MONEY Saving & Budgeting

3 Ways to Cut the Fat From Your Budget—and Save More

male athlete drinking 100% Mega Wealth fitness shake
Gregory Reid

Nowadays technology makes it easier to whip your spending into shape.

Welcome to Day 6 of MONEY’s 10-day Financial Fitness program. You’ve already seen what shape you’re in and started to track your spending. Today, look for ways to free up cash.

Even if you hit the gym regularly, you can probably still pinch an inch here and there.

Your spending, too, is bound to have a little flab. But here’s the good news: If you haven’t combed through your budget in a while, you may be surprised to discover how new technologies, shifting business models, and other recent developments can help you find more money to save.

1. Join the Sharing Economy

Are there any big-ticket items you could get away with renting rather than buying? For instance, maybe now that the kids are in college or you’ve retired you could do without that second car, which, according to AAA, costs almost $9,000 a year to own and operate. Consultancy Alix-Partners found that by 2020 more than 1 million families will use carsharing services to avoid buying a second ride. In some areas, Zipcar and Enterprise Car Share charge less than $50 a day for fully insured cars with gas, while a one-way car-pooled ride with Uber or Lyft can cost as little as $2.25.

For vacations, how about trying a home-swapping service such as Intervac or HomeExchange.com to chop that hefty hotel bill? Then there’s the pricey item you need only once or twice. Rent that fancy camera from BorrowLenses.com or see if your area has a tool-lending library where you can borrow a rototiller or other item for free.

2. Take a “Financial Health” Day

To cut regular expenses such as cable, phone, or insurance bills, set aside a few hours to compare rates from different firms or to ask your current provider for a discount, says Joe Ridout of advocacy group Consumer Action: “A lot of companies rely on your inertia to keep business they no longer deserve.”

To really dig in, take a day off to devote to haggling with insurers, banks, and more. Robert Brokamp, a financial planner and writer for Motley Fool, persuaded his firm to set aside a day for employees to deal with finances. “A lot of these things have to be done during work hours,” he says.

3. Tap Technology

Sites and apps that monitor your spending are great for catching expenses that could fall through the cracks. BillGuard, for one, flags mistaken or duplicate charges and allows you to challenge them right from the app.

Technology can also help rein in impulse purchases and find deals on the things you do buy. These top shopping apps and browser add-ons help you pay the lowest price every time you shop online. To avoid the daily deluge of online shopping temptations, use Unroll.me to pull all retailer emails into a single message. Out in the real world, try the GroceryIQ app before you hit the market. Create a shopping list using the app and it will search for coupons for those specific items. Finally, gas may be cheap, but don’t just fuel up willy-nilly; use an app like GasBuddy to get the best price possible.

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  • Day 7: Find Ways to Save More
  • Day 8: Boost Your Earning Power
  • Day 9: Learn How Better Health Can Help Your Finances
  • Day 10: Shore Up Your Safety Net

 

MONEY portfolio

5 Ways to Invest Smarter at Any Age

dollar bill lifting barbells
Comstock Images—Getty Images

The key is settling on the right stock/bond mix and sticking to your guns. Here's how.

Welcome to Day 4 of MONEY’s 10-day Financial Fitness program. So far, you’ve seen what shape you’re in, gotten yourself motivated, and checked your credit. Today, tackle your investment mix.

The key to lifetime fitness is a powerful core—strong and flexible abdominal and back muscles that help with everything else you do and protect against aches and injuries as you age. In your financial life, your core is your long-term savings, and strengthening it is simple: Settle on the right stock/bond mix, favor index funds to keep costs low, fine-tune your approach periodically, and steer clear of gimmicks such as “nontransparent ETFs” or “hedge funds for small investors”—Wall Street’s equivalent of workout fads like muscle-toning shoes.

Here’s the simple program:

1. Know Your Target

If you don’t already have a target allocation for your age and risk tolerance, steal one from the pie charts at T. Rowe Price’s Asset Allocation Planner. Or take one minute to fill out Vanguard’s mutual fund recommendation tool. You’ll get a list of Vanguard index funds, but you can use the categories to shop anywhere.

