“College” is a training program designed for high school graduates to receive more education (“higher education”) with a certificate (“degree”) for successful completion of studies.The available degrees are a trade school degree, 2-year associates degree, 4-year bachelors degree, masters degree, doctoral degree, and professional degree.Students may apply for federal student aid to earn any of these degrees (ref 1).
Children need a good education in order to manage their adult lives.Graduation from high school signifies an educational achievement that offers opportunities for immediate employment or enrollment in college.Furthermore, graduation from college generally results in a higher income, healthier lifestyle, and greater contribution to society compared to the completion of high school (ref 1, 2).
A WORLD OF OPPORTUNITY
Students who graduate from college (rather than dropping out early) earn the most value for their type of higher education (ref 2).College offers the opportunity to expand knowledge, improve thinking, launch a career, and build new relationships [my opinion: college also increases the student’s capacity for making financial decisions]. Although other organizations offer a similar opportunity through on-the-job training (e.g., armed forces, businesses), colleges offer opportunities that can’t be obtained elsewhere.For example, many professions require a college degree.
RETURN AND RISK
College is not free and can be quite expensive; it’s a risky investment in your child’s future (ref 3).Is it worth the investment?Yes, if your student graduates with reasonable financial and emotional health.College graduation improves students’ chances for financial success as measured by the return-on-investment (ROI). Here are several measures of the ROI in college (ref 2):
graduation from college increases the employment rate
college graduates have more job security
college graduates earn more money than those with less education
The payback period for a college degree is the number of years needed to recoup the cost of college.The length of the payback period depends on the annual salary of the college graduate and total cost of college (ref 3).The choice of school and total time of enrollment are prime determinants of total cost.
Nearly all parents want their child to attend college, yet only one third of college students earn a bachelors degree or higher (ref 2).The high dropout rate may be due to academic or emotional stress, especially during the transition from high school to college.The student and family may not be prepared for the academic and social life of college (ref 4).
The process of college preparation (“College Prep”) can help motivate children to attend college and graduate with a degree (ref 5).College Prep should start at home as early as possible and continue through high school.
Children have the advantage of a long TIME-period for investing toward college and retirement. Family teamwork is essential to that process and grandparents can be an integral part of the team.
This presentation will explore ways that seniors can facilitate their grandchildren’s long-term investments. In viewing my presentation, please understand that I am not a professional financial advisor; I merely advocate frugal, do-it-yourself investing for all ages. I would like to emphasize the following thoughts:
Young investors have the advantage of TIME.Will they use it wisely?
Becoming informed investors starts at home with the family traditions of money management.
Save for retirement?Form the savings habit early in life.
College is any certified program of higher education. Paying for college requires ‘college prep’.
Grandparents have the resources to help young investors and college students.
The Advantage of TIME
The advantage of TIME is to help build wealth by reinvesting dividends and capital gains. Those reinvestments promote the growth of a long-term investment project. The black growth curve in chart 1 predicts the future value of $1 invested in the stock market. The colored dots represent the increasing value of the invested dollar with the passage of time.This method of growth is called compounding interest or compounding returns.Notice that,
the growth of $1 to $3.40 in 18 years is a predictable outcome of saving for college.
the growth of $1 to $30-$114 in 50-70 years is a reasonable outcome of investing for retirement.
Wise money-management is an essential skill for investing successfully and protecting those investments.Money management may be a family tradition or a new family experience.Either way, children usually start forming money habits early, before entering elementary school.Many families teach the wise management of money by encouraging their children to store money in jars.
the spending jar facilitates decision-making.Children love money and typically don’t have enough to pay for everything.They should learn to spend wisely and accept the consequences of their choices.If they borrow money, they should learn to pay it back on time.
the saving jar helps make future payments. Saving leads to investing.Help them save for short term goals and encourage them to gradually save larger amounts over longer time periods.Introduce them to the stock market. Consider helping them to buy shares of stock issued by their favorite company.
the sharing jar builds community awareness.Expose children to the needs of others in their community.Sharing money and volunteering to work will cultivate relationships and humane values.
