Investing Your Year-End Bonus

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1 February 2014 Investment Update Investing Your Year-End Bonus What to do with that year-end bonus is a pressing concern because bonuses are increasingly supplanting annual pay raises as a means of rewarding employees. Here are a few ways to make the most of your bonus. Pay Down Debt: Before you put any money into the market, consider paying off your debt. Credit-card debt, which often has a high interest rate, is a good place to start. Also, consider sending an extra payment to your mortgage lender, which can help shorten the life of your loan. Maximize Your Match: Check with your employer to find out whether your 401(k) contribution is being deducted from your bonus. If it is, you may want to lower the percentage amount that you're contributing to your 401(k) before you receive the bonus. In so doing, you'll ensure that your contributions are spaced throughout the year, and you'll be able to take full advantage of your employer's matching contributions. Feed Your Tax-Sheltered Accounts: If you haven t already done so, consider contributing to a regular or Roth IRA. Tax-deferred portfolios can grow faster than taxable ones, and the gains on Roth IRAs are tax -free. Match Your Investments to Your Time Horizon: Pay attention to your investment time horizon. If you're in your 30s and saving for retirement, aggressively positioned stock funds may be a good option. But if you plan to tap the money within a shorter time frame, you may want to focus on conservative investments. Returns and principal invested in stocks are not guaranteed. Funds in a regular IRA grow tax-deferred and are taxed at ordinary income tax rates when withdrawn. Contributions to a Roth IRA are not taxdeductible, but funds grow tax-free. A 10% penalty may apply for withdrawals prior to the age of 59 1/2.

2 Investment Update February Dos and Don'ts of College Savings For many families, the cost of college has become daunting. During the past decade, tuition, fees, room and board costs have increased at a much higher rate than general inflation. Knowing financial-aid rules is key, given these rising costs. Keep in mind that some financial aid is need-based while some is not, and that aid includes not just grants and scholarships, but also work-study programs and loans. Below are some ideas to help parents get started. Do: Start Saving as Soon as Possible. Some parents worry that saving for college will negatively affect their student's chances for financial aid. But that's misguided. Most financial aid is in the form of loans, which people are better off not having to pay. The important thing to keep in mind is that every dollar saved for college reduces a student's borrowing costs. In light of this simple principle, parents and students should start saving for college as early as possible. Do: Apply for Any Scholarships for Which the Student Might Be Eligible. An obvious place to start is by filling out the Free Application for Federal Student Aid, or FAFSA, the federal government's form for need-based grants, loans (both need-based and non-need-based), and work-study opportunities. Good online resources for scholarship searches include Fastweb and Scholarships.com. One important tip when applying for scholarships: The more optional information you provide, the better your odds of matching. For example, if a student or parent has had cancer, including that in the student's profile helps improve his or her chances of matching one of the many scholarships related to the disease. Don't: Put Assets in the Student's Name. In financial aid calculations, assets belonging to parents have less of a negative impact than those belonging to students. So money in a 529 plan, which is considered the parents' property, counts less against financial aid than, say, money held in a custodial account such as a UGMA/UTMA, which is legally considered the student's property. One way around this problem is to spend down the student's assets before applying for aid. UGMA/UTMA funds can be used for a wide variety of qualifying expenses, so long as they are for the minor's benefit. Incidentally, money in a 529 opened by a grandparent on behalf of a student does not count against financial aid. Don't: Count on Your Student Getting a Full-Ride Scholarship. Expecting your child's academic or athletic brilliance to bail you out from having to pay for college is simply not realistic. Fewer than 0.3% of students win full-ride scholarships or need-based fullride grants, whereas about two thirds of all undergraduates receive some kind of financial aid, including student loans. Don't: Sell Assets the Year Before Applying for Aid. A common mistake parents make is to sell a large chunk of taxable investments to help pay for college the year before applying for aid. This might trigger capital gains that add to parental income and thus reduce financial aid eligibility. Keep in mind that students usually must reapply for financial aid each year, so holding off and waiting a year to sell might not help. It's best to plan ahead, if possible, by putting funds for college in a 529, where their impact on financial aid is reduced. Do: Have Your Kids Close Together in Age. Having multiple kids in college at the same time actually improves financial aid eligibility because it reduces the amount parents are expected to pay for each. For example, someone who has twins is going to get more aid than someone who has single children separated by four years. Of course, it may be a little late to put this plan into action for most readers, and it s not always under the parents control, but it also works if, say, a parent attends college at the same time as their child or children. Having an older child delay college to attend at the same time as a younger sibling also

