Saving for College: 529 Plans

Summary: If you want to save for college, there’s probably no better choice for Coloradans than the College Invest 529 plan.

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We live in an interesting time. There’s no question that, right now, having a college degree is really helpful both in getting and staying employed and in earning more while employed. But that doesn’t mean that college is the right choice for everyone, and some folks are beginning to wonder if the traditional college degree will retain it’s place of prominence for much longer.

Of course the purpose of an education is more than just preparation for employment, but certainly that’s a big part of why many folks choose to go to college, so this poses a dilemma. We don’t know if college will continue to be the “path” to career success, yet it is so expensive that most folks with children will need to save up some money ahead of time to help pay for it. My crystal ball is way too cloudy to definitively answer this but, should you choose to at least hedge your bets and try to save up some money in advance, I can give you some good advice on how best to do that.

The short answer is, especially in Colorado: a 529 plan. Like 401k and Section 125 plans, it’s named after a section in the tax code. It allows you to invest money for your child(ren) and the investment grows tax free, and then any qualified withdrawals (used for higher education expenses) are also tax free. It’s similar to a Roth IRA in the sense that you put after-tax dollars into it and then earnings and withdrawals are tax free, except the purpose for the money is different and the timeline is shorter.

While you can choose any 529 plan, in many states (including Colorado) it makes sense to choose your state’s plan because they offer additional incentives. In Colorado’s case, your contributions are tax deductible which, in effect, means you earn an automatic 4.63% return on your money when you deposit it. (You don’t actually get that money until you file taxes for that year, at that point it reduces the taxes you owe Colorado so that you either pay less or get a larger refund.)

They are way too many nuances to 529 plans to cover in one blog post (this site has lots of information), but here are the basics of what Coloradans needs to know:

  1. College Invest is the Colorado state plan
  2. Choose the Direct Portfolio
  3. Decide what your total goal is by the time your child(ren) graduate from high school and contribute accordingly
  4. Get started now

There’s much more to it, of course, including choosing how to invest the money, but those are the basics. We started ours for our daughter as soon as she had a social security number, because that’s required to open a 529 plan. (Because she was adopted at 9 months, and then had to go through the citizenship process, this was a little later for us than for many of you.) But you can even begin to save before they are born, either by putting away money that you will eventually transfer into a 529 plan after they are born, or by opening up a 529 plan and then changing the beneficiary once your child is born.

Once the account is opened, you can invest lump sums whenever you want, or set up automatic investments from a checking or savings account that occur every month. We did both, plus for a while we had a rewards credit card where the rewards went directly into the 529 account. You then choose your investment options, choosing between an age-based option (similar to target-date funds) that automatically shift to more conservative investments as your child approaches age 18, or by choosing a particular portfolio. The portfolios changed a bit in 2004, but since that change we’ve been in the “Growth Portfolio“, which is 75% stock/25% bond.

That might be too aggressive for some folks (especially as our daughter is about to begin her senior year in high school which means we’re close to the withdrawing phase), but because of our overall financial security, and because of the bond-like nature of our PERA pension, it was a good fit for us. For reference, here are the actual returns our account has earned (your account will always be somewhat different than the generic portfolio return because of the timing of your contributions).

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Note that the 10-year return currently includes 2008, which is pretty remarkable that it’s still so high. Going back to October of 2004 (when the portfolio changes occurred), our total annualized return has been 6.7%. At this point we are debating whether to shift the portfolio to a bit more conservative choice but, because the conservative portion of these portfolios are in bonds and that segment of the market has its own issues right now, we’re not sure. Given we still have 5 years left (senior year plus at least four years of college), equities are still likely to outperform bonds over that period.

Either way, this account has been incredibly successful for us (more on that below). Which brings up a big concern that some folks have – what if you don’t need the money? The reasons to not need the money can vary from your child ends up not going to college, to your child earns scholarships, to you actually saving and earning more than you need. Thankfully, there are options for dealing with each one of these.

