Student Loans vs. Saving

This is the second post in a series of six blog entries focused on topics that might be of interest to the Millennial generation. If you would like to see our attempt at making these subject matters entertaining, visit our YouTube page to see a video version of this article.

 

You’ve recently graduated from college and you have a load of student debt. It can be overwhelming. You think it will take forever to pay it off. To make matters worse, you know you are supposed to be saving for retirement but you feel like you can’t because you need to pay off your student loans first.

To make the best financial decision it is important to remove the psychological barriers that often accompany the ‘saving versus paying down debt’ trade-off. The millennial generation is particularly opposed to debt – more so than older generations, so they tend to pay their student loans off before they start saving. Unfortunately, this could be the wrong choice.

The long run average of large company stocks is 11.3% (1950-2013). If your student loans are at an 8% interest rate, you would be better off investing money over and above your minimum loan payment if you have the risk tolerance for investing the money in equities.

Maybe an 11.3% return sounds unrealistic. It’s common for this historical return to seem disconnected from the present. A common psychological condition causes us to take recent past experiences and extrapolate them into the future, creating a false sense of predictive ability on what the future holds. If the good times are rolling, they will always roll. If we are in crisis, we will be in crisis for the foreseeable future. But the truth is that things change. Our economy is cyclical in nature and that’s why we use long-term historical observations to make long-term decisions.

Even with the worst recession since the Great Depression the average return of large company stocks in the 10-year period from 2004 -2013 was 7.4%. And while that’s not huge, you may be willing to take the chance that we won’t soon see a repeat of the worst stock market period in history. Those loans will get paid off eventually and you’ll have more money in retirement simply by saving more and saving earlier.

Don’t forget about your employer match on your 401k. If you have a 401k match, by all means take it! Even if your student loan interest rate is 12%, you’d be better off (after paying the minimum) putting enough money into your 401k to get the free money. That’s a 100% return, guaranteed.

Harli Palme, CFA, CFP®
Partner

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7 Reasons to Consider a Prenup

This is the first in a series of six blog entries focused on topics that might be of interest to the Millennial generation. If you would like to see our attempt at making these subject matters entertaining, visit our YouTube page to see a video version of this article.

I believe Kanye West said it best when he said, “We want prenup!”

There is nothing that can kill the romance of upcoming nuptials more quickly than your partner asking you to sign a prenuptial agreement (aka prenup). But do you know what can really kill the romance? Divorce! Perhaps you are thinking, “our relationship is going to last… we’d never get a divorce.” Well let’s face it, I don’t think anyone goes into a marriage thinking that in 5-10 years they are going to split. Other people may think that the agreement is only for the rich… this is actually a misconception. While it’s true, a prenuptial agreement may not be right for everyone, the following are a few scenarios in which it will make a lot of sense:

1: One partner earns the majority of the income. If you know going into a marriage that one person will be the primary “bread winner,” a prenup can be used to determine the amount of alimony that will need to be paid upon a divorce.

2. What about the partner that doesn’t make a lot of money? The prenup can also be used to make sure that the partner who is less financially set is protected in the event of a divorce.

3. For the spouse with substantial assets. If you own a home or other substantial assets prior to a marriage, you can use a prenup toestablish that those assets that came with you, will leave with you.

4. For the stay-at-home parent: This will obviously affect your income. If it is decided prior to marriage that one parent will stay at home with the children, a prenup can be used to make sure that each parent shares in the responsibility of taking care of the children financially.

5. One partner has a significant amount of debt. A prenup can establish who will be responsible for paying off debt in the event of a divorce. This can prevent you from getting straddled with debt that the other spouse created prior to marriage.

6. Children from a previous marriage. When entering into another marriage you need to make sure that you kids are protected from another divorce. This can ensure that in the event of your death/divorce that assets that should be going to your children won’t go to your disgruntled spouse.

7. You own a business. It is possible that in the event of a divorce your spouse will end up owning part of the business. Your partner will then go from being an unwanted spouse, to an unwanted business partner. Establishing that the business is off limits in a prenup can prevent this from happening.

