Category: Home Improvement

529 Plans: A Complete Guide to Funding Future Education

Do you have kids? Are there children in your life? Were you once a child? If you plan on helping pay for a child’s future education, then you’ll benefit from this complete guide to 529 plans. We’ll cover every detail of 529 plans, from the what/when/why basics to the more complex tax implications and investing ideas.

This article was 100% inspired by my Patrons. Between Jack, Nathan, Remi, other kiddos in my life (and a few buns in the oven), there are a lot of young Best Interest readers out there. And one day, they’ll probably have some education expenses. That’s why their parents asked me to write about 529 plans this week.

What is a 529 Plan?

The 529 college savings plan is a tax-advantaged investment account meant specifically for education expenses. As of the passage of the Tax Cuts and Jobs Act (in 2017), 529 plans can be used for college costs, K-12 public school costs, or private and/or religious school tuition. If you will ever need to pay for your children’s education, then 529 plans are for you.

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529 plans are named in a similar fashion as the famous 401(k). That is, the name comes from the specific U.S. tax code where the plan was written into law. It’s in Section 529 of Internal Revenue Code 26. Wow—that’s boring!

But it turns out that 529 plans are strange amalgam of federal rules and state rules. Let’s start breaking that down.

Tax Advantages

Taxes are important! 529 college savings plans provide tax advantages in a manner similar to Roth accounts (i.e. different than traditional 401(k) accounts). In a 529 plan, you pay all your normal taxes today. Your contributions to the 529 plan, therefore, are made with after-tax dollars.

Any investment you make within your 529 plan is then allowed to grow tax-free. Future withdrawals—used for qualified education expenses—are also tax-free. Pay now, save later.

But wait! Those are just the federal income tax benefits. Many individual states offer state tax benefits to people participating in 529 plans. As of this writing, 34 states and Washington D.C. offer these benefits. Of the 16 states not participating, nine of those don’t have any state income tax. The seven remaining states—California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina—all have state income taxes, yet do not offer income tax benefits to their 529 plan participants. Boo!

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This makes 529 plans an oddity. There’s a Federal-level tax advantage that applies to everyone. And then there might be a state-level tax advantage depending on which state you use to setup your plan.

Two Types of 529 Plans

The most common 529 plan is the college savings program. The less common 529 is the prepaid tuition program.

The savings program can be thought of as a parallel to common retirement investing accounts. A person can put money into their 529 plan today. They can invest that money in a few different ways (details further in the article). At a later date, they can then use the full value of their account at any eligible institution—in state or out of state. The value of their 529 plan will be dependent on their investing choices and how those investments perform.

The prepaid program is a little different. This plan is only offered by certain states (currently only 10 are accepting new applicants) and even by some individual colleges/universities. The prepaid program permits citizens to buy tuition credits at today’s tuition rates. Those credits can then be used in the future at in-state universities. However, using these credits outside of the state they were bought in can result in not getting full value.

You don’t choose investments in the prepaid program. You just buy credit’s today that can be redeemed in the future.

The savings program is universal, flexible, and grows based on your investments.

The prepaid program is not offered everywhere, works best at in-state universities, and grows based on how quickly tuition is changing (i.e. the difference between today’s tuition rate and the future tuition rate when you use the credit.)

Example: a prepaid credit would have cost ~$13,000 for one year of tuition in 2000. That credit would have been worth ~$24,000 of value if used in 2018. (Source)

What are “Qualified Education Expenses?”

You can only spend your 529 plan dollars on “qualified education expenses.” Turns out, just about anything associated with education costs can be paid for using 529 plan funds. Qualified education expenses include:

  • Tuition
  • Fees
  • Books
  • Supplies
  • Room and board (as long as the beneficiary attends school at least half-time). Off-campus housing is even covered, as long as it’s less than on-campus housing.

Student loans and student loan interest were added to this list in 2019, but there’s a lifetime limit of $10,000 per person.

How Do You “Invest” Your 529 Plan Funds?

529 savings plans do more than save. Their real power is as a college investment plan. So, how can you “invest” this tax-advantaged money?

