Please share your view of convertible bonds as an asset class for folks entering retirement.

Convertible bonds are a unique asset class in that they have features of both stocks and bonds. They are often referred to as “hybrid” securities. This, along with their typically sub-par credit rating, is why they do not fit into our bond portfolio.

We prefer to keep the stock and bond components of our portfolios separate. Our bond portfolio is designed to buoy the allocation in times of stock market stress. The potential for convertible bonds to act like stocks does not jive with this logic. If convertibles – due to their hybrid nature – were showing stock-like tendencies when stocks were declining, your portfolio would have much less downside protection. As we have seen in the recent past, it is extremely important that investors maintain some level of protection in their portfolio. We do not believe convertible bonds are the solution.

Also worth your consideration is the credit quality of convertible bonds. Our MarketWise tax-deferred bond allocation uses exclusively US government and treasury debt (we also use municipal bonds in our MarketWise tax-managed bond allocation). This supports your portfolio when the stock markets fall. How it works is pretty straightforward. During a recession or market correction, there is typically a flight to quality. One of the most sought after destinations for this flight is US government and treasury debt. If people are flooding into these securities, guess what happens to their price? That’s right, it goes up. When stocks are falling this is exactly what your portfolio needs. Convertible bonds do not offer this same level of protection. In fact, they are typically offered by companies with poor credit ratings. This translates to increased risk for your portfolio. At the end of the day, we don’t think convertible bonds are a substitute for high quality bonds.

We look to our bond portfolio for security and capital preservation. In this context, convertible bonds are simply not a good fit.

The cost of education

According to The College Board, the average tuition for an in-state student at a public four-year college is $8,244. The tuition cost for an out-of-state student is often more than twice this cost, and a private college may cost over three times the amount. After adding in additional costs for housing, food, books and supplies, it’s not difficult to imagine why the annual cost of education can easily range from $20,000 – $50,000 in today’s dollars. Financial aid and scholarships can help, but most parents will need to be intentional about saving for college if they want their children to graduate without a mountain of debt on their backs.

How 529 plans can help

529 plans come in two flavors: savings plans and prepaid plans. All 50 states have one form or the other, and some states offer both. The benefits and drawbacks of 529 plans typically apply to both.

The primary benefit of a 529 plan is tax-free growth, as long as the funds are used for qualified educational expenses. As an example, $10,000 invested today and growing at a 7% annual average for 18 years will become $33,799 by the end of that period. This growth of $23,799 can be withdrawn and spent entirely tax-free if used for qualified educational purposes—and the definition is fairly broad, including tuition and fees, books, supplies, room and board, meal plans, and even computer equipment and internet access. It can be a huge benefit in coping with the high cost of education.

Although the growth in a 529 account is tax-free, contributions to the accounts are not tax-deductible for federal purposes. However, some states offer a state income tax deduction if you contribute to that state’s 529 plan. Each state manages their plan differently, so it’s important to understand the rules and costs of the plan because the state income tax savings alone may not be worth giving up access to a more flexible or cost-effective plan elsewhere.

Another important benefit of 529 accounts is that the donor remains in control of the assets, even though the value of the account is removed from the donor’s estate. This is especially useful for donors who want to reduce their taxable estate (federal or state, as many states have a lower estate exemption than the current federal estate exemption of $5,120,000) but who also want to ensure the funds are used as intended. Gifts to 529 accounts qualify for the annual gift tax exclusion of $13,000 per donor per donee, and a special provision even allows 529 accounts to be “front loaded” by providing donors the ability to contribute up to five times the annual gift tax exclusion and electing to spread that gift over five years. This ensures maximum growth inside the 529 accounts while eliminating the need to pay gift tax (although a gift tax return is still required to be filed in the year of the front loading).

In addition to maintaining control, assets in 529 accounts are considered assets of the owner for financial aid purposes, which is far more beneficial than having the assets belong to the beneficiary/student. For example, assets in a parent-owned 529 account for the benefit of a child will be assessed at the parent rate of 5.64% when calculating the expected family contribution for financial aid purposes, as opposed to the 20% rate applied to assets belonging to the student. Even better still is to have a grandparent own the 529 account; those assets are not factored into the calculation of expected family contribution at all! This may allow the student to qualify for a higher financial aid award than they might otherwise receive.

The primary drawback to 529 plans – and it’s a big one – is that any earnings withdrawn for non-qualified purposes are taxed at ordinary income rates and assessed a 10% penalty. One concern my clients often voice is, “what if my child doesn’t go to college?” It’s a valid concern, and there isn’t an easy answer. 529 plans do contain provisions that allow for changes in beneficiaries, so if one child doesn’t attend college, you could reassign the funds to a different child or family member (including stepchildren, nephews or nieces, spouses of family members, or even yourself) – but if no one goes to college, you may wind up having to pay the income tax and penalty to withdraw the assets.

