Rising Tuition Costs Weigh Heavily on Prepaid Plans

The Illinois Student Assistance Commission, which administers the college savings plan for more than 46,000 beneficiaries, sold just 438 new contracts in the 2013-14 sales season that ended April 30.

The program had a little over 72 percent of the assets needed to meet long-term future payments as of June 30, according to the most recent actuarial report on College Illinois’ health. College Illinois wouldn’t have enough money to cover its obligations in 13 years if it sold just 1,000 contracts annually, the report said. Presumably, if this year’s sales pace continues, the program would fall short sooner than that.

“There’s going to be no state bailout,” said Illinois House Minority Leader Jim Durkin, R-Western Springs.

College Illinois Contract Sales Plummet, Crain’s Chicago Business, May 19 2014

What do you get when you combine tuition inflation over 8% from 1992-2012 (which is 5.5% HIGHER than general inflation), a 8% stock market return, a 6% bond market return, and a tuition program that promises to cover the cost of college? You end up with a prepaid tuition plan that does not have enough money to fund its obligations.

And as the article states, the plan today is dependent on additional sales to keep the plan afloat. I don’t know about you, but that is not something I’d like to hang my hat on. According to the 2013 Actuarial Soundness Valuation Report, the plan will run out of money in ten years if the program is only able to sell 500 new contracts each year. Last year’s number was 438.

What Does This Mean To You

So what if you purchased a pre-paid contract and the plan does not have money to fulfill its end of the deal? College Illinois’ FAQ section states the following:

Although the taxing power of the State is not pledged to make payments under a program contract, under the Illinois law that set up the program, the Governor of Illinois is required to request funding from the Illinois legislature sufficient to pay all program benefits during any year there is a current funding shortfall.

In the event the Commission, with the concurrence of the Governor, determines the program to be financially infeasible, the Commission may discontinue, prospectively, the operation of the program. Any beneficiary who has been accepted by and is enrolled or will within five years enroll at an eligible college shall be entitled to exercise the complete benefits specified in the College Illinois! prepaid tuition contract. All other contract holders shall receive an appropriate refund of all contributions and accrued interest up to the time that the program is discontinued.

To learn more about the benefits and responsibilities of owning a College Illinois! Prepaid Tuition Program contract, read our Disclosure Statement and Master Agreement.

Simply stated, you are guaranteed to receive your plan contributions plus some undetermined amount of interest. If your child is already accepted/enrolled in college, you don’t need to worry. The plan will pay for their tuition.

Based on the financial problems of the State of Illinois, I would not count on a financial bailout from general tax dollars. The House Minority Leader even said so. I’m hopeful that if the plan does begin to run out of money, the State will able to broker some kind of deal with the Universities. After all, whose fault is it that costs have increased 8% over the last 20 years?

So What Is A Parent To Do?

  • Discuss your overall plan to pay for college, retirement, and that small beachfront property with your trusted advisor
  • If you own a prepaid tuition plan, be sure to review the plan documents and financial reports in detail to understand your risk
  • Have a plan B for if the plan does run out of money and the state is not willing or able to pick up the tab

A part of your plan B may be funding a 529 plan with different investment options that can be adjusted based on your child’s age and risk tolerance. The Illinois 529 investment plan vehicle is BrightStart. If the College Illinois prepaid plan has enough money for tuition – fantastic! You can still use the BrightStart funds to pay for non-tuition qualified costs like room and board and other required expenses. If your child chooses a more expensive state school or goes out-of-state, your plan B funds could be used to pay for the additional cost.

Bottom line is until the tuition inflation problem is addressed, parents need to be even more diligent and aware of their funds dedicated to paying for college.


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Reach For Yield At Your Own Risk

I originally posted the following in the Moller Financial Services May Newsletter. Everywhere I look, there are signs of people searching for or creating investments that offer more income with low risk.  This reaching for yield is one of the biggest mistakes an investor can make.

