Concepts:Impractical investing is the riskiest, often expensive, way of saving money for future use. Practical investing is the safest way to save money. The most practical investments are savings accounts, bonds, and brokerage accounts.
Practical investing is the long, slow process of saving money for future use.Not by stashing it at home, but by giving it to a trustworthy person outside of home who will protect it, and better yet, put it to work earning extra money on your behalf. ‘Protected money’ helps defend against future emergencies. ‘Extra money’ helps pay for expensive things, caring for family members, and retiring from work.The most practical investments are savings accounts, bonds, and brokerage accounts.
Savings accounts are available in banks and credit unions.Shop around to find the best deal for you and when you apply for an account, be sure it is FDIC insured (FDIC stands for the Federal Deposit Insurance Corporation). The FDIC insures against accidental or criminal loss of all the money held in your account up to the limit of $250,000 per account holder, per bank.
ADVANTAGE- Money is easily deposited and withdrawn.
DISADVANTAGE- The interest rate is very low, usually below our national rate of inflation.
RECOMMENDATION- Use your savings account as an emergency fund to pay for catastrophes such as job loss, medical bills, and other overwhelming events. Try to save 3-9 months of wages in your emergency fund for the rest of your life.
Bonds and CDs (CDs are certificates of deposit) usually pay more interest (interest is ‘extra money’) than savings accounts.Bonds sold by the U.S. Government are guaranteed to be fully repaid with interest after a specific period of time.Bonds sold by companies are fully repaid with interest unless the company is unable to make the payment.CDs are sold by banks and credit unions, and insured by the FDIC.
ADVANTAGE- The seller promises to repay you the full amount of the bond plus interest.
DISADVANTAGES- The full amount plus interest is not repaid until the maturity date. “Investment grade” bonds are usually repaid, but “junk bonds” may not be repaid.
RECOMMENDATION- Purchase bonds and CDs with maturity dates at or below 5 years in order to save for startup projects such as buying a car, new business, or new house.
Brokerage accounts sell securities such as stocks and stock-index funds.The accounts are “SIPC insured” if the broker is a member of the SIPC (SIPC stands for the Securities Investor Protection Corporation).The SIPC insures against financial failure of the broker and unusual loss of securities by the broker.The SIPC insurance limit is $500,000 per customer, including no more than $250,000 cash, for all of the customer’s accounts combined. SIPC insurance does not protect against investment losses.
‘Extra money’ from stocks and stock-index funds might exceed the interest rates of bonds and CDs, and also exceed the rate of inflation.But stocks and stock-index funds are riskier investments than bonds and CDs because you could lose money in the stock market.
Three good ways of earning money in the stock market are 1) buying shares of a reputable stock-index fund, 2) holding the shares for a long time, and 3) reinvesting stock dividends. All three ways are illustrated in the following graph:
The graph shows 33 years of growth-in-value of a stock-index fund that was invested in a group of stocks measured by the Standard & Poors 500 Index (the “S&P 500″). The stock-index fund earned ‘extra income’ in 2 ways: 1) from stock dividends and 2) from growth-in-value of the fund. When all dividends were reinvested by buying additional shares of the fund (blue line), the final fund value of $6,000 was twice what it would be, $3,000, when the original number of shares were held without reinvestments (red line) for the entire time. The blue line represents compounded growth.
Impractical investing is a very risky, often expensive way to save money.The very risky investments include junk bonds, initial public offerings, partnerships, leveraged funds, commodities, currencies, collectibles, options, derivatives, hedge funds, and property ownership.The possible expenses are high commissions, high tax rates, tax accountant fees, illiquidity (tied-up money), and costly mistakes.
Questions: I was wondering if you have some favorite web sites to get information about investing for a thirty something person.And also for a teenager that has a part time or full time job.In both cases, to save for retirement or even to save up for a down payment on a condo or house.
Thanks for your questions. My advice to teens and young adults is to start an emergency fund before investing in securities.They should gradually build a large emergency fund of dollars in the bank to use for job-loss and other big financial emergencies (see book called the Index Card in the Young Adults section of the link below).
