The latest insights
Portal
Let's talk

Teaching Teens to Invest: The Roth IRA Way

by

[Updated October 12, 2022]

What’s the best way to introduce your kids to investing?

It used to be with stock certificates—elaborately engraved documents that served as physical proof that you owned shares of a company—often proudly framed and displayed in a child’s bedroom.

While stock certificates for kids are less common today, there’s another way to get them excited about investing.

Set up a Roth IRA when your teens start their first summer job.

Why a Roth IRA?

Funded with post-tax income, Roth IRAs give teens a huge head start on saving for retirement. Income grows tax-free, and funds withdrawn at retirement are not taxed.

Parents can open a Roth in a teen’s name. To qualify, the teen must have earned income that does not exceed $144,000—a pipe dream for most kids.

The Power of Compound Interest

Albert Einstein famously said, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.”

To illustrate this, let’s say that your 18-year-old invests $6,000 of savings from their summer job this year in a Roth IRA. Assuming an 8% annual return, he or she would accrue approximately $150,000 by age 60.

When they catch on to the power of compounding early in life, teens can enjoy decades of watching their wealth grow.

Contribution Limits

Individuals can contribute a maximum of $6,000 each year to a Roth IRA (up to age 50 and then $7,000 after that).

While few teens can maximize Roth contributions on their own, parents, grandparents, and other relatives can help. Matching your child’s contributions is a great way to incent saving.

One caveat: The most your child can deposit (his or her money plus anything you contribute) is what he or she earned during the year, up to the $6,000 limit.

The Making of a Millionaire

If an 18-year-old opens a Roth IRA with $6,000 and continues contributions at the same level every year, he or she would be a millionaire by age 52, assuming an 8% annual return.

This could motivate even the most apathetic teen to save. If not, a friendly reminder might.

An 18-year-old who invests an initial $6,000 and nothing more would have only $82,000 by age 52—a far cry from the cool $1 million that the same 18-year-old would have if he or she consistently maximized contributions during this same time period.

Better than a Stock Certificate

To paraphrase a wise line by Albert Einstein – compound interest is the eighth wonder of the world.  The person who understands it, earns it… the person who doesn’t… pays it.

Opening a Roth IRA can be one of the best gifts you ever give your teen. Your child won’t get that colorful stock certificate, but he or she will get something infinitely more valuable—a lesson in how to build a stable financial future.

Today’s Hot Stocks? You Already Own Them

by

Summer in the Northwest. That glorious season of hiking, swimming, and indulging in all things outdoorsy—including the quintessential neighborhood BBQ.

Perhaps this scene sounds familiar: Beer in one hand, tongs in the other, your neighbor confidently rattles off a list of hot stocks to own as he absentmindedly checks the char on the steaks. He mentions Amazon, up a whopping 45% this year. And Netflix, up 104%.

Feeling uneasy, you start to wonder, “Why don’t I own Netflix?”

Hold the Phone

Believe it or not, humble index fund investors already have exposure to today’s market winners.

It’s true. Index funds—the low-cost, broadly diversified powerhouses of a balanced portfolio—hold all of today’s hottest stocks. Think Amazon, Apple, Google, Microsoft, and Facebook.

Even better, because index funds hold virtually all publicly traded stocks, tomorrow’s winners will be in there, as well. Investors don’t need to pick which stocks will perform best to be successful.

Picking stocks, as we’ve said many times, is a losing proposition.

What’s in an Index Fund?

Consider a Vista client with a diversified 65/35 portfolio worth $3 million.

Whether he realizes it or not, he holds many of today’s hottest stocks in his index fund—$24,000 worth of Apple; another $17,000 of Google; $14,000 of Amazon; $10,000 of Facebook; and $3,000 of Netflix.

Not only is he invested in one of the most effective tools for building and maintaining wealth, but he owns the very stocks that everyone—including your neighbor—is talking about.

Why Own Anything Else?

With companies like Amazon and Google providing eye-popping returns over the past decade, why diversify?

While research shows that a few top performers such as Amazon do, in fact, produce a large part of the market’s long-term returns, these stocks are incredibly difficult to find—even for seasoned pros.

By owning all stocks through a diversified portfolio, investors get their best chance for owning tomorrow’s winners and capturing the market’s top performers.

A Winning Portfolio

Built with index funds from Vanguard and asset class funds from Dimensional, Vista’s portfolios contain 12,000 companies diversified across 44 countries around the globe.

