Diversification—eggs in many baskets

Put all your eggs in one basket, and watch that basket, a quote variously attributed to Mark Twain and Andrew Carnegie, is really bad advice. While Andrew Carnegie knew what he was doing financially, Mark Twain most certainly did not. So listen to me, not him (I know better than to invest in crazy printing press inventions the way Twain did).

Pinning all your hopes on the success of one thing–one investment, one college admission, one friend—is quite simply playing roulette and you’re probably going to lose. Here’s my rationale for diversification:

• If one basket goes kaput you don’t lose everything

• You can control your choices, but you can’t control external factors. Worry only about what you can control

• Sentiment on various investments can vary greatly. Some part of the time you’ll be in-sync, sometimes not. You have a better chance of success if things are not correlated or all the same.

Quantity is not the same as diversification. If you own Dell, Hewlett-Packard, and Apple, you’re not diversified. If your child applies to Harvard, Yale and Stanford, you’re not diversified. If all your friends are from Civil War re-enacting, you’re going to be pretty lonely in the wintertime. You have to make your investment in things with true differences. In financial terms, this is why I recommend index mutual funds and/or ETFs. Put 90% of your money into funds and you can own Dell, H-P, and Apple as one basket (nicely diversified within that basket but not necessarily one I recommend), but also a fund of small value companies, international bonds, REITs, or just about any other type of investment that might be suitable for you. You develop a suitable mix based on your goals, the amount of money you have to invest, and your tolerance for stomach churning. That’s one of the things a financial advisor can help you sort through.

On the other hand, you probably don’t need 65 different investments. Research has shown that more than about 10-12 core holdings begin to lose the value of diversification. You’re spread out among so many things that you have no chance of “beating the market”—you ARE the market. Plus, keeping up with what’s going on just becomes ridiculously time consuming. 10 or 12 mutual funds you can monitor, 25 individual stocks become your full time job, with no evidence that you’ll actually do better and probably do a lot worse than an index. Ask any big-time money manager. Ask Bernie Madoff.

You know all this already? Are you doing it? Are you in love with a stock? Holding it because it will “come back some day”? You inherited it from your dad who worked for the company forever? Um, were you formerly employed at Enron? Reserve your love for your friends, family, art, music, hobbies. Investments are just money—get professional advice and make rational decisions.



Paying for college without having a heart attack

Only a few short months to go and many of us will be filling out those FAFSA and CSS PROFILE forms and thinking about how much we should have saved. But if you’re a little further from judgment day than I am, let me suggest that the way to eat the elephant is one bite at a time. Or divide the elephant up into three large chunks…

Let’s just assume that you won’t qualify for one penny in aid, and Junior hasn’t been offered any scholarship money at all.

Student contributions—the first chunk

Yup, I said the first chunk. If your kid isn’t willing to invest in his education, why should you? Let’s work with some nice round figures here to make it all easier to calculate. Say four years at Ivy U. costs $60,000/year. Yes, I know that colleges aren’t quite up to that yet, but wait a month or two and we will be. So, four years is going to cost at least $240,000—probably more, with college cost inflation at 6%, but let’s just go with the $240K for purposes of illustration.

Now, I firmly believe that any student, even one whose parents have no problem footing the bills, should be paying something. Not only does it tend to cut out some of the late night booze and barf parties, but it also makes the kid a better consumer. No kid who is working hard enough to come up with $20K a year is going to shell it out for classes in Bowling 101, or tolerate a professor who doesn’t show up for class. As an aside, when I was putting myself through college and grad school, I used to calculate how much each individual class session was costing me, and ask myself if I would put that much money in a meter (had there been one outside the classroom)—did I get as much value from the class as it would take me to earn that much money? Sharpens your focus, no?

So, is it possible for little Jason or Jennifer to earn $20K? Let’s see—15 hours per week for 36 weeks at $10/hour equals $5,400. Then, there’s, say, two weeks at Christmas where you could theoretically work full time—35 hours x 2 weeks x $10=$700. That leaves 14 weeks for summer break. Let’s give Junior a two week vacation. 12 weeks x $10/hour x 35 hours=$4,200. Junior now has $10,300. Sure, I know Junior will probably spend some of this, or taxes will grab a chunk, but then again, Junior probably could hold down 20 hours during school (I used to work 32 hours and take 18 hours a semester as an undergrad. But then, I didn’t have any choice—no one else was paying.) With a little attention to skill development and early hustling, he might be able to nail a job paying a little more. Maybe Jason can mow a few lawns in high school?

