In my post yesterday, I mentioned 529 Plans as a great tool to save for college.  I thought I would expound on them a bit today.

A 529 Plan is a investment account in the United States  that allows you to save for college in a tax-advantaged manner. You get to save money for the education expenses of a specific person, called the beneficiary. The plan is named after section 529 of the US Internal Revenue Code.

Each state has its own plan, with significant differences from state to state, but because of the underlying federal legislation, they all have quite a few things in common.

Two Plans

The first thing you should know is that there are actually two types of plans; a pre-paid one and an investment one.

• The pre-paid plan is basically what it sounds like; you pay the current tuition now, and when they go to school, the bill has been paid. In other words, you are paying future expenses with current dollars.  Generally, this is not a good idea. Besides, the problem for most people is they don’t have the money to pay for college; thus, they need to save for it.

• The investment plan is based on investment options in the account, usually mutual funds. Most plans offer quite a few options, both equity and debt based (stock funds and bond funds). You can typically move the money within the account from fund to fund as your needs change. The inner workings (as far as the owner are concerned ) are a lot like your 401K at work; there is the Growth fund, the Aggressive Growth fund, the Risk Free (savings) fund and so on.

The investment plan is best for most folks. While it is administered by the state, the day to day operation is typically out-sourced to a mutual fund company. You are not required to use the plan offered by the state you live in but there may be tax advantages to doing so; do your research or ask your adviser.

Pros and Cons

Pros:

• All growth is income tax free (both state and federal).
• Beneficiary can be changed to another family member.
• Most states do not tax withdrawals as long as they are used for education.
• Withdrawals can pay for tuition, fees, dorm expense, books and almost any educational expense.
• Very High Contribution Limits
• A very attractive estate planning vehicle for those who qualify.
• 529 Plans offer some bankruptcy protection.
• Very low minimum monthly contribution limits, putting it in the range of most budgets

Cons:

The only real con is that some states have outrageous fees. You can use this website to find out the details of your state’s plan and can use it to compare the fees. In fact, sometimes the excessive fees are a good enough reason to abandon your state’s plan in favor of another, even disregarding the tax benefits you get from staying in state.

Perhaps you are struggling to find that oh-so perfect Christmas present for your children or grandchildren. Well, join the club, because it seems like it gets harder and harder each year. You ask yourself if those kids really need another toy, another gadget or more clothes that will just be out of style next year or, much more likely, next month!

Every year, banks all over the US push savings bonds on ill informed grandparents and parents, urging them to buy these bonds to “help pay for college”. While it is no doubt better for their future than the latest ipod, there are much better ways to pay for college.

I suggest that you look into some sort of investment vehicle, such as the 529 plan. The 529 plan (the exact details vary from state to state) allows you to put after tax dollars into an account that grows tax deferred and can be withdrawn tax free for qualified educational expenses. The funds are invested in mutual funds that can be tracked and followed on the Internet or in the local paper and you are allowed to move the money between funds in the plan.

Even if you did not opt to use a 529 plan, or if you live outside the US, it is still a good idea to skip the savings bonds and buy your grandchild a stock or a mutual fund. After all, the sooner they learn about investing in equities, the more likely they are to be comfortable investing when they get older.

With the advent of the internet, the phenomenon of the day trader and near instant access to information, more and more people are focusing on the short term with their investing. This is almost always a mistake.

If you are a short term investor (which used to mean 5 years or less, but in todays hyper-frenzied world is measured in weeks or months), you honestly have no business being in the stock market. Many people have grown used to the near perpetual bull market over the last 30 years (with, admittedly, minor hiccups along the way) and have lost site that participating in the stock market is, in fact, participating in the ownership of a company.

My favorite analogy is that of home ownership. If you were only going to live in a new city for 3 months, you would not dream of buying a house, because you know that, over a three month time frame, you are unlikely to have enough growth to make it worth your while. However, if you will live there for 5 years, it might be worth it to buy, and if it is 10 years then it is an absolute no brainer.

