Spend Your Values

Finance Gourmet on December 19, 2014

I have written here before about how people are not robots and that earning, spending, savings and investing money is seldom done in an emotionless vacuum. Of course, that doesn’t mean you shouldn’t understand what is the “right” move according to an unemotional spreadsheet, but actually living with your money and personal finance is much more important than trying to pretend you should strive toward never doing anything but what the calculator says is right.

Spending My Values

The concept of spending your values, is not mine. I’m not sure where it came from originally, but now that I’ve heard of it from someone else, I thought it would be interesting to take a look at it, and pass the idea on to you.

When we look at spending money responsibly, the first thing we do is look at a budget, whether formally written down and calculated, or just sort of sketched out mentally. The main component of spending responsibly is not spending more than you have. After that, personal finance at its most basic level is paying your obligations in any given month, and then, determining where to spend and save whatever is left over.

For many of us, there are certain unconscious value judgements made along the way whether we realize them or not. For example, saying something like, “I shouldn’t be spending that much money eating out,” or that much money on shoes, or clothes, or movies, or whatever, comes from an unarticulated value system inside of you. After all, you are the one that determines how much spending on clothes, or restaurants, or happy hours, is “right” and how much is “too much.”  If you ever examined the same ideas from others, you would likely find much different answers.

Part of this stems from what we consider to be luxury versus necessity. But, here too, there are a lot of different ways to value such things. For example, food is necessary, but one can spend more or less on groceries depending upon what is important to them. For example, I spend more money on organic milk because my children drink a lot of it, and I’m concerned about all the stuff they put in it. That makes my mile cost about a $1 more than the other milk. I’m fine with this because I feel that it is “worth it.” On the other hand, I don’t buy certain other things because they are “too expensive” even if that is what they cost.

In a real way, this is spending your values. I buy organic milk because my values say that is an important thing to do for me and my children.

But, have you ever thought about the rest of your values?

For example, a friend of mine, who brought up the concept of spending your values to me, is a big believer in the arts, in particular performing arts. Now, before, she would do her budget just like I do, with various categories of bills, gas, food, etc…

At the end, she would have an “entertainment” or “extras” category. It was from that money that she would buy things like tickets to shows or concerts. But, it dawned on her one day that those events and purchases were the most important things to her. So, she decided to spend her values by allocating more money to those types of events, than to things she valued less such as clothes or wine.

When developing a budget, tricks like spending your values are important because they give you the willpower to hold true to your budget. When the decision is between buying those boots or not is just between it is or isn’t in the budget, the decision can be tough. But, when the same decision is between valuing boots over a holiday performance at the local orchestra, well, that’s a different thought process entirely.

If you have trouble sticking to your budget, try consciously attaching your values to how you categories and spend your money. Make sure what is really important to you doesn’t end up in the “extra” or “leftover” category. It just might help you find the will to stick to your budget better.

Tags: , ,

Finance Gourmet on December 15, 2014

As a former Certified Financial Planner, or CFP, I tend, like many other financial experts, to think (and write) in terms of the tricky, the convoluted, and the complex. The truth is that money and personal finance can be very intricate and complex. However, it is also true that the biggest bang for the buck financial planning wise comes from doing the most basic things. Too often, we get caught up in things that actually end up being tiny details of your overall financial life.

For example, many people shop endlessly for higher savings account interest rates. Whether you have a high-yield savings account, a regular savings account, or even a kids savings account, the interest rate matters far less than how much money  you put in it.

If you have $10,000 and you put it in a regular savings account earning 0.5 percent, your interest for the year will be approximately, $50. If you got double that rate, 1.0%, then you’d have $100 in interest. In either case, you would still basically just have $10,000 at the end of the year, $10,050 or $10,100, respectively. Neither has a meaningful impact on your overall financial status. On the other hand, if you saved $100 per month for that same year, you would have amassed an additional $1,200. While that doesn’t change you from middle class to wealthy, the difference between $10,000 and $11,200 is actually meaningful. In other words, what really matters is finding a way to save, not finding the highest rate, especially when you are often talking about tenths of a percent between accounts most times, rather than the mythical “double.”

So, just what would a basic financial plan look like for someone who has managed to get their personal finances to the stage where they can save and invest some money, and they want to go beyond just sticking it in a savings bond, bank account or CD account? Actually, it’s pretty simple. Just a few moving parts to get started, and then plenty of room to grow into a more advanced personal financial plan when the money starts building up.

Starter Financial Plan

Step 1: 401k Retirement Plan

Most people will tell you to build up some savings first. That is the correct advice for robots, spreadsheets, and humans without any emotions toward money. For everyone else, I’m here to tell you that real people “figure it out” when it comes to things like covering their expenses. Figuring it out almost always involves eventually raiding your savings. That means that your savings are not a long-term financial building block for you, not yet.

Instead, you should start saving in your 401k. A 401k not only helps you save for retirement, and helps you save money on taxes, it also prevents you from robbing the money you work so hard to save in response to life. There is a 10 percent tax penalty on early withdrawals, plus you have to fill out paperwork, and go talk to that lady in accounting. Trust me when I tell you that for most people, the difficulty of raiding a 401k plan means they don’t end up doing it. You figure something else out, and that is why it is the one place regular Americans actually build up wealth over time. I’ve seen it over, and over again.

