7 Tips And 7 Risks For IPOs: Part Two of An Investing Series

7 Tips And 7 Risks For IPOs: Part Two of An Investing Series

With all the upcoming IPOs expected in 2019 from the likes of Levi Strauss, UBER, Palantir, Airbnb, Pinterest, and Postmates, what could investors do to be better prepared whether they have an opportunity to buy at the IPO price, or will consider buying shares in the secondary market.

This is part 2 of a two part series. Please see Part 1 for Steps in the IPO process and 13 Reasons Why IPOs perform poorly long term.

Seven tips for investors on whether to buy at IPO price or in the aftermarket:

What’s in the prospectus

  1. Read and analyze the company’s S-1 registration once it is filed. Be aware that this document may be amended several times before the final IPO pricing with potentially material information.
  2.  Get an understanding of the company, its markets, its near-to-intermediate term plans for market and product expansion. 
  3. What is company management experience, their compensation,  their share ownership of the company before and after the expected IPO. How deep is their bench as they grow more significantly. Some of the management have been very young (Alphabet’s founders skateboarded to work, Zuckerberg’s hoodie on the Facebook roadshow) and investors needed to get a reasonable comfortable level and trust in their short years as head of the company. 
  4. Lockup provisions of existing shareowners and timing of their expiration must be disclosed to potential investors.
  5.   The current plans for the capital raising associated with the IPO but what about future expansion plans and follow-on offerings which may dilute these shareowners.
  6. Does the share structure reflect a dual ownership where the company’s founder/management retain super voting power of the company at the expense of the new shareowners? This has become more common but there are some institutional investors who have policies against buying  this structure.
  7. The risk factors identified in the prospectus are increasingly comprehensive as the SEC is requiring more disclosure of any potential issues that may arise. These factors will provide you with the possible flags that you should be concerned about regarding  the company. You should also factor in your concerns from your previous experience or what you know about the management from their public comments.

Among the possible concerns that are presented in the “Risk Factors” section: 

  1. Industry issues vary and should be disclosed and understood. Some industries are more capital-intensive, more competitive, subject to more regulation, more people-intensive, exposed to commodity pricing or shortages. This section was particularly important for the telecom sector I covered as an equity analyst. Investors were just becoming familiar with the deregulatory environment for traditional telecom companies. This meant increased competition from smaller companies that were rapidly undergoing the IPO process to raise capital. Many alternative carriers (eg. new wireless companies, cable companies providing telecom services) swarmed the larger existing telecom companies.
  2. Regarding economic issues, some companies may be more exposed to global economic pressures while a few may be more defensive and able to weather recessions better.
  3. Substantial risks to the company’s business model due to changes in technology that may make a certain company’s technology obsolete.
  4. Low barriers to entry from potential competitors plague some existing companies. Think how Amazon has transformed the retail industry and the existing brick and mortar retailers like Macy’s.
  5. Revenue concentration by a small number of customers could make it difficult if the company loses any one of those customers.
  6. The company’s need for high capital investment over the next few year will potentially impact the company’s balance sheet, borrowing needs, earning potential and potentially dilute shareholders.
  7. Management may disclose that their primary focus is on growth and leveraging the market while the “window of opportunity” remains open to the company. Emerging growth companies are letting you realize that losses should be expected or worsen with less emphasis on earnings. 

This is certainly not an exhaustive list for what you should read and understand about a company and its fundamentals in the S-1 or hear from companies on their roadshows as they meet with potential investors. It is also a working list of questions or issues you need to understand about any company you are considering when making any stock investment for your own stock portfolio. 

Buying at the IPO price if after you read the final version of S-1 and have done your homework:

You’ve done your research! 

  • The company has outstanding management and you have comfort that they have a talented team and a good plan you think they can execute.
  • The company’s risk factors are surmountable and the capital raising will enable to company provide investors measurable indicators of the success.
  • The company is well positioned and differentiated in an attractive market and has a solid game plan.
  •  The company’s valuation is rich but is comparable to peer companies in the universe. The company may be priced at a rich valuation, usually a multiple of revenue, or EBITDA which stands for earnings before interest, taxes, depreciation and amortization or a very high price-earnings ratio but is expected to normalize over the next couple of years.

The big question is whether you should buy the stock soon after the company goes public because you are enthused about the company but were not able to buy at the IPO price but you watched as the stock went straight up on the first day. It is also tempting to chase a company you see performing well after IPO but sometimes that is the worst time to buy it.

Generally, I would say exercise an abundance of caution. I don’t want to be cute but what goes up often goes down. There are particular times when you may be able to buy that particular stock in the near-to-intermediate future.

Five possibilities of when you may have an opportunity to buy the targeted shares:

  1. When the company reports its first quarterly results after the IPO, the company may report in line or slightly better than what was forecasted. Investors may have hoped or expected  “a big beat” in results and instead the report is largely in line or may even be a little light because of management distraction by the IPO process. This may depress the stock, making more attractive for you.
  2. The lockup waiting period is usually well known and about to expire and it may put some short term pressure on the shares you want to buy. Sometimes the underwriters and the insiders who own the shares have arranged for an organized sale of those shares and the disruption of the shares may be very temporary but provide you with a chance to buy those shares. 
  3. More IPOs will flood the market and some institutional investors may need to shift their stock portfolio around, putting pressure on some of the stocks that recently.came to market. When there is a very active IPO market, as is expected in 2019, it can become a more volatile market. Jim Cramer discusses this here. This digestion period for the new supply can benefit prospective investors looking to make new investments.
  4. For investors seeking to participate in the IPO market, there are opportunities to invest in mutual funds and ETFs that specialize in IPOs. You can read and research here and here.
  5. The market declines on worries over a bunch of factors (eg. trade talks fail, economic woes that have little to do with the company whose shares you wish to buy but it takes all of stocks down with one brush. Sometimes it provides an investor with a chance to buy a stock they were looking to buy and it has declined enough to warrant your attention.

Investors must always do their own research, consult your financial professional and exercise some level of caution based on your risk levels. Have you ever bought a stock at the IPO price? Please share your experience so others can learn more. We would like to hear from you!

