the risk in your portfolio, and give up all of your previous gains and then some, then you lose the investment game.

9) Jason Zweig, Wall Street Journal

“Regression to the mean is the most powerful law in financial physics: Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.”

The chart below is the 3-year average of annual inflation-adjusted returns of the S&P 500 going back to 1900. The power of regression is clearly seen. Historically, when returns have exceeded 10% it was not long before returns fell to 10% below the long-term mean which devasted much of investor's capital.

[22]

10) Howard Marks, Oaktree Capital Management

“The biggest investing errors come not from factors that are informational or analytical, but from those that are psychological.”

The biggest driver of long-term investment returns is the minimization of psychological investment mistakes. As Baron Rothschild once stated:"Buy when there is blood in the streets." This simply means that when investors are "panic selling," you want to be the one that they are selling to at deeply discounted prices. The opposite is also true. As Howard Marks opined: “The absolute best buying opportunities come when asset holders are forced to sell.”

As an investor, it is simply your job to step away from your "emotions" for a moment and look objectively at the market around you. Is it currently dominated by "greed" or "fear?" Your long-term returns will depend greatly not only on how you answer that question, but to manage the inherent risk.

“The investor’s chief problem – and even his worst enemy – is likely to be himself.” - Benjamin Graham

Source URL: http://www.zerohedge.com/news/2014-12-11/10-legendary-investment-rules-legendary-investors

Links:
[1] http://www.zerohedge.com/users/tyler-durden
[2] http://www.zerohedge.com/taxonomy_vtn/term/7902
[3] http://www.zerohedge.com/taxonomy_vtn/term/9344
[4] http://www.zerohedge.com/taxonomy_vtn/term/9715
[5] http://www.zerohedge.com/taxonomy_vtn/term/9737
[6] http://www.zerohedge.com/taxonomy_vtn/term/8336
[7] http://www.zerohedge.com/taxonomy_vtn/term/8366
[8] http://www.zerohedge.com/taxonomy_vtn/term/12427
[9] http://www.zerohedge.com/taxonomy_vtn/term/8444
[10] http://www.zerohedge.com/taxonomy_vtn/term/9851
[11] http://www.zerohedge.com/taxonomy_vtn/term/9264
[12] http://www.zerohedge.com/taxonomy_vtn/term/8763
[13] http://www.zerohedge.com/taxonomy_vtn/term/12218
[14] http://www.zerohedge.com/taxonomy_vtn/term/240
[15] http://www.zerohedge.com/taxonomy_vtn/term/8834
[16] http://www.zerohedge.com/taxonomy_vtn/term/10139
[17] http://streettalklive.com/index.php/daily-x-change/2528-10-legendary-investment-rules-from-legendary-investors.html
[18] http://streettalklive.com/images/1dailyxchange/2014/SP500-Energy-Perf-121014.PNG
[19] http://25iq.com/
[20] http://streettalklive.com/index.php/component/flexicontent/2-the-daily-x-change/2265-5-cognitive-biases-that-are-killing-your-returns.html?Itemid=164
[21] http://streettalklive.com/images/1dailyxchange/2014/Investor-Psychology-Cycle-082814.PNG
[22] http://streettalklive.com/images/1dailyxchange/2014/Reversion-To-The-Mean-121014.PNG

Tax Tips: How to Avoid Getting Audited by the IRS (Kiplinger)

Ever wonder why some tax returns are eyeballed by the Internal Revenue Service while most are ignored? Short on personnel and funding, the IRS audited only slightly less than 1% (0.96%) of all individual tax returns in 2013. And we expect the 2014 audit rate to fall even lower as the agency's resources continue to shrink and even more employees are reassigned to work identity theft cases. So the odds are pretty low that your return will be picked for review. And, of course, the only reason filers should worry about an audit is if they are fudging on their taxes.

That said, your chances of being audited or otherwise hearing from the IRS increase depending upon various factors, including your income level, the types of deductions or losses claimed, the business in which you're engaged and whether you own foreign assets. Math errors may draw IRS inquiry, but they'll rarely lead to a full-blown exam. Although there's no sure way to avoid an IRS audit, these 14 red flags could increase your chances of unwanted attention from the IRS.

Making a lot of money

Although the overall individual audit rate is a little less than one in 100, the odds increase dramatically as your income goes up. IRS statistics for 2013 show that people with incomes of $200,000 or higher had an audit rate of 3.26%, or one out of every 30 returns. Report $1 million or more of income? There's a one-in-nine chance your return will be audited. The audit rate drops significantly for filers making less than $200,000: Only 0.88% of such returns were audited during 2013, and the vast majority of these exams were conducted by mail.

We're not saying you should try to make less money—everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you'll be hearing from the IRS.

Failing to report all taxable income

The IRS gets copies of all 1099s and W-2s you receive, so make sure you report all required income on your return. IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a 1099 showing income that isn't yours or listing incorrect income, get the issuer to file a correct form with the IRS.

Taking large charitable deductions

We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag.

That's because the IRS knows what the average charitable donation is for folks at your income level. Also, if you don't get an appraisal for donations of valuable property, or if you fail to file Form 8283 for noncash donations over $500, you become an even bigger audit target. And if you've donated a conservation or façade easement to a charity, chances are good that you'll hear from the IRS. Be sure to keep all your supporting documents, including receipts for cash and property contributions made during the year.

Claiming day-trading losses on Schedule C

Those who trade in securities have significant tax advantages compared with investors. The expenses of traders are fully deductible and are reported on Schedule C (investors report their expenses as a miscellaneous itemized deduction on Schedule A, subject to an offset of 2% of adjusted gross income), and traders' profits are exempt from self-employment tax. Losses of traders who make a special section 475(f) election are fully deductible and are treated as ordinary losses that aren't subject to the $3,000 cap on capital losses. And there are other tax benefits.

