529 Accounts v. Retirement Accounts

future investingA version of this post appeared today in the San Antonio Express News.

People who give financial advice – like me – can be so annoyingly contradictory sometimes.
Some friends of mine with young kids – like me – asked me recently to look over their investment plans, and to give them my opinion on what they were already doing, as well as what they should do next.

They had already embarked on an automatic-deduction investment plan with their financial planner, and they also had an available $5,000, and they wanted to know where to invest it next.
They were doing something I had been urging my fellow parents to do – funding 529 educational savings accounts for their two girls – so, naturally, I told them it was all wrong.

Let me back up and explain.

I already wrote about the panic attack I experienced when I visited a useful College Board website to calculate the future cost of college. At the present rate of tuition increases, in ten years from now college tuition will cost the equivalent of checking your little darlings into a 5-Star Hotel in the fanciest building in Dubai.

Seven_Star_Hotel_College
Here’s the 7-Star hotel you will send your child to

For. Four. Years.

(*All prices here are my best estimates, using round numbers. Actual results may vary. Always read less than six financial columns in any 24-hour period. If headaches persist, please call your doctor.)
The only way to deal with that impending college tuition catastrophe, of course, is to start eating rice and beans today and send your surplus savings into a college savings account like a State-sponsored 529 Account. 529 Accounts, as you probably already know, typically offer tax-advantages for education savings and investments.

My rice-and-beans-and-529-account advice still holds if you can do it, provided one other condition is already met, which I’ll tell you about in a moment.

So like I said, my friends had set up their 529 account contributions in the name of their 9- and 11-year old girls, complete with automatic deductions.

The problem, however, is that they planned to contribute to these 529 accounts before they maxed out their IRA contributions and 401K contributions.
You see, there’s a clear “order of operations” when it comes to tax-advantaged investment accounts, and it goes like this:

1. Personal IRA – up to $5,500 this year (And more if you’re older than 50)
2. Employee 401K – up to $17,500 this year (and more if your employer matches)
3. 529 Education accounts, or other savings accounts for health or medical expenses

So, I told my friends they have to first contribute $5,500 each to an IRA this year, then make sure they have filled up their 401K bucket to the max. Then – and only then – should they direct any surplus to their girls’ 529 account. Their existing financial advisor had not made this order of operations clear.

Dubai_hotel
If they don’t get into the Seven Star hotel, Try the Six Star hotel in Dubai

Why do I insist they fund IRAs and 401Ks before funding a 529 account?
At least four factors make IRAs and 401Ks a better target for initial investment than 529 accounts.

First, both IRAs and 401Ks offer federal income tax savings on contributions, whereas 529 accounts do not. State-by-state legislation created 529 accounts, and in some states a 529 account offers state income tax relief. Since we all live in Texas, which has no state income tax, their Texas-based 529 account has no income tax advantage. So right off the bat, IRAs and 401Ks beat 529s by somewhere between 20% and 39.5%, depending on your marginal income tax bracket. But even outside of Texas, state income tax relief from 529s pales in comparison to the federal income tax relief of IRAs and 401Ks.

Second, while both a comfortable retirement and a four years college require big chunks of cash, as parents we get the opportunity (misfortune? punishment?) to borrow money for college, but not for retirement.

The student loan industry – all $1 trillion of debt and counting! – stands ready and willing to lend your little darlings what they need to check into Hotel Dubai University (Fight Fiercely Sand Dunes!) at pretty low interest rates too. I know of no similar program to lend to retirees, except halfway-predatory programs like reverse mortgages.

Next, 401K plans often come with an employer match, one of the few real-life examples of free money here on planet Earth.

Finally, compound interest – the secret sauce to the long-term growth of money – works best over the longest time periods. For my friends, they can watch their investments compound for 30 to 40 more years in their retirement accounts, versus merely 10 to 15 years in the 529 accounts for their girls. Always choose the longer time horizon when it comes to investing.

Of course, we know the best option is to fund them all and not have to pick and choose. For my friends, and for most of us, however, we need to choose, and that means picking our investment vehicles in the right order.

In sum: first retirement accounts, then college accounts. Ok? Ok.

By the way, some clever readers will urge maxing-out the 401K first, before the IRA, to take advantage of any employer match. That’s good advice, it just so happens that my friends don’t have 401Ks at their jobs now, so I told them to max out the IRAs first, then pressure the boss to start a 401K plan second, and then fund their 529 accounts third.

Here’s the TL:DR – Place the mask over your own face first, before placing it over your child. Now, just, apply that to investments.

Max out retirement account contributions first, then place the mask over your child
Max out retirement account contributions first, then place the mask over your child

 

Please see related posts:

 

College Savings vs Retirement Savings

College Savings and Compound Interest

Interview with College Advisor Part I – The Rising Cost of College

Interview with College Advisor Part II – Is The College Model Broken?