 

 

7 Tips And 7 Risks For IPOs: Part Two of An Investing Series

13 Reasons Why IPOs Perform Poorly Long Term: An Investing Series

The IPO market is revving up in 2019, after solid IPO activity in 2018. As ride-sharing Lyft shares recently took off in the public market, many companies are ready to take the plunge into the public market.

Should the average investor buy shares of a company at the IPO price? Or, if they weren’t able to buy at the IPO price, should they seek the shares in the secondary market after the stock has made its debut? What are the risks?

As a former Wall Street insider, let me explain:

  • the initial IPO process
  • the potential risks of buying at the IPO price
  • buying shares in the secondary market shortly afterwards.

Let me also throw an alternative: buying after some risks are better known or after the lockup provisions expire for original owners and  employees. See our Part II of this series.

The Initial public offering (IPO) process in 7 steps:

  1. When a private company first sells shares of its stock to the public, that is you and I, they are seeking to transition the company’s ownership from private ownership to public ownership. The company and its board of directors make the decision “to go public” for a variety of reasons but largely to raise capital to further expand the company into new and existing markets. The private company may have received venture capital or private equity and expertise at earlier stages of its development.
  2. The rule of thumb is that a private company should not tap the market before they are of a minimum market capitalization (or caps) of at least $250 million-$300 million to establish a more liquid trading market.  However, many companies have been going public at far larger market caps like ride-sharing Lyft. They raised $2.34 billion for a market cap of $20.462 billion at the $72 per IPO share price.
  3. Some companies remain private without plans to sell shares to the public market (think Koch Industries run by the very private Koch brothers), or ultimately tap the public markets after being a private company (such as Levi Strauss & Co. planning an IPO in 2019), or a certain amount of maturity (like Alphabet, Facebook).
  4. Once a company decides to sell shares, it chooses a lead underwriter, such as Morgan Stanley, to help with the very detailed securities registration process required by the SEC (Securities Exchange Commission), company management go on an intense “roadshow” to meet with potential investors, to determine the distribution of the shares and gauge aftermarket support of the public shares. In large IPO deals, the lead underwriter will select a couple of underwriters among a group of investment bankers and broker dealers who will handle the syndicate, or the distribution of the shares to the larger institutional investors and retail investors.
  5. Investors will see more IPOs coming to the public in bull markets, that is when there is more enthusiasm for the stock market and better valuation comparisons (often called “the comps”) for the company going through the IPO process compared to valuation of existing peer publicly traded companies. The IPO market dries up in the bearish stock markets, when investors are more worried about the existing shares in their portfolios and have less appetite to look at new issues.
  6. Typically, the lion’s share (about 90%) of the IPO shares are allocated to institutional investors, (5%-10%) going to retail investors and direct shares that go to the “friends” of the company, including friends, family and key employees.
  7. Institutional investors are entities including banks, pensions, investment advisors,  insurance companies, endowments, and mutual funds. They have pools of money to invest in newly issued IPOs to add to their stock portfolios. When they are allocated shares by the underwriters, they get only a small percentage of their desired ownership, particularly if it is a particularly “hot deal.” The bankers’s expectations are that these large investors will be actively buying more shares in the aftermarket which supports or further boosts the newly traded shares.

IPO performance after initial offering and longer term can be very different

The average IPO on its first day of trading rises about 15%-20% above the IPO price as the excitement of the new issue spreads to all investors along with the institutional investors adding to the shares they received at IPO price. Linkedin shares soared over 100% but others weaken soon after. The IPO market was pretty active in 2018 and assessment of their performances are here and here.

Facebook’s IPO experience provides some lessons for future IPOs

  • Take the case of Facebook’s huge IPO which priced at $38 per share on May 18, 2012. Its lead underwriter was Morgan Stanley, along with co-underwriters JP Morgan and Goldman Sachs. The original IPO range was $28-$35 per share, but the price range was raised along with the expanded number of shares offered as order demand was very strong, including from retail investors who were able to get more shares than was customary.
  • This was Facebook and hoodie-laden Zuckerberg, among the fast-growing Internet players on earth with close to 1 billion eyeballs on its network. I was among the retail investors clamoring for some shares. The stock rose quickly to $45 per share but it hit a wall and closed that initial day up pennies higher than its IPO $38 price, dropping fairly quickly to the teens by the end of 2012, before recovering in 2013.

Using Facebook IPO as case study, what were some of the problems that their shares faced so soon:

  • The expansion of the Facebook share offering simultaneously with the higher price tampered down the typical buying that supporting the shares in the aftermarket. Those who wanted to buy more shares had already gotten bigger portions.
  • Rich valuation concerned some investors given that Facebook was focused on growth, not earnings. While it was expected to have 1 billion users and grow significantly from that base, investors started questioning where earnings were going to come from. Facebook’s plan for advertising was well into the future and not well developed as the advertising behemoth is now is.
  • Facebook was won over by NASDAQ, rather than listing its shares on  NYSE. A big win for NASDAQ but they had trouble handling all the shares of the offering and there were glitches. Indeed, I recall hearing many retail investors were getting twice the number of shares they bought in the aftermarket in error.
  • Given the larger amount of Facebook shares that were allocated to retail investors, you sometimes see investors flipping shares soon after they received the shares. Flipping of shares, that is, not holding them a longer time, usually occurs when there is a big pop in the early days of trading in the secondary market. Flipping is frowned on as bad practice and an institutional investor flipper will likely not get new shares of the next hot deal. However, retail investors that were allocated shares may tempted to sell their shares. Fidelity, among other online brokers, warns retail investors not to sell their shares for a period of time.

An explanation here about how the pricing of IPOs are generally decided

  •  Underwriters and the companies typically debate the final IPO price in the last day or so, weighing the strong demand for shares and the expectations for share price appreciation in the aftermarket. The company whose shares are going into the public market are hoping to raise the highest amount of capital as that was their goal. The underwriters also enjoy a big payday that revenues generated from the deal based a percentage of the amount of the capital raised.
  • On the other hand, there is a strong argument for underpricing the deal too for the new investors to the company. These are the largely institutional  investors who will benefit from the potential appreciation from the shares in their portfolios. Remember, the bankers need these same investors for their next deals!
  • Underwriters do support the newly public shares immediately after the pricing. Analysts associated with the underwriters of the investment banking firms are expected to cover the new companies with research and recommendations through ratings such as Strong Buy, Buy, Hold or Sell after the “quiet period.”. These quiet period restrictions are placed on analysts affiliated with the investment banks involved in taking the company public.
  • Although this period has been relaxed to 10 days in 2015 by the SEC, those analysts will likely to wait the traditional 25 day period. As an analyst about to initiate research coverage of a newly minted public company,  I often found the longer time was a comfort for management about to face a larger more public world while letting the stock settle down.