    1. Your child doesn’t go to college: First, there are a variety of post-secondary options other than college that sill qualify. If none of those apply, you can always change the beneficiary to another child or even to yourself or eventually a grandchild, or you can withdraw the money for non-qualified expenses. If you do the latter you pay federal and state taxes plus a 10% penalty on any of the earnings that you withdraw (not on the contribution portion). For any of the contribution portion you withdraw that you took a Colorado tax deduction at the time of contribution, you would have to make Colorado “whole” on those taxes. While this may sound bad, it’s really not. In the end it’s “extra” money that you wouldn’t have had otherwise (because it would have gone to the college).
       
    2. Your child earns scholarships: For whatever dollar amount in scholarships they get, you can withdraw that amount of money for other purposes. Similar to #1 above, you would have to pay federal and state taxes on any of that that was from the earnings portion (not contributions, as you already paid tax on those), but you would not have to pay the 10% penalty. You can of course still pay for expenses not covered by the scholarship, and you can leave the money in for future use (or for a future beneficiary).
       
    3. You end up with more money than you need: Your options are the same as #1 above.

For us, we may actually end up being in the position of having more than we need. Because we did a good job of contributing (especially a fair amount in the early years so it could compound), and because the returns have also been pretty good (recently the earnings portion of our portfolio exceeded how much we’ve contributed), it’s likely Abby’s total expenses will be less than what we currently have in the 529 plan (barring a severe market downturn in the next couple of years, or she decides to go to med school). (Make no mistake, this is a good position to be in.)

We can’t really tell yet, because we don’t know for sure which college Abby is going to, how much it will cost, what if any scholarships she might receive, how many years it might take her to finish, or whether she chooses to pursue anything beyond a bachelor’s degree. Plus there are other factors, including the American Opportunity Tax Credit, which means that at a minimum we’re going to want to spend $2000 a year from outside of the 529 plan (and perhaps as much as $4000) in order to claim that credit. But at this point my best prediction is that when she finishes her college work, we’ll have to decide whether to withdraw what’s left or leave it for possible future use by us or Abby’s possible children. Again, a good problem to have, and definitely not a potential reason to shy away from using a 529 plan.

If you live in Colorado and want to save some money for your child(ren)’s higher education, you should definitely be looking at a 529 plan as part of your larger financial plan. If you choose to work with me, this would certainly be part of our discussions. And keep in mind that while it’s better to start right after they are born to maximize the compound investment earnings potential, it’s never too late. Even if your child is in college now it makes sense to funnel your payments through the 529 plan. Even though they might not be in there long enough to really benefit from the tax-free investment growth, you will still get the 4.63% Colorado state tax rebate. When most folks are paying $20,000 and up (sometimes way up) a year, 4.63% isn’t nothing ($926 if it was $20,000).

Working Teens and Roth IRAs

Summary: If you have a teenager with a job, opening a Roth IRA for them is really good idea from both a learning and a financial perspective.

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Our daughter is 17 and has had a part-time job for a little over a year. She makes minimum wage and probably works about 8 hours a week on average during the school year, and a bit more during breaks if we are in town. (Ironically, this summer she’s interning at a summer camp, which means she’s working full-time but making less.) While I think it’s safe to say that not many 17-year-olds are thinking much about retirement, ours is (well, at least she is when I make her :-).

As a result, as soon as she received her first paycheck, she opened a Roth IRA via Vanguard (since she’s not yet 18, it’s a custodial account, but will become completely hers once she turns 18). Why in the world would we do that? Simple, because it’s a fantastic opportunity for her to learn about finances and planning ahead, and also because it’s an incredibly smart move financially for her to do this now.