Young children dream about becoming grown-ups.They wonder what adults do for a living and how parents earn incomes. Older children are inspired by classmates, adult role models, field trips, group activities, etc.Family support can help transform these imaginations and inspirations into simple financial goals.Examples of dreams (chart 3):
teenagers want expensive things like cars and computers.
young adults think about weddings and buying a home.
The habit of saving for retirement can be inspired by dreams of becoming millionaires.[My granddaughter read a story in her favorite magazine about saving to become a millionaire.She was fascinated.I discussed the article with her and shared her excitement.I asked her mother (my daughter) if I could provide some seed money to open an investment account at a reputable brokerage firm.A year or so later, my granddaughter started earning money as a tutor and used her earnings to open a Roth IRA.She enjoys reading her financial statements and watching her investments grow in value.]
Financial markets have cycles of market prices that expose investors to the risks of profits and losses.How willing are you to risk the loss of money from an investment compared to its potential profit? Compared to bonds, stocks are high risk, high return investments. It’s very reasonable to expect a good profit from the stock market after 30 years!Children have the advantage of waiting 30 years for a profit after investing in the stock market. Therefore, they can tolerate more risk compared to someone entering retirement.
Finance is the art of putting money to good use. Simple financial plans have an approximate time interval (short-term or long-term), the desired item (chart 3), and a funding method.
Short-term plans are usually low-risk, low-return projects
low-risk refers to dependable investment returns and guaranteed repayment of invested money
low-return refers to low rates of return (e.g., 4% interest rate from high-grade bonds)
Long-term strategies are suitable for high-risk, high-return investments
high-risk suggests a good chance of either earning or losing money from an investment
high-return suggests a higher rate of return than earned from high-grade bonds
Chart 5 summarizes several well-regulated investments for FUNDING desired items. I would like to emphasize that saving and investing are the best ways of avoiding the hazards of debt.
‘Good’ debt is cheaper than ‘bad’ debt.Lenders of good debt require an acceptable credit rating before lending money at a competitive interest rate and reasonable maturity date.Student loans are usually reputable when brokered by college financial aid officers to pay for college costs.Beware: Students can incur high debt by borrowing for extra years of college or attending elite schools. High debt can cause emotional and financial distress.
Informed investing involves selecting the right type of investment, using a frugal method of payment, and forming a plan to protect the investment. Short-term investments (chart 5) have time periods of 1-5 years. The following investments are guaranteed to pay small amounts of interest in addition to returning the investor’s money at a time called the maturity date:
money market funds
certificates of deposit
government bonds that mature within 1 year
Long-term investments (chart 5) have time periods that extend beyond 5 years.
Stocks are certificates of ownership in a company that guarantee the shareholders a claim on the company’s profits.Stockholders earn returns from dividends and capital gains.The expected long-term return is an average annual rate of 7%. There are no guaranteed returns.
Bonds are contracts that guarantee scheduled payments of interest and repayment of the invested money.The expected long-term return is an interest rate of 4%.
REITs are real estate investment trusts that must distribute at least 90% of the trust’s annual profit to its shareholders. There are no guaranteed returns.
Investment funds are pooled investments, typically stocks or bonds, owned by a group of investors.Funds pay interest, dividends, or capital gains to shareholders in proportion to their share of the investment fund.Shareholders also earn capital gains by selling their shares of the investment fund. There are no guaranteed returns.
Mutual funds and ETFs are investment funds governed by the Securities and Exchange Commission (SEC) for the benefit of investors.
529 Plans and Roth accounts are portfolios of government-regulated, tax-advantaged investments.529 Plans are only used as an educational savings plan.Roth accounts are used as a retirement savings plan, but may also be used for the qualified expenses of an education or purchase of a first home.
Frugal investing enhances investment profits by minimizing the impact of fees and taxes. Chart 6 summarizes the traditional ways of investing frugally in stocks and investment funds.
Trading fees: An investor must pay trading fees for every purchase and sale of stocks or investment funds unless otherwise enrolled in a direct purchase plan or no-fee plan.
Automatic reinvestments: Many stock brokers will automatically reinvest their client’s investment returns for free if the shares are already owned.