If you work a decent job with a professional company, they almost certainly offer a 401k. If your employer does not offer a 401k, chances are you need a better job for long-term financial success. That doesn’t have to happen today, but accept that reality and start working toward it somehow.

Opening a 401k plan is usually pretty easy because your company’s HR department will help you with the paperwork. The two main things you’ll need to figure out are

  1. How much money to put in your 401k
  2. Where to invest your 401k

I’m going to tell you a big secret of long-term financial planning like retirement planning. What you do with #1 matters WAY MORE than what you do with #2. Most people think it is the other way around, but the truth is that putting in 10 percent instead of 5 percent will matter much more over the long run than if you pick the investment that earns 8 percent over the one that pays 10 percent.

Your goal is to eventually save 10 percent of your income into your 401k plan. That is probably impossible as you start today. That isn’t a problem. Pick an amount and start getting it in there. Even 2 percent is fine.

The secret is to increase it as you get the opportunity. Did you spouse start a new job?  Great, boost your 401k by 1 percent before you get used to the extra money. Did you get a raise? Great, boost your 401k contributions by 1 percent. Keep going. If you do the math, you are only 8 raises away from a 10 percent contribution rate if you start at 2 percent.

Now, here is the key to financial planning for retirement. No matter what ad you see, no matter what some finance guy tells you, no matter what you hear about taxes in retirement, or whatever the song is, do not do ANYTHING ELSE for retirement until you are contributing 10 percent of your salary into your 401k. Then, AND ONLY THEN, should you worry about stuff like an IRA, or some kind of life insurance or annuity, or anything else.

The truth is that those other things are good ideas and a good way to save money for retirement, but every single one of them should be done AFTER you are putting 10% into your 401k, and not a penny before. (I’ll try and cover this in more detail another time, but for now, your basic financial plan success depends on you getting 10 percent of your salary into your 401k plan as soon as you can.)

Where To Invest Your 401k Plan Money

Too many people get hung up on where to invest. The actual key to financial planning success is how much you invest, and for how long. Your plan will have several different choices. If it is too confusing and you just don’t want to deal with it, pick one of the Asset Allocation, or Target Date funds. These funds choose the investments for you and adjust them as you get older. However, these funds are pretty much always too conservative, almost to a fault. So, pick the one above where you think you should be.

That is, if you plan to retire in 2040, pick the 2050 target plan. If you think you are a Moderate investor, pick the Moderate-Aggressive plan.

If you want to pick your own investments, feel free. Since this is a basic financial plan for everyone, we won’t go into that right now, but read some of the investing and retirement plan articles on this site to help educate yourself. Whatever you do, do not trade in your 401k plan account. Each year, at the end of the year, rebalance your money so that you don’t get overloaded into any one investment, but that is it. Let time and the market do the work for you.

No matter what you do, DO NOT pull your money out of your investments when the stock market goes down. It will go down again. It always does, but it always goes back up too. Even more importantly, do NOT stop contributing or lower your contribution when the market looks bad. It will feel like the right thing to do, but it isn’t. Buying while the market is going down is buying LOW. That’s a good thing, remember?

stock market recovery

Look at this chart. You’ll notice that if you bought at the very top before the crash that led to the Great Recession, you made all of your money back, no losses, in just 5 1/2 years. But, even more importantly, every single dollar you contributed to your 401k plan during those 5 1/2 years isn’t just recovered back to zero losses, everyone of those dollars is making a profit. The money you contributed there when things were bottoming out has has almost doubled in value. Bet you wish you could go back and put more in then, not less.

401k Part of Financial Plan Steps

  1. Open your 401k plan
  2. Start contributing what you can
  3. Increase your contributions whenever you can
  4. Keep contributing
  5. Don’t stop contributing
  6. Seriously, don’t stop contributing

Next Step? Savings, banking, and credit cards.

Tags: , , , , , , ,

Finance Gourmet on December 10, 2014

OK, I get asked all the time about where to get the best rates for a savings account.  First off, you want a money market account, not a savings account.   Money market accounts pay better rates in exchange for restrictions that should be very easy for you to meet. (You can check here for information about kids savings accounts.)

The Online Banks

Next, if you are purely interested in rates, then online banks are the way to go.  There is a catch, but it isn’t what you think.  99% of the online banks you will find through a reputable source are backed by real banks with real assets offering better rates in exchange for not having to hire tellers to process your transactions.  The catch is that you probably still need a regular local bank of some sort to handle certain things.  The time it takes to transfer money from your local bank to your online bank is usually 3 or 4 business days, so we are not talking about instant access to your cash.  However, many online accounts come with ATM cards, so if you just need $40 for gas, no problem, but if you need $800 to cover your mortgage payment, then you’ll need to plan ahead.

If you haven’t shopped for savings rates in a while, you might be in for a little shock.  As you may have noticed, the Fed has been slashing interest rates in an effort to prop up the sluggish economy.  That means loan rates are down (good news), but so are savings rates (bad news).  Right now, you’ll be looking at 1% for the highest yielding accounts and closer to 1/2% for your more standard accounts.  As always, you can get higher rates with higher balances.