2. Push Yourself When You’re Young

Investors 35 and under seem to be so concerned about a market meltdown that they have almost half their portfolios in cash, a 2014 UBS report found. Being too conservative early on—putting 50% in stocks vs. 80%—reduces the likely value of your portfolio at age 65 by 30%, according to Vanguard research. For starting savers, 90% is a commonly recommended stock stake.

3. Do a U-turn at Retirement

According to Wade Pfau of the American College and Michael Kitces of the Pinnacle Advisory Group, you have a better shot at a secure retirement if you hold lots of stocks when you’re young, lots of bonds at retirement, and then gradually shift back to stocks. Their studies found that starting retirement with 20% to 30% in stocks and raising that by two percentage points a year for 15 years helps your money last, especially if you run into a bear market early on.

4. Be Alert for Hidden Risks

Once you’ve been investing for several years and have multiple accounts, perfecting your investment mix gets trickier. Here’s a simple way to get the full picture of your portfolio.

Dig out statements for all your investment accounts—401(k), IRA, spouse’s 401(k), old 401(k), any brokerage accounts. At Morningstar.com, find “Instant X-Ray” under Portfolio Tools. Enter the ticker symbol of each fund you own, along with the dollar value. (Oops. Your 401(k) has separately managed funds that lack tickers? Use the index fund that’s most similar to your fund’s benchmark.)

Clicking “Show Instant X-Ray” will give you a full analysis, including a detailed stock/bond allocation, a geographic breakdown of your holdings, and your portfolio’s overall dividend yield and price/earnings ratio. Look deeper to see how concentrated you are in cyclical stocks, say, or tech companies—a sign you might not be as diversified as you think or taking risks you didn’t even know about.

5. Don’t Weigh Yourself Every Day

Closely monitoring your progress may help with an actual fitness plan. For financial fitness, it’s better to lay off looking at how you’re doing. A growing body of research finds that well-diversified investors who check their balances infrequently are more likely to end up with bigger portfolios, says Michaela Pagel, a finance professor at Columbia Business School. One reason: Pagel says savers who train themselves not to peek are more likely to invest in stocks. And research by Dalbar finds that investors’ tendency to panic sell in bear markets has cut their average annual returns to 5% over the past 20 years, while the S&P 500 earned 9.2%.

When you have the urge to sell, remind yourself that your time horizon is at least 20 years, says Eric Toya, a financial planner in Redondo Beach, Calif. “Outcome-oriented investors agonize over every up-and-down whim of the market and make poor timing decisions,” he says. “If your process is sound, you don’t need to panic.”

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MONEY Financial Planning

10 Days to Total Financial Fitness

Bench press with gold painted weights
Gregory Reid

Presenting MONEY's 10-day program designed to pump up your finances for 2015. 

When you think about what kind of shape your finances are in nowadays, you may be feeling downright buff. Retirement plan balances are at record highs, home prices are back to pre-recession levels in most parts of the U.S., and the job market is the strongest it’s been since 2006.

No wonder Americans are more optimistic about their finances.

Given that, it’s understandable that some bad habits may be creeping back into your routine. Americans, overall, are slipping into a few: Household debt is at a record high, fueled by an uptick in borrowing for cars and college and more credit card spending. Vanguard reports that investors are taking risks last seen in the pre-crash years of 1999 and 2007.

What’s more, the financial regimen that’s been working well for you of late may not cut it anymore. In this slow-growth, low-interest-rate environment, both stock and bond returns are expected to be below average for several years to come.

To pump up your finances in 2015, you need to shake up your routine. The plan that follows can help you do just that. Every day for the next two weeks, we’ll target-train you for a different financial strength. This program includes seven quick workouts, inspired by the popular exercise plan that takes just seven minutes a day, that will push you to raise your game in no time at all. What are you waiting for?

See What Shape You’re In

Even if you’re a dedicated exerciser, you could be ignoring whole muscle groups, leaving yourself susceptible to injury. For example, 39% of people earning more than $75,000 a year wouldn’t be able to cover a $1,000 unexpected expense from savings, according to a 2014 Bankrate survey. So the first step is to establish your baseline by asking yourself these questions.

