The following is a guest post from Kim Cooper with of Jemstep’s The Better Investor Blog.
You’ve been scoring 2-for-1 deals on diapers, cough syrup and coffee creamer. Will your penny pinchin’ help you secure your child’s college fund?
The short answer: yes. Saving just $1 or $2 a day can help you pay a significant chunk of your child’s college bill, especially if Junior won’t be college-bound for several years. Those cereal coupons you’re clipping could end up paying for your baby’s diploma.
But to maximize your money, you’ll need to invest those savings in the right vehicles.
“What does that mean? That sounds technical.”
Don’t worry; saving for college isn’t complicated. Here’s a guide to help you along the way.
Step 1: Anticipate the Price
How much will college cost? This answer will form the backbone of your plan. You won’t know if you’re on track until you define your target.
Public, in-state colleges have a lower “sticker price” than private and out-of-state colleges. Though, some private colleges have larger endowments that might offset the high sticker price by generous financial aid.
As a baseline, research the cost of a four-year, public college in your state. The total cost should include tuition, fees, room and board, transportation and books.
Step 2: Define the Goal
Decide how much of your child’s education costs you want to cover. Remember, you don’t need to pay 100 percent. What limits do you want to place on your contribution?
Your answer should depend on your own financial position. Focus on two key areas: debt and retirement.
Are you in debt? Does that debt come in the form of a low-interest mortgage, or are you drowning in credit card bills with a 29 percent APR?
Place a higher priority on repaying debt, especially high-interest debt. After all, your child’s student loans will likely be low-interest and tax-advantaged.
Review your retirement accounts with a financial advisor. Are you on track? If the answer is no, prioritize this. Retirement trumps saving for college.
Why? Your children have the option of taking out student loans. You can’t take out a retirement loan.
Feel queasy about the thought of your baby taking out student loans? Don’t forget that later in life, you can always help your child repay their student loans, after your own retirement is secure.
Your children also have a long time horizon to build their net worth. You have a much shorter timeframe. If you haven’t saved as much as you should, make up for lost time by accelerating your savings, not your risk.
Step 3: Study the Details
Don’t just stash your money in a savings account, where you’ll earn an interest rate that’s lower than inflation. Invest your money in a tax-advantaged college investment account.
There are three major types of college saving plans: the Coverdell ESA, 529 Plans and PrePaid Tuition Plans. Coverdell ESA plans and 529 plans both allow your savings to grow tax-deferred, and the proceeds can be withdrawn tax-free for qualified education costs.
We’d need to write another article just to describe these plans, so we won’t delve into the comparisons here. Each plan offers benefits, limits and tax implications.
Weigh these plans against one another, and toss the pennies you pinch into whichever vehicle suits your goals, your state laws and your tax situation.
Step 4: Consider Your Time Horizon
Once you’ve chosen your savings vehicle, start investing. Don’t worry if “investing” sounds like a scary word; you don’t need to pick individual stocks. You simply need to follow some basic principals.
First, what’s your time horizon? When will you need this money? Remember that you’ll need to start withdrawing the money during your child’s freshman year, regardless of how the market is performing. If the market has tanked at that time, you won’t be able to “wait” for it to recover.
Second, how long is your withdrawal period? Will all your children be attending college during the same 4-5 year window, or will you slowly be withdrawing money over a 10-year timespan? The shorter your withdrawal period, the more impact short-term market fluctuations will have on your overall returns.
What do the answers to those two questions imply? It means your asset allocation (that’s a fancy way of saying “the way you divide your money”) should be based on your time horizon and your willingness to accept the risk of loss.
If your child is heading to college in a few years, you’ll withdraw the money over a four-year span, and you don’t like the thought of losing money, you may want to choose more conservative investments.
If, on the other hand, your children won’t be starting college for another decade, you’ll withdraw money over an 8-year timeline, and you’re willing to accept the risk of loss in exchange for the opportunity to make higher returns, you may want to choose more aggressive investments.
You’re off to a great start: your penny pinchin’ habits allow you to pare down your regular bills, so you can put the savings towards your child’s college fund.
Now it’s time to take the next step: invest that money. You’ll enjoy watching both your savings and your child grow over the years. Graduation day will appear before you know it.
Kim Cooper is the editor of Jemstep’s The Better Investor Blog, where she aims to educate investors and help them make the best investment decisions to reach their goals. Jemstep.com believes that all investors should have access to high-quality comprehensive, transparent investment advice, including specific step-by-step advice for making the best investment decisions for themselves and their families to achieve their financial goals. Jemstep’s free online fund evaluation engine uses patented technology to analyze mutual funds and ETFs to find the ones that fit the investor best – based on the their profile – defined by their goals, preferences, and financial situation.