Dollar-cost-averaging is the practice of investing a fixed amount of money in a stock or investment fund at regular time intervals, typically every month. The advantages are those of having an affordable investment plan and the freedom from worrying about fluctuations in market prices. The potential disadvantage is that trading fees can dilute the investment profits. Some companies and brokers support dollar-cost-averaging by excluding trading fees.
Taxes: Investors must pay federal income tax on investment returns. The Kiddie tax is a provision that excludes children from paying taxes on the first $1,050 of gross income, including investment returns. Nor do children don’t pay taxes on investment returns they acquire in a tax-advantaged education savings account (e.g., “529”) or a Roth IRA.
In childhood, the first serious step toward planning for retirement begins with forming the habit of investing in stocks (chart 7). The prospect of getting ‘rich’ is a strong (but temporary) motivation.Grandparents could help with the investment program.The child investor might have to pay a “Kiddie tax” on investment returns until they can open a custodial Roth IRA.As soon as they start earning income from outside the family, and report that income to the Internal Revenue Service (IRS), they are eligible to open a Roth IRA that can then be used for a lifetime.It’s also important to teach children about the tax-advantaged retirement account known as the employer-sponsored 401(K) plan.
TIMELINE FOR RETIREMENT SAVINGS
introduction to stocks during pre-teen years
teens who earn income from any legitimate employer outside their family can open a Roth IRA
qualified withdrawals will not be penalized or taxed
qualified withdrawals are restricted to paying education expenses, making a partial payment to buy a first house, people with disabilities, and people over the age of 70 ½ years.
employed young adults can participate in employer-sponsored (e.g., 401(K)) or self-employed (SEP) retirement accounts. The contributions are deducted from salaries and may be supplemented by the employer.It’s important to enroll as soon as possible and participate to the fullest extent.
dollar-cost-averaging is the habit of making regular monthly contributions to an investment plan to help protect against fluctuations of the stock market.
Colleges are institutions of higher learning (beyond high school) that are certified trade schools, 2-year community colleges, 4-year schools, graduate schools, or professional schools. College prep is a family enterprise aimed at preparing students for higher education.The family’s financial goal is to balance the cost of higher education with an equal amount of savings and scholarships (chart 8).
Financial aid is used if needed.Grants and work-study programs are types of financial aid that don’t incur debt. Student loans are financial aid that incur ‘tenacious’ debt.
Unlike consumer loans, student loans can’t be cancelled by declaring bankruptcy. The 3 ways of cancelling a student loan are 1) payment-in-full,2) debt-forgiveness for performing public service, or3) death of the borrower.
TIMELINE FOR ‘COLLEGE PREP’:
start early; age 1 or as soon as possible.
the Coverdell and 529 Plan are tax-advantaged educational saving accounts that work best when owned by an adult for the benefit of the student.
grandparents can contribute to their family’s educational savings accounts and help motivate their grandchildren to seek higher education.
the required savings can be estimated with the help of net-price and affordability calculators available for free online.
Scholarships are debt-free awards of money to students based on eligibility and possible conditions of student performance required by the sponsor.Tips for seeking a scholarship:
applications for relevant scholarships are the responsibility of the high school student
require considerable research and effort by the student applicant
start research in first or second year of high school
academic achievement is important, but not the only factor considered by many sponsors
try to accumulate large awards by seeking several relevant scholarships
grandparents might help with the research, proof-readings, practice interviews, travel costs, etc.
Cost of attendance is provided in college web sites.Several ways of reducing the cost are:
high school student may be able to enroll in “early college”
college credit may be earned by successful performance in advanced placement courses and CLEP exams.
more expensive 4-year colleges may accept transcripts from less expensive 2-year colleges.
apply for admission to a “financial safety” college that offers a quality education
Financial Aid is offered by the college’s financial aid officer after the family completes the necessary application forms for enrollment.
submit the forms before, not after, the deadline; early submissions are ‘first in line’ for review by the college and many colleges have a limited amount of un-loaned aid.
expect to complete and submit a Free Application for Federal Student Aid (FAFSA) and College Scholarship Service (CSS) Profile.Both forms are detailed, lengthy, and inquisitive.
