Month: January 2016

How to Invest for College

by smallivy, posted in Investing

Ask SmallIvy

When looking for advice on investing for college, many sources will talk about accounts that shelter income from taxes such as 529 plans and Coverdell Educational Savings accounts. Certainly saving money on taxes is a good thing and something families should take advantage of, but how you save and how you invest is just as important as sheltering your income.

How to save:  How you save for college is the same as how you save for retirement – early and regularly.  If you can attain a return of 10% per year, you’ll double your money about every seven years.  This means you double money you invest when a child is zero almost three times before they get to college, while you’ll only double it once if you wait until he/she is in middle school.  If you put away $10,000 when a child is born for college, that would be somewhere around $60,000 – enough to pay for at least a couple of years.  Wait until he/she is 10 years-old to invest the same $10,000, and you’ll be lucky to have around $20,000 before he/she heads off to school.

Regular investment is important too.  You may not have $10,000 to drop into a 529 plan when your son is born, but if you put away a few hundred dollars per month regularly into a college savings plan and make it part of your regular monthly budget, savings can build up faster than you might think.  Regular investing also means that you’ll be buying in during times when the price of your investments slump, meaning that you’ll get a better price than you might get if you just dump a bunch of money in all at once.

Don’t let tax limits limit your investment:  If you hit the yearly maximums for tax-sheltered accounts and still have money to save, consider opening up taxable accounts for college saving as well.  The amount you save should be driven both by how much you can save and the expected cost of college.  Index mutual funds have very low fees and most generate very little in terms of dividends and capital gains during any given year, so as long as you just put money into them and avoid selling shares and moving the money around, you may pay very little in taxes until you start to withdraw the money for college.  And even then, taxes may not be so bad since capital gains taxes are often lower than taxes on regular income.

How you invest – be aggressive early:  The greatest risk when saving for college is not having enough.  When your child is very young – under ten years-old – you have more than a decade to invest.  Both of these factors point towards being aggressive with your investments while the child is young.  Because the stock market has had better returns than bonds and other assets over virtually every 10-year period, and because stock market returns approach about 12% annualized when held for periods of ten years or more, most of your money should be in growth stocks when your child is less than eight years old.

How you invest – take gains and preserve returns late:  As you get closer to your child needing the money, such as when she enters high school, it is time to pare back on growth stocks and start to move into more fixed income assets.  This include high yield stocks like utilities and bank stocks, both corporate and government bonds, and REITs.  One strategy would be to start at 40% income and 60% growth when your daughter enters high school, then shift 20% into income each year so that they are in 100% income and 0% growth (or even sell some shares so that they are 20% cash and 80% income) their senior year, but this ignores the behavior of the market during those times.  If you suffer through a bear market when your daughter enters high school, it makes little sense to shift into bonds and lock in your losses, especially if that would leave you without enough money to pay for college given the 4-8% returns of fixed income assets.

Instead, use the ebbs and flows of the market to time your shifts.  If the market has a banner year when your son completes 7th grade, shift some of the money to fixed income early.  If the market is routed during their eighth grade year, maybe wait another year for the market to recover a bit before you make the shift.  Just keep in mind that stock market returns become less and less predictable as your time period shortens, so always weigh the consequences of suffering loss in your savings to the consequences of not gaining a greater return.  If you feel like you have about enough, cut back on your growth stock holdings and move into income and even cash as you near graduation.  If you feel like you have a long way to go and losing 20% wouldn’t make much of a difference on your ability to pay for college, stay more invested in growth and wait for a better exit point.  Also, look for ways to increase your income temporarily or cut back on expenses to allow you to save more.

