In the last twenty years, the cost of a college education has increased at more than double the rate of inflation. In some Ivy League schools, alumni children are literally paying more for one semester's tuition than their parents paid for four year's tuition thirty years ago.
If you start an educational funding investment plan when your child or grandchild is an infant, it will be much less of a strain on your finances. To begin formulating your investment plan, you need to calculate how much it will cost and how much you will need to invest (either in one lump sum or annually). Most major brokerage firms have computer programs designed to determine the cost for college educations for up to four children in a family. These programs usually have a selection of 1,700 or so colleges and universities, heir associated four-year costs and historic annual increases.
A growing number of people have postponed starting a family until they were in their 40s. Instead of funding their retirement plans, they are now paying college bills and may also be providing support for elderly parents.
Although it can represent a financial challenge to fund a child's education, most people realize the importance of doing so: studies have shown that a college education can help boost lifetime income by $1 million.
Monday, April 6, 2009
Paying For College
Understanding Bonds - Question 102
Does a T-bill differ from a treasury note? A treasury bond? or are they all the same?
A T-bill (Treasury bill) is a short-term obligation of the U.S. Government. They have maturity lengths of one year or less, are purchased at a discount and mature at face value. At maturity (either 13, 26, or 52 weeks), the difference between your purchase price and maturity value is considered taxable interest income.
Treasury notes and Treasury bonds are also U.S. Government obligations but have longer maturities. The maturities are:
- Treasury notes: 2-10 years
- Treasury bonds: more than 10-30 years
Both Treasury notes and Treasury bonds pay interest every six months and are issued in $1,000 denominations.
When financial broadcasters refer to the interest of the “long bond,” they mean the 30-year U.S. Treasury bond.
Understanding Bonds - Question 101
What does “secondary market” mean?
After a stock is issued in an initial public offering (referred to as an “IPO”), its shares may be sold and bought again and again. The "again and again" constitutes the secondary market.
Understanding Bonds - Question 100
On cable TV they talk a lot about the yield curve being normal or inverted. What does this mean and why is it important?
A yield curve is a graph that plots interest rates for a security that is issued with different maturity lengths. Yield curves can be plotted for municipal bonds, corporate bonds and treasury securities. (Interest rate is measured on the vertical axis and the time period on the horizontal axis.)
The yield curve that is generally referred to on TV is the yield curve for Treasury securities. It usually slopes upward because interest rates are higher as maturity lengths increase. This is what is called a "positive" or "normal" yield curve.
When short-term interest rates shoot up because of inflation fears, the yield curve slopes downward because longer-term maturities have lower rates. The yield curve in this scenario is called “inverted.”
In rare instances, short-term and long-term interest rates are almost equal. The yield curve is then called “flat.”
Understanding Bonds - Question 99
What does “laddering a portfolio” mean?
“Laddering” is a strategy for protection against interest rate risk when buying tax-free or taxable bonds that have different maturities. Think of a portfolio with bonds that have varying maturities as resembling rungs of a ladder. By purchasing bonds that mature at set intervals, the investor has diversified in case of changes in interest rates. In addition the investor can plan for income and reinvest principal at set intervals.
Understanding Bonds - Question 98
What is a callable bond?
When interest rates drop, an issuer (such as a corporation or municipality) may wish to redeem its outstanding bonds and refinance them at a lower rate. It's similar to an individual refinancing a home mortgage when interest rates drop considerably since the date the mortgage was issued. Bonds with call provisions protect investors from having their bonds called or redeemed before a specified date (such as 5 or 10 year call protection).
Understanding Bonds - Question 97
I am retired and have recently changed my residence from New York to Florida. Does it make sense for me to “swap” or exchange my New York municipal bonds for Florida ones?
Compare your New York municipal bonds with those available in Florida, and see if the return justifies the swap. If your return in New York is equal to your potential return on a Florida bond, then the additional Florida Intangible Tax may make it worthwhile for you to “swap” into Florida municipal bonds.
Sunday, April 5, 2009
Understanding Bonds - Question 96
Am I better off investing in registered or book-entry municipal bonds? Can yon purchase the same bond either way? Is there a price difference?
Most municipal bonds are issued in book-entry form only. You are probably better off buying book-entry municipal bonds because, that way, you will not have to worry about losing your certificates. A bond cannot be purchased both in book-entry and registered form. They are only issued in one form or the other.