“More money has been lost reaching for yield than at the point of a gun”
– Raymond F. DeVoe, Jr., of Legg Mason Wood Walker Inc., February 1995

Reaching for yield is one of the common behavioral follies of the human race, not just with money management but throughout everyday life. We always try to make something out of nothing and ignore the potential cost. Some of my favorite examples of “reaching” are:

  • How many people can we pack into this tiny elevator?
  • This tank of gas can go one more exit before I need to fill it up, right?
    • Or if you’ve ever had young children – C’mon son, you can make it to the next rest stop to go to the bathroom, right?
  • I can squeeze one more dab out of this toothpaste tube!
  • Just 10 more important photos, then I’ll back them up.

Then, there is my own recent “reaching for yield” mistake of trying to get one extra slice from the butternut squash using a mandolin slicer. I’ll spare you the details, but let’s just say I paid the price for trying to squeeze an extra gluten-free noodle from my squash. As Raymond DeVoe described, I lost some money reaching for yield with my emergency room visit.

Reaching for yield not only gets us in trouble in the kitchen, but with investing as well.

What Is Investment Yield?
Yield is the cash (or income) that ends up in your pocket by owning investments like stocks, bonds, and real estate. For example, if you have an investment worth $100,000 that pays $3,000 cash each year, your yield is 3% ($3,000 ÷ $100,000). For stocks, yield comes in the form of dividends. Bonds, CD’s, and other forms of fixed income pay interest. Real estate has net operating income (rental income minus operating expenses). In general, you would receive the most yield from real estate, followed by bonds, then stocks.

Since 1871, the average yield of a U.S. Treasury bond due in 10 years is 4.6%. This number is not bad, especially when you consider today’s interest rate is around 2.7%. How do bonds compare to stocks? Surprisingly, they are very similar. Large U.S. stocks have averaged a yield of 4.4% since 1871, but currently pay about 1.9% to shareholders.

How much yield can an investor expect from real estate? According to the National Council of Real Estate Investment Fiduciaries, real estate has earned a 3% higher “yield” than bonds on average (1992-2012). This higher yield is necessary to compensate investors for capital improvements and other costs of owning a property. In addition to these additional costs, real estate income and bond interest are generally taxed at an investors “ordinary” (higher) tax rate. Qualified stock dividends, on the other hand, receive preferential tax treatment with rates at 0%, 15% or 20% depending on your level of income.

Examples of Reaching for Yield
Now that I’ve described what investment yield is, how does an investor “reach” for it? There are three primary ways to reach for yield (besides risking one more slice on the mandolin):

1. Loan money over a longer period. Investors should expect to receive a higher interest rate for money loaned over 30 years compared to 10 years.

2. Loan money to less creditworthy people/entities. Investors should receive more interest when lending money to their friend Sam or Sam Corporation than to Uncle Sam (the U.S. government). Less creditworthy borrowers pay a higher interest rate, but investors carry a greater risk of not getting their money back.

3. Invest in a financially engineered product. Leveraged loans, collateralized debt obligations, asset backed securities, mortgage backed securities, and structured notes are all examples of financial engineering.

Unfortunately, I see examples of each of these mistakes fairly often. Each strategy sounds great at first, but oftentimes end very badly.

Let’s take #1, lending money over a longer period. Today, the U.S. Treasury pays 2.7% interest on the 10-year bond and 3.6% interest on the 30-year bond (as of March 31, 2014). An investor can reach for yield and buy the 30-year bond because it pays more interest. But what happens if interest rates rise by 1%? Before giving the answer, it is important to understand that a change in the interest rate has a compounding affect – longer term bonds are more sensitive to interest rate changes than shorter term bonds. According to J.P. Morgan, the 10-year bond would lose 8.4% that year. If you think that sounds bad, the 30-year bond would suffer a 16.4% loss. OUCH!

With #2, lending money to less creditworthy people/entities, investors should know better. The risk of lending money over longer periods is not intuitive, but understanding creditworthiness is pretty basic. According to J.P. Morgan, the least creditworthy companies had to pay a 5.9% higher interest rate than the government over the last 25 years on average. Today, these riskier loans only pay 4.1% more interest than the government. If riskier bond interest rates rise to their long-term average (a 1.8% increase), high yield bond investors will feel like junk, losing 10% compared to plain vanilla U.S. Treasury bonds.