Government student loans are generally preferred to private loans.Federal subsidized loans for deserving students with financial need have additional financial benefits.
Government grants are special scholarships offered to deserving students with financial need.
recommendation:apply for financial aid even it is unnecessary.The family could still incur a financial disaster during the next school year.
EFC: The student’s annual financial aid (AID) is computed by subtracting the expected family contribution (EFC) from the annual cost of attendance (COA). The EFC is determined by authorities who review the FAFSAs and CSS Profiles on behalf of college admissions officers. Aside from the EFC, there are net price calculators available online that can help families estimate their college payment and financial aid package before completing the FAFSA and CSS Profile applications.
The EFC computed from the FAFSA is derived from an impartial assessment of the family’s income and assets. The assets are various savings and investment accounts aside from the parents’ retirement savings plans. Parents are expected to pay 6% of their assets and dependent students are expected to pay 20% of owned assets. Parents are also expected to pay 22-47% of their annual income (depending on financial circumstances) while dependent students are expected to pay 50% of annual income. FAFSA offers an annual automatic income allowance (~$6,000) to be excused from the child’s reported income. Independent students who are married or further along in life are assessed differently than dependent students. The CSS Profile’s EFC is somewhat different based on different policies.
Financial gifts from grandparents and other third parties may reduce a student’s need-based financial aid by inflating the EFC. Chart 9 enumerates the ways that cash gifts can affect the eligibility for financial aid.
There are several good ways for grandparents and other third parties to help students prepare for college (chart 10). Some ways may reduce the student’s eligibility for financial aid as just mentioned for chart 9. Other ways help inspire the student to attend college and graduate with a useful education. Contributions to parent-owned savings plans have much less impact than contributions to student-owned savings. Health insurance and student loan payments will help recent college graduates.
Children must learn to spend wisely in order to avoid future financial insecurity
Saving and investing are the best ways to finance goals.Investing starts at home!
Parents and grandparents can help children transform dreams into financial goals and plans.
Effective “ college prep” will create opportunities. “College prep” should be a family commitment AND the high school student’s responsibility.
The goal of this workshop is to discuss ways of helping grandchildren invest for college and eventual retirement. Grandparents have the time, experience, and resources to help those investments.
My role as moderator is to introduce today’s topics.Mr. Eric J. Robbins will then describe ways of investing in your grandchildren’s future.Eric is a senior investment advisor at Buckeye Wealth Management with over 30 years of experience in the financial services industry.Finally, Mr. Jefferson R. Blackburn-Smith will suggest ways of preparing grandchildren for college.Jefferson is Otterbein University’s Vice President for Enrollment Management.
The reinvestment of stock market returns is the preferred method of saving for college and retirement (chart 1).“College” is any certified program of higher education at trade school, the 2-year Associates degree, the 4-year Bachelors degree, graduate school, or professional school. Family savings, student scholarships, and financial aid are principal sources of funding to pay the cost of college. There are also ways of reducing the cost of college. Paying for college deserves early planning.
Chart 2 shows 3 goals for gradually improving children’s knowledge of personal finance.
The first goal, financial training, is an important program which is best taught at home by parents. The topic of money for pre-school children is an ideal place to start. Proper management of money will become the child’s most important skill for personal finance and college preparation.
The second goal, “college” graduation, is headed for success when parents start saving for college early-and-often in a 529 plan. Grandparents can contribute funds to the 529 and also help nurture the lives of their grandchildren. Grandchildren thrive on dreams, experiences, and skills to help prepare for college. Well prepared students are those most likely to graduate from college with a useful education. “College prep” refers to the high school student’s tasks of choosing colleges, obtaining scholarships, and reducing the costs of college; guidance counselors and librarians are excellent resources.Negotiation is the process of comparing college acceptance letters and seeking the best financial terms of paying for college. Excessive student loans can be a disturbing financial burden after graduation.
