Now’s the time to plan your 529!

Summmerrrtttime!  Every day in the summer at our office here in Charleston, we are regaled with the carriage tour drivers’ versions of this famous song from Porgy & Bess.  We end up having that song stuck in our head a lot of the time!  Already the ads for back to school sales are appearing and it reminds us that, while the “livin’ is easy” right now, the hustle of getting kids ready to head back to school isn’t far away.  We hate to interrupt your summer fun, but it is a good idea to get ready for college tuition payments no matter what age those students are!

We wanted to highlight the particular advantages of using 529 plans for funding your education purposes, as it is the most cost-effective way to manage the expenses of higher education.  Enacted in 1996, Section 529 of the Internal Revenue Service Code allows an account owner to establish a plan to pay for a beneficiary’s qualified higher education expenses using two types of plans – a pre-paid tuition program or the more popular, state-administered college savings plan.  The beneficiary can be a family member or friend or an owner can set up a 529 account for their own benefit.  Anyone can then donate to the account, regardless of the owner or beneficiary.  Funds can be deposited and used almost immediately (need to wait 10 days) or can be invested and grown until needed.  Surprisingly, according to a Wall Street Journal article recently, only 14% of Americans plan to use 529s to pay for college.

Although there is no allowable federal tax deduction for 529 contributions, the income and gain in the account are not taxable, as long as they are used for qualified education expenses.  These qualified expenses include tuition, room & board, books and, in a 2015 legislative change, payments for many technological expenses like a computer, printer or internet access, even if not specifically required by the educational institution.  The costs for off-campus housing can also qualify, as long as the amount used matches the average cost of resident-living at your university.  Many states, like SC and IL, also allow a tax deduction for 529 contributions to in-state plans.  Another recent legislative change allows for an increase from one to two annual investment selection changes per year, unless there is a rollover and then a change can be made at that time.  This gives the 529 owner a little more benefit, flexibility and control over their accounts.

When funding 529 accounts, we recommend that our clients not fund more than 50% of the total cost of estimated expenses for the education of their student before the student selects and starts college.  One nice feature about 529 plans is that they are transferrable to a sibling or other close family member, if a student doesn’t use or exhaust their entire 529 account.    However, you don’t want to overfund an account and then have some leftover.  Only the gains in the account are taxed, but there is a 10% penalty on the account if the funds are withdrawn and not used for qualified education expenses.  Another reason for not overfunding is that there are many scholarships available – you may have an accomplished science whiz or an amazing athlete that earns scholarship money.  Once final amounts of tuition requirements are determined, 529 account owners can make necessary additional contributions to take advantage of tax benefits.

There are many scholarship opportunities available for those who take the time to look and apply.  Checking with the high school guidance counselor, local civic groups or community organizations about scholarships or awards opportunities can give your high school student some hands on involvement in paying for their own education!  All high school seniors should also fill out the annual FAFSA (Free Application for Federal Student Aid).  There are many opportunities for earning money for college and nothing should be ruled out.

We know that using 529 accounts is the least expensive way to pay for college.  Research shows that the most expensive way to pay is by taking out student loans or paying out of pocket as the student needs it.  At DWM, we want to help you strategize how to save for and pay for any education expenses that you may have before you, no matter when those costs are expected.  We can help you evaluate the various state plans and the investment options in the 529s and calculate an appropriate annual or lump sum amount of savings.  We will be glad to help make your summertime livin’ easy and carefree!  Okay, now back to summer fun…already in progress!

Warning: Alternative Facts May be Hazardous to your Portfolio Returns

Alternative facts may work sometimes in business and politics, but they don’t work with investments.  Returns are based on reality, which can be complicated, random and uncertain.

30 years ago, in his book, “The Art of the Deal,” Mr. Trump extolled the virtues of “truthful hyperbole” which he described as “an innocent form of hyperbole-and a very effective form of promotion.”  In interviews over the years, Mr. Trump has inflated everything from the size of his speaking fees to the cost of his golf club memberships to the number of units he had sold in his new Trump buildings.   His decades of habitually inflating claims about his business acumen and his wealth have helped produce lucrative licensing deals for the Trump brand around the world.