It’s understandable that many couples don’t even want to entertain the idea of a prenuptial agreement. The important thing to remember is that this is a document used to protect all parties. Communicate openly and listen to the concerns of your partner. Even if you do live “happily ever after,” there will always be a peace of mind involved with foresight and deliberate planning.

Ashley Woodring, CFP®

Financial Advisor

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Giving Away Your Cake (and eating it too), AKA Charitable Remainder Trusts

ImageOne of the first recorded instances of the age old phrase “a man can not have his cake and eat it too” was written from Thomas, Duke of Norfolk to Thomas Cromwell, speaking about how the construction of Kenninghall had cut deeply into his finances. Today, we use this phrase when considering saving something of value, or giving it up for consumption. When thinking about our own personal assets, we have many choices. We have the opportunity to hold on to them (having our cake), swap them out (trading for a different cake), or selling them and buying a consumable asset (eating the cake).

With responsible planning for the future, the size of your portfolio should grow through the years. At the point of retirement for someone, a combination of pension, social security, and portfolio income may be able to provide for all of their expenses. This is a fantastic place to be in as a retiree. A dependable cash flow can empower gifting to the extent that the cash flow remains intact.

A few months ago, I wrote about Charitable Remainder Trusts here. For a retiree that has an excess income stream from investments, a Charitable Remainder Trust (CRT) can provide a certain and continued stream of income from donated property.  As the name suggests, a charity will inherit the property held in the trust when the beneficiaries pass away, just as it would if you left the property to a charity in your will. However, the additional benefit of a CRT is the income tax deduction received for giving the property occurs immediately. As a beneficiary you retain an income interest.

Give thought to the idea of giving some of your cake away now. There are many great non-profits and charities that will thank you. Now, I know all this talk of cake has really gotten that sweet tooth going, so feel free to eat some cake now too!

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Gen Y, Say Yes to Stocks!

It started with anecdotal evidence: a conversation with a co-worker about a group of professionals he spoke to about their 401k. The wiser (by which I mean older) folks were asking about the outlook for the economy and how they could maximize their 401k contributions. But the young man in the group, who was in his early 30s, expressed complete contempt for the stock market.  All of his money, he said, was in cash. Then a client of mine who is nearing retirement called me just to tell me about a dinner he went to where the topic of investing came up.  He was shocked at how vehement the young people at the table were about not investing in stocks due to their risk.

Since then I’ve read about a growing body of evidence coming from surveys and other research that suggests that the younger generations are too conservative in their investments. Gen Y is saving but not investing aggressively enough. The problem is that they distrust financial institutions (we don’t count) and believe another financial meltdown is all but imminent.

Gen Y, we don’t blame you. You were in your teens on Sept. 11, 2001, which had to have rocked whatever concept of stability you had. By the time you were old enough to know what the stock market was, the technology-driven crash of 2001-2002 was causing strife in budding 401k plans. And just when you were starting to dream about home ownership the housing market was spiraling out of control in 2008-2010. Many of you watched your parents go through extreme financial duress during this time period, something you were well old enough to understand.

It’s no wonder that Generation Y is too conservative. Your generation doesn’t have the benefit of personally experiencing the roaring 80s and 90s to boost your confidence about the markets. You don’t know who Crockett and Tubbs are. Looking at historical stock returns on paper just isn’t the same as living through it. And it’s hard to understand why men ever wore over-sized shoulder pads, but they did. Even the last five (amazing) years of positive stock markets seems like mere payback for the horror of 2008-2009. Despite this, we have to remember that stocks have historically provided the highest long-term return. No matter what your steadfast beliefs are about the future of the economy, it probably carries no more predictive capacity than the next differing opinion. That’s why we look to history as a guide, rather than trying to guess the future.

