Where to Keep Your College Money ?

Once you have started putting money aside for college, your next decision is where to save or invest it. CDs? Savings bonds? Mutual funds? A state-sponsored college-savings plan? The answer depends primarily on the amount of time you have left before you’ll start writing tuition checks. In this article, we’ll describe the best choices for your long-term investments—funds you don’t need to touch for five years or more— and short-term savings. But, because it’s fairly common for parents to get a late start at saving, we’ll work backward, starting with the safest choices for short-term money, including money-market mutual funds, certificates of deposit and government bonds, and progressing to investments that provide better returns but involve a little more risk, such as growth-and-income, long-term-growth and aggressive growth mutual funds. All of those investments are among your choices for college savings that you keep in an education IRA, Roth IRA, custodial account or ordinary taxable account in your own name.

If you’re willing to give up some investment discretion, turn to pages 79–86, where you’ll find a thorough
discussion of the newest—and, in our opinion, best college-savings vehicle: state-sponsored college-savings
plans, which give you many of the same investment choices in a convenient—and tax-free—package. And,
if you really don’t want to formulate a saving and investing plan yourself, you’ll learn how to find a financial
planner who can help you.

Before we begin discussing specific types of investments, let’s consider why and how your strategy

should change with the time you have left before college. In this instance, it makes most sense to begin with
a look at the long-term.

Using the Time You Have
If the first tuition payment will be due more than five years in the future, you can put the pedal to the
metal—that is, go for the highest possible returns by investing most of your college savings (or as much as
your tolerance for risk will allow) in stocks or stock mutual funds. The stock market invariably rises in
some years and falls in others, but when you average out the ups and downs, stocks historically have earned
more than any other investment. This data from Ibbotson Associates, for investment returns from 1925
through 2000, makes that clear. One dollar in 1926, compounded at the rate of inflation, equaled $9.71 at
the end of 2000.
■ Invested in Treasury bills it would be worth $16.56;
■ In long-term government bonds, $48.86;
■ In large-company stocks, $2,586.52; and
■ In small-company stocks, $6,402.23!

You won’t be saving for college over 75 years, of course, but the point is that over the long haul, nothing
else will keep you as far ahead of inflation as stocks. A long time horizon mitigates the risk of the market’s
going down in any given year—you can simply wait for a better time to cash out. (It’s interesting to note that
the results above include the impact of the 1929 market crash.)

How does the last decade compare? According to data compiled by Ibbotson Associates, one dollar at the
beginning of 1991 was worth $1.30 at the end of 2000, after inflation.
■ Invested in Treasury bills it would be worth $1.59;
■ In long-term government bonds, $2.66;
■ In large-company stocks, $5.00; and
■ In small-company stocks, $5.01.


With fewer than five years until your child heads off to college, you don’t need to avoid stocks entirely, but
you want to reduce your risk by keeping some of your money in less-volatile investments, such as bonds, certificates of deposit or money-market accounts. By pulling your chips off the stock-market table gradually
(or if you’re starting late, by putting only a modest stake into the market in the first place), you avoid the potential for disaster—say, having to tap a stock mutual fund to pay tuition just after a 1,000-point drop in the market.

By the time you’re writing tuition checks, in fact, you probably want your college fund to be entirely or
almost entirely out of the stock market. Here’s a rough guideline to follow for allocating your savings among stocks or stock mutual funds (equities) and bonds, money-market accounts or CDs (fixedincome investments).
■ Elementary school years: up to 100% equities
■ Junior high school years: 75% equities, 25% fixed income investments
■ Freshman and sophomore high school years: 50% fixed income, 50% equities
■ Junior and senior high school years: 75% fixed income, 25% equities
■ College freshman year: 100% fixed income.

This isn’t a rigid schedule. The point is to give yourself roughly five years to get out of equities so that you
won’t be forced to sell in a lousy market when you need the money. You don’t need to bring your investment
mix down to 50% stocks and 50% bonds the very day your son starts his freshman year of high school—and
you shouldn’t if the market has just suffered a big drop.
But that’s the right time to begin looking for a good opportunity to sell some stocks and buy bonds or CDs.
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