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7 tips to safe college savings investments
Posted: 2010-04-02 - Erin Peterson is a freelance writer based in Minneapolis.
Today's volatile stock market can make investing in a college savings plan a stomach-churning affair, but it doesn't have to be.
While it's easy to assume that the return on investment is directly proportional to the risk you take, that's not always the case, says Rebecca Pavese, client service manager at Palisades Hudson Financial Group in Atlanta.
"In some cases, you can take on a very small amount of risk but still get a higher return, and that increase in return will significantly outweigh your increase in risk," she says.
Consider a few of these lower-risk college savings options to boost your account balance without giving yourself volatility-induced vertigo.
Try a conservative track on an age-based plan. Not every 529 plan's age-based option is alike, says Mary McConnell, director of college savings products for Charles Schwab in San Francisco. While they all follow the same general philosophy, which is to start aggressively and grow more conservatively over time, not all plans are equally aggressive at the beginning.
"(Many age-based investment options) have different risk tracks," she says, noting that they range from very aggressive to moderate to conservative. "These tracks give clients more options to invest in what they're most comfortable with in terms of risk. Not only that, but age-based plans take the burden off of people of having to make decisions themselves. The investments are professionally managed. It's a buy-and-hold type of strategy."
Consider a prepaid option. Several states have a prepaid 529 plan, in which investors prepay for a portion of future college expenses. The essential benefit is that you lock in those costs: Once you've paid the plan's price, it becomes the obligation of the plan to deliver the promised benefits down the road.
"If you're looking for a less risky option, this is the direction I would go," says Russell Dunkin, Certified Financial Planner at McKinley Carter Wealth Services in Wheeling, W.Va. "If you have a newborn and can start making payments, you could see dramatic results."
Try money market funds or an equivalent. Money market funds and other similar options invest in a combination of CDs, commercial paper, short-term notes and U.S. Treasury obligations.
"At this point, there is very little difference between a savings account and these diversified funds because they're all working off of the federal rate, which is very low," Pavese says. "Over time, however, a diversified fund of these various investments would do better than a straight savings account. The two options might never diverge significantly, but you'll get a bit better return with this type of fund."
Select a short-term portfolio. A short-term portfolio is designed to minimize risk during the last few years of an investment, but the same portfolio can be used for those who just want to lower the volatility in their portfolio.
"Short-term portfolios are typically made of up some bonds and money market funds," says McConnell. "That gives clients a very stable investment but with a bit of potential for growth."
Choose a bond index fund. Bonds have tended to be a safe haven for investors, and by choosing the full spectrum of bond options through an index fund offered by your 529 plan, you can get more security without forgoing the chance of a reasonable return.
"Bond funds tend to take on investments with an average duration of two to five years and a mix of government, corporate and international dollar-denominated exposure," says Pavese. "A diversified bond fund is a good, low-risk option."
Get long-term certificates of deposit. Because CDs are insured by the FDIC, they have no potential for loss. Offered through a number of 529 plans, they carry a guaranteed return and are backed by the federal government.
"These are basically bank CDs, with terms ranging from a few months to 10 or 12 years," says Dunkin. "Rates vary from a half-percent all the way up to 5 percent or so if you look long term. There aren't many other options out there where you know you're not going to lose and you're going to get a 4 percent or 5 percent return."
Remember that investment performance isn't the only risk to consider. You may loathe the idea of losing even a dime of your investments for college, but keep in mind that the risks in your investments need to be balanced by the risk of not keeping up with college costs.
"Investing conservatively has real trade-offs," says Pavese. "Accepting a low return in comparison to a high annual inflation rate for college -- roughly 6 percent to 7 percent -- is an inherent risk."
After all, earning 2 percent on an investment in a year when costs go up by 6 percent is essentially the same as losing 4 percent. Do your best to mitigate these risks by investing wisely and taking advantage of all the perks of college savings.
"If you use a low-risk option, make sure you're taking advantage of all potential state income tax benefits," says Pavese, adding that you should choose a college savings plan that has low fees.
Posted April 2, 2010