When you look at stock volatility over long time frames, it isn’t nearly as risky as the day-to-day movement would have you believe. In the last 87 years large company stocks’ annual returns ranged from -43% in the worst year to +54% in the best. That’s quite a spread! But those same stocks in any given 20 year period (starting on any given day in any year) averaged returns in a range of +3% in the worst 20-year period to nearly +18% in the best 20-year period. That includes the Great Depression and the market crashes of this century. That’s a lot easier to swallow. You have a long time before liquidating your accounts for retirement – probably more than 30 years, so you should be taking a longer term view.

And let’s not forget about inflation. That cash that’s in your 401k is doing less than nothing for you. Long run inflation is around 3%. If you are getting a 0% return on your cash, that is actually -3% in real dollars, guaranteed.

Saving money isn’t good enough. Millennials need to invest with a little more oomph. Yes, diligently putting away $500 a month for 30 years is hard work and no one wants to see their money shrink. But consider this: if you get a modest 4% average return on those savings, you will have $347,000 in retirement; if you double that return to 8% an amazing thing happens: $745,000. Taking risk means a lot of ups and downs along the way, but potentially twice the money in the end. If you can go cliff-jumping with your friends, you can buy stocks, right? (No? Was that just my friends?)

There is no reward without risk, to be sure. Any investment plan should be done with the full comprehension of the volatility, range of outcomes and potential for return. There certainly is risk in losing money in the stock market over short and intermediate time periods. However, those losses only become permanent if you sell out during periods of decline. It seems all but certain that an all-cash/fixed income portfolio is doomed to growth too slow to possibly reach any long-term financial goals.

 

Harli L. Palme, CFA, CFP®

A Gen-exer who believes all of the above applies to her generation too, except the part about over-sized shoulder pads.

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College Savings for the Kids, or Retirement?

Many a financial advisor has been asked how to balance saving for retirement while also funding a child’s college education. Which brings up the question: Is it a parent’s responsibility to pay for their child’s education? And is it possible to do both? As with most difficult questions, there are no black and white answers.

While I’m not a parent myself, I’ve heard passionate positions on both sides of the argument. Some parents didn’t receive any college financial support and feel pride in having paid their own way, working and going to school part time in order to earn their four-year degree. Others, myself included, felt fortunate enough to receive monetary support from their parents, and the gift of graduating with a four-year degree debt-free. In a perfect world, most parents would choose to provide for their children’s education but unfortunately not everyone has the income to do it. In that case, what is the best course of action?

Before tackling that question, there is some good news. A recent Gallup Poll shows that expensive, prestigious colleges don’t necessarily produce happier people who lead more fulfilling lives. Specifically, graduates of colleges in the bottom-ranked U.S. News & World Report schools faired just as well as graduates from top-ranked colleges in terms of overall well being. The poll looked at several quality of life factors, including income level and “engagement” in graduates’ careers. See the article here. Of particular note, high college debt loads had a meaningfully negative impact on graduates. Sadly, 70% of students who borrow have a national average debt balance of $29,400.

I would tend to agree with these findings. As a state university graduate (go Gators!) I received a great education, learned and worked with some world-renowned scholars, and feel pretty darn satisfied in my life and career today. All-in, college cost my parents about $12,000 a year. Granted, that was seventeen years ago. Today, attending the University of Florida costs about $21,000 a year, including room and board; still a pretty attractive price tag considering sky-high tuitions at some of the top private colleges and universities. Don’t get me wrong, if money had been no option and my grades were a little better back in high school, I would have jumped at the chance to attend an Ivy League school. Such were not my cards. The point, however, is that state schools often offer a phenomenal education at a fraction of the cost of many private schools which can make the dilemma of whether to save for your retirement or your child’s secondary education a little less challenging.

However, different students have different needs and may be searching for what those more expensive colleges offer – whether that’s a smaller setting, specific academic programs or special facilities. So if your child is interested in what the pricier schools have to offer, consider applying even if you don’t have all the funds available to pay. Some of the most expensive schools have a tremendous amount of scholarship money available for qualified students in need. It’s a great reason for your child to stay motivated with grades and extracurricular activities throughout high school.

