How to Make the Most of Your College Savings

NEW YORK (MainStreet) – Most parents try to set something aside for college costs, but although many put a lot of thought into just how to invest this money, many overlook an equally important question: when to shift out of growth-oriented investments like stocks and into bank savings or other cash vehicles that are safer?

Do it too soon and you could miss substantial investment gains. But if you wait too long, you could be forced to sell stocks or bonds during a downturn to meet the next semester’s bills and lose money as a result.

It’s an especially tricky dilemma today, because the stock market is unusually volatile, while bank savings are unusually stingy.

People saving for a 30-year retirement face a similar decision but have more margin for error, because they have options like working a few more years or tightening the budget. For most college savers, the shift to cash has to be done right the first time, so the money will be available during that narrow four-year window.

Because the financial markets are so unpredictable, there’s no guaranteed way to pick the optimum moment to shift college investments to cash.

If the accounts are fat – big enough to pay four years of tuition, room and board at a pricy private college – it can make sense to get out of stocks and other volatile holdings well ahead of time, to avoid the risk a market plunge would wipe out some of those savings.

Keep in mind, though, that college costs often rise by 6% or 7% a year. With many cash accounts yielding less than 1%, your college savings could easily fall short if you move everything to cash five years before college starts.

Most families don’t have enough set aside to pay 100% of college costs, and they want to get the best investment gains they can for as long as possible.

For guidance on timing the switch to cash, it’s worth seeing how the pros do it. Like a number of mutual fund companies, The Vanguard Group offers a series of age-based college savings portfolios in its tax-free Section 529 plans.

For people with children 5 or younger, Vanguard’s moderate-growth option puts 75% of assets into stocks, 25% into bonds and nothing in cash. A conservative option is 50% stocks, 50% bonds, while an aggressive one is 100% stocks.

As the child gets older, assets are gradually shifted to bonds, and eventually to cash, trading growth for safety.

The moderate option moves 25% of assets into cash when the child is 16, leaving the rest of the account in bonds. This balance is maintained thereafter. The conservative portfolio puts 25% into cash when the child turns 11, while the aggressive one waits until age 19. (Check the Vanguard website for details on the conservative and aggressive portfolios, and to see how the portfolios move from stocks to bonds.)

So, as a rule of thumb, savings for the first year of college could be shifted to cash as early as the child’s 11th birthday, though many people would wait until age 16 – two or three years before college starts.

Note, however, that the move out of stocks begins much earlier, as a shift from stocks to bonds that gradually reduces the portfolio’s assumed risk. In fact, all three portfolios start the process quite early, when the child turns 6. At that point, the moderate portfolio reduces stock holdings to 50% from 75%, while the conservative one goes from 50% to 25%, and the aggressive one from 100% to 75%.

A target-date fund keyed to the child’s expected college start date makes the process automatic, but doesn’t allow the family to adjust as conditions change. If you manage a portfolio on your own, you could shift to cash gradually instead of in big chunks, making the moves when the opportunities are appealing, like selling stocks during an upswing, for example.

Or you could make small moves for a number of months around your reallocation date. That way, shifts that are ill-timed would average out with ones that were well-timed, so you would not have to worry about the best moment for each move.

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