If your time line is less than 3 years and you are buying stock, you are doing more gambling than investing. After all, there is something to be said for having a long term perspective.

There is perhaps nothing that will so affect your success as an investor as your capacity for risk. If you are the sort that freaks out over any loss at all, then you will not be able to invest in the things that will give you the rate of return you need to grow your portfolio at a rapid rate. Similarly, if you are a risk junkie, then you will have access to the potential returns, but perhaps you will not sell at the right time, preferring to let it all ride. (Note, by the way, that there is a profound difference between investing and gambling, but I digress).

In all, it is a search for a balance between a reasonable rate of return and a reasonable margin of safety. The problem, of course, is in your definition of reasonable.

Cruising through the archives of CNNMoney, I found this cute and irreverent test to determine just what sort of investor you really are. While it is very funny, it also contains a lot of truth. While relaxing this weekend with turkey leftovers (if you are in the USA), you may want to check it out.

Have a great weekend, and we will get back to serious investing talk next week, when I tackle the subject of investing time-frames.

If you are like a lot of small investors, you may have an account at E-Trade. If so, you may be comforted by a full page ad they have in today’s Wall Street Journal, where E-Trade maintains it is NOT going under and that all deposits are safe and are fully protected by the FDIC.

On November 9th, E-Trade’s stock declined by 59% (!), [click here for a chart] causing many to wonder if their money is safe and if they should “get their money while they can”. E-trade has put a link on their homepage to a letter from the President of E-Trade, Jarrett Lilien. In the letter, Lillen says, “The credit crunch has had a tremendous impact, but we are taking appropriate and decisive action to manage through it.” Further, on the subject of whether your money is safe, he says this:

Many of you have also asked me about asset protection, so to be clear—your money is safe at E*TRADE FINANCIAL. Here are the facts:

• FDIC insures all E*TRADE Bank accounts to at least $100,000 and Extended Insurance Sweep Deposit Accounts to $500,0001.
• SIPC protects E*TRADE Securities customers up to $500,000 (including $100,000 for claims for cash).
• Additional E*TRADE Securities protection provides up to $150 million per brokerage account, underwritten by London insurers (aggregate $600 million).
• E*TRADE is well-capitalized by regulatory standards.

Only time will tell if E-trade can pull itself out of this, but I would probably not go out of my way to open an E-trade account right now.

Yesterday I got an email from Sharebuilder letting me know that they have been acquired by ING DIRECT. ING Direct is the American banking subsidiary of Dutch-based insurance and banking giant ING Groep NV. I am pretty sure that all Sharebuilder’s customers got this email as well.

Sharebuilder is one of my favorite online brokers and I usually recommend it to Coolinvesting readers, who are mostly beginner investors, mainly because Sharebuilder has no minimum balance to open an account and no inactivity fees.

Time will tell what kind of change this will bring to over 661,000 Sharebuilder’s customers (including myself, and I am sure many of you) who hold over 2 million accounts.

It is still not know what will hapepen to Sharebuilder’s 170 employees, but considering that that the company is looking for a larger office space in downtown Bellevue, it looks like they are about to expand even more.

This acquisition is in line with ING Direct’s aim to become the world’s most preferred consumer bank by expanding geographically and developing its product range, while focusing on growing its mortgage business and investment services,” said Dick Harryvan, ING Group executive board member and CEO of ING Direct, in a statement.

ING paid $220 million to acquire Sharebuilder.

If you were to pick a list of the greatest stock market investors of all time, any serious list would be topped by Warren Buffett. His exploits as the Prime Mover behind Berkshire Hathaway are the stuff of legend, with consistent double digit returns and occasional years when he beat the overall market by 10 percentage points or more. However, the real secret to Buffett’s success is his long term perspective.

Over on Motley Fool, they point out that there are occasional five year periods when even the Oracle of Omaha falls behind the S&P 500 (for a chart, check this one out). If you looked at just that five year period, you would think this guy is an idiot, that he did not know his armpit from third base and why in the heck would anybody follow his advice. Obviously, you would also be very, very wrong.

