Investing a Coverdell ESA/Educational IRA during the Last Few Years


Clingdome2It is pretty easy to plug a few numbers into an investment calculator and expect a return from your stock portfolio in a certain number of years.  The issue is that returns are hard to determine over relatively short periods of time.  If you’re investing for retirement and you’re starting at age 18, you can reasonably plug in a 12 or 15% return into an investment calculator and probably come fairly close to makign that return over 40 or 50 years.  If you’re investing for shorter periods of time, like ten to twenty years, you’re almost guaranteed a positive return over the period, and that you’ll do better than you will in a savings account, but the return you’ll get is more difficult to judge.

The issue is that those 12% to 15% returns include some really fantastic periods like the 1980’s and 1990’s.  Go without them, and your returns can be a lot less.  The 2000’s were pretty rotten, starting with the dot com bust in 2000 and including the housing bubble burst in 2008.  Luckily, we’ve had some good years, such as in 2003 and 2004 after taxes were cut, 2009 and 2010 after the housing bust when investors rushed in to buy cheap stocks, and even 2013 and 2014 thanks to historically easy monetary policy.  This has helped reduce the sting.  Still, it hasn’t been the roaring eighties or the roaring twenties.

In bad timing from an investing standpoint, my son was born in 2001.  We started an educational IRA/ Coverdell ESA the year he was born and invested $2,000 in it each year.  We put mostly mutual funds into it with a few individual stocks (probably a 60%/40% ratio).  Some of the individual stocks have done very well, others not so well.  Our best pick was Stryker, up 110% from what we paid back in 2010.  The worst was Pier One Imports, which lost about 50% of its value before we sold it.

Estimating a 12% return, I expected the account to have about $95,000 in it by now.  With the market issues we’ve seen, however, and some iffy stock picks, we have about $40,000, or an annualized return of about 4%, which is just a little better than the return of the S&P500.   That leaves me with a tough decision over the next few years.

With $40,000, I should be able to cover tuition at a four-year instate school.   It is, therefore, tempting to sell most of the stocks and invest in income and cash investments.  That would lock in the gains I have and mean that tuition was covered.  We or our son would just need to come up with living expenses.  That is probably what I would do if this was all of the money I had for college expenses since I couldn’t take a chance of a loss, which is a real possibility with only three years left until our some goes off to school.

Because we do have other money available for school expenses, if need be, I’m thinking of staying mostly in stocks, with a few income elements.  If the market does really well over the next few years, I might be able to raise the balance to $60,000 or even $80,000, which would be enough to pay for most of his college costs.  Also, because I don’t necessarily need to cash it all out his Freshman year, I actually have about six years to invest – not just three years.  I could, therefore, wait and watch, taking an opportunity that arises before he heads off to school or a few years into school to cash out.  If another 2008 crash occurs, I would probably make most of the losses back if I were able to wait a year or two.  Most crashes recover quickly.

Really this is the flexibility that comes with saving and investing so that you have reserves available.  It allows you to take a few more risks that may very well work out well.  Even in retirement, I plan to stay invested mostly in stocks because I expect to have more than enough to generate the income I need to pay for necessities.  I will take a portion of my portfolio and manage it like a retiree – with an appropriate mix of stocks and bonds – producing enough income to provide for expenses.  The rest can be left in stocks and tapped as the opportunity arises to increase the income being generated.

So what are your plans to pay for college for your children?  Are you saving and investing?  Planning the student loan route?

Got an investing question?  Got a great idea to share?  Please leave 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.

Simple Steps to Making 401Ks Better


Clingdome2My broker feels that 401Ks – the retirement plans that have largely replaced pensions – are a terrible idea and that most people would be better off in a traditional pension.  The main issue with pensions is that they can become a burden on a company since the company may need to add more money from time-to-time, depending on how the markets do.  When companies fail, they can also end up dumping their pension plan on the US Government, which will both cost the taxpayer money and can result in substantial reductions in the payouts the retiree receives.  Another issue is that companies tend to promise a lot in the pension plan when workers start to demand higher salaries and benefits since it is easier to promise to pay money later than it is to actually come up with the cash today.

The issue with 401Ks isn’t the plan itself.  It is the poor level of financial literacy that most people have.  This is surprising, given how important money is to most people (and by money, I mean shelter, food, and clothing, not gold rings and trips to the Riviera).  If people would spend a little bit of time reading and learning (The Smallivy Book of Investing is still on sale), they would find that managing their 401Ks is really not that difficult.