The third goal, secure retirement, begins when grandchildren start saving for expensive things; those things become more expensive as a child’s interest shifts from toys to stylish clothes, electronic devices, and cars. Bank accounts offer security to a child’s savings. A grandparent can help grandchildren buy a stock and then periodically review its performance; it’s an excellent introduction to the world of finance. Jobs help grandchildren form entrepreneurial ideas. The taxable earnings can be deposited in a custodial Roth retirement account. Grandchildren need to be encouraged to save taxable earnings in the Roth account as a matter of habit. All children need safety lessons to avoid truancy, cyber attacks, gambling, credit card debt, and other risks to their wealth and health.
After college, young adults should enter the workforce even if their first job is not a ‘dream job’.Job success will enhance their future workforce mobility.
Investing for Your Grandchild’s Future. It’s Never Too Early to Start, Eric J. Robbins
The key points of my talk are:
college is an expensive investment that often incurs debt
grandparents’ financial assets are not detrimental to student eligibility for federal financial aid
families have many ways of saving for college; among them are several tax-advantaged savings programs
parents and grandparents should avoid making 4 big mistakes when paying for college
careful planning will reduce expensive mistakes
The average cost of college tuition and fees in 2017-18 varied from $9,970 [for in-state public schools] to $25,620 [for out-of-state public schools] and $34,740 [for private colleges].To cover these costs, my recommendation is to start a college payment plan early!Otherwise, a large debt from student loans could cause significant financial distress after graduation from college.The average cost of student-loan debt is $351/month (chart 3).
In general, students use loans to pay for 19% of college costs and parents borrow an additional 8%.Grandparents typically pay no more than 4% of college costs (chart 4)
College students are required to submit a FAFSA form (chart 5) to the college admissions office when applying for federal financial aid.High-income families with large savings accounts (“assets”) receive less federal financial aid than low-income families with small accounts.For a given amount of family assets, larger portions of student savings attract less federal financial aid.Grandparent-owned assets are invisible and have no effect on federal financial aid (chart 5).
Families have many ways of saving for college (chart 6)
Qualifed series EE savings bond, 529 savings plans, Coverdell IRAs, and Roth IRAs are protected from federal taxation of investment returns.Chart 7 offers a useful comparison of these tax-advantaged plans with taxable custodial accounts.
Several comments about chart 7: Investment returns are not taxed except in the UGMA/UTMA accounts; annual income limits may restrict participation in the Roth and Coverdell accounts; contribution limits to all accounts are regulated by the government except for the UGMA/UTMA; untaxed returns can be withdrawn for qualified educational expenses (UGMA/UTMA returns are always taxable); account owners are allowed to change the student beneficiary in all but the UGMA/UTMA accounts;account owners or custodians are generally allowed to control the account with some exceptions; non-FDIC investments are not guaranteed (but why invest in a low-return FDIC account for long-term growth of savings?)
The reason for having a college savings plan is avoid mistakes that lead to unnecessary personal losses.The biggest mistakes that parents and grandparents make are shown in charts 8-11.
If a parent waits 5 years before starting to invest $200/month, the $17,380 opportunity-cost of waiting to invest would decrease the final savings balance to $13,680 instead of $30,998 (chart 9).If the parent initially invested $10,000 and then waited 5 years before investing $200/month, an opportunity cost of $29,885 would reduce the final balance to $64,906 instead of $94,791.
Additional mistakes are: failing to plan for college; allocating college savings and other financial assets to the student instead of the parent; and, no planning for possible investment losses.
Families can reduce financial mistakes for college by gathering useful information (chart 12), selecting a suitable investment return (chart 13), and seeking alternative sources of funding (chart 14).
Helping Grandchildren Invest: Strategies for College, Jefferson R. Blackburn-Smith
The agenda for my talk:
some truths about college
Many families aren’t prepared for college.Here are four ‘truths’ that college-student families need to know:
Truth #1: College is worth the effort of careful planning (chart 17).Grandparents can help by promoting the opportunities of a college education.
Truth #2: College is expensive but few students pay the full price (chart 18).For example, students can seek grants and scholarships that reduce their payments.