The best place to find online savings rates is at Bankrate.com.  If you aren’t familiar with Bankrate, you probably should be.  Overall, it is a pretty honest site without too much flash or smoke.  Yes, there are ads, but they tend to be non-intrusive.  Skip the articles or whatever on the front page and click to go right to what you are looking for whether it is home equity loans, car loans, or bank rates.  Don’t take these rates as the gospel, but they will give you a solid ballpark of what you are going to be looking at when you are ready to move forward.

Choose the minimum balance you are looking at and click next.  Be sure to watch the fine print for introductory rates or other tricks.  You aren’t some sucker who is going to get all dazzled by a high rate for 3 or 6 months.  You are a savvy customer who wants the goods, not the gimmicks.  Again, don’t take this chart as set in stone.  Use it as a place to start your research.

The Fine Print

Watch out for the fine print.  Most commonly you’ll find things like being required to also have a checking account, or being required to have a direct deposit.  Before you sign up make sure that all the fine print and monthly fees makes sense for you.

Remember, don’t fall for intro rates, and read all the terms and conditions.  It might sound like legal mumbo jumbo, but somewhere in there you will clearly understand if you are required to have direct deposit or make 3 ATM withdrawals per month.  Whatever account you choose, be sure it fits how you use your money.

Tags: , , ,

Finance Gourmet on December 4, 2014

OK, if you have already opened a 529 plan, and you have chosen which investments to use in your 529 plan, then the next step is to actually start getting money into your college savings account. And, it is here where the most important thing about saving money for college comes into play. The most important thing, more important than choosing the right college savings plan, more important than choosing which investments to use in your college savings plan, and more important that updating your higher education financial plan, is consistently automatically investing money in your college savings accounts.

Let me go into a little more detail, it’s that important. We get caught up in the notion that what matters when saving or investing money are things like investment returns, taxes, using the right account, or getting the right financial advice. None of those things matters nearly as much as consistently investing more. When I was a financial advisor some of the biggest 401k accounts, or 457 plans, I ever saw were from people who didn’t know a thing about them. These people opened the account when they were hired, set some sort of amount to contribute, picked an investment, or just used the default, and then never touched it again. The reason these people were so successful had nothing to do with their understanding of investments or knowing everything about 401k accounts. Every single bit of their success came from putting 5 percent (or whatever) of their paycheck into their 401k retirement plan, every single paycheck without fail.

I’ve talked before about how compound interest and investing returns take a VERY LONG time to add up to real money, so I won’t recover it here (click that link if you want the proof) but what really speeds things up is to keep investing, keep saving, without delay, and without excuses.

So, in a very real way, setting up your saving and investing schedule for your 529 plan is the most important thing about saving for college.

Automatically Save Monthly into 529 Plan

Fortunately, pretty much every 529 savings plan out there allows you to save automatically in one way or another. The Colorado 529 College Invest Plan that we have been using as an example allows you to save via payroll deduction (if your employer allows) or via ACH, which is the technically term for an automatic withdrawal from your checking account. (You could theoretically set up an ACH from a savings account, but federal regulations limit those accounts to just six withdrawals per month, so usually that isn’t recommended.)

529 plan automatic contributions

The best way to save for college in your 529 plan is to setup automatic monthly withdrawals (called an AIP, or automatic investment program, by the folks at college invest.) For most people the best time to setup automatic payments or investments is right after you get paid. Some people like to call this, “paying yourself first.” The idea is that we are creatures of emotion and impulse, and we don’t live our daily lives according to a budget spreadsheet. That means that if you wait until later to save, you may find out that you are off of budget, that you don’t have enough money to save that month for college. This is the biggest impediment to your building up a big college savings account. Every month you skip is money you not only lose by not saving, but money you don’t earn any interest or investment returns on. Don’t kid yourself that you will “make it up.” In all the years I was involved in personal finance and planning, the number of people who ever made it up was minuscule. If you don’t have extra money now, you won’t have extra money later. The people who did eventually make it up, usually did so out of an unexpected windfall of some sort.

If you get paid on the 1st or the 31st, then set up your automatic investment for the 2nd or 3rd (this allows you to avoid any issues with weekends or holidays). Make it automatic, that way you don’t have to remember. There is another reason to make it automatic. You know how I just told you that we are creatures of emotion and sometimes we don’t roboticly follow our budget? We are also creatures of effort. In order to make a non-automatic investment, you not only have to remember, but you have to actually sit down and do it. How many times do you remember things while you are in the shower, or the car, or at work, and then they don’t get done because you forget about them by the time you get home, or wherever you need to be to actually do it?

If you have an automatic investment, you not only won’t forget, but you’ll be less likely to cancel it either. Just like you have to remember and then actually do it to make a non-automatic investment, you have to remember and then actually do it to cancel an automatic one. If it takes that much extra effort to cancel and investment, you are less likely to do it. That is using human behavior to your advantage, rather than the other way around.

If you get paid weekly or bi-weekly, that can be trickier. Still, you can set up an automatic investment just the same. Figure out when you have a peak in your checking account. Maybe it’s a time of month far away from when your mortgage payment or rent is due. Ideally, if you keep some extra cash in your checking account, this issue would be moot.