Even the most sophisticated investors get hoodwinked into believing financially engineered products (#3) are a safe place to get some extra yield. As we learned during the 2008-2009 financial crises, even the brightest individuals and biggest investment banks can go bankrupt with these products. And some of the banks that survived did so by selling financially engineered products to their “clients” and taking the opposite bet themselves.

Observations for Today
You don’t need to look far before you find examples of investors reaching for yield today. Below are some of my favorites (as in, I would never invest in any of these).

1. Peer-to-peer investing is the latest craze and is a billion dollar industry in the U.S. Since banks have been rather tight-fisted, yield seeking investors have stepped into the marketplace of directly lending money to other individuals. Now, you can lend money to people with credit grades of A through G and hope they can pay you back. I like the free-market idea, just not as an investment.

2. I remember thumbing through Barron’s last year and saw an ad for a new product – a gold fund that pays a dividend! My first response was “how can a shiny metal that does nothing provide income that will go in my pocket?” Silly me, I forgot about financial engineering! The engineers created an investment product (kind of like the Twinkie is a food product) that owns a gold fund and sells options. The option selling creates the “income”. Unfortunately, this investment lost over 30% in 2013 – even worse than just plain gold.

3. Now for my favorite. Would you like to own a yogurt shop in Chicago in the middle of the polar vortex? Well now you can! Simply invest $10,000 and you will get 9% interest plus an equity option. I wish I made this up, but this “offer” is for real, search for it yourself. I have no doubt that some “crowdfunding” investments will turn out to be wildly profitable, but most will simply end up lining the pockets of brokers and individuals who sold their business.

Reaching for Yield Solution
Before we get to the solution, it is important to understand a company’s options for allocating their profits. A company can

1. Return profits to shareholders in the form of dividends.
2. Reinvest profits in the company including new products, services, and equipment or paying off debt.
3. Acquire stock from shareholders or another company.

If an investor solely focuses on yield (dividends and/or interest), they ignore the benefits of reinvestment and acquisition which can generate growth and appreciation for investors. In fact, the S&P Price Index of U.S. stocks has grown over 5% per year since 1900 in addition to dividends paid to shareholders. That is a total return of over 9%. Over the last century, investors have benefited more from growth than from yield.

Savings + Growth + Yield + Goals = Successful Financial Plan
For our investment management, the focus is on achieving a good balance of total return and downside risk management. Whether the total return comes from yield or growth, it does not matter. Return is return. What matters most is having personalized strategy to save enough, invest wisely, and spend within our means.

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Olympic Training for Your Portfolio

I published this post for our company’s newsletter a couple weeks ago.  While the Olympics are over (and with disappointing overall results), these training tips for your portfolio are timeless.  Enjoy!

After building an ice rink in my backyard this winter, my daughter has taken an interest in ice skating.  When she’s not skating circles around me, we have enjoyed watching the Olympics together from the warmth of our family room.  She has enjoyed watching Highland Park native Jason Brown’s rendition of Riverdance and the U.S. figure skating team.  Meanwhile, I’m looking forward to more snowboard tricks and hockey.  No matter the sport every athlete needs to prepare, practice, and be patient to do their best.

These important traits also lead to success as an investor.  Fortunately, Mr. Market has provided smooth sailing for stock investors for the past two years.  It has been the equivalent to eating donuts and drinking pop all day, but still being able to maintain an Olympian’s physique.  The downside to this easy ride is investors can become complacent and overreact to market swings when they return, and they will.  Donuts and pop will catch up to you, eventually.

To help you PREPARE for the inevitable correction (what is that anyways?), I will share some information about the current bull market and what a pullback could mean to your portfolio.  The more prepared you are for a correction or bear market, the easier it will be for you to Practice your investment strategy, and be Patient for your plan to work.


First, let’s start out with the basics.  A correction is defined as a 10% stock market decline following a previous 10% increase.  The S&P 500 (large U.S. stocks) reached an all-time high of 1,848 on January 15th.  A 15% decline would put the S&P at 1,570.  So even after a mild correction, the market would still be almost 2.5 times higher than the 2008-09 Financial Crisis bottom and equal to the 2007 pre-crisis high.  The idea of a correction does not sound as dramatic as the talking heads on CNBC and the internet make it, does it?