Longer term, 6-12 months later, the average price is generally poor, well below the IPO price. There have a number of companies whose shares performed poorly. Among companies that have faced challenges were Groupon, Zynga, Snap,Twitter, Pets.com, Blue Apron, and some of the companies have since been able to right themselves.

 

 

13 reasons why there is poor performance after 6-12 months:

  1. Young management, often founders, are inexperienced with dealing with public investors with short term goals. The transition for many such company management, going from a private company to the public arena is tough. They are now responsible to many more owners who have their own responsibilities to generate good returns in their portfolios and shorter term horizons from their investors. Institutional investors may not be as patient with fractional price declines.
  2. Communicating with “the street,” that is analysts and investors, can be difficult. I often found that there was a learning curve for the management of new public companies. They were clearly uncomfortable, becoming defensive at the questions thrust at them by the analysts, they themselves having their own learning curves with the new company.
  3. Some management may get very hostile. Remember the Elon Musk’s scolding of analysts on Tesla’s earning call? This is not good for the stock price performance. I was often the only analyst covering a small company, and I felt responsible to the institutional investors when the company missed earnings, and the company was either hostile on the call, or worse, no where to be found to answer the question.
  4. Lockup provisions that expire soon after the company go public. The original owners of the company, which include the founders, management, employees, and venture capital/private equity funds (VCs and PEs) among other possible owners can be potential substantial owners of shares that are “locked up” for a waiting period of a time, usually from 3 months to 24+ months.  In other words, they are prevented from selling their shares in the public market for a specific period. New shareowners do not want these shares to be sold enmasse, because these sales will depress their share price. Investors typically prefer senior management to remain owners of their stock to reflect their confidence in the company, “their skin in the game.”
  5. There is often an overhang or dampening effect on the shares until certain investors, especially the VCs or PEs, who want to get their capital investment plus appreciation for their years of managing and grooming the company for public ownership. Investors grow concerned about the timing of potentially millions of shares being sold into the market at the same time.
  6. Some companies, shortly after their public offering disappoint their new investors with a myriad of issues and challenges in communicating  and explaining the reasons for the “bad news”  to their shareholders and to new analyst coverage on conference calls. Some young companies with spectacular growth look like nothing could harm their skyrocketing path, until of course it does.
  7. Missed revenues or earning results compared to expectations. If this occurs in the earnings report shortly after the company became public, it will cast doubt in investors about managements’s grasp of its company. And if this recurs in a subsequent earnings report, management credibility could be lost.
  8. Revised forecasts that are adjusted downward for missed orders, lost customers, or  declining growth.
  9. Delays in new products or services or misjudging demand.
  10. New or emerging competition that is occurring at a faster rate than previously realized.
  11. Increased capital spending, increased losses, increased borrowing. This doesn’t have to be necessarily bad news for investors if the management is adept at explaining this as an opportunity for  the company.
  12. A key management departure that was not expected.
  13. Insensitive Twitter comments made by management.

With all the upcoming IPOs expected in 2019 from the likes of Levi Strauss, UBER, Palantir, Airbnb, Pinterest, and Postmates, what could investors do to be better prepared whether they have an opportunity to buy at the IPO price, or will consider buying shares in the secondary market.

5 tips for investors on whether buying at IPO price or in the aftermarket:

Read and analyze the company’s S-1 registration once it is filed. Be aware that this document may be amended several times before the final IPO pricing with potentially material information.

What’s in this preliminary prospectus:

  1. Get an understanding of the company, its markets, its near-to-intermediate term plans for market and product expansion.
  2. What is company management experience, their compensation,  their share ownership of the company before and after the expected IPO. How deep is their bench as they grow more significantly. Some of the management have been very young (Alphabet’s founders skateboarded to work, Zuckerberg’s hoodie on the Facebook roadshow) and investors needed to get a comfortable and trust in their short years as head of the company.
  3. Lockup provisions of existing shareowners and timing of their expiration must be disclosed to potential investors.
  4.  The current plans for the capital raising associated with the IPO but what about future expansion plans and follow-on offerings which may dilute these shareowners.
  5. Does the share structure reflect a dual ownership where the company’s founder/management retain super voting power of the company at the expense of the new shareowners? This has become more common but there are some institutional investors that have policies against this structure.

The risk factors are increasingly comprehensive as the SEC is requiring more disclosure of any potential issues that may arise. It will provide you with possible flags you should be concerned about regarding  the company. You should raise your concerns from your previous experience or what you know about the management from their public comments.

7 Risk Factors in the  S-1 to be aware about:

  1. Industry issues vary and should be disclosed and understood. Some industries are more capital-intensive, more competitive, subject to more regulation, more people-intensive, exposed to commodity pricing or shortages.
  2. Regarding economic issues, some companies may be more exposed to global economic pressures while a few may be more defensive and able to weather recessions better.
  3. Substantial risks to the company’s business model due to changes in technology that may make a certain company’s technology obsolete.
  4. Low barriers to entry from potential competitors plague some companies.
  5. Revenue concentration by a small number of customers could make it difficult if a company any one of those customers.
  6. The company’s need for high capital investment over the next few year will potentially impact the company’s balance sheet, borrowing needs, earning potential and potentially dilute shareholders.
  7. Management may disclose that their primary focus is on growth and leveraging the market while the “window of opportunity” remains open to the company. Emerging growth companies are letting you realize that losses should be expected or worsen with less emphasis on earnings.

This is not an exhaustive list for what you read and understand about a company and its fundamentals in the S-1 or hear from companies on their roadshows as they meet with potential investors. It is also a working list of questions or issues you need to understand about any company you are considering when making any stock investment for your own stock portfolio.

