Must Read Book for Anyone with Children Approaching College Age: The Price You Pay for College

Is his newly published book, The Price You Pay For College, New York Times money columnist Ron Lieber breaks down the merit aid system that runs parallel to the traditional financial aid system in determining the price you’ll ultimately pay for your child’s college education. Merit aid differs from traditional need-based financial aid in that it does not consider a student's financial need but rather is awarded based on academic or other factors.

Over the past several decades, as tuition has regularly outpaced inflation, merit aid has become an important tool for colleges and universities trying to remain competitive or increase the selectivity of their student body.

The merit aid practice is akin to what economists refer to as “price discrimination” (and what everyone else calls “discounting”) and is a way for colleges to manage revenue and their yield (that is, the number of students accepted who actually agree to come). So with the price of college regularly outpacing base inflation, even some children of one-percenters might get some merit aid—that is, a discount disguised as a scholarship to make them feel more inclined to attend a particular college over another.

Beyond explaining the basics of this merit aid system, Lieber also provides a guide to approaching the college admission process with the idea of “value” in mind rather than the “education at any cost” model.

I highly recommend this book for anyone with kids approaching college age as it also gives some structure to thinking about what you and your child want out of a college experience and the particular aspects you might be willing to pay more for. Lieber also has good advice for talking to teenagers about money issues and priorities in the lead up to the college application process so that your expectations are aligned at the outset before any acceptance letters or aid packages roll in.

Here is further info: https://ronlieber.com/books/the-price-you-pay-for-college/

Investing involves substantial risk and has the potential for partial or complete loss of funds invested. Investments mentioned may not be suitable for all investors. Before investing in any investment product, potential investors should consult their financial advisor, tax advisor, accountant, or attorney with regard to their specific situation.

Portfolio Myopia: Not Seeing the Forest for the Trees

The expression “can’t see the forest for the trees” describes someone who is too involved in the details of a problem to look at the situation as a whole.  

I often talk to individual investors who are overly focused on specific funds in their portfolio or specific accounts without first taking stock of their bigger picture.  

The big picture when it comes to investing is your overall mix of stocks, bonds, and cash across all of your accounts.  This ratio is what’s known as your Asset Allocation.  You’ll often hear numbers thrown around such as a 50%/50% portfolio or a 60%/40% portfolio and what they mean is the percent of stocks and bonds that comprise a portfolio.  This asset allocation ratio is the most important decision you make when it comes to investing as it drives your return and your risk.  Without risk, there is no reward!  But the big question is, how much risk are you currently taking? And how much risk do you want/need to be taking to achieve your goals?

Most people get to mid-life or later having accumulated multiple investment accounts such as IRAs, taxable brokerage accounts, 401Ks, and 403Bs which makes it a lot harder to know where you stand in terms of your overall asset allocation across all of your accounts.  

Instead of focusing on specific fund holdings, you first need to take stock of the big picture and be clear on your ratio of stocks, bonds and cash across all of your accounts.  Once you know that, then you can focus on the sub-asset classes such as having the right diversification in terms of small-, mid-, and large-cap equity exposure as well as international equity exposure and/or commodities and real estate.  Lastly, you can focus on the individual fund holdings within each of these categories to make sure you are utilizing low-cost, broadly diversified mutual funds or ETFs.  

Ideally you want to approach your asset allocation decision, one of the most important decisions you make when it comes to financial planning, with the goal of being able to withstand political or economic shocks similar to the Great Recession from 2007-2009 or the Corona virus crash (a.k.a. the “Coronacrash") in March 2020.  The work I do with clients is informed by the client’s specific risk tolerance and with these types of shocks in mind so that clients can weather them without panicking and making bad market timing decisions in the heat of the moment. The goal is to set you up in advance to weather these storms, knowing that they will eventually come, so that you won’t make rash moves and react out of fear. 

Once you know your target asset allocation, you can periodically rebalance back to it.  Rebalancing is the process of paring back the winners and using the proceeds to rebalance the portfolio back to your target allocation in order to keep risk in check.    