But back to our main question: should you save for your retirement or your child’s college education? Ideally, everyone would do both, but given a median US income of about $51,000, this isn’t always possible. Taking an economic perspective, the classic airplane analogy comes to mind: when the oxygen masks come down due to a drop in air pressure, air regulations require parents to first secure their own oxygen mask before helping their child. Why? Because we can’t take care of someone else, children included, until we’ve first tended to our own needs. I believe the same holds true regarding retirement savings and a child’s college education. Funding your child’s college education at the expense of your retirement savings plan implicitly shifts the financial burden of retirement from parent to child. Essentially, parents who first try to support their child at the expense of their own retirement are making the bet that their child will earn more than them, or at least enough to provide for them in their twilight years. While parents may have good intentions, this dynamic can ultimately prove unhealthy for all parties involved. As with the oxygen mask analogy, a sound strategy would suggest first meeting your own retirement savings needs and then, as you’re able, contributing to a child’s college fund. In the end, you’ll have peace of mind regarding your own financial security and likely be in a better position to further support your child – who may just be thriving on her own.

Carrie A. Tallman, CFA
Director of Research

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Paralysis from Analysis

This month, I celebrate my 500th year at Parsec.  OK – it is really 22 years, but sometimes it feels like 500 years.

During that time, I have been involved in a lot of highly technical projects.  With one project in particular, I was really stressed out about the details.  I analyzed every piece of data so much that I made little progress.  Bill Hansen, one of our Managing Partners, said I suffered from “paralysis from analysis.”  After some reflection, I realized he was right.  At some point, I had to let go and realize nothing would ever be perfect.

In my lengthy career here, I have seen the effect of “paralysis from analysis.”  Some investors may be reluctant to act based upon the endless stream of information available now.  One can flip on the TV at any hour and hear the opinions of investment commentators.  Peruse the Internet, and one can find a vast amount of data about the stock market and the economy.  With so much information and contradictory opinions, it is easy to sit on the sidelines and do nothing.

In some cases, inaction can be as devastating as making the wrong choice.  Consider this scenario.  On March 9, 2009, the S&P 500 hit bottom.  A lot of people panicked and sold all holdings, leaving the proceeds in cash.  Five years later, the index was up 205.84 percent or 22.6 percent annualized (total return).

At the bottom point, there were probably a few people on TV who claimed the end was near.  One could probably find endless charts and articles foretelling great doom to come.  If an investor was paralyzed by this data overload, sat on the sidelines, and did not invest during that five-year period, he or she could have missed an opportunity to recover from deep losses.

What should a person do?  For starters, it helps to leave emotion out of the decision as much as possible.  Then, develop an investment plan that will not lead to sleepless nights.  The real test will come when the market has wild swings – either up or down.  One must commit to the plan and not deviate based upon the mood of the moment.  It is fine to alter the plan if goals or needs have changed, of course.

We at Parsec try to help our clients develop these plans and weather the inevitable market fluctuations.  Communication is a key factor in success.  We encourage our clients to tell us their goals, their changing life situations, or anything that is relevant to staying on target.

So, let’s switch off the talk shows, put down the business magazine, and take a nice walk.  Let’s try to enjoy life instead of obsess over every little detail.

Cristy Freeman, AAMS®
Senior Operations Associate

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How much is that Doggie in the Window?

According to a recent announcement from the American Pet Products Association, Americans spent $55.7 billion last year on their pets. That’s billion, not million. An article at Time.com (http://time.com/#23451/pets-dogs-cats-spending-americans/) cleverly noted that the figure is $10 billion more than Germany spends on its defense budget.

I admit I am one of these people. My little rescue dog hit the lottery when she came to live with me. She has seven dog beds, if you include her car seat (yes, car seat). She owns more jackets than I do, although they are all for function, not fashion. She has multiple, color-coordinated harnesses, collars, and leashes so that she need never feel ashamed about how she looks. When we go on vacation, she has as much luggage as I do. Yes, she is spoiled rotten.

