The World's Best Investment Is an Investment in One's Self

For the longest time, I've had an interest in the stock market. The whole concept of making money from just using my brain turned me on. And don't get me wrong - being invested in the stock market over the long term is an excellent idea. A dollar invested in the S&P 500 Index (a group of companies that are generally thought to be a bellwether for the United States economy) in 1970 is now worth $77.79. For a shorter time frame example, imagine buying an index fund in 1994 - twenty years ago. If you invested $10,000 in that index fund, today you would have $106,960.86, for a compounded annual growth rate of 12.98%! 

All of the above goes to show that the stock market can be a fabulous investment. However, I do not believe that the stock market is the best investment.

After learning so much about personal finance and travelling along my own journey to being at peace with money, I've realized that the world's best investment is an investment in one's self. An investment in one's self can be obtaining higher education, getting coaching, getting training, doing something enjoyable that relieves stress, building one's self esteem or one's business.

The primary reason that I believe that an investment in one's self beats investing in the stock market every time is that the returns from the stock market, over the long-term, are capped at around 20% per year. That is an astounding compounded annual growth rate, but it's not one that the majority investors can achieve. In fact, the only investor who has achieved such a feat by investing in companies/stocks over a 40 year period is Warren Buffett. So unfortunately, it's unlikely that we can achieve the same sort of rate of return. When we invest in ourselves though, the potential return is unlimited.

Investing in ourselves allows us to get and maintain a job, which allows us to save money to even put to work in the stock market or other prudent risk taking endeavors. Without employability or marketable skills, there is no ability to build wealth. Also, Warren Buffett is famous for saying that in all risk taking endeavors, one should stay within one's circle of competence. That is to say that if you are most interested in fashion or the culinary arts, then you should devote all of your time and energy to becoming the best couturier or chef/restaurateur, and not to picking stocks. You can have a professional do that for you.

When you invest in yourself, you increase your human capital and financial capital to invest in things outside of yourself!

How to Save for Your Child's Education - 529 Plans vs. Coverdell ESAs

Hello everyone.
I'm sure a lot of us are acutely aware of the growing student loan debt crisis in this country. According to the Wall Street Journal, student loan debt topped $1 trillion last year. Such being the case, not only is it much more important nowadays that students make wise choices about where to attend college, but it's also more important that parents do as much they can to give their children a leg up financially by saving for the child's educational expenses when she (the child) is young.

According to the College Board, the average cost of tuition and fees in 2011 for a private college was $28,500, and this doesn't even include room and board. At private universities like my alma mater, Duke University, the total cost of the college experience is $56,056 per year! But don't let this number scare you. When it comes to saving for college, there are a number of options that you have available to you.

529 SAVINGS PLAN - PREPAID TUITION PROGRAM

A 529 Savings Plan comes in 2 flavors - the prepaid tuition program and the college savings plan. A 529 plan is an investment vehicle, akin to a Roth or traditional IRA, which allows you to set aside funds to invest, and which are never taxed, in order to pay for a beneficiary's (student's) college expenses. Once a 529 Plan is opened, it is managed (the assets within it are invested) by a trustee. Depending on who you open the plan with, you can sometimes also choose how the money is invested. And fortunately, its existence does not affect the beneficiary's (student's) eligibility for financial aid. Moreover, contributions to a prepaid tuition program decrease a donor's state income tax liability.

The prepaid tuition program allows the people who contribute to the student's 529 plan to lock in tuition rates where they are right now, regardless of how much higher they are at a later date, at a predetermined university/college or from a list of predetermined colleges. With a prepaid tuition plan, you can prepay all of a child's tuition if you happen to come into a windfall. However, because  prepaid tuition programs vary from state to state, availability of prepaid tuition 529s might be limited to residents of the state where the college is located.

Lastly, if the beneficiary of the prepaid tuition program 529 was to die, the amount in the plan can be transferred to any of the following qualifying relatives: spouse, child (includes foster and stepchildren), father, mother, brother, sister (includes all step-siblings), and a first cousin.

