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investing

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Hi Anna,

I love your financial advice/information, so I came up with a question for you–and no surprise, it’s baby related! If you feel so inclined to share your wisdom…

We’re starting to look into the idea of a 529 [education savings account] for the little one–something I believe you’ve got Mini hooked up with?–but we both keep questioning whether now is a good time to START an investment such as the 529, given the uncertainty in the market.

Basically, the question for me comes down to should we start a 529 and hope that time balances out the current market, or should we put the same money into a savings account until some later date (at which point we would probably start the 529).

Thoughts from the financial whiz?

. . . And here’s my response:

Thanks for the question, I will try to answer it in more detail on the blog, after doing some research about what other people think, but the short answer is, yes, I do think it’s a good time, and I’ll tell you why we continue to invest every month for Mini:

Mini has 16 years until college, and your baby has over 18. That’s a long time for the stock market to recover, and in most cases the stock market goes up over that amount of time. The market will be volatile for a long while, but if you invest in stuff that’s reasonably diverse, I still think you’ll end up way ahead over the course of 18 years. If you put money in a savings account, it will not even keep up with the inflation rate, and if you then decide to put money in the market in a few years, the chances are that prices will have gone up and you’ll be buying less shares in mutual funds for more money. Plus, you won’t have as many years to “buffer” yourself from market fluctuations.

Mini’s 529 has lost money (on paper) in line with the market. It sucks, but I don’t really check the statements very often, because unless it goes down like 50% or something totally out of sync, I know it’s just the crappy state of the market. We continue to invest every month, though we might start breaking it up over a weekly basis, just to dollar cost average as much as possible.

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After looking around the web for more information, I’ve determined that whether or not you choose to use the 529 right now has a lot to do with how much time you have before your child is due to start college. So for young kids and unborn babies, I think the 529 is still a good option, even if the market is volatile for many years to come. [Insert disclaimer here about how you are taking financial advice from somebody who has a PhD in English literature, and absolutely no financial training whatsoever--not even an Econ class, mind you--other than the School of Hard Knocks and Bad Debt Balances and several readings of Capital, so your mileage may vary, and take my advice at your own risk.]

Additionally, the Federal government’s financial aid page seems to agree with my rationale for the long time frame afforded by starting early on college savings via 529 accounts:

If the stock market plummets when the child is young, the percentage losses might be high, but the dollar losses are relatively small. That’s because the family most likely has not yet saved a lot of money in the college savings plan. On the other hand, when the student is about to enroll in college or is already in college, there is much more money at risk and much less time to recover from losses. You should plan for the possibility of losses, since the stock market has historically had a big drop at least once a decade. Even so, overall returns on investment tend to higher than other savings vehicles if you have long enough of an investment timeframe.

There are many people, of course, who have been putting money in 529 accounts for years, and saw their balances drop significantly in recent years, when their child is within a few years of attending college. I would have to say that these people are more or less in the same position as those people near retirement who had too much of their money still in the market and not removed to more conservative investments. If you are thinking of starting an educational savings account now for your child who has less than ten years to go before college, you may want to think carefully before investing in a savings account that invests in the market. For information on how 529s are handled in your state, see SavingForCollege.com, which also has recommendations about age-based allocations, etc.

  1. Investing is distinguished from savings by the introduction of risk. As I discussed in my post about savings, a good savings plan is not exciting because it does not involve risk. A savings account involves a stable interest rate, with low returns and little expectation of gain. You just want to keep your savings somewhere safe while you are waiting around to use it. Investing is different because it concerns money that you want to grow, and that you are willing to risk in order to grow. Investing is done with money that you do not need today, and that you do not anticipate needing for at least the next five years.

  2. The level of risk involved in investing varies greatly according to types of investment, and can be adjusted to your comfort level. Lately, just putting your money in the bank seems a little risky. This is not ordinarily the case, but investing your money always involves an element of risk in exchange for a chance at a higher reward. How much you are willing to risk your money depends upon a variety of factors, including the amount of money you have to invest, how much time you have before you may need to use your money, current economic climate, et cetera. Assessing risk is the skill you need to acquire if you want to be a successful investor.

  3. Investments are used for funds such as retirement, college savings, and general wealth-building. You do not put your emergency fund in an investment fund. Similarly, you do not use your short-term savings funds (such as new car funds, christmas funds, or house downpayment funds) for investments. You cannot afford to expose these monies to any kind of risk, and besides, you will need to use the principal from these funds long before you can hope for a significant return.