If you aren’t familiar with Roth IRAs, they allow you to put money (earned income up to $5500 per year for those under 50) in post-tax (so you don’t get an immediate tax deduction like regular IRAs or 401ks). That money then grows tax-free (like a regular IRA or 401k) but then, and this is key, upon withdrawal is also tax free. That means for my daughter, and most teens working part-time like her, this money is never, ever taxed because she doesn’t make enough in a year right now to owe state or federal taxes.

In 2016 she earned a total of $1651 and contributed the same amount to her Roth IRA. In 2017 so far she has earned $2133 and contributed that to her Roth IRA. With some investment gains, her current balance is about $4000. She’s invested in a low-cost Vanguard Index ETF because since she started with $0 she didn’t meet the $3000 minimum for the index mutual fund, and the ETF allows you to buy individual shares at whatever the current cost is. We’ll wait until she surpasses $10,000 so that she qualifies for the low-cost admiral fund and then probably move it over into the mutual fund version (same expense ratio as the ETF, but a little less hassle on our part to invest).

So why is this an “incredibly smart move financially”? In a word (okay, two words): compound interest. If she continues to work about the same amount between now and August 2018 (she graduates in May 2018 and will probably be going to college in the fall), she will have invested somewhere around $7,500 in her Roth IRA. Including the investment gains she’s had so far and assuming a bit of a gain in the next year, let’s call it $8,000 at the point she starts college.

Now she’s likely to work part-time in college, and eventually she will begin full-time work, at which point she will most likely add a 401k to her retirement savings plan and she may or may not continue to contribute to a Roth IRA depending on the circumstances. For the moment, let’s assume she never contributed another dollar to her Roth IRA for the rest of her life, let’s explore what happens.

Well, predictions are just that, predictions, but we can do some decent estimates based on historical results. The stock market has typically returned over 10% a year on average for a long time (and small-cap value, what our daughter is invested in, is even a bit higher), but most folks think that at least in the short term (the next 10 years or so), those returns will be muted a bit. So for demonstration purposes, we’ll use 8% returns (feel free to substitute in a lower or higher amount if you want). So if she has $8,000 invested in her Roth IRA at age 18, doesn’t invest another dollar for the the rest of her life, and “retires” (whatever that will mean at that point) at age 68, how much money will she have? Over $375,000.

That’s fantastic, considering it’s totally tax free and it came simply from the part-time jobs she worked while in high school. But it also overstates it a bit, as those are not today’s dollars, but 2068 dollars, which means you have to take into account inflation. We’ll assume inflation of 3%. Historically inflation has averaged 3.5%, but it’s been lower lately, and governments try harder now to manage that rate, so lots of folks think it will be lower going forward (that’s also part of the reason that the expectation is that stocks will earn lower than 10% going forward as well). So, in reality, what we’re calculating here is a 5% real return after inflation (8% nominal return minus 3% inflation). That amounts to over $91,000 in today’s dollars. That may not sound quite as impressive, but keep in mind that’s assuming no additional investments after she graduates from high school, and that money is completely tax free. (That’s also likely more than a lot of the adults reading this post currently have saved in their retirement account.)

This entire scenario assumes, of course, that the teen can afford to invest this money. Many teens have to work to help support their family day-to-day, so this unfortunately isn’t an option for them. Ours doesn’t have to help support the family, so this is another advantage of us being financially secure – we can not only help our daughter learn about saving, investing, financial planning and retirement planning, but we can give her a head-start on her savings and investing. If your family is in a similar position, I highly recommend you consider this option and, if you choose to work with me, this is something we will investigate.

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Focus On: LPS Retirement Plans (401k/403b/457 Plans)

Summary: Choose the PERA 401k plan and invest as much as you can.

lpsretirement

The idea of retirement is a fairly new one. It wasn’t until early in the 20th century that the concept of retiring from work and “living a life of leisure” was even a concept. Many employers started offering pension plans and then Social Security came along in 1937. Then in 1978, the idea of a tax-deferred savings plan (401k) was created, although it’s original intent was not the way we’ve ended up using it.