529 SAVINGS PLAN - COLLEGE SAVINGS PLAN

The college savings plan version of the 529 Savings Plan is very similar to the prepaid tuition version, but it is infinitely more flexible. It has all of the perks of the prepaid tuition program such as transferability and tax deductibility, but you can use it for any university. Also, you are not locking in tuition prices with this plan. You are just saving/contributing a specific amount of money that is to be invested and will cover the beneficiary's qualified educational expenses. The lifetime contribution limits in each state tend to rise with the cost of college, so many states have current contribution limits upwards of $300,000.

It should be noted however that the government does not permit you to use the assets in the plan for anything besides educational expenses, so it is important not to overfund this type of plan. And be sure to coordinate with grandparents and relatives who may want to contribute to the plan. Doing so prevents overfunding of the plan.

Lastly, this type of plan, as I mentioned before, is the most flexible plan. You should use it if you want your child to be able to choose his own college and want the ability to allow the child to use the funds when she desires. There is no age or time limit by which the beneficiary must use the assets in the plan. Unfortunately, the prepaid tuition program does have certain age limit and time for use restrictions and these vary by state.

Here's a quick summary of the major differences between the two types of 529 Plans before we jump to Coverdell Educational Savings Accounts.

COVERDELL EDUCATIONAL SAVINGS ACCOUNTS

Coverdell ESAs are also tax free educational saving investment vehicles. However, in contrast to 529 Plans, Coverdell ESAs can be used to fund elementary and secondary school expenses if you would like to send your children to expensive private schools when they are young.

These types of plans, in my opinion, should rarely if ever be used though because even though the maximum contribution to the account was $2,000 per year per child for the past ten years, it is scheduled to be reduced to $500 per year per child at the end of this year. Moreover, Coverdell ESAs require that the balance in the plan be used for educational expenses by the beneficiary's 30th birthday, or else the plan will be hit with taxes and penalties. As you can see, a 529 Plan is way more preferable than using a Coverdell ESA. And if you want to save money for your child's K through 12 school expenses, you'd be better off investing as much as you possibly can in an individual investment account and bearing the tax burden rather than being hamstrung by a $500 maximum contribution limit per year per child.

I hope this post was informative. If you'd like to begin planning for your child's future, you can do so by clicking here or here.  Until next time...

The Six Pillars of Financial Independence

Hey everyone.
In my last post, I spoke about limiting beliefs and how they restrict us, especially when it comes to money. Removal of limiting beliefs is actually one of the pillars of financial independence I have developed, but I will discuss all six today. Let's get started.

In order to achieve financial independence, which means being able to live without financial worries, debt, or wondering about the stability of your income source, you must abide by these six precepts. They follow an order and the higher up on the list a pillar is, the more important it is. They are as follows:

1) Accepting responsibility for your financial situation.

2) Acknowledging and removing limiting beliefs regarding money from your life.

3) Identification of goals for your money.

4) Saving.

5) Investing.

6) Patience.

ACCEPTING RESPONSIBILITY FOR YOUR FINANCIAL SITUATION
Look, all of us make mistakes. Some of us have made more than others, but no one gets off the spinning dirt ball without making mistakes. This includes financial ones. Financial mistakes include taking on too much student loan debt, using credit cards to buy stuff we don't need, not paying attention to our credit score and making late payments when paying bills, and the list goes on and on.

As we get older and wiser, hopefully we stop making these mistakes. But it's easy to look back on your life and beat yourself up about how much money you wasted making imprudent financial decisions. Forgive yourself and move forward. Forgiving yourself doesn't mean you are letting yourself off the hook for your poor financial decisions. In fact, it's quite the opposite - it means that you are aware that YOU are the only one who made you make those financial decisions in the past.

Until you accept that you are in control of your decisions, and not someone else or some outside force, you will never be in control of your money.

ACKNOWLEDGEMENT AND REMOVAL OF LIMITING BELIEFS
Check out my last post on limiting beliefs regarding money. It provides insight on what a limiting belief is and what you can do to get rid of it.