Your target asset allocation may change over time as you get closer to retirement or even during your retirement.  This is sometimes referred to as a “glide path” as investors begin to gradually shift into bonds and take less risk as they approach their retirement date. This evolution is natural but the most important thing is to be clear on what your target is so that you don’t find yourself taking more risk than you meant to during times of crisis. That is what causes people to panic and sell stocks at the bottom of the market. 

Working with a financial planner can help you to think through your risk tolerance and asset allocation decision in advance of market turmoil so that you’ll have confidence in your long-term plan and not be tempted to make rash decisions during the inevitable market stumbles.

Investing involves substantial risk and has the potential for partial or complete loss of funds invested. Investments mentioned may not be suitable for all investors. Before investing in any investment product, potential investors should consult their financial advisor, tax advisor, accountant, or attorney with regard to their specific situation. 

Corona Virus & Market Volatility: Where the Rubber Hits the Road

Given the extreme market volatility in the last several weeks, and the continued spread of the Coronavirus (COVID-19), it’s times like these when you find out if your asset allocation—that is, your mix of stocks, bonds and cash—truly matches your risk tolerance. 

If you are feeling a strong urge to sell and lots of stress given the extreme market drops, then your asset allocation might not be right for your risk tolerance.  This is when the rubber hits the road and you find out what your risk tolerance really is… or, maybe in this case, we should say where the rubber hits the “Street.”

Given the historic market run up since its low point in 2009 during the depths of the Great Recession, it’s easy to have been lulled by recency bias—assuming that things were going to continue to go up indefinitely.  Thus, the recent precipitous market drops were a shock that most didn’t see coming. 

I realize this time the market drop feels unprecedented given it's a global pandemic causing it.  But every market drop feels like the “new normal” when you are in the midst of it, often making it hard to stay the course with your asset allocation decision.

Translating Your Asset Allocation Into Practical Terms

For retirees or those on the verge of retirement, it’s helpful to translate your asset allocation, which can feel academic, into practical terms.  To do this, I like to use the “Bucket Approach” to retirement as espoused by financial planning guru Harold Evensky.  There are lots of variations on the Bucket Approach, but in simplest terms, view your asset allocation as if it were three buckets of money: Bucket #1 is your cash bucket (the most liquid portion of your portfolio), Bucket #2 is your bond bucket (the stability portion of your portfolio) and Bucket #3 is your stock bucket (the growth engine of your portfolio).   

Here is how it works in practice: if equity markets are down, you will be able to raise cash to cover living expenses from Buckets 1 & 2 (cash and bonds) without having to sell out of stocks when they are down.  And conversely, when the market is up, you can sell out of Bucket 3, the stock bucket, to rebalance into the other two buckets and raise cash to cover your living expenses.  

As a starting point, Christine Benz of Morningstar recommends having at least one to two years’ worth of living expenses in Bucket 1 and five or more years’ worth of living expenses in Bucket 2 (bonds).  These are rules of thumb and you should customize your buckets to match your own risk tolerance. Ideally you should have enough in cash and bonds to cover any expenses above what Social Security and other sources of guaranteed income cover, for enough years to carry you through a recovery without having to sell stocks when they are down.

To give the bucket strategy more context, view this chart showing how long the stock market has historically taken to recover from drops: https://fourpillarfreedom.com/heres-how-long-the-stock-market-has-historically-taken-to-recover-from-drops/.  Two things to take away from this chart is that the overall trend over the long-term has been upward and that market drops have become less frequent over time, but the severity of the drops and length of recovery have increased.  

Market Timing

As soon as you start tinkering with your portfolio in times of market volatility or bad news, it means you are engaging in market timing out of fear.  Realize that most people do a bad job of market timing and end up selling low and buying back high.  You have no way of knowing what will happen in the short-term: the market could get much worse or it could go up on an unexpected announcement and you would have missed the subsequent run up.  

This is one of the most damaging mistakes made by investors: jumping into the market at its peak when things are hot and expecting the trend upward to continue indefinitely and selling out at its lows believing that this time things are different and that there won’t be a recovery.  

