Questions and Answers

Q. Peggy, I have always heard that I should diversify my investment portfolio, but I’m not completely sure what that means.

A. Most simply, diversifying a portfolio means purchasing multiple kinds of investments that respond differently to the same event. However, before you buy anything, you need to determine your risk tolerance. Many variables impact your risk tolerance, like time horizon, growth requirement, market experience, and other characteristics. Your risk tolerance can range from aggressive to conservative, and as you diversify your portfolio, you want to do it with your risk tolerance level in mind. The more aggressive you are, the more likely you will be to own “equities,” more commonly called “stock.” Stock or stock funds typically increase as the stock market goes up. They provide good growth opportunities but are relatively risky. When people think of investing, they often think of purchasing stock. However, another type of investment called “fixed income” or more commonly “bonds” has different characteristics than stocks. Bonds have risks, but they come from different situations than stocks. Additionally, bonds have less risk than stocks and offer less return as a result. Other kinds of investments, like real estate, commodities, and more exotic offerings, have different characteristics than stocks and bonds. Be extremely sure that you understand both the returns and the risks that exist. Without getting too far into the weeds, you will want to diversify within your stock and bond funds, as well. Stocks divide into many categories including large, medium, small, domestic, international, and sectors. Bonds also divide into categories including government, corporate, high quality, junk, and international. Work with a financial planner to be sure you understand the risks of each of these potential investments. Take time to understand your portfolio, know what you own, and be sure it matches your risk tolerance. It could lower both your stress and potential issues in a poor market environment. Even though Peggy is answering questions, this article is educational, not investment advice.  Investing is risky, and you can lose money.  Talk to your financial team about any strategies before you implement them.

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Q. Dear Peggy–My 401(k) plan invested my account in something called a Target Date Fund. What is it, and why did they do that?

A. In the past, if you didn’t make an investment choice in your retirement plan, the money stayed as cash or money market. However, this caused many individuals to have no growth in their accounts, leaving them unprepared for retirement. As a result, retirement plans now have default investment choices. These choices are blended investments deemed to have an appropriate risk level for the age of the plan participant, and target date funds have become a popular option. Basically, target date funds are structured in five-year increments (2020, 2025, 2030, etc.), and the later the year, the higher percentage of stock in the fund. Closer dates have a higher percentage of bonds, and as a result, theoretically have a lower level of risk because the owner is closer to retirement. Target date funds can be very effective tools, but it’s important to remember several things. First, they are created by different fund companies, and the risk level (or the percentages of stocks and bonds) varies widely between issuers. As a result, it’s very important to look at the underlying portfolio, even if you ultimately decide to choose the default option. Second, individual factors impact risk tolerance, and the profile of your default fund may not meet your personal risk tolerance. This is easy to control, as choosing a fund with a date prior to your anticipated retirement should be more conservative, and a fund with a date after your retirement should be more aggressive. Finally, target date funds have “glide paths,” or the schedule of how the fund replaces stocks with bonds. It is important to understand the glide path of your target date fund and the final portfolio allocation once the fund is static. Target date funds can be a useful tool to gain diversification in a risk-adjusted way, especially for investors who want an automated investment process. However, it is important to understand their characteristics, and you should talk to your CFP® professional to see if the investment is appropriate for you. Even though Peggy is answering questions, this article is educational, not investment advice.  Investing is risky, and you can lose money.  Talk to your financial team about any strategies before you implement them.

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Q. My wife and I are currently retired. We wish to invest $75,000 in our son’s pursuit of a graduate degree. Can we receive any tax benefits for doing this?

A. Based off the ZIP Code associated with your question, I think you live in California. Unfortunately, California does not offer a state income tax deduction for contributions to 529 college savings plans. Many states do allow you to take a state income tax deduction, so if my assumption is incorrect, you may be able to deduct a contribution. One advantage of the 529 plan is that you have no income limitations, and the recipient of the account does not have to be below a certain age. As a result, this funding strategy works quite well for graduate school. Additionally, you would need to be careful with the amount you funded into the plan. Although 529 plans do not have contribution limits, you would give your son money higher than the gift tax exclusion amount with a contribution of $75,000 unless you structured it carefully. In 2017, you are allowed to gift $14,000 to anyone you want without having to file a gift tax return. If you are married, your spouse can do the same thing, but you would then need to file a gift tax return indicating that you both gave to the same person. Although this gift splitting does not result in gift tax, it is an additional step and can be a headache. 529 plans allow an unusual bulk funding of five years of gift tax exclusion in one year. This would result in a maximum gift of $70,000 given by one of you in a single year without needing to split the gift. The $70,000 is, however, still lower than the amount you wanted to fund. To get to $75,000, you would have to trigger the gift splitting mechanism. Additionally, you should know that this is all you can give your son for five years without triggering gift tax issues, and if you should die during the five year period, some of the money would need to be recharacterized. The following IRS link might be useful to you. You can click on it, or type in the URL Remember, though, if you live in California, this is a lot of information you can't use, as you aren't allowed to deduct contributions to 529 plans at all. Best of luck! Peggy

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