Buy at the IPO price if after you read the final version of S-1 and have done your homework:

  • The company has outstanding management and you have comfort that they have a talented team and a good plan you think they can execute.
  • The company’s risk factors are surmountable and the capital raising will enable to company provide investors measurable indicators of the success.
  • The company is well positioned and differentiated in an attractive market and has a solid game plan.
  • The company’s valuation is rich but is comparable to peer companies in the universe. The company may be priced at a rich valuation, usually a multiple of revenue, or EBITDA which stands for earnings before interest, taxes, depreciation and amortization or a very high price-earnings ratio but is expected to normalize over the next couple of years.

The big question is whether you should buy the stock soon after the company goes public because you are enthused about the company but were not able to buy at the IPO price but you watched as the stock went straight up on the first day. It is also tempting to chase a company you see performing well after IPO but sometimes that is the worst time to buy it.

Generally, I would say exercise an abundance of caution. I don’t want to be cute but what goes up often goes down. There are particular times when you may be able to buy that particular stock in the near-to-intermediate future.

Four possibilities of when you may have an opportunity to buy the targeted shares:

  1. When the company reports its first quarterly results after the IPO, the company may report in line or slightly better than what was forecasted. Investors may have hoped or expected  “a big beat” in results and instead the report is largely in line or may even be a little light because of management distraction by the IPO process.
  2. The lockup waiting period is usually well known and about to expire and it may put some short term pressure on the shares you want to buy. Sometimes the underwriters and the insiders who own the shares have arranged for an organized sale of those shares and the disruption of the shares may be very temporary but provide you with a chance to buy those shares.
  3. More IPOs will flood the market and some institutional investors may need to shift their stock portfolio around putting pressure on some of the stocks that came to market.
  4. The market declines on worries over a bunch of factors (eg. trade talks fail, economic woesthat have little to do with the company whose shares you wish to buy but it takes all of stocks down with one brush. Sometimes it provides an investor with a chance to buy a stock they were looking at and it has declined with.

 

This is part 1 of a two part series on investing in IPOs.

Please read part 2 of our Investing Series on 7 Tips and 7 Risks For IPOs

 

To some extent, the active IPO market in 2019 is very reminiscent of the 1990s “dot.com” era when the IPO market was filled with many great companies and not-so-great companies, many vying for public capital raising just by literally adding “com” to their names. While it gave us companies like Amazon, names of many of those companies are no longer remembered.

Do you typically participate in the IPO market, or wait for the dust settle on the newly minted stock? What is your experience in the stock market with new companies? Can you share your experience with us? We would like to hear from you!

 

 

 

 

 

 

 

 

 

 

 

 

 

How To Pay For College: A Family Guide

How To Pay For College: A Family Guide

“The more that you read, the more things you will know. The more that you learn, the more places you will go.” Dr. Seuss

You got into your college. How to pay for college?

At $1.56 trillion, student loan debt held by 44.7 million Americans is ranked number two behind mortgage debt within consumer debt according to the Federal Reserve.

A college education does lead to higher income, job security and great opportunities in life but it may take until age 34 for the average bachelor’s degree recipient to fully recoup these costs. Student debt can put a damper on one’s ability to obtain wealth. It pays to plan to save as much as possible ahead of time and lessen the burden ahead of time, supplementing with more attractive federal loans, scholarships, grants and work study programs before tapping higher cost private loans.

Here are my five recommendations:

  1. Plan for your child’s college as early as feasibly possible. Get a jump with these six possible ways.

Six Ways To Save For College Early

2) Fill out the FAFSA (The Free Application for Federal Student Aid) application. Don’t think of it as an option.

3)Reduce your  Expected Family Contribution (EFC)

4) Get as much as you can from federal loans for students before private loans. They are not all need-based. On the other hand, parents may want to consider private loans if they are borrowing above their contribution through their income and savings.

5) Go for work study, grants and scholarship money. Scholarships are merit-based.

If you do not get the award you had hoped, there is an appeals process for you to follow below.

I want to share my personal story about going to college to perhaps provide you with a different perspective.

I went to a four year public college (City University New York or CUNY) at age 15.5 years in the Bronx. My parents did not want me to go away to college given my age but truth be told we just couldn’t afford it. I was young, foolish and too immature for it to matter much to me as to where I went. I was going to go to college to make my parents proud as the first born to attend college. My textbooks were more expensive than the tuition. I lived at home. I later earned an MBA, also attending a public college at night while working on Wall Street where I earned a seven figure compensation. I subsequently went back to school and earned a law degree. Do I regret my college experience? No, I don’t, though I would have liked the college dorm experience. I certainly benefited from not having loans to pay for. I want my children to go to a good college and have a great college experience. Though we have 529 plans for each child, I expect we will need student loans.

There are many questions families need to consider when choosing the college and funding sources for college tuition, room and board:

Four year in-state and out-of-state public colleges and private colleges, two year community colleges. If you were selecting on the basis of costs only, clearly in-state four year and two year colleges are your least expensive options, benefiting from that state’s taxpayers. Average tuition, fees, room and board in 2018-2019 for four year in-state college were $21,370 and for two year in-district state college were $12,320. Average four year out-of-state public colleges were $37,430. Average four year private schools top the list at $48,510.

Keep in mind these are average published prices and are not reflective of respective college reciprocal programs offered between certain states. Also, if your child’s major is not offered at your in-state public college, you may able to go to an out-of-state college at a similar price if they offer that program. While it may be overwhelming, and you are almost at the finish line, do your research.

The composition of paying for college in annual year 2017-2018, amounting to a total of $26,458 by the typical family based on the Sallie Mae’s survey of families was as follows:

Parents and students share most of cost for college through own sources and borrowing.

Parent income and savings were the largest source at 34% of the total, student income and savings at 13% with relatives contributing an additional close to 2% for almost half of the needs for college or 49%.

Importantly, when parents are contributing their savings, it should be largely savings associated with college savings plans, and not from emergency fund savings or money needed for their own lives. It may seem obvious but parents have used their own retirement savings for their children’s college education only to regret it later on.

53% of families borrowed to help pay for their undergraduate’s education, with students much more likely to borrow than parents. In 32% of the families, only the student borrowed; in 14% only the parent borrowed; and in 7% of families, both the student and parent borrowed.

