Ask the grumpies: Retirement vs. college savings

Alice asks:

How do you decide at what income level to begin funding a 529? I know the mantra of ‘max out tax-advantaged retirement accounts first’, but that is a lot of money to put away (~30% of income) before starting any college savings…I assume we’ll be in the ‘squeezed’ middle on college, with too much income for aid but not enough to pay full freight outright. It seems that at least some dedicated college savings are worthwhile after 15-20% retirement savings, even if not optimal as far as taxes go…We’re assuming private or out-of-state public are in the cards, and want to avoid student debt. I’ve heard the ‘Roth contributions can be used’ chorus, but that won’t go far with current tuition rates.

TBH, if I had to do it all over again, I would max out retirement first instead of regularly contributing to 529s. Because of financial aid.  You can read about how our minds have changed on this topic via this cut of our archives, though I’m not sure we ever spelled out the history in one concise post.  (For an alternate cut, here’s the college tag.)

If you’d asked us this question when we started the blog, we’d have told you to make sure you were (getting any employer matches and) saving 15% of your income for retirement (more if you need catch-up savings– we’d have recommended you play with online retirement calculators to see whether or not you were on track) and then put a regular amount away for college with every paycheck.  We’d have told stories of how we knew people whose parents had spared no luxury (cds, cars, clothes, regular vacations to Hawaii, etc.) but then the kids couldn’t go to the fancy college they’d gotten into because their parents made too much money for decent financial aid and they had nothing saved.  And that’s not terrible advice– make sure you’re on track for retirement and then put money away for college to give your kids more options.  I don’t completely regret having taken it when the kids were younger.  Their college savings have grown at a nice clip, and it’s likely both will be on track to go to the private schools of their choice even without financial aid.

These days we’re much more attuned to the importance of College Financial Aid (Forbes Magazine has a great series on the topic– click here for the latest updates).  You can ignore this concern if you prefer to think of tuition as a donation to the school (which for us depends on the school… I’m always irritated at the fundraising letters we get from DH’s graduate alma mater given their endowment).  Will you be squeezed?  It turns out there are calculators for that, and those calculators depend a lot on how much money you have that can be tapped for college.  Formalized retirement savings (even the Roth savings) do not count for financial aid.  This Forbes article from 2017 is a little out of date, but should give you a good idea of how your income translates into financial aid (or not) for different types of schools.

To get an even better idea, you should pick a set of colleges that you could see your kid potentially attending, and spin through their financial aid calculators.  These individual aid calculators have become quite sophisticated and you can see how different colleges will treat your different levels of assets vs. income etc.  So you can run the counterfactuals to see that, for example, if my DH loses his job and makes no income, that won’t at all give us any more aid at Harvey Mudd (which is stingy for high-income folks and extremely expensive) or our local state school (which we could cash-flow), but would make a big difference at Harvard (which is generous up the income distribution).  (Here’s us doing those exercises and contemplating how much we would need to save for a set of private schools .  I just spun through the super simple Harvard calculator and for spendthrift high income folks with no savings, your kids can still get a scholarship at a joint parental income of 260K!  You can play with how hiding assets in retirement changes aid compared to having to report them like with a 529.  Note that Harvard is a bit of an outlier both in terms of generosity and how easy it is to use their calculator.)

Loans for college are not a terrible idea, especially if you can get subsidized loans.  You can put money away for retirement now and then take out loans for college that you can repay more quickly by contributing less to retirement later when the contributions will no longer count for college.  If you’re maxing out your retirement options today at 30%, then you can drop down to the match later when your children need the money.

Many people feel uncomfortable using money for purposes that they have not initially dedicated that money to.  For this set of people, putting money in a 529 is the only way to guarantee that a child will be able to go to something other than the cheapest college option.  If this feeling is acknowledged, however, and planned for in advance, I think it can be gotten around.  You can decide now what money you want to earmark now for college, put that in retirement funds instead, then take out loans and repay them later for the amount in question by putting less in retirement later and cash-flowing.

In terms of using a Roth to save for college– there are a couple of wrinkles to doing that.  Drawing money out while your child is still in school can decrease your financial aid eligibility because some of that hidden money turns into income.   Here’s another post with more details on the pros and cons of Roth IRAs for college savings.  Note that these cons can be gotten around by delaying when you use the Roth until the child is close to graduation, assuming that doing so will not affect a younger child’s financial aid eligibility.  (And the principal rather than the earnings can be withdrawn after college is complete for no penalty.)

College is not cheap, and it may be worth saving 30% or more of your income now knowing that some portion of that is being saved for college (in terms of needing to save less than 15% of your income later) even if you’re not earmarking it.

Now, I noted that today we regret not having put the $500/month/kid in our kids’ 529s (not to mention mortgage pre-payments) in our retirement options instead.  The reason for that is that we are now high income and we are maxing out our retirement options (DH also has much less space to save than he did when he was working for the university).  Any money we save over that amount cannot be hidden from colleges.  There are a number of pricey schools out there that we will not get financial aid at should DC1 get in and decide zie wants to attend.  (DC2 may be better off in terms of financial aid since DC1’s tuition and living expenses will do a good job of eating all of those assets.)  We’ve paid off our house, have replaced DH’s car, will replace mine sometime in the next two years (Financial aid starts counting 2 years before college starts), and are renovating our kitchen, but even after all of that we will have assets leftover that could have been hidden in retirement accounts.  We could in theory buy a bigger house or I could get something other than a sensible car, but I guess I’d rather donate tuition to a university than make those changes.  (#richpeopleproblems)  (Note that if our income goes up more, then we can ignore all of this because we won’t be eligible at any asset-level, but if DH loses his job and our income is halved, then all of this becomes extremely important.)  Here’s our most recent recommendation of what order to save for multiple big financial goals, and here’s our recommendation of what vehicles to use.  Finally, if you haven’t opened up a 529, here’s our thoughts on which one to pick.