So, the next time someone mentions a hot new stock, you can reply, “Oh, Netflix? I already own that,” and get back to enjoying the rest of your summer.

A Bright Future for Oregon’s 529 Plan

by

Whether you’ve been saving for college for a while or are about to start saving, you’ll want to know about upcoming changes to Oregon’s 529 College Savings Plan.

With a new financial partner and enhanced investment options, Oregon’s 529 Plan is on track to earn top grades.

Q: What is the Oregon College Savings Plan?

A: Launched in January 2001, the Oregon College Savings Plan is a state-sponsored, tax-advantaged 529 savings plan designed to help participants save for future college costs.

Earnings grow free from federal tax, and Oregonians can deduct 529 contributions from their taxable state income – up to $4,750 in 2018 for married couples filing jointly. (Note that recent legislation disallows Oregon’s tax break for private K-12 education.)

Withdrawals used for qualified expenses are tax-free at both the federal and state levels.

Q: Who is managing the plan’s assets?

A: Sumday Administration, a subsidiary of BNY Mellon, one of the world’s largest financial institutions, will replace TIAA as the Plan’s financial partner.

We see the transition as a positive one.

Along with robust new investment options (with the same level of risk as current options), there will be a reduction in fees—from the current all-in plan fee of 0.33% to a projected all-in fee of 0.18% in 2030.

Q: Are the plan’s underlying investments changing?

A: Yes—for the better. Sumday will give plan participants access to previously unavailable DFA funds and Vanguard index funds.

This is a big win for investors. Vanguard offers greater diversification and lower costs across domestic stocks, international stocks, and bonds.

Q: I currently have an age-based Oregon 529 plan. Will this change?

A: Yes. There is a growing trend toward nontraditional education paths. Some students take a gap year, some continue on to graduate school, and still others enter school as adults.

Because not everyone starts college at age 18 or follows the same path, Oregon’s 529 Plan is moving from age-based to target date (or “enrollment date”) portfolios.

Enrollment date portfolios allow participants to better align funds with a student’s college plans and goals.

Assets will automatically be mapped over to a target enrollment date portfolio.

Q: I have auto deposits set up. Do I need to do anything?

A: If you have auto deposits set up with your bank savings or checking account, everything automatically rolls over.

If, instead, your contributions are deducted from your paycheck, you will need to complete new paperwork that notifies your employer of the change.

Where can I go for more information?

To learn more about upcoming changes, visit Oregon’s 529 College Savings Plan FAQ or contact Vista.

Live outside of Oregon? We can also help you with questions about 529 plans across the country.

This post is Part One of a three part series on Oregon’s 529 College Savings Plan. In Part Two, we share how to withdraw funds from your plan.

Tax Changes & Charitable Giving: Have Your Cake and Eat It Too

by

With standard deductions nearly doubling under the new tax law, far fewer taxpayers are expected to itemize in coming years.

Given this change, how should taxpayers approach charitable giving?

You might consider “bunching” several years’ worth of charitable donations into a donor advised fund (DAF). This approach lets you have your cake (get a tax deduction for charitable gifts) and eat it, too (take advantage of the increased standard deduction).

Why Bunch?

Taxpayers who normally fall short of itemizing may benefit from using the bunching strategy.

Rather than waiting until tax time to add everything up to see if it’s more beneficial to take the standard deduction or to itemize, you can proactively bunch multiple years of charitable donations in one year to exceed the standard deduction threshold.

Accordingly, you would itemize in the bunching year and take the standard deduction for subsequent years. Under the new tax law, this approach would yield higher deductions and greater tax savings.

Bunching, however, leaves open a big question. What happens to charities that rely on a steady stream of donations to operate every year?

Enter the donor advised fund.

What’s a Donor Advised Fund?

Donor advised funds allow taxpayers to make a charitable contribution, receive an immediate tax benefit, and then later (sometimes years later) release grants from the fund to charity. Like a charitable investment account, a DAF gives you the flexibility to donate funds at your own pace.

Bunching and DAFs: A Winning Combination

In the context of tax strategy, bunching several years of charitable donations into a donor advised fund makes sense.

Consider the Smiths. Under both previous and current tax law, taxpayers can elect to claim the standard deduction or itemize deductions – whichever is greater. The Smiths’ itemized deductions usually include a donation of $6,000 per year to their favorite charity and $20,000 per year in state and local taxes.