3 Investment Update February 2014 Like A Fine Wine Like a fine wine, a portfolio only gets better with age. Well, not exactly, but the longer your investment time frame is, the greater the chance that your portfolio will be able to build more value. This happens because of a little phenomenon called compounding: the ability of an investment to generate earnings from previous earnings, accelerating the growth of your assets over time. For example, if you invested a sum of money on January 1st this year, you will get interest on your money at the end of the year. Next year, you will get interest on your money and interest on the interest and, if this happens over many years, you have a chance of ending up with a portfolio as delicious as a bottle of perfectly aged Chateau Margaux. Exploration in Diversification Investors often wonder how many funds they need to reduce risk through diversification. The answer isn t a specific number of funds, but rather the holdings of each fund. If multiple funds in a portfolio have similar holdings, an investor can fail to achieve diversification benefits. Portfolio A and Portfolio Z in the image contain five mutual funds. Each oval represents the ownership zone, which accounts for 75% of the fund s holdings. The funds in Portfolio A overlap, indicating that each fund shares similar style characteristics. Too much overlap defeats the purpose of using multiple funds to create a diversified portfolio. Portfolio Z spans across many styles, so positive performance by some investments can neutralize the negative effect of others. As illustrated, it is important to be aware of the possibility of security overlap when constructing a diversified portfolio. 3

4 Investment Update February Financial First Steps After Having a Baby The arrival of a baby is an exciting event, but it also brings additional financial challenges and decisions for the whole family. Outlined below are four key financial considerations to help new parents prepare for many of life's unknowns. Prepare for the Unexpected: Check your individual health insurance policy for specific guidelines on adding coverage for your newborn (most plans give parents 30 days after the birth of the child). Missing this deadline may require waiting until the next annual enrollment period to add your baby to your plan. Life insurance is an important aspect of your financial plan and something that you may now want to consider. You may also want to consider purchasing umbrella liability insurance (particularly if hiring an in -home caretaker for the baby), to provide additional protection in case an accident occurs on your property or if you are sued. On the other hand, skip insurance that you don't need: Unless you depend on your children for financial help, insuring young children is usually unnecessary. Kick-Start Your College Savings Plan: The most compelling college-savings vehicles offer attractive tax advantages. State-sponsored 529 plans have built-in tax incentives, and the age-based all-in-one 529 options allow you to invest money in a portfolio that gradually becomes more conservative as your child nears college age. If the baby's grandparents or favorite aunts and uncles would like to save on your child's behalf, they too can make state tax-deductible contributions into a 529 plan. beneficiaries, consider creating a trust fund (after death a trust doesn t go through the probate process like a will does). Take Advantage of Tax Benefits: Start by applying for your child's Social Security number right away for tax purposes. All parents are eligible to claim each child under 19 as a dependent on their tax returns, which reduces taxable income by what is called the dependent exemption ($3,900 in 2013). This exemption also applies if your child is a full-time student under the age of 24. Another potential tax break for parents is the $1,000 annual child tax credit, which applies to children under 17, provided your income falls below certain thresholds. If you're paying for child care, your workplace might also provide ways for you to save on taxes. Through flexible spending accounts (FSA), parents can put away up to $5,000 in pre-tax dollars for child care (if their child is under the age of 13) through an employer-sponsored program. Parents may also qualify for the child-care tax credit as long as both spouses are working and the child is under 13. Unfortunately, you can't double up on the FSA and the tax credit. 529 plans are tax-deferred college savings vehicles. Any unqualified distribution of earnings will be subject to ordinary income tax and subject to a 10% federal penalty tax. Tax law is ever-changing and can be quite complex. It is highly recommended that you consult with a legal, tax, or financial professional with any questions or concerns. An investor should consider the investment objectives, risks, and charges and expenses associated with municipal fund securities before investing. More information about municipal fund securities is available in the issuer's official statement, and the official statement should be read carefully before investing. Don't Forget Basic Estate Planning: Another key step is to designate a legal guardian for your child; a person who understands and is comfortable with the implications and responsibilities involved. You should also consider drafting a will and living will. Many assets can be transferred to a beneficiary at death, but be aware that assigning minors as beneficiaries presents several potential pitfalls. For example, minors cannot legally own any assets. So if you want to name a child under 18 as your beneficiary, he would need a court-appointed guardian, which can be a costly process. Instead of naming your children as direct

5 Investment Update February Annual Market Barometer 1 Year, ending December 31, The U.S. Market returned 33.13%. The Morningstar Market Barometer provides a visualization of the performance of various stock market indexes. The color scale (red for losses and green for gains) allows you to assess which areas of the market performed strongly and which areas showed weakness for the time period analyzed. The ninesquare grid represents stocks classified by size (vertical axis) and style (horizontal axis). There are three investment styles for each size category: small, mid and large. Two of the three style categories are value and growth while the central column represents the core style (neither value nor growth characteristics dominate). Large-caps account for the top 70% of the capitalization; mid-caps represent the next 20%; and small-caps represent the balance Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is not warranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. "Morningstar" and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar Market Commentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.