Social Security was really designed to be part of a “3-legged stool” concept of retirement, that retirees would draw from their company pension, from social security and from their personal savings. As pension plans have gone out of favor and 401ks have taken their place (particularly in the private sector), it has really become a two-legged stool (which is somewhat problematic). For public school employees in Colorado, PERA is a social security replacement plan, so basically covers those two legs, leaving the personal savings leg for you to figure out on your own. That’s where employer-offered tax-deferred savings plans come in.

All PERA employers offer the PERA 401k plan to their employees, and some employers also offer access to the PERA 457 and the newly created PERA Roth 401k/457 plans. Many school districts also offer additional, non-PERA options for tax-deferred accounts. This post will focus on what’s offered in Littleton Public Schools, but you should check with your employer to see what options they offer.

LPS allows you to choose between PERA and TIAA for retirement savings vehicles, offering the PERA 401k, 457, Roth 401k and Roth 457 plans, and the TIAA 403b, 457, Roth 403b and Roth 457 plans. There are subtle differences between 401k, 403b and 457 plans that can be important but, for the purposes of this discussion, we’ll treat them as roughly the same, with the important exception that you have separate contribution limits for 401k/403b and 457 plans which gives you the ability to save more if you have the cash flow to do that.

This post is not intended to be an in-depth explanation of 401k/403b/457 plans (or their Roth versions), but let me try to briefly describe them (if you decide to work with me we can dive deeper if need be). The idea behind 401k/403b/457 plans is to save money in a tax-deferred account, which means that you are not taxed on your income that you place into those accounts now, nor are you taxed on the earnings in those accounts as they accumulate, but you are only taxed when you make withdrawals which will hopefully be when you are retired. The traditional thinking is that most folks will be in a lower tax bracket when they are retired, so not only do you reap the benefits of saving “extra” all those years by not paying taxes up front, but when you do pay taxes upon withdrawal you will pay a smaller amount.

More recently Roth 401k/403b/457 plans have been created (along with Roth IRAs, which don’t flow through your employer) that take a different approach. For these plans you do pay taxes on any income you invest, but the earnings grow tax free and all withdrawals in retirement are tax free as well. In other words, pay the tax up front, never have to worry about taxes on this money again. For folks who think their tax bracket might actually be higher in retirement, this is a better option.

The obvious conundrum is how do you know for sure whether your tax bracket will be higher or lower in retirement? You don’t, which is why many folks choose to put money into both types of accounts to hedge their bets and give themselves more flexibility in retirement by giving them the option to withdraw from whichever account makes the most sense based on their current tax situation. (There are also some really nice benefits of a Roth if you are trying to leave an inheritance.)

Many employees, especially younger ones, kind of throw up their hands at all this. Retirement seems like a long way off, the choices can be complicated, and of course choosing not to spend money right now can be difficult for some folks. But the beauty and power of investing is compound interest, and it’s most effective the more time you give your money to grow, so the sooner you start, the better (and easier) it is to generate the retirement savings you want.

Many folks thinking about 401k/403b/457 plans also don’t take into account the effect on the tax-deferral on their current income. They think about putting say $100 a month into a 401k, but then worry they can’t do without that $100 a month. But they’re missing that their actual paycheck won’t go down by $100, but more like $70 (if you are in the 25% federal bracket, plus 4.65% for Colorado taxes). The government is basically saying, “invest $70 and we’ll give you $30” (always remembering that eventually they are going to tax you on that when you withdraw it). If you choose the Roth options, you don’t get that tax break up front, so your paycheck will decrease by $100 (but the potential for tax-free growth over time is tremendous).

So, with that overview, if you are an LPS employee, should you choose PERA or TIAA? Well, again, that depends on your individual circumstances and I’d be happy to discuss those with you, but for most people PERA is the better choice because of lower fees.