Truth #3: The student debt crisis needn’t be as bad as reported by the media (chart 19).Low-income students tend to borrow more carefully, high-income students less carefully.
Families can shop for government and private student loans with the best interest rates and repayment plans. College graduates might choose to participate in debt-forgiveness programs by seeking employment in certain public service programs.
Truth #4: Cost, quality, and educational outcomes are important factors to consider in selecting a college (chart 20).
One way of paying for college is to distribute the expenses equally among 3 financial accounts (chart 21).
Among ways of paying for college, an educational savings account works best when started by an adult early in the grandchild’s life.Grandparents can encourage their family to open a savings account and then make contributions to that account (chart 22).
There are many advantages to using a 529 college savings account owned by parents (chart 23).
In comparison, student-owned savings accounts may be taxable and could reduce the student’s eligibility for financial aid (chart 24).
Student performance and lifestyle have a signficant impact on the cost of college.Roughlyhalf of Ohio’s 4-year college students graduate on time, which means that the other half are either dropping out or paying much more to graduate. In chart 25, “Lifestyle” borrowing refers to students paying for unnecessary college expenses such as extravagant vacations.
Grandparents have the time, experience, and resources to help prepare grandchildren for college and retirement.
Continual reinvestment of stock market returns is recommended for college and retirement savings plans that are started early in the grandchild’s life.
Protect college and retirement savings in a tax-advantaged education account (e.g., 529 plan) and retirement account (e.g., Roth IRA).
Help grandchildren acquire the lifetime habit of saving for retirement
Help grandchildren channel their dreams and experiences into goals for careers and adult life; college could help them achieve those goals.
Many families are unprepared for college. Early planning and careful preparation will reduce the cost of graduating from college.
Minimize student-loan debt by starting a 529 plan early. Other ways of minimizing student debt include grants & scholarships, work-study programs, reduced college expenses, and loan forgiveness programs.
[additional references are listed in the LITERATURE page of this blog]
Education and Investing are the best ways for young people to develop their future. Their success is measured in terms of personal security for a lifetime rather than in millions of dollars. Investing starts with learning how to save for future wants and needs despite many distractions. Family teamwork is an invaluable aid. This Overview is aimed at helping families inspire and train their young people to make investing a lifetime habit.
Journalists and educators agree that children learn about spending, saving, and sharing money very early in life. Whether their money habits become useful or futile depends on the examples and coaching of trusted adults. Financial education starts at home where family traditions of money management set the standard. If there is no family tradition, then start one. Young investors need a team of parents and trusted adults to provide,
Money management is essential to investing and protecting financial assets such as stocks, bonds, and savings. Building good habits can be a family tradition or a new family experience. Either way, children start forming money habits early, before entering school. Many families teach the wise management of money by encouraging their pre-schoolers to store money in jars (chart 1). Any container would work -envelops, cartons, bowls, socks, etc.- but transparent jars are the favorites.
Spending Jar teaches decision-making and accountability. Children love money and never have enough to pay for everything they want. They should learn to spend wisely, track their expenses and accept the consequences of their choices. Learning to spend wisely can help them avoid future financial insecurity due to fluctuating income and overwhelming debt.
Saving Jar teaches investing. Saving leads to investing and the funding of financial goals. Start by helping children save for short term goals, then encourage them to gradually save larger amounts over longer time periods. Introduce them to the stock market by explaining that their favorite businesses sell shares of ownership. Consider helping them buy stock in their favorite company.
Sharing Jar helps build relationships. Expose children to the needs of their community. Community engagement will cultivate relationships and humane values.
Dreams are gateways to an exciting and prosperous life. Teamwork can help turn those dreams into financial plans for earning and protecting money. The earlier your child’s team begins the process, the better the chance of success.
Dreams can become realistic financial goals. Younger children dream of becoming grown-ups. For example, they wonder what adults do for a living and how parents earn incomes. Older children are inspired by classmates, role models, field trips, activities, etc.
Chart 2 shows examples of goal-starters:
teenagers want expensive things like cars and computers; they should save for it!
young adults think about weddings and buying a home; they should invest in it!
children dream of becoming millionaires; they could invest in a retirement account!