How are my vital signs? Tick off the basics: Check your credit, tally up your emergency fund (aim for six months of living expenses), look at how much you are contributing to your retirement plans, and get a handle on how you’re splitting up your savings between stocks and bonds.

Less than half of workers have tried to calculate how much money they’ll need for retirement, EBRI’s 2014 Retirement Confidence Survey found. Take five minutes to use an online tool that will show you if you’re on track, such as the T. Rowe Price Retirement Income Calculator.

What’s my day-to-day routine? The very first thing Rochester, N.Y., CPA David Young does with his clients is go over their spending. Budgeting apps, he notes, “make the invisible credit card charges visible.” As important as the “how much” is the “on what,” says Fred Taylor, president of Northstar Investment Advisors in Denver. Divide your expenses into the essential costs of living, investments in your future (savings, education, a home), and the discretionary spending you have the flexibility to cut.

Am I juicing my finances too much? In other words, how toxic is your borrowing? Your total debt matters. But the kinds of debts you have and the implications for your future are crucial too, says Charles Farrell, author of Your Money Ratios and CEO of Northstar. As a young saver, you shouldn’t be worried about high debts due to a house and education, Farrell says, as long as you can handle the payment, will be debt-free by your sixties, and are using debt only to fund investments in a low-cost or high-earning future, such as a low-maintenance home or new job skills. Farrell suggests in your twenties and thirties you should limit total mortgage debt to less than twice your family income. In your fifties, you should have a mortgage no higher than what you make. At any age, total education debt should not exceed 75% of your pay.

What’s my biggest weak spot? You need to guard against familiar risks, like insufficient insurance. But David Blanchett, head of retirement research for Morning-star, says you should also think about less obvious threats. Will new technology put your livelihood at risk? Are you counting on a pension from a financially shaky firm? Do you live in an area, such as Northern California, where home values hinge on the success of one industry?

Once you know how much progress you’ve made so far and what areas need the most work, you’re ready to get going on your financial fitness plan.

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MONEY College

The Most Important Thing to Know Before Applying to Grad School

two diplomas two graduation caps stacked
Wendell and Carolyn—Getty Images/iStockphoto

A record number of college students think they'll need a master's to land a job. They'd be smart to weigh the costs against the benefits before applying.

Four years of college is no longer enough to give you an edge in the job market—at least that’s what most of the nation’s college students seem to believe.

More than three-fourths of freshmen at four-year colleges plan to go to graduate school, according the latest in a 49-year long UCLA survey of the attitudes of college first-years. (More than 150,000 full-time students at 227 universities were polled.)

That’s up from 51% in 1974, and only slightly below the record sent in the depths of the recent recession, says Kevin Eagan, interim managing director of UCLA’s Higher Education Research Institute.

Usually, interest in grad school spikes during economic downturns. But with the economy healthy, there’s clearly something else going on.

“The percentage of freshmen who think it is important to be well-off financially is at its highest point ever—more than 82%,” explains Eagan, “and during the recession these students were hearing of all of these folks with bachelors’ degrees who were unemployed. So they are recognizing that in order to achieve their objective they need additional credentials.”

Higher Degrees = Higher Pay

Indeed, recent evidence indicates that those with more education have better job prospects. The unemployment rate for those with professional degrees is almost half of the 4% rate for those with just a bachelor’s, for example.

And an analysis by the Georgetown Center on Education and the Workforce found that while the average bachelor’s-degree holder earns about $2.3 million over a lifetime, a master’s degree holder typically earns about $2.7 million and a professional degree earner typically takes home $3.6 million.

Higher Pay ≠ Fast Payoff

But Eagan and other analysts who’ve crunched the numbers say that graduate degrees are also an expensive gamble—and in some cases, have low odds of a financial payoff.

Tuition and fees for a two-year master’s program exceed $20,000 at the average public college, and $45,000 at the average private school. The tuition and fees for a degree from an elite graduate program such as Harvard Business School totals more than $120,000. Living costs can another $12,000 to $24,000 per year, depending on location. All together, you’re looking at a considerable expense on top of the more than $28,000 in undergrad debt new grads who borrow are carrying.