Understanding Bonds - Question 95
What is a money-market account? Now does it differ from an account at a bank? Can you write checks against it?
A money-market account is not guaranteed by the brokerage firm from which you buy it. There is no fluctuation of principal. The interest rate is, in almost all cases, considerably higher than is found at a bank. Many brokerage firms offer accounts that enable owners to write checks against their account.
Understanding Bonds - Question 94
What are mortgage-backed bonds?
Mortgage-backed bonds or collateralized mortgage obligations (CMOS) are pools of mortgages repurchased by the agencies that issue them. Some of these agencies are better known by their nicknames:
- Ginnie Mae stands for Government National Mortgage Association (GNMA)
- Freddie Mac stands for Federal Home Loan Mortgage Corporation (FNLMC)
- Fannie Mae stands for Federal National Mortgage Association (FNMA)
Each payment the investor receives is for interest only until the returns of principal payments begin.
Understanding Bonds - Question 93
Is there a rating service for bonds (similar to Morningstar Ratings for mutual funds and Value Line for stocks)?
There are three rating services: Moodys, Standard &Poor's and Fitch. The highest rating is AAA, then AA, A, BBB, BB and B for investment grade quality. When a municipality pays to insure their bonds, their credit rating is enhanced and becomes AAA.
Understanding Bonds - Question 92
CDs (certificates of deposit) are' insured by the Federal Deposit Insurance Corporation (FDIC). There is no risk of default on the principal of a CD, but there is risk that the value of the CD will diminish through loss of purchasing power. Remember, the only true value money has is the value of the items it can buy. If the value of the items an investment can buy is reduced, then there is a risk of inflation. Many retirees are frustrated when their CDs or bonds come due and the amount of purchasing power has been reduced by inflation.
Understanding Bonds - Question 91
By computing whether the return net of taxes is greater than tax-free versus tax or vice versa. How do you do this? There is a formula for computing the tax equivalent. Take your tax-free return percentage-wise, divide it by one minus your income tax bracket. That will give you the tax equivalent. Let’s assume somebody has a six percent tax-free investment and is in the forty percent tax bracket. Put 6% in the numerator and then (1 - 40) in the denominator (so you have .06/.60). The answer is .10 or 10%. So, the 6% tax free bond would be the equivalent of 10% before taxes (if an investor is in the 40% bracket).
Understanding Bonds - Question 90
I'm 68 years old and I understand the benefit of investing in insured tax-free municipal bonds. But are there any disadvantages?
Yes, there are three disadvantages; market risk, inflation risk and call risk. The principal of these bonds is only guaranteed upon maturity.
- If you wish to sell them prior to maturity and interest rates have gone up considerably since you've purchased them, you will find that the principal is less than the purchase price, and you will be taking a loss if you sell them. This is market risk.
- If you hold tax-free bonds until maturity, the money you get back (even though it is equal to the face-value of the bonds) has lost purchasing power over the years because of inflation. Bonds that you've held for thirty years may only have 25% of the purchasing power they had when you purchased them. This is inflation risk.
- When interest rates drop, the issuer of your bonds may wish to call or redeem them and refinance them at a lower rate. This is call risk.
Sunday, March 29, 2009
Understanding Bonds - Question 89
When a bond is issued by a corporation or a municipality, it is sold at face value. The investor usually pays $1,000 per bond. The par value also includes the amount that will be redeemed or repaid at maturity.
To calculate the market price of a bond, use the following formula:
current yield = amount of coupon / market price
If a 6% bond is issued at par or $1,000, the amount of
coupon interest = $60
.06 = $60 / $100
When the Federal Reserve raises interest rates to 8% in order to reduce inflationary pressures, the market price is reduced as follows:
current yield = amount of coupon / market price
current yield = .08
coupon (remains constant)= $60
market price = X
.08 =$60/X ; 08 X = $60; X = $601.08; X = $750 market price
When interest rates are lowered, the market price of a bond increases. Let's assume the Federal Reserve lowers interest rates from 6% to 5% to stimulate the economy. The effect of the market price is as follows:
current yield = amount of coupon / market price
current yield = .05
coupon = $60
.05 = $60/X X = $1,200 market price
Understanding Bonds
Many investors view bonds and bond mutual funds as conservative investments that provide a steady income and represent a minimal risk to principal. That’s because if you hold your bond until maturity, you get the full amount of your investment plus interest. (A bond is an obligation of its issuer to pay the interest and principal as promised.)
