Best Tips for Your Young Child’s College Savings

I was recently quoted in the Ask the Expert section of regarding tips on savings for a young child’s education.  The entire article can be found here, but a summary of my comments are in bold below.

Q: My daughter turned 5, and I’ve set up a 529 account for her and a custodial account as well. What are some of the best ETFs I can buy for her to get the account going? — Robert in Braintree, Mass.

A: Kudos to you for taking steps to save on behalf of your daughter. The earlier you start, the better your odds of keeping pace with rising college costs.

Before you dive in and think about specifically where to invest in a custodial account — or any account for that matter — make sure this is the best strategy at this stage of the game. A custodial account for your child should come low on your list of financial priorities.

Before picking funds, prioritize

“Make sure you are saving enough for your retirement before you focus on saving for your child,” says Mike Eklund, a certified financial planner with Financial Symmetry in Raleigh, N.C. “As they say, you can borrow for college but not for retirement.”

If you qualify for a Roth IRA — which is open to individuals whose modified adjusted gross income is less than $117,000 ($184,000 if you are married, filing jointly) — this might be a next step. “It can serve as a dual purpose,” says Eklund. While you need to wait until you’re 59½ to make tax-free withdrawals of earnings, “you can withdraw your contributions at any time,” he says.

Assuming that you’ve checked all the boxes on retirement savings, a 529 college savings plan is generally a no-brainer; these plans offer high contribution limits, a low impact on financial aid and tax-free growth and withdrawals for qualified expenses.

529s before custodial accounts…

The trick with a 529 is to contribute enough to make headway against rising college costs without over-contributing. Many experts, including Eklund, recommend aiming to save half of your expected college costs in a 529 plan, assuming you can afford to do so.

How to Invest

“In this case, we would recommend a globally-diversified stock mutual fund,” says Eklund.

Most U.S. investors are guilty of “home bias,” allocating most of their assets to U.S. companies, despite the fact that they account for roughly half of the total value of the global stock market.

Globally minded funds offer another potential advantage looking out over the next decade or so, while you are saving for college. That’s because foreign stocks, which have lagged U.S. shares for several years, are trading at cheaper valuations to domestic shares. As a result, foreign stocks are expected — though not guaranteed — to produce better returns over the coming decade.

But as your daughter gets older and the account balance grows, you’ll want to revisit your choices and adjust the allocation anyway — perhaps adding bond funds to the mix, for instance — to suit her changing goals.

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