Teens who declare earned income to the IRS can deposit an equal amount of earnings in a custodial Roth account (see video on Hannah’s Roth account in the teens section of the link below). It’s important for teens to learn how to open and manage an investment account such as the Roth. In the Roth, I recommend holding a broad index stock fund for life; it will weather the ups and downs of the stock market over time (several good internet sites for teens in the link below).
Thirty something persons need a tax-advantaged retirement account. Employed persons should participate in their employers 401(K) plan [or similar plan] to the fullest extent above all other financial goals, with exception of building an emergency fund and getting out of debt as very top priorities; the condo and house are lower priorities. Unemployed persons should check eligibility for SEPs, other retirement accounts, or IDAs (start with the “money basics” and sec .gov websites in the Young Adults section link)
Starting your family’s tradition of investing [under FAMILY TRADITIONS]
Childhood is the perfect time to learn about investing and responsible adults are the ideal teachers. The best way for parents to teach money management is by setting a good example. Parents can reinforce their example by playing financial board games and video games as a family activity. Assistance and supervision reinforce the development of good financial habits such as creating and using a budget. Discussions and field trips are powerful methods for showing children how adults use bank and investment accounts.
An emergency fund is used to pay 3-9 months of living expenses during unemployment. Keep it for retirement.
Unemployment means that you aren’t paid for doing work.People who either lose their job or retire from work are unemployed. Could you pay for living expenses during unemployment?If not, you should start building an Emergency Fund. There are two important savings plans during life: the Emergency Fund and Retirement Account (ref. 1).
The emergency fund is used to pay living expenses during temporary unemployment and other unusual expenses such as big bills.Workers should save 3-9 months worth of earned income in a secure savings account (ref. 2).That’s a difficult task when also planning to buy expensive items such as cars and houses, or paying-off college loans.Get a headstart in childhood by slowly saving cash in a custodial bank account.
The retirement account is needed to pay living expenses during permanent unemployment in old age.Contribute to your own retirement accounts as soon and often as possible (ref. 3).Begin by opening a Roth IRA during childhood when you start reporting earned income to the Internal Revenue Service (ref. 4).Employer-sponsored and Self-employed retirement plans should be opened at the first opportunity (ref. 5).
About forty to fifty years of regular investing are needed to build adequate savings for retirement (ref. 3). Plan on investing in quality securities such as stock index funds and government bonds (ref 1,6).Begin with stock index funds early in life and add the bonds late in life, finishing with a 90% investment in stock funds and 10% investment in bonds (ref. 7).
Retirement accounts have special rules for investing money (contributions) and removing money (withdrawals).
Withdrawals before age 59½ years are generally not permitted without paying a fine and taxes [check the rules for exceptions in ref. 5].There are no fines after age 59½ years.
Roth IRA. You must pay taxes on all contributions and the contribution limits are $5,500 per year [check ref. 5 for changes].Withdrawals after age 59½ are not taxed and there are no mandatory withdrawals.
Other IRAs and retirement plans. The contribution limits vary from $5,500 to $19,000 depending on the account [check ref. 5 for changes].You don’t pay taxes on any contribution, but withdrawals are always taxed.The government requires partial withdrawals each year after age 70½ years.
Walt Disney made a wonderful cartoon about a famous race between the tortoise and the hare [‘tortoise’ and “hare” are old-fashioned names for ‘turtle’ and “rabbit”]. The story began when the rabbit teased the turtle for walking slowly. To everyone’s surprise, the turtle challenged the rabbit to a race. Their race course was a long track that had a starting line and a finishing line. At the start of the race, the rabbit ran fast and far ahead of the turtle. But the careless rabbit suddenly stopped to tease the turtle some more by going to sleep along the race course instead of crossing the finishing line. The turtle quietly passed the sleeping rabbit and won the race by crossing the finishing line in first place (ref. 1,2).
What happened? The turtle refused to feel bullied by the rabbit and fought back by suggesting the race and then running the entire length of the race course. The turtle was determined to finish the race and didn’t quit running.
The moral for investors: success depends on determination and patience.
The goal of this workshop is to discuss ways of helping grandchildren invest for college and eventual retirement. Grandparents have the time, experience, and resources to help those investments.