Parental  borrowing contributed an additional 10% while students contributed 14%, borrowing more than their parents, on average.

With parents, students, and relatives sharing responsibilities through their own sources and borrowing for college amounting to 72% of the costs, grants and scholarships (discussed below)  provide the remaining 28%.

Should I complete the FAFSA? Yes, end of story.

If you are borrowing, federal loans are far more attractive but have loan limits by year with the freshman year maximum loan the lowest at $5,500 rising to $12,500. These amounts are set by the government but the colleges calculate the amount per individual student based on the college’s cost of attendance so it is possible your child will get less than the limit.

FAFSA  needs to be filled out for each academic year. Make sure you file on time, if not early  as some states award on a “first come, first served” basis. Check your state’s practice as they differ.

FAFSA determines whether you are eligible for need-based federal financial aid for college and may help you with getting scholarships, grants and work study programs for your student.

It is always a pain to fill out applications but if the goal is to get more affordable federal loans to supplement your income and savings contribution, go for it. Their website gives you the average time it should take to fill out the application but that doesn’t take into account the extraordinary amount time it takes to compile the supporting records and paperwork. No doubt you have to be super organized.

In a Sallie Mae survey regarding how college is paid for, 75% of families, largely middle-income based, completed the FAFSA application, with lower filing rates for both higher income and lower families. The biggest reason given by those families that did not complete the application was “believe they won’t qualify.”

In filling out the FAFSA application, the government expects you to divulge your financial situation. They look at a family’s taxed and untaxed income from two previous years, assets, benefits like unemployment, social security, bonuses,  severance payments,  family size and what other family members are attending college in that academic year to calculate Expected Family Contribution (EFC). Regarding assets, check which assets may not need to be included such as your primary family home, including an active farm that is part of the family home; a business that you control; pensions/ retirement funds; cash value of your insurance; and personal property such as your cars.

There are legal ways to lower your expected family contribution.

Among some of the strategies you can use to reduce your EFC:

Don’t do anything rash like trash your savings but don’t increase your earnings either. Instead you can put money into your retirement savings account to the maximum levels. Retirement savings should be a parents’s priority.

Household size matters so if you have a dependent family relative living with you but a move is being considered, a delay may be worthwhile. Better to have more dependents. If your great aunt Matilda has been staying with you, let her stay!

Paying down some high-interest rate debt associated with credit cards is worthwhile and may help your credit card score at the same time. You may need to take a private loan in addition to federal loans.

There are several federally sponsored loan programs including:

Stafford Loans are among the most common, desirable and low cost loans offered directly to students, rather than to parents, ranging from $5,500 to $12,500 per year, gradually rising after the first year.

Students borrowed proportionately more federal loans (72% of borrowing) versus private loans (28%).

There are the Direct Subsidized Loans and Direct Unsubsidized Loans. The US Department of Education is the lender and to whom you make payments to. These loans are also available to graduate and professional degree students but at higher interest rates than for undergraduate degree programs. Your FICO score won’t count against you for these loans as everyone approved for these loans get the same rate. There are 4% origination fees on the loan amount. The loan terms are generally fixed and have a 10 year maturity.

The Direct Subsidized Loans are need-based loans to students who demonstrate the need for financial help to cover higher education costs. You must be in school at least half-time. For loans disbursed on or after July 1, 2018 and before July 1, 2019, the interest rate is fixed at 5.04%. The loan rate during the previous year was 4.45%. The government pays your interest while you are in school and the loan repayment is more flexible, beginning after you complete school. If you can satisfy the  needs threshold requirement, this is clearly a desirable option.

The Unsubsidized Loans are different as they are not need-based but you, not the government are paying the interest cost which accrues immediately though repayment is deferred until after you graduate like the subsidized loans These loans have the same caps on loan amounts and the interest rate is currently 5.05% (4.45% in the previous year) according the Federal Aid website. This is also a very desirable loan.

Direct PLUS (Parent Loans for Undergraduate Students) Loans are directed at parents, not at students and are not financially need-based. Parents’ proportion of federal loans at 62% were higher than private loans. The maximum amount of the loan is not capped at a specific amount but instead is tied to the cost of attendance minus any other financial aid the student receives via the Stafford loans. These loans are set at a higher rate of 7.6% and are designed to supplement what other sources of funds the students were able to obtain. These amounts are subject to a 4% origination fees of the loan amount. The rates for this option for parents is not very attractive. While there may be some flexibility with federal loans discussed below, if you have a good credit score you might want to look at private loans for yourselves, not your children.

Federal loan programs have Income Driven Repayments (IDR) features which students and/or parents have to apply for, however, the student cannot use this if  they are in default on all of their loans and it cannot be used for PLUS Loans by parents if that is the only loan the family has. The one problem with applying for any repayments change is you may be extending the time of your repayments beyond the typical ten years which may lower your amounts but burden you longer.

Federal loan programs for students and parents, under certain conditions may provide for forgive, cancellation or discharge of loans. Separately, if parents work for the federal government or a not-for-profit entity, there may be eligibility for loan forgiveness through the Public Service Loan Forgiveness if at least 10 years of payment have been made.

Federal Grant and scholarship programs account for funding  28% of the needs of the average family in 2017- 2018. This is money for college and does not have to be paid back. Almost all of federal grant programs are needed based. See the list of grants here.

The federal scholarship programs are merit-based, received from school, outside organizations, or businesses. Information as to how to apply can be found here. Sallie Mae’s survey of 2017-2018, showed higher dollar contributions of $4,598 for those families making more than $100,000. Another place to look for scholarship opportunities is on fastweb.

In addition to the “free aid” you can get through the federal government, there are federal work study programs which pay at least the federal minimum wage and are on-off campus. These programs are need-based so check out their website here.

You can look at state programs for additional loans, grants, and scholarship opportunities which can potentially supplement what you are getting through the federal programs. Take a look at the different programs by state for possible loan/grant/scholarship opportunities here. You can look for merit-based scholarships by college, if your college is on this list. Some colleges have supportive loan programs for those families that are need-based as the 25 colleges, including Harvard, on this list.