The closer you are to even, the less risk you can take:  If you have two or three times what you need to pay for college, including both your investments and you ability to pay tuition from your regular income, you can be more aggressive.  Even if your stock portfolio suffers a 40% loss, you would still have enough money to pay for things.  Likewise, if you only have 10% of what you need to pay for college, you might decide to be more aggressive, knowing that you will probably need to rely on student loans anyway so making gains on your investments would change things more than the suffering of a loss.  If you have just enough, however, or almost enough, then preservation of your money becomes the key.  Given that it is only four years, leaving little time for inflation to affect your spending power, a staggered set of bank CDs might be the best move if you were in this situation.  Even buying into fixed income might result in a loss since you can’t necessarily wait for the bonds to mature so you might need to sell bonds at a loss, leaving you uncovered.

Consider scaling college to your ability to pay:  Many people think that their life will be totally different if they get into their dream school than if they go somewhere else.  Spend a little time in any college, or look back after graduation, however, and you’ll often find that it is the effort you put in and the things you learn while in school that really makes the difference and not the ranking of your school or the snob appeal of the name.  If you have a half million dollars saved up and your son wants to go to Harvard, you could afford the indulgence.  If you would need to fund everything on student loans, however, maybe going to a state school would be a good option.  Even better – consider having him go to a community college for the first two years and then transfer to a university and save on both tuition and a couple of years’ worth of room and board by living at home.  This option would also give your college accounts a couple of more years to grow.

Some investment options:  When you’re looking for growth, the best places to be would be in a growth mutual fund, or maybe a small or mid-cap index fund.  Reducing fees and expenses is always the key with mutual funds, so take a look at the expenses when choosing between funds.  As you start to look for more security and income, shift into bond funds, REITs or REIT funds, utility funds, and perhaps growth and income mutual funds.  You can also shift from small and mid-cap index finds and into large cap funds such as an S&P500 fund, which will have larger and more  stable companies than a small-cap or mid-cap fund.

Got something to add?  Got and investing question? Please  leave in a comment or send it to vtsioriginal@yahoo.com.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

So How Does Free College Work?

by smallivy, posted in Careers, Commentary

Sparkplug bear1One proposal by Presidential Candidate Bernie Sanders is to make college “free for all.”  (He also thinks healthcare and daycare should also be free for all.)  This has made him very popular among college students and young adults who are facing their student loans.  After all, what’s better than “free?”

Still, how exactly would that work, free college?  Somebody would need to maintain the buildings and the grounds of the college.  Someone would need to mine the fuels and then run the plants to generate the electricity for the college, mine and distribute the heating gas, and maintain all of the internet equipment and miles of cables and wireless towers that provide the internet bandwidth for the college.  Beyond that, someone would need to produce the food the professors and staff ate, make their clothes, build their houses, build their cars, extract and refine the gasoline they use, and provide the hotel rooms and food they enjoyed while on vacation.  This means that someone somewhere would need to be creating the goods that would be traded to pay for all of these things.  If the students and their parents weren’t working and paying for college, someone would need to do so.  Where would this come from?

Take it from the wealthy.  We could just levy a high tax on people who make a lot of money and have them pay for these things, right?  How about a 70% income tax on those making more than a million dollars per year?  Well, first of all, even if you confiscated all of the money earned over $1 M, you wouldn’t get enough to pay for everyone’s college, certainly not at the level of quality seen today.  This means that you would need to tax people at lower and lower income levels.  This means people making $100,000, or even $50,000 per year would need to pay.

Also, people who make a lot of money are very mobile.  Many travel all over the world and may own homes in several different countries.  If you raise taxes on them enough, they may just decide to leave.  They may also decide to stay but put in less time at the office, or start fewer new projects.  They may decide that making $500,000 per year is just fine, because they only get 30 cents on the dollar if they make more anyway.  Why not catch up on some hobbies instead?  As the wealthiest leave or just make less, the burden on lower-income people would grow and grow.  Also, when the wealthy start fewer projects, it means fewer jobs.

Who would pay for all of this?  Middle class Americans, and for the rest of their lives.  Currently parents save and pay for part of their children’s college, then the children put a portion of their income towards paying off their student loans after college.  Everyone pays for their own college and for part of that of their children.    Students have the ability to pay less by doing things like going to a state school, working hard and getting scholarships, or taking classes at a community college before moving up to a more expensive university.