Thinking you can time the market is irrational.  There are always stories of people supposedly moving all their assets to cash just before a big drop.  What you don’t often hear are the more common stories of people selling when prices are low and not getting back into the market in time for a subsequent recovery.  The only solution is to ensure you have the right target asset allocation that matches your risk tolerance to begin with and then stay the course: buy and hold and of course rebalance when necessary to get you back to your target asset allocation.  

Thinking about your portfolio in terms of buckets and how much each bucket can cover in retirement living expenses is way to help you ride out market drops without reacting out of fear.  In times of market turmoil, being able to stay the course without a lot of worry means that you had the right asset allocation going into it.  

Bottom line is that we need to set our asset allocation initially with the expectation that corrections and bear markets are inevitable.  So when they do happen, we aren’t tempted to react out of fear.  Working with a financial planner can help you to think through your risk tolerance and asset allocation decision in advance of market turmoil. 

Investing involves substantial risk and has the potential for partial or complete loss of funds invested. Investments mentioned may not be suitable for all investors. Before investing in any investment product, potential investors should consult their financial advisor, tax advisor, accountant, or attorney with regard to their specific situation.

College Savings – Avoid These Common Mistakes:

Mistake #1: Not Understanding How 529 Plans Owned by Grandparents Affect the FAFSA

529 plans owned by grandparents are counted differently on the FAFSA (Free Application for Federal Student Aid) than 529 plans owned by parents.  This difference can directly affect how much need based financial aid your child qualifies for.  Any distribution from a 529 plan owned by grandparents gets counted as untaxed income to the student and could reduce the student’s financial aid by as much as 50%.  Whereas a 529 plan owned by parents gets counted as an asset and has minimum impact on eligibility for need based financial aid.   According to SavingforCollege.com, “As the custodial parent of a dependent student, your non-retirement investment assets are assessed at a maximum 5.64% rate in determining your child's Expected Family Contribution (EFC).  Any 529 accounts under your ownership are counted as parent assets for this purpose.”   Whereas a distribution from a grandparent owned 529, could reduce the student’s financial aid by as much as 50%.

Two Possible Workarounds:

• Rather than having grandparents open their own 529 plans, you can ask that they contribute to the parent-owned 529 account instead—ideally on a regular basis.

• Grandparents can wait and pay for expenses from their 529 starting second semester sophomore year through senior year (2.5 years of a 4-year degree) without affecting financial aid eligibility as long as the student plans to graduate in four years. This is because the FAFSA uses “prior-prior” year for income and tax information.  See more info at MEFA.org.

Mistake #2: Assume You Won’t Qualify for Any Aid:

Some colleges are awarding need based aid to families with incomes of $200,000 or more especially if they have more than one child in school at the same time.  Thus, it pays to fill out the FAFSA even if you aren’t sure you’ll qualify for aid.

Mistake #3: Not Understanding How Retirement Fund Withdrawals Affect the FAFSA

If you plan to tap your IRA to pay for college expenses, make sure you understand how this could affect your child’s potential aid.  The value of your retirement accounts (401k, Roth and traditional IRAs) are not counted in determining your “expected family contribution” but withdrawals from these accounts are and they can reduce potential aid by as much as 50% of the withdrawal each year.  And although both traditional and Roth IRAs allow you to withdraw money for qualified higher education expenses before age 59.5 without incurring the 10 percent early withdrawal penalty, the entire amount of the withdrawal will count as untaxed income on the FAFSA.  And as much as 50% can be considered to be available funds to pay for college.  

Mistake #4: Not Understanding how UGMA / UTMA Accounts Affect the FAFSA

Custodial accounts held by the parents of a student (UGMA / UTMA Accounts) get counted as a student asset and can reduce student aid by as much as 20% of the account balance each year.

Mistake #5: Missing out on Tax Deductions 

Those of us in Massachusetts are able to deduct up to $1,000 in contributions to the Massachusetts Educational Financing Authority (MEFA) U.Fund 529 plan from state income tax through the 2021 tax year, when the deduction is scheduled to expire.  And married couples filing jointly can deduct up to $2,000.  MEFA’s U.Fund, the Massachusetts 529 college savings plan is managed by Fidelity Investments and the plan received a Silver rating (Gold is the highest rating) from Morningstar as of Oct 22, 2019.   