PERA offers a choice of several funds or a self-directed brokerage account if you want more control. For most folks, the funds are the better choice. In 2011 PERA chose to go with a “white-label” approach to investments. Research has shown that many folks make poor investment choices when given too many choices so, instead, a “white-label” approach has you choose among asset allocation choices instead of picking individual funds.

whitelabel

I’ll write more in future posts, but there are basically three things you can control when saving for retirement:

  1. How much you save.
  2. What asset allocation you choose.
  3. How much in fees you pay.

By going with a white-label approach and trying to keep fees low, PERA has tried to simplify the second and third choices for you. For each of their asset classes, PERA has typically gone with a combination of a passive (index) approach and an active (managed) approach. This combination gives you lower fees than a fully active approach, but higher fees than a strictly indexed approach. PERA thinks that they can achieve higher returns than the index this way. I’m a big fan of index funds, so I’m not totally convinced of this approach but, so far in their short lifespan (since 2011), they have mostly achieved this to  a small extent.

perafees

PERA does also give you a self-directed brokerage option (for an additional fee), which allows you almost unlimited choices in investments. For most folks, the additional complication of choices and fees make this sub-optimal, but it’s there if you want it.

selfdirected

TIAA is more like the self-directed brokerage option, which is one of the reasons the fees tend to be a bit higher (although still not bad compared to many other companies, 0.42% plus the underlying fund fees). Here’s a comparison of fees for a large-cap investment in the PERA white-label fund, the PERA self-directed brokerage option invested in a large-cap index fund (they require you to keep $500 in PERAdvantage funds), and the TIAA option invested in the same index fund. (You can view comparisons for other asset classes here.)

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If you look carefully, you’ll notice that the cheapest option is the PERA self-directed brokerage option (as soon as you pass about $20,000 in your account), with the PERAdvantage funds coming in second, and TIAA coming in last. Since the middle and third columns are essentially the same choice in terms of what you’re investing in, there’s no reason to choose the higher fee TIAA option over the PERA option. If you are investing a lot, you can save in fees by going the self-directed brokerage option, but this is where PERA would argue that they think they will outperform the index and make up those fee differences. The differences are small enough between the first two columns that, for most folks, it’s probably best to stick with the PERAdvantage options.

In future posts I’ll write more regarding possible asset allocations (which fund(s) should you choose), contribution limits (and the fact that you get separate limits for 401k/403b vs. 457, allowing you to save much more if you can), and the power of compounding. But, for now, this gives you an idea of where to start. The key thing is to start now and put as much as you can into one or more of these vehicles so that your “stool” will be sturdy enough to support you in retirement.

Why You Should Go Solar

Summary: Going solar, either rooftop or via a community solar farm, is not only the right thing to do for the environment and to combat climate change, but it will save you money.

Let me be clear up front, I’m passionate about sustainability, particularly the use of sustainable energy, and I believe climate change is a very serious threat. I think everyone should be concerned, not just for themselves, but for their children as well, so I of course think you should go solar. But, even if I didn’t believe all of those things, you should still consider going solar for financial reasons.

We put solar panels on our roof at the end of 2009. That’s only 8 years ago, but there’s been tremendous change in the solar energy industry since then. In 2009 solar panels were much more expensive than they are now (and the continue to get less expensive), and they weren’t as efficient as they are now (and still getting incrementally better each year). On the flip side, the incentives (at least in Colorado) were much better then than now.

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We purchased a 5.04 kW system from Standard Renewable Energy (SRE) and they installed it. (They’ve since been bought by GridPoint and no longer do solar installations, at least in Colorado.) The total cost was listed as $38,307, but then there was an “instant rebate” from SRE of $10,080, which took what I would consider the real cost down to $28,227. But we didn’t even have to pay that as, at the time, the combined utility and state rebate for that size installation was $17,020, which means our out-of-pocket cost (the check we had to write) was $11,207.