My role as moderator is to introduce today’s topics.Mr. Eric J. Robbins will then describe ways of investing in your grandchildren’s future.Eric is a senior investment advisor at Buckeye Wealth Management with over 30 years of experience in the financial services industry.Finally, Mr. Jefferson R. Blackburn-Smith will suggest ways of preparing grandchildren for college.Jefferson is Otterbein University’s Vice President for Enrollment Management.
The reinvestment of stock market returns is the preferred method of saving for college and retirement (chart 1).“College” is any certified program of higher education at trade school, the 2-year Associates degree, the 4-year Bachelors degree, graduate school, or professional school. Family savings, student scholarships, and financial aid are principal sources of funding to pay the cost of college. There are also ways of reducing the cost of college. Paying for college deserves early planning.
Chart 2 shows 3 goals for gradually improving children’s knowledge of personal finance.
The first goal, financial training, is an important program which is best taught at home by parents. The topic of money for pre-school children is an ideal place to start. Proper management of money will become the child’s most important skill for personal finance and college preparation.
The second goal, “college” graduation, is headed for success when parents start saving for college early-and-often in a 529 plan. Grandparents can contribute funds to the 529 and also help nurture the lives of their grandchildren. Grandchildren thrive on dreams, experiences, and skills to help prepare for college. Well prepared students are those most likely to graduate from college with a useful education. “College prep” refers to the high school student’s tasks of choosing colleges, obtaining scholarships, and reducing the costs of college; guidance counselors and librarians are excellent resources.Negotiation is the process of comparing college acceptance letters and seeking the best financial terms of paying for college. Excessive student loans can be a disturbing financial burden after graduation.
The third goal, secure retirement, begins when grandchildren start saving for expensive things; those things become more expensive as a child’s interest shifts from toys to stylish clothes, electronic devices, and cars. Bank accounts offer security to a child’s savings. A grandparent can help grandchildren buy a stock and then periodically review its performance; it’s an excellent introduction to the world of finance. Jobs help grandchildren form entrepreneurial ideas. The taxable earnings can be deposited in a custodial Roth retirement account. Grandchildren need to be encouraged to save taxable earnings in the Roth account as a matter of habit. All children need safety lessons to avoid truancy, cyber attacks, gambling, credit card debt, and other risks to their wealth and health.
After college, young adults should enter the workforce even if their first job is not a ‘dream job’.Job success will enhance their future workforce mobility.
Investing for Your Grandchild’s Future. It’s Never Too Early to Start, Eric J. Robbins
The key points of my talk are:
college is an expensive investment that often incurs debt
grandparents’ financial assets are not detrimental to student eligibility for federal financial aid
families have many ways of saving for college; among them are several tax-advantaged savings programs
parents and grandparents should avoid making 4 big mistakes when paying for college
careful planning will reduce expensive mistakes
The average cost of college tuition and fees in 2017-18 varied from $9,970 [for in-state public schools] to $25,620 [for out-of-state public schools] and $34,740 [for private colleges].To cover these costs, my recommendation is to start a college payment plan early!Otherwise, a large debt from student loans could cause significant financial distress after graduation from college.The average cost of student-loan debt is $351/month (chart 3).
In general, students use loans to pay for 19% of college costs and parents borrow an additional 8%.Grandparents typically pay no more than 4% of college costs (chart 4)
College students are required to submit a FAFSA form (chart 5) to the college admissions office when applying for federal financial aid.High-income families with large savings accounts (“assets”) receive less federal financial aid than low-income families with small accounts.For a given amount of family assets, larger portions of student savings attract less federal financial aid.Grandparent-owned assets are invisible and have no effect on federal financial aid (chart 5).
Families have many ways of saving for college (chart 6)
Qualifed series EE savings bond, 529 savings plans, Coverdell IRAs, and Roth IRAs are protected from federal taxation of investment returns.Chart 7 offers a useful comparison of these tax-advantaged plans with taxable custodial accounts.
Several comments about chart 7: Investment returns are not taxed except in the UGMA/UTMA accounts; annual income limits may restrict participation in the Roth and Coverdell accounts; contribution limits to all accounts are regulated by the government except for the UGMA/UTMA; untaxed returns can be withdrawn for qualified educational expenses (UGMA/UTMA returns are always taxable); account owners are allowed to change the student beneficiary in all but the UGMA/UTMA accounts;account owners or custodians are generally allowed to control the account with some exceptions; non-FDIC investments are not guaranteed (but why invest in a low-return FDIC account for long-term growth of savings?)