We’ve got a deficit here of $9,700/year. It’s grant or loan time. $38,800 will need to be borrowed by Jennifer over four years. Maybe that film or speech major isn’t looking so great right about now. But, under my principal of only borrowing up to what you can expect to make your first year out, I think this is doable. The average starting salary for a college grad in 2011 is about $50,000, according to CNNMoney. Round numbers here, don’t forget. And gosh, if you’re forking over $60K a year for Ivy U., you ought to be able to get a job with at least an average salary. Good questions for the admissions and career services officers.

There are worse things than graduating with 4 years of work experience, a cultivated eye for the bottom line, and some consumer smarts. Some people don’t learn that until they’re 40, if then.

Savings—the second chunk

The next $80,000 should come from savings. I’m not going to go through the growth vs. inflation of the four years of college—you’ll need to come see me for that level of specificity. Let’s just say you want $80,000 “in the bank” by the time Jennifer is ready to move into the dorms. Say you didn’t get religion until she was 10 years old, giving you 8 years to come up with the $80,000. Let’s be conservative and assume a 4% rate of return on your investments. You need to save $8,682/year or about $708/month. (Not figuring inflation—round numbers, remember?) Get going earlier, say when Jason was 5, and you can cut that down to about $4,811/year. I don’t think this is unreasonable—if you’re making enough money that you won’t qualify for any aid at all, you’re making enough to stash this amount of cash. Worst case scenario is you’re grossing at least $130,000/year. At more than $10K a month, it’s reasonable to think you could save less than $400 per month (it’s less than 4% of your gross).

Repeat to yourself as often as needed, “I will not skimp on my retirement savings to fund this.” If you get to this point, it’s time to think about a cheaper college.

Payment from current parental income—the third chunk

$20,000 is around $1,667 per month. Okay, you’re already used to saving $400-$800 per month toward the education, right? Now, Junior isn’t going to be eating at home—say $250 per month in savings right there, maybe more. Gassing the car once a week @ $50=$200. No more music lessons, math tutor, SAT test prep course—well, you get the picture. Most parents don’t stop to think that while they’re paying for the kid at college, they don’t have the kid vacuuming out the refrigerator with 20 of their closest hungry friends at home.

These aren’t authoritative figures and they don’t take into account your particular situation—more than one child at home, no savings, child who takes more than 4 years to complete (oh no!). That’s what individual college financial planning is for–you know, that’s the stuff I do. This is just a suggestion of how to think about dividing and conquering, without the feelings of overwhelm and panic that hit parents toward the beginning of senior year.



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Surprises for college loan borrowers

With news from Washington, we always hear about the hot buttons and often not about the details that really affect our lives. But as in annual reports, most of the meat is hidden in the footnotes. The new 11th hour debt ceiling deal has some big surprises in it for student borrowers.

In case you missed the fine print, here’s the change. For graduate students, Stafford loan interest will no longer be waived while the student is in graduate school. Formerly, these loans did not charge interest on the principal until six months after the student graduated. As we all know, for graduate students that can take a verrrryyyy long time. Now, interest will accrue while the student is in school, and be added to payments when repayment begins. It can be thousands extra in costs for students who borrow the max. How much is this “tiny” change worth? Well, the estimate is that it will total $21.6 billion over the next two years, with the savings to be applied to maintain Pell Grants. These changes will go into effect on July 1, 2012.

Also gone is the credit for students who make on-time loan payments for 12 months. Now, all you get is a thank you—okay, probably not that either.

This change makes it even less desirable to have loans, and I still recommend borrowing as little as possible and certainly no more than what the student can expect to make in the first year out of school. The reason for this rule of thumb is that if the student is repaying with 10% of income (a reasonable figure) it will take 10 years to pay it off. As the student’s income increases, there’s some chance that a loan can be paid off early.

While I strongly believe that undergrad education should be all about acquiring a broad base of knowledge, students should keep a closer eye on career choices if they’re borrowing significantly. You don’t want $80,000 in loans as a speech or film major. However, as much as I believe in a liberal education as an undergrad, graduate school is all about specializing and it IS job training. Don’t enter that PhD program in English unless you’ve really thought through and researched what the career paths might be.

For many graduate level programs, not being offered scholarships is a pretty good indication of how much (or little) they’re really interested in you. It’s a good idea to think about WHY you’re not getting any offers. For professional school programs, less money is not necessarily an indication of how desirable you are, but employment in these fields is not the slam dunk it once was—ask any recent law graduate.

As in any financial planning issue, don’t borrow money for any investment unless you have investigated and thoroughly understand the risks involved. Start young understanding this and you’ll save yourself a lot of flimflam, whether from graduate school admissions offices or “venture capitalists” with yet another hot idea for your hard earned dollars.