Annual AIP Increase

You remember those people with the big 401k accounts when they retired who didn’t know anything about investing or retirement planning I was telling you about. One of the other advantages they had is that 401k contributions are typically done via a percentage of your salary. The brilliant thing about using a percentage for your salary deferrals into a 401k retirement plan is that your contributions automatically increase when you get more income. Very few people contributing something like 8% of their salary to a 401k savings plan go back in and lower the percentage when they get a raise in order to keep contributing the same amount. Instead, they start contributing more, before they ever have a chance to notice or get used to what the higher pay is like. Again, that’s using human nature to your benefit.

529 college investment increase

Which brings us to an interesting feature of the College Invest 529 savings plan. Although this is not unique, not all plans have this. It’s called an Automatic AIP increase. It works by automatically increasing the amount you invest in your college education fund. You pick a month, and an amount and every year, they will automatically start taking more money from your account. Again, use this feature to take advantage of human nature. Even if you don’t feel like doing an increase in a year, it will happen automatically. What are the odds you’ll actually go back in and change it when it happens? On the other hand, if you don’t use this feature, what are the odds you’ll go back in and increase in a year, instead of it being 18 month, or 3 years, or never?

Click the AIP button and choose a month. If you usually get a raise in December, then pick January. The increase should be meaningful, but doesn’t have to be huge. If you are contributing $100 per month, maybe make a $10 increase. That’s 10 percent. If you can do more, then do it. Don’t forget to manually increase it, or contribute a lump sum when you get a bonus or tax refund, all the way up to your maximum 529 plan contribution.

Remember, contributing automatically, consistently has the biggest impact on your overall success.

Tags: , , , , , , , ,

Finance Gourmet on December 1, 2014

When the Affordable Care Act, better known as Obamacare was passed several years ago, it’s provisions were slated to take effect gradually. One of the big ones finally came to pass last year with the troubled launch of the health insurance enrollment sites. The next one comes home to roost next year when you file your 2014 income taxes.

It is officially called the “individual shared responsibility provision.” What it is, is an additional amount you must pay with your income taxes. That means it comes with all the usual interest payments, and penalties for owing money on your taxes. In fact, it just folds in with your regular Form 1040 tax amount.

2014 Tax Penalty for No Health Insurance

congress tax lawasThe premise of Obamacare is based on three legs. First, you make it so everyone can get health insurance by prohibiting companies from refusing people with pre-existing conditions. Second, you make it so people can afford to have health insurance by giving lower-income people a subsidy to help pay for their newly available insurance. And third, you ensure that the health insurance coverage pool grows enough to handle these newcomers by requiring that everyone, especially healthy people, get insurance. This third piece is accomplished by imposing a tax penalty on anyone who refuses to carry health insurance.

People like hard numbers that are easy to remember. For that reason, many people have latched onto the $95 per person MINIMUM fee for not having health insurance during 2014. People like complications less, so a lot of people missed out on that part about it being the minimum fee. The actual payment is the HIGHER of that $95 or an income-based amount.

The actual 2014 Obamacare fee for not having health insurance is one-percent (1%) of your household income above the tax filing threshhold, which is basically $10,150 for a single filer, or $20,300 for a joint filer. In other words, if you are filing single, your Obamacare penalty for 2014 is 1% of your income minus the threshold amount.

For example, if you are single filer with an income of $50,000, your penalty is:

$50,000 – $10,150 = $39,850 * 1% = $398.50

To calculate the payment if you had coverage for some of the year, you divide the above amount by 12 to get a monthly amount. Then, you pay that amount for each month you did not have the required health insurance.

For example, in the same situation as above, if you were only missing insurance for five months, you would pay:

$398.50 / 12 = $33.21 (per month with no insurance) * 5 months w/out coverage = $166.04

Don’t get confused about what you are paying.

Most Americans fill out their tax forms for 2014 during early 2015. Your 2014 income taxes are due on April 15, 2015. The amount you are calculating for the taxes you are filing in 2015 is from the 2014 tax year, so what matters is how many months you did, or did not, have health insurance during 2014.

2015 Obamacare Tax Penalty for No Insurance

Looking ahead, you will again be required to have health insurance during 2015. While the above numbers are the ones you’ll be using to do your 2014 taxes during the early part of 2015, there will be different numbers used for not having health insurance during 2015, when you file those taxes at the beginning of 2016.

The payments go up for 2015 income taxes.

Starting in 2015, the Obamacare tax penalty is 2 percent of your income above the threshold level, or a minimum of $325 per adult. That’s a very big difference. The person above would pay roughly double when filing their 2015 income taxes in early 2016.

There are, of course, a lot of exemptions and other provisions, but if you don’t qualify, you’ll start paying when you file your 2014 taxes, and pay even more next year when you file your 2015 taxes. And, if you are wondering, it goes up AGAIN in 2016. Suffice to say, that eventually, the point is for it to be cheaper for you to buy health insurance than to pay the tax penalty.

