Invest systematically, not emotionally
A client recently contacted me with concerns about his portfolio after listening to the previous night's presidential debate. The client was alarmed by the comments made about the weakening economy and worried that the economy and the market would plunder. He wanted to radically change his investment mix based upon these recent concerns. This is a classic example of an investor's behavioral response to information that more sophisticated investors would use to their advantage.
While the U.S. certainly has economic issues to deal with, the presidential debates or elections are not going to be the driver behind the stock market. Consistently overtime, fundamental investment factors, such as corporate profits and inflation, have been and will continue to be the driving force of both the market and the economy. I understand that it is difficult for investors to remind themselves of this every time they are bombarded with negative information.
Although most would like to believe that all of their decisions are based solely upon rationale judgment, the reality is that emotions do, indeed, play a role in the decision-making process. A newer academic field, behavioral finance, has attempted to explain how our emotions and cognitive errors influence investors and their decisions. Some of the more common emotional reactions are as follows:
Projecting recent results into the future
It can be risky to draw conclusions based upon current events. The market typically trades based upon expectations of nine months into the future. Yesterday's news is old news and is already factored into the market. This is evidenced by numerous studies on historical mutual fund performance that have consistently shown that the top mutual funds in a given year trend toward the bottom of the list in subsequent years.
Making rash decisions
It is typical to have an emotional reaction when the value of your investments drops suddenly, but making decisions with this mindset is dangerous. It often leads to investors following questionable advice or chasing the latest trends without reason.
Avoiding action/holding investments too long
Consistent with avoiding taking action, investors may hold onto their investment too long. It is much easier to do nothing with your portfolio than to make a decision to change your portfolio; but a portfolio needs to be regularly monitored and re-balanced at least annually.
Safety in numbers
Often investors feel overly confident in their investments if they are invested similarly to their peers or based upon how the media tells them to invest. Everyone should invest based upon their individual goals and objectives. No two investors are alike.
- Robert Ballsrud, CPA, CFA, is vice president of Busey Wealth Management. He can be reached at (217) 351-2707 or firstname.lastname@example.org.
Saving for child's college education is as important now as ever
March Madness is coming, and Hank is holding out hope that his alma mater will make it into the NCAA tournament.
Boy, the good ol' days of college life. Saturday football games, sleeping late, spring break. But most importantly, tuition for one semester was just $750.
Not any more!
The dream quickly transformed into a nightmare for Hank: How is he going to pay for his own children's education?
Tuition rates have increased about twice the pace of inflation over the last 30 years. In fact, for any 17-year period from 1958-2001, the average annual tuition inflation rate was between 6 and 9 percent, ranging from 1.2 times general inflation to 2.1 times general inflation.
On average, tuition tends to increase about 8 percent per year. This means tuition doubles every nine years.
But there is hope, thanks to the college education savings vehicles called Section 529 plans.
These plans can be divided into two types--prepaid tuition plans and college savings plans.
Prepaid tuition plans are contracts between the student and the state in which the plan is sponsored. In essence, you pay the state now for future tuition.
For example, Hank could buy eight future semesters of college today for his 9-year-old daughter at any public college in Illinois under the state's plan by paying $43,773.
These types of Section 529 plans only cover tuition. And there are no investment decisions to be made. You simply pay for a promise in the future.
Section 529 savings plans, on the other hand, can be used for any college expenses, such as room and board, computers, fees and books.
The tax benefits of both types of the plan were made permanent by the Pension and Protection Act of 2006. That makes them even more attractive.
Section 529 savings plans are one of the most significant, flexible and generous tax provisions ever passed by Congress.
Under a Section 529 savings plan, an account is opened with both an owner (you) and a beneficiary (the future college student). Money that is contributed to the plan and ultimately taken out for college expenses can be withdrawn tax free. So, the sooner the money is invested, the better the tax benefits.
For example, if you invested $10,000 in a Section 529 plan that earned an average of 7 percent annually, it would have a value in 15 years of almost $28,000. That means $18,000 ($28,000 minus the $10,000 invested) in tax-free money.
And if little Johnny decides not to pursue a college degree, you, as the owner, can replace him with another beneficiary--like his darling cousin Katy.
In fact, the owner maintains complete control over the account, including the ability to change the beneficiary, change the owner of the account, make direct distributions and add direct investments.
What if you don't have any extra money lying around? Hit up grandma and grandpa or even Uncle Harry. Anyone feeling generous can open an account for your sweet Johnny.
How does Hank find one of these great savings plans?
All Section 529 savings plans are sponsored by a state. But don't think you have to use the plan in your state or the beneficiary's state. Other than some state tax savings, most plans are completely portable and can be used for college expenses anywhere in the U.S.
Every state and the District of Columbia has at least one state-sponsored plan. In fact, you can choose from more than 80 plans. Compare plans at www.savingforcollege.com.
The main things to consider are fees and investment performance. After all, the faster the money grows, the more tax-free benefits the beneficiary receives.
Don't hesitate any longer. Look into Section 529 plans and you, like Hank, will be turning those nightmares into tax-free dreams.
- Mary McGrath, CPA, CFP, is an executive vice president and portfolio manager at Cozad Asset Management of Champaign. She may be reached at email@example.com or (217) 356-8383.