If we had “free college,” those who were working would be paying for all of the people who were in college at a given time.  They would not be able to save money through their choices because the people getting the “free” college education would decide how much things would cost by how and where they decided to go to college.  It all cost the same to them, so why not go where they wanted and take eight years to finish?  (Why not put off getting a job when college is “free,” including, one would assume, room and board?)  If there were a lot of people born after you started working, you’d pay a lot more for college over your lifetime than you would have if you had just paid for yourself.  Realize also that if this passed in the next few years, people in college now would pay for their college but then be paying taxes for all of the people after them getting “free college” since those in college now would not benefit.

You would see quality decline and restrictions placed in an effort to cut costs.  At first you might be able to go where you want and take as long as you wanted.  But as costs increased because so many people were spending longer in college and going to more expensive places, you would see things cut and restrictions placed.  You might be forced to go to a community college first, even if you wanted to go straight to a university.  You might see restrictions on the majors you could take since those graduating with French History degrees might contribute a lot less after they graduate than those with engineering degrees, and someone would need to be producing enough to pay for all of this free stuff.

You would no doubt see a rationing system and large amounts of bureaucracy form as rules were passed to prevent fraud and abuse.  In this kind of environment, corruption would appear as people paid off officials and used influence to get ahead in line and get around the system.  Ironically, the very people Bernie Sanders rails against would be the ones getting access to a quality educations because they would have the influence to get the best slots while those in the middle class would be shut out.

You could choose better options, but only if you could afford to pay twice.  Almost everyone would agree that private prep schools provide a better education than the average public school.  In inner city neighborhoods, schools may even be dangerous and have rates of proficiency in reading and math in the single digits.  Yet still many students attend public schools instead of private.  Why would they do this if there was a better choice?  The reason is that everyone has already paid for the public schools through their tax dollars.  While the private school may not cost any more than the public one (many times the cost per student is less), in order to send your children to the private school you need to find the money to pay again for something you’ve already paid for through taxes.  Many families can’t afford to do this, so they are forced to take whatever the public school option is.

With “free college,” it would be the same way.  You and your family would be paying for the public college regardless.  You might be able to go to a nicer private college, but only if your family was wealthy enough to pay again.  Because your taxes would be higher than they are today, because you were paying for all of this “free college,” most people in the middle class would be forced into public colleges.

Those paying would see an increase in the cost of college.  Because taxes would be high if you were working, many people would delay working, or not worry about getting a job that made much money after they finished college since most of it would be taken in taxes anyway.  Someone might decide to play guitar on the streets for (tax-free) donations while also getting money from welfare programs rather than work in a job where they were producing a lot and therefore being paid a lot and paying a lot in taxes.  Because fewer people would be paying, the cost to those who were paying would go up quickly.

Think about going out to eat with a group of friends at a casual dining restaurant.  If everyone paid their own way, the average check might be $12 and everyone would be able to pay it easily.  If a few people stopped paying and everyone else needed to cover them, the cost might go up to $20 each.  This increase in price might make it more difficult for for some people to pay, so they would stop paying or need to be subsidized by others, increasing the burden still further on those still paying the full bill.  As the price of paying the dinner increased because fewer and fewer people were paying, more and more people would stop paying, either because they couldn’t pay or because they decided it was better to make less and let others pay, so the price of dinner would keep increasing for those still paying the full bill.  Prices of things are much lower if everyone shares the burden.

The same thing would happen with “free college,” where people would find ways to not work and pay their share, or perhaps stay in college their whole lives and never pay.  This would make the cost of college for those paying increase to the point where the taxes paid for college would be much higher than it would be if people just paid their own way.  They would be paying for themselves and several others.  Note that this is the reason the list prices for medical services are so high.  If is also why the full prices for college is so high – most people aren’t paying the full cost, so those who do need to pay the costs of several other people.