Tags: , , , ,

Finance Gourmet on November 24, 2014

Both the Dow Jones Industrial Average and the S&P 500 closed at all-time highs on Friday. It seems that every week brings new record-breaking highs for the Dow and the SP500. The question is, what do all of these record highs mean. Should an average investor do anything when the stock market hits a new record?

What Is a Stock Market Record High?

Let’s start with the basics. While individual stocks on the stock market are going up and down based on their own merit, and supply and demand, the stock market is often reported as a single thing. What financial reporters and analysts mean when they say “the stock market,” is one of the indexes of the markets. There are numerous indexes, but the most widely touted are the Dow Jones Industrial Average and the Standard and Poors 500 index. When people say the stock market broke a record high, they mean that one (or both) of those indexes is higher than it has ever been. (You can’t invest directly in the indexes, which are just academic, mathematical statistics, but you can get close using index funds.)

In a way, higher records are inevitable. Even if the intrinsic value of every investment somehow stayed constant, the forces of inflation would eventually cause stock prices to increase anyway.

What Should I Do With My Investments?

While stock market records make good headlines, they are really neither that uncommon, nor a reason to change your investing strategy.

However, they do provide a way to learn the most valuable lesson in investing. Panic, isn’t necessary.

stock market record recovery

What the stock market record means is that it is “up” even if you got in at the worst possible time right at the top.

If you recall the 2007 – 2008 implosion of the financial markets, the accompanying swoon in the stock market, and the Great Recession that followed, you may remember being worried about your investments. What a new record means to you, is that no matter how much money you “lost” during that downturn in the market, if you left it invested, you would have it all back.

That’s because the new stock market record means that the current index price is not only higher than when you lost all of your money (on paper at least) but also higher than it was BEFORE you lost any of your money.

In other words, a new stock market high means only one thing. The market, as of today, has recovered any loss it ever had. (And it will do it again next time as well….)

Tags: , , , , , , , ,

Finance Gourmet on November 17, 2014

If you don’t already have a 529 plan opened, you should start with the instructions for opening a 529 plan before worrying about which investments you use. Trust me, when I tell you, as a former financial planner, that the biggest drag on saving money for college isn’t choosing the wrong investments, it’s taking too long to get started.

This is not an offer buy or sell securities. This entire article is for general informational purposes only and is not specific recommendations for you to buy, sell or invest. Only you understand your individual situation. Consult an investment or tax professional for advice specific to your needs.

529 Plan Investment Options

Every 529 plan has different investment options. Even within the same state, different plans will have different investment options. We’ll continue using the Colorado 529 plan Direct Portfolio option here as our example, but the concepts apply to any 529 plan option from any state. If you are curious about a specific stat’es 529 plan investments, leave a comment below, preferably with a link to the plan you are talking about, and I’ll take a look.

Like many 529 plans, the Colorado 529 Direct Portfolio offers different investment options including an age-based investment option.

529 college investment choice screen

Before we make a choice on this screen, notice the rules that you have to follow for choosing investments in this 529 plan. You can choose up to five total investment, and each investment must have a minimum of 5 percent allocation, and you can only use whole percentages.

Age-Based Option versus Choosing Investments in a 529 Plan

There are two main choices here. Beyond this screen there are more choices as well. The concept of age-based portfolios may be familiar if you have a 401k plan with age-based (or retirement date based) options. The idea is that with an age-based investment you can set it and forget it. As your child gets older and closer to college, the plan will automatically make your investments more conservative by increasing the amount of bonds in the portfolio.

Of course, I’m not a fan of forgetting about your money or investments, no matter how much autopilot you can use. However, if the investment part is stressing you out, just go this route. Again, you’ll lose a lot more ground by not getting started than you will by picking the wrong investments.

If you select Age-Based Options on this screen you’ll see three sub-options. You can be aggressive, moderate, or conservative. You can click the little “i” in the circle to read up on the choices. Typically, most experts will tell you that age-based investments are usually too conservative in the first place. Also, remember you are really going to need the investment growth to keep up with the rising cost of college unless you can contribute a lot of money to your child’s college savings.

In this case, the conservative option starts you at a 50/50 mix of bonds and stocks when your child is under age 5. That’s WAY too conservative to get you anywhere investing wise. Stick with Moderate or Aggressive. Frankly, the only way you really have a shot of getting enough investment gains to make it worthwhile is with Aggressive. Don’t worry, it gets more conservative the closer your child gets to college. If you just must have a safe portfolio for piece of mind, the conservative portfolio probably isn’t conservative enough. There will still be plenty of ups and downs even with that allocation. If you need safety, click the next button and select Money Market Portfolio for your funds. You won’t get any growth, but you won’t lose any money either.

If you select Blended and Individual Portfolios on this screen, it will expand to show the individual portfolios. You’ll notice you can also still use the age-based options just like a regular investment choice by allocating a percentage. In this way, you could do half age-based, and half-regular investment options just by making the percentages do what you want to do.

Choosing Your Own 529 Plan Investments

In this case, you’ll notice that the good people who run the Colorado 529 plan have decided to go all out in the cause of simplification. Your only investment choices are:

  • Aggressive Growth Portfolio
  • Stock Index Portfolio
  • Growth Portfolio
  • Moderate Growth Portfolio
  • Bond Index Portfolio
  • Conservative Growth Portfolio
  • Income Portfolio
  • Money Market Portfolio.