Given that they probably won’t, there are a few things that could be done that would make it a little harder for people to mess up their 401K.  These are:

1.  Make enrollment at the maximum company match opt-out.  Many people fail to enroll at all since they must opt-in to the 401K plan, or they don’t contribute up to the full company match, leaving money on the table.  This could be changed where employees are automatically enrolled at the amount needed to capture the full company match.  If they choose to not participate or reduce their contributions, they would need to go in and opt out.  Given that most people are slow to act, this would cause most people to do the right thing financially and put money away.  Actually, it would be even better if you were enrolled at 10% of your pay regardless of the company match since you need to be putting at least that amount a way to have a secure retirement at your current level of lifestyle.

2.  Make a target date retirement plan the default.  Given the choice, I’d choose my own funds rather than use a target date retirement fund.  For many people, however, a target date retirement fund is better than what they tend to choose.  Many plans drop people into a money market as a default, and many people then just leave it there.  This guarantees that they will lose a lot of their money to inflation and will lead to a dismal retirement unless they sacrifice like crazy and put a lot of money away.  For those who don’t want to mess with it, a target date fund would provide at least the returns that a traditional pension would.

3.  Eliminate the ability to withdraw funds before retirement.  One of the worst things about a 401K is that you can withdraw funds before retirement.  Often this comes with a 10% penalty plus a large tax bill, such that you lose 50% of your money by taking it out early, yet people continue to take the money out on a whim or when they change jobs.  You wouldn’t be able to go to your pension plan manager and say you want to take your money out before you reached retirement age.  You shouldn’t be able to do so in your 401k either.

These three simple changes would totally transform the landscape when it comes to retirement security in the United States.  Are any Congressmen reading?  I’d be happy to discuss them.

Got an 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.

The Good and Bad of Adding Fiduciary Duty


Lost Cave1I was talking to my broker the other day about the changes that are coming for individual retirement accounts.  The biggest change is that brokers and others who manage or advise people on individual retirement accounts will need to take on a fiduciary duty.  This means that they will be required to work in the best interest of the client,rather than their own best interest or the best interest of the firm.  Currently, they are required to recommend “suitable” investments, but not necessarily the lowest priced investments.

In many ways this is a good thing since it will help to prevent the common practice of selling things like annuities and proprietary funds that perform poorly relative to other investments but pay the salesman and their firm a big sales commission.  Unfortunately, there are many who take advantage of the lack of knowledge of their clients to make money for themselves.  We don’t need people with the stereotypical used-car salesmen approach selling financial instruments.

The downside is that there will be a lot more paperwork, particularly if you do have knowledge of what you’re doing and want to go against the conventional wisdom.  For example, I see no reason to own bonds at my stage of life (although I do own some REITs) since I have more than 20 years until retirement.  I know that stocks will return several percentage points more than bonds over that period and I don’t want to give up that additional return.  I take the chance in any given year of seeing 40-50% of my portfolio value evaporate because of this position, but I also feel that stocks will recover from any such drops before I need the money because I have 20 years.  As I get closer to retirement, as long as I have at least 2-3 times what I really need to make it through retirement, I’ll probably stay heavily invested in stocks since I’ll be able to take a 50% drop without it really affecting me. I’ll have excess funds, so if I lose some money I can still eat.

The conventional wisdom for someone my age would be to have about 35% invested in bonds by this point.  This would help shelter me from market downturns since bonds usually fall less than stocks since the interest they pay helps prop their prices up.  The issue with this strategy is that it doesn’t take the effect of time in reducing risk into account.  It uses diversification – spreading out investments into more than one type of asset – to reduce risk, but holding the investments for a couple of decades also reduces the risk.  Having 35% of my portfolio invested in bonds would mean that I would get about a 6-8% return on that money instead of the 12-15% I can get in stocks over the same period of time.  That can add up to be a lot of money.  The new laws, however, will certainly require me to sign a lot of documents saying that I understand the risks of doing so.  Perhaps in the future I won’t even have the choice.

The reason these laws were enacted, however, was that most people aren’t financially literate (and generally proud of it, for some reason), and the people taking care of their money for them were lining their own pockets.  Generally, this was not by offering them investments that were too risky, but investments that we’re risky enough, such that they lost a lot of the return they would have gotten if they had invested properly, but have high fees.  These are things like annuities, which almost no one under age 65 or maybe 70 should have.

So in summary, because most people don’t even get the preliminary education in investing and money management that they could get through reading a couple of books (The SmallIvy Book of Investing, Book 1 on sale now!) or reading blogs like this one, they need to rely on “experts.” Many of these “experts” have little financial education other than on how to sell the high-fee annuities and funds their firm is pushing.  Because of this, we’re going to see a lot more controls on the people who manage money and sell financial instruments.  Unfortunately, people are ignorant enough about finances and some advisors are unscrupulous enough that this is needed.  I’m just hoping that the rest of us who do know what we’re doing will be able to still make the choices we feel are right for our situation.

Got an 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.