Grumpy Nation, what are your experiences with saving for college?

 

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Reminder: Check your retirement (and other stock) accounts!

My sister had 12K that was just sitting in the IRA she opened in college (and thinks she contributed to a couple/few times after getting her first job) making no interest in her etrade cash– it had been sitting there in cash for TWELVE YEARS.  (Her other two stocks in that account were etrade and paypal that she bought in college.  I’m pretty sure I didn’t advise her on that– I was telling everyone my age and younger to buy QQQ!  I understood both that tech was important *and* that broad-based funds (in this case a technology ETF) are the best.  I assume that was advice from our father.)  I put in a order right off to buy Vanguard’s 2060 target date fund with that cash (we chose 2060 because she has a defined benefit pension that has vested, so she can afford to be riskier with retirement savings).  Because if you’re going to set and forget…

Then she put in another 11.5K for 2018 and 2019 and is going to follow the steps to set up a backdoor Roth even though she thinks it’s sketchy.

She also has 30% of her 401(k) portfolio invested in company stock.  She’s been meaning to sell it off for a while, but with one thing and another over a decade has passed and here we are.  She’s not sure if she’s going to sell it all on Monday (the company value is currently coming out of a low point) or if she’s going to set up automatic quarterly sales.  I recommended the quarterly sales (there’s still more of this stock coming in!), and found the number for her to call in an email the retirement provider had sent to her this year saying she had too much invested in company stock, but I also said that if that’s too hard to set up to satisfice and just sell what she’s got.

I’m not a saint either– When I checked at tax time, I had over 1K sitting in my own etrade cash account (taxable) because one of the stocks my father had bought when he was managing my stuff got bought by another company and rather than me getting the other company, I ended up with just the cash.  Which sat there for a few months because I don’t pay attention to that account.  And for some reason last quarter all our QQQ etrade accounts stopped DRIPping (maybe there was a name change again?  It looks like it has lost a Q.) — there was enough in each account to buy one share, but with a $6.95 commission, so I put the money into VFINX instead.  Luckily I do look at these accounts once a year around tax time…  Etrade’s cash account doesn’t even make reasonable interest like Vanguard’s money market fund does!

The other thing we needed to change on my sister’s IRA account was her beneficiary– she’d listed our father, but she’s fairly sure that her niblings have a higher probability of being alive when she’s gone, so now that over a decade has passed and there is a younger generation that didn’t exist when she set up the account, she switched those over too.

To sum:

  1.  Take a look at your accounts to make sure you’re still invested in what you think you’re invested in.  (I’m not even talking about something complicated like rebalancing!)  Sometimes companies merge or die or your dividends stop dripping and you end up with a bunch of cash where you thought you were getting market returns.
  2.  Make sure the people you have listed as beneficiaries are still alive and are still the people you think should be inheriting.  If you’ve had additional kids since listing a beneficiary, make sure you’re not just listing the oldest!

When was the last time you checked your stocks?  Do you know who you’ve listed as beneficiaries?

Ask the grumpies: How best to save for kids’ college

First Gen American asks:

I would love a post on savings bonds as a vehicle for college savings…pros and cons vs 529. Also is one better for high earners. There seems to be some language about earning limits on the tax deductability of the earnings but no penalty if not used for educational expenses.

Disclaimer:  We are not professional financial planners.  Before making important financial decisions, talk to a fee-only financial planner with fiduciary responsibility and/or do your own research.

According to this page from the treasury:

For single taxpayers, the [education] tax exclusion income limit [for savings bonds] is an adjusted gross income of $92,550 and above. For married taxpayers filing jointly, the tax exclusion income limit is an adjusted gross income of $146,300 and above.

So to me that says that savings bonds are not a good vehicle for college savings for high earners.  Maybe if they’re the kid’s and the kid is not filing as a dependent, but that seems risky too given how FAFSA and CSS heavily weight the kids’ savings (exceptions here).

Savings bonds are also a less risky, lower earning asset.  Given the lack of tax advantages for higher earnings and current interest rates, they’re not much better than CDs or high interest savings accounts for low-risk low-earnings savings and will also show up in financial aid decisions.

So… for both high and low earners in the “may get some financial aid” range, the best thing to do with your money is to put your savings in places that won’t count against your financial aid– so fill up retirement accounts (especially IRA Roths if you can since you can take out the principal on those in case of emergency), pay off credit cards, put money in home equity below what CSS forms pick up, fill up your HSA, and so on.  (Forbes magazine is probably the best place to look for these kinds of limits/suggestions.)  That may seem counter-intuitive that the best way to save for college is to hide money in ways that it is more difficult to tap for college, but financial aid is powerful and you can take out (short-term) loans for college but you can’t take out loans for your retirement (and taking out loans for your mortgage can be expensive and problematic).