But it gets even better, because that doesn’t take into account the federal rebate, which turned out to be an $8,693 tax credit on our 2009 taxes, so we effectively paid $2,514. At the time SRE showed the break-even point to be between 3 and 4 years, but we estimated it at more like 5 (they had built in 10% electricity rate increases each year). We didn’t track it exactly, but we estimate the break even point was at about 4.5 years, which means that since mid-2014, our electricity has been close to free (not completely free, as we still pay a grid-access charge).

So what’s our “return on investment” on solar? Well, that’s a bit hard to tell, as the solar panels are still operating great and effectively generating income for us, and we don’t know how long that will continue or what electric rates will do. We spent $2514 at the end of 2009 and, so far, have “made” probably more than $4,000 in saved electricity bills. That’s currently around a 6% compounded yearly return (with no associated tax liability).

Plus keep in mind with all of the solar options I discuss in this post, these returns are tax-free, unlike the equivalent equity or bond investment so, depending on your tax bracket, that could significantly close the difference in returns between going solar and investing the money in the markets.

As part of the agreement with the utility company, solar systems are generally sized to generate approximately the same amount of electricity you use in a year, plus or minus a bit. (You can choose to install a smaller system and generate less, but they don’t like you to overshoot the mark.) Ours was sized at about 98% of our usage, although over the subsequent years we have actually used a bit less electricity (we installed new windows and replaced some appliances), so each year we typically have received a small rebate check from Xcel at the end of the year for the excess we’ve generated.

That was true until the beginning of this year, when we started again using more than we generated. This is because at the end of December we bought a used 2013 Chevy Volt, which is a plug-in hybrid. Much more on this in a future post, but basically because we are charging it each night, our electricity use has gone up and now surpasses what we generate. (To keep that “cost” in perspective, however, we still haven’t had to put gas in the car, having driven it more than 3,800 miles and only used 3.2 gallons of gas so far.)

Being the sustainability guy that I am, I of course wanted to figure out a way to make that new energy clean energy as well. We still had some room on our roof (perhaps not the ideal orientation, but still okay), but it turns out that most solar companies don’t want to add on to an existing system (I’m sure for liability/insurance reasons) and, since our system is still working great, we certainly didn’t want to tear it off the roof and put a whole new system on.

So we began looking at alternatives and ended up purchasing 4 panels at a community solar farm operated by Clean Energy Collective. Community solar farms are big arrays of solar panels, typically installed in big open fields, that generate electricity and feed it back into the grid. Individuals or businesses can then buy a portion of the array and get credit for the electricity generated to offset their own usage. It’s often called “roofless solar” and, in many ways, it’s better than solar on your roof. Solar farms are generally more efficient (they can align the panels perfectly) and cost effective (cheaper to install on the ground than on a roof, as well as economies of scale). I still prefer putting solar panels on roofs, as then I know for sure it’s new energy generation and it provided at the source, not simply purchasing already existing solar farm panels and feeding into the grid, although by purchasing those you are using up existing farms and therefore they are likely to build additional ones. But, because we couldn’t easily add any more to our roof, this was a great solution for us.

cec

The cost of this, of course, varies, but let me share the specifics in our case to give you an idea. Because we only needed to generate the additional amount of electricity we were using by charging the Volt, we only “purchased” 4 panels (which is the minimum) at the solar farm (located in Arapahoe County). We are effectively leasing the panels for 19 years (for initial customers it was 20, but because this farm has been in use for a little while, I guess we only have 19 years left). The cost for those panels was $3,050 out of pocket (ironically, more than our entire solar system after rebates in 2009).

Those 4 panels will generate 1.22kW. The way we get “paid” is that we get a credit on our utility bill from Xcel each month, currently 7.6 cents per kWh (that rises and falls with whatever the current rates are), as well as an 8 cent per kWh renewable energy credit (REC) that gets paid quarterly. The estimated yearly savings for 4 panels comes out to about $322. CEC then estimates that electricity rates will rise 4.8% per year. This is more realistic than the 10% SRE used back in 2009, but still perhaps a bit too high (unless a carbon tax is eventually passed, in which case it might be much too low). Using those assumptions they calculate a 9.5 year break-even point and a total return of “187%” after 19 years. Assuming no increase in electric rates, the return is about 4% per year compounded. Given that electricity rates will likely rise some, I’m going to guess it will turn out to be about 4.5% per year compounded.