IDENTIFICATION OF GOALS FOR YOUR MONEY
Money should be a 'means' in your life, and not an 'end' in itself. A lot of people want to amass money so they can see it sit in a bank account, as if that would bring them tremendous joy. The thought of having enough money to do whatever is necessary might be comforting, but eventually you would use that money in that bank account to enjoy yourself along with family and friends. Working toward a goal is that much more fun when you know specifically what your goal is.

Do you want to travel the world and stay in five star hotels the whole way? Do you want to open a bakery and paint on the side? Money can help you do all of these things, but when you know what you are working for, making tough decisions becomes easier for you than if you have an amorphous goal of 'having a lot of money'.

SAVING 
Trying to achieve financial independence without saving is like trying to cook without ingredients - you can't do it! Saving money allows you to have capital that can work for you, even when you are not working. I know that it takes discipline, but you have to ask yourself if that new iPad or having cable tv is more important to you than achieving your dream some day.

INVESTING
Investing allows your money to make money for you. Just look at the fact that even in these economic times, the U.S. has a record number of millionaires. Why? Because the rich don't get most of their income from their paychecks - they get it from investing in assets. There are lots of posts on this blog about getting started with investing (particularly in stocks). I recommend that you check them out.

PATIENCE
In most aspects of life, patience is a virtue. It is no different with regard to becoming wealthy. Patience will keep a saver from getting frustrated and abandoning her savings plan. It will keep an investor from trading too much in his account because he thinks he can 'time' the market. Most importantly, it will allow investors to take advantage of the power of compound interest and tax-deferral if s/he is using a Roth IRA, traditional IRA, or 401(k).

It takes time to implement all of these pillars into your life. But if you make a commitment to do so, bit by bit, your financial 'house' will be in order. Until next time...

Money and Limiting Beliefs

      "Whether you think that you can, or that you can't, you are usually right." - H. Ford
Hey everyone.
Today's topic is limiting beliefs and how they restrict us, especially when it comes to money. Let's jump in.

So, what exactly is a limiting belief? I think that we have to begin by defining a belief. A belief is defined as an acceptance that a statement is true or that something exists. Another definition is something that one accepts as true or real or a firmly held opinion or conviction. However, not all beliefs are true. If a belief can be an opinion or conviction, then of course all beliefs are not true!

For the longest time, people believed that the earth, instead of the Sun was the center of the universe. Then, a brilliant mathematician and astronomer came along and shattered people's beliefs in 'geocentrism' and replaced it with 'heliocentrism'. And for the longest time, people believed that no one could ever run a mile in under four minutes, but then came Roger Bannister who ran a mile in under four minutes in 1954! And even after that, Bannister's record has been broken over and over again.

The point is that a lot of times, humankind believes things and these things turn out to not be true. And there are myriad reasons for these beliefs - sometimes our minds cannot comprehend things being different than they appear to be. I mean, before we as humans landed on the moon, it was pretty crazy to think that we could be on the moon! But we did it. Which leads me to my next point. A lot of times, we (myself included) look at life as it is at the moment and not how it could be, even though we wish life could be different or better. Such is what a limiting belief is - a negative belief about things as they are, and not a positive one about how they could be.

Limiting beliefs do not serve us as humankind very well. Can you imagine if Barack Obama just moped along with everyone else and said "there's no way a Black man can ever get elected President"? If he had 'believed' that statement, then he would have never taken action and run for President. And if you don't run, then how can you win?

Limiting beliefs show up a lot in our lives. Some of us believe that we are unattractive, unintelligent, unlucky, or whatever. And even though not all of us believe the things in the sentence above, a lot of us who were not born into money believe that money is hard to come by or that we will struggle for the rest of our lives or that  we just can't get a break. This system of beliefs that I just described is known as a 'poverty consciousness', as opposed to a 'wealth consciousness'. And, believe it or not (and I hope that you will believe it), the more that we think and feel these things, the more they become a part of our identity and we will continuously see the manifestation of that belief in our life.

