If you're projecting having to bear college tuition expenses in the future, investing in mutual funds can be an excellent way to accumulate money as well as to have it grow while you are waiting. However, given the relatively short amount of time that you may have to save for college expenses, mutual funds also carry some market timing concerns. At the same time, tax-advantaged college savings plans may also be suitable alternatives.
College Tuition and Growth
On average, tuition goes up faster than the rate of inflation. From the period spanning the 2003-2004 academic year through the 2013-2014 academic year, tuition and fees at private four-year schools increased 2.3 percent after inflation. Public four- and two year schools were even worse, posting 4.2 and 3.0 percent increases respectively, according to the College Board. According to Forbes, during the period from 2003 through 2013, just over 500 mutual funds grew quickly enough to keep up with or exceed expanding college costs, even after taxes.
Mutual Fund Strategies
If you get an early start, saving in advance for college gives you additional time in advance of when college starts to amass enough money to cover four or more years of tuition. The idea behind using mutual funds as a part of this process is that they offer diversification and relatively rapid growth, letting your money work harder to pay college costs. The hope is that their growth will be enough to stretch your savings to meet or exceed increasing college costs.
Risk and Tuitions
The problem with some mutual funds is that, while tuition payments have set payment dates, prices in the market fluctuate. If you, for instance, have enough money to cover tuition expenses one week before they are due and the market tanks, you could end up short when you go to withdraw funds and make the payment. As such, if you use mutual funds to save for university payments, you may want to consider gradually pulling money out of the mutual funds and into more stable investments as you approach needing to have the money for college expenses.
One alternative to using mutual funds to save for college is to invest in tax-advantaged Section 529 prepaid tuition or college saving plans. Prepaid tuition plans are provided by states as a way to lock in tuition rates at in-state schools. The way that they work is that you put a sum of money in that corresponds to a certain amount of tuition at that time. The state invests your money and, when you need it to pay college expenses, it uses it to pay them at the current rate. For instance, if tuition is $15,000 when your child is born, and you put $22,500 in a 529 plan for him, he will have enough money to pay 1.5 years' worth of tuition, whether it costs $35,000, $45,000 or $55,000. The state takes that risk. If he chooses to go somewhere other than a state-run school, he can usually take the equivalent amount and apply it to that school's cost of attendance. College savings plans are also tax-advantaged but don't offer the guarantees or inflexibility of the prepaid tuition plan. They can offer higher returns, and some have asset allocations that automatically rebalance as college approaches.
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