AFTER you’ve hidden as much as you can, I still think the 529 in a state that either gives you a state tax break or, failing that, a state that has good Vanguard options with low fees is your best bet.  You could also do a Coverdell if your income is low enough (<220K in 2017 and 2018), but they’re not really any better than 529s unless you have private K-12 tuition that it could go towards, and the limit is pretty small.

If you are too high income to qualify for financial aid (and note that that income may be higher than you think) then you don’t need to play games hiding your income and savings because there’s not anything you could do to get things low enough for colleges to pitch in.  It may also be worthwhile in this case to push some savings onto the child so as to take advantage of the child’s lower income.  If you’re in this situation, don’t just read free advice from the internet– pay for a fantastic fee only financial planner with fiduciary responsibility and get all of your financials in order.

High earners and grandparents cutting down their estates may want to look into frontloading 529s with 5 years worth of 14K gift exclusions or, if they don’t want to force the money to be used for college, they can look into a gift trust.

How are you saving for kids’ college (if applicable)? 

College Savings are hard to plan

If DH and I remain employed at our current jobs for the next ~6 years (something that is not incredibly likely given DH’s job situation), then we will not qualify for financial aid at most schools.  (IIRC, we’ll be in the phase-out range for Harvard and Princeton and may be able to move money around to get some aid there.)  If one of us loses a job, then DC1 will qualify for about ~10K/year in aid at many private schools, which isn’t that much given sticker prices (although on just one income, hiding moving money around will have a larger effect).

We currently (barring weird changes in the stock market between the writing of this post and its posting) have around 98K in DC1’s college account.  That’s $500/mo for the last 10 years invested in Vanguard.  That’s enough to go to our local flagship schools for 4-5 years if we stop saving now.

And that really sounds like a lot.  But in the world of private schools it isn’t.

It’s hard to tell what DC1 will want to do in 6-10 years, but current indications are that computer science or some form of electrical engineering will be involved.  Zie might want to go to MIT or Harvey Mudd or Stanford (and zie might get in– it is hard to say).  These schools are not cheap, and at >55K/year in total costs (and rising), there’s not enough in the 529s to pay for even two years of school. We have another $170K in taxable stocks (that’s from the 50K we had in 2005 and the leftover money from leave we just put into the market) that presumably we would use for the remainder.  However, we will be taxed on that remainder, so it might make sense to start saving *more* in the 529 vehicle while we still have six years for earnings to accrue.

Indeed, the simple saving for college calculator suggests that we would need to more than double our monthly contribution for MIT and almost triple it for Harvey Mudd.

If I drop DH’s income, then the college calculator suggests we should start putting away $638/mo, which is still more than the $500 that is currently going towards college.

Both Harvey Mudd and MIT have 5-year BS/MS programs that are a good deal.  DC1 is so young– maybe we should be open to funding some graduate school.   It is also true that we have two children, and by the time DC2 is ready for college, we should know how much DC1’s experience ended up costing, so we’d be able to move some money over.  As of this typing, DC2 has $33K in hir 529 plan.  We’re on an oversaving path for hir for state school (the calculator recommends cutting back to ~300/mo), but would need to put away more for the average private school– for my alma mater, for example, zie would need more than double what we’re putting away (same for engineering schools, though it’s harder to tell if engineering is likely with a preschooler compared to a 6th grader).

Looking over all my old 529 posts, I usually contemplate putting less money into the 529s.  This is the first time I’ve addressed putting more money there.  I’ve been assuming we wouldn’t pay for any graduate school and have been worried about the risk of over-saving.  But with only 6 years left before college, I think it is unlikely I’ll end up moving to work for a university that pays even part of school tuition.  And college costs have been increasing, as has our net worth.  Maybe it makes sense to get more tax advantage, especially given that in 6 years taxes may have to go way up (or inflation may be sky rocketing).  It’s hard to say.  Not to mention that $500/month isn’t worth what it was 10 years ago.

And we’re no longer paying $1200/mo in principal and interest on a mortgage.  If DH doesn’t lose his job, that money has to go somewhere.

Under what circumstances would we regret putting more money in the 529s?  1.  If we move to the bay area for DH’s job and want to buy a house.  That scenario suggests needing loans for private school and DC1 being on hir own for graduate school.  2.  If for whatever reason neither DC1 nor DC2 end up using the money (ex. tragedy, one or both of the DCs becoming successful entrepreneurs, both DCs deciding they prefer much cheaper college options).  3.  The world goes to heck and we have to leave the country (in which case money in the 529s will be very low on our list of regrets).

Ugh, I keep going back and forth on this.  I could increase our monthly contribution to be more in line with what the simple calculator thinks we should be contributing, and then we could cut if off if DH loses his job.  We could put in a lump sum (though dollar-cost averaging seems much less risky given the current uncertain political environment).  I could split the difference and put in, say $750/month per child instead of either $500 or $1000 (which is about what we would need if I kept my job and DH stopped bringing money in entirely).  Or we could just keep doing what we’re doing, which is usually the easiest thing to do.

*note for newer readers:  We are already maxing out our easy retirement options (required contribution, one 401K, one 403b, one 457) and will pay off our house very soon.  So don’t worry about our retirement savings or debt loads!