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There’s a two-part answer to how your 529 plan funds are invested. The first part is that only savings plans can be invested, not prepaid plans. The second part is that it depends on what state you’re in.

For example, let’s look at my state: New York. It offers both age-based options and individual portfolios.

The age-based option places your 529 plan on one of three tracks: aggressive, moderate, or conservative. As your child ages, the portfolio will automatically re-balance based on the track you’ve chosen.

The aggressive option will hold more stocks for longer into your child’s life—higher risk, higher rewards. The conservative option will skew towards bonds and short-term reserves. In all cases, the goal is to provide some level of growth in early years, and some level of stability in later years.

The individual portfolios are similar to the age-based option, but do not automatically re-balance. There are aggressive and conservative and middle-ground choices. Thankfully, you can move funds from one portfolio to another up to twice per year. This allowed rebalancing is how you can achieve the correct risk posture.

Advantages & Disadvantages of Using a 529 Plan

The advantages of using the 529 as a college investing plan are clear. First, there’s the tax-advantaged nature of it, likely saving you tens of thousands of dollars. Another benefit is the aforementioned ease of investing using a low-maintenance, age-based investing accounts. Most states offer them.

Other advantages include the high maximum contribution limit (ranging by state, from a low of $235K to a high of $529K), the reasonable financial aid treatment, and, of course, the flexibility.

If your child doesn’t end up using their 529 plan, you can transfer it to another relative. If you don’t like your state’s 529 offering, you can open an account in a different state. You can even use your 529 plan to pay for primary education at a private school or a religious school.

But the 529 plan isn’t perfect. There are disadvantages too.

For example, the prepaid 529 plan involves a considerable up-front cost—in the realm of $100,000 over four years. That’s a lot of money. Also, your proactive saving today ends up affecting your child’s financial aid package in the future. It feels a bit like a punishment for being responsible. That ain’t right!

Of course, a 529 plan is not a normal investing account. If you don’t use the money for educational purposes, you will face a penalty. And if you want to hand-pick your 529 investments? Well, you can’t do that. Similar to many 401(k) programs, your state’s 529 program probably only offers a few different fund choices.

529 Plan FAQ

Here are some of the most common questions about 529 education savings plans. And I even provide answers!

How do I open a 529 plan?

Virtually all states now have online portals that allow you to open 529 plans from the comfort of your home. A few online forms and email messages is all it takes.

Can I contribute to someone else’s 529?

You sure can! If you have a niece or nephew or grandchild or simply a friend, you can make a third-party contribution to their 529 plan. You don’t have to be their parent, their relative, or the person who opened the account.

Investing in someone else’s knowledge is a terrific gift.

Does a 529 plan affect financial aid?

Short answer: yes, but it’s better than how many other assets affect financial aid.

Longer answer: yes, having a 529 plan will likely reduce the amount of financial aid a student receives. The first $10,000 in a 529 plan is not part of the Expected Family Contribution (EFC) equation. It’s not “counted against you.” After that $10,000, remaining 529 plan funds are counted in the EFC equation, but cap at 5.46% of the parental assets (many other assets are capped higher, e.g. at 20%).

Similarly, 529 plan distributions are not included in the “base year income” calculations in the FAFSA application. This is another benefit in terms of financial aid.

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Finally, 529 plan funds owned by non-parents (e.g. grandparents) are not part of the FAFSA EFC equation. This is great! The downside occurs when the non-parent actually withdraws the funds on behalf of the student. At that time, 50% of those funds count as “student income,” thus lowering the student’s eligibility for aid.

Are there contribution limits?

Kinda sorta. It’s a little complicated.

There is no official annual contribution limit into a 529 plan. But, you should know that 529 contributions are considered “completed gifts” in federal tax law, and that those gifts are capped at $15,000 per year in 2020 and 2021.

After $15,000 of contributions in one year, the remainder must be reported to the IRS against the taxpayer’s (not the student’s) lifetime estate and gift tax exemption.

Additionally, each state has the option of limiting the total 529 plan balances for a particular beneficiary. My state (NY) caps this limit at $520,000. That’s easily high enough to pay for 4 years of college at current prices.

