The following investment strategies provide advice on how best to
invest the money you are saving for college. You may also find the
easy savings tips
helpful in this regard.
- Start early. The best investment advice anyone can give is to
start now. It is never too soon to start saving for college. Even the
day the baby is born is not too soon. At 10% interest, money saved
during the first year of a child's life is worth five times as much as
the same amount saved the year before the child enrolls in
- Begin with an aggressive strategy, and switch to a more
conservative strategy when college comes closer. Choose your
investments according to the number of years until enrollment and your
tolerance for risk. For example, you might
start with high yield high risk
investments when the child is young, and gradually shift the college savings
to lower risk investments as college approaches. This can be either
through a change in the asset allocation, or a change in the nature of
the securities in which you invest.
When college approaches, however, you need to have the
money in safer, more liquid form. You don't want to be forced to sell
your investments at a loss, should the market drop, just because you
need the money to pay for tuition. The choice of when to sell should
be based on your evaluation of the performance of the investments, and
not based on external factors.
(Some families stick with low risk
investments from the beginning because they don't want to deal with
the complexity and stress that accompanies high risk investments. But
tuition rates increase at about twice the inflation rate,
you'll need to earn at least 7% to 8%
after taxes in order to keep up with increases in college costs.)
If the stock market plummets when the child is young, the percentage
losses might be high, but the dollar losses are relatively
small. That's because the family most likely has not yet saved a lot
of money in the college savings plan.
Thus a good overall strategy is to have a mixture of high and low risk
investments and to change the proportion as college approaches, with
an aggressive strategy when the child is young and a more conservative
strategy when college is just around the corner.
- When the baby is born, put 75% of the money in high risk
investments and 25% is low risk investments. (Age 1-5)
- When the child enters the 1st grade, put
50% of the money in high risk investments and 50% in low risk
investments. (Age 6-10)
- When the child starts the 7th grade, put 25% of the money
in high risk investments and 75% in low risk investments. (Age 11-15)
- When the
child reaches the middle of the junior year in high school, put
almost all of the money in low risk investments. It is important to
realize any capital gains by December 31 of the junior year in order
to not have them count as income during the financial aid need
Note that if the investments are in a 529 college savings plan as
opposed to a taxable brokerage account capital gains within the plan
do not affect aid eligibility.
Many state section 529 college savings plans offer age-based asset allocation portfolios motivated by such considerations. Such portfolios base their asset allocation according to either the age of the child or the number of years until matriculation. Be aware of the risk associated with your investments.
- Evaluate investment vehicles carefully before investing.
Carefully evaluate all the various investment vehicles before deciding
where to invest. For example, you might be told to invest in tax-free
municipal bonds in order to minimize the tax bite. But you might be
able to find a mutual fund that isn't tax-exempt but which has a
higher yield after taxes. Similarly, growth funds might have a
investing philosophy that seeks to maximize long-term returns, but the
actual returns on other types of funds might be just as good.
Although life insurance and annuity products are sheltered from
financial aid need analysis, using them as an investment vehicle is
not your best option, since the rate of return, after subtracting
fees, commissions and other loads is often very low.
Likewise, some of the section 529 college savings plans have very high
sales charges (as much as 5% or 6%) and expenses, while others may be
Setting up a trust or using the Uniform Gift to Minors Act
might save you a little on taxes, but significantly reduce eligibility
for financial aid.
So always compare investments based on the
net return after all expenses including taxes are subtracted, and
consider the impact on need-based financial aid. It pays to shop around.
Remember that historical
performance is no guarantee of future return, so you should choose
funds based on what you think will do well in the long term, not which
funds happened to do well last year.
Good resources in this area include:
- US Securities and Exchange Commission: SEC Introduction to 529 Plans
- National Association of Securities Dealers:
NASD Smart Saving for College
and Investor Alert on 529 Plans
- Morningstar publishes a
guide to 529 plan performance, as does Money Magazine.
- Reevaluate your investments at least once a year.
If you find that the assumptions behind your investment strategy are
not correct or your risk tolerance has changed, you may want to change
your investment allocations. Remember, you should not sell an
investment just because the market is down, but instead based on how
you feel the investment will do in the future.
- Diversify your investments. Don't put all your eggs in one
basket. If you invest in
stocks, for example, it is better to invest in mutual funds,
since mutual funds spread out the risk over many stocks. This prevents
a significant drop in the value of one stock from affecting your
entire portfolio. You might
find mutual funds which try to mimic the behavior of the market as a
whole, such as the S&P 500, to be a good investment strategy. Such
index funds often have lower fees. Very few managed funds outperform
the indexes on a long-term basis.
Likewise, you may want to invest in a mix of stocks and bonds, so that
your money isn't all in stocks, and keep some portion of the money in
a money market account or savings account.
You should choose approximately four to six
different investments in order to minimize your downside risk.
- Save regularly. Investing a fixed amount of money at regular
intervals (e.g., once a week, once a month)
gets you the benefit of dollar cost averaging, a good investment
technique. It also gets you in the habit of
planning for your future.
If possible, have it done automatically through payroll deduction or
bank drafting (EFT), so that the money is taken out of your bank account
before you have a chance to spend it.
- Save in the parent's name, not the child's name. This
will minimize the impact of the fund on need-based financial aid.
- Save in tax-advantaged savings vehicles. Section 529
plans offer many tax advantages. They allow your
money to grow in a tax-deferred fashion, and qualified withdrawals are
exempt from Federal income tax. Many states also exempt section 529
plans from state income tax, and may even give you a tax deduction for
If you are nervous about investing in stocks and bonds, and just want
to preserve the principal while earning a modest amount of income, you
should seriously consider using a section 529 college savings plan or
a section 529 prepaid tuition plan. Most section 529 college savings
plans offer a money market fund or a protected principal fund, and
some even have a guaranteed option which protects the principal and
guarantees a minimum rate of return (typically at least 3%). Section
529 prepaid tuition plans allow you to lock in future tuition rates at
today's prices, and are typically guaranteed by the full faith and
credit of the state.
- Avoid capital gains starting two years before college.
When college is two years away, move most of the money into
safe investments, such as FDIC insured certificates of deposit or a
money market fund. This
will make the investment more liquid, so that you'll have the money
available to pay the college bills. You don't want to be forced to
sell a stock at a loss in order to pay tuition. Should you
realize a significant capital gain when you sell the stock during the
tax year before applying for aid, not only
will the financial aid formulas charge you for having an asset, but
they'll also treat the capital gains as income. You need to realize
the capital gains early enough so that they don't affect eligibility
for financial aid. (If you did realize significant capital gains the
tax year before applying for financial aid, ask the college's financial
aid administrator for a "professional judgment" review, on the grounds
that the one-time capital gains is not reflective of award year
income and that the formula is effectively double-counting them. Many
financial aid administrators will use their authority to
exclude such capital gains from base year income, if you ask politely.)