 

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Michael Lewis Still Says It Better Than Anyone

Microphone-Trophy-psd86307When Bankers Anonymous hands out its annual awards for the best “recovering banker” essays of the year, the black tie crowd typically goes on chattering amongst themselves, unheeding the speaker at the stage holding the golden microphone trophies.

Why? Becuase they know that Michael Lewis will win the best essay trophy once again. Like clockwork. It’s so unfair.

If you’re at all sympathetic to what I’ve been trying to do for the past few years then – like those unheeding black-tie guests – you’ll not be surprised in the least that I’ve linked to his article in Bloomberg again, lamenting the Occupational Hazards of Working On Wall Street. Read this, its good.

Damn him for taking the trophy again this year.

Michael-Lewis

Please see related posts:

Michael Lewis reviewing John Lanchester’s Capital

Michael Lewis’ Liar’s Poker

Michael Lewis’ The Big Short

Michael Lewis’ Boomerang

Michael Lewis’ Flash Boys

 

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Gross to Janus – Wait, What?!?!

This makes zero sense. PIMCO founder Bill Gross will join Janus Funds?

one does not simplyIf you founded and built the largest bond fund company in the world,

If your name is synonymous with that company,

If you are the rockstariest rockstar of bond managers (if such a thing can exist),

Why would you ever quit that firm and join someone else’s mutual fund company?

Lots of people leave their jobs all the time, and especially talented and notable people can demand great terms from a new employer by leaving their old employer.

But Gross is not an employee of PIMCO. He’s the founder, the brand, the face of PIMCO.

One does not simply found the largest bond fund in the world, and then turn around and join Janus Funds.

This would be like George Washington stepping down from being the first President of the United States mid-term to become Secretary of Transportation for British Guiana.

This would be like Steve Jobs quitting Apple in 2011 abruptly to take over the accounts receivable department at Nokia.

This would be like Howard Shultz quitting Starbucks to become Northwest regional sales manager for Dunkin’ Donuts.

This would be like Michael Jordan quitting basketball at the height of his talents to play minor league baseball. Well, that actually happened. But it was insane.

Short of temporary insanity in Gross, or a legal investigation of PIMCO, this does not compute.

At all. Whatever he says his reasons are, it’s one of those two. I’m guessing temporary insanity.

 

UPDATE EDIT: This Headline makes sense to me: Gross was going to be fired Saturday for erratic behavior

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New HUD Secretary – The Good and Bad So Far

Editor’s Note: A version of this post ran this morning in the San Antonio Express News.

I can’t remember any speech Mayor Julian Castro ever made to which I paid much attention.

julian_castro_sub_prime_mortgages
Shouldn’t be pushing Subprime Mortgages

Decade of Downtown?
Meh. I had just moved to San Antonio’s downtown and I didn’t have any context.
Democratic National Convention?
I missed it because I was recovering that day from a blowout wedding in the Yucatan.

But last Tuesday’s speech introducing his priorities at HUD?

Did somebody say mortgage and housing policy?

Now you’re in my wheelhouse, Secretary Castro. As a former mortgage bond salesman, I’ve got some strong opinions about federal mortgage and housing policy.

Two things stood out for me from his speech, one bad, and one good.

First, the bad:
HUD Secretary Castro named increasing access to mortgages for borrowers with low credit scores a top priority of HUD.
I cringed.

home_ownership_rates
Home Ownership Rate Comparison, 2011

Do you know another name for increasing access to mortgages for borrowers with low credit scores?
That’s called sub-prime mortgage lending.

Restricting mortgage loans from people with bad credit scores is not housing discrimination or lending discrimination.
Rather, restricting mortgage loans from people with bad credit is prudent practice for both borrowers and lenders.

People with low credit scores are people who have not previously paid their bills on time. That’s just the definition of bad credit.

People can fix their bad credit over time, and government can play a positive role in encouraging financial education, for example, or by regulating credit reporting and consumer protections.

But most importantly, people with bad credit are people who should probably wait a bit longer before taking on the largest loan generally available to them – a home mortgage.

Encouraging more people with low credit scores to take out mortgages is a bit like breaking out the champagne at the AA meeting to celebrate a month of sobriety. Bad things can and will follow.

 

Look, I get it, when you’re a hammer, everything looks like a nail. And when you’re HUD Secretary, more home ownership is always better.

I guess my larger problem with Castro’s stated HUD priority is that home ownership isn’t always better.

It’s fine with me if banks or private lenders want to take extraordinary risks and lend to people who won’t pay them back in the future, but I really don’t think the federal government should be encouraging more of that activity.

Back in the pre 2008-Crisis days, mortgage giant Fannie Mae used to run constant radio advertisements proudly proclaiming “We’re In The American Dream Business!” and at the time, who could argue with them?

