Episode 10: Certified Financial Planner Jeb Jarrell does some investment myth busting in today’s episode. There’s a lot of misinformation out there. Jeb’s going to provide some insights to help you to clear up some of the issues and help you to avoid a few common mistakes.
Passive Investing
This is how people often describe “indexing.” This was popularized by John Bogle, the founder of Vanguard Funds. It can be a good strategy for some situations. The SPIVA report card shows they can outperform certain mutual funds. In reality, all investment is active. You have to select a portfolio, so isn’t that the opposite of passive investing?
Indexes are often cap-weighted. The larger companies tend to make up a bigger portion of the overall portfolio, compared to the smaller company stocks. Bond funds have additional challenges for the investor, making them difficult to index.
Jeb tries to actively manage his personal portfolio. He wants to manage the risk and the return profiles of the portfolio. Beating the market consistently is extremely difficult to do.
Adjustable Rate Mortgages
This type of mortgage took it on the chin in recent years. However, the economy is not what it once was. The issue is that the rates can reset, often taking the homeowner by surprise. They may have trouble handling the resulting monthly payment.
The attractive aspect of adjustable rate mortgages (“ARM”) is the lower interest rate in the initial years. This usually holds for the first 7 years. There’s usually a maximum rate listed in the mortgage contract. For instance, that rate may be around 6.5%. But compare this to the current 30-year fixed rate. It’s not that much different.
The average homeowner will stay in the home for 5-10 years. The ARM allows you to lock in the lower rate for the first 7 years. The math may work in your favor, when you consider the breakeven point (the money saved in the initial 7 years, compared to a traditional 30-yr mortgage). Even with the increase at year 7, the money you saved may put you ahead of the game. Remember, it’s all about the math.
Factors such as the cyclical nature of recessions or market pullbacks and how the Fed reduces the interest rate to deal with related effects may open up another window for you to refinance at a better rate or to buy a new house using an adjustable rate mortgage. Again, it depends on your specific situation.
529 Plans Suck
These are college savings plans. Some can make sense, but Jeb’s generally not a fan of them. They fit their need, but are not always the best route for every investor. The advantage of a 529 plan is that there are certain tax benefits. When the invested funds are used for educational purposes, it can be withdrawn tax-free. It’s similar to a Roth IRA.
One drawback is that the tax benefit is rather limited. There’s much more tax-free growth in a Roth, given the shorter time span of an educational investment. The growth is generally limited. There’s also the loss of flexibility offered by other investment tools.
The alternative would be to start a non-qualified investment account and tell yourself that’s for your child’s education, purchase of their first home or even to start a business.
A 529 plan can be started in your own name, listing you as your own beneficiary. Later, you can switch the beneficiary designation to your child or someone else. This provides a longer time horizon than simply waiting until a child is born to begin saving and investing.
Indiana offers a state income tax deduction for funds contributed to a 529 plan. Currently, Kentucky does not.
You don’t have to use the 529 plan, based on the state in which you reside. I could start a 529 in one state (i.e. Utah) and have a child go to school in yet another state (i.e. West Virginia).
If your first child decides he/she doesn’t want to go to college, the 529 plan beneficiary can be changed to another sibling, a niece/nephew or even a grandchild. The fund will continue to grow tax-free until it’s used appropriately.
At the end of the day, you should sit down with a qualified, investment advisor who can help you to think through your investment strategies. A good advisor will bring a solid perspective, but also know how to develop and implement your strategy.
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