Plus, many graduate programs don’t result in big salaries.

Besides, in some fields, those with advanced degrees aren’t immune to the challenges of finding a job: For example, Eagan says he cautions students pursuing PhDs in humanities about the low odds of finding full-time jobs as professors, as more colleges are replacing tenured instructors with part-time adjuncts.

When a Grad Degree Makes Sense

Wondering if continuing your education pay off for you? There are three situations in which going back to school will put you ahead, according to several recent studies:

  1. You are aiming for a job in a field that either requires a graduate degree or in which employers use graduate degrees as a hiring screen. Besides the traditional graduate-degree-requisite jobs of doctor, lawyer and professor, a growing number of jobs require graduate study, including as librarian, social worker and physical therapist.And, in a study of 19 major employers, Sean Gallagher, an administrator at Northeastern University, found that a growing number of human resources administrators are giving preference to job applicants with masters’ degrees, and that masters’ often helped in competitions for promotions.
  2. You need the degree to get the public service career you want anyway. Students who use the federal direct Stafford and PLUS loan programs to borrow the full cost (including living expenses) of their graduate study and then spend 10 years working for a government agency or a non-profit can have much of their graduate school expenses forgiven under the government’s Public Service Loan Forgiveness program.According to research by Jason Deslisle, director of the federal education budget project at the New America Foundation, a new veterinarian with the typical education debt load of $132,000 who gets a government job and signs up for Income-Based Repayment (which caps payments at 10% of disposable income) will likely pay a total of only $36,000 in debt payments over 10 years. After the 120th on-time payment, the government would forgive a total of $147,000, which is all of the original debt, plus some unpaid interest. But beware: if you don’t end up making 120 on-time payments while working at public service, you will likely either have to pay off your debt in full, or have to keep making on-time income-based payments for at least 20 years, after which you may be eligible to have any remaining debt forgiven.
  3. You are in a field in which graduate degrees tend to lead to higher earnings. The Georgetown study found that graduate degrees typically add about $1 million to the lifetime earnings of, for example, chemists and financial professionals. But graduate degrees appear to have little overall impact on the average earnings of writers, editors, architects and many kinds of health-related therapists, such as audiologists. You can see the affects of advanced degrees on other occupations by viewing the full report.

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MONEY Airlines

These Airlines are Offering In-Flight College Classes

Learning in the skies
Dennis Helmar

Your legroom may be shrinking, but at least you can now expand your mind.

Just because you’re on an airplane doesn’t mean your head has to be in the clouds.

In addition to the usual fare of straight-to-DVD movies that will certainly rot your brain, two airlines have recently begun serving up some smarter in-flight entertainment to their passengers: complimentary audio and video of interesting college lectures.

In December, Jet Blue started streaming recorded lectures from some of the nation’s most elite courses, including marketing classes from University of Pennsylvania’s Wharton School, a Brown University archeology class, and an introduction to guitar and rhythm from the Berklee School of Music. The college lectures are pieces of full courses that are available free through Coursera, a platform for massive open online courses (a.k.a. MOOCs).

Jet Blue also offers video cooking lessons such as “How to brine meats” and “How to read labels on chocolate,” provided by a company called Rouxbe.

On February 1, Virgin America started offering audio and video from the “Great Courses,” a series of recorded lectures from top-shelf professors. Among the talks available: Neil deGrasse Tyson, director of the Hayden Planetarium on “The Inexplicable Universe: Unsolved Mysteries” and David Christian, history professor at Macquarie University in Sydney, Australia, on “What is Big History?”

Both airlines said they would rotate in new lectures every month or two—about how often some college kids attend class.

Gary Leff, a frequent business traveler who blogs at Viewfromthewing.com, says that while he usually works during flights, the college lectures would be at the top of his list for distractions. And he thinks they may be a pleasant surprise for many travelers: “People seem to like the serendipity” of unexpected audio and videos on long flights, he says.

