Morningstar Advisor - December 2013/January 2014 - (Page 14)
Know-How
How to Allocate College Savings
By Christine Benz
Families must deal with tough challenges: steep glide paths and high inflation.
If you take a minimalist approach to collegesavings planning, it may be tempting to
buy a good-quality balanced fund and call it a
day. But before you invest your college
savings in anything, it's worth considering how
investing for college is different than saving
for that other long-term goal: retirement.
Those differences, in turn, argue for taking a
more hands-on approach to asset allocation
than a balanced fund would allow.
1 Know the Time Horizon
typical glide path for retirement. A college
portfolio's asset allocation should begin
downshifting into cash and bonds when the
child is in grade school and the portfolio should
be dominated by bonds by high school. That's
because an equity-heavy college fund that
encounters a bear market in the years leading
up to college could incur losses that it couldn't
recoup during the student's time horizon. Even
parents who worry that they're grievously
behind on college savings should resist the
urge to swing for the fences by maintaining a
too-high equity allocation too long.
In contrast with retirement, a child's collegematriculation year isn't a negotiable date.
A person who encounters a bear market shortly
before retirement may have some wiggle room
to keep working or rely on other sources of
income to avoid tapping his or her nest egg at a
low ebb. By contrast, try telling an 18-year-old
to wait until age 21 to start school.In addition,
the time horizon for saving for college is
much shorter than is the case for retirement, as
is the time horizon for spending those assets.
One might save for retirement for 40 years or
more and be retired for another 30 or 35 years.
By contrast, savers have less than half that
amount of time to amass the funds needed for
college, and if all goes well, they'll spend down
those assets quickly-in four years or so.
The risks of being too conservative also loom
large. Inflation is a major foe for college savers,
and a portfolio heavy in bonds and cash could
have trouble keeping up with rising tuition
costs. College costs have been increasing at a
rate more than 3 percentage points greater
than the general inflation rate during the past
few decades, notes Morningstar head of
retirement research David Blanchett. If college
costs continue to outstrip general inflation by
that margin, college savers will be contending
with a 5.5% inflation rate. Extremely conservative asset-allocation plans are going to have
difficulty matching the rate of college inflation.
2 Be Smart With Asset Allocation
4 Is Prepaying an Option?
Both of those facts call for a much steeper
"glide path"-the gradual shift to
more conservative investments-in the years
leading up to and during college than the
14 Morningstar Advisor December/January 2014
very conservative asset-allocation mix.
"If someone is relatively certain their child is
going to attend an in-state school, and there is
a prepaid state savings plan and the individual
would otherwise invest conservatively in a 529
college-savings plan, it may make the prepaid
plan more attractive," he says. Blanchett notes,
however, that the trade-off doesn't factor
in the tax benefits that can accrue to investors
in 529 college-savings plans. Alternatively,
investors might use a 529 college-savings plan
but make sure that plan includes at least
some inflation protection-albeit not a direct
hedge against college costs-such as Treasury
Inflation-Protected Securities.
3 Monitor the Impact of Inflation
Blanchett says that prepaid 529 plans, which
allow you to lock in today's tuition levels
by paying in advance, may be a better option
for families who would otherwise maintain a
5 Compared and Contrast
Finding the right asset allocation for college
is difficult, so it's probably no wonder that 529
plan age-based options have historically held
the lion's share of assets. But the age-based
plans also vary widely in their glide paths, and
plans are increasingly offering multiple options
for a given age band. That makes it important
to conduct due diligence on a plan's assetallocation framework and see how it compares
with other options within that same general
age band. If it's an outlier, make sure you
understand and agree with the rationale that
its managers use for diverging from the peer
group. The overview tab of Morningstar.com's
529 plan reports provides a look at how each
state's age-based glide path compares with the
529 averages for that same age band. K
Christine Benz is Morningstar's director of
personal finance.
Table of Contents for the Digital Edition of Morningstar Advisor - December 2013/January 2014
Morningstar Advisor - December 2013/January 2014
Contents
Contributors
Letter From the Editor
What’s Your Purpose?
Working for Gen Y
How to Allocate College Savings
Mobius Looks to a New Frontier
Investments á la Carte
Investment Briefs
How to Manage Bonds for Today and Tomorrow
Cloud Is the New Engine of Growth
Knowing Where to Look
Economic Vulnerability Varies by Country
Factor Investing in Emerging Markets
Following the Rules
Exploring Indexing’s Next Frontiers
Frequent Fliers
Family Blind Spots
Optimal Portfolios for the Long Run
Finding Value in a Pricey Sector
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Emerging-Markets Roller Coaster
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