I am not alone. Bill Geist of the “CBS Sunday Morning” program tells a hilarious story about his “free” rescue dog: http://www.cbsnews.com/news/even-cat-people-fall-in-puppy-love/.  Sometimes, the unexpected costs can really add up.

In our industry, I see a number of fees that some people pay for investments: high commission rates for certain products, either on the front or back end of the transaction; frequent, unnecessary trade costs from a practice called “churning;” and expensive investment counsel fees. Before long, that simple purchase of 100 shares of ABC Widget Works has cost a fortune in added fees.

When you are evaluating an investment advisor, consider how the person earns his or her money. Does he receive a commission for his or her investment recommendations? Is he or she directly affiliated with a broker? Does he or she charge an additional investment counsel fee? While he or she may promise a great gross return on investment, the net return after all of those fees may be no better than what you would find with a simple savings account.

At Parsec, we do not receive commissions for any of the investment products we recommend – no commission from the trade, no commission for recommending a certain security, nothing. In addition, when we recommend mutual funds, we look for funds that do not carry significant internal fees.

We are not beholden to a particular broker. We have four brokers who we like to recommend, based upon client needs.

We do charge an investment counsel fee that we think is reasonable to industry standards. When you sign a service agreement, you see upfront what your fee schedule will be. On a quarterly basis, you receive a reports package that includes information about net-of-fee investment performance, current holdings, et cetera. We are also here to help with planning – everything from college savings to retirement to estate. We like to think service goes beyond placing a trade. Our clients pay us to act as a partner in planning their future.

Everything in life – from owning a home to adopting a rescue dog – has the potential for unexpected costs. How you invest your money, though, should be a little more straightforward. With a little research in advance, you can evaluate whether or not fees charged for service are reasonable and affordable.

Now, if you will excuse me, I need to order organic food for my doggie. And maybe I will pick up a bottle of shampoo. She told me she is tired of smelling like a bowl of oatmeal.

Cristy Freeman, AAMS
Senior Operations Associate

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Taxable Income Reduction Strategies

As a trusted financial advisors for our clients, our priority is to stay apprised on current tax laws, as well as provide planning opportunities to reduce future tax liabilities. For many of our clients, their Traditional IRAs are also their largest tax liability. When an IRA is responsibly managed, the hope is that the account will continue growing until the owner’s late 70s. At that point in time, the mandatory withdrawals from the account may offset any capital appreciation and earnings on the account. When taking into account these growth expectations, as well as the client’s necessary cash flow, many clients find that the RMDs in their 80s will far exceed their necessary cash flow. These factors contribute to an increasing likelihood of the client having a higher tax rate later in life. Higher Modified Adjusted Gross Income(MAGI) is one concern that has a trickle down effect. When MAGI gets high enough, it can result in an income based adjustment for Medicare Part B and D. It should be clear by now that a healthy retirement can actually increase tax concerns.

So, by now you may be saying, “Thanks for the depressing news Daniel, I don’t think I want to read any further. ” I encourage you to keep reading.
 
Controlling Income

The first step in keeping MAGI low is controlling income. For retired individuals, there are two main sources of cash flow. The first being social security and pensions. These are fixed amounts that cannot be changed. The second source is income from personal assets. This includes brokerage accounts, Traditional IRAs, and Roth IRAs. A brokerage account is not a tax-deferred account. Therefore any income produced by the account will contribute to MAGI. It is possible to manipulate a brokerage account’s holdings to reduce taxable income. The second source of cash flow is withdrawals made from Traditional IRAs to supplement income or fulfill an RMD. These withdrawals are fully taxable to the individual. In addition to Traditional IRA withdrawals, Roth IRA withdrawals can be made, however, these withdrawals are not taxable to the individual if made after 59 ½. The IRS gives us tax tables, from these, we are able to determine the maximum amount of taxable income we want to produce for clients. As I said before, it may become impossible to keep income below this desired threshold when RMDs get larger and larger. If this is the case, we move on to advanced planning techniques.