The reason for having a college savings plan is avoid mistakes that lead to unnecessary personal losses.The biggest mistakes that parents and grandparents make are shown in charts 8-11.
If a parent waits 5 years before starting to invest $200/month, the $17,380 opportunity-cost of waiting to invest would decrease the final savings balance to $13,680 instead of $30,998 (chart 9).If the parent initially invested $10,000 and then waited 5 years before investing $200/month, an opportunity cost of $29,885 would reduce the final balance to $64,906 instead of $94,791.
Additional mistakes are: failing to plan for college; allocating college savings and other financial assets to the student instead of the parent; and, no planning for possible investment losses.
Families can reduce financial mistakes for college by gathering useful information (chart 12), selecting a suitable investment return (chart 13), and seeking alternative sources of funding (chart 14).
Helping Grandchildren Invest: Strategies for College, Jefferson R. Blackburn-Smith
The agenda for my talk:
some truths about college
Many families aren’t prepared for college.Here are four ‘truths’ that college-student families need to know:
Truth #1: College is worth the effort of careful planning (chart 17).Grandparents can help by promoting the opportunities of a college education.
Truth #2: College is expensive but few students pay the full price (chart 18).For example, students can seek grants and scholarships that reduce their payments.
Truth #3: The student debt crisis needn’t be as bad as reported by the media (chart 19).Low-income students tend to borrow more carefully, high-income students less carefully.
Families can shop for government and private student loans with the best interest rates and repayment plans. College graduates might choose to participate in debt-forgiveness programs by seeking employment in certain public service programs.
Truth #4: Cost, quality, and educational outcomes are important factors to consider in selecting a college (chart 20).
One way of paying for college is to distribute the expenses equally among 3 financial accounts (chart 21).
Among ways of paying for college, an educational savings account works best when started by an adult early in the grandchild’s life.Grandparents can encourage their family to open a savings account and then make contributions to that account (chart 22).
There are many advantages to using a 529 college savings account owned by parents (chart 23).
In comparison, student-owned savings accounts may be taxable and could reduce the student’s eligibility for financial aid (chart 24).
Student performance and lifestyle have a signficant impact on the cost of college.Roughlyhalf of Ohio’s 4-year college students graduate on time, which means that the other half are either dropping out or paying much more to graduate. In chart 25, “Lifestyle” borrowing refers to students paying for unnecessary college expenses such as extravagant vacations.
Grandparents have the time, experience, and resources to help prepare grandchildren for college and retirement.
Continual reinvestment of stock market returns is recommended for college and retirement savings plans that are started early in the grandchild’s life.
Protect college and retirement savings in a tax-advantaged education account (e.g., 529 plan) and retirement account (e.g., Roth IRA).
Help grandchildren acquire the lifetime habit of saving for retirement
Help grandchildren channel their dreams and experiences into goals for careers and adult life; college could help them achieve those goals.
Many families are unprepared for college. Early planning and careful preparation will reduce the cost of graduating from college.
Minimize student-loan debt by starting a 529 plan early. Other ways of minimizing student debt include grants & scholarships, work-study programs, reduced college expenses, and loan forgiveness programs.
[additional references are listed in the LITERATURE page of this blog]
Education and Investing are the best ways for young people to develop their future. Their success is measured in terms of personal security for a lifetime rather than in millions of dollars. Investing starts with learning how to save for future wants and needs despite many distractions. Family teamwork is an invaluable aid. This Overview is aimed at helping families inspire and train their young people to make investing a lifetime habit.
Journalists and educators agree that children learn about spending, saving, and sharing money very early in life. Whether their money habits become useful or futile depends on the examples and coaching of trusted adults. Financial education starts at home where family traditions of money management set the standard. If there is no family tradition, then start one. Young investors need a team of parents and trusted adults to provide,
Money management is essential to investing and protecting financial assets such as stocks, bonds, and savings. Building good habits can be a family tradition or a new family experience. Either way, children start forming money habits early, before entering school. Many families teach the wise management of money by encouraging their pre-schoolers to store money in jars (chart 1). Any container would work -envelops, cartons, bowls, socks, etc.- but transparent jars are the favorites.