So before you jump on the bandwagon and vote for “free college,” think about the results.  Someone needs to pay for everything.  If everyone does their part and pays for themselves, costs will be far lower, there will be more choice, and quality will be better.  Let the government pay for it and you’ll see higher costs, less choice, lower quality, and lots of corruption.  There is always a cost for “free.”

Got and investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Start Investing in Stocks with $10,000

by smallivy, posted in How to Invest, Investing, Stock Picking

Spider

There are really two different ways to invest in stocks, also known as equities:  1) invest via mutual funds (or ETFs), and 2) invest in individual stocks directly.  There are plenty of financial advisers who will tell you that investing through mutual funds is the only way to go, and given the way that a lot of people invest in individual stocks, they are right.  Because many people go in and out of stocks, churning their account, creating a lot of taxes and fees, and often missing out on a lot of big moves because they sell a stock too early, most people would be better off investing only through mutual funds.

Still, if done right, individual stock investing can make sense and be very profitable, especially for money that you have to invest after putting away money in your 401k and kids college plans that is invested primarily or entirely in mutual funds.  People can (and do) beat the market averages by investing in individual stocks over long periods of time.  This isn’t done by timing the market or jumping from stock to stock in an effort to be in the next hot stock at just the right time.  It is done by investing in a very uncommon way that actually takes far less time and effort than the market speculating most people do.  Here’s how to start investing in individual stocks with $10,000:

Find businesses, not stocks.  The first thing to do is to get the mindset of a business investor, not a stock trader.  A stock trader is concerned about the movements  in the price of individual stocks and tries to time purchases to make profits.  People who say things like “buy low and sell high” are stock traders.  Instead, make investments in businesses that you think will do well over the next several years.  Think the same way you would if a friend presented you with the opportunity to invest in his business.  You would check things out from the standpoint of being locked into the investment for the next several years, knowing that it would be difficult to sell.  Once you invested, you would also see the money as “gone” unless the business succeeds and does well.  You wouldn’t expect to see any of your money back if the business failed.  If the business did succeed, you would expect to receive profits from the business for many years rather than selling your stake to someone else immediately.  You want to find businesses that will grow and become more profitable over the next ten or twenty years, eventually paying out a share of the profits to you each year in the form of dividends.

Things to look for when choosing a stock are the earnings growth rate (something in the teens is good), a history of steady increases in share price, a good management team who has shown that they know how to manage the business well, a high return on equity figure (at least 10%), little or no debt, and the ability to continue to grow the business.  Earnings growth is what causes the share price to increase over long periods of time and is what eventually leads to dividends and then dividend growth.

Concentrate your investments enough, but not too much.  If you are going to buy 50 or 100 shares of twenty different companies, you might as well just put your money into a mutual fund.  The advantage individual stock investors have over the pros is that they can concentrate their money so that when the stock does well they’ll make huge, life-changing profits.  Hold 100 shares of a company at $20 and its stock price goes to $80 and you’ll make $8000.  This is nice, but not life changing.  Hold 1000 shares and you’ll make $80,000 – enough to maybe pay off your home or put a child through a couple of years of college.

Still, you don’t want to have so much of your money in a single stock that it would be financially devastating should you be wrong.  Individual companies do go bankrupt, and when they do, even though the company may emerge out of bankruptcy a few months later, the stock investors are usually wiped out.  Don’t put more into a single investment than you can stand to lose, and cut back on positions that get too large and start to dominate your portfolio.    You can (and should) eventually start to put some of your profits into mutual funds to gain diversification and preserve the gains you have made.  If you do well, the dollar amount you have invested in individual stocks will remain about the same but it will become a smaller and smaller portion of your portfolio as you shift money into mutual funds.

Gather a watch list.  You’ll want to find 3-5 stocks that will become your watch list.  These are the stocks that will become your initial holdings and will be your only holdings until your portfolio has grow substantially.  When you have money to invest, you’ll buy whichever of these stocks is at the best price at the time and which best balances your portfolio based on the amounts you hold of each stock.