It is no surprise that President Trump has continued his pattern in his first days in office.  He has made inflated claims about how many people attended his inauguration, his insistence (contradicted by his own Twitter posts) that he had not feuded with the intelligence community, or his claim that Hillary Clinton won the popular vote only because millions of people voted for her illegally.  No worries. Trump adviser Kellyanne Conway simply refers to these as “alternative facts.”  Others might call these falsehoods, some would call them lies.  Regardless, they are part of the “post-truth” era in politics.  Very disturbing but apparently part of the current political landscape. Overall, it reminds some people of George Orwell’s “1984” in which the Ministry of Truth had three slogans:  “War is peace.  Freedom is slavery.  Ignorance is strength.” Yes, very scary.

Even so, in business and politics, alternative facts may be effective.  Voters live in their own bubbles of perception and confirmation bias.  Once they lock in on a candidate, it’s tough to change their minds regardless of subsequent facts.  It’s true- all of us have patterns of irrationality.   We all get lead astray.  This is described brilliantly in Michael Lewis’s new bestseller, “The Undoing Project.”  We can become victimized by the “halo effect” in which our thinking about one positive attribute causes us to perceive other strengths that aren’t really there.  Another is “representativeness” which leads us to see cause and effect when we should accept uncertainty or randomness.  Mr. Lewis showed how pioneer behavioral economists Daniel Kahneman and Amos Tversky demonstrated that all of us misanalyse all sorts of situations, in business, politics, and everyday life.  We accept alternative facts rather than true reality.

Investors can lose lots of money when their beliefs diverge from the reality and they are led by alternative facts and subjective reality.  They believe they understand major issues; such as how tax reform might impact corporate earnings, the odds for a recession, and repatriation of overseas capital.  The real problem is their absolute certainty in areas which are, in reality, uncertain or random.  (The U.S. election results and the markets’ behavior thereafter is a great example).

The subjective reality investor imagines they can understand complex issues and predict what the marketplace will do and even how specific sectors and individual securities will perform.  They exhibit “representativeness,” believing they understand the cause and effect, when it fact they should accept uncertainty or randomness.  Subjective reality investors often believe they know how to “time the market” which has been shown to be a losing strategy over and over again.  Even full-time mutual fund “active” managers consistently underperform benchmarks over time.  Using alternative facts and subjective reality, these subjective reality investors put their (and others) capital at far more risk than they should.  Sometimes they get lucky, most often they don’t.

What really gets these subjective reality investors in trouble is the difference between fact and opinion and falling prey to overconfidence.  No one knows the future.  None of us can possibly comprehend all the forces at work every day and how these continually change.  Each of us has our own baggage we bring to our decision-making every day that turns facts into opinions and often truth into alternative facts.

At DWM, we always say, focus on what you can control and respect what you can’t.  Establish a diversified portfolio with an asset allocation commensurate with your risk profile.  Keep costs low.  Stay tax efficient.  Stay invested.  Stay disciplined.  Monitor results and rebalance as necessary.  Don’t try to time the market.  Don’t think you’ve found the “silver bullet.”  Don’t kid yourself-your subjective beliefs and alternative facts can be hazardous to your portfolio returns.

Recent Success Projects Cubs to Win 2015 World Series!

cubs_headlineIt’s simple. The Cubs have won eight of their last nine games. If that pace continues for the next nine games, the Cubs will win the World Series for the first time since 1908. Wouldn’t that be wonderful!

Yes, let’s hope the Cubs do, in fact, get to the World Series and win it. However, how they fared in the last nine games may or may not extend for the next series or two. We don’t know what’s coming, although we would certainly love to see a Cub dynasty for the next century as was forecasted in 1908, based on the 1907 and 1908 victories. As you can see, it’s easy to use our recent experience as the baseline for what we think will happen in the future. In behavioral terms this is called “recency bias.”

Behavioral biases can have a big impact on our decision making, particularly in investment matters. As Jason Zweig points out in his book “Your Money and Your Brain”: “When you win, lose, or risk money, you stir up some of the most profound emotions a human being can ever feel.” It’s a very important topic. Brett and I will be talking about some of these behavioral biases at our seminars in Palatine on October 28 and Mt. Pleasant on November 4th.

The recency bias is one of the reasons undisciplined investors chase performance and buy high and sell low. When a bull market keeps rising, it’s not surprising that people will forget about the ups and downs in a typical market cycle and believe this upward trend will last forever. They keep adding more equities to their allocation and then are shocked when the bubble bursts.