Is that a great return on investment? Well, no, not compared to investing it in equities (but, again, keep in mind there’s no tax liability, so that boosts the return up some). If I was just trying to maximize my return, this would be a bad idea, investing $3,050 into an index fund would likely generate more return. But since I can generate clean energy, help combat climate change, and still earn a return that’s better than a money market account and probably pretty equivalent to what bonds would return, I think that’s a pretty good trade-off (as well as diversifies my investments a bit).

Now, if you don’t already have solar on your roof, you should definitely first investigate the cost and return on investment for that (more on that below). But, if you don’t own a house, or if you can’t or simply don’t want to put solar panels on your roof, then this is a great option. If you are interested, I’d recommend contacting Pete Stein at CEC (pete.stein@easycleanenergy.com or 720-623-0618), he was very thorough and helpful.

Full disclosure: If you mention my name and end up purchasing from CEC, I will receive a $200 referral fee. If you feel icky about that, don’t mention my name :-). But keep in mind that if you do, you also will receive a $200 check after completion of your purchase and $100 will be donated to charity, which is why I decided to go ahead and include it in this post.

Since we already had solar on our roof, I couldn’t get a quote for what it would cost to install solar now. Luckily, I have a friend who just installed solar in my neck of the woods in Colorado and he was willing to share his information. As I mentioned previously, much has changed in the solar industry since we installed in 2009. In addition to the changes in cost and efficiency, you now have many more choices of installers and many of them now offer solar leasing in addition to up-front purchasing.

My friend ended up going with Ion Solar and, so far at least, he’s been very happy with them. Let’s take a look at some of the details for his install. They installed a 4.85kW system, so roughly equivalent to the system on our roof. Their total system cost was $18,896, less the federal rebate of $5,669, for a net system cost of $13,227. There are no longer the huge state/utility rebates like when we installed ours, instead you now get a minimal REC from Xcel for the energy generated. (From the information shared with me, I can’t tell how much this is or exactly where it figures in the calculations, but I know it’s often less than 1 cent per kWh).

ion

My friend chose to finance the system, which is basically a solar lease. The amount financed is the full amount of $18,896 at 4.99%, and they’ll make payments of $79 per month for the first 16 months, then $91 a month thereafter for the remainder of the 20 years of the lease (this assumes that the $5,669 tax credit is then applied to the loan when it’s received). In their calculations Ion assumes a 4% yearly increase in electricity rates and, based on this information, after 25 years they will end up $20,667 ahead.

How does that work? Well, each month the (average) amount they save on their electric bill is more than their loan payment, so they come out ahead. Ion even does a calculation where if you apply that savings to the loan payments, the loan is paid off in 15 years and the 25 year accumulated savings is then $22,743.

So what’s the return on investment? Well, since there’s no money put down up front, it’s complicated. But for the sake of argument, let’s assume they had decided to purchase the system for the net cost after federal rebate of $13,227. Ion estimates that over 25 years (factoring in the estimated 4% yearly increase in electricity rates) they will save $42,280, which is about 4.8% per year compounded (again, tax-free). Again, compared to investing in equities, that’s not a great return. But given the good that you’re doing, along with diversifying your investments and earning a bond-like return, I think it’s more than worth it.