What are you doing in terms of college savings?  How do you decide to change what you’re doing?

Ask the grumpies: save for retirement or save for graduate school?

P asks:

I’m a fairly recent graduate, 23, and just started my first real job as a paralegal at a big law firm at a salary of $42,000 a year.  I will probably start graduate school, most likely in law or another $$ professional master’s program, in the next five years. (Future schooling is an important goal for me.) After grad school, I could be in biglaw, making very good money, or elsewhere, probably not making as much. Should I be directing money to grad school savings or to retirement? What would you do?
Other considerations:
  • I have ~60,000 from an inheritance in an investment account–This could be used for school, or I could think of it as my retirement nest egg. It’s in a mix of no-load/no-fee mutual funds.
  • Looking at my budget now, I’m planning to save definitely $500/mo, and probably up that to $600 once I’m more confident about what my general living costs will be.
  • I also have probably over-budgeting for general spending (groceries, entertainment, eating out, clothes, etc.), by maybe $100/mo, and I was planning to save the rest of that for travel.
  • There’s no match in my employer’s 401(k) plan, but in a year I’ll be eligible for profit sharing. I…don’t know exactly what that is or how it works yet, but I have a year to figure it out!
  • No student loans. (Grandma, thank you!) No other debt.
  • $2000 in a traditional IRA
My long-term financial goals:
  • Pay for my hypothetical future children’s college at whatever school they want to go to, possibly with help from my parents. (No kids for probably close to ten years)
  • Travel as much as possible
  • Flexibility to quit a job, take a lower-paid job, etc
  • Live reasonably well. (Right now I live in a cheap, gross apartment BUT it’s in a great area and I have an indulgent $70/mo. membership to a nice gym.)
  • Retire, at some point in the very far future
So where should I put my savings? Should I open a 529 with the thought that I’ll probably use it, and if not, my kids will appreciate the early help? Split it half and half? Some in the 401(k) and some just in my regular investment account? In a year, when my profit-sharing kicks in (???), would your response change?

All righty, first a disclaimer– this is a bit more complicated than our usual financial questions and we are not financial planners.  Always do your own research and/or consult with a fee-based certified financial planner before making big money decisions.  When we say “you” here, we’re actually answering the question of what we would do in your situation.

First off, if you had an employer match, generally the no-brainer thing to do would be to put in money up to the match amount because the return on investment there is larger than anything else.  But there isn’t an employer match.  :(   Once the profit-sharing starts, it’s likely that the best bet will be to begin to contribute up to the match and then convert your company stocks to index funds as soon as your holding period is over (you don’t want to be in an Enron situation where your retirement savings are all in company stock– that increases your risk).  You will have to look carefully into the details of your company’s program when that time comes.

Before that time period, the next thing you should consider is the Roth IRA.  Roth IRAs are extremely flexible– they’re great for retirement, but the principal can be taken out penalty free while the earnings remain in the account.  Although you probably won’t want to take money out once you’ve put it in until you’re actually ready to retire, they provide more flexibility than your company plan, 529, or traditional IRA.  Max this out before even considering the 529.

Because you are (moderately) low income, the money that you put away for retirement may have an additional tax advantage, the saver’s credit  during your first year of work.  For example, if you started your job during the summer so you’ve only got half a year of income the first year on the job, then you would get a credit for something like 20% of your contribution at tax time.

If you can’t afford to max out your IRA with your monthly income, gradually convert your savings into tax-advantaged savings.

So, what would we do in your situation?

1.  Max out the Roth IRA each year using a Vanguard Target-Date fund from Vanguard.  (Alternatively, just put it in the S&P 500 index– you’re still young and have time to diversify your portfolio manually.  There’s a small additional fee for setting and forgetting for the Target-Date fund and you don’t need any bonds at your age/distance from projected retirement.)  Use your inheritance savings to do this if you need to, though at your current savings rate, you may not (a lot will depend on calendar year considerations).  Be sure to get the saver’s credit at tax time!

2. Make sure you have a reasonable emergency fund that will cover, for example, moving costs, or late reimbursements.

3.  In a year, look into the profit-sharing option and see what you need to do to get that.  If it is manageable on your budget, go for it, but make sure to convert company money to index funds as soon as they allow it.  (This is assuming it’s a standard profit-sharing match where the company is already established, if it’s stock options instead… that’s a much more difficult question.)  If you can’t afford to get both the match and do the IRA (but you should be able to given your savings), look deeper into your budget/emergency fund.  It is most likely that you will want to contribute to the profit-share up to the match and then max out your Roth IRA as much as you can, but there are some situations in which the profit-share wouldn’t be as good of a value as the Roth IRA.  Note that if the match is good, even if you don’t plan on keeping the money in your 401k, you may still be better off getting the match and then taking the withdrawal penalty than not taking the match.

4.  When time comes to go to graduate school, look at your projected student loan rates (and whether they’re subsidized or unsubsidized– the government may change its mind yet again about whether or not graduate students can get subsidized loans) and compare them to stock market rates (use ~7% for comparison if you don’t want to put in your own number) before deciding if you’d rather take the loan or withdraw savings/IRA principal.

tl/dr:  Put it in retirement, but in a way that it can be used for school in a pinch (Roth IRA).

What have we missed, grumpy nation?