Under the new tax law, the standard deduction for a married couple filing jointly increased from $12,700 to $24,000. Additionally, the deduction for state and local taxes was capped at $10,000. This means that the Smiths need another $14,000 of itemized deductions to crest the new $24,000 standard deduction amount.

The Smiths can take their original annual charitable contribution of $6,000 and bunch it for, say, 5 years. Accordingly, the Smiths will contribute $30,000 to a DAF in 2018. Combined with their state and local tax deductions of $10,000, they will now have itemized deductions of $40,000, which exceeds the standard deduction of $24,000.

They can now itemize and receive the upfront tax deduction for their contribution. Using this approach, over the next five years, their deductions will total $136,000 compared to $120,000 if they had taken the standard deduction of $24,000 over all five years.

Just how valuable is an extra $16,000 in federal tax deductions for the Smiths? Assuming they are taxed at a rate of 30 percent, this bunching strategy will save them $4,800—more than enough to buy one fine cake.

For tax years 2019 through 2022, they will take the standard deduction but can still release funds from their DAF to their favorite charities.

Let Them Eat Cake

Supporting worthy causes is a gratifying experience. By planning in advance and bunching charitable donations into a donor advised fund, you can enjoy giving to favorite charities and maximizing tax benefits under today’s tax laws—always a great reason to celebrate with cake.

2017’s Expert Predictions: More Pain than Gain

by

“This could be the year,” predicted Barron’s in January, “the movie runs backward. Inflation awakens. Bond yields reboot. Stocks stumble. Active management rules.” 1
Or maybe not.

As it was, inflation remained unchanged in 2017. The 10-year Treasury yield went down, not up. Stocks were up 20% in the US and 25% outside the US, making 2017 the best year for global stocks in years. And active management continued to lose out to index funds in terms of performance and investor preference.  So much for Barron’s bold prediction.

Financial media predictions wrapped in shiny headlines such as “Ten Stocks to Buy Now” and “Five All-Star Mutual Funds” appear like clockwork every year to attract attention and spur media sales. They don’t, however, help investors.

A review of this year’s forecasts proves once again what we’ve said here, here, and here. When it comes to predictions, don’t believe what you read.

Last January, Money magazine issued top stock picks from professional investors “who keep beating the market.”2 Their picks included National Oilwell Varco, which declined by 9%, CVS (down 2%) and Kia Motors, which lost 13%. The average return on the experts’ select picks was 17.9%, while the entire stock market gained 19%. That’s right, the best stocks to own as per Money’s experts did worse than all stocks combined—no picking required.

Kiplinger’s predictions for 2017 didn’t fare much better. In “5 Stocks You Should Dump Right Now,”3 experts recommended investors jettison Caterpillar, which ended the year with a 67% gain, Deere (+68%) and Tesla (+61%). Conversely, Kiplinger’s experts recommended investors buy a group of eight stocks including MEDpace (-4%), Palo Alto Networks (-10%) and Regeneron (-10%).4

Ironically, Kiplinger’s “buy list” not only underperformed the broad market by 5%, but underperformed the stocks they urged investors to sell by a whopping 26%.

For their part, U.S. News and World Report exhorted readers to “start 2017 off right” with a “selective” list of 25 of America’s biggest blue chips.5 Without question, blue chips were a great place to be in 2017, with the bellwether Dow Jones Industrial Average of 30 stocks returning 27% over the period.  U.S. News’ select list returned 2% less. So much for paring back the list from 30 to 25….

What’s the takeaway? As 2017 ends and 2018 approaches, the next round of expert predictions will beckon from the headlines. But investors should ignore them, as time and again these predictions fail to deliver anything more than entertainment.

  1. Rublin, Lauren R. “Stocks Could Post Limited Gains in 2017 as Yields Rise.” Barron’s, January 14, 2017.
  2. Bigda, Carolyn. “Top Stock Picks From 4 Professional Investors Who Keep Beating the Market.” Money, January 10, 2017.
  3. Fonda, Daren. “5 Stocks You Should Dump Right Now.” Kiplinger, November 30, 2016.
  4. Fonda, Daren. “8 Good Stocks to Buy Now for 2017.” Kiplinger, April 2017.
  5. Divine, John. “The 25 Best Blue-Chip Stocks to Buy for 2017.” US News and World Report, December 7, 2016.