Spending Jar teaches decision-making and accountability. Children love money and never have enough to pay for everything they want. They should learn to spend wisely, track their expenses and accept the consequences of their choices. Learning to spend wisely can help them avoid future financial insecurity due to fluctuating income and overwhelming debt.
Saving Jar teaches investing. Saving leads to investing and the funding of financial goals. Start by helping children save for short term goals, then encourage them to gradually save larger amounts over longer time periods. Introduce them to the stock market by explaining that their favorite businesses sell shares of ownership. Consider helping them buy stock in their favorite company.
Sharing Jar helps build relationships. Expose children to the needs of their community. Community engagement will cultivate relationships and humane values.
Dreams are gateways to an exciting and prosperous life. Teamwork can help turn those dreams into financial plans for earning and protecting money. The earlier your child’s team begins the process, the better the chance of success.
Dreams can become realistic financial goals. Younger children dream of becoming grown-ups. For example, they wonder what adults do for a living and how parents earn incomes. Older children are inspired by classmates, role models, field trips, activities, etc.
Chart 2 shows examples of goal-starters:
teenagers want expensive things like cars and computers; they should save for it!
young adults think about weddings and buying a home; they should invest in it!
children dream of becoming millionaires; they could invest in a retirement account!
– My granddaughter read a story in The American Girl magazine about saving to become a millionaire. She was ‘hooked’. I discussed the article with her and asked her mother (my daughter) if I could provide some seed money to open an investment account. A year or so later, my granddaughter started earning money as a tutor and used her earnings to open a Roth IRA. She enjoys reading her financial statements and watching her investments grow in value. –
Starting a Roth IRA: www.irakids.com
Chart 3 outlines the sources of income for children.
Unpaid chores are work assignments needed to run an efficient household.
Allowance is a regular gift of money that ‘allows’ young children to practice spending, saving, sharing, and budgeting money.
Jobs are types of labor performed by older children to earn money without a work permit. Not only do jobs enhance wealth but they also improve social skills and help children make decisions about future vocations.
Those who chose to turn a job into their own business are called Entrepreneurs. A successful business matches the skills of the child with the type of job; it also requires planning, organization, perserverence, and reinvestment.
Employment for wages in a regulated business requires children to have a work permit issued by the State.
Investments are a good way to save money for future use. Children have a BIG OPPORTUNITY to create wealth by reinvesting stock returns that will multiply the value of their investment. Chart 4 shows the future value of $1 invested in the stock market when all dividends and capital gains are reinvested in stocks. This mechanism of growth is called “compound interest”.
Dividends and capital gains are types of interest called “stock returns”. The colored dots in chart 4 represent values of compounded returns at selected time intervals. One application of a growth curve is the use of time intervals to help plan big projects. For example, childhood goals of saving for college and retirement fit into uniquely different time intervals:
The growth of $1 to $3 in 18 years is a realistic expectation of saving for college.
The growth of $1 to $30-$114 in 50-70 years is a nice investment for retirement.
Young investors need trustworthy adults to help navigate the red tape of opening a banking or investment account (chart 5). Minors (those youth under the age of 18 or 21 years depending on the state where they live) are unable to open the account without the written consent of an adult parent, guardian, or acceptable attorney. Full control of the account reverts to the young person at the age of majority (age 81 or 21 depending on the state).
Big projects require saving thousands of dollars.
Short term projects include saving for a computer, car, vacation, or wedding.
Long term projects include saving for college, a house, or retirement.
Planning a big project requires setting the goal, estimating the deposits of money, overriding the obstacles, and occasionally reviewing the plan. A simple Retirement plan might be the following:
goal, save a million dollars [this may change later]
deposit 10% of earned income [this will change later]
override obstacles with frugal investing (chart 6) and other protections (chart 8)
review the plan when there are substantial changes of income, expenses, or personal life.
Brokerage firms charge fees for professional advice, trading services, accountants, and safekeeping of securities. The fees are inescapable, but they can be minimized by frugal investing (chart 6).