Ponderings on college costs

We have saved $74,000 for DC1’s college so far.  That’s $500/mo for 8 years in a Utah Vanguard 529 account.

Is it enough?

I don’t know.

This basic calculator says we need to increase our contributions another $470/month if we want to pay full tuition for both kids at a four-year private school.

Will we need to pay the full amount for school, or will we be eligible for financial aid in 9 years (give or take)?

I don’t know.

Whether or not we have to save more for say, Harvard (easy-to-use calculator) depends a lot on assumptions– (using this year’s numbers and pretending inflation cancels out) DH loses his job, we’re eligible for mondo financial aid.  We get a combined raise of 40K (not that that’s going to happen given my salary hasn’t been matching inflation, but DH does work in tech!), we lose any eligibility.  I haven’t figured out how they treat retirement funds– if we include them as savings, we’re not eligible, if we exclude them we’re quite eligible.  Oh, and don’t leave 50K in your savings account when it can be hidden away elsewhere.

MIT (ironically painful to use calculator) says no financial aid at all unless DH loses his job.  Financial aid is pretty good on just my income alone.

I want to throw in an elite SLAC or two there, but I think it’s safe to assume they’re probably between Harvard (known for being giving at relatively high levels of income/savings) and MIT (known for its stinginess) in generosity and costs.  (Actually, I checked Wellesley from a Phil Levine link and it says we get no aid based on annual income alone, similar to MIT.)

74K is already more than ze would need to go to the state school I teach at.  But I know what it’s like here, and ze won’t be going.

Btw, in terms of the cost of education inflation, my underlying assumption is that tuition costs will rise about the same rate as the stock market, but more than inflation.  So if I had my eye on a local state college for DC1, I should stop now.  If I have my eye on private school, then we should probably increase our contributions each year along with our salary increases (if any…) to match inflation.  But who knows.

I guess we’re just going to keep on doing what we’ve been doing.  Even if it’s not enough.  Even if it might be too much.  Because I don’t know what else to do.  And it’s not that painful, really,  because we’ve been doing it for so long and it’s automated so we don’t even notice it.

Update:  related:  Another blogger looks at Stanford costs.  Almost everyone we know who went to Stanford is now a multi-millionaire (the one exception being our classmate who is now an international bum after getting an engineering PhD at an absurdly young age and burning out).  Oh, and one of us knows a guy who decided to get an English PhD after Stanford.  He’s also not a millionaire, to our knowledge.

[tiny rant warning]

I also have a serious problem feeling sorry for people like us [in the over 100K/under obviously-rich range] who complain about not getting financial aid at elite schools, as in this Tenured Radical post.  If your family makes a lot of money, even if it’s not Obama definitions of rich, you can still start early and save.  And there’s still plenty of places to hide money in order to keep eligibility at most private schools at those income levels (ex. retirement and your mortgage, also you may time your car replacement to decrease your cash savings).  This acting like you shouldn’t have to pay large amounts of money as if you didn’t know college was coming and so it’s all coming out of your annual paycheck is ridiculous.  And even if it *is* coming out of your annual paycheck, you’re still doing better than well over 75% of Americans.

In other words, I have trouble feeling sorry for the top 10% even if I’m one of them.  Even if things aren’t anywhere near as nice for us as they are for the top 1% or top 0.01%.  Even if I think that the government should subsidize public education more.  I still don’t see that as something that people like me need (except, of course, as a state university employee where I worry about the long-term viability of my employer, but you know, as a parent I’m doing fine).  It’s the other 90% that I care about.

[/end rant]

How do you decide how much to save for your kids’ college?  Do you feel sorry for the upper-middle class who might have to pay full-freight for their kids’ school, even though their ability to spend will still be pretty darn high?

Should parents pay for their childrens’ college?: A deliberately controversial post

A common discussion on PF blogs is whether or not parents should pay for a kid’s college education.  The discussants generally fall into two camps:  Yes, we are trying to save for it now (though often they don’t go into why) and here’s how, and No, we think kids should pay for their own education mainly to help build their character.

We at Grumpy Rumblings will flesh out some of these reasons, and discuss why we think some of the reasons may be more or less valid.

Yes:  Graduating without student loans is a great gift and can provide kids with a head start in life once they graduate.  They will also be better able to concentrate on their studies if they’re not forced to work all the time or go into massive debt.

No:  Kids whose parents pay may not take college seriously.  They may be more likely to goof off or drink or skip class etc.  College is expensive and parents should take care of their own wants and needs– kids can work or take out loans.  Learning how to pay off college loans isn’t a bad lesson.

Yes or No depending on your perspective:  Some of the differences in beliefs about paying for college seem to be in part class based.  One potential effect of parents paying for college is that students can follow what they’re interested in in terms of majors without having to think about how profitable that major is.  If you come from a privileged background, then being able to major in anything, even a *gasp* humanities major, is a benefit.  If you come from a less-privileged background, this may be considered to be a waste.  Similarly being allowed to experiment with different majors can be seen as a plus or a minus depending on the parent’s viewpoint.  Is college a coming of age experience vs. career preparation?  Is the goal to make the most money or to leave the world a better place?  One’s view of college depends greatly on one’s background.

