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Finance 101: September 2023 Thumbnail

Finance 101: September 2023

In September the financial advisors at Ruedi Wealth Management wrote four more “Finance 101” columns for The News-Gazette’s Business Extra section. Make sure to look for them every Sunday, but in case you missed the columns from September all four are below.


Top Concerns About 529 College Savings Plans

Ryan Repko, CFP®

In my last column I covered the basics of 529 College Savings Plans and how they help parents and grandparents fund future education expenses. But even after I explain the benefits to those who are considering contributing to one, there are almost always some concerns.

The first concern is that the state of Illinois does not have a good track record of financial responsibility, and consequently using an Illinois 529 plan could suffer from financial mis-management. Though the state is the sponsor, the assets are managed by an independent third party, and the investment assets in the plan are owned by you.

The state of Illinois cannot reclaim your 529 plan assets because of their current or future financial health. I also have to give Illinois credit where credit is due, as the Illinois 529 College Savings Plan is usually rated one of the best due to the low administrative costs and high-quality investment options.

The second concern is if a child does not go to college or a trade school, that the money will be lost. This is not true, and there are several options to consider. All 529 plan contributions can be withdrawn tax-free and penalty-free. The earnings in the account can be withdrawn for non-college uses, but they are taxed at your ordinary income tax rate, and a 10% penalty is also applied. However, if a student gets a scholarship, becomes disabled, or passes away, the earnings in the 529 plan avoid the 10% penalty, and only ordinary income taxes are applied.

If you want to avoid the taxes and penalties on earnings you have some options. The first is just to switch the beneficiary of the 529 plan to someone who will use the money for college. If that is not an option, starting in 2024 there is the ability to rollover $35,000 from 529 plans into a Roth IRA for the 529 beneficiary.

However, there are some rules that must be followed. The 529 plan must have been open for at least 15 years. Contributions and earnings can be rolled over if they have been in the account for at least 5 years. Lastly, the rollover contribution cannot exceed Roth IRA contribution limits in any year.

As you can see, many of the common hesitations people have with funding a 529 College Savings Plan aren’t really as big of a concern as they thought. If you think a 529 College Savings Plan may be a good option for you, you may want to talk to a financial advisor or consider opening one yourself.

Ryan Repko is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.


Cost of Ownership

Paul R. Ruedi, CFP®

When people buy goods, they often focus only on the purchase price when considering the financial implications. What takes a little more foresight is considering how much that thing will cost you in the future.

Mayer Amschel Rothschild, founder of the Rothschild banking dynasty, thought this was so important he told his sons one of the main reasons wealthy families lose all their money is simply because housekeeping and other expenses are not being considered. Suffice it to say, “cost of ownership” is very important to consider when making financial decisions.

Suppose somebody was deciding between two cars they hope to have for 10 years, a newer car that cost $20,000, or an older car that costs $15,000. A frugal person would be tempted to say a car is a car and buy the one with a lower price, but that would ignore the cost of ownership.

Suppose the newer car only required $100 of maintenance each year to stay on the road, while the slightly older car needs around $1000 per year. At the end of 10 years the person who bought the more expensive car will have paid $21,000 to drive that car for 10 years. The person who bought the “cheaper” car, will have paid a total of $25,000.

The example above ignored the fact that the cheaper car may die sooner, which brings up another lesson: the useful life of something – how many years it will last – is highly related to cost of ownership, as it spreads any up-front cost over more years. I remember picking out a car battery years ago and asking why one battery was twice as expensive as a different one. It turns out that the more expensive battery lasts three times as long and was actually less expensive from a cost of ownership standpoint.

Cost of ownership must be considered before purchasing any big-ticket item. Maybe you can afford the up-front cost of a boat right now, but will your budget accommodate spending 10% of the price in maintenance each year? The same goes for houses: bigger houses mean more things that can break and cost you money. Perhaps you can afford the money down and monthly payments, but is fixing an irrigation system, replacing an extra-large fence, maintaining a pool, or replacing air conditioners going to be a problem?

Moral of the story, you simply cannot make any important purchase without considering the true cost of ownership. You must make sure you are able to pay for anything you purchase both now and later.

Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.


When Growth Exceeds Savings

Paul R. Ruedi, CFP®

As a financial advisor in my 30’s, I am always looking for ways to explain just how beneficial saving early is to people my age. Unfortunately, talking about the growth that takes place over a 30-year period versus a 20-year period just doesn’t get their attention as much as I would like. So I started thinking about a different savings milestone: the point at which the growth of your current savings will actually exceed the amount you save annually. It is at this point that you will really start to feel like your money is working for you.

Suppose a person decides to save $10,000 per year for retirement. If that money is invested in a stock portfolio that grows at a 10% annual rate (this is just below the historical long-term average return of the S&P 500), it would only take eight years for that person’s total savings to exceed $100,000. Given that a 10% return on anything over $100,000 is over $10,000, this person would expect the growth of their current portfolio to exceed their annual savings from that point forward.

Yes, this was an over-simplified example, as stocks cannot be expected to produce anything close to their “average” returns even over a period as long as eight years. But the mathematical truth remains the same: it can take less than a decade for your existing savings to start driving more of your portfolio growth than your annual additions. Someone my age could easily be at the point where their portfolio growth exceeds their annual savings. I know several people who have done it. I also know people who have not saved anything and really need to start.

I think the example above shows that second group what they have missed out on over the last eight years. But hopefully rather than discourage them, it will motivate them not to make the same mistake twice. If you want to get to the point where your money works harder to build your wealth than you do, start saving and investing as soon as possible. If you need help with that, you may want to talk to a financial advisor.

Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.

Failing Quickly or Slowly 

Paul R. Ruedi, CFP®

When you hear people talk about the investment portfolios of retirees, you almost always hear about a reasonably balanced portfolio. Whether that be 60% stocks and 40% bonds, or 50% of each, you almost always hear about an allocation that is somewhat in the middle instead of at the extremes. Given that there is never a one-size-fits-all best portfolio when building financial plans, it may seem somewhat peculiar to have so many people gravitating towards similar portfolio allocations.

This is likely because there is an increased risk that your financial plans will run into trouble if you concentrate your portfolio allocation too much in stocks or bonds. The difference between those two extremes is when that risk can show up and cause problems. Stocks run the risk of failing quickly, bonds run the risk of failing slowly.

A portfolio that is highly concentrated in stocks subjects an investor to sequence of returns risk – a fancy way of saying you may get a temporary decline big enough to cause problems. For example, suppose a couple begins retirement with a 100% stock portfolio and catches a temporary decline of 50% within the first few years of retirement.

If they were planning to take a reasonably conservative 4% withdrawal rate and their portfolio is cut in half, they now need to take out 8% of their portfolio to fund their lifestyle. If they continue to withdraw from their portfolio at this high rate without a substantial recovery from the stock market, they may deplete their portfolio to such an extent that their assets will no longer be able to support the spending they had planned on.

A portfolio of 100% bonds is subject to failing slowly on the back end of retirement. This is because bonds provide a fixed income stream, but retirees need to support their lifestyle for multiple decades in a rising cost world. A financial death by 1,000 papercuts, inflation can slowly grind away at the value of a portfolio that is made up primarily of fixed income, until it is no longer able to provide the same lifestyle in the later years of retirement.

Naturally, with large risks at the extremes that can be balanced by having a good mix of stocks and bonds, it is generally much more sensible for people to fall somewhere in the middle with respect to their ratio of stocks to bonds. If you are not sure how to balance the risks of failing quickly and failing slowly when making investment decisions, you may want to talk to a financial advisor.

Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.


Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.