One of the biggest expenses faced by American families is the cost of a child’s education.
While scholarships and student loans may help bear much of the burden, it’s increasingly crucial that families set money aside in a college fund in preparation for a student’s formative years.
However, it’s often overwhelming to sort out the best method by which to begin saving. Parents tend to, mistakenly, assume that the best way to save is to open an account and make deposits.
But there’s much more to preparing for the costs of education than simply a bank account. There are, in fact, two types of accounts that work best when setting aside money for college and, equally important, there are ways to invest some of that money in order to grow those savings, as well.
The Duality of Savings
Based on my decades of experience as a broker, I have developed a keen understanding of the two ways to save for a child’s education.
The first of which is the 529 plan, which came about in 1996.
This is a tax-advantaged education savings plan sponsored by states or educational institutions.
The big advantage with the 529 plan is that funds withdrawn for legitimate education expenses are not subject to federal or state taxation in most cases. There are gift tax consequences, however, if someone contributes more than $14,000 to the plan in any one year.
Other important characteristics include:
- Whomever sets up the plan is considered the owner of its assets.
- The beneficiary of the plan may be changed without any tax consequences.
- The investment choices are limited to a number of mutual funds determined by the institution offering the plan.
The second and more flexible savings option is a UTMA account.
UTMA stands for the Uniform Transfer to Minors Act of 1986, which is a more flexible extension of the Uniform Gifts to Minors Act (UGMA).
There are major differences between the UTMA and 529 plans.
First, a parent or legal guardian controls the UTMA account. But only until the child reaches the age of 18 or 21, depending on the state in which the account was opened. At the age of majority, the money is then transferred into the child’s custody. He or she may decide not to spend it on education.
Additionally, funds withdrawn from the account are subject to income tax, no matter what the money is spent on.
UTMA accounts are also considered to be the child’s assets, which may make it more difficult to receive financial aid from the government and institutions.
As I stated before, 529 plan assets are considered the assets of whomever set up the account in the first place, rather than ever transferring custody.
Nevertheless, I prefer UTMA accounts based solely on the investment flexibility. Without rigorous guidelines, the money that’s put into a UTMA can be used to invest in just about anything.
The fund choices in most 529 plans, on the other hand, are often index funds. As I’ve discussed on several prior occasions, index funds are a poor investment choice because, in a bear market, they’re a guaranteed loser.
Investing in Zeroes
Now that we know the savings account options, it’s just a matter of figuring out where to start investing that money.
When I was a broker, it was easy – central bankers hadn’t yet gone crazy with zero and negative interest rates.
Clients had the reliable option of taking the safe route and buying zero-coupon Treasuries, also known as STRIPS. That’s because they’re created by “stripping” the interest-paying coupons from a long-term (10 years or more) Treasury bond.
In simple terms, these STRIPS sell at a discount to regular Treasury bonds. For example, today you can buy a $1,000 face value Treasury bond, set to mature in 10 years, at a price of about 81, or $810.
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Clients used to be able to place an order for a batch of zero-coupon Treasuries in the year that their child would be going off to college, and their investment was set.
But of course, back then, yields were reasonable. I remember seeing double-digit yields on these bonds.
Now the yield is a lousy 2%, if you’re lucky.
I would, however, still opt to use these bonds for a portion of the assets in a UTMA account. At the very least, you’re guaranteed a return on your capital with them and they can easily be purchased through most brokerage firms.
Thanks to central bankers, the financial risks involved in saving for college are far greater than ever before. Just to avoid drowning a child in debt, families now have to go out on the risk curve to get a decent enough return.
Another possible investment in the fixed income sector is the PowerShares International Corporate Bond Portfolio ETF (PICB).
Why PICB? Because it only makes sense, in this day and age, to invest where the central bankers are buying.
The ECB has announced a massive European corporate bond-buying program, beginning in June. This ETF has about 50% of its portfolio in corporate bonds of European blue-chip companies.
Now the tough part – equities.
I would stick with ETFs, rather than individual stocks. After all, it’s important to be conservative with college funds rather than run the risk of losing it all.
But still, it’s wise to stay away from index funds. In today’s investing climate, something that emphasizes dividends will have the most potential profit.
Further, global investments offer sound opportunities. While the U.S. stock market is flat-lining near all-time highs, overseas markets are far cheaper.
Fund managers have an increasingly negative sentiment toward overseas markets, as well.
That’s music to the ears of a contrarian investor like myself – I think of the words of legendary investor Sir John Templeton, who wrote: “Buy when others are despondently selling and sell when others are avidly buying.”
He would often say, “People are always asking me where the outlook is good, but that’s the wrong question. The right question is: Where is the outlook most miserable?”
Putting all of that together – global exposure with some U.S. investments, as well as dividends and conservatism – there are a number of ETFs from WisdomTree that fit the bill.
For U.S. exposure, there’s the WisdomTree U.S. Quality Dividend Growth Fund (DGRW). For large-cap international exposure, a solid ETF is the WisdomTree Dynamic Currency Hedged International Equity Fund (DDWM). Finally, for the emerging markets, the WisdomTree Emerging Markets Quality Dividend Growth Fund (DGRE) is a reliable choice.
Of course, while there are other ETFs out there that may produce similar results and high-yield investments, remember that conservativism, global markets, and dividends should remain your focus when it comes to investing in a student’s education.
The future depends on it.