What we think:

We do not believe that the best way to get kids to care about the value of an education is to make them pay for it.  The value of education in general can be instilled at home from an early age.  And if it doesn’t take, then we doubt that forcing the kid to work 40 hour weeks is going to make hir any more likely to attend class.  In fact, we think it’s going to make hir more likely to sleep through class if ze attends at all.  If that’s the case, then perhaps ze should be doing something else besides going to school.  #1’s parents paid 100% for her college education.  #2’s parents left her with a reasonable loan load.  They both took college very seriously, seriously enough to get into good graduate schools.

One thing that really bothers us is when wealthy parents refuse to pay at all for college.  The ones who value fancy cars and exotic vacations over paying for some of the kid’s tuition.  The problem is that when your parents are poor, you are pretty likely to get financial aid at some portion of the schools to which you’re accepted.  However, if you’re rich, that’s much less likely to happen unless you luck into some pretty amazing merit or sports scholarships.  That means a poor kid may be on the hook for 10K in subsidized loans after graduation, but a rich kid 40+K unsubsidized from a state school or upwards of 200K from a private school.  Even if the rich kid has had more opportunities K-12, it still seems to be an unfair burden to be on the hook for full-tuition with four years of unsubsidized loans.  Less wealthy parents should obviously secure their retirements first and their kids are likely to not come out with as horrific loan burdens precisely because of financial aid.

No matter what you decide, it’s a good idea to let kids know early on what to expect.  I felt so bad for my friends who applied and got in awesome places but then had to do 2 years at community college because their parents figured Hawaii and/or a new car was a better deal that year than paying some of the tuition at Dartmouth or Notre Dame.  On the other hand, knowing that I could go anywhere because my parents had been saving their whole lives opened up a world that would eventually propel me into a higher economic class.  If I hadn’t known I could go anywhere (and given how little money we had growing up, I wouldn’t have assumed I could), I might not have aimed as high.

Update:  Cherish the Scientist asks about her situation.

Do you think these reasons are valid?  Where do you stand on the paying for kid’s college education question?

Adventures in Retirement Saving: Part 4

Previously: Part 1, Part 2, Part 3

After a bunch more comparisons, I decided that Fidelity had the best options with its Spartan Index Funds available for fees of 0.10% and 0.20%, compared to TIAA-CREF at 0.34. I did two more things to make sure. First, I called up Fidelity and made sure that there aren’t any additional fees like there are with Ing and second that the full line of Spartan Index funds would be available (unlike Ing). A nice lady on the other end assured me on both those counts. The second thing I did was flip through the Bogleheads forums to see what people advised other people in my position. It looked like the majority thought Fidelity a good second choice if you can’t get Vanguard and TIAA-Cref a distant third.

Next up I decided to do some asset allocation. Sadly our library does not carry the Bogleheads Guide to Investing/Retirement and friends and family have declined to get it off my wish list for me for the past two years. I may have to buy a copy myself. In the absence of the book I scoured Google, the Bogleheads forums, and finance sites I like such as CNNMoney or the motley fool.

I’m somewhere in my late 20s early 30s, as is DH. I have a fairly high risk tolerance over the long term (but pretty low-short term). Some of the calculators I looked at suggested 90% stocks, 10% bonds, and the 120-your age rules suggests the same. Because of our IRA savings is 100% stocks, I figured 80% stocks, 20% bonds would be good for our 403(b) portfolios. I’m not currently counting either cash or our house in the asset allocations (or the 529), the former because that’s short-term stuff and I get all risk averse about it, the latter because I am viewing it as a place to live rather than an asset– if we have to sell we will be readjusting everything at that time anyway.

Within stocks and bonds, there are many different calculators and random peoples suggesting many somewhat different allocations. Here are a few examples:

(random bogglehead for someone my age):
55% domestic large cap
25% domestic mid-small cap
20% intermediate term bonds
This is equivalent to the US Total Market Fund and has no international exposure

(another random bogglehead for someone my age):
25% large cap
15% midcap
15% smallcap
25% international
10% emerging market
10% bonds

(a random bogglehead for a college prof my age):
25% S&P (large cap)
25% Extended (I don’t know what these are)
30% international
20% intermed treasury bonds

CNN Money’s Calculator
10% Bonds
50% Large Cap
20% foreign
20% smallcap

Bankrate and a bunch of other places with the same calculator
25% large cap
23% midcap
18% smallcap
17% foreign
8% bonds
9% cash

Some other folks recommended FFNOX which is a mixed index with a 0.22% fee
It is something like just under 50% S&P, just under 25% international, 15% bonds, 13% extended market, give or take a few % (and adding up to 100).

As you can see there’s a lot of variation, but in the end it probably won’t make a whole lot of difference. I did see some allocations that I did not care for– 50% stocks, 50% bonds, or 25% of 4 different random asset classes (or 1/N of some other set of asset classes). If you are overwhelmed though, doing 1/4 for four different index funds is not going to hurt you too badly, especially if 3 of them are stock funds and one of them is a bond fund. Satisficing will always beat paralysis in investing for the long-term.

I do notice that there’s a lot more pre-made portfolios for Vanguard Funds, so it took a bunch more searching to figure out what exactly the different Fidelity funds are. I like Yahoo’s paragraph long descriptions best, but the bogleheads forum was also full of interesting information. From this I found out that Fidelity does not do emerging market funds in index form– if you want them you have to pay a lot for them. Secondly, they’re not so big on small-caps, their mid-cap FSEMX does have small-cap but they call it a midcap. Also their total market fund FSTMX is listed under largecap, but actually contains you know, the total market, or 80% of it anyway.