Right to appeal should be exercised.

It is always a good idea to challenge your initial financial offer via an appeals process or a professional judgment process, especially if there are circumstances that occurred after the submission of your financial aid application.

Among the special circumstances are such as the sudden illness of a parent or another dependent in the home, job loss, unexpected medical illness or your primary home was destroyed via force majeure or act of God.

Call or write a letter to the financial aid office at the college you intend to go to.

You will need documentation.

The student financial aid administrators have discretion to make decisions regarding your special circumstances codified by  law here.

You may be undergoing significant stress as you are faced with these circumstances but it could substantially help you financially.

It may seem like a daunting task to figure out how to pay for college and all the related costs, but keep your eye on the long term benefits that your child is going to get by taking advantage of a valuable lifelong education that can be leveraged for a career of their choice. This is the beginning of their journey away from home.

Have you begun your exploration of college for your children? While it is a stressful time, it can certainly be another chance to learn from your child about their preferences and readiness for adulthood.

Commenting here would be helpful for those who could learn from you in the future. Do you have a story you would like to share? We would like to hear from you!

 

 

 

Six Ways To Save For College Early

Six Ways To Save For College Early

“Training is everything. The peach was once a bitter almond; cauliflower is nothing but cabbage with a college education.” Mark Twain

“If you think education is expensive, try ignorance.” Derek Bok

“College is part of an American dream. It shouldn’t be part of a financial nightmare for families.” Senator Barbara Mikulski

How early can you start saving for your child’s college education?

Planning for your children’s financial future should begin as early as their birth. Actually, I did set up a 529 plan before we had children. I intended to go to law school and I wanted a 529 savings plan to help pay for escalating tuition fees for three years. Our first child coincided with my first year of school and I ended up changing the beneficiary to my son. I set up a second 529 plan soon after my daughter arrived.

While technically you can’t have a 529 college savings for an unborn child because you need a social security number, you can set it up in the parent’s name and change beneficiaries later on. It makes tremendous sense to take advantage of as long a timeframe as possible using the benefits of compounding growth.  The House tax plan in 2017 tried unsuccessfully to expand eligibility to include unborn children as long as “the unborn child is in utero.”

The more you begin saving today, the less you need to borrow later on. There are imposed federal student loan limits, the more affordable borrowing source, as compared to private loans. Your best bet, if your child’s education is a priority as I am sure it is or will be, is to adopt a saving strategy.

The cost of a college education

Average annual college tuition rates over a ten year period  between 2008-2009 and 2018-2019 rose 2.3% for private nonprofit four year colleges and 3.1% public four year colleges according to The College Board. Average tuition, fees, room and board published prices are $48,510 for private nonprofit four year colleges, $21,370 for public four year in-state colleges and $37,430 for public four year out-of-state colleges. College tuition prices rise with inflation and other costs offset by continued political pressures to provide reduced or free tuition. I would not count on that ever becoming a reality.

There are several ways to save for your children’s college education and reduce borrowing that you or your child will need to do for college later on. By contributing early and often to these accounts, you may avoid the need to face the prospect of borrowing for your child’s college tuition, fees, room and board, or at least ease a substantial part of the burden.

Funding your children’s tuition well ahead of their needs allows for compounding benefits while enhancing your tax situation. There are differences in offerings by age, income, and contribution limits, flexibility to make changes,  investment opportunities, and tax implications. Make sure to speak to your accountant or tax professional regarding the tax issues.

Six ways to save for your child’s college education and take advantage of some income tax breaks are:

  1. 529 College Savings Plans
  • A 529 plan is a college savings plan that offers tax-deferred savings and financial aid benefits.
  • Originally begun to save for college, the plans may now be used to save and invest for K-12 tuition at private schools, retaining their tax-deferred nature. The Tax Reform Act in 2017 expanded 529’s ability to include $10,000 per year for K-12 tuition.  Under the Act, the $10,000 withdrawals per year are federally tax-free. State tax treatment of these withdrawals differs from state-to-state. So check with your state’s taxing authority or state 529 plan administrator. For example, Connecticut’s 529 plan allows you to withdraw tax-free for up to $10,000 per child to be used for private school tuition.
  • Virtually every state has a 529 plan and you do not have to live in that state to set up an account in each child’s name. Each state plan may vary so check what works for you.
  •  There are no maximum caps as to how much money can be invested per year.
  • Parents can typically choose among a range of investment portfolio options which may include Vanguard mutual funds, exchange-traded funds (ETFs), static or fixed allocation fund portfolios, and age-based portfolios sometimes called target-date portfolios. Which fund you choose depends on your appetite for control and risk. You can make changes between the funds based on your children’s age or the target date portfolios which shift from more aggressive growth rates to more conservative rates as your child ages.
  • The amounts can be used for any eligible higher education, not just four year colleges or universities including vocational and trade schools; community colleges and graduate schools.
  • 529 plans typically do not have income or age limits. An older person can use it for school later on.

2. Coverdell Education Savings Account (ESAs)

  • These accounts are similar to 529 plans offering tax-free investment growth and tax free withdrawals when funds are spent on qualified education expenses. Like 529 plans the invested amounts are not limited to college and can be used not only for K-12 tuition but also expenses, including books. At one time Coverdell ESAs were the sole tax-advantaged way.
  • Unlike 529 plans, contributions made to Coverdell ESAs are limited  to $2000 annually per beneficiary similar to limits set for IRAs .This means grandparents can each set up their own account for the same beneficiary with a $2,000 limit for each account.
  • A Coverdell investment option is self-directed. It is not pigeon-holed into  the state’s specific options like 529 investment track options.
  • Coverdell ESA’s have age and income limits. A beneficiary must use the funds by age 30 unless the beneficiary is a special needs person.  If your adjusted gross income is over $220,000 as a married couple or $110,000 as a single taxpayer, you cannot contribute any longer.
  • While Coverdell ESA’s give you greater investment flexibility than 529 plans, the imposition of limits have caused some to consider rolling  their Coverdell ESAs into 529 plans.

