Saving for College-
College Funding 101
Sending our children to college is a financial goal that needs to be taken
seriously. However, too often the seriousness of this goal causes us to avoid any risk
with our investments planned for college.
Hoping for sufficient funds for future college bills, we sometime choose investments that
we feel assure the return of principal (i.e.: insured certificates of deposit, money
market accounts, U.S. Treasury securities, etc.) But....even though these
investments may provide a good night's sleep now they may fall short of providing the
necessary financial resources when needed.
Consider the facts. Statistics show over the past five years, tuition and fees for public
colleges have risen faster than the inflation rate and private schools.............. the
increase is even greater. If the inflation rate of the tuition fees is larger than the
return on your "college fund", you are in essence "losing money" each
year eventhough you are earning money on your account. The high inflation rate of
education is eating away at your investment return causing your "real rate of
return" (i.e.; purchasing power) to be negative." And.........we haven't yet
considered the income taxes you pay on the earnings each year.
The key to College Funding 101 is to increase to potential for return on our investments
to keep up with tuition inflation while minimizing the exposure to different types of
risk. Generally, this is accomplished by finding the proper balance between fixed-income
(debt) investments and equity investments.
Debt instruments, such as savings bonds and CDs, promise the
investor a designated interest rate during the security's lifetime plus the return of the
initial investment at maturity. However, while debt instruments are usually more
stable and predictable than equity investments, the dollars returned at maturity don't
have the buying power they did when the investment was made. This may make debt
instruments an ineffective hedge against inflation.
Equity investments, like stocks and real estate, represent a
complete or pro-rata ownership in the asset or entity. Equity investments have no
maturity. The value at anytime is whatever another buyer, or the market, is willing to
pay. This supply and demand component causes greater price fluctuation when compared to
debt instruments. Therefore, because the values tend to reflect the changing costs of
related goods and services, equities may be a more effective hedge against inflation.
However, the investment return and your principal is not guaranteed or insured.
Thus, with equity investments you now have "investment risk" rather than
"inflation risk". The degree of investment risk depends on the type of
equity investment chosen. Some equity investments are very safe....and some.....very
volatile. Generally, low risk investments offer a low and high risk offer the
potential for a high rate of return.
What is the proper balance between debt and equity investments? Unfortunately, the answer
is, "It depends." The proper balance depends on factors such as the age of the
child, the rate of return needed to marry your investment amount to your goal, and your
personal tolerance for risk (your good-night's-sleep threshold).
Parents with young children should consider a heavier allocation toward equities. An
abundance of time reduces the impact of short-term market volatility. However, as college
days draw closer, the relative stability of debt instruments like bonds or bond mutual
funds will help minimize any surprises due to market volatility.
Mutual funds are an excellent place to turn as you prepare for college expenses. Most fund
families offer a variety of debt and equity funds. Within each mutual fund, shareholders
benefit from broad investment diversification and professional management. Then, as your
objectives change, you can easily switch all or part of your holdings among the different
funds of the fund family, usually avoiding any additional sales charges. Finally, mutual
funds are very affordable. Monthly investment programs are usually available for a small
monthly investment. Or initial, if you prefer, lump sum minimum deposits of
just a few hundred dollars may suffice..
The single, most important point about college preparedness is to start investing early.
The earlier you start, the more prepared you are.