Of course, the free lectures also allow organizations such as the Great Courses and Rouxbe, both of which charge for their entire courses, to market their content to a very captive audience. On the upside for passengers, that likely means other airlines will announce educational content alliances, Leff predicts.

Unfortunately, you won’t get a degree from attending school in the sky. But at least while you’re onboard you can learn something besides the appropriate way to apply an oxygen mask.

MONEY alternative assets

The Risky Allure of ‘Go-Anywhere’ Bond Funds

It's okay to let your bond managers roam, just don't let them run completely wild.

This is the fifth in a series of five articles looking at the most popular bond alternatives and the safest ways to use them to improve your income prospects when rates are low. Adapted from “Reaching for Yield” in the January/February issue of MONEY magazine.

At a time when traditional routes to investment income aren’t paying off, it’s only natural to seek out pros who are willing to go off the beaten path. Enter “unconstrained” bond funds.

The appeal of these actively managed portfolios is that they’re not bound to invest only in the low-yielding government and corporate debt. Instead, they buy anything—foreign debt, asset-backed securities, stocks, preferreds, and even derivatives—to boost yields and hedge against price drops if interest rates rise.

Sounds good in theory. Alas, there’s no proof that derivatives and other exotica lead to better results. Pimco Unconstrained Bond, one of the biggest funds in the group, is up 2.8% annually over the past three years—that’s less than the plain-vanilla Vanguard Total Bond Market Index Fund. Plus, unconstrained bond funds are expensive, with average fees of 1.3% of assets, vs. 1% for the average bond fund and 0.28% for bond index funds.

Your best strategy: Let your managers roam—just don’t let them run completely wild. Before unconstrained bond funds came along, investors who wanted to give their managers a longer leash turned to multisector bond funds. These fixed-income portfolios also allow managers to invest in a wide variety of assets, such as junk and foreign debt, in addition to high-quality bonds. However, these funds typically set boundaries over what those areas are—and how much of the fund can wander there. This reduces risk, which should help to limit losses in bad markets. The approach also results in lower costs; the typical multisector bond fund has annual fees of 0.8% of assets.

T. Rowe Price Spectrum Income ­T. ROWE PRICE SPECTRUM INCOME RPSIX 0.08% , for instance, can stray into emerging-market bonds and floating-rate bank loans, but only up to 10% of assets for each. This has been enough freedom for Spectrum Income to beat the Barclays Aggregate U.S. Bond index over the past three, five, 10, and 15 years. The same goes for Loomis Sayles Bond LOOMIS SAYLES BOND FUND RET LSBRX -0.2% , a MONEY 50 fund that has also ­beaten at least 80% of its peers over the past three, five, 10, and 15 years.

Recognize, though, that while boosting your investment in multisector bond funds and other alternative assets can help boost your yield, the strategy isn’t a cure-all. Shifting 20% of a portfolio split fifty-fifty between stocks and traditional bonds into a mix of higher-paying alternatives might raise your yield from about 2% to 2.6% with little additional risk, says Geoff Considine, who runs the portfolio modeling firm Quantex. If you’re retired, that means you’ll still probably have to rely on principal and capital gains to fund at least some of your living expenses.

You might prefer to just cash dividend checks to pay the bills and leave the rest of your savings intact—but in reality, where you pull the money from isn’t that important, says Chris Philips, a senior investment analyst at Vanguard. Says Philips: “What really matters is maximizing the total return of your whole portfolio.”

More in this series:
The Smart Way to Invest in Dividend Stocks
High-Yield Bonds: Where to Look for Quality Junk
How Real Estate Can Boost Your Income in Retirement
How to Boost Returns When Interest Rates Totally Stink

MONEY alternative assets

Finding Bargains in Cheap Oil

With oil plunging, these energy investments no longer look as expensive as they did last year.

This is the fourth in a series of five articles looking at the most popular bond alternatives and the safest ways to use them to improve your income prospects when rates are low. Adapted from “Reaching for Yield” in the January/February issue of MONEY magazine.