Let's be real. Our thoughts are usually on overdrive. We let things play over and over again in our heads and sometimes we feel as if we have no control over them. The subconscious mind is essentially our slave and whatever we tell it to believe, that's what it will believe. Which is why it's so important to never, even in a tough economy, let words of discouragement and despair, be the predominant thoughts in your head. Stop listening to news about high unemployment or complaining about how you're having a tough time making ends meet. What you might be saying or thinking probably is very much a reality in your life. It does not matter what problems you are having (and we all have them) in you life though. Start repeating and thinking to yourself the things that you would like to see in your life. The more you think something or say it, the more you will believe it. And when you believe something, you will take definite action to make that belief become a reality. Here are a few statements that are positive affirmations about money that you should try on and see how you feel about them:

1) Money comes easily to me.

2) I have more than enough and am at peace with my finances.

3) I am a truly rich wo/man.

For even greater impact, try stating/thinking these affirmations when in a heightened state such as eating good food, listening to music you enjoy, or even orgasming. When you attach a positive emotion to these thoughts, your energy is heightened and the message sent out into the ether is that more powerful.

To wrap it up, no matter what your financial circumstances, you can make things better for yourself. However, you must begin speaking and believing the things that you would like to exist. When you believe that deserve money, you will make better financial decisions. When you believe that you have more than enough, you can donate to charity, which makes room for more money to flow into your life. I recognize that not everyone wants to be rich, but I'm sure everyone wants to be at peace with their finances and live comfortably. Such is possible by being aware of and ridding ourselves of limiting beliefs regarding money.

The Proper Way to Invest Within a Roth IRA, Traditional IRA, and a 401(K) - Part 2

Hello everyone.
In the first part of this two part blog post, we spoke about the most tax-efficient way to invest using your Roth IRA. Essentially, my advice was to load up on dividend paying stocks. Today, we'll discuss the most efficient ways to invest using your traditional IRA, if you have one, or your 401(K). Let's get started.

Traditional IRA
Because a traditional IRA allows for tax deferred growth of your money, you should invest as aggressively as possible within this vehicle. As I mentioned in previous posts, the money in your traditional IRA will be taxed  at the income tax bracket that you are in at 59.5 yrs. old or whenever you decide to withdraw it, instead of the long-term capital gains rate of 15% (Note that mandatory withdrawals must be taken at age 70.5). The majority of people go into higher tax brackets as they age, assuming of course that their incomes go up as they progress in their careers. The point of investing aggressively though is to achieve the maximum possible gain and offset the tax bite that the investor will feel when she withdraws her money for retirement. The top marginal tax rate of 35% is 2.33 times higher than the regular long-term capital gains tax rate, so the investor should want to make sure that being taxed at a higher rate does not diminish her purchasing power later on in life. The best way to do this is load up on small-cap and mid-cap growth stocks and mutual funds.

If you are looking for a place to begin with choosing these types of stocks so that you achieve gains that are potentially multiples of what you initially invested, I recommend the following newsletters:

1) Motley Fool's Hidden Gems

2) Thestreet.com's Breakout Stocks

3) Cabot's China & Emerging Markets Report

All of the newsletters above have great track records and are available for reasonable prices on a yearly basis. Moreover, not to sound like an advertisement for them, but one great investment pick from one of these newsletters will more than pay for the price of subscription multiple times over!

401(K)
Investing within your 401(K) plan is relatively simple - not because investing is simple, certainly not. But because the investing options within 401(K) plans usually stink! And that is one of the reasons that
I advocate only placing enough money in your 401(K) plan to get the company match and then choosing another investment vehicle for your excess money.

Within 401(K) plans, you mostly only have the options of investing in your company's stock (if it's publicly traded) and various mutual funds. In order to invest in mutual funds effectively, it's useful to go to people whose job it is to evaluate their track records on a daily basis. The preeminent source for mutual fund rating is a company called Morningstar and with premium membership to it, you will find TONS of information on every possible mutual fund in your 401(K) plan and Morningstar's analysts will even rank the funds for you! At $189 a year, I think that's a great value. Especially if you don't have the time or the inclination to research your own investment choices.