Zero-coupon bonds are very popular among parents and grandparents who are funding a child's education. A zero-coupon bond is issued at a discount from its par value (or face value). It only pays interest with principal at maturity or at the time the bond is called. Unlike other types of bonds, interest on zero-coupon bonds is not paid to you every six months; it is automatically reinvested or compounded at the agreed-upon rate at time of purchase. The combination of compounding and the discounted price means that a relatively small investment can multiply significantly before the bond matures. The longer the maturity length of the bond, the deeper the discount usually is.
In addition to being used to fund a college education, zero coupon bonds appeal to many individual investors who are planning for retirement. If placed in SEPs, IRAs or Keoghs, they are not subject to immediate taxation since these accounts are tax-deferred. By making an investment in a zero-coupon bond today, investors know exactly how much they will receive at maturity.
Municipal bonds are debt securities issued by public authorities (such as states or municipalities) to raise funds for building or repairing schools, highways, prisons, bridges, tunnels and other public works. The interest payments you receive on municipal bonds is free from federal income taxes. The higher your tax bracket, the more you will benefit by investing in “munis” and earning tax-free income.
If you live in a high income tax state you may also derive additional benefits from owning in-state bonds that are also state income tax-exempt.
Interest on bonds issued by the U.S. Virgin Islands, Guam and the Commonwealth of Puerto Rico are exempt from federal, state and local taxes in all fifty states.
Corporate bonds complement many investment portfolios especially retirement accounts and accounts with low marginal tax rates.
Many reputable companies raise capital by issuing corporate bonds to purchase or update equipment, build plants, and replace outstanding debt with lower cost issues. Credit rating agencies such as Moody’s and Standard & Poor’s (S&P) study the creditworthiness of the issuer of the bond, and assign a rating to that bond as a general guideline for investors.
Investment grade ratings used by agencies are:
Moody's S&P
Aaa AAA
Aa AA
A A
Baa BBB
These agencies revise their ratings when they feel the creditworthiness of an issue changes.
United States government securities are among the most\ secure of all income-producing investments. They are available in two forms: direct obligations of the U. S. government and those issued by various agencies which are indirect obligations of the U.S. government.
All bonds (U.S. Treasuries, federal agencies, zero-coupons, corporate and municipals) are subject to market fluctuations if you sell them before they mature. Investing in bonds has become more complex in recent years as the choice of taxable and tax-exempt bonds has expanded and volatility in bond prices and interest rates has increased. (Question 89 to 102)
Understanding Equities - Question 88
Should I invest in retail company stocks?
Your question is very general and, while there are many dynamic retail corporations, there are also retailers who have either been unable to find their markets or have lost them.
An excellent way to judge retail sales is to make a “samestore sales comparison.” To do this, you need to compare sales at-stores that have been open for at least one year. By looking only at stores that have been open for a year or more, you eliminate the effects of increased sales caused by recent new store openings.
When analyzing a manufacturing company, use comparative unit sales rather than dollar sales to get a better indicator of demand for the company's products.
Understanding Equities - Question 87
What are defensive stocks?
Defensive stocks are stocks that are less vulnerable to the savings of the business cycle than most other stocks tend to be. Some defensive stocks include utilities, tobacco and food stocks. They are considered defensive because consumers need to buy these products or services regardless of changes in their personal incomes or job situation.
Understanding Equities - Question 86
What is the difference between “technical analysis” and “fundamental analysis” in evaluating stocks?
Fundamental analysis studies the basics of a company’s finances and its economic prospects before making a decision to buy, hold, or sell its stock. Fundamental analysis studies a company's prime earnings ratios, dividend history, rate of return, sales, and profitability history and trends.
Technical analysis uses past and current stock price movements to predict future prices of a company's stock. It relies heavily on charts to plot the price movement of stocks. No consideration is given to any of the components used in fundamental analysis.
Understanding Equities - Question 85
What is the difference between a limit order and market order?
A “limit order” specifies the highest price you are willing to pay for a stock, or the lowest price you will accept for the sale of a stock you own. If you make a “market order,” you are not specifying a price; your order will be executed for the best price available at the time you place the order. You'll learn the price after the order has been executed.