Like the real estate investment trusts we mentioned previously, master limited partnerships pass on to investors most of the income they generate from their core business, typically storing or transporting oil, natural gas, and other energy resources. And like REITs, MLPs spent much of 2014 looking frothy. In the 10 years through September, these shares nearly doubled the gains of the S&P 500. As a result, by fall MLPs were yielding only 2.7 points more than 10-year Treasuries, vs. their typical premium of 3.2 percentage points.

Since then, the partnerships have suffered a sharp reversal. As fears of a global slowdown grew, oil prices slid by more than half to $46 a barrel, and skittish investors started dumping MLP shares. That has pushed the average MLP yield up to 6.2%, which means they’re now paying more, relative to Treasuries, than they have historically.

Many analysts believe the panic has been overdone. While a minority of MLPs are involved in drilling and oil production, most are pipeline companies that simply collect transmission fees, with much of their revenues set by long-term contracts.

Still, these complex investments aren’t for everyone. As a result of the partnership structure, payouts from MLPs are considered a return of capital, on which taxes are ­deferred until you sell. That tax ­benefit can create a paperwork nightmare, since you may have to file separate tax returns in states the company operates in so there is a government record of the income you’ve received, notes Tom Roseen, head of research services at Lipper. You can invest via a fund that will eliminate the need to file, but that is likely to reduce your returns.

Your best strategy: Since these are still rocky times in the energy sector, your best bet is to go with a fund that gives you exposure to a diversified collection of MLPs. Stick with a fund that focuses on pipeline companies and that won’t tie you up in tax knots. That means investing via an ETF that’s set up as a corporation, not as a partnership.

One fund that meets all the criteria, says Kinney: the Alerian MLP ETF ALPS ETF TRUST ALERIAN MLP ETF AMLP 0.77% , which tracks an index of pipeline MLPs. It paid out 6.25% last year. But thanks to the pullback in share prices and a 4% hike in its distributions in 2014, buyers are likely to collect a yield of almost 7% in 2015. Because it is a corporation, not a partnership, Alerian can’t defer taxes on its payouts; that gets rid of the hassle of filing multiple state returns every year. But convenience comes at a price: The tax bite dampens Alerian’s total return relative to other MLPs. If you’re focused on income, though, that 6% to 7% yield may be ample compensation.

More in this series:
The Smart Way to Invest in Dividend Stocks
High-Yield Bonds: Where to Look for Quality Junk
How to Boost Returns When Interest Rates Totally Stink

MONEY alternative assets

How Real Estate Can Boost Your Income in Retirement

REITs have been hot for a while. But there's still a corner of the market that has room for growth.

This is the third in a series of five articles looking at the most popular bond alternatives and the safest ways to use them to improve your income prospects when rates are low. Adapted from “Reaching for Yield” in the January/February issue of MONEY magazine.

High demand over the past year for the traditionally lofty yields on ­real estate investment trusts—the trusts are required to pay out 90% of their profits—has led to spectacular returns. Among the most popular REIT funds, for example, iShares Real Estate Fifty ETF and longtime MONEY 50 member Cohen & Steers Realty both gained more than 27% in 2014.

The rally has resulted in skimpy payouts for new investors: REIT index funds were yielding about 3% by year-end, far below their 7.5% historical average.

That’s led many analysts, such as Brad Thomas, editor of The Intelligent REIT Investor newsletter, to urge investors to be very picky about where they put new money. One pocket of opportunity now, he says, can be found in health care REITs, which specialize in leasing space to nursing homes, hospitals, and other medical facilities and will profit from the aging of the population. While their high P/Es may be off-putting—some are selling at more than 40 times earnings—a better way to assess REITs is to look at their funds from operations, or FFO. Whereas reported earnings treat depreciation on real estate holdings as an expense that lowers results, FFO adds depreciation back, which more accurately reflects the value of a trust’s property. Using that metric, health care ­REITs look relatively inexpensive, trading at 14.5 times FFO, compared with the industry’s average of 15.5.

Your best strategy: While you’re usually better off investing via mutual funds and ETFs, there are none now that substantially overweight health care trusts. That’s why ­Thomas and Morningstar senior REIT analyst Todd Lukasik instead favor individual health care REITs.