When looking for highly rated mutual funds on Morningstar's site, I recommend loading up on small- to mid-cap growth/value stocks if you are in your late 20s to late 30s. Because people in these age groups have time to withstand the inevitable cycles of the stock market, they should be about 50 - 65% invested in growth mutual funds and less focused on income. As you get older though, you should shift your 401(K) balance more toward income than growth. You do not have time to sit idly by and withstand the ups and downs of the market when you want to leave the work force in a year or four! A good resource for determining a good asset allocation mix for your 401(K) plan without consulting a financial advisor can be found here.

I hope this was informative. Feel free to email me at jonathan@pollardfinancialcoaching.com with any questions or suggestions you have for blog posts! Take care and until next time...

The Proper Way to Invest Within a Roth IRA, Traditional IRA, and a 401(K) Plan - Part 1

Hey everybody.
My last two posts were about the differences between a Roth IRA, a traditional IRA, and a 401(K) plan. Today, we're going to talk about how to invest the most effectively within each of those investment vehicles. By effectively, I mean in order to achieve the maximum tax advantage since all of these investment vehicles are in fact tax savings vehicles. Let's begin.

ROTH IRA
As I mentioned in the second to last post, the Roth is the most flexible of the three. And when you withdraw your money from a Roth IRA at 59.5, you will not be taxed on any of the gains. The reason that you will not be taxed is because the dollars that you are putting into the Roth IRA are after-tax dollars. That is to say, they have already been taxed. Because you will never be taxed, you want to load up your Roth IRA with stocks that pay dividends and stocks of smaller companies with lots of room to grow. Let's start with dividends first.

 Normally, dividends are taxed at 15%, so they already have preferential tax treatment and since you're not paying taxes on any capital gains, it doesn't matter that dividends have a lower rate of taxation than regular capital appreciation on a stock. However, dividends, when reinvested and coupled with capital appreciation on a stock can generate significant income. When you receive this income, you can choose to reinvest it and buy more of the same stock, or some other company's stock, or just take it out and spend it. But the idea is to create a stream of income that is nontaxable and that flows into your account no matter what the stock market does.

Take a company like Pepsi for example. At the beginning of 2001, Pepsi paid $.14 a share every quarter. So this means that whether Pepsi stock went up or down in the first 3 months of 2001, if you owned 100 shares, you got a guaranteed $14 (100 * $.14) in 3 months. If you owned 1000 shares, you received a guaranteed $140 ($.14 * 1000) in 3 months. In the second quarter of this year, Pepsi's dividend was approximately $.54. This means that if you owned 100 shares, you earned $54 whether Pepsi's stock went up or down. If you owned 1000 shares, you earned a guaranteed $540. And the longer you hold dividend paying stocks, the more dividends you get, which allows you to purchase more dividend paying shares without even having to sell anything from your portfolio to do so. Click here for a visual demonstration of what I was just saying about Pepsi. As you can see, Pepsi's dividend nearly quadrupled over 11 years. Companies whose stock price increases along with increasing their dividends are prime candidates for your Roth IRA.

Unfortunately most companies that have dividends like the ones that I'm referring to are really large, and as a result, do not provide as much potential for capital appreciation. However, small cap stocks (stocks of smaller companies) that have dividends are what you should really look for when trying to build up a nest egg. Small cap stocks can potentially provide for 10- to 20-fold gains over several year periods, and when the company grows, the dividend usually grows along with it. Further, since Roth IRAs only allow you to place a limited amount of money into them, you need to supercharge the gains that you receive within them to make up for the limited contributions. Small cap stocks allow you to achieve outsized gains that can help you achieve financial independence. And because you cannot access the money in full until 59.5, you can afford to sit back and let those small cap stocks you've chosen run their course to maturity.

Take Deckers Outdoor Corporation - the maker of UGG boots - for example. Had you bought $1000 worth of this company's stock in May 2005, you would have $7000 today, even after all of the stock market ups and downs from 2008 to 2010. The moral of the story is that even though you are always trying to achieve maximum returns when investing, you want to make sure you achieve the maximum amount when using a Roth IRA because your gains will never be taxed.