Home ownership traditionally fell somewhere between Motherhood,
Baseball, and Apple Pie on the spectrum of unimpeachable good things.
Well, since 2008 we’ve gotten wiser:
Apple pie causes obesity.
Baseball is full of PED cheaters.
And Mothers are the direct catalyst for about 50 percent of all of the adults who seek psychotherapy. (Since you’re curious, scientific studies show that Fathers are responsible for the next 25 percent of all therapy-seekers, and scary, scary clowns make up the final 25 percent. In my case, it was the clowns.)

monopoly_housing
Housing as an investment tool

And home ownership? Well, it’s both an incredibly powerful tool for building middle class wealth, as well as the cause of the worst financial crisis since the Great Depression.

While I would advocate home ownership for many people, pushing home ownership to excess – like Apple Pie, Baseball, and Motherhood – also leads to terrible outcomes.

We don’t need more subprime lending, and we don’t need government agencies encouraging more subprime lending.

Speaking of Fannie Mae and the American Dream Business, I really liked a different part of Castro’s speech.

Castro advocated passage of a bi-partisan Senate bill (sponsored back in March 2014 by Tim Johnson D-South Dakota, and Mike Crapo R-Idaho) currently languishing indefinitely in the Senate purgatory between Banking committee passage and the Senate floor.

The GSEs worth killing
The GSEs worth killing

The bill would set broad guidelines for mortgage lending and securitization in the future. Most importantly – from my perspective – the bill would kill former mortgage monstrosities Fannie Mae and Freddie Mac, which themselves currently languish indefinitely in conservatorship purgatory.

Why were they monstrosities?

To me, the definition of a monstrosity is a company that enriches private investors and its executives, all the while enjoying a government guaranty, and therefore represents a massive public subsidy of private enrichment.

And yes, I understand that all of Wall Street briefly earned monstrosity status by that definition in 2008.

But the difference between Wall Street and the mortgage monstrosities Fannie Mae and Freddie Mac is that the latter companies always had this monstrosity status, from their very inception.

Technically, they were described as “Government-sponsored entities” and government officials occasionally tried to point out that their debt was not explicitly guaranteed by the Federal government.

In practice, Fannie and Freddie bond investors always assumed that when push came to shove Fannie and Freddie would be bailed out by the Federal government. Of course, push did come to shove in 2008, and bond investors were proved right.

Would you like an example of the kind of private enrichment and public liability I am talking about? Fannie Mae’s CEO Franklin Raines earned $90 million in compensation between 1999 and 2004. Their next CEO, Daniel Mudd, earned $80 million between 2004 and 2008. And then the federal government (that’s you and me, fellow-taxpayer) assumed all of the liabilities of Fannie Mae and Freddie Mac in 2008, up to $800 Billion.

I don’t know. That just seems like a lot of money to be paid to run a government sponsored (and guaranteed) entity. There’s no flies on that pair of Dickensian-named CEOs, Raines and Mudd, despite SEC investigations of both of them for securities and accounting fraud, and a paltry settlement with Raines.

The Senate bill supported by Castro would not eliminate federal government subsidies for the housing and mortgage markets, but it would greatly reduce the future taxpayer subsidies for the enrichment of quasi-private monstrosity entities like Fannie Mae and Freddie Mac, and their investors and executives.

The bill would replace them with a much more narrowly-functioning government entity – modeled on the banking deposit insurance agency FDIC – to provide mortgage insurance and a taxpayer-protection fund against mortgage losses.

That would lead to much less private enrichment with a public subsidy.

That would represent great progress.

 

Please see related posts

Mortgages Part I – I am a Golden God

Mortgages Part VIII – The Cause of the 2008 Crisis

Book Review – Edward Conard’s Unintended Consequences

On Housing Part II – The Risks

On Housing Part III – The Opportunity

 

 

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On Mortgage Spreadsheets and Old French Origins

Khan Academy Mortgage spreadsheetI was scouring the interwebs lately for a financial education project I’m doing and I came across Sal Khan’s joint educational venture with Bank of America called www.bettermoneyhabits.com

There’s some very good stuff there, but I was drawn in particular to his “How does a mortgage work” video.

I recommend checking it out here.

I happen to have this weird belief that everybody who takes out a mortgage (or car loan, or business loan, whatever) should be required – as a pre-condition of their borrowing the money – to build their own ‘loan spreadsheet,’  in order to learn the nuts and bolts of how it works. If you’ve programmed it into a spreadsheet, and calculated how the principal and interest gets paid every month, and how it amortizes, you gain insight into interest rates and cash flows that you can’t get any other way.

Anyway, I know this weird belief will not be implemented by any lender anytime soon, so the next best thing is to introduce people to pre-made spreadsheets on mortgages, and to walk them through the component parts. As a master teacher, Sal Khan is suited to do this very well. There are a ton of pre-made mortgage spreadsheet available online, but Khan Academy’s is as good as any.