Both, for example, are fans of Ventas VENTAS VTR 0.94% , which owns about 1,500 senior housing communities, skilled nursing facilities, and similar properties in the U.S. and Britain and was recently selling for 15 times FFO. Ventas raised its dividend 9% in December, giving it a yield around 4%. They also like HCP Inc. HCP, INC. HCP 1.39% , which owns $22 billion worth of medical-related property. It is selling for 12 times FFO and yields 4.5%.

More in this series:
The Smart Way to Invest in Dividend Stocks
High-Yield Bonds: Where to Look for Quality Junk
How to Boost Returns When Interest Rates Totally Stink

MONEY alternative assets

High-Yield Bonds: Where to Look for Quality Junk

High-yield bonds are paying more than they did a year ago, but investors still need to stay away from the junkiest junk.

This is the second in a series of five articles looking at the most popular bond alternatives and the safest ways to use them to improve your income prospects when rates are low. Adapted from “Reaching for Yield” in the January/February issue of MONEY magazine.

Falling oil prices have really pummeled the high-yield bond universe, where energy issues make up 15% of the market. Worried that these developments raise the risk of defaults for junk—issues rated BB+ or ­lower —investors have been selling their bonds. That has driven yields up sharply as new buyers demand higher payments to offset greater risk.

That’s a big change from last year, when you might as well have called these securities the “bonds formerly known as high yield.” Halfway through 2014, amid high demand, junk was paying just 3.4 percentage points more than Treasury securities of similar duration—well below the long-term average premium of 5.8 points and a world away from the yawning 20-point gap during the financial crisis in late 2008.

Now the yield gap is back near the norm. “The spreads are close to fair value,” says Marty Fridson, chief investment officer at Lehmann Livian Fridson Advisors. Fridson believes the fall in oil will turn out to be a positive for junk investors: “Eventually the economy will benefit from lower oil prices, which will help the 85% of high-yield bonds not in the energy sector.”

Stay away from the junkiest junk, though, where yields aren’t good enough to justify the higher default risk, says Gershon Distenfeld, director of high yield at AllianceBernstein. According to Standard & Poor’s, 65% of issues rated CCC to C historically have defaulted within five years, compared with 3.4% for BB-rated bonds. Sure, the C’s yield a lot more—11.3%, vs. 5% for BB’s—but that won’t matter if the issuer stops making payments.

Your best strategy: Focus on funds that overweight bonds rated BB+ through B, which are still paying roughly twice as much as Treasuries. Jeff Tjornehoj, head of Lipper Americas Research, calls USAA High Income Fund USAA HIGH-YLD OPPORTUNITIES FD USHYX 0.12% “a stellar performer” because of its ability to manage risk while still providing high returns. The fund was recently yielding about 6% and has only 8% of its holdings in C-rated bonds. Morningstar analyst Sarah Bush also praises the conservatism of Vanguard High-Yield Corporate VANGUARD HIGH-YIELD CORPORATE INV VWEHX 0.17% , yielding 6%. The fund has 93% of its portfolio in bonds rated B or better and a ­razor-thin expense ratio of 0.23%.

More in this series:
The Smart Way to Invest in Dividend Stocks

MONEY 529 plans

Why Obama Wants to Tax College Savings

U.S. President Barack Obama delivers his State of the Union address to a joint session of Congress on Capitol Hill in Washington, January 20, 2015.
Mandel Ngan—Reuters

In this week's State of the Union address, the president proposed ending a popular tax break on 529 plans. Here's what's behind that pitch.

In his State of the Union address Tuesday, President Obama promised to make college more affordable for low- and middle-income families. But one way he would pay for that would be to make college more expensive for millions of upper-income Americans.

The president proposed ending a key tax break on state 529 college savings plans. Today, the money you invest in a 529 plan isn’t deductible on your federal taxes (34 states and the District of Columbia give you a break on state taxes), but your savings grow tax-deferred, and you won’t owe any taxes on your earnings when you withdraw that money to pay for higher education expenses, including tuition, room and board, and books. Under Obama’s plan, those investment profits would be taxable, even if the money went toward college.