  4. Sane, smart investing requires patience and persistence. This is particularly true in the current market. You cannot put your money in the market today and expect a return any time soon. Yes, I know there are day traders and hedge fund managers out there who will tell you different. If you have a ton of money to dick around with, then I invite you to try these tactics. Try to steer clear of ponzi schemes, at the very least. However, if you are like me, and just looking to retire without having to eat dog food, then I beg of you to approach the market in a smart way. Losses are not losses until you sell (or, in the case of people who owned Lehman Brothers stock, until your company goes out of business). So, if you see your 401K going down a lot lately, remember that this money is meant to be in there a long time. If you sell now, you are guaranteeing a loss. If you hang in there (with a well-managed portfolio), you can hope to do better in the future.

  5. You should never, ever buy a product you don’t understand. Investing is a complex topic, and you won’t understand everything about it today. That said, there is no hurry. Do not go out and buy mutual funds without understanding what they are. Similarly, if you choose to buy single stocks, do not do so without understanding the company and why it is a good investment. I don’t care who your sister-in-law works for, or what your golf buddy told you. You will not feel safe and confident about your money until you understand where it is invested yourself. A good resource for researching investment products online is Morningstar, or if you go to a brick-and-mortar investment company, you need to find a broker with the ability to teach you about all of the products he or she is endorsing.

  6. Learning about investing is a lifelong process. You will make mistakes when you invest, no matter how well-prepared you are. The market is unpredictable and surly, even for seasoned investment professionals. Your best bet is to keep learning and keep assessing your risk and your risk-tolerance as you go along. The rest will come with time and patience.

Well, it’s Monday again, so it’s time for a list, and I had a little trouble coming up with an idea this week. I felt like I needed to talk about insurance again, but an in-depth discussion of insurance doesn’t lend itself nicely to a list. So then I thought, hey, when I was getting out of debt and trying to get my financial life in order, I felt like I needed a checklist of things to get done/taken care of so that I could officially move into the grown up category. You know, like the stuff responsible people just automatically already know, but somehow I missed? So yeah, I thought maybe that could be our list this week.

  1. Renter’s Insurance/Homeowner’s Insurance. If you own a home, you probably already have this since I don’t think you can have a mortgage these days without a homeowner’s policy. But I know there are a bunch of you renters out there who do not have renter’s insurance, and this is just to let you know that you need to look into it–it is generally not very expensive, and even if you live in a place where there aren’t hurricanes, there are probably fires and earthquakes nearby or, say, airplanes that randomly crash into houses. You need to insure the contents of your apartment so that replacing everything will not totally max out your emergency fund in the event View definition in a new window of a disaster. Now, you may be thinking, “None of my stuff is valuable!” and that may be the case, but just think about having to buy a new bed, TV, clothes, etc.–these things are going to add up fast. So go get a policy now, kid.
  2. “Gap” Insurance for People Who Have Homeowner’s Policies Through an HOA. If you have a Homeowner’s Association, you might pay for the bulk of your homeowner’s policy through your HOA fees. That’s fine, but you need to check the numbers and details on these policies just to make sure you understand your coverage. For example, some HOA homeowner’s policies cover the rebuilding of the structure, but everything on the inside of the home/condo/apartment is not covered–including things like faucets, toilets, lights–so that if you don’t have another policy, you’ll find yourself with a rebuilt home that’s totally uninhabitable. You can get additional coverage by talking to your own insurance agent–they will call it earthquake insurance or contents insurance, or something similar–just make sure to explain the situation to them so that they can recommend the best policy to meet your needs.
  3. Advance Directive for Health Crises Everyone remember Terry Schivo? You need to make sure you have instructions on what to do if you have a major health catastrophe and someone else has to decide what to do with you. There are a couple of ways to do this: 1) go to a lawyer, or 2) ask your insurance company for a form. I have not looked into this, but I believe you could do this kind of thing with one of those legal forms place like Legal Zoom or We the People. Personally, I would opt for the checking with your insurance company first, though, since there is no reason to pay for this.
  4. Burial Instructions and Life Insurance to Cover Burial Costs. I discussed this in my article on life insurance, but provided you do not have kids yet (or other dependents), you only need enough life insurance to cover your own burial. Along with this, you will want to have instructions and a will, if you have sufficient assets to require instructions for their disbursement.
  5. Emergency fund. I’ve already discussed this, but as a grown up you should aim for always having an emergency fund of 3-6 months of expenses in place. If you lose your job or have some kind of crisis, this will help you avoid going into debt. If you’re in the middle of doing your debt snowball, then you can have a smaller emergency fund, but it should always be in place, regardless of your other financial circumstances.

OK, how about you people? Anything to add to the grown up list?

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