Khan Academy makes available a pre-made spreadsheet under the “Fixed Mortgage Calculator” link here, that lets you input amounts, and fixed interest rates and even tax rates to calculate interest savings.

Also, I had no idea that Mortgage comes from Old French meaning Dead-Contract, since presumably the contract or title to the real estate gets killed off over time, eventually releasing the borrower from the lien. Fun!

 

 

 

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On Selling – Sell Solutions Not Features

Editor’s Note: A version of this post appeared in the San Antonio Express-News.

When I interviewed for my first bond sales job on Wall Street, half-way through the conversation the guy at JP Morgan sat back, held up a yellow #2 pencil, and said “Sell me this pencil.”

At that point, age 24 or so, I hadn’t yet read about this classic interview question. Nor, for that matter, was I a natural salesman.

I wish I had a recording or transcript of the interview, because I know I was terrible. He let me fumble around for about five minutes, completely flubbing the question. Afterwards, he told me what I should have said. [For the record, I got the job offer, but took the competing job at Goldman instead. In retrospect, though, my flubbing of the sales pitch should have been a clue. Anyway.]

The art of selling does not come naturally to me, but teaching does.

When given the opportunity to teach “the art of sales,” I’ve got plenty of confidence, not because I’m a great salesman but because I know how to teach concepts.

On the gap between my sales ability and my teaching ability, I’m reminded of the phrase “Those you can, do. And those who can’t, teach.”

Anyway, I mention this because a friend recently invited me to visit his startup business called Codeup, housed in San Antonio’s startup-incubator Geekdom, in order to teach his class sales concepts over an informal lunch.

always_be_closing
Not my preferred sales method either…

Codeup is such a cool business that I should take a moment to explain my friend’s concept before returning to today’s main topic, “How to Sell.”

At Codeup, 30 adult students — post-High school, post-College, post-first career, whatever — pay tuition to enter a 12-week “Learn to Write Computer Code” bootcamp. The program promises the opportunity to go from beginner to well-compensated web programmer in just three months.

At the end of the 12 weeeks, Codeup students prepare a portfolio of programming work, including a start-up pitch, to present to prospective employers. I attended the first Codeup presentation at the Briscoe Museum downtown last spring, a science-fair type scene in which teams of newbie techies stand in front of their screens and explain their web solutions.

The art of selling matters to the students, who either need to find a job after Codeup or who need to win support for their startup. I noticed a few things about the sales pitches during that first portfolio presentation. I visited the second Codeup cohort to pass on some sales tips that could help them.
Here’s my No. 1 piece of advice on how to sell: Don’t sell me features. Ask me about my problems.
One of the most common mistakes in sales – especially by techies – is to describe the unique features of their product without figuring out first what the customer wants.

A bad pencil salesman: “See this pencil? Look, it’s a pretty mustard yellow. It has smooth graphite gliding action on the page and feels firm and wooden in your fingers. Would you like to buy it?”

sell_me_this_pencil
Sell my this pencil

“No. I need something in blue ink.”

“Ah, sorry.” Whah-wah-waaaaaa goes the sad trombone of bad sales.
A good pencil salesman asks me up front what problems I’m seeking to solve.
“Have you ever used a writing tool, and if so what’s worked and not worked for you in the past? What are you looking for when you write?”

When I walked into the presentation at the Briscoe, I occasionally got the hard sell on the features of the apps, rather than a question about what I’m trying to solve.
I recall one very cool app, but one of the guys needed help with his sales skills.

He was breathless with all the features. My (paraphrasing) recollection of his sales pitch:
“See this app on the big screen here? Our new app is programmed in JAVA Wargames XYZ machine language and displays food-safety data on restaurants in San Antonio, ranking them in reverse order by number of health citations, and coding them for food safety risk by red, yellow and green. This map uses OS Skynet 2.0 software to show all the restaurants in the city, and you can zoom in and out.

shall_we_play_a_game
Excessive technology turns me off

Then you click on the Hal9000 interface to see the actual citation on record with the city health department in a PDF format if you want. You search by food category of restaurant. Also, pretty soon we will try to link this to Yelp. Also, in the meantime, we hope to be able to get customer comments.”

Wrong approach. Too many features.

The better sales approach would start by asking me questions. Something like:
“When you eat out at restaurants, is food safety something you’ve ever considered when choosing a place to go? Have you ever tried to figure out for yourself the food safety of any restaurant? How have you tried to do that in the past?”

Now I feel like he could solve a problem of mine. Now I’m interested in the solution. Now the sales pitch works.
Incidentally, speaking of my friend’s Codeup business, how’s the job search going for you?
Have you ever wondered how to get into computer coding? Have you wondered how to get training for a good-paying job in just three months?

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