Similarly, when the market is down, they become convinced that it will never go up again and emotionally want to put their money in a mattress. When investors sell low they are typically victims of the recency bias. Of course, these same folks will “jump back in” after the markets have come back and by then have missed out on much of the recovery.

Recent events are easier to remember and understand than either events in the distant past or unknown events in the future. Rather than doing the hard work of analyzing/understanding the full range of possibilities (both positive and negative) in the future and assessing/understanding probabilities to each, investors emotionally really don’t want to be “confused with facts”. Using recent events to make quick decisions is easier and in many circumstances in our daily lives it can work well. However, recency bias can be a problem when it impacts our investment decisions.

Recency bias gets amplified in down markets. Behavioral finance has demonstrated that fear is a stronger emotion that greed. So, in a year like 2015, when, after a strong January and February, the markets first go sideways and then start declining, the fear of losing money coupled with the recency bias of a weak market naturally causes people to worry about their funds, and for undisciplined investors to want to put money into cash.

Behavioral finance is a tremendously interesting topic. We look forward to seeing many of you at our seminars where we will discuss more about investor biases and how to avoid falling prey to them. And, perhaps by the time we meet, the Cubs will actually be on their way to winning the World Series. Let’s hope the prediction from the movie “Back to the Future 2” comes true. Go Cubs!

BacktothefutureCubs

Women and Money

woman-and-calculatorWe hear so much about a ‘gender gap’ in incomes between women and men. Patricia Arquette received a standing ovation during her Academy Award acceptance speech for her rallying cry for wage equality. But when it comes to women and money, it seems what we really have here is a ‘confidence gap.’ We are all perhaps influenced by the many stereotypes about a female’s approach to money. Women are sometimes characterized conversely as bargain-shoppers or shopping addicts. Maybe this comes from the idea that men are the hunters and women the gatherers, a “Men are from Mars and Women Are from Venus” explanation for different behaviors by the sexes in regards to personal finance. In a Real Simple article by Geraldine Sealey, one quoted survey found that “90% of women identify themselves as the chief bill-payer and shopper for the household”, yet 60% think their investing and financial planning skills are below average. This might be where we need to boost equality!

Many women are identified as anxious and conservative about investing and more concerned with frugality and saving. In a DailyWorth.com survey, 83% of men are interested in investing while 79 % of women are more interested in saving. Consumer spending is arguably driven by the chief household purchaser. So, in that context, a woman is highly influential in budgeting for the real costs of the goods and services needed for her family – she may be the gatherer, researching purchase decisions carefully and bargain-hunting. Women are the caretakers, generally, and achieving their financial goals may be tailored to consider the needs of others – like children or parents. The other side of that coin is the aggressive and confident hunter. Men tend to be more interested in achieving goals through investing or entrepreneurship, and so focus on macro goals of higher salaries, retirement planning and investment portfolio growth. Again, these are perhaps outdated stereotypes and certainly many women are savvy investors and confident entrepreneurs and many men are care-takers and thorough purchasers. However, as financial planners, we do see some of these issues played out with our clients. Men tend to be more confident that they understand the issues of different investment vehicles, stocks and bonds and retirement planning. Women are sometimes intimidated by Wall Street jargon and tend to be overly risk-averse and cautious with investing.

Women face some unique challenges as well. 80% of American women will find themselves as the sole keepers of their personal financial situation at some point in their lives. However, most women feel that they are financially insecure, in spite of the fact that they have more education, control more wealth, and are more involved in making financial decisions than ever before. Women’s careers are often interrupted by family needs, both for childcare and eldercare. This can limit their potential for income growth and prevent them from saving adequately for retirement. In fact, many women who leave the family finances up to their husbands may become widows who are in need of financial guidance and someone who they can trust to advise them. For these reasons, it is important for women to take charge of their own financial future.

So how do we close this gap and give women the same confidence in their personal financial situations as men? One very important way is education. At DWM, one of our most critical tasks when working with clients is to help them understand all aspects of their financial plan. Our weekly educational blog last week focused on financial literacy for our kids. Education on successful financial management is a good goal for all of us, adults and kids! There are many great resources to help with this such as seminars, books, and many internet sites. One example is the Women’s Institute for a Secure Retirement (WISER) that specifically addresses women’s issues. We also recommend the National Association of Personal Financial Advisors (NAPFA), to which we belong. NAPFA offers many informative webinars on their website on all financial basics, like Money 101, Investments: The Basics and Women and Money. Let’s close the gap!