So what should you do? If you own a house, I’d suggest getting bids from several vendors for installed solar and compare, and perhaps also contact Pete at CEC to compare roofless solar as well. There are lots of vendors to choose from, but I would certainly include Tesla Energy (formerly Solar City), because I anticipate with their new Gigafactory 2 coming online shortly their prices will be very competitive. (In addition, if you happen to need a new roof sometime in the future, look into their new solar roof option. It’s more expensive because it’s tile, but when you factor in the electricity savings, it ends up being cheaper than an asphalt roof, plus it has an infinite warranty on the tiles themselves – you’ll never have to replace the roof again.) If you don’t own your own home, or for whatever reason don’t want to install solar panels on your roof, then definitely contact Pete at CEC and get all the details.

Any of these options will give you a decent, but not great, return on investment, as well as contribute to a better world. In future posts I will talk more about the used Chevy Volt we recently purchased, electric cars in general, and why your next car should be electric, as well as about the opportunity to invest in solar directly.

How Do You Measure Investment Risk?

risk

There are a lot of sophisticated measures in the investment business: P/E Ratios, Cash Flow Analysis, EBITDA, etc. The list goes on and on (and on). The one I find most interesting, however, is how most people measure risk. The generally agreed upon method is to measure volatility, which is how much the price of a particular asset (stock, bond, whatever) goes up and down, often in conjunction with looking at expected return of the particular asset. To simplify it a bit, the more the price of something changes, the riskier it is.

I find that fascinating and mostly wrong. If you are a long-term investor armed with self-control, measuring risk by measuring volatility is not very useful. This analogy is a bit of a stretch, but I’ll use temperature as an example. If a particular day starts at 60 degrees Fahrenheit and goes up to 80 then back down to 60, that would be considered “worse weather” than a day that starts at 100 degrees and stays there (or 40 degrees and stays there).

Now, if you are an investor who is actively trading, constantly moving in and out of different positions, volatility is important. Likewise, if you are an investor that is going to need to take money out of a particular investment in the near future, volatility could be important. But I prefer a different measure of risk: how likely are you to meet your goals?

To me, this is really the only measure of risk that matters. Will your investment portfolio/strategy achieve the goals you have set for it? If you are a long-term investor (and if you end up working with me you will be :-), you don’t care all that much about the daily ups and downs of your investment, as long as at the “end” your investment is up a sufficient amount that allows you to achieve your goal. Which means that if you construct your portfolio correctly, there is really only one sub-component of that risk that matters: you.

More specifically, do you have the self-control, the discipline, to follow your investment plan? When bad things happen (like the Great Recession in 2008, or the dot-com bubble in the early 2000’s, and the value of your investments drop, sometimes by a lot), will you be able to stay the course and not bail on your plans? One of the main reasons to hire a real financial planner (or even avail yourself of my services), is that they hopefully will help you to stick to the plan. While there are no guarantees, based on the entire history and theory of financial markets, if you invest for the long-term and don’t sabotage yourself by abandoning your investment plan at the worst possible times, you are (almost) guaranteed to be successful.

In fact, there is plenty of research that most investors earn less (often far less) than the mutual funds and other investments they invest in earn. How can that be? They buy high and sell low. They typically buy into a mutual fund (or stock, or whatever) after if has performed really well for a while (missing out on most of the gain), then lose heart and sell when it inevitably goes down. It’s the investor’s behavior that causes them to under-perform, and hence the riskiest part of investing isn’t typically what you choose to invest in, it’s you.

So what’s the secret?

  1. Spend less than you make.
  2. Regularly invest the difference in low-cost index funds.
  3. Don’t sell (unless you’ve achieved your long-term goal).

I’ll write several more posts exploring different aspects of this, but it pretty much is that simple. That’s one of the most frustrating aspects when I hear others talk about their finances. Either they are too afraid of “investing” because they are worried about losing their money (or somebody taking advantage of them), or they are constantly moving from investment to investment to try to outperform the market (generally with poor results, as that study indicated).

As I mentioned in one of the FAQs, about 90% of what you need to do is really pretty straightforward, and not all that hard to do, if you simply know a little bit and have that self-discipline. I’d be happy to get you started on that path.

Photo credit: Foter.com