A Coverdell education savings account (Coverdell ESA) is a custodial account established for paying education expenses for a designated beneficiary. Here are the Coverdell basics:
- The beneficiary must be under the age of 18 or have special needs when the account is created
- Adjusted gross income must be under $220,000 as a married couple or $110,000 for other taxpayers (2021)
- Contributions are limited to $2,000 per year
- Contributions are not deductible
- Investments grow tax-free
- Distributions are tax-free when used to pay qualified education expenses
- Self-directed Investment options: stocks, bonds, ETFs, mutual funds, and REITs
The year after my son was born, I created a Coverdell ESA. While contributions were not deductible like those to a 529 plan (can be at the state level), I was attracted to the fact that Coverdell was self-directed. Rather than be relegated to investment portfolios chosen by someone else as is required under 529 plans, I liked the freedom a Coverdell gave me to choose my own investments. I had been a stock market hobbyist since high school and enjoyed the game. This would be a twofer: saving for college and having fun! Also, I was comfortable with the Coverdell’s $2,000 per year limit. College seemed such a long way off, and $2,000 per year felt okay when holding a one year old child. I thought maybe I should be doing more, but at least I was doing something.
I contributed $2,000 annually from 2008 through 2015. I skipped 2016 and contributed $2,000 in 2017. After that, I stopped contributing. I used a variety of investment strategies, always with stocks and/or options. Along the way, I hit a few home runs in some concentrated positions. I had three value plays that did very well. First, there was a company called Prepaid Legal that was misunderstood and thus undervalued. Eventually a private equity firm came to understand the mispricing and took the company private at a nice premium. The next home run was Whole Foods. It wasn’t as misunderstood or undervalued as Prepaid, but it was languishing and vulnerable. I established a concentrated position and some time later, when activist hedge fund Jana Partners, with whom I had some familiarity, disclosed a large position, I loaded up even more. Shortly thereafter Amazon bought Whole Foods for a premium. The other value play that did well was Tofutti Brands, Inc. Tofutti was an OTC microcap that was run more like a closely held company–all that led to it being undervalued. Eventually, as word spread that the founder and majority shareholder was ailing and then died, the stock moved up as speculators smelled a sale. I sold most of the stock into that strength (but continue to hold a smaller position as we wait on the New Jersey probate process to play out).
In another case, I swung for the fences on a name that was not a value play, but one that I found to be misunderstood at the time. I bought a lot of call options for Snapchat with a strike price of approximately 11.5. Those options became very valuable, and I converted many of them into shares which I eventually sold for a lot more than I paid (although a lot less than they eventually came to be worth–doah!).
Also, through the years, usually during the lulls when I couldn’t find any companies that I liked enough for concentrated positions, I deployed a covered call strategy as best explained in Wade Cook’s “Wall Street Money Machine”. By focusing on relatively small periodic returns comprised of call premiums, dividend captures, and small capital gains, with repetition over time, the covered call technique worked well along with some basic position trading here and there.
Using these various strategies, by the end of 2019 I was able to grow the portfolio enough to cover four years in-state tuition, room, and board for my son. Then COVID hit. Within about a month in early 2020, the value of the portfolio was cut in half. That sucked. Fortunately, although I was full of fear, I held onto my positions and rode the historically rapid market recovery back up. After getting just about back to even, I decided to take a deliberate pause and liquidated almost everything.
Then I spent several months observing, thinking, and waiting. I reflected on how in one month’s time (mid-February through mid-March 2020), about a decade of investing work had been slashed over fifty percent. I considered how fortunate I and other investors were that the market recovered as quickly as it did. I thought about how much time had passed since my son was a baby and how in just a few years he’d be heading off to college. Who knew when the market would drop again? Worse, maybe the recovery wouldn’t be so quick next time.
I decided it was time for a conservative approach–one focused more on not losing than on winning. Thus, today, with my son starting 9th grade, the Coverdell portfolio consists of about two years of college tuition sitting in cash with the rest of tuition, room, and board spread out amongst shares in mostly dividend paying stocks that yield an average just shy of 4%. Any capital gains will be gravy, and any losses will be mitigated by diversification and the dividend yield. With each year that we get closer to my son’s freshman year, I’ll convert more shares to cash. Basically, this game is in the bag. We are in the fourth quarter and we’re far enough ahead that if we play decent defense, we can just let the clock run out. The Coverdell ESA worked. I am grateful.
That’s what I did and am doing. You?
With Love,
P. Gustav Mueller, author of The Present
Relevant Links:
Coverdell education savings account (Coverdell ESA)
Wall Street Money Machine, by Wade Cook (I bought this book about two decades ago at a liquidation sale in a Christian bookstore in Hershey, Pennsylvania that I stumbled into when I was in the area for unrelated reasons. What are the chances? To say the book paid for itself would be the ultimate understatement).