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I Be Thinking About My Kids’ College Education? A Financial Adviser Urges INVEST NOW Here Are 5 Tips By Carol Anderson 1. Start Today 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, let’s 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 you’re 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. 2. 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 IRA’s 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 available. 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 great—namely 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 state’s current requirements. 3. 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 child’s likely lower tax bracket. You are technically making a gift to your child when you fund these accounts. UTMA/UGMA’s 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 child’s 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 don’t 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. 4. 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 results 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 don’t 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. 5. Monitor Performance 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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