Remember those donuts and pop?  As of January 30th, Bespoke Investment Group reports that the market has gone over 835 days (27 months) and increased 68% since the last correction.  Do you remember when Standard & Poor’s  downgraded the U.S. debt in 2011?  It has been that long without a correction.  The market averages a correction every year, but it is approaching 2.5 years without one.  During this time, the stock market has climbed the “wall of worry” – hurdling debt limits, sequester, tax increases, stagnant employment, the Affordable Care Act, and QE tapering to name a few.  Are there any more hurdles ahead of us?  Government debt and high under/unemployment are the two nagging obstacles to the market and economy, but these are not an imminent concern.

The recent period without a correction is also the fifth longest run since 1928!  The only longer periods ended in 2007, 1997, 1987, and 1966.  Unfortunately, the subsequent periods after these corrections did not bode well for future returns.  So a correction sooner than later may be good news!  The table below shows the months before each correction, year of the correction, price of the S&P 500 before the correction, and the years it took for the market to permanently recover and exceed the pre-correction price.  The most important observation to me is despite corrections, wars, inflations, and bubbles, stocks have doubled every 10 years on average!

Months Before Correction

Correction Year

S&P Price Pre-Correction

Years to Pass Correction High

















Price information using S&P 500 Index from Yahoo! Finance

The Years to Pass Correction High is also attention grabbing.  It took a dozen years to permanently exceed the highs from the 1966 and 1997 pre-correction levels.  The 1966 period preceded the Nifty Fifty stock market bubble, oil crisis, and rising inflation of the 1970’s – a difficult time to recover.  The double bubble of Dot-com and Housing caused the market to take so long to finally exceed 1997 levels.  While the 1987 run-up ended with a single day decline of over 20% known as Black Monday, the market recovered quickly and actually had a positive return for the year.  It is too early to say the market has permanently moved above the 2007 high, but the S&P 500 did reach that level in early 2013.

The fact that we are overdue for a correction does not mean it is imminent and a bear market (price decline of 20% or more) will ensue.  As you can see in the table above, many bull markets have continued to run without interruption.  When the correction does happen, it may not even result in a big decline.  According to blogger Barry Ritholz, there have been 27 corrections since 1945 and only 12 have turned into a bear market.    Perhaps the only thing worse than going through a correction or bear market is sitting in cash for another two to four years while stocks prices continue to climb like they did in 1997.

Now that you are prepared and knowledgeable about corrections, what should an investor do with their portfolio?


Simply owning a diversified portfolio with a fixed allocation to stocks and bonds will put you in a better position than most.  Investors who are able to continue saving during a correction benefit from picking up more shares for their money.  If you are not able to save, rebalance!  Selling what has done well and buying what is on sale can improve your portfolio returns over time.

Following a risk managed investment strategy may help avoid the big portfolio declines and provide an investor with more peace of mind by systematically avoiding investments that are declining in value.  This type of approach will not track “the market” like a traditionally diversified portfolio, but it may be a preferred approach for clients looking for more stability from their investments.

For either approach, using low-cost index funds and ETFs are our preferred investments – the equipment, like ice skates.  After you get the equipment, are you going to focus on managing risk (figure skating) or rebalancing (speed skating)?  Both sports use skates, but in different ways.  Finally, having the equipment and attempting the sport is worthless unless you have a clear idea of what you want to achieve.  From an investment perspective, some common goals include a comfortable retirement, college education, legacy for your family and charities, etc. Practice is the purposeful combination of objectives, strategy, and tools.


Whatever investment approach you use, it will not work as you expect every time.  It can take years for your preparation and practice to pay off.  For example, countless studies have shown that rebalancing improves portfolio returns over time.  However, you may buy an investment that is “on sale”, but the market may discount it further until the price finally recovers.  This characteristic can make it difficult for investors who want to mitigate losses in their portfolio.  On the other hand, a risk managed approach may work better at mitigating the losses, but can miss the sharp and unexpected positive moves in the market.  Patience is required for any successful investment strategy.