Another state-based limit involves how much income tax savings a contributor can claim per year. In New York, for example, only the first $5,000 (or $10,000 if a married couple) are eligible for income tax savings.

Can I use my state’s 529 plan in another state? Do I need to create 529 plans in multiple states?

Yes, you can use your state’s 529 plan in another state. And mostly likely no, you do not need to create 529 plans in multiple states.

First, I recommend scrolling up to the savings program vs. prepaid program description. Savings programs are universal and transferrable. My 529 savings plan could pay for tuition in any other state, and even some other countries.

But prepaid tuition accounts typically have limitations in how they transfer. Prepaid accounts typically apply in full to in-state, state-sponsored schools. They might not apply in full to out-of-state and/or private schools.

What if my kid is Lebron James and doesn’t go to college? Can I get my money back?

It’s a great question. And the answer is yes, there are multiple ways to recoup your money if the beneficiary doesn’t end up using it for education savings.

First, you can avoid all penalties by changing the beneficiary of the funds. You can switch to another qualifying family member. Instead of paying for Lebron’s college, you can switch those funds to his siblings, to a future grandchild, or even to yourself (if you wanted to go back to school).

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What if you just want you money back? The contributions that you initially made come back to you tax-free and penalty-free. After all, you already paid taxes on those. Any earnings you’ve made on those contributions are subject to normal income tax, and then a 10% federal penalty tax.

The 10% penalty is waived in certain situations, such as the beneficiary receiving a tax-free scholarship or attending a U.S. military academy.

And remember those state income tax breaks we discussed earlier? Those tax breaks might get recaptured (oh no!) if you end up taking non-qualified distributions from your 529 plan.

Long story short: try to the keep the funds in a 529 plan, especially is someone in your family might benefit from them someday. Otherwise, you’ll pay some taxes and penalties.

Graduation

It’s time to don my robe and give a speech. Keep on learning, you readers, for:

An investment in knowledge pays the best interest

-Ben Franklin

Oh snap! Yes, that is how the blog got its name. Giving others the gift of education is a wonderful thing, and 529 plans are one way the U.S. government allows you to do so.

If you enjoyed this article and want to read more, I’d suggest checking out my Archive or Subscribing to get future articles emailed to your inbox.

This article—just like every other—is supported by readers like you.

Source: bestinterest.blog

Selecting the Perfect Trading Timeframe as a Forex Trader

This page may include affiliate links. Please see the disclosure page for more information. Which trading timeframe is best? As a new forex trader in the Foreign exchange market, there’s a bit of a learning curve on which is best. A new Forex trader can become frustrated and try different timeframes until they eventually lose a significant…

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Grow Your Money: Mutual Funds, Index Funds, & CDs

If you’re looking to save money for a short, intermediate or long-term goal, such as retirement, you need to find a safe place to park it, earn interest, and have fairly access to your money.

But, how do you find such a safe place?

The good news is that there are several places to put your hard-earned savings.

Besides a savings account, three of the most common accounts available to you are mutual funds, index funds and certificate of deposits.

We will discuss the advantages and disadvantages of these short and long-term investments below.

Before we go in detail with the differences between these accounts, you might be wondering about mutual fund.

You may have heard a lot about certificate of deposits, but you may not know a lot about mutual funds.

But one thing you should know is that the question of ‘what is a mutual fund?’ is searched online more than 16,000 each month.

So people are actively looking for the definition. This is what a mutual fund is:

What is a mutual fund?

A mutual fund is an investment vehicle, where investors pool their money together to buy shares.

A professional manager manages the fund. They invest the money for you in securities such as stocks and bonds.

However, a mutual fund differs from an index fund, a certificate of deposit, or Vanguard CDs. 

CDs are safer than mutual funds and index funds, because mutual funds and index funds invest in stocks and bonds. One type of mutual fund, money market fund, invests in money and is quite safe.

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Nonetheless, mutual funds and index funds in general are safe for various reasons (more on this below).

One thing for sure is that in most cases, you can expect a higher return on your investment with a mutual fund and index fund than a certificate of deposit.

However, be ready to come up with a bigger minimum deposit with a mutual fund and index fund.

Mutual funds vs index funds vs certificate of deposits: what’s the difference?