While these are simple names, they hide what is really going on. To find out, click the little i in the circle. In the little pop-up window, you’ll notice a section called “Investment Strategy.” This tells you what you are actually investing in. In the case of the Aggressive Growth Portfolio, the actual investment is 80% in Vanguard Total Stock Market Index Fund and 20% in Vanguard Total International Stock Fund. The Stock Index Fund invests only in the Total Stock Market Index Fund (no international). And so on…

529 aggressive growth investment

 

What Investments Should I Use for My 529 Plan?

Using the information form the descriptions, you can put together a portfolio based on your own risk tolerance and situation.

Now, as a former financial advisor, what I know, is that most people do not know what their risk tolerance is. They like risk when it leads to higher returns; they hate risk when it means they are losing money. Asking someone what their risk tolerance is, is like asking someone how important safety is to them. In the abstract, the answer is worthless.

Should you wear a helmet when riding a bike? When skiing? When driving? — Each yes represents a different risk tolerance. You would be safer in your car if you wore a helmet, and a five-point harness like race car drivers. Yet, you probably do neither. Don’t you care about your safety? Didn’t you say above that safety was very important to you? Of course you want to be safe, but it’s a real world choice you make based on what is going on at the time. Just saying you are safe, very safe, or extremely safe is all but nonsensical.

The same thing happens with investing risk. People say they are aggressive, then panic when they have a 20 percent loss. Other people say they are conservative, and then get angry when they have a 5 percent return in a year when more aggressive investors have a 15 percent return.

My official advice, is to figure out what is right for you while realizing that with time, the market always eventually recovers, and that most investment losses come from pulling out when the WORLD looks scary, not from when your risk tolerance changes.

Cheatsheet for 529 Investing

Right about now, you probably feel gypped. It said I was going to help you step by step and now I’m telling you to figure it out for yourself. You’re right. I have to. Otherwise, someone would sue, or something.

That being said, what I would tell a good friend (Not you, of course, you are a stranger. I would never make a specific recommendation to you. Of course, I can’t help it if you read along too…) is that you should be aggressive when your child is young. As long as you never withdraw your money, or change your investments in response to the market, you have plenty of time to recover.

Remember the super-duper Great Recession? Remember when Wall Street and sub-prime lending, and banking crisis, and so on and so forth led to the market taking a huge drop? Remember when the world was ending, and we would all never get our money back? Remember PANIC?!?

The time from when the drop started in about September, 2007 to when the S&P 500 made all its money back, about February, 2013 was a total of 5 1/2 years. In other words, in the biggest bust of our time if you left your money where it was, you got it all back in five years. Imagine how much shorter it could have been if Congress had actually helped. If a kid is four years old, that’s plenty of time to recover from a market drop.

The key is to leave your money. The way people lose money is by pulling out when it’s down. That locks in your losses.

 

stock market recovery

If you not only never took your money out, but you kept putting money in, you broke even a lot sooner, and were way ahead after 5 1/2 years. Why? Because you were buying low, below that line, all that time. That’s what it means to not time the market.

So, what I would tell a friend is, that they should use the Aggressive Growth Portfolio for 80% or more (even 100%) for their child’s 529 plan investment from age 0 until age 12. The rest should go in Growth. Then, they should switch to more in the Growth Portfolio (which is 75% stocks and 25% bonds) until they are 15. Then, switch to 50% Growth Portfolio and 50% Money Market. When you withdraw money, take it from the Money Market.

It would look like this when my friend signed up their 3-year old.

which 529 plan investments to use

What I really, REALLY emphasize to both you and my friend is that what will really matter over those years is consistently putting money in, every single month, or year, or whatever. In fact, the most important thing you can do for your 529 plan is to setup the automatic monthly investment direct from your checking account. Set it for the day after you get paid, or right when you pay your bills.

$100 a month for 15 years is worth a lot more than getting the investment allocation just right for some lower amount of inconsistent investments.

That gives my friend a solid chance to earn actual money on your investments over time while still dialing about the risk when it comes time to use the money.

Investing Advice

Here is the most important advice I can give you about investing for your kid’s college, or anything else. When I was a financial planner, I had two kinds of clients. The kind that signed up with me while the market was going up, and the kind that signed up with me when the market was going down. The former always thought I was doing a good job, even when the market did eventually go down in later years. The latter took much longer to ever trust me. Many left.

The reason is that when you start doing something and it goes up, it feels good. You will remember that, even when things start getting back. When you sign up for something and it starts going down, it feels bad. You will feel like you are doing it wrong, or like your new advisor is doing it wrong. Even when it comes back, you will have issues for a long time about it.

If you are lucky, your investments will increase in the first few years. By the time you start losing money, you’ll have the confidence that comes with losing your earnings, and not your principal. If that happens, great. You’ll be fine.

If you are not so lucky, you will start putting money in and it will decline in value. You’ll look at your statement and see that you put in $600, but it’s only worth $400. You’ll feel like this was a mistake. There will be an enormous temptation at this time to change your investments, or worse, stop investing, “until things get better.” This is the wrong move. Keep saving. Stick to your plan. Remember your time frame. Eventually, your returns will be higher, and you’ll be miles ahead for having kept saving than for pausing or quitting.