So what am I going to do? (expense ratios in paren)

20% Bonds FIBIX (0.20)
40% Largish Cap FSTMX (0.10) I’m choosing this total market index over the S&P 500 FUSEX because my IRAs are almost but not quite 100% in domestic large cap Indexes and ETFs, so this tilts a little more towards small/midcap.
20% Foreign FSIIX (0.20)
20% Small-Mid Cap FSEMX (0.10)

If you have any idea on any of this stuff, I’m still a newbie… am I messing up? I’m wondering if I should just go 10% bonds. It’s a long time before retirement, or at least before I’ll be drawing down, and the expense ratio is 2x as big, even though it’s still less than 1/7 of what I was paying before. I guess to know the answer to that you’d have to know how much was in my IRAs and I’m not entirely sure on that myself– I tend to ignore the retirement accounts. Last I knew it was about the same size of my current 403(b) but the 403(b) will be growing a lot more starting this year now that I know we’re not limited in contributions.

Unlike Ing, Fidelity doesn’t want to send people around so they’re just sending us the paperwork, though I do have a number for a person in case we get overwhelmed by how to switch our mandatory retirement plan from ING and start the new elective 403(b).

What do you do for your work plan? Do you have access to Vanguard and their wonderful Target date funds? Were you as overwhelmed as I am? I think I’ve got a better handle on it now though.

Ask the grumpies: When to get a fee-only planner?

Ali asks:

When does it make sense to get a (fee only) planner?

Disclaimer:  We are not professional financial advisors.

I think the answer to this question is going to vary a lot.  I think most people don’t actually need one if they are making a reasonable amount and managing to put away 15-20% of their income away for retirement.  Those folks can just use a low-fee index-based target-date fund, continue paying down their mortgage (on schedule or early), and doing whatever system they use for budgeting shorter-term needs.  There’s just not much there that a financial planner can add that will be better than the basics, and unscrupulous folks can give so much worse advice (hence the (fee only) that you mention in your question).

People who are low income generally can’t afford a fee-only planner.

In some cases, I’m not sure if it would be better to get a financial planner or an accountant or lawyer who specializes in your particular problem.  For example, say your parents die and their finances are a tangled mess.  You might want a forensic accountant or to hire someone from a team that specializes in this kind of untangling (my mom says she plans to use Charles Schwab should my father pre-decease her).  Or let’s say you’re obscenely wealthy and interested in cheating the tax man– a tax attorney seems like the best bet for finding and exploiting loopholes.

Money Under 30’s perspective on this question.  Here’s smart-asset on the different kinds of fee-only financial planners.  Here’s the simple dollar’s answer to this question.

The Simple Dollar’s post seems the best of these three to me, though I have some commentary on it.

1.  I think that yes, it makes sense to hire a financial planner for a limited number of sessions (so not as a % of assets, and not as a retainer) to develop a retirement plan when you’re nearing or in  retirement.  They can tell you how to best withdraw your assets, any rebalancing you should be doing, and how to best deal with the spousal issues involved in claiming social security.  You can find all of this out yourself, but it’s complicated and is probably worth a $1K one time fee for many people.

2.  Starting a family– I don’t really see this as a good reason to hire a financial planner.  If you’re super wealthy, then you’re going to want to be talking with a financial lawyer to get trusts and things figured out.  The point that if you’re joining finances– that again seems like something you should be talking to a lawyer who specializes about.  I don’t think a financial planner will be much value added for most college savings plans either– $1K or more seems like a steep fee to be told which 529 plan to use and to put numbers into a “how much should I save” calculator for you.  The answers won’t be any better either.  Maybe if you’re high income there will be some good advice about how to game the system, but a financial accountant may be better able to help with that.

3. You’re a high earner.  A financial planner may be able to help… but a good accountant will probably be able to help more.

4.  Self-employed.  See #3.

5.  You have high net worth.  See #4.

6.  You have a specific planning need.  Maybe?  But again, having a child with long-term special needs seems more like a lawyer thing than a planner thing.  But perhaps a lawyer in conjunction with a planner (one to set up a trust, the other to talk about … how to fill the trust?  I don’t know.)

So… I guess my best suggestion is if you feel like you need one as you’re approaching retirement, go for it.  Don’t set up a long-term relationship where they get 1% of your assets each year though.  Just get things figured out.  For the other things, think about if you need an accountant or a lawyer instead.  And if you don’t know what to do or who you should hire for your specific situation, I think my first step after googling would be to make a bogleheads account and ask on their forums.  They seem to give really sensible advice, better than many financial planners, and it is free.

Grumpy Nation, have you ever used a fee-only planner?  Was it worth it?  When would it make sense to you to get one?

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Ask the grumpies: How do you approach diversification?

Ali asks:

We are good savers but I fear not great investors (i.e., I have a good bit just sitting in the bank now because I don’t know what to do). How do you approach diversification?

Disclaimer:  We are not professional anything except academics.  Consult with a fee-only financial planner with fiduciary responsibility and/or do your own research prior to making major decisions about your money.