All of these accounts are safe comparing to investing in individual stocks. However, there are key differences between mutual funds, index funds and certificate of deposits.

First of all, most mutual funds and index funds invest in stocks or bonds — with the exception of money market funds, which invest in “money.” 

Even though there is a possibility that shares in a mutual fund and index fund can drop significantly due to volatility of the stock market, mutual funds and index funds return a much higher yield than a certificate of deposit.

However, index funds deliver a better return than mutual funds.

Index funds, unlike mutual funds, are managed by a computer. An index fund simply invests to match the performance of an index such as the Standard & Poor’s 500 index of 500 large U.S. company stocks.

So, they stay invested and thus deliver better returns.

Unlike certificate of deposits, mutual funds and index funds do not require you to keep money for a specific period of time.

With a mutual fund, just like an index fund, you are free to withdraw your money at anytime you want. In other words, there is no penalty for selling your share in a mutual funds.

However, CDs have something that mutual funds and index funds lack. They are insured by the federal government (FDIC insurance) for up to $250,000. That means your money is always protected.

Having said, mutual funds that invests in stocks or bonds are still safe due to their diversification.

Mutual funds are safe, because they invest in dozens of stocks (from large, mid, and small size companies) across different and multiple industries.

Advantages and disadvantages of mutual funds vs index funds vs CDs

To understand better how these products can grow your money, it’s important to know their pros and cons. Here they are:

Mutual Funds

Generally, mutual funds offer higher returns than certificate of deposit.

Pros

  • Higher returns: Compared with CDs and savings account, expect a a higher return on your money.
  • Accessibility: You can easily sell your shares, either via your fund company’s website online or via their toll-free number. Also, most money market funds offer check-writing privileges.
  • Diversification:  while most mutual funds can be risky (especially those that invest in stocks), their diversification make them a safer investment. Most mutual funds own stocks or bonds from dozens of companies across multiple industries. So, if one stock is not doing well, another stock can balance it out.  

Cons

  • Less safe: Unlike CDs which are FDIC insured, mutual funds are not. If you want to make sure that you don’t lose your money because you want it in the short term, stick with money market funds. Although, they too are not federally insured, they are considered very safe.
  • Initial investment minimum: Most mutual funds have high minimum investment requirements compared with saving accounts and certificate of deposits. Many mutual funds have minimums of $3,000 or more.

Index Funds 

Index funds, unlike mutual funds, are passive. That means they are managed by a computer and not actively managed by a fund manager.

Index funds seek to track the performance of a particular index, such as the Standard & Poor’s 500 index of 500 large U.S. company stocks or the CRSP US Small Cap Index.

Index funds don’t jump around; they stayed invested in the market.

Pros

Easy to purchase: Just like mutual funds, you can buy index funds through fund companies like Vanguard and Fidelity.

Expense is low: Like mutual funds, index funds have low-cost, which is usually less than 1% annually. This lower operating expenses help boost your returns. 

Diversification: Another benefit of index funds is that they are diversified. Like mutual funds, they invest in multiple companies, thus spreading out the risk.

Tax-friendlier: When you invest in index funds in non-retirement accounts, you are taxed less than you would in mutual funds.

Because mutual fund managers are actively buying and selling in an attempt to increase returns, that increase a fund’s taxable capital gains distributions. Index funds are traded less frequently. 

Cons:

One of the downside with index funds, is that they won’t outperform the market they track.

Certificate of Deposit

If you need safety and a competitive yield on your money, CD is a good place for you. But you will need to agree to leave a certain amount of money with a bank for a specific period of time.

If you withdraw your money before the agreed period of time, you will end up paying a penalty.

Depending on the length of the CD and the amount of money you put in, you might earn a higher return than a regular savings account, but not a mutual fund.

Pros

  • Safety: CDs like savings accounts are federally insured up to $250,000. That means your money is protected.
  • Interest rate: CDs pay a higher interest rate than savings account. 
  • No fees: Unless you don’t withdraw your money before maturity, there is no fee.

Cons

Low accessibility: When you invest in a CD, the money is not easily accessible. You can withdraw the money, but a penalty will apply.