The real key though, is that Buffett has a 10-20 year perspective, and sometimes much, much longer. After all, this is from the guy who said that his favorite holding period is “forever”.

The original article points out that in addition to his outstanding understanding of the market, Warren Buffett also has tremendous patience (that 10-20 year perspective) and tremendous confidence, as seen in his famous statement that “risk is not knowing what you are doing”.

What sort of time frame are you looking at to meet your investing goals? Let’s talk about it in the comments.

There are many schools of thought when it comes to selecting companies. There are value methods, as endorsed by Benjamin Graham and Warren Buffett. There are technical methods that look at numbers and statistics only. There is the dart board method, the dogs of the Dow and hundreds or thousands of others. I would like to talk about something that can be used in concurrence with any of them. This has been in the news lately and I think it warrants a bit of discussion. How responsible is the company that you are investing in and do their practices match up with your beliefs?

This is a highly individual perspective on investing and is different for each of us. I have invested in a small biotech company that is totally outside the parameters of my usual stock selection methods. I did so because I felt the product they were researching would have a highly positive impact on humanity and I wanted to be a part of that process. I also thought that if when they succeed; I would make a boat load of money.

I spoke to a friend about the company and she asked how they tested their product. I had no idea. She refused to invest unless she knew their methods were ethical and that they didn’t do animal testing. That statement got me thinking about other investments I have made. Do you feel right investing in companies that have huge returns, but have really bad environmental practices? Do you invest in companies that are looking to the future and have positive charitable causes?

Phillip Morris spends a lot of money on educating people on the dangers of tobacco use, but they still make their money by selling a product that is known to kill people as a side effect. It also is a product used more by the uneducated and the poor. They also only make those commercials and provide that education as part of a lawsuit settlement. So can you invest in a company that has practices like that?

I am not making a judgment on them, or on anyone who chooses to invest in them. I just feel that people need to realize what they are getting into and how companies make their money. This issue has become larger as more information gets out to the public and people begin to live their lives to a higher standard. British Petroleum, BP, has started to shift their focus to other energy sources than oil. They have gone so far as to say that the BP now also stands for ‘beyond petroleum.’ Is it just hype in their commercials or do they have a mission that rises above their roots? That is also for you to judge.

Many investment firms now are offering mutual funds that take the socially responsible investing into account. There are funds specifically for alternative fuels and funds for environmentally responsible companies. Other focuses include quality of life, avoiding nuclear power usage, employment policies, community relationships, alcohol and weapons production, just to name a few.

Where do you stand? Again, this is not passing judgment. The purpose is to expose you to the concepts of what is available out there for your consideration.

There are many different factors you can use to select the stocks you choose to invest in. There are also many different tools you can use to screen out stocks that don’t meet your criteria. For the purpose of this article, I am going to use the screener available for free at USA Today. You can work along with me by opening up a new tab and entering this web address: http://markets.usatoday.com/custom/usatoday-com/screener/screener.asp. This is one of my favorite tools, because 1) it’s free and more importantly 2) it allows you to enter in many different factors.

To start off, the main categories of screening are listed on the left side of the page. They are price, volume, fundamentals, technicals and ‘exchange and industry.’ You can use any or all of the factors for your screening process.

Under the price function you can enter a range of prices you are interested in, for instance between 12 and 15 dollars. And then you can look at ones that have risen or fallen a percentage during the day, hour, 15 minute or five minute period. You can also enter if it is trading above or below the 52 week high or low. So just using two of those parameters, if we search for a twelve to fifteen dollar stock that has risen 1% in the past day; press the next button and then choose how you want to view the results. Default settings have been selected already, so you can just push the “show stocks” button and look at what is available. On the day I did this I got 119 different stocks that fit that range.

