A trip to financial planning geekdom (as if I ever left).
I guess I am the idiot for not regarding all financial columnists with as much skepticism as I reserve for the political commentators on television. After all, someone like Jim “Mad Money” Cramer can make everyone else seem reasonable when, in fact, they may be just as deluded by the latest financial trends.
For years I have respected Jane Bryant Quinn. Best-selling author of “Making the Most of Your Money,” advisor to financial services firms, columnist for Newsweek, the Daily News and The Washington Post. A director at Bloomberg. Normal, not a wild-eyed entertainer like Suze Orman or as much of a snooze as Jonathan Pond. But her advice on investing for college reveals her to be like all the rest: Follow my advice, except that when I am wrong it is someone else’s fault. Pay no attention to what I said before.
I recently rolled over my 401(k) to an IRA and so began the slippery slope of trying to figure out our financial goals and the best way to allocate our investments. Having worked on financial security issues for years it got ugly pretty fast, and I think Elysia is thankful she was in Brunei for at least some of it. In-depth reading and out-loud musings on expense ratios, the long-term growth of wages compared to inflation (about 4.1 percent to 3.1 percent), and finding the best way to invest in Treasury Inflation-Protected Securities (TIPS) and I-Bonds. You know, beach reading.
I have been teaching financial workshops to service members and have always felt comfortable with the conventional wisdom that investing in stocks is good, and safe, for the long term. After all, with enough time you should be able to weather any financial downtown. But then I read Zvi Bodie’s book and, combined with last year’s stock market crash, my perspective changed dramatically. [I highly recommend reading this PBS interview with Zvi Bodie.]
Basically, Bodie makes a very strong case that the risks of investing in the stock market have been grossly downplayed by financial planners, the SEC, and financial services companies. He points out what we all know by now, that while the stock market has averaged 9-10 percent over many decades, it can take years for your investments to recover from a severe market downturn.
Much like the mortgage crisis, he argues that the amount of money to be made on individual stock and mutual fund commissions creates a strong bias against inexpensive, safer, investments. He personally recommends putting all of your investments in virtually risk-free inflation-protected bonds.
The downside to this strategy is that you will have to save more than if you planned on becoming wealthy through the stock market. About 25 percent of your income per year, less if you count Social Security. The benefit is that you will not run the risk of a stock market crash in your 80′s and run out of money because of it.
After running a number of Monte Carlo simulations — a way of estimating the probability of whether your investments will last in retirement — I discovered that I am far more risk-averse than I thought. I know I can hang tight in a market crash while in my 40′s, but I do not think I ever fully considered the potential impact on life in my 70′s. Feast or famine outcomes put into motion from the start.
In the end, I agree with Bodie’s recommendation to decide on a minimum amount you want in retirement and be risk-averse with those investments. Then, if you have any money left over to invest, you can be more speculative. With this in mind, I tried Vanguard’s risk tolerance quiz.
No matter how risk-averse I said I wanted to be, the Vanguard quiz told me to invest 75-80 percent in stocks because I have a long time horizon. In other words, you are supposed to rely on the historical average of the stock market. Never mind that you should never walk across a river which is, on average, four feet deep.
In the end, of course, there is no right answer other than to try to make an informed decision and go with what you are comfortable with. After all, as I discovered when saving for our daughter’s education, investment advice is no less trend-driven than fashion advice.
In some years, stocks drop. On rare occasions, the market has gone nowhere for a decade or more. So hedge by owning some bonds or bond mutual funds. But the odds strongly favor stock-market investments. Over the long term, nothing beats them for growth (p554). [...] By the time your child reaches 14, 25 percent of your college savings should be earning interest in secure investments. . . . Keep the other 75 percent of your money in stocks, for your child’s sophomore, junior, and senior years (p556). [...] Take a look at the 10-year performance of stocks on page 577. It should comfort you . . . You’ll be okay. When college finally starts, I’ll wager that your stocks have won the day. (p572)
Jane Bryant Quinn,
Making the Most Out of Your Money, 1997
So let’s say you were a parent who followed Quinn’s advice in 1997 and kept 75 percent in the stock market only to watch it plummet by 35-50 percent.
Today, as those students head to college, she blames the 529 plans for “imprudent investment allocations” and parents who take too many risks chasing stock market returns. No mention of her role as a widely-regarded expert whose advice was probably followed by many 529 plans.
In the two years right before college, a good age-based 529 plan should be invested largely in shorter-term bond funds, money-market funds and insured certificates of deposit.
At the other extreme, West Virginia’s direct-sold Smart529, administered by Hartford Life Insurance Co., kept their 17- and 18-year-olds 45 percent in stocks last year. North Carolina’s CollegeHorizonFunds, managed by J.W. Seligman & Co., stayed 38 percent in stock. Rhode Island’s CollegeBoundfund, run by AllianceBernstein Investments, chose 35 percent for stock. They all got slaughtered when the market dropped.
Why did the states go along with such imprudent investment allocations?
Nelson Sorah, communications director for West Virginia, says the plan has to keep up with college inflation, which requires a high commitment to growth. That’s a dandy theory for long holding periods, even if it doesn’t always work. But no sensible adviser would say that it’s safe to gamble on a rising market over any one- to two-year timeframes.
When you are shopping for an age-based 529, look on the plan’s Web site to see when it begins to lower its stock allocation. When children reach 13 would be about right. Then see how much stock the plan is still holding when the child reaches 17. The right number is zero.
If you discover that you are in a high-risk plan, switch out. Or construct your own age-based one, by owning a stock fund when the child is young, a balanced stock-and-bond fund in his or her early teens, and an income fund from 16 or 17 on.
Some managers argue that you should hold stocks in your plan even when the child is 18. You have four years of tuition ahead and stocks might go up. True. But they might also go down. Better the security of cash than the risk of having your college fund sliced in half.
So, her book argued strongly for high stock allocations and cautioned the reader many times that doing anything else meant you were going to short-change your children. Of course, she also gave advice on less-risky investing but it was pretty clear that advice was for fraidy-cats.
Now that the chickens came home to roost, she blames the parents and other financial advisors but does not glance in the mirror.