President Obama says he’d use the estimated $2 billion in additional tax revenues to raise the American Opportunity tax credit, which is a $2,500 write-off targeted at low- and middle-income families paying tuition bills. The administration points out that 529 plans disproportionately benefit higher-income households.

In essence, Obama is proposing making college more expensive for an estimated 2 million mostly upper-income families to ease the tuition burden for more than 8.5 million low- and middle-income families.

A Question of Fairness

This proposal—which is already facing Republican opposition in Congress—is based on concerns about the fairness of the 529 tax breaks that have been widely discussed among education-related think tanks and experts of all political leanings for years.

In all, federal taxpayers spend more on educational tax breaks than they do on popular financial aid programs such as Pell grants, noted a 2013 report by the Reimagining Aid Design and Delivery (RADD) Consortium for Higher Education Tax Reform. Not only are all the education tax breaks confusing and hard to collect, “students from families with the least financial need receive the most tax-based aid,” the report noted.

In theory, 529 plans aren’t just for the rich. Anybody can open one of these tax-protected colleges savings account for a child or for themselves. You can choose either a prepaid tuition plan, which lets you buy tuition credits ahead of time, or a college savings plan, which lets you set money aside for a future college student.

That tax break that the president wants to eliminate has been a key to 529 plans’ popularity. Since President George W. Bush signed the 529 tax exemption into law in 2001, families have opened nearly 12 million new 529 accounts and have socked away almost $250 billion for college.

And states have been marketing the savings programs. In 2012, the GAO found that 14 states offered matching grants to encourage low-income families to save. Some states even offered 529 brochures to new parents leaving the hospital.

Despite these efforts, very few low- or middle-income families have managed to save very much in 529s. In 2012, more than 97% of families had no special college savings account, according to a Government Accountability Office report. (The large number of accounts may be due to some families opening separate accounts for each child and parent.)

One reason for the low participation: Many still don’t know about 529s. Of parents who say they’re planning to send their kids to college, 49% don’t even know what a 529 plan is, Sallie Mae found in its annual “How America Pays For College” report.

Another factor: Low and middle-income families pay comparatively low taxes, so the tax break is not much of a lure to lock up money for one purpose. Families can take money out of 529s to spend on non-college expenses, but they’ll have to pay regular income taxes, plus an extra 10% penalty, on any earnings.

As a result, 529 investors tend to be wealthy. Families with 529s earned a median annual income of $142,400 and reported a median of $413,500 in financial assets, according to the GAO. About half of families with 529s (or similar Coverdell accounts) had an income above $150,000 in 2010.

And, in part because high earners typically owe higher taxes, the wealthy reaped large tax breaks from using 529s. In 2012, the GAO found that Americans who made less than $100,000 withdrew a median $7,491 from their 529s, saving just $561 on their taxes. But Americans who earned more than $150,000 withdrew a median $18,039, saving $3,132 in taxes.

In place of the tax break at withdrawal, Obama wants to expand the American Opportunity Tax Credit, which is currently phased out for families earning more than $180,000 a year.

The administration would like to expand the write-off to more students, such as those who attend college part-time. “It’s targeted in such a way that it will be most impactful to the students who need the assistance the most,” says Cecilia Muñoz, White House domestic policy director.

What Changes You’ll Really See

What does this all mean for you: Not much, at least for the near term.

If you’ve already got money in a 529, don’t worry. The president’s plan wouldn’t be retroactive. It would repeal the tax break on earnings only for future contributions.

And if you’re planning to start saving for college, there’s probably not much to worry about either. Republicans, who control both houses of Congress, have come out in opposition to the proposal. “You don’t produce a healthy economy and an educated workforce by raising taxes on college savings,” Brendan Buck, a spokesman for Rep. Paul Ryan, R-Wis., told the Wall Street Journal.

That means there probably won’t be extra money in the budget for much additional financial aid for low- and middle-income families. So you may as well start saving for tuition bills. Here’s how to find the best 529 plan for you.

Correction: An earlier version of this story misstated the proportion of new tax revenues that would come from families earning above $250,000 if Obama’s proposal was enacted. The reference has been removed.

 

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