While you don’t need to spend the same amount of time training to be an Olympian, any investor will benefit from time spent preparing, practicing, and being patient with their portfolio.

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Turn Your New Year’s Resolutions Upside Down

Do you have a New Year’s resolution?  Reading for pleasure is one of mine for 2014.  Since I am fairly busy with my family, career, commuting, and the gym, I decided that “listening” to books counts toward this resolution.

One week into the new year and so far, so good.  Thanks to the Overdrive app on my iPhone and the Mount Prospect Public Library audio catalog, I am currently listening to Antifragile by Nassim Taleb.  More on Antifragile in a minute.  My current reading selection is  Home Ice by Jack Falla which is rather odd since I have never played hockey in my life.  However, I built a backyard ice rink this year for a unique family experience and just to say I did it.  Some people bungee jump, I built an ice rink.  May as well read a book on it.

While listening to Antifragile, Taleb wrote that eliminating a bad habit is more effective than adding a good one.  This one piece of advice really connected with me and it makes complete sense.  Time and energy cannot be created nor destroyed, they can only be wasted or enjoyed.  In order to begin a new good habit and hope to keep it, we must first part ways with a bad one.

My Script (My Story)

When I went “paleo” a couple year’s ago, the focus was on eliminating the bad.  Without getting into too much detail, the most important aspect of paleo is diet.  By eliminating processed foods that are bad for you like grains, dairy, and sugar (real and artificial), you gain most of the health benefits.  As a part of eliminating the processed foods, you will naturally eat more nutritious foods.  You need to get full by eating something, may as well be more vegetables, eggs, lean meats, and the occasional red wine and dark chocolate.

I strictly followed the “diet” for about six months and consequently lost a few inches from the waistline, reduced my difficulty with asthma and allergies, and improved my blood pressure and cholesterol.  I have followed the diet for more than two years by varying degrees, but the benefits have remained.  By framing the lifestyle change as “excluding processed foods” instead of “eating more vegetables”, I accomplished more than I ever imagined.

Your Script (Taking Action)

Below are common general and finance related resolutions with the goal based and elimination style phrasing.  Do any of the goal based resolutions sound familiar to you?  Which resolution would be easier to follow for you?

Goal Based

Elimination Style

Lose weight; be healthy Stop eating junk food
Enjoy life; spend time with family; exercise more; learn something new Stop consuming so much TV and internet
Save more money; pay off debt Spend less money
Make better investment decisions Stop watching CNBC and looking for stock tips

Another added benefit to the elimination style resolution is that you can kill two or more birds with one stone.  By consuming less TV and internet, it is possible to enjoy life more fully, spend time with family, exercise, learn something new, and make better investment decisions!  How you spend your new found time is up to you, just don’t waste it.

As for my own resolutions, I will rephrase them right now (one more resolution helper is making it public).  Here’s to a new year and time well spent.

  1. Spend less time listening to talk radio (more time reading or listening to books)

  2. Put the phone away while eating with my family (be present with my family)

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Roth Conversion – Opportunity and Caution

Should you convert your IRA or 401(k) to a Roth?  The decision to convert is specific to each investor’s set of circumstances.  This post shares some key factors to consider for the Roth decision.

What is a Roth Conversion?

A Roth conversion is a transfer of money from an IRA or 401(k) to a Roth.  In general, you have to pay taxes on the amount you convert – this is the cost.  The benefits are twofold:

  1. No taxes on future earnings and qualified withdrawals.

  2. No requirement to withdraw money after age 70.

Reasons to Convert

Temporary Income Opportunity

If your income is temporarily low for the year, a Roth conversion can make a lot of sense.  Temporarily low income (by choice or misfortune) allows an investor to take advantage by paying a lower income tax rate on the Roth conversion.

Long-Term Income Planning

Take a close look at your retirement income plan.  Your taxable income may increase over time – especially in your 70’s and 80’s.  This income “problem” happens when an investor has been successful in growing a multi-million dollar tax-deferred portfolio.

For example, if an investor is age 70 and owns a $2,000,000 IRA, the required distribution is $73,000.  After adding a joint Social Security benefit of $40,000, this investor could have over $110,000 more income at age 70 than in their 60’s.