3. Custodial accounts: Uniform Gifts to Minors Act (UGMA) or Uniform Transfers Minor Act (UTMA)

  • Custodial accounts can be set up for each child if they are under the age of 14 years and managed by the parent until the child turns the age of majority, typically age 18 years unless stated otherwise.
  • Investments in these accounts are not limited.
  • For children below 18, the first $1,050 of unearned income from the investment is tax-free to the child, after which the next $1,050 is taxed at the child’s tax rate, then income above the $2,100 is taxed at the parents’ (usually higher) tax rate. When the child turns 18, they will be paying taxes at their own rate.
  • Couples filing jointly can contribute up to $26,000 annually for each child, or $13,000 if an individual is setting up an account. Anyone can set up a custodial account, including grandparents, aunts and uncles.
  • Once the child has access to the account based on their age of majority, it is their asset. The invested money may be used for anything that child wants, including frivolous things which unfortunately the parents have little power in reclaiming that asset.
  •  These type of accounts are typically for supplemental spending for college, and not likely to go to tuition.

4. Traditional IRAs

  • Traditional IRAs, typically used for retirement savings, would normally incur a 10% penalty for withdrawals before age 59.5 years.
  • There is an exception if an individual wanted to use this account for qualified college expenses for themselves, child or grandchild and they would not be penalized for early withdrawals. Frankly, retirement accounts should never be tapped for college tuition.
  • Since you cannot borrow for retirement, but you can for college, parents or a child would be better off to take out a loan for college.

5. Invest in discount bonds

  • Another way to save for college costs, is to invest in deep discount corporate, US government (Treasury) or municipal deep discount bonds. These bonds are often referred to zero coupon bonds because its owners are not collecting coupons twice a year.
  •   These bonds come in maturities of one year-40 years and do not pay semi-annual dividends like regular bonds. However, the IRS requires that you pay tax on the interest portion annually.
  • Check with your tax professional about the possible tax implications of zero coupon municipal bonds and tax treatment in the years before redemption given that interest income from municipal bonds have favored federal tax treatment and sometimes state preeemption unlike corporate and treasury bonds.
  •  Treasury bonds have triple AAA ratings so they are considered virtually risk-free while ratings of municipal bonds and corporate bonds vary.
  • You can redeem the bonds at full face value upon their maturity. The proceeds of these bonds can be used for  college costs.
  • Deep discount bonds are not just used to save for college tuition but their long term nature are suitable for planning for your children’s non-tuition college needs as all.

6. Series EE Savings Bonds

  • Savings bonds are sold by the federal government for half their value or $5,000 for maturity denominations of up to $10,000.
  •  Like treasury bonds, they are safe based on their triple A rating.
  • Usually savings bonds are taxed at the federal level and tax-exempt on state and local levels but if you are using these savings bonds for college tuition expenses than they are typically tax-exempt at the federal level as well.

It is never too early to start saving for your children’s future, especially for a college education.

Tuition costs are high but far more bearable if you save early. The more you save, the less you need to borrow on that day your child gets into college. Keep in mind that there are federal loan limits and private loans are more expensive.  As I mentioned earlier, you can set up a 529 plan for yourself or for an unborn child and change the beneficiary once you have their social security number. It is exercising prudence on behalf of your child’s financial future. The alternative to not saving is the hardship you may encounter when applying for college loans and need to decide whether you as the parent or your children will take on the debt or some combination. Lessen your burden as early as you can.

Have you looked into 529 plans or alternatives to begin saving? Are you doing something different to save and like to share? We are interested in hearing from you!

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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9 Ways To Better Protect Your Privacy Against Fraud And Scams

9 Ways To Better Protect Your Privacy Against Fraud And Scams

We are a connected and an open society.

According to Business Insider Intelligence  survey’s forecast released in January 2019, there will be more than 64 billion Internet of Things (IoT) devices by 2025, up from about 10 billion in 2018, and 9 billion in 2017. The IoT industry refers to the interconnection of all of our computing devices that surround us in our everyday objects like our smartphones, smart speakers, and smart machines. This wondrous ecosystem allows us to send and receive data to and from each other with greater control and efficiency at home and work.

That’s the good news. The bad news is that we may be more vulnerable to all different kinds of fraud.  All this pervasive interconnection requires our private information: names, birthdates, addresses, online login, passwords, account information, bank account numbers, mother’s maiden name, health information,  and often our social security numbers. We share a lot of our information too freely, even genetic information we received from Ancestry.com and 23andMe. Well what if we learn something that is very private and it is disclosed to our insurance company?  Then there may some in our open society who would like to wrongly access to our most private information and deceive us for their personal gain. Without data security, there would not be privacy in an electronic interconnected world.

There have been several significant data breaches in recent years. The largest among them was  Yahoo with 3 billion accounts in 2013 plus another 500 million in 2014. Then 500 million by Marriott Hotels in 2017, 412 million by Friend Finder in 2016 but the 146 million in 2017 by Equifax, one of the three credit bureaus was a bit shocking, wasn’t it?

Why should we care about privacy?

Of course, it is not news that we share a lot of information. We have increased our awareness of the need to be more private even in the midst of marked security improvements. Identity theft in the US was highest in 2012 at $21.8 billion, dropped to nearly $17 billion in 2017 according to Javelin Strategy.

In early March 2019, the Federal Trade Commission (FTC) released its latest findings in the Consumer Sentinel Network Data Book. It tells us we need to continue to be vigilant. The following statistics are illuminating:

  • In 2018, there were nearly three million reports collected, up from 2.7 million reports in 2017.
  • The top reports in 2018 associated in three areas: Fraud or imposter scams rising to the most notable area with 1.4 million, 1.1 million in debt collection, and 444,602 in identity theft.
  • Of the number one category of fraud in 2018, consumers reported a loss amounting to $1.48 billion in total fraud losses equating to a $375 median loss.That is a significant increase from $905 million in total fraud losses and equates to $429 median loss reported in 2017. In both years, one in five people are lost money to scams.
  • 43% of younger people aged 20-29 years reported losing money due to fraud as well as the 15% of people in their 70s who reported losses due to fraud. However, losses between the two vulnerable age groups differed. Those in their 20s reported a median loss of $400, but those in their 70s had a median loss of $750, and those in their 80s reported median losses of $1700. While the young are being exploited by fraudsters, the elderly with more assets are losing larger amounts.
  •  Credit card-related identity theft grew 24%, as misusing someone’s information to open a new credit card account was reported more often than other forms of identity theft. Tax-related identity theft was down 38% in 2018.

