College Savings 101

college savings

The college acceptance letters have been tucked away and it is a time of senior-itis, prom nights, and graduation celebrations. Spring of senior year in high school is an exhilarating and anxious time for students and their families preparing for the transition to college. Now come the nuts and bolts of paying for it… have you set your student up well for this next phase? There are some strategic decisions that can and should be made to make sure your high school senior (and your family) have more excitement and exhilaration and less anxiety when the time comes!

Currently, the most popular and arguably the most appealing college-savings options are the state-sponsored 529 plans. According to the College Savings Plans Network (CSPN), the popularity of these funds has steadily grown and increased the last decade’s assets by upwards of $100 billion. 529s offer Federal and usually state tax benefits through tax-free investment earnings on accounts ultimately used for qualified education expenses. They allow (and encourage) parents, grandparents, and relatives to participate in the student’s future. And, 529s will not usually affect financial aid status. Another plus is that the unused assets of 529s can transfer to another family member for qualified costs. Each state offers unique versions of these federally tax-exempt plans that generally fall into three categories: direct-investment, advisor-sold, and pre-paid or guaranteed funds.

The direct-investment options offer the greatest flexibility and choice with lower fees and typically no commissions. Regardless of your residency, most state plans are available to all. However, there may be additional tax benefits by using your state plan, as in South Carolina, where you can deduct contributions from your state taxable income and save 7% tax on each dollar spent. Some states, like Illinois, cap their allowable state benefit. Investment menus of plans include either passive (index) funds, actively managed funds or both. Historically, the passive funds have outperformed. Furthermore, funds can be allocated on an age-based option or, what we prefer, a target allocation option, reviewed and rebalanced over time. The ceilings for maximum contributions on direct investment accounts range from $235,000 to $450,000, which can then cover the costs of all tuition, room and board, books, travel, etc.

Guaranteed or pre-paid options are designed to have contributions keep up with the increasing costs of tuition. If you contribute an amount equal to a year’s tuition today, the student will get credit for a full year of tuition when he or she enters school, regardless of the then current cost. Hence, the pre-paid options do protect your investment from any market volatility, but have lower maximums and less flexibility. The advisor-sold 529 plans are also less flexible in investment strategy and pack on higher fees for commissions and management costs. 

Other college-savings methods can be a Uniform Gift to a Minor or Trustee (UGMA/UTMA) which are not tax-exempt after the $14,000 gift tax exclusion and also will transfer to the beneficiary at the age of majority. However, these assets have much greater investment flexibility and the first $1,000 of annual earnings (2013 and 2014 limits) are not taxed to the student. Other regular investment accounts provide greater investment flexibility, but earnings are taxed at the owner’s rates. Straight savings options are out there in the form of bonds or an education IRA (Coverdell Education Savings Account), which are tax-exempt for qualified education costs.

There are many options worth reviewing to prepare for the ever-increasing costs of tuition. Some models predict that education costs will more than double over the next 15 years. Starting the process early and putting together a plan with the right mix of contributions, investment selections and tax benefits will help ensure that your student’s high school graduation someday will be all celebration and very little worry about paying for higher education. It will be here sooner than you think!

Economist: “Pope Francis as a Turnaround CEO”

pope francisRegardless of your religion, you have to admire Pope Francis. He’s done a remarkable job in his first year in office, including an 85% approval rating from American Catholics. The Economist and other publications have started calling the septuagenarian Argentine as one of the great turnaround CEOs; similar to Apple’s Steve Jobs and IBM’s Lou Gerstner.

One could think of the Catholic Church as perhaps the oldest multinational organization. For the past few decades, its brand has been in trouble. When, Pope Benedict XVI, became the first “CEO” to retire in 600 years, the College of Cardinals (as the “Board of Directors”) appointed Pope Francis to re-launch “Brand Vatican.”

In just a year, the brand has recovered significantly. It has done this by focusing on three management principles important to organizations of all forms and sizes.

First, core competencies. Pope Francis has refocused his organization on one mission: helping the poor. He took the name of Saint Francis of Assisi who is famous for looking after the poor and animals. He moved out of the papal apartments into a boarding house. He swapped Benedict’s red shoes for plain black ones and ditched his Mercedes for a 30-year-old Renault for his trips within Vatican City. On his first Holy Thursday, he washed the feet of young prisoners in an act of uncommon humility.

The new focus has not only demonstrated the Pope’s willingness and ability to walk the walk, but also has reduced costs. In addition, the Economist believes the “’poor-first strategy’ is aimed squarely at emerging markets, where the potential for growth is greatest.”

Second, brand repositioning. Pope Francis clearly continues to support traditional teaching on abortion and gay marriage, but in a more modest way than his predecessors. He recently asked homosexuals, “Who am I to judge?”

Third, restructuring. One of Pope Francis’s first actions was to form a group of eight “super” cardinals from around the world to advise him on government of the Church and to study a “project of revision.” In addition, he has hired McKinsey and KPMG to look at the Church’s administrative structure and overhaul the Vatican bank.