These should be stocks that you expect to do well over the next several years and your watch list will change little from year-to-year.  This is why it doesn’t take a lot of time to invest once you have developed your watch list.  You only move companies from the watch list if the business fundamentally changes and you only add companies to the list once your portfolio has grow to the point that you need additional diversification.  Having a small number of companies allows you to get to know the businesses very well.

Wade in slowly.  You’ll want to buy in stages, rather than investing all at once.  Don’t expect to buy at the bottom.  Sometimes you’ll buy in, only to see the stock decline in value.  Don’t despair – that just means that you’ll be able to buy more shares at a bargain price.  Remember that it is the business you’re buying, not the stock, so share price movements shouldn’t matter much to you for a while.

With $10,000, I would take $6,000 and invest about $2,000 each in three of the companies on my watch list.  I would then wait a couple of weeks to a month and hope that one or more of them would decrease in price.  As they did, I would take the $4,000 remaining and buy more shares until I was fully invested.

Keep adding to your positions.  From that point, I would keep saving up money from my salary and investing whenever I had $2,000-$3,000 to invest, buying whatever was the best bargain from the companies on my watch list or adding to smaller positions to keep things in balance.  I would wait until I had a reasonable amount to invest to avoid paying too high a percentage in brokerage fees.

It is regular investing that helps you succeed.  By buying over a long period of time, you get a better price for the stock since you’ll be buying more on dips.  This also helps psychologically since you’ll see decreases in share price as buying opportunities rather than losses on your portfolio.  I’ve had stocks that were paper losses in my portfolio for a year or more who later turned around and become some of my biggest successes.  Remember that you are buying the business, not the stock.  Share price won’t matter for many years down the road.

Monitor the company, not the stock price.  Of course you’ll glance at your brokerage statement from time-to-time and see which positions have grown and which have fallen, but that shouldn’t be your primary focus.  In fact, if you wanted to just ignore the share price most of the time, that would be just fine.  When the stock drops in price, there is nothing you can do – the damage has already been done.  When it shoots up,  watching the price closely may allow you to convince yourself to do something foolish like selling out and wait for a decline to buy back in, perhaps only to see the stock continue to climb.

Instead, you should focus on the fundamentals.  Read through the annual report when it comes out and get an idea of how the company is doing and what their plans for growth and expansion are.  If they see earnings decrease, see if there is something systemic or just a result of market forces beyond their control.  It is only if something has fundamentally changed in their business or their opportunities that you would sell out of a company.

You should also monitor for things like decreases in earning growth rate, changes in return on equity, and taking on a lot of debt.  Changes wouldn’t necessarily result in your selling, but they may point to fundamental changes in the business or market that would mean it was time to sell.  Sometimes you’ll also just choose a company that just doesn’t work out, and by monitoring fundamentals you’ll decide that you made a mistake.  Sometimes the share price will have already fallen, other times it will not.

Trim back if a position does too well.  You certainly want to leave your holdings with room to grow.  You don’t want to sell out each time that a stock goes up a little or you’ll end up with a lot of losing positions and miss out on a lot of growth.  Companies that do well tend to keep doing well since it normally means that management has hit upon a good business strategy and you have effective managers and employees working for you.  Sometimes you’ll also get a Microsoft or a Home Depot that will make you a millionaire if you bought in early and held your stake.

Still, you don’t want a position to become so large that it will become financially devastating for you should something happen, because it can.  You should always ask yourself if you could withstand the loss of the entire position.  If the answer is no, sell some shares and invest the proceeds elsewhere, holding some of the profits back to pay for taxes on the gain.  Also, if you’ll be needing the money for something in the next few years and you have a stock that has done really well, it is generally a good idea to cash out and put the money in bank CDs or elsewhere so that it will be there ready when you need it regardless of what happens to the stock.

Got and investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.