Wade or Plunge?

by

With broad market indices recently hitting record highs, many investors have expressed fear of investing available cash before a market correction.

Are those fears justified? Is it better to invest right away—“plunge”—or is it better for investors to tiptoe into the market over time, aka “wade?”

While the future is uncertain, the historical record is clear. From a return standpoint, plunging has beaten wading about three-quarters of the time. As legendary investor Warren Buffett has said, “The best time to plant a tree was 20 years ago. The second best time is today.”

Another Way to Plant the Tree

While plunging is most likely to provide the best investment outcome, it may not deliver the best experience for every investor. Indeed, despite the evidence, some investors may prefer a more gradual approach to becoming fully invested. For those who don’t plunge, is there an optimal approach to wading?

To answer this, think of wading as an insurance policy. Since getting invested over a protracted timeframe means holding more cash, wading provides some protection against a sudden stock market decline. As financial author William Bernstein noted, wading “allows the investor to digest the market in many small bites, rather than one big gulp.”

But just as a $2 million life insurance policy costs more than a $1 million policy, wading comes with an expected opportunity cost in the form of lost stock returns.

Research on Wading

To determine the optimal wading strategy, we used historical stock market data for a balanced stock/bond portfolio to quantify both the cost of, and protection provided by, this “insurance.” We evaluated three different wading strategies—investing equal amounts over six, nine, and twelve months—and compared them to a plunging strategy, as well as against each other.
Consistent with other studies, our research showed that—first and foremost—plunging is still the best bet for maximizing returns. Investors looking to maximize their investment outcome for the long term should get fully invested immediately.  Exhibit 1 shows how often plunging beat wading, based on the average performance for each strategy over all observed periods.

 

 

Next, we looked at the cost of wading.  We found that the longer an investor wades, the higher the cost in terms of foregone return. Exhibit 2 shows the average outperformance of plunging, relative to wading, for the three wading strategies. The longer you intend to wade, the higher the cost you should expect to pay for that insurance.

 

 

Lastly, we wanted to understand the protection provided by wading during times when an investor would want this insurance policy most.

Keep in mind, the data above reflects the average result for all rolling six-, nine- and twelve-month periods since 1973. In our experience, however, investors aren’t so concerned with protecting their portfolios in periods when plunging results in low, but positive, or slightly negative returns. No, we believe investors’ reluctance to plunge stems from a desire for protection against a large market drop, say 10% or more, immediately after becoming invested.

When we focused our research on just those historical periods when plunging resulted in a loss of 10% or more, we found the protection provided by wading over six, nine and twelve months was very similar. In other words, wading over twelve months didn’t provide much additional protection than wading over nine months. And, interestingly, wading over nine months provided less protection than wading over six months.

 

 

The takeaway? Since the cost of protecting one’s portfolio via a wading strategy is higher the longer one wades, yet the protection provided by wading in the times it might be wanted most is similar, we believe wading over six months is likely to provide the most cost-effective protection.

Plunge…or Wade with Purpose

After reviewing the data, Warren Buffet’s advice stands—plant your tree today. Investors looking to maximize returns should plunge and get fully invested immediately.
For those who just can’t bring themselves to plunge, history suggests wading in equal parts over the course of six months provides the most cost-effective protection.

Odds Overwhelmingly Favor Diversification Over Stock Selection

by

Which is more appealing: a high probability of earning a good return or a small chance of earning a phenomenal one? Before you answer, you might consider the findings of a paper recently published by Hendrik Bessembinder, professor of finance at Arizona State University.

The paper’s title, “Do Stocks Outperform Treasury Bills?” is certainly provocative. One-month Treasuries, or T-Bills, are cash equivalents widely regarded as risk-free. Stocks, on the other hand, represent the opposite end of the risk spectrum. The paper, therefore, addresses a question fundamental to investing; are investors indeed compensated for bearing the additional risk associated with owning stocks?

The study analyzed 90 years’ worth of monthly returns for all U.S. stocks. Bessembinder estimates from 1926 to 2015, total U.S. stockholder wealth increased by a staggering $32 trillion. This return was assured to any investor who simply owned all U.S. stocks all the time.

Bessembinder’s shocking discovery is the market’s growth was fueled by just 4% of all publicly-traded companies. The remaining 96% just matched the return of T-Bills. Think of the implications! Investors who owned only a handful of stocks were very likely to be disappointed. With the odds of stumbling upon a rare winner so low, it’s more probable investors’ portfolios were filled with losers—stocks that failed to outperform cash.