The other key ingredient is that Pope Francis seems to actually love his job. Father John Wauck, a professor at Opus Dei in Rome, told NPR that he has seen many popes, but what separates Pope Francis’ leadership is his positive disposition. “He is not a showman in the way John Paul was, and he’s not retiring the way Benedict was. Francis is completely comfortable in his own skin. He is transparently a happy man.”

Pope Francis offers some great lessons that go well beyond religion. These include loving your job, focusing on your core competencies, being mindful of your brand, and not being afraid to monitor and restructure when change occurs. Great goals for all of us.

DWM 1Q14 Market Commentary

Brett DetterbeckGrinding higher. That’s what the markets did in the first quarter of 2014, evidenced by both the S&P500 Equity Index and Barclays US Aggregate Bond Index, registering a 1.8% advance. There may be a sense of calmness now, but January tested investors’ nerves with stocks experiencing one of their worst months in a long while. What we liked seeing was how the liquid alternatives investments that we follow performed during that time.  As a group they had a positive result, thus behaving in a non-correlated manner to stocks which is exactly what we like to see.  Please recall that the use of multiple assets classes helps to smooth out overall results, which leads to better long-term results. January served as a good reminder why it is necessary to look beyond just the equities asset class.

That being said, we aren’t “Debbie Downers” on stocks. We think for most investors they should represent a majority allocation. Frankly, there is a lot of good news out there:

  • Continued low interest rates and the belief that, even as the Fed pulls back from its most aggressive measures (i.e. “tapering”), it will keep them low for an extended period.
  • US growth remains on track, enough to keep currently strong corporate earnings rising.
  • The job market is slowly but steadily improving.
  • Consumers and companies that delayed spending during the harsh winter may soon be playing catch-up from pent-up demand.
  • Housing is no longer a drag.
  • Political parties in Washington have actually been cordial lately, and somewhat productive.
  • Outside of the US, Europe’s economy is seen as slowly mending.
  • The violent swings in emerging markets have calmed after central banks moved swiftly to defend their currencies by raising interest rates thus luring investors with higher returns.

On the flipside, it’s not all coming up roses entering 2Q14:

  • The Fed has done a great job of late walking its tightrope on tapering. Nevertheless, nervousness comes hand in hand with the Fed’s plan to end unprecedented efforts to aid the economy which could lead to choppy waters.
  • The stock market is showing some strains. For example, many investors in the first quarter shifted from growth companies to value companies, suggesting that some sectors may have run their course.
  • From a fundamentals perspective, stocks in the S&P500 were trading at 15.2 times the next twelve month’s expected earnings, which is higher than the 13.2 times average of the past five years, and 13.8 times average for the last decade.
  • There has been a lot of soft economic news out of China. With China being the second biggest country in terms of GDP, the whole world can feel the effects of their hiccups.
  • Cold War nervousness – all bets are off if a huge geopolitical issue unfolds. Frankly, it was pretty amazing how investors shrugged off the Crimea headlines, but who knows what the next event will be and what it will bring.

It might be overwhelming to think about all the factors at play and how they can affect you and your portfolio. But no matter what the world throws at you, remember we cherish our role as our clients’ first-line of defense for their portfolio and helping them reach long-term goals. We take pride in filtering out the noise and keeping them abreast of what is really important.

Consider talking to a wealth manager like DWM today if you feel like you’re lacking that first-line defense and want help in achieving those long-term goals.

Brett M. Detterbeck, CFA, CFP®


Michael Lewis Strikes Again with “Flash Boys”

flash-boysOur regular readers know that Michael Lewis is one of my favorite authors.  His books such as “The Blind Side”, “Moneyball”, “Liar’s Poker”, and others are great reads. He focuses on a significant development in an industry, finds compelling characters and tells a great story. He’s done it again with “Flash Boys”, which focuses on high-frequency trading (“HFT”) and how we investors are being scammed by the HFT firms Lewis dubs as “Scalpers, Inc.”

Michael Lewis started his career with Salomon Brothers in the mid ’80’s as a bond salesman. Back then, trading was done by humans; think of “thick-necked guys in color-coded jackets standing in trading pits hollering at each other.” The Black Monday market crash of October 19, 1987 changed all of that. It set in motion a process where today all trading is being done by computers, not humans. HFT is a type of rapid algorithmic trading. The faster the better.

After the collapse of Lehman Brothers in 2008, exchanges such as the NYSE started a program designed to add competition and liquidity to the market. They pay HFT companies a rebate of $.0015 for doing this. But the real money for the HFT firms is matching orders. Acting as intermediaries to buy and sell securities, they are in a unique position to do this in a way that can provide them a nice profit.

Discount brokerages such as E*Trade, TD Ameritrade and Charles Schwab are paid by the HFT wholesale companies for their order flow. The HFT firms capture tiny profits on many of the trades, without even using the exchanges. It’s big business. It’s estimated that HFT companies generated $5 billion of revenue in 2009. For 2013, about $1 billion.

It’s all legal. The speediest HFTs have great advantages. They can co-locate their equipment inside the exchanges, their orders go to the front of the queue, and they can pay to get early peeks on news releases. This information allows them to front-run orders- knowing how someone is going to trade and profiting from getting in front of that trade. The result is that some HFT traders claim to be profitable on over 99% of their trading days. Making pennies on transactions, but millions of them, with virtually no risk- ergo, “Scalpers, Inc.”