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Roth Conversions and Charitable Remainder Trusts 
One of our favorite techniques to reduce the impact of RMDs is to combine the benefits of a Roth IRA with a charitable gift. The establishment of a Charitable Remainder Trust may allow someone with charitable intentions for their estate to realize the benefit now. The Charitable Remainder Trust can provide a lifetime income stream for the donor, as well as provide a large charitable deduction. In this tandem planning technique, the charitable deduction can offset the income incurred from a Traditional to Roth conversion. The reduction in the size of the Traditional IRA will also truncate the amount of the RMD going forward.
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This particular technique is just an example of some of the advanced planning options we evaluate with our clients. Every situation is different with special circumstances to consider. If you have any questions about these strategies, contact one of our advisors.
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Time is Running Out!

When we were kids, it seemed to take FOREVER for Christmas to get here.  After Thanksgiving, you knew it was close but oh so far!  Nowadays, it seems as if December just flies by.  We have so much to do!  How do we get it all done?

In the midst of the holiday chaos, let’s take a moment to handle charitable donations.  Your favorite non-profit organization appreciates anything you can do for them. 

You still have time to make a donation.  You must make cash donations by December 31 to count them toward the 2013 tax year. 

If you want to donate securities, call us the second you read this blog post.  Time is running out to ensure processing of these types of donations by December 31.

Also, if you have old clothes, furniture, or other items to donate, you should deliver the items to the charity by December 31.  (Some charities even offer pick-up service.)  Make a detailed list of the items you donated.  If something is particularly valuable, it would be a good idea to snap a picture.  You would have proof, if you are ever audited, of the item’s condition.

It is possible to get everything done on time.  As I mentioned, charities need our support.  Just take a deep breath, make a list, and do one thing at a time.  If you planned to make a donation, just add them to the “to do” list.

We hope everyone has a safe holiday season and a healthy, happy new year.

Cristy Freeman, AAMS
Senior Operations Associate

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Mise en Place: To Put in Place

Don’t hate me for this, but I am one very luck woman. My husband does 99.9% of the cooking in our house. And best of all, he enjoys it! That said, once every so often he has to work late, or he is out of town or he craves one of my few specialties and I have to put the apron on. Such was the case this past Tuesday when I decided to tackle a new recipe. Since I cook so infrequently, I can get rusty between stints, so I decided to put to practice the concept of mise en place (pronounced meez ahn plahs). Mise en place is literally translated as “to put in place.”

Mise en place is simple. Before you pre-heat the oven, you want to make sure you have all of the required ingredients and equipment needed to make the dish. Think of your kitchen as an operating room; prior to surgery, all of the surgical implements have been sterilized and the accompanying supplies (sutures, gauze, etc) are neatly lined up on a tray. Imagine if mid-procedure your surgeon cried out for gauze and the assistant had to run to the drug store to buy more. Things would not turn out so well.

So, back to my kitchen and my rusty cooking skills; as I began to dice the onions and mince the garlic, I realized there are other applications for the use of mise en place. Packing for a trip is one such example. Preparing your taxes is another. And then I thought how well this could work in estate planning. If you have all of your documents prepared, in one place and up to date (sort of like within the sell-by date), your passing will be that much easier on your survivors.

Preparing your estate doesn’t just mean you have prepared the necessary documents. You must also sit down with your heirs and explain your plans and your wishes. Tell them why you have made certain decisions pertaining to the distribution of your assets. In addition, share with them your wishes concerning your living will and health care power of attorney. This can greatly reduce conflicts over your desired medical treatment should you become terminally ill and alleviate any stress and guilt family members may have. And finally, make sure you have your documents reviewed every 3-5 years to ensure they are current with state legislation. Remember, the only constant in life is change.

My husband does not utilize mise en place very often. He doesn’t really need to. Since he cooks daily, he doesn’t get rusty in the kitchen. But when it comes to executing an estate, he fortunately has zero experience. That is why he truly appreciated the very candid meeting we had with his parents this year. We now know where everything is and what the plans are and that gives us peace of mind.

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