If you don’t know what to do and your money is just sitting in savings, the easiest thing to do is to pick out a retirement date (or house purchase date or whatever) and buy some of Vanguard’s target date fund for that year.  It will take care of diversification for you both right now and over time and you’re done.  (You can also mimic it on your own by purchasing the major indices in it.  Mimicking it will save you some money early on (far from the target date) when there’s not much movement because you’re not actually doing much rebalancing early on– you’re mostly in stocks.  It is still better just to buy the target date than to leave it in the bank trying to figure out how to mimic.)

Here’s #1’s original post about how she decided on percents in her retirement account.  They’re probably a bit conservative (too bond-heavy) for when she was younger, but are more appropriate now.  But #1 wasn’t trying to optimize– diversification isn’t about optimization, it’s about getting decent returns while still staying safe.  In fact,  diversification will always return lower than some subset of undiversified portfolios (it will do better than another subset though!).

Let’s step back a little bit an think about why we diversify.

Diversification is all about moderating risks.  We put some money in stocks, which are high risk/high return and some money in bonds which are lower risk/lower return because bonds keep their value in downturns while stocks are likely to lose value (but stocks shoot up high in up-turns while bonds… keep their value).  We keep some money in cash in the bank because it keeps its value and can be drawn on quickly in an emergency.  In general, we want money that we will draw on decades from now to be in stocks and money we will draw on within the next 5 years in something more accessible like cash or bonds.  The closer you get to your target date, be it retirement or buying a house or starting college payments, the more safe and accessible you want your money to be (with some disclaimers for college savings as where those are put can affect financial aid).

More advanced asset allocation will have you thinking about blue chips vs. tech stocks or emerging markets and international markets.  But the thing is, if you’re at the point where you’re not sure what to do with your money, you can just ignore these.  International stock indices tend to have higher fees.  If you get a broad-based index fund it will already include blue chips and tech stocks.  If you get a target-date fund, it will most likely include emerging markets and international markets in addition to bonds.

Diversification can also hide money from creditors like colleges or debt collectors.  Your primary residence has certain safety threshholds depending on where you live, but it can also be taken away if you use it to secure debt (as with a mortgage).  Your retirement savings is often protected.  Trusts and companies are other ways of protecting assets.

So… I recommend some thought exercises.

1.  Do you have an emergency fund that can cover reasonable emergencies (ex. water heater explosions, a delayed reimbursement, etc.) until your next paycheck?  That should be your first priority.

2.  Are you investing up to the match in your employment retirement account?  If you have low-fee options, put it in a target-date fund.  If you don’t, then compare the fees for the different index funds and pick a broad-based fund (if all things are equal, try to get one that matches the total market or the Russell 5000, but if the cheapest fund is the S&P 500 get that, and it’ll be ok).  For additional retirement savings it’s all about your employer fees and whether you qualify for an IRA and if you want to do a backdoor IRA.

3.  What are you doing about housing?  How much of your house is your net worth?  Do you want to buy a house in the future?  If you already own a house, how accessible is the money in case of an emergency (ex. having to move and the house not selling right away)?  For many people, the house is their main form of retirement saving besides Social Security, but in terms of diversification, this is not a great idea.  On average real estate goes up at the rate of the markets, but that’s the average– owning a single home doesn’t give you the average (it is the opposite of diversification).  If your housing market drops, you could lose a lot of savings (of course, it can go the other direction as well– we have friends in California who bought in 2008 and have gained a million dollars on paper since then).  So try not to invest so much in a house that having the market crash could devastate you.  Note though that whether or not you think it is ok to foreclose should also guide how much you’re willing to have in housing mortgage debt vs. equity (vs. renting).  In general, we do not recommend home-ownership unless you can put 20% down– yes lots of people manage ok putting less down, but lots of people were also put in bad situations having to short-sell or foreclose during the last housing crisis.  Basically, think about the worse case scenario and what would happen.

4.  When do you need the money that’s sitting in your bank account wanting to be invested?  If it’s less than 5 years, you can leave it there, or put it in cd ladders.  If it’s more than that, think about your time horizon–   are you investing for college?  Use a 529 (put it in one of their target-date funds).  Are you investing for retirement?  Use a target-date fund (or read some bogleheads forum about people in your situation).  Are you planning on buying a house in 8 years? Put it in a taxable mixture of stocks and bonds (what mix?  depends on how flexible your plans are given the vagaries of the market– to be honest, we just put it in the S&P 500 and cds as we got closer.)

Always do a mental run about what you expect on average to happen and what will happen in a reasonable worst case scenario (ex. 2008 stock market drop plus job loss, keeping in mind that the stock market increased before the drop, so it’s not like it’s 40% off what you put in, but 40% off what you put in plus your gains– the longer you’ve had it in the market, the more money you still have even after the drop).

Because a lot of diversification is about avoiding the low lows even if you miss out on the high highs.

And about acknowledging that long-run risk is different than short-run risk.  In the long-run, stocks will go up more than bonds or savings.  In the short-run, stocks are risky.

Satisficing will get you pretty close to optimizing risk vs. return.  A Vanguard target date fund is probably good enough, and it’s definitely better for long-term investing than just leaving money in a low interest savings account.

Here’s some next stage financial advice. Resources for asset allocation.

Grumpy Nation, how do you approach diversification?