Extra income is not a bad problem to have, but this tax burden is something that may be avoided.  Converting a portion of the IRA to Roth during your 60’s may be a great way to save taxes in the long-run.

Generational Wealth Transfer

For those subject to federal and/or state estate tax, a Roth Conversion may save your family estate taxes.  The income tax on the Roth conversion is money spent, but is no longer a part of your taxable estate.  Years later, the Roth is tax-free income for beneficiaries!

Reasons for Caution

Alternative Minimum Tax (AMT)

If you pay AMT or the Roth conversion pushes you into AMT, a conversion could cost more tax than expected.  Depending on the amount of income in AMT, the tax rate on a Roth conversion may be 26%, 28%, or 35%!

New Taxes and Phase Outs

2013 is the first year for the Medicare surtax and a comeback for phase-outs to deductions and exemptions.  These tax increases affect individuals with $200,000 of income and couples/families with $250,000 of income.  Investors may want to plan around these taxes.

College Tax Credits, Financial Aid, and Insurance Subsidies

There are financial incentives to keep income low for college and health insurance purposes.  Converting an IRA to a Roth may prevent an unknowing investor from realizing these benefits.

The American Opportunity Tax Credit, Lifetime Learning Credit, and Tuition and Fees Deduction are all valuable tax savers for college education costs.  Each benefit has its own income limit and may be more valuable than a conversion.

Financial aid offices review income and net worth information on the FAFSA to make decisions on grants and scholarships.  If an investor’s net worth does not disqualify their child from financial aid benefits, there is a good chance that income from a Roth conversion  will.

If an investor needs health insurance and is able to keep their income low, they may qualify for a tax credit subsidy.  For example, a 60 year-old couple with $60,000 of income would qualify for an $8,000 health insurance premium subsidy, regardless of net worth.  In this case, the future tax savings of a Roth conversion can take a back seat to cash back subsidy today.

The decision to convert a tax-deferred account to a Roth requires a full check-up on an investor’s net worth, portfolio, income, and circumstances.  By considering several key factors, an investor may have a general idea if this advanced planning strategy is right for them.  If a Roth conversion is right for you, a financial advisor can help you take the necessary steps and possibly use additional strategies to add value to the conversion.

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Four Ways to Donate with Four Weeks Left for Tax Deductions

There are many ways to support the charitable organizations that are important to you.  Goods, monetary donations, and the most limited resource of all (YOUR TIME) are all generally accepted and appreciated throughout the year.  Are there ways that you can donate to your favorite organizations and get a tax benefit as well?  Let’s find out.

  1. Cash is the easiest way to donate to a charity.  Send a donation through the website, a check through the mail, or even text from your phone.  Donating cash is simple and you get a tax deduction for your donation if you itemize.
  2. Donating appreciated stock (or mutual fund or ETF) is an even better strategy than simply giving cash.  Why?  Well, you get a similar tax deduction benefit AND you avoid having to pay tax on the growth of the stock price!  And if you really like the stock, you can always buy more shares using the cash that you would have donated to charity in the first place.
  3. “Wow donating stock sounds great, but I don’t donate enough to one charity to make it worth my time.”  This is a where a Donor Advised Fund comes in handy.  You can make one stock donation to a Donor Advised Fund and make several “grants” to the charities of your choice.  Less tax paperwork and more fun finding charities and giving.  This is also a great tool for accelerating tax deductions into the current year and granting funds to charities in future years.  For more information, check out Schwab Charitable or Vanguard Charitable.
  4. If you are over 70 1/2 and have an IRA, a Qualified Charitable Distribution (QCD) may be the best donation strategy for you.  The QCD counts towards your required minimum distribution (RMD) and does not count as income on your tax return!  Since it does not count as income, you do not get a tax deduction – no double dipping.  The QCD could be a nice benefit for taxpayers who are subject to the new Medicare surtax, do not have enough deductions to itemize, or have to carry forward other charitable deductions.  2013 will be the last year this strategy is available unless Congress decides to extend it.

These are four great ways to make a positive impact for charities and only four weeks left to make tax deductible gifts for the year.  Be sure to check with your advisor to see which one is the best of your situation

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