You can then go back and check out the next area for screening I recommend, which is the fundamentals section. If you use the back arrow function on your browser, you will not lose the criteria selected. The two available tools in fundamentals are the price to earnings ratio (Abbreviated P/E) and the market capitalization. For the sake of discussion, I will enter a P/E of 5 to 10, and a market cap between 100 and 500 million. Press the “next” button and then the “show stocks.” On this particular day that brought the number of stocks that fit the criteria down to one.

By using the tools already discussed you can see how this could help you in your selections. Look at what parameters you think you ideal stock would fit into. Try entering different amounts in the various fields and see what results pop up. The amounts that I used for the example here are not necessarily what you want to look for. They were merely used for illustration purposes.

Maybe you want to concentrate only on companies that have large market capitalizations. That means that you are investing in companies with a worth of over 10 billion dollars. How you set your search parameters is another discussion, the simple fact is you can use this tool to help you to separate the stocks you are interested in from the rest of the market. The more factors you decide to use, the more selective your results will be. You can choose companies that had a constant growth of 15 percent per year for the past five years, past five quarters, etc.

Once you have found the criteria for your stock selection and used this tool to give you some companies that meet that criteria, then you are ready to examine the companies, doing your due diligence, and decide which really looks good to you.

Another good stock screener with tons of features is MSN Deluxe Stock Screener. It is probably the best free stock screener available, and one of my favorite. To access it you will have to use Internet Explorer because it looks like it doesn’t work in Firefox. It is pretty advanced though, so you will definitely have to know what you are doing.

Another good free stock screener is Yahoo Finance Stock Screener. But make sure you check out all three to see which one is the best for you.

Stock screener is truly invaluable tool for finding good stocks so in the future I will talk more about it and how to use is to find potentially good stocks.

Investment clubs can truly be a beneficial way for anyone to learn about investing. These investment clubs are quickly gaining popularity thanks to all of the great information that can be learned from them. However, it would be extremely wise of you to follow some simple and straightforward guidelines before you join any type of investment club. Knowing exactly what you are getting yourself into is an important part of protecting yourself and your assets. 

Local Investment Clubs – Do you enjoy face-to-face socializing, and personal interactions? Joining an investment club that is local to you may be the best option depending on how you feel about face-to-face interacting. In these investment clubs, you typically meet with other members around once a month, and investing professionals and other experts are typically invited to speak at these meetings on various topics.

These meetings are an excellent opportunity for any and all members to learn from past investing experiences and to ask questions of the experts who truly have been there and tried virtually everything. There are plenty of local investment clubs out there; you simply have to know who to ask and where to look in order to find them.

Online Investment Clubs – These investment clubs are meant to offer convenience to their members. Online investment clubs typically have forums or chat rooms that make it possible to post and respond to questions and to participate in text-based conversations. If you have little time to get together in person for some like-minded mingling, it may be best for you to join an online investment club instead.

Investment Capital – After you have determined what type of investment club to join, you have to determine how much money you are looking to invest. Some investment clubs actually have a set minimum in place for how much investing you must do. What makes investment clubs so great is that the investment money is pooled and invested on a joint basis. This means that you do not have to have a lot of investment money from the beginning but can still participate. 

The Investment Period – You absolutely must make sure that you know how long your investment capital is going to be tied up before any single investment is made. Many investment clubs actually have set rules and limits regarding the minimum length of time for a particular investment. Avoid getting stuck paying penalties by pulling money out early, simply by knowing how long you are expected to be a part of the investment for.

Read, and Understand the Fine Print – Before you sign on any dotted lines, make sure that you read over everything completely and thoroughly. You need to make sure that you understand every facet of your commitment, and that you are completely comfortable with whatever conditions and terms are set forth for this investment club. Look for early withdrawal penalties and hidden fees, and avoid them at all costs.

Investing through investment clubs can be an extremely interesting, easy and fun way to learn how to invest and to experience new forms of investing. But it is important for you to make wise decisions and to take care of your assets when investing; otherwise you may not enjoy the experience you were looking forward to.