Either way, remember your time frame. That little one will keep getting bigger. When they start driving, re-evaluate. Start applying for loans and grants and scholarships. Help them out with that as well. Who knows, maybe you’ll be one of those very rare people who has to figure out what to do with left-over money in a 529 plan.

Next, unless you are contriubting a sizable lump sum, you’ll need to setup automatic 529 plan contributions if you want to be really successful.

 

 

Tags: , , , , , , ,

Finance Gourmet on October 30, 2014

When it comes to saving money for college, there are a lot of options. A parents saving money for children’s college fund there are different ways to title those accounts, jointly or otherwise. Believe it or not, saving up money so your kid can go to college is a lot more about actually doing it, than how you do it. Most parents let a sizable amount of time pass in between college investments and that is a much bigger deal than exactly which kind of college savings account is right for you.

types college savings education planningWays to Save Money for College

Assuming you don’t want to stick money into a mattress, you are going to need some kind of bank account or other financial account to store up that money you need to save and invest. Here are the options.

529 College Savings Plans

If the 529 plan came first, there wouldn’t be so many other ways to save for college. It is, quite simply, the best possible way to invest for college for most people. A 529 college account works a lot like a Roth IRA plan for college. You don’t get a federal income tax deduction for your contributions, but the money you put inside grows tax deferred, meaning you don’t have to pay any capital gains taxes or taxes on interest earned. As long as you use the money for expenses at college or university, you don’t have to pay any taxes on the withdrawals as well. This is much better than coping with the difficulty of owing a few thousand dollars in taxes from selling investments to pay for school. Many states do give you a state income tax deduction for contributing and investing in a 529 plan. The limits for 529 plan contributions are also very high.

Coverdell IRA

The Coverdell IRA was a try at a tax-advantaged college savings account before the 529 plan was invented. It works in much the same way as the 529 plan. However, there are some major differences. The first is that contributions to a Coverdell IRA are limited to only $2,000 per year. Furthermore, it is only available to families with a modified adjusted growth income of $110,000 for filing individually and $220,000 for filing jointly. Transferring the money between different children is also much more difficult. However, the one advantage of a Coverdell IRA is that money from the account can be used for high school (and even elementary and middle school) education as well. In other words, this is a good way to save up for a prep school or private high school. Otherwise, the vast majority of families will be better off using a 529 plan.

Trusts UTMA UGMA and so On

Before there were 529 plans, people used trust accounts, typically a UTMA or UGMA account as a way to save for college with at least some tax advantages. Unless you are wealthy, there is no reason to go this route. Even then, a 529 plan often works better.

Regular Savings Accounts or Regular Brokerage Accounts

If you don’t want to open a specific college investing account, you can, of course, just open a regular savings account or regular brokerage account at the financial institution of your choice. There are two major drawbacks to this arrangement, and one advantage. First, someone has to pay the taxes on all interest and capital gains during the years you are saving money. This likely won’t be much at first, but if you end up building a nice chunk of money chances are that it either generates a fair amount of interest and dividends, or capital gains. Assuming you never sell any of your investments, you might get away with it for a few years. However, if you invested $10,000 and watched it grow to $30,000 over the years, you’ll owe at least 15 percent capital gains taxes on that $20,000 of growth as you withdraw the money.

You can help with the tax issues by putting the account in your child’s name, which brings us to the other big disadvantage of these accounts. While a 529 plans funds stay in control of the owner (you), that is not the case for a regular account unless it is held exclusively in your name (which means you are responsible for the taxes.) The nightmare scenario here is that your child joins a cult, turns 18 and wants to turn all the money over to them. The more likely scenario is that they buy a car, take a trip, or do something other than what was intended for the money.

Furthermore, unless you end up paying for the whole higher education experience, your child might be able to qualify for some student aid. Much student aid is calculated based on “need.” That need is calculated based upon a small percentage of the parent’s assets being used for college and a large percentage of the student’s assets being used. A big account in the name of the student will lessen the award of need based aid.

The one advantage of this kind of account is that there are no restrictions on what the money can be used for. The bad examples of that are above, but the good examples are that this type of account could be used for down payment on a house, a wedding, or to start a business.

Best Way to Save for College

Unless you have specific, well researched, reasons for using another type of account, open a 529 plan to save money for your child’s college education. Chances are very good that any disadvantages will be outweighed by the long-term advantages. But, remember, the amount you save matters more than where you save.

Tags: , , , , , , ,

Finance Gourmet on October 22, 2014

Saving money for college has always been an important financial goal for many parents. It is only becoming more important as college tuition continues to skyrocket, and stories of people buried under huge student loan burdens become more common. Before we jump into the nuances of the many different ways to save for college, let’s start with the basics.