– My granddaughter read a story in The American Girl magazine about saving to become a millionaire. She was ‘hooked’. I discussed the article with her and asked her mother (my daughter) if I could provide some seed money to open an investment account. A year or so later, my granddaughter started earning money as a tutor and used her earnings to open a Roth IRA. She enjoys reading her financial statements and watching her investments grow in value. –
Starting a Roth IRA: www.irakids.com
Chart 3 outlines the sources of income for children.
Unpaid chores are work assignments needed to run an efficient household.
Allowance is a regular gift of money that ‘allows’ young children to practice spending, saving, sharing, and budgeting money.
Jobs are types of labor performed by older children to earn money without a work permit. Not only do jobs enhance wealth but they also improve social skills and help children make decisions about future vocations.
Those who chose to turn a job into their own business are called Entrepreneurs. A successful business matches the skills of the child with the type of job; it also requires planning, organization, perserverence, and reinvestment.
Employment for wages in a regulated business requires children to have a work permit issued by the State.
Investments are a good way to save money for future use. Children have a BIG OPPORTUNITY to create wealth by reinvesting stock returns that will multiply the value of their investment. Chart 4 shows the future value of $1 invested in the stock market when all dividends and capital gains are reinvested in stocks. This mechanism of growth is called “compound interest”.
Dividends and capital gains are types of interest called “stock returns”. The colored dots in chart 4 represent values of compounded returns at selected time intervals. One application of a growth curve is the use of time intervals to help plan big projects. For example, childhood goals of saving for college and retirement fit into uniquely different time intervals:
The growth of $1 to $3 in 18 years is a realistic expectation of saving for college.
The growth of $1 to $30-$114 in 50-70 years is a nice investment for retirement.
Young investors need trustworthy adults to help navigate the red tape of opening a banking or investment account (chart 5). Minors (those youth under the age of 18 or 21 years depending on the state where they live) are unable to open the account without the written consent of an adult parent, guardian, or acceptable attorney. Full control of the account reverts to the young person at the age of majority (age 81 or 21 depending on the state).
Big projects require saving thousands of dollars.
Short term projects include saving for a computer, car, vacation, or wedding.
Long term projects include saving for college, a house, or retirement.
Planning a big project requires setting the goal, estimating the deposits of money, overriding the obstacles, and occasionally reviewing the plan. A simple Retirement plan might be the following:
goal, save a million dollars [this may change later]
deposit 10% of earned income [this will change later]
override obstacles with frugal investing (chart 6) and other protections (chart 8)
review the plan when there are substantial changes of income, expenses, or personal life.
Brokerage firms charge fees for professional advice, trading services, accountants, and safekeeping of securities. The fees are inescapable, but they can be minimized by frugal investing (chart 6).
Automatic reinvestment: Ask your broker to automatically reinvest cash payments from stocks and investment funds.
Infrequent trading: Otherwise, frequent trading (especially small amounts of money on a daily or weekly basis) will dilute investment returns.
Low trading fees: Consult online ratings and reviews of brokerage firms to assess their trading fees.
Dollar cost averaging: The best way of compensating for fluctuations of market prices is to make monthly contributions to the investment account which will then purchase varying numbers of investment units (i.e., shares) depending on the market price. Dollar cost averaging requires a dependable source of money (e.g., payroll deduction, bank account) and a receptive account (e.g., direct deposit plan, 401-K, brokerage).
Taxes reduce the profits from investing. Here are several ways of protecting the profits from taxes:
The Kiddie tax defers some of a child’s investment returns from taxes.
Tax-efficient investments reduce the capital gains & dividends taxes (e.g., growth stocks) or state taxes on bond interest (e.g., muni-bonds).
Federal taxes are not charged on the profits from Roth retirement and Education Savings accounts.
Long term investing: stock prices rise and fall frequently during the short term, but in general the price of a stock will gradually rise in the long term. The young investor can expect a rise in stock price over 30-70 years.
Diversified investments: Some stocks fail to earn returns for the investor. Consequently, it’s a good idea to own several different kinds of stocks to protect the total investment.