Penalty: if you withdraw your money before it becomes “due” or before it “matures,” then you will pay a penalty.

However, there are some banks that offer CDs with no penalty. But these CDs usually come with lower APYs.

Who should benefits from mutual funds, index funds and CDs? 

Choosing among a mutual fund, index fund, and CDs depend on your goals (whether short-term and long term) and your current financial situation.

If you don’t have a lot of money, it might make sense to start with a CD, since some CDs have minimum deposit requirement as low as $1000 or less.

A CD investment can be used as short-term investment as well.

If you’re thinking of buying a house in 2 years  and want the money for the down payment, a CD is a good choice.

But if you’re thinking of tapping into your money at any time, then a savings account can be a better option.

On the other hand, if you want to save for retirement, mutual funds and index funds are good long-term investments.

These investment vehicles are the most aggressive because they invest in stocks and bonds. More specifically, they are good for you if:

  • don’t expect to tap your money for 5 years or more;
  • you want to maximize your income and are willing to tolerate the stock market volatility.

How to use mutual funds, index funds, and CDs for your saving goals

These accounts can help you save money for different type of goals.

If you invest money for long-term goals, such as retirement, index funds and mutual funds are great choices.

So, don’t use these funds to invest money you plan to use in the next 5 years or so, because the stock market can drop significantly and you can lose your money.

For short-term goals, consider CDs. As mentioned, CDs are a safe, higher-yielding alternative to savings accounts.

Best Index Funds

So what are the best index funds?

No doubt, Vanguard has some of the best index funds. Among them is the Vanguard S&P 500 Index Admiral (VFIAX). 

This fund invest in 500 of largest U.S. companies with a few a midsize stocks. Some of the big companies in this index fund includes Apple (AAPL), Microsoft (MSFT), and Google/Alphabet (GOOGL).

Moreover, this Vanguard index fund has a pretty low cost, (0.04%) if not the lowest of all the index funds.

Plus, the initial minimum investment is also low ($3,000).

So if you’re looking for an index fund that maintains low operating expenses while enjoying a good rate of return, the Vanguard S&P 500 Index Admiral is for you.

Best Mutual Funds

We are big fan of Vanguard Mutual funds. The reason is simply because they are of high quality, reasonably cheap, professionally managed and are cost-efficient.

So, if you’re in the market for the best Vanguard funds, you have many options to choose from. One is the Vanguard Total Stock Market Admiral (VTSAX).

This Vanguard fund gives long term investors a broad exposure to the entire US equity market, including large, mid, and small cap growth stocks.

Some of the largest stocks include Apple, Facebook, Johnson And Johnson, Alphabet, Berkshire Hathaway, etc…

Note this Vanguard fund invests exclusively in stock. So it’s the most aggressive Vanguard fund around. You need a minimum of $3000 to invest in this fund. The expenses are 0.04%, which is extremely low.

Best CDs

Vanguard CDs are the best out there. But you should know that Vanguard only offers brokered CDs.

Banks issue brokered CDs. Banks sell them in bulk to brokerage firms such as Vanguard and Fidelity.

Vanguard CDs are some of the best, because they offer higher rates than most Bank CDs.

In conclusion, there are several options to choose from when it comes to finding a safe place to save and invest your hard-earned money.

Speak with the Right Financial Advisor

  • If you have questions beyond investing in index funds, mutual funds and CDs, you can talk to a financial advisor who can review your finances and help you reach your goals (whether it is making more money, paying off debt, investing, buying a house, planning for retirement, saving, etc).
  • Find one who meets your needs with SmartAsset’s free financial advisor matching service. You answer a few questions and they match you with up to three financial advisors in your area. So, if you want help developing a plan to reach your financial goals, get started now.
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How To Get Free Stock: 10 Companies That Will Give You Free Shares

There are quite a few ways to get free stock. This article will look at 8 companies that are offering free shares and cash bonuses to new investors.

The post How To Get Free Stock: 10 Companies That Will Give You Free Shares appeared first on Bible Money Matters and was written by Lorraine Smithills. Copyright © Bible Money Matters – please visit biblemoneymatters.com for more great content.