Mistake #6: Missing Out on Tax Free Growth

Proceeds from a 529 plan compound and can be withdrawn tax-free if used for college expenses. If you were to save in a regular savings or brokerage account, you could needlessly be taxed on interest, dividends and capital gains.

Mistake #7: Managing Your Retirement and College Savings Together

For most families, colleges expenses are coming a lot sooner than retirement expenses.  The way you invest your retirement savings, which is most likely further in the future, might not be appropriate for college savings.  For example, if you have 6 more years until your child goes to college and 20 years until you retire, you can afford to take more market risk with your retirement savings than you could with your college savings which have a shorter time horizon.  You might be comfortable with an 80% stock and 20% bond asset allocation and its associated risk for your retirement assets given that retirement is 20 years away but an 80% stock and 20% bond asset allocation and its associated risk is not appropriate for a shorter-term goal.  With a shorter-term goal, you have less time for the market to recover after a downturn.  Thus, a higher allocation to bonds, which are the stability portion of your portfolio, makes sense for a shorter-term goal.  

The Massachusetts’ U.Fund 529 college savings plan manages the asset allocation automatically for you if you choose an age-based option.  An age-based fund, similar to a target-date retirement fund, works by gradually becoming more conservative as the college start date draws closer.  The fund manager takes care of this gradual shift in the asset allocation, between stocks and bonds, so that you don’t have to worry about it.  It is truly set it and forget it especially if you automate your contributions each month.

Mistake #7: Not Contributing to a 529 Because You Think Your Child Will Get a scholarship

If your child happens to get a full scholarship, you can withdraw up to the scholarship amount from your 529 without having to pay the 10% penalty but you will still owe taxes on the earnings. 

Beyond tuition, qualified expenses that a 529 can be used for include required fees, books, room, board (for students attending at least part time), and required supplies and equipment at a college or university.

Mistake #8: Paying Too Much in Investment Fees and Expenses

Not all 529 plans are the same when it comes to costs. Make sure your 529 plan offers low cost options like target date index fund.  High investment fees and expenses eat into returns over the long-term and will leave you with less money for college.  Index funds tend to have lower expenses than actively managed funds.

Mistake #9: Missing out on the American Opportunity Tax Credit (AOTC)

According to SavingForCollege.com, “the American Opportunity Tax Credit (AOTC) provides $2,500 in partially refundable federal income tax credits based on $4,000 in tuition and textbook expenses. The AOTC is worth more per dollar of tuition and textbook expenses than a tax-free distribution from a 529 plan.” 

This means that before using any 529 funds, make sure you use cash or loans to pay for $4,000 worth of tuition and textbook expenses in order to qualify for the maximum AOTC before using your 529 plan to cover any remaining costs.  Note that this credit is phased out at certain income levels. 

Mistake #10: “Early and Often”

Lastly, the number one mistake when it comes to saving for your child’s college education is not starting early enough and not automating it.  Having your contributions automatically deducted from your checking account each month and invested into a 529 is a great way to automate a college savings program so that you’ll never miss out on the potential for tax-free earnings growth while taking advantage of dollar-cost averaging into the market over time.

Investing involves substantial risk and has the potential for partial or complete loss of funds invested. Investments mentioned may not be suitable for all investors. Before investing in any investment product, potential investors should consult their financial advisor, tax advisor, accountant, or attorney with regard to their specific situation. 

Forbes Hourly Planners Directory

If you are looking for an hourly or project based financial planner in your area, a great resource to check out is a list compiled by William Baldwin, former Editor of Forbes Magazine from 1999 to 2010 and frequent Forbes contributor on all things personal finance and investing.

As Baldwin points out, most of the country’s 300,000 financial advisors get paid via commissions on products they sell to consumers (e.g., life insurance and annuities) or alternatively as an annual percentage of the assets they manage.

There aren’t many advisors who get paid on an hourly or project basis but we are growing.

To see Forbes’ full Hourly Planners Directory, please click here.