Automatic reinvestment: Ask your broker to automatically reinvest cash payments from stocks and investment funds.
Infrequent trading: Otherwise, frequent trading (especially small amounts of money on a daily or weekly basis) will dilute investment returns.
Low trading fees: Consult online ratings and reviews of brokerage firms to assess their trading fees.
Dollar cost averaging: The best way of compensating for fluctuations of market prices is to make monthly contributions to the investment account which will then purchase varying numbers of investment units (i.e., shares) depending on the market price. Dollar cost averaging requires a dependable source of money (e.g., payroll deduction, bank account) and a receptive account (e.g., direct deposit plan, 401-K, brokerage).
Taxes reduce the profits from investing. Here are several ways of protecting the profits from taxes:
The Kiddie tax defers some of a child’s investment returns from taxes.
Tax-efficient investments reduce the capital gains & dividends taxes (e.g., growth stocks) or state taxes on bond interest (e.g., muni-bonds).
Federal taxes are not charged on the profits from Roth retirement and Education Savings accounts.
Long term investing: stock prices rise and fall frequently during the short term, but in general the price of a stock will gradually rise in the long term. The young investor can expect a rise in stock price over 30-70 years.
Diversified investments: Some stocks fail to earn returns for the investor. Consequently, it’s a good idea to own several different kinds of stocks to protect the total investment.
“College” is a Big Project
“College” is defined as any 2-year, 4-year, or career school after high school graduation. College prep is a family enterprise that prepares the high school student to negotiate their admission to college. Negotiation is the bargaining process that occurs between the student who wants to attend a desirable college and the college who wants to admit desirable students. The student’s ideal financial goal is to balance the cost of college with family savings and scholarships. Financial aid is only used if needed (chart 7).
TIMELINE FOR COLLEGE PREP
Family starts saving for college 15-18 years early with a “529 Plan” or “Coverdell account” owned by the parents. Grandparents can help fund the plan.
Family has early discussions about college and the opportunities offered by a college education.
Student starts seeking scholarships during the freshman year of high school. Start with the school guidance counselor and librarian. The family can help with the research, proof-readings, practice interviews, travel costs, etc.
Student reduces the cost of attending college by earning college credit during high school.
Family applies for financial aid during the senior year of high school.
FAFSA (Free Application for Federal Student Aid) is required by all colleges.
CSS Profile (College Scholarship Service Profile) is required by colleges that award non-federal aid
Student negotiates the terms of college admission.
Secured loans are based on a collateral asset such as the borrower’s property or financial account. The lender can take ownership of the collateral asset if the borrower fails to repay the loan. Unsecured loans are based on creditworthiness of the borrower. Lenders usually rely on credit reports to assess creditworthiness. Credit card accounts and student loans are unsecured loans. Beware: Students can incur high debt by borrowing for extra years of college or to attend an expensive school.
The short-term investor typically lends money to an investment fund (money market fund), bank (certificate of deposit) or government (Treasury Bills) on the condition that the borrower promises to pay it back with a small reward (called “interest”) at a specified time no longer than 1 year.
Stocks are certificates of part-ownership in a company. Stockowners earn returns from dividends and capital gains. The expected long-term rate of return is an average annual rate of 7%. REITs are real estate investment trusts that distribute 90% of the annual profit to shareholders. REITs earn profits from rental fees and real estate investments. Bonds are contracts that guarantee scheduled payments of interest and repayment of the invested money. The expected long-term return is an interest rate of approximately 4%. Investment funds are pooled investments, typically in stocks or bonds, which are owned by a group of investors. Shareholders earn profits from cash distributions by the fund and by selling shares of the fund at a higher price. Shareholders lose money if they sell shares at a lower price than paid to make the investment. Mutual funds and ETFs are registered investment funds governed by the Securities and Exhange Commission (SEC.gov) and Internal Revenue Service (IRS.gov). 529 Plans, Coverdell ESAs and Roth accounts are portfolios of government-regulated, tax-deferred investments. Homes are illiquid assets, meaning that they are difficult to sell quickly for cash. Owners earn a profit or loss at the time of sale.