I Be Thinking About
My Kids College Education?
Financial Adviser Urges INVEST NOW
Here Are 5 Tips
With the increases in college tuition and related expenses far outpacing
general inflation, it is important to start the process of college
savings as soon as you can. It may be tempting to remodel your kitchen
this year, but it is far more rewarding in the long run to do the
right thing for your children.
Let the time value of money work for you. Basically, the longer time
that an investment is making money, the greater amount you will have
when that money is needed. Here is a hypothetical example:
Suppose you have an 8 year old child and have 10 years to save for
college. If you invest $100 a month for 10 years at a 10% pre tax
rate of return, you would have $20,482 in 10 years.
However, lets say you wait just 4 years and start investing
at age 12. Assuming you want to catch up and invest $200 a month for
6 years at a 10% pre tax rate, you would have only $15,486. That is
almost 25% less. And youre investing a lot more. These examples
are hypothetical and are not representative of any particular investment
or the possible returns you may receive, but they do demonstrate the
dramatic impact of having time on your side.
A good way to set up an account is through systematic monthly investments
into diversified mutual funds. This is called dollar cost averaging.
First, you identify an amount to be automatically deducted from your
checking or savings account. That money will automatically buy fund
shares each month. When the market is up, you buy fewer shares. When
it is down, you buy more shares. The net effect is an averaging of
the cost on the investment. This also avoids the problem of trying
to "time" when the market will go up or down. However, remember
that using dollar cost averaging does not assure a profit and does
not protect against loss in a declining market. Also, using this method
involves continuous investment in securities regardless of fluctuating
price levels of securities. Therefore, an investor should consider
his/her financial ability to continue purchasing through periods of
low price levels.
Educate Yourself About Some Basic Tax Issues
You may qualify financially to establish an Education IRA. These programs
allow you to set aside $500 in a tax-deferred account specifically
ear-marked for college savings. Education IRAs have tax exempt
benefits that are only available if your income falls within a specified
maximum level. You need to check that your income makes this option
There are also new plans called 529 plans. 529 plans are state-sponsored
investment programs that are given special tax status under Section
529 of the Internal Revenue Code. Forty-one states currently participate
and each state may develop its own program. Each program is different,
but the potential benefits are greatnamely tax deferred college
savings with no income limit. The funding can be made at levels between
$50,000 and $100,000 depending on your state. But remember: You get
a potential tax break, but lose control over how the money is invested.
Be sure to check your states current requirements.
What About A Custodial Account?
Set up a custodial account for college savings or just earmark some
of you own investments for college? UTMA (Uniform Transfer to Minors
Act) or UGMA (Uniform Gifts to Minors Act) account? These are accounts
designed to fund college education expenses and take advantage of
your childs likely lower tax bracket. You are technically making
a gift to your child when you fund these accounts. UTMA/UGMAs
have some distinct tax advantages such as permitting all income within
the account up to $700 per year be excluded if the child is under
the age of 14. After age 14, income and realized gains are taxed at
the childs rate. This results in lower taxes payable at your
higher bracket. The drawback is that it is their money when they pass
the legal age in the state of residence. Your child may decide that
they dont want to go to college after all, but want a new red
Corvette. You then have no recourse, since it is in fact, their money.
Don't Put All Of Your Eggs In One Basket
Whether you are using an advisor or are designing the portfolio on
your own, it is critical that you diversify the portfolio. That way
your returns are not contingent on one single investment. The market
can go up and down as seen in the recent volatility in the Dow and
the NASDAQ. By establishing a strategy based on your risk tolerance
and time frame you can start with two or three different asset classes
depending on the amount you are going to invest. This diversification
will mitigate the risk of concentrating in one market sector because
market sectors go in and out of favor. It also lessens your risk when
you are diversified and one particular sector goes down. Diversification
may help reduce, but cannot eliminate, risk of investment losses.
Historical performance relative to risk and return points to but does
not guarantee the same relationship for future performance. There
is no assurance that by assuming more risk, you are guaranteed better
Mutual funds that invest in stocks are categorized as large, medium
and small cap (capitalization). They can also be further categorized
as value style or growth style or U.S. only or international or a
combination. The S & P 500 index, for example, is a blend of large
cap growth and large cap value. (You cannot directly invest in the
index, only a fund that clones the index). While you may be successful
in picking a hot stock or fund, most people dont have the time
or expertise to do this. Successful mutual fund money managers get
paid lots of money to do this on a full time basis. Their performance
is reported daily and most of them have a performance track record.
This is one of the most critical elements. Money managers leave, market sectors go up and down and stocks get hot then they fall out of favor. Review your performance at least quarterly. See how the overall account performed. More importantly, see how the funds did versus their peer group. Only compare small cap growth funds, for example, to other small cap growth funds or indices of this category. There are services available to do this. Or, if you have financial advisor, they should be able to provide this performance information for you.
We are in a rapidly changing investment environment. With the arrival of the Internet, many more people have access to the same information that a few years ago was available to professional money managers. Whether you are working with an advisor or investing on your own, it is critical to have the discipline to begin as soon as you can. It is equally important to diversify and monitor your performance. These are the key elements to starting a college savings program.
Carol L. Anderson is a registered representative offering securities through Lincoln Financial Advisors Corp., a broker/dealer She can be reached at clanderson@LNC.com
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