One of the best investments you can make for a loved one — whether a child, grandchild, niece or nephew — is an investment in his or her educational future. College graduates with a bachelor’s degree typically earn twice as much, over a lifetime, as those with a high school diploma.1
Given escalating college costs, you may need more than a bank savings account to fund the college of your loved one’s choice. According to 2006 data from The College Board and Standard & Poor’s, the projected average cost for a newborn’s four-year degree at a public college could total almost $125,000. You would have to save $4,232 per year in a savings account earning 5% per year to equal that amount by the newborn’s freshman year. And should the newborn ultimately decide to attend a private college, you would need to add approximately $175,000 to your savings goal, bringing your annual contribution to $10,156.2
But don’t despair. A sound investment strategy, coupled with knowledge of other college financing options, may put your loved one on the road to a valuable four-year degree. Your financial advisor can help you determine how much you will need to save for each child based on his or her age. Outlined below are a few general guidelines to consider.
Final Tuition Bill Due in 12 to 22 Years
With time on your side, your portfolio can potentially withstand a bit of volatility in your quest for higher returns. You may want to consider investing the majority of your college savings assets in stocks, as these investments have historically provided the greatest long-term growth potential based on the S&P 500. For example, a $1,000 investment in a vehicle that mirrored the Standard & Poor’s Composite Index of 500 Stocks at the end of 1986 would have grown to $9,310 by year-end 2006. By comparison, an equal amount invested in lower-risk, lower-returning money market instruments over the same period of time would have grown to only $2,550.3 Of course, past performance does not guarantee future results. Consider the volatility and possible loss of income involved in stock investing and your ability to wait out potential fluctuations in the value of your college savings.
Final Tuition Bill Due in 8 to 11 Years
As your future scholar gets older, you may want to complement a stock portfolio with a fixed-income element to balance risk. Also, consider encouraging your loved one to save a portion of dollars earned through paper routes, babysitting and other jobs in a college account.
Final Tuition Bill Due in Less Than 8 Years
You may start allocating more of your portfolio to fixed-income and money market instruments. If you have only a small amount saved, you have a challenge ahead of you, but some cost cutting in other areas of your life may allow you to make substantial monthly investments.
Whatever the age of your future scholar, remember that any investment plan needs a fresh look every year or so to determine whether adjustments need to be made. As the day nears when your loved one goes off to college, preservation of your principal becomes a primary concern, and you may need to adjust your investment strategy accordingly.
Consider All Your Options
Reviewing the time frame available to you is probably your best strategy in seeking to meet college costs, but there are other options to consider as well.
Explore Section 529 Plans. These state-sponsored plans allow individuals to invest in a predetermined investment pool and offer some flexibility in how much you can contribute. But if you invest in a 529 Plan outside of the state in which you pay taxes, you may lose tax benefits offered by the state’s plan. Tax treatment at the state level may vary.
Encourage Savings Gifts. For birthdays or holidays, consider giving Series EE Savings Bonds that will mature close to the time you will need the money for college expenses. These bonds are sold at a 50% discount to face value at maturity. For example, a Series EE paper bond issued today with a face amount of $1,000 costs $500 and will be worth $1,000 in 17 years.
In addition, you may contribute up to $2,000 annually (per beneficiary) to a Coverdell Education Savings Account where earnings can accumulate tax free and withdrawals can be made tax free for qualified education expenses. You may also make annual gifts of up to $12,000, free of federal gift taxes, to a minor. And you can pay any amount directly to a loved one’s college for tuition and fees, with no gift tax consequences. Remember to brief yourself on the tax considerations of each of these gifts so you’re not caught off guard by Uncle Sam.
Together, time and a smart investment strategy are likely to be your best options for meeting the rising costs of higher education.
1Source: The College Board.
2Sources: Standard & Poor’s; The College Board. Data assumes current average college costs for one year of higher education ($30,367 for a four-year private college and $12,796 for a four-year public college) will increase at an average annual rate of 5% per year. Figures include tuition, fees and room and board.
3Performance is for the period December 31, 1986 to December 31, 2006. Stocks are represented by the total return of the S&P 500 Index and money market accounts by 3-month Treasury bills. Past performance cannot guarantee future results. Individuals cannot invest directly in any index. Results include reinvested dividends. Keep in mind that unlike investments, which involve risk and possible loss of principal, bank savings accounts are FDIC-insured.
Copyright © 2007 MWBoone and Associates, LLC All Rights Reserved. MWBoone and Associates is a Registered Investment Advisor. Further disclosures at www.mwboone.com. Securities offered through Linsco/Private Ledger Member FINRA/SIPC.