How Much To Save For College

paying for college graduatesI’ve talked before about how hard it is to make a financial plan for retirement because of how many variables there are. You don’t know when you will start retirement, you don’t know how long you will live once you do retire, and you don’t really know how much money you will spend each year during retirement. Add it all up, and any retirement plan is a lot of guesswork.Fortunately, making a financial plan for education comes with a little more certainty to work with. For starters, you have a pretty good idea of when your children will start college. Take the grade they are in now, and count until you get to their senior year. The next year, is the first year of college. Granted, there are always exceptions, and your child may take a year off, but unless they start skipping grades, you know when you’ll need the money.

Next, you have an idea of how long they will be in college. This number is a little more vague. Many students take five years instead of the traditional four. There is also the issue of potential graduate school or professional school. However, as we’ll look at in a minute, getting that four or five years locked down is going to be tricky enough, so let’s start there. After all, if you “over save” you can always use that for more schooling.

Finally, we need to know how much college will cost each year. This is where we have the least certainty in part because different colleges cost different amounts of money, and the cost of university tuition increases every year. As a rough estimate, you can take the current tuition at the college you want to target and then increase it at a rate of 7 percent per year to get a pretty good projection of how much each year will cost.

Calculating the Amount To Save For College

Now that we know the variables, we can calculate how much you need to save to pay for your child’s education.

OK, ready for the math?

For most people, don’t even bother.

Seriously.

Unless you have a lot of disposable income, you are not going to save enough money to pay for a full ride to a four year public university. Instead, you should just focus on saving as much as you can.

Shocked?

Yeah, I used to do very meticulous calculations and reports when I was a financial planner, but the reality is that it takes a LOT of money to pay for a full ride to college. If you have more than one kid, it takes even more. Nine times out of ten, not even couples making $250,000 a year would fully fund the educational part of the financial plan.

Let’s do a couple of examples to demonstrate:

Let’s say your kid is 5 years old, and starts college in 13 years. Now let’s say he is going to a school that costs $25,000 per year today. Let’s say tuition increases at 7 percent per year. Let’s say you do pretty well and earn 8% return on your investments. You’ll need to save $771 per month to pay for four years.

Somewhere like Harvard, of course, takes much more.

If you have two kids you have to save $1450 per month.

Now, let’s look at if you are getting started right away. Same situation as above, but instead, your child was just born. (Congratulations!)

  • Now, you’ll have to save $561 per month starting right now.

But, wait, what if you have been meaning to save for college, but you haven’t really gotten around to it yet?

  • If your kid is 10 years old, you’ll need to save $929 per month.
  • If they’re 15 years old, you’ll need to save $1,569 per month.

If you really want to do some math, here is a calculator you can use. There are dozens (probably hundreds) of them out there on the internet, and they’ll all tell you the same thing, start saving several hundreds of dollars a month, right now. But, the reality is that if you have that kind of disposable income, you probably already have really nice nest egg building up somewhere. Just use a hunk of that money to contribute up the the 529 plan maximum.

Saving for College Mentality

Whether your can save the full amount per month or not, don’t worry about that. The fact is that there are many options for financing college. In addition to whatever money you save, you’ll likely be earning paycheck when the kiddos hit college age as well. Some savings plus some discretionary income will get you closer. Remember the problem with student loans isn’t that people have ANY, it’s that they have too much. So, if you save enough to cover half, or even just one or two years, you are doing a lot to help.

Also, keep in mind this isn’t your last chance to help out. Helping with the down payment on their first home might be just as helpful.

Either way, the key is to get started right away saving as much as you can. If you want to skip ahead to the end, go open up a 529 plan and setup automatic monthly investments. Otherwise, the definitive guide to saving for college continues with the next post.

Avoid the temptation to cannibalize your retirement savings plan to save for school. Unlike college, there are no retirement loans and no retirement grants or scholarships. And, unlike college, when you stop earning income, there really is no way to “make it up” later.

Tags: , , , , , ,

Finance Gourmet on October 19, 2014

For some reason, I thought I had written about 529 plans to death. After all, figuring out a way to pay for a child’s college education is a top priority for many people, and something I worked on a lot when I was a financial planner. More than that, I’m also a dad with a couple of rug rats that I’ll want to send off to get a great education, and then on to a wonderful life in the real world unencumbered by the all too common, crushing student loan debt. So, naturally, I think a lot about how education planning and college savings fit into a person’s personal financial plan. And, usually when something money related stays on my mind, I write about it a lot.

529 plans college savings education planningThen, a family member shot me a message asking a question about paying for college for her growing sons. I figured I’d send her a dozen links to all my best college saving advice and 529 plan information. Only, it turns out, I haven’t covered near as much over the years as I thought I had.

So, starting Wednesday, I’ll be cranking out the Complete Definitive Guide to 529 Plans and College Savings in a series of blog posts here on the site. Eventually, I bundle them all into an eBook that you can buy to have a reference all in one place, but for now follow along here to get it all free, as it comes out.

I’ll cover not only what a 529 plan is, and how a 529 savings plan works, but also things like how much money you need to save each month to pay for college, and how to find money to save for college. I’ll also dip into how financial aid works, and how repaying student loans works including the various student loan forgiveness options that you might qualify for.

First up, the basics of 529 plans.

Then, check out how to open a 529 college savings plan.

You’ll need to see about the 529 contribution limits for 2014.

Up next, the ways to save money for college.

Tags: , , , , , ,