An Easy Way to Make College Affordable


Paying for college is a concern of many parents, and well it should be.  College debt is a concern of many graduates, and well it should be.  An issue is that the children of parents who decide to do something about paying for college by saving up money and doing without some things so that they will have at least some of the money needed for room and tuition end up with about the same amount of debt as those whose parents save nothing.  This is because colleges just raise the tuition for those children whose parents have saved.  OK, they actually reduce the tuition for those whose parents have not saved, but it is really the same thing.  Go into college with $50,000 in a college savings account and the college will figure that you can pay $50,000 more than someone without a savings account.
Now if the child with the $50,000 account came from parents who made $250,000 per year while the child without anything came from a family making $30,000 per year, the difference in tuition is understandable.  But often both families may make $80,000 per year.  One family just choose to maybe drive older cars or vacation locally so that they could put a few thousand dollars away each year into an Educational IRA, while the other family was trading in cars every few years and vacationing at Club Med, living for today and figuring that they would worry about college later.

              

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The issue with this system is that it encourages exactly the kind of behavior you don’t want.  It encourages spending and penalizes savings.  This means that more people show up at the financial aid office with no savings.  People are not foolish — they will find ways to go to college for less or for free if they can.  Why save up if there is no advantage?  As a result, not only do only children from poor backgrounds show up with nothing to contribute.  Many children of middle-class families who could have paid a significant portion of their own tuition and room-and-board show up as well without any savings.

Because colleges need to provide a lot of grants (as does the Federal Government) to prevent their colleges from being full of only the children of the wealthy who can float the tuition with their yearly income, they raise the base tuition so that those who can pay, pay more.  This provides more money for grants and scholarships, so long as people don’t decide it isn’t worth the cost and as long as all colleges do the same thing.  Because the cost is higher, however, it means fewer people are able to pay full tuition from income, which means more student debt and less people saving up since when the amount they can saved is dwarfed by the cost, they figure, “Why bother?”

So what is the easy solution to fix his issue?  Simple – stop using college savings when determining eligibility for tuition reductions and other grants.  Instead, base tuition rates purely on income.  Children who come from families with little income would still find a lower tuition bill that they can afford, but those from a family with a higher income will need to put away more money, use more of that income to cover tuition, and/or take out student loans.  Because tuition would be lower for everyone (since the colleges would be giving out less tuition aid because more people would be paying most or all of their bill), the cost would actually be lower for everyone.

Several colleges could also band together and establish a birth-to-college saving plan where parents could contribute an amount each year based on their income as their children grow with the guarantee that tuition and a certain portion of room-and-board would be covered for any of the colleges in the network.  This would eliminate the uncertainty we currently see when it comes to college tuition and also means that everyone will be paying what they can.  Parents whose children decide not to attend college could have their money returned with a reasonable interest rate applied.

So what do you think?  Would it work?  Do you have a better idea?  Let’s hear it!

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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 Every 16 Year-Old with a Job Can Retire a Millionaire


I’ve been encouraging a couple of twins who I’ve known since they were five to start an IRA since they are now 17 and working a job at a grocery store.  An IRA, or individual retirement account, is a little gift from the government that allows individuals to save money either tax-deferred or tax-free.  They come in two flavors: Traditional and Roth.    A traditional IRA is tax-deferred, meaning you pay no taxes on the money you invest or any of the money you make in the account until you withdraw it at retirement age.  With a Roth IRA, you pay taxes on the money you invest, but then pay no taxes on the money you withdraw or the interest it earns.

So how would these little wonders turn a 16 year-old into a millionaire at retirement?  Well, if one of the twins were to open an IRA and put $4,000 in it, and then invest entirely in a diversified stock mutual fund like the Vanguard Total Stock Market Fund, it would double in value about every six years. Because it would double eight times between the time they were 16 and 65, every dollar they put into it would be worth $256 when they reached 65.  This means that $4,000 would be worth about  $1 M at retirement age, even if he invested nothing else after putting the original $4,000 away.

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If he invested in a traditional IRA, he would also save on the taxes on the year he put the money into the IRA.  If he were in the 10% tax bracket, he would get to keep $400 more of his money right now, so it is like he gets extra money for making the investment.  Went he withdrew the money from the IRA at age 65, however, he would be taxed on the money he was withdrawing.  If he were in the 25% tax bracket during retirement, this would mean that he would actually only get $750,000 after taxes.