Make no mistake: as a group, stocks do outperform T-Bills. But with almost 60% of stocks delivering returns below T-Bills, the returns realized from investors’ picking and choosing among stocks is another matter entirely.

Bessembinder’s research adds even more weight to the established wisdom of diversification, as well as clarifying its proper definition. To fully diversify all stock-specific risk, one must own all stocks. This is the only way to ensure capturing the top performers and to consistently harness stocks’ power for growth.

This brings us back to our original question. Armed with Bessembinder’s discovery that most stocks underperform cash, and the top 4% deliver all the excess return, which is more appealing—a probable good return or a possible amazing one?

Vista’s answer may come as no surprise. Built with index funds from Vanguard and asset class funds from Dimensional, our stock portfolios contain 12,000 companies diversified across 44 countries around the globe.

When it comes to our clients’ life savings, probable trumps possible 100% of the time.

Focus on Dividends

by

In today’s low-yield environment, dividend-paying stocks have become a popular choice. But are income investors really better off with this coupon-clipping alternative?

To address this question, we compared two $100,000 portfolios over the past ten years; one invested entirely in a high-dividend strategy, the other in a index fund portfolio comprised of 60% U.S. stocks, 30% international stocks, 10% real-estate investment trusts (REITs). To replicate a dividend strategy, we used data from the iShares Select Dividend ETF (ticker: DVY), since it is one of the largest dividend funds, by assets, and is the only dividend fund with at least a 10-year history.

Dividends from the DVY, and an equal amount from the diversified portfolio, were withdrawn each year. Since annual dividends from the DVY portfolio were greater, some principal was withdrawn each year from the diversified portfolio to make up the difference. Creating such “homemade” dividends via asset sales in the diversified portfolio are functionally equivalent to dividends from DVY as, of this writing, tax rates for qualified dividends and long-term capital gains are the same.

Over the ten year period, the two portfolios produced identical cash flow, but what about their ending values? Despite dipping into principal each year, the diversified portfolio value ended $20,000 higher than the DVY portfolio.

These findings suggest a total return approach based on a well-diversified portfolio may be superior to a singular focus on dividends. A total return approach relies on multiple asset classes to generate cash flow: Dividends (from stocks and REITs), capital gains and the occasional return of principal (each from asset sales).

What’s more, cash flow under a total return approach can be prudently generated regardless of the dividends stocks provide in any given year.

Stock Picking: A Cinderella Story

by

Maybe “March Madness” is getting to us, but the hoopla surrounding the NCAA basketball tournament seems a lot like the hype on Wall Street. Betting on a team to win in the tournament isn’t too different from picking a stock to buy (or sell). In both cases, participants are subject to what Eugene Fama, professor at the University of Chicago Booth School of Business, refers to as a “zero sum game.” Just as two parties must take opposing sides in a basketball bet, a stock transaction requires a buyer and seller. Success for one participant means failure for the other.

Professor Fama spoke recently at the Chartered Financial Analyst Annual Conference where he discussed the mathematical implications of active manager (stock pickers) performance. He explained how active management before fees is a zero sum game. After fees and trading costs, Fama noted, “only the top 3% of managers produce a return that indicates they have sufficient skill to just cover their costs.” His conclusion? “An investor doesn’t have a prayer of picking a manager that can deliver true alpha (a winning record).”[1]

Despite this research, many investors still try to pick winners. Some will even succeed. For the few who do, the real question is was it due to luck or skill. It is easy to confuse the two. Once again, there is a basketball tournament parallel. Frequently, so-called “Cinderella” teams, improbable, low-seeded schools, defy the odds and beat a higher seeded team. It is hard to deny that luck is the culprit in predicting those victories. Research showing few active managers duplicate past successes suggests luck is responsible for many stock picks as well.

Many investors would benefit from considering whether their future success is probable or merely possible. For the NCAA basketball tournament, the thrill of possibly picking the year’s Cinderella is fine. For your life’s savings, you probably want better odds. At the risk of carrying this basketball analogy too far, a diversified portfolio is like betting on the arenas and concessions rather than the teams. You can count on a small piece of the ticket and hot dog sales no matter who is in the tournament.
________________________________________
[1]Harrison, Mark.“Unapologetic After All These Years.” CFAinstitute.org. May 14, 2012.