When choosing mutual funds for our portfolio too often we get caught up in the returns of the fund while not asking ourselves the most important question. How much does this fund cost? A common thought is the fund which returned the most last year or over the last handful of years must be the best fund and thus the right fund for me, but that is not always the case. Click here read more and to find out how to get yourself a better return.
GIVE YOUR KIDS THE GIFT OF TAX-FREE GROWTH
The best way to pay for college out of pocket is with a 529 college savings plan. These plans were created in 1996 with the intent of participants setting aside funds to pay for college sometime in the future. The best part of these plans, and what makes them such an effective tool to pay for your kid’s college, is earnings in the plan grow tax-free if used for qualified higher education expenses. Why is tax-free growth so important and what are qualified higher education expenses?
Tax-free growth is so important because it saves you a ton of money. If you set aside money in a taxable account you will have to pay capital gains tax on any earnings when you sell an investment (for example if you bought a mutual fund for $5,000 and you sold it for $7,500 you will have a $2,500 capital gain that is subject to capital gains tax). Currently (and they can and have changed), capital gains rates will be either your ordinary income tax rate, 20%, 15%, or 0%. So the tax on your $2,500 capital gain can be anywhere from $990(.396 tax bracket * $2,500) to $0.
If you put that same investment into a 529 college savings plan your $2,500 of earnings will not be subject to capital gains tax as long as you use the earnings to pay for qualified higher education expenses. In the most egregious example you would not pay $990 to the IRS; instead with a 529 college savings plan that $990 goes to your kid’s college expenses. In other words, the full $2,500 instead of $1,510 goes towards paying the tuition bill. In addition, unlike with a taxable account, you will not owe taxes if you move money around in the account (like exchange shares of one low-cost mutual fund for another).
Fortunately, the government allows a wide range of expenses to be classified as qualified higher education expenses, such as, tuition & fees, room & board, books & supplies, and possibly computer related equipment & software and internet access if used for educational purposes.
What is also great about these plans is anyone can contribute to them. You can set up a plan and have grandpa and grandma contribute some birthday money to it. For example, the plan we have for our children makes is very easy for us to send out an email link asking for a contribution as little as $15 to our kids’ plans for birthdays and holidays. $20 towards a college savings plan goes a lot further than some plastic toy our kids are done with after two weeks.
How do I get access to 529 plans? There are two ways: direct sold plans and advisor sold plans. With direct sold plans you take it upon yourself to open up the 529 plan; with advisor sold plans an advisor acts as a middle man and sells you a more expensive plan. But beware, a more expensive plan can come with higher fee mutual funds (bad) and with the advisor skimming a few bucks off of the top (worse) for not really doing anything additional that warrants the added fee. High fee funds and a commission charge negatively impact the returns of your plan. Over time you will have less money for college expenses in an advisor sold plan than with a direct sold plan. Clearly, the choice is obvious, go with a direct sold plan.
If you need help check out this site to learn more about 529 college savings plans, or contact a fee-only financial advisor who specializes in college planning if you want to pay for his/her guidance. Keep in mind, a fee-only advisor should only charge you a one-time nominal fee to set you up with a direct sold plan (not advisor sold plan).
The nuts and bolts of college savings plans: plans come with contribution limits, so check with the plan administrator; you may owe gift taxes if you contribute more than annual gifting limits; you will owe taxes and possibly a 10% penalty if you withdraw money from the account and do not use it for qualified higher education expenses; some states will offer a tax deduction on your state tax returns if you contribute to your state’s plan; if your kid’s situation changes and she doesn’t end up getting a higher education, you still have many options to name a new beneficiary of the account (say a niece or nephew), so all is not lost.
The bottom line: if you think you’ll be footing the bill for your children’s higher education needs start saving with a 529 college savings plan today – it’s the smartest move you can make. One of the best gifts you can give your children is the gift of an education. It’s clear how important an education is in today’s society, but education, especially higher education, comes with a hefty price tag. There are various ways to pay for college, such as scholarships, grants, loans, or to pay outright for the education itself. Scholarships, grants, and loans aren’t guaranteed to be available, so some parents will have to fall back to paying for college out of pocket.
IS YOUR 401(K) PLAN SECRETLY STEALING YOUR MONEY?
In January my wife started a new job. She gave me her 401(k) plan brochure so that I can discuss her investment options with her. I was pretty upset to find out that her plan offered extremely high-fee actively managed mutual funds (every fund had an expense ratio greater than 1%) and her plan only presented one index fund - an S&P 500 fund that charged a pretty high .60% expense ratio.
An expense ratio of 1% means $1 on every $100 you have in the plan is paid by you to the fund itself. You don't see these fees come out of your account at the end of the quarter, these fees are rolled into the price of the mutual fund. The mutual fund price is known by the acronym NAV (net asset value) - it's like the price of a stock, but for a mutual fund instead. It might not seem like a lot, but it is, and it adds up over time to a lot of lost money on your part. If your plan offers low-cost investment alternatives in the form of index mutual funds you can see that fee drop to maybe 20 cents on $100 or even less.