If he invested in a Roth IRA, he would not get a tax break now, so he would pay $400 more in taxes now.  But when he withdrew money at age 65, he would get to keep all of the money he earned, tax-free.  This means he would get to keep the whole $1 M.  The only catch is that he would need to find the extra $400 to invest.  (In fact, if he invested that extra $400 he got to keep from taxes when he invested in the traditional IRA, putting in $4,400 instead of $4,000, he would end up with the same amount of money after taxes as he would have had with a Roth IRA if his tax rate at retirement were the same as it was when he was working.)

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For the twins, I’m advising they go to Charles Schwab since they offer an IRA account with a $1 minimum investment.  This means they could put whatever they can this year, even if it is only $100, an then add to it as they can.  If they could get used to putting in $20 per paycheck, that would get them to a little over $1,000 per year.  They could also go to Vanguard, but they require a $1,000 minimum to start.  Both are great companies with a wide selection of funds to choose from for investments.

Filling out the paperwork and opening the account only takes 15 minutes or so online.  Because they are minors, the twins would need to have a parent be a custodian on the account until they turn 18.  After opening the account, they would just need to send in a check or send money from a bank account electronically, then choose investments.  At Schwab, I would start with the Schwab Total Stock Market Index Fund (SWTSX).  At Vanguard, I would buy the Vanguard Total Stock Market Index Fund if I had the minimum $3000 to invest, otherwise I would choose the 2065 Target Date Retirement Fund which only has a $1000 minimum.

 

So what else do you need to know about IRAs?  Well, there are some important rules:

  1.  You must have earned income equal to or exceeding the money you put into the IRA during the year you put the money in.  This means you need to make at least $4,000 from a job or from running a business in 2018 if you want to put $4,000 in an IRA this year.
  2. Right now you can put in up to $5,500 per year.  If you were to put $5,500 away each year between age 16 and age 35, you would be absolutely set for retirement, no matter what else you did financially.  (Lone exception, you must not touch the money in the IRA and it must stay invested in a diversified stock portfolio your whole working life.
  3. If you take the money out early (before retirement age), you’ll pay a penalty plus you’ll need to pay taxes on the money.  (Actually, there are a couple of exceptions with the Roth IRA, but why would you want to raid your retirement funds? Just stay invested.)
  4. With a traditional IRA, you’ll be forced to start taking the money out when you’re about 70 1/2 years old, so you may need to pay some hefty taxes then, especially if you invested a lot more than the original $4,000 and have several million dollars in the account.  With a Roth IRA, there is no need requirement to take the money out ever, so you could let it grow for another 30 years and leave it all to your heirs, if you wished.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

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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.

Would you Rather Have a Million Dollars, or a New Car Every Three Years?


Would you drive a used car until you were 55 if someone would pay you a million dollars to do so?  Understand this doesn’t mean driving a junker – just driving a four-year-old car until it was eight years old and then trading for another four-year-old car.  If you would take this deal – and I think that most people would – why would you go on buying new cars anyway?

The fact is, if you can save up and buy used cars for cash every four years, rather than taking on a new payment schedule and dropping deeper underwater with each new car loan, you can invest the savings and have over $1 million by the time you are 55 just from the savings on the car loans.  Even more insane, that $1 million will turn into $2 million by the time you are 62, $4 million by the time you are 69, and a cool $8 million by the time you are 76 (which will probably be the new retirement age, given current life expectancies).

How could this be so?  Two reasons: depreciation and interest.

Basically, any car will drop in value by 50% in four years.  This means that a new car which cost $30,000 will be worth about $15,000 in four years.  This means that the car will lose an average of $3750 per year during each of the first four years.  This, by the way, is if you sell it to another individual.  If you trade it in, you’ll be lucky if the dealer will give you $10,000 (because he wants to make a profit from the sale of your used car to someone else).

 

              

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The same depreciation rate is true when you buy a used car – it will still lose about 50% of its value over four years –  but because the price of the car is less, the depreciation loss per year will be less.  Let’s say you pick up that car someone else bought new for $30,000 after four years when it was worth $15,000.  Even if it drops in value to $7500 over the next four years, you’ll still only be losing $1,875 per year.  This means that you will save $1,875 per year, which you can invest.

The second reason that what seems like a small amount of savings can turn into a large amount of money in 35 years is compound interest.  Specifically, while you are paying interest when buying a car on payments, you are being paid interest when you are able to save money that would have been going to a car payment and invest.  If you were going to be paying 8% interest on a car loan, but instead pay cash for the car and invest the rest, you will be getting an effective interest rate of 20% on your money, assuming a 12% return on stocks.  This means that instead of working extra hours to pay the interest on your car loan, you will be making money for simply letting others use your money to build their businesses.

So before you fall into the trap of endless car payments, think about what that car payment is really costing you – millions of dollars over your lifetime.  Is that new car smell and 32,000-mile warranty really worth that?

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @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.