“College” is a Big Project
“College” is defined as any 2-year, 4-year, or career school after high school graduation. College prep is a family enterprise that prepares the high school student to negotiate their admission to college. Negotiation is the bargaining process that occurs between the student who wants to attend a desirable college and the college who wants to admit desirable students. The student’s ideal financial goal is to balance the cost of college with family savings and scholarships. Financial aid is only used if needed (chart 7).
TIMELINE FOR COLLEGE PREP
Family starts saving for college 15-18 years early with a “529 Plan” or “Coverdell account” owned by the parents. Grandparents can help fund the plan.
Family has early discussions about college and the opportunities offered by a college education.
Student starts seeking scholarships during the freshman year of high school. Start with the school guidance counselor and librarian. The family can help with the research, proof-readings, practice interviews, travel costs, etc.
Student reduces the cost of attending college by earning college credit during high school.
Family applies for financial aid during the senior year of high school.
FAFSA (Free Application for Federal Student Aid) is required by all colleges.
CSS Profile (College Scholarship Service Profile) is required by colleges that award non-federal aid
Student negotiates the terms of college admission.
Secured loans are based on a collateral asset such as the borrower’s property or financial account. The lender can take ownership of the collateral asset if the borrower fails to repay the loan. Unsecured loans are based on creditworthiness of the borrower. Lenders usually rely on credit reports to assess creditworthiness. Credit card accounts and student loans are unsecured loans. Beware: Students can incur high debt by borrowing for extra years of college or to attend an expensive school.
The short-term investor typically lends money to an investment fund (money market fund), bank (certificate of deposit) or government (Treasury Bills) on the condition that the borrower promises to pay it back with a small reward (called “interest”) at a specified time no longer than 1 year.
Stocks are certificates of part-ownership in a company. Stockowners earn returns from dividends and capital gains. The expected long-term rate of return is an average annual rate of 7%. REITs are real estate investment trusts that distribute 90% of the annual profit to shareholders. REITs earn profits from rental fees and real estate investments. Bonds are contracts that guarantee scheduled payments of interest and repayment of the invested money. The expected long-term return is an interest rate of approximately 4%. Investment funds are pooled investments, typically in stocks or bonds, which are owned by a group of investors. Shareholders earn profits from cash distributions by the fund and by selling shares of the fund at a higher price. Shareholders lose money if they sell shares at a lower price than paid to make the investment. Mutual funds and ETFs are registered investment funds governed by the Securities and Exhange Commission (SEC.gov) and Internal Revenue Service (IRS.gov). 529 Plans, Coverdell ESAs and Roth accounts are portfolios of government-regulated, tax-deferred investments. Homes are illiquid assets, meaning that they are difficult to sell quickly for cash. Owners earn a profit or loss at the time of sale.
Retirement savings plans are increasingly used to supplement Social Security pensions. The 401(k) is the most common retirement savings plan offered by employers. What will happen to the future retirement income of young employees if their Social Security benefits are reduced or their employers suspend 401(k) matching contributions? The employee will then have to make up the savings deficit. It would help if they have their own long-term investing plan for retirement.
Imagine an investment in stocks that grows by multiples of 3, 30, and 90 times the original value during successive time periods of 18, 50 and 67 years. Helping a child make such an investment would help them retire in comfort IF that child learns how to manage the investment throughout adulthood. Homeschooling will help determine how well the youngster ultimately manages the investment.
Many of today’s retirees worry about a shortfall of lifetime savings. Children could avoid this future worry by starting a long-term investment in stocks that accumulates more than two million dollars. Today’s formula is simple: Start early to make regular deposits in a Roth IRA that invests in a broad-market, stock-index fund. Then build the fund with payroll deductions.
Why aren’t there more millionaire retirees? Because of obstacles along the way; college, debt, taxes, and low income to name a few. Dedication and planning are needed to circumvent the obstacles. And here’s an idea for low income families: Help your child open a custodial savings account to accumulate sufficient funds for starting an investment account. Irrespective of family income, parenting skills can instill motivation, participation, and the investment habit in a growing child.