I am saving money for two children who are heading for college. One will start this year, and the other will start in six years. I have saved approximately $20,000. What asset allocations would you recommend in these 529 accounts at Vanguard?
First, I have to say your children are very fortunate to have a parent who supports them in this way.
To address your question, I assume you have two separate 529 accounts, one for each child.
With a total of $20,000 saved for two presumably four-year college educations, I do not believe you can afford the risk of losing what you have set aside. Some people might be tempted to invest in equities for a student, who is starting this year, in the hope of growing those savings over the next three years.
However, I believe you should expect any growth in that account to come from additional savings you can add, not from market gains.
So, for the student who starts college this year, you should start by separating whatever you will have to pay this year and keep that in cash. With the rest of the balance in that account, I would split it 50/50 between Vanguard’s short-term fixed income fund and short-term cash reserves. I realize this is very conservative, but take it from me: You will not be a hero to your son or daughter if you lose this money in the stock market.
The student who starts in six years has more time, and some of the money is likely to remain invested for nine years. Over that length of time, there is a pretty fair probability of some stock-market gains, though their magnitude is totally unpredictable.
I would still take a very conservative stance and rely on yourself and your child to add savings over the next nine years. Accordingly, for this account I suggest an allocation of 50 percent in Vanguard’s short-term fixed-income fund, 30 percent in short-term cash reserves and 20 percent in global equities.
One way to think about this is by time horizons. One quarter of the money in the one account has a time horizon of zero years (needed in 2010). The second quarter has a time horizon of one year and the third quarter has two years. The final quarter has a three-year time horizon. Three years are not enough to have much confidence in the stock market, even with the best diversification.
In the other account, 25 percent will be due in six years, 25 percent in seven years, 25 percent in eight years and the last of it in nine years. For this money, I think it is reasonable to seek some stock-market gains.
As your second child gets closer to needing the money, I suggest you gradually make the allocation more conservative. By the time of the first tuition payment, 2016, this account’s allocation should mirror the one that I’m suggesting for the student who is starting this year.
The point of getting a college education is learning, and I suggest you use this issue to teach your children a few basics about saving and investing. By setting up these accounts in the first place and seeking expert advice about the investments, you are demonstrating some important lessons from which your children can benefit. Here are a few:
1. Live below your means, so you can save for important future needs. This is obvious to you and me, but young people don’t always embrace this. If you can instill this attitude as a habitual way of dealing with money, your children will benefit enormously over their lifetimes.
2. Make sensible investment choices. You make it a priority to make sure the money you saved is there when needed.
3. You have thought about what might go wrong and did your best to protect this money. You could talk with your children about what might happen if half or more of this money were lost in a stock market downturn. What would that do to their available options?
4. Seek outside advice instead of making seat-of-the-pants decisions.
5. Keep your costs low (Vanguard) and your taxes low (a 529 plan).
Finally, you are casting a vote of confidence in your children’s future, and you are backing up that vote with a financial investment. Your two children may take this for granted now, but I’m betting someday they will come to appreciate this a lot.