What do the numbers mean in our daily lives?

The reality of what really happens when you are a victim is not fully reflected by the above statistics. Fraudulent charges may appear on your credit card. They may appear in small amounts and then grow faster before you notice them to dispute the charges with the credit card company.This could impair your credit score and report. I will address later how to better protect yourself.

A family expecting a much needed tax refund may not receive because it was apparently stolen. When your refund is wrongfully taken, you lose opportunities. For example, you were hoping to use that earmarked refund for an appliance or a downpayment for a car. The elderly or the disabled may be unable to access government benefits they use to pay for their basic needs when someone else has wrongly used their account information. When our privacy is violated, potentially embarrassing and sensitive information could be revealed about us in terms of our education, finances, and our health.

The FTC, an independent government agency that promotes consumer protection, posts valuable information for consumers about the most recent and varied scam alerts and warning signs. I recently perused the latest list of scams that the FTC has filed lawsuits in 2018 and found three scam examples:

  1. Job seekers were deceptively charged thousands of dollars by a so-called executive recruiter when applying for executive level positions. They were tricked into believing they were strong candidates. They even went on interviews that were staged.
  2. One of the biggest types of scams in 2018, were romantic scams. these scams amounted to a reported loss of $143 million, arising from dating apps where attractive photos and profiles are posted, first enticing people and then they ask for you to send money or gifts.
  3. A Netflix phishing scam was uncovered in Ohio. Phishing is when someone uses fake emails or texts to get you to share your valuable information, including account numbers, Social Security numbers, login IDs and passwords. Police in Ohio found a phishing email circulating that claimed that the Netflix’s user was being put on hold because the company is having trouble with the user’s current billing information and then invites the user to click on a link that would update their payment method. Bam! This last one hit very close to home as I can imagine my teens at home, especially my daughter who bingewatches, would be over our shoulders urging us on to click that link.

How do we better protect ourselves?

Acknowledging that data collection will only increase as we provide more of our data online through social media, fintech companies, collected by cookies (small files stored on a user’s computer to hold data specific to websites) and the multitudes of apps that are not yet available, we will need to be more watchful.

What we need to do, besides having a healthy dose of skepticism:

Be on the alert to imposters and phishing emails. According to the FTC, scammers are sometimes posing as someone you can trust, such as a family member, government official, or charity. Never send money or give out personal information in response to an unexpected request.

  1. Safely dispose of your personal information. Use a paper shredder or wipe your computer hard drive. Find ways to delete all your information from smart phone and remove your SIM card. To be honest, I keep all my old electronic devices.
  2. Don’t use public wifi. This is a recent change for our family. I always used Starbucks’s wifi  when I literally lived at my local place when studying for the bar (to practice law).  I have also encouraged my kids to use the public wifi rather than drive up our data bill. No more! The same reason we find it easy to connect to public wifi because there isn’t authentication is beneficial to hackers.
  3. Don’t believe your caller ID as it easy for scammers to fake names and numbers. I once picked up my house phone because I recognized my own cell number. I hung up that baby so fast that I almost broke my phone.
  4. Consider how you pay. While credit cards have significant fraud protection when detected, wiring money is among the worse methods you can use according to the latest FTC report. If you are using Western Union or MoneyGram,  be aware that you can’t get your money back. When I worked on a case for the court, an elderly woman who was losing her mental capacity was literally giving away a large portion of her significant net worth through MoneyGrams to a constant caller who would meet in her mysterious places in her neighborhood, unbeknownst to her family who were unaware of her declining capacity or her constant money wiring.
  5. Keep your passwords private. Young people tend to overshare everything including their smartphones, and often will provide friends their passwords. Change passwords often and use strong passwords.
  6. Don’t carry your social security number in your wallet or on you. This seems obvious but also don’t carry any private information that may contain your social security number which can be on many different kinds of documents, such as credit card applications, bank applications, your health plan.
  7. Take outgoing mail to the post office or to post office collection boxes. As a kid, I remember what those boxes for. Well they are back in style again. There is too much of our private information in those letters. Do more correspondence online.
  8. Review your credit report for possible issues. The three nationwide credit reporting companies–Equifax, Experian, and TransUnion–are required to provide you with a free copy of your credit report at your request, once every 12 months. You can also visit annualcreditreport.com to your free report. The FTC does not recommend that you use other websites for free reports.
  9. Monitor your personal information as soon as you get it or go paperless. Review all your statements when you get them and call vendors when you spot a mistake.

Things happen even to the most careful among us

If your identity is stolen, you need to take action promptly. Experian provides some information on their website.

Here are a few steps:

  • You need to go to the FTC’s ID Theft Reporting website in order to access identitytheft.gov to report the fraud.The FTC will walk you through the report and provide important resources. You will also be issued an identity Theft Victim’s Complaint and Affidavit.
  • Assess the damage and let the three credit bureaus know to put a fraud alert for a year on your credit report and freeze credit which is free as of late 2018.
  •  Contact your creditors, credit card companies, and financial institutions.
  • You will need to contact appropriate state and federal agencies such as the Department of Motor Vehicles, US Postal Service, Passport Services of the US State Department and any other agencies that you might routinely be in contact with.

Our privacy is costly when we lose it. We have a lot of freedom in our lives and benefit greatly from the wondrous interconnected digital world we live in but we need to protect all we have. If and when we are violated, we are robbed monetarily, we lose trust and we lose our piece of mind. Our job is to be aware, be more protective and continue freely and well.

My friends and family have been impacted, some more than others. It is never funny when it happens to you and your loved ones. Years ago I recall the data security breach of Ashley Madison, a dating website designed for people who wanted to have extramarital affairs. Many customer records were disclosed by hackers no doubt causing some harm to spousal relationships.

There are so many ways to protect yourselves based on stories you may hear from others. How are you protecting yourself so you can avoid the loss of private information. We can learn from each other. We would like to hear from you!

 

 

 

 

 

 

 

 

 

 

Your credit scores may be impaired by others and will take time to take corrective action.

 

 

 

 

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