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5 Best Hedges in the Face of Inflation

Inflation measures how much an economy rises over time, comparing the average price of a basket of goods from one point in time to another. Understanding inflation is an important element of investing.

The Bureau of Labor Statistics CPI Inflation Calculator shows that $5.00 in September 2000 has the purchasing power equal to $7.49 in September 2020. To continue to afford necessities, your income must pace or rise above the rate of inflation. If your income didn’t rise along with inflation, you couldn’t afford that same pizza in September 2020 — even if your income never changed.

Inflation represents a real risk for investors as it could erode the principal value of your investment.

For investors, inflation represents a real problem. If your investment isn’t growing faster than inflation you could technically end up losing money instead of growing your wealth. That’s why many investors look for stable and secure places to invest their wealth. Ideally, in investment vehicles that guarantee a return that’ll outpace inflation. 

These investments are commonly known as “inflation hedges”. 

5 Top Inflations Hedges to Know

Depending on your risk tolerance, you probably wouldn’t want to keep all of your wealth in inflation hedges. Although they might be secure, they also tend to earn minimal returns. You’ll unlikely get rich from these assets, but it’s also unlikely you’ll lose money. 

Many investors turn to these secure investments when they notice an inflationary environment is gaining momentum. Here’s what you should know about the most common inflation hedges.

1. Gold

Some say gold is over-hyped, because not only does it not pay interest or dividends, but it also does poorly when the economy is doing well. Central banks, who own most of the world’s gold, can also deflate its price by selling some of its stockpile. Gold’s popularity might be partially linked to the “gold standard”, which is the way countries used to value its currency. The U.S. hasn’t used the gold standard since 1933.

Still, gold’s stability in a crisis could be good for investors who need to diversify their assets or for someone who’s very risk-averse. 

If you want to buy physical gold, you can get gold bars or coins — but these can be risky to store and cumbersome to sell. It can also be hard to determine their value if they have a commemorative or artistic design or are gold-plated. Another option is to buy gold stocks or mutual funds. 

Is gold right for you? You’ll need to determine how much risk you’re willing to tolerate with your investments since gold offers a low risk but also a low reward. 

Pros

  • Physical asset: Gold is a physical asset in limited supply so it tends to hold its value. 
  • Low correlation: Creating a diversified portfolio means investing in asset classes that don’t move together. Gold has a relatively low correlation to many popular asset classes, helping you potentially hedge your risk.
  • Performs well in recessions: Since many investors see gold as a hedge against uncertainty, it is often in high demand during a recession.

Cons

  • No dividends: Gold doesn’t pay any dividends; the only way to make money on gold is to sell it. 
  • Speculative: Gold creates no value on its own. It’s not a business that builds products or employs workers, thereby growing the economy. Its price is merely driven by supply and demand.
  • Not good during low inflation: Since gold doesn’t have a huge upside, during periods of low inflation investors generally prefer taking larger risks and will thereby sell gold, driving down its price.

2. Real Estate Investment Trusts (REITs)

Buying real estate can be messy — it takes a long time, there are many extra fees, and at the end of the process, you have a property you need to manage. Buying REITs, however, is simple.

REITs provide a hedge for investors who need to diversify their portfolio and want to do so by getting into real estate. They’re listed on major stock exchanges and you can buy shares in them like you would any other stock.

If you’re considering a REIT as an inflation hedge you’ll want to start your investment process by researching which REITs you’re interested in. There are REITs in many industries such as health care, mortgage or retail. 

Choose an industry that you feel most comfortable with, then assess the specific REITs in that industry. Look at their balance sheets and review how much debt they have. Since REITs must give 90% of their income to shareholders they often use debt to finance their growth. A REIT that carries a lot of debt is a red flag.

Pros

  • No corporate tax: No matter how profitable they become, REITs pay zero corporate tax.
  • High dividends: REITs must disperse at least 90% of their taxable income to shareholders, most pay out 100%.
  • Diversified class: REITs give you a way to invest in real estate and diversify your assets if you’re primarily invested in equities.

Cons

  • Sensitive to interest rate: REITs can react strongly to interest rate increases.
  • Large tax consequences: The government treats REITs as ordinary income, so you won’t receive the reduced tax rate that the government uses to assess other dividends.
  • Based on property values: The value of your shares in a REIT will fall if property values decline.