Charles Schwab & Co. declared last week that “HFT is a growing cancer that needs to be addressed.” Schwab believes HFT has “run amok and is corrupting our capital market system by creating an unleveled playing field for individual investors and driving the wrong incentives for our commodity and equities exchanges.” Schwab continues, “HFT isn’t providing more efficient, liquid markets; it’s a technological arms race designed to pick the pockets of legitimate market participants.”

Michael Lewis isn’t the first or only person to focus on HFT. Two years ago, Scott Patterson of the WSJ wrote a book titled, “Dark Pools: The Rise of Machine Traders and the Rigging of the U.S. Stock Market”, which also exposed the scam. What’s great about Michael Lewis is that he really has brought major attention to the problem. His appearances on “60 Minutes” and other shows have become ubiquitous over the last two weeks. The F.B.I., the Justice Department and NY’s Attorney General, and the SEC are now investigating HFT.

The dollar impact on a typical investor’s portfolio is tiny- probably less than $50 per year on a $1 million portfolio. The real problem is bigger than that.

HFT undermines integrity and causes the market to lose credibility and investors to lose trust. This hurts our economy and our country. I’m glad that Michael Lewis has brought attention to HFT. There are alternatives. There is even a new exchange that has been created by Lewis’s hero in the book, Brad Katsuyama. The focus of IEX Group Inc. is all about fairness and transparency. Its website describes IEX as “A Market That Works for Investors.” What a novel idea!

Grim(m) Waters: Will New Flood Rate Legislation Help Property Owners Stay Afloat?

Floating houseThere has been much discussion and legislative wrangling about flood insurance rates and how properties rated for high flood risk should be paying to insure that risk. In 2012, the Biggert-Waters Flood Insurance Reform Act eliminated flood insurance subsidies for those properties and sought to introduce true risk ratings for all properties needing flood insurance. This generates some huge increases in premiums for some of the most at-risk areas and could leave many affected owners unable to afford their properties and dampen home sales in those areas. Hundreds of small river towns and coastal communities in every state with significant numbers of homes and businesses in flood hazard zones are at risk. There are about 5.5 million policies in force today, about 20 percent of which are subsidized. New 2014 legislation will delay many of the increases to help minimize some of the immediate negative impact.

Congress created the National Flood Insurance Program in the late 1960s, in part because private insurers had abandoned the market. Today, in most places, it is the only option for buying flood insurance, which is required for most mortgages on any property in a flood hazard zone. There are two ways that insurance rates can be affected. First there is the system used by the NFIP to rate properties according to their base flood elevation (BFE) and the lower the elevation level, the higher the risk for those properties. Many insurers are now requiring elevation certificates at renewal. Another way is through Flood Insurance Risk Maps or FIRM. New FIRMs are being issued nationwide. When the new FIRMs take effect, some residents and business owners will learn that their properties’ flood risks have changed and that their homes or buildings have been mapped into high-risk flood zones. In order to combat the cost of higher premiums for these properties, the government has previously provided subsidies on the high hazard properties or on those that were built before the flood rate maps were drawn in 1975, also called Pre-FIRM properties. Previously, these properties were allowed a “grandfathered” rating offering lower and subsidized premiums. The 2012 legislation was enacted in an effort to eliminate the large accumulated debt carried by FEMA through the NFIP after recent significant storm claims, in large part from Hurricane Katrina and Superstorm Sandy. The law eliminates grandfathering and subsidies for the flood hazard areas. Legislators felt the rates should reflect the true cost of the risk and wanted to use the increased premiums to reduce the Programs’ debt.

However, in response to an outcry by property owners who sometimes have seen their flood insurance bills increase by 5-10 times current premiums, new legislation signed in early March by President Obama reverses or postpones some of the increases from 2012. This new 2014 Grimm-Waters bill will allow for gradual increases to the full actuarial rates, restoring the “grandfathering” and capping annual increases between 5%-15%. Still, some secondary homes or businesses and severe repetitive flood claim properties will see premiums increase by 25% annually until the actual targets are met. Although the new legislation was signed, it will take FEMA and the insurance carriers several months to put the reduction policies in place. The new legislation also calls for refunds of increased premium payments generated under the existing legislation. Property owners are eligible for a refund once the new requirements are processed.

Some communities, like Charleston, SC, have undertaken proactive ways to improve their flood rating and help residents lower their premiums. The National Flood Insurance Program’s (NFIP) Community Rating System (CRS) is a voluntary incentive program that recognizes and encourages community floodplain management activities that exceed the minimum NFIP requirements. Communities are given certain points for public information or city regulations, for example, and then given a rating. A decrease for a community’s class rating can translate to as much as a 20% savings in premiums.

Flood insurance is necessary for many communities in these hazardous waterfront zones. Legislators are working to balance the cost for the affected individuals with the burden to the taxpayers for carrying flood subsidies. Certainly, the goal is to minimize the economic impact that higher premiums have on the housing market and help property owners keep their heads above water… It is a work in progress as they put these regulations in effect.