It’s a calculated risk, and I advise clients to consider splitting their intended contribution between a 529 account and a regular taxable account as a way to hedge against this risk. They may not be maximizing the potential tax-free growth, but they’re also not stuck with a potentially large account that would be taxed at ordinary income rates, in addition to a hefty penalty, if the child doesn’t go to college.

I encourage you to speak to your financial advisor or accountant if you believe a 529 plan is appropriate for your situation. With the increasingly high cost of education, families need all the help they can get to maximize the value of their money. A 529 plan is a great start.

Putting aside my addiction to improving my golf handicap, the desire to surround myself with the beauty of nature provides me a calming perspective.  Often when I am in the fairway, I stop to look at the beauty that surrounds me.  Not in a passive sort of way, but to really take it all in. On some courses there are breathtaking views of The Puget Sound, gorgeous colors of foliage and wildlife.  Just last weekend, we encountered two deer walking across the fairway.  Visual reminders like the deer stick with me when I am making environmental choices.

In going about our daily lives – working, eating, commuting, and taking care of our home – we have an impact on our surroundings.  If you take a moment to pause and appreciate the beauty around you, you may be motivated to make small changes in your own life to decrease your carbon footprint and keep the beauty that is in nature.

Why do I golf in the rain?  Well, we live in Seattle. All this beautiful nature often happens in rain. In the elusive sun, clouds, or in the rain, the Pacific Northwest landscape is visually magnificent.

This Sunday is Earth Day, and I challenge you to celebrate this magnificence with a hike, walk, gardening, or a round of golf – any activity that will take you outside to enjoy the beauty of nature, even if it’s raining.

Just last week, local news stations shared a warning from the U.S. Geological Survey: There is an 84% chance of a 6.5 magnitude earthquake in Seattle in the next 50 years. Our office is certainly prepared for an event like this — we have trained floor wardens, supply kits in the office and plans for running operations in the event of a disaster — but at home, I’m not nearly so prepared.

Between the USGS warning and the seminar I just attended, I became highly motivated to make sure my family will be taken care of in the event of a major emergency or natural disaster. Now, I’m sharing some of the steps I’ve taken, in the hopes that you too will be inspired to get prepared.

1. Make a plan.

• Assign an out-of-area contact. After an emergency, it can be easier to get through to an out-of-area number than to make a local call. Appoint someone out of state and make sure everyone in your family has their contact information. Print a copy of their information and keep it in your wallet, in your car, by your home phone.
• Designate a meeting place. Consider the places you go most frequently. If you’re at work, can you walk home? What if a bridge is down and can’t make it? Have a back-up location as well.
• Don’t forget about pets, if you have them.
• Make sure everyone in your family knows your plan.

2. Make a kit for your home. The Red Cross recommends three days’ worth of supplies, and a major catastrophe might require at least seven to 10 days’ worth. You can decide how much you think is prudent, but even three days’ worth is better than none! Here are some lists to get you started:

• Basic supplies for 7 to 10 days
• Red Cross recommendations

3. Make a kit for your car. What if you’re on the road when disaster strikes? There’s a checklist for that too – build a car kit.

4. Most cities have a plan too – find out yours.

• Some have emergency update hotlines that provide recorded updates. Keep that number in your phone and with your kits.
• Know where the closest shelter will be, and how to get there.

These are just a few of many things you can do to help prepare yourself and your family for a major emergency. Check out these resources for more valuable information:

American Red Cross

What to do to Make it Through

Studies continue to find that investors earn lower returns than the funds in which they invested. Dalbar, a market research firm, issued their 2011 report showing investors achieved a mere 41.9% of the S&P 500‘s performance over the twenty years ending December 31, 2010. In other words, investors managed to leave a staggering 58.1% on the table. What could possibly explain missing out on these returns? It is largely due to investor behavior.

The goal of investing is to buy low and sell high – that’s a given – but our emotions, intuitions, and bias frequently work against us. Most investors did not begin buying technology related stocks in the early 90’s when prices were still reasonable; the vast majority bought in the late 90’s at astronomical prices, just before the “tech bubble” burst. Similarly, it was incredibly difficult to keep many investors positive about the prospects of the future during the first quarter of 2009 – the market bottomed on March 20, 2009 from the “housing bubble”- just before the markets began a climb to double in less than 2 years.

I recently read a wonderful new book written by Larry Swedroe & RC Balban, called “Investment Mistakes Even Smart Investors Make, And How To Avoid Them,” and I think it’s worth adding to your reading list.

I won’t re-write their book for you here, but Swedroe and Balban have done a great job of compiling a list of the most common mistakes and what you can do to avoid making them. This book will help you better understand why our investment strategies work, even though they can sometimes seem counterintuitive.

If you are not a client of ours and are considering hiring an advisor, this book may help you understand the mistakes a disciplined investment strategy can help you avoid.

By studying history and behavior, we can learn to avoid the same mistakes in the future. We can also understand why the disciplined investment decisions are sometimes the most uncomfortable. If we do our job well, you’ll be encouraged to stand by them anyway, knowing that discipline will pay off in the long-run.