If you are looking for a stock newsletter that has recommendations of dividend paying stocks, I recommend
Dick Davis Dividend Digest or if you want a dividend exchange traded fund, check out the iShares Dow Jones Select ETF or the SPDR S&P Dividend ETF. For newsletters that recommend small cap stocks, I recommend Cabot's Small Cap Confidential or TheStreet.com's Stocks Under $10. I've just said a mouthful, so I'll continue talking about tax advantage maximization in the next post.

The Difference Between a Roth IRA, a Traditional IRA, and a 401(k) Plan - Part 2

Hello everyone.
Last time, I spoke about what a Roth IRA is and all of the nuances of it regarding contribution limits, withdrawal restrictions, and how it is taxed. Today, we will discuss the traditional IRA and 401(k) plans. Let's dive in.

TRADITIONAL IRA
A traditional IRA is very similar to a Roth IRA in that its purpose is to help middle income Americans save for retirement and provide them with significant tax savings. However, the crucial distinction between a Roth IRA and a traditional IRA is that whereas a Roth IRA is funded with after tax dollars, a traditional IRA is funded with pretax dollars. That is to say, you can write your traditional IRA contribution off on your taxes, thereby lowering your annual income. This allows you take advantage of the power of compounding interest without being taxed until you withdraw your contributions and gains, if any, at 59.5. The chart below shows just how powerful the power of not being taxed is when coupled with the power of compound interest over an extended period of time.

(*Note: The example above assumes a tax bracket of 25%, a weekly investment of $25, an annual wage increase of 3%, and 8% annual investment growth.)
 
Because the money that you contribute to a traditional IRA is pretax money (money that you have never paid income taxes on), you will be taxed on your gains and contributions at the income tax bracket into which you fall at 59.5 - the age when you can withdraw your money without penalty. In contrast to a Roth IRA though, you may not withdraw your contributions at any time. If you withdraw your contributions prior to 59.5, you will be taxed on the withdrawal at your current income tax bracket, in addition to being hit with a 10% penalty on the withdrawal.

For single people who wish to contribute to a traditional IRA, in order to qualify, you must not make more than $58,000. For those who are married and filing jointly, you may not make more than $92,000 if you wish to make a full contribution. Also, just like a Roth IRA, you make only contribute up to $5,000 a year if you are under 50 and $6,000 a year if you are 50 or older. However, unlike a Roth IRA which has no age at which you must begin taking distributions from the account, in a traditional IRA, you must begin taking distributions at age 70.5.

401(K) Plan  
A 401(K) plan - or for those who work for non-profit institutions, a 403(b) plan - is an employer sponsored retirement savings plan where usually an employer matches (puts the same amount of money in for every dollar that you put in) your contributions up to a certain point. Usually this match from the employer goes up to 5 - 6% of your salary. Let's say you make $100,000 a year and are 35 years old. The maximum amount  that an individual under 50 can contribute is $17,000 in 2012 and $22,500 for those 50 or older. Let's say you contribute the maximum of $17,000 per year. Your company will usually match no more than $5,000 to $6,000 a year of your contribution. Because 401(K) plans usually have mediocre investment options, are relatively inflexible, and concentrate all of your wealth in your job, I recommend only contributing just enough to your 401(K) to get the company match. Any left over money that you would like to invest should be socked away into a Roth IRA.

401(K)s are inflexible because if you want to make an early withdrawal, just like the traditional IRA, you cannot withdraw your contributions without being hit with a 10% penalty and federal income taxes. You may however take a loan from your 401(k) plan, provided that you pay it back within 60 to 90 days (the amount of time varies from employer to employer). However, you are paying interest on this loan while it is outstanding. Also, if you quit or lose your job, then the loan becomes immediately payable. Lastly, if hardship withdrawals are allowed in the plan, you may be able to withdraw money to prevent foreclosure/eviction, pay for qualifying educational expenses, and cover any medical expenses not covered by the company insurance plan. However, a 10% withdrawal penalty will still apply to any distribution.

In my next post, I will discuss how to choose investments for each of these vehicles so as to maximize the tax advantage you receive in each. But if you would like a chart view of the distinctions between a 401(K), a Roth IRA, and a traditional IRA, click here. Until next time....