3. Aggregate Bond Index

A bond is an investment security — basically an agreement that an investor will lend money for a specified time period. You earn a return when the entity to whom you loaned money pays you back, with interest. A bond index fund invests in a portfolio of bonds that hope to perform similarly to an identified index. Bonds are typically considered to be safe investments, but the bond market can be complicated.

If you’re just getting started with investing, or if you don’t have time to research the bond market, an aggregate bond index can be helpful because it has diversification built into its premise. 

Of course, with an aggregate bond index you run the risk that the value of your investment will decrease as interest rates increase. This is a common risk if you’re investing in bonds — as the interest rate rises, older issued bonds can’t compete with new bonds that earn a higher return for their investors. 

Be sure to weigh the credit risk to see how likely it is that the bond index will be downgraded. You can determine this by reviewing its credit rating. 

Pros

  • Diversification: You can invest in several bond types with varying durations, all within the same fund.
  • Good for passive investment: Bond index funds require less active management to maintain, simplifying the process of investing in bonds.
  • Consistency: Bond indexes pay a return that’s consistent with the market. You’re not going to win big, but you probably won’t lose big either.

Cons

  • Sensitive to interest rate fluctuations: Bond index funds invested in government securities (a common investment) are particularly sensitive to changes to the federal interest rate.
  • Low reward: Bond index funds are typically stable investments, but will likely generate smaller returns over time than a riskier investment.

4. 60/40 Portfolio

Financial advisors used to highly recommend a 60/40 stock-bond mix to create a diversified investment portfolio that hedged against inflation. However, in recent years that advice has come under scrutiny and many leading financial experts no longer recommend this approach. 

Instead, investors recommend even more diversification and what’s called an “environmentally balanced” portfolio which offers more consistency and does better in down markets. If you’re considering a 60/40 mix, do your research to compare how this performs against an environmentally balanced approach over time before making your final decision.

Pros

  • Simple rule of thumb: Learning how to diversify your portfolio can be hard, the 60/40 method simplifies the process.
  • Low risk: The bond portion of the diversified portfolio serves to mitigate the risk and hedge against inflation.
  • Low cost: You likely don’t have to pay an advisor to help you build a 60/40 portfolio, which can eliminate some of the cost associated with investing.

Cons

  • Not enough diversification: Financial managers are now suggesting even greater diversification with additional asset classes, beyond stocks and bonds.
  • Not a high enough return: New monetary policies and the growth of digital technology are just a few of the reasons why the 60/40 mix doesn’t perform in current times the same way it did during the peak of its popularity in the 1980s and 1990s.

5. Treasury inflation-protected securities (TIPS)

Since TIPS are indexed for inflation they’re one of the most reliable ways to guard yourself against high inflation. Also, every six months they pay interest, which could provide you with a small return. 

You can buy TIPS from the Treasury Direct system in maturities of five, 10 or 30 years. Keep in mind that there’s always the risk of deflation when it comes to TIPS. You’re always guaranteed a minimum of your original principal at maturity, but inflation could impact your interest earnings.

Pros

  • Low risk: Treasury bonds are backed by the federal government. 
  • Indexed for inflation: TIPS will automatically increase its principle to compensate for inflation. You’ll never receive less than your principal at maturity.
  • Interest payments keep pace with inflation: The interest rate is determined based on the inflation-adjusted principal. 

Cons

  • Low rate of return: The interest rate is typically very low, other secure investments that don’t adjust for inflation could be higher. 
  • Most desirable in times of high inflation: Since the rate of return for TIPS is so low, the only way to get a lot of value from this investment is to hold it during a time when inflation increases and you need protection. If inflation doesn’t increase, there could be a significant opportunity cost.

The Bottom Line 

Inflation represents a real risk for investors as it could erode the principal value of your investment. Make sure your investments are keeping pace with inflation, at a minimum. 

Inflation hedges can protect some of your assets from inflation. Although you don’t always have to put your money in inflation hedges, they can be helpful if you notice the market is heading into an inflationary period. 

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Source: goodfinancialcents.com