To put that into prospective would you pay $20 for a gallon of gas or would you go across the street and buy it for $4 a gallon. And the gas is the same; $20 gas isn't 5 times better. And what if your car maker forced you to buy $20 gas and you had no other choice even if you knew there was equally good gas out there for $4?
It's not my wife's fault, and it's not even her company's fault either. Too many companies are unknowingly placed into 401(k) plans with poor investment options because they haven't been shown there's a better way to invest and unfortunately I think at times advisors are someway incentivized or even compensated to set up employers with these inferior plans. Those additional fees are going to somebody.
Check out this great mutual calculator provided by bankrate.com: http://www.bankrate.com/calculators/retirement/mutual-funds-fees-calculator.aspx
Keep these numbers constant: investment amount, rate of return, and holding period (you want to compare apples to apples). Take the expense ratio for your mutual fund, that amount goes into total operating expenses, put in 1%, .5%, .2% and see how that impacts your final balance over time - it's drastic and startling at the same time.
Here's an example: say my wife had $100,000 in the S&P 500 Index fund with the .6% expense ratio. She's got 30 years until retirement (holding period), if she were to get an average annual return of 7% (rate of return), she would have $635,484 in her plan at retirement. This is good, but it can very easily be better. If her plan offered a low-cost S&P 500 Index Fund with say a .15% expense ratio, my wife would have $727,705 in her plan at the end of 30 years - both plans will offer the same return cuz they simply track the same index - they're both the same gallon of gas. That's a difference of over $92,000 just because of the lower operating expenses!
Fees matter!!! Check your 401(k) plan's investment options, are your mutual fund choices loaded with high fees? Look at the expense ratio for the fund, if you can't find it (generally a warning sign right there) punch the fund symbol (it should be 5 letters long and end with an X) into the quote lookup box at yahoo/finance.com. Click on 'profile' and check out the Fees & Expenses box at the bottom. Generally if your fund is not less than .5% you've got a high-fee fund and it is secretly stealing your retirement fund!
The solution: go to your employer and demand low-cost index funds for your 401(k) plan; it will simply save everyone more money for retirement. If enough people speak up, or maybe it just takes one person to alert his/her employer that there are better less expensive options out there, we can all start saving more money for retirement.
WHY YOU SHOULD STOP PICKING STOCKS NOW!
“Good stock picking is controlled by good luck; bad stock picking is controlled by bad luck. Luck determines your stock picking ability.”
There is no evidence proving anyone can consistently pick stocks and outperform the market’s return over time. We all get lucky and we all get unlucky, too. Picking individual stocks is a coin flip, you will be right 50% of the time and you will be wrong 50% of the time.
I don’t like those odds. Some people will get lucky a few years in a row; these people attract the press and get labeled stock pickers or great mutual fund managers. But the truth is these people inevitably underperform the market average over any given length of time – history has proven this. The general consensus is that a stock picker or a fund manager needs at least 20 years of performance to remove luck and chance from their return track record before any conclusions can be drawn.
WHAT CONTROLS STOCK PRICE MOVEMENT?
“The only stock price pattern is randomness; you cannot predict the future price movement of a stock (and no one else can either)”
Stock prices are determined by supply and demand; because prices reflect all known information a mispriced security cannot be known in advance. Take every single investor in the stock market universe; they are all doing technical analysis, fundamental analysis, following the advice of a broker, listening to a friend with a hot stock tip, throwing darts at board with ticker symbols on it, etc. – they are doing anything and everything to form an opinion about a stock.
All of those opinions get priced into each and every stock. So when you pick a stock because you think it is underpriced and it will go up in value more so than the entire market you are wrong and you are fighting an uphill battle. You have to understand you do not know any more than anyone else; you do not know more than the stock picker doing the same analysis or opposite analysis as you. The most accurate price of a stock is what that stock is trading at right now; know that market prices are the best estimates of value, price changes follow random patterns and future news and stock prices are unpredictable.
WHY DO WE INVEST?
We invest to make money. We buy stocks because we want to see the stock price go up. Have you ever met anyone who buys a stock hoping it will go down in price? But we also invest because we want to see our stocks go up more than the stocks we didn’t pick or all of the stocks out there (known as the market).
So we look for something that predicts the future and tells us our stocks will go up more than the stocks we didn’t pick or more than the market itself. No one can predict when a stock will outperform other stocks or the entire market; nothing and no one will ever tell us the future direction of a stock price’s movement. Stock price movement is random and picking stocks is all controlled by luck. However, if we all agree that our goal is to make money then the method that has proven to make us the most money over time becomes The Right Way to Invest.