But to qualify as a trader, you must buy and sell securities frequently and look to make money on short-term swings in prices. And the trading activities must be continuous. This is different from an investor, who profits mainly on long-term appreciation and dividends. Investors hold their securities for longer periods and sell much less often than traders.

The IRS knows that many filers who report trading losses or expenses on Schedule C are actually investors. So it's pulling returns and checking to see that the taxpayer meets all of the rules to qualify as a bona fide trader.

Claiming rental losses

Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. But this $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and 750 or more hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation.

The IRS is actively scrutinizing rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. It's pulling returns of individuals who claim they are real estate professionals and whose W-2 forms or other non-real estate Schedule C businesses show lots of income. Agents are checking to see whether these filers worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business. The IRS started its real estate professional audit project several years ago, and this successful program continues to bear fruit.

Deducting business meals, travel and entertainment

Schedule C is a treasure trove of tax deductions for self-employeds. But it's also a gold mine for IRS agents, who know from experience that self-employeds sometimes claim excessive deductions. History shows that most underreporting of income and overstating of deductions are done by those who are self-employed. And the IRS looks at both higher-grossing sole proprietorships and smaller ones.

Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don't satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast.

Claiming 100% business use of a vehicle

When you depreciate a car, you have to list on Form 4562 what percentage of its use during the year was for business. Claiming 100% business use of an automobile is red meat for IRS agents. IRS agents are trained to focus on this issue and will scrutinize your records. Make sure you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for the revenue agent to disallow your deduction.

As a reminder, if you use the IRS' standard mileage rate, you can't also claim actual expenses for maintenance, insurance and other out-of-pocket costs. The IRS has seen such shenanigans and is on the lookout for more.

Writing off a loss for a hobby activity

You must report any income you earn from a hobby, and you can deduct expenses up to the level of that income. But the law bans writing off losses from a hobby. For you to claim a loss, your activity must be entered into and conducted with the reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes that you're in business to make a profit, unless the IRS establishes otherwise. So make sure you run your activity in a businesslike manner and can provide supporting documents for all expenses.

Claiming the home office deduction

Like Willie Sutton robbing banks (because that's where the money is), the IRS is drawn to returns that claim home office write-offs because it has found great success knocking down the deduction and driving up the amount of tax collected for the government.

If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs that are properly allocated to the home office. That's a great deal. Alternatively, you have a simplified option for claiming this deduction: The write-off can be based on a standard rate of $5 per square foot of space used for business, with a maximum deduction of $1,500.

To take advantage of this tax benefit, you must use the space exclusively and regularly as your principal place of business. "Exclusive use" means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night, or as a guest bedroom or children's playroom. Don't be afraid to take the home office deduction if you're entitled to it. Risk of audit should not keep you from taking legitimate deductions. If you have it and can prove it, then use it.

Taking an alimony deduction

Alimony paid by cash or check is deductible to the payer and taxable to the recipient, provided certain requirements are met. For instance, the payments must be made under a divorce or separate maintenance decree or written separation agreement. The instrument can't say the payment isn't alimony. And the payer's liability for the payments must end when the former spouse dies. You'd be surprised how many divorce decrees run afoul of this rule.

Alimony doesn't include child support or noncash property settlements. The rules on deducting alimony are complicated, and the IRS knows that some filers who claim this write-off don't always satisfy the requirements. It also wants to make sure that both the payer and the recipient properly reported alimony on their respective returns. A mismatch in reporting by ex-spouses will almost certainly trigger an audit.

Running a small business

Small business owners in cash-intensive businesses—think taxis, car washes, bars, hair salons, restaurants and the like—are a tempting target for IRS auditors. Experience shows that those who receive primarily cash are less likely to accurately report all of their taxable income. The IRS has a guide for agents to use when auditing cash-intensive businesses, telling how to interview owners and noting various indicators of unreported income.

Other small businesses will also face extra audit heat, as the IRS shifts its focus away from auditing regular corporations. The agency thinks it can get more bang for its audit buck by examining S corporations, partnerships, limited liability companies and sole proprietorships. So it's spending more resources on training examiners about issues commonly encountered with pass-through firms.

Failing to report a foreign bank account

The IRS is intensely interested in people with money stashed outside the U.S., especially those in tax havens, and tax authorities have had success getting foreign banks to disclose account information. The IRS has also used voluntary compliance programs to encourage folks with undisclosed foreign accounts to come clean—in exchange for reduced penalties. The IRS has learned a lot from these amnesty programs and has been collecting a boatload of money (we're talking billions of dollars). It's scrutinizing information from amnesty seekers and is targeting the banks that they used to get names of even more U.S. owners of foreign accounts.

Failure to report a foreign bank account can lead to severe penalties. Make sure that if you have any such accounts, you properly report them. This means electronically filing FinCEN Form 114 by June 30 to report foreign accounts that total more than $10,000 at any time during the previous year. And those with a lot more financial assets abroad may also have to attach IRS Form 8938 to their timely filed tax returns.

Engaging in currency transactions

The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious-activity reports from banks and disclosures of foreign accounts. So if you make large cash purchases or deposits, be prepared for IRS scrutiny. Also, be aware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as persons depositing $9,500 in cash one day and an additional $9,500 in cash two days later).

Taking higher-than-average deductions

If deductions on your return are disproportionately large compared with your income, the IRS may pull your return for review. But if you have the proper documentation for your deduction, don't be afraid to claim it. There's no reason to ever pay the IRS more tax than you actually owe.