Our college savings plan investment strategy to Outperform the S&P 500.
Why should I save for my kid’s college? When do I start saving for my kid’s college? How do I even know where to start saving for college, what is a 529? Which funds do I choose for my kid’s college savings? Here’s our family’s approach to saving for our kids’ educations.
Why save for your kid’s college?
In previous generations having any education beyond high school was the cherry on top. Now days, having only a high school diploma in hand might limit your child’s future. Today even many basic jobs prefer employees have a bachelors degree or higher. Even if your child later decides to do trade school or something else, the advantage of a 529 is that the funds can be passed among the family and used for different education options.
When should you start investing for college?
Starting today, if you haven’t already, gives you the greatest earning potential. Plug numbers into a compounding interest calculator and you will likely be shocked. Financial advisors will tell you to not worry about trying to time the markets. It’s best to start as early as you can especially since you only have 18 years, or less, of time for those dollars to grow from compounding interest. Our family believes it’s so important to invest early in 529s that we include a college fund check as part of any baby shower gift. We didn’t realize this with our oldest so we’ve had to try making up for lost investment time for her, missing out on thousands of dollars compound interest. As soon as your child has a social security number you can open an account naming him/her as the beneficiary.
How do you decide which state’s 529 to use when saving for college?
A 529 is a tax-sheltered investment account. Thus, like the Roth IRA you invest with post tax dollars today to avoid needing to pay tax on the earnings later. Some states even allow you to deduct some from your state taxes if you invest in their 529 plan. Each state has their own offerings. Many are similar. After you choose the state to buy your “529 bucket” you’ll choose the investment funds and mutual funds to invest in.
Two elements to consider when choosing the state college savings 529 plan:
- A) Does your state of residence offer any tax benefits for investing in their 529 options?
- B) If your state doesn’t have any tax benefits for staying in their 529 plan, what are other states with better options? Lower cost and better fund choices.
Which investments do you choose for your 529 college savings account portfolio?
Our first year of investing I chose funds mostly based on their expense ratio. This year when we reevaluated our asset allocations we put together a spreadsheet to evaluate our options. I encourage you to do the same. The funds you have access to may be different than the choices we had.
To note, our children are four and under so we are investing only in aggressive growth and growth funds, as they near high school we will probably add in some lower risk allocations to their portfolio.
Each stock option has a ticker (like VTSAX) which is how you can search for the details. Your state may provide fact sheets for each stock option, but it’s always a good idea to search these directly on a site like Market Watch, Fidelity, Morningstar or whatever site you prefer. I used Market Watch because it provides handy graphs comparing the fund’s statistics to the S&P as a benchmark. Make sure to check the stats online through an outside source for the most up to date information – our state lazily provided fact sheets that were over 2 years old!
We choose our investment funds based several criteria:
- A) Using the guidelines laid out by Dave Ramsey’s Financial Peace University (FPU) we choose funds in four categories. 25% international, 25% aggressive growth, 25% growth & income, 25% growth.
- B) Does the fund consistently meet or beat the S&P 500 index as its baseline?
- C) Does the fund have at least a 10 year track record?
- D) What is the expense ratio? If there are two similar options for earning potential, but the expense ratio is different, I’ll most likely choose the lower expense ratio. Most of the funds we’ve chose have expense ratios of .04%. Anything over 1% expense ratio is high.
- E) Does the fund have a turnover rate less than 50%? Meaning the managers aren’t trying to time the market?
What is the best option for saving for college?
When you first start comparing your options it may surprise you that some of the options have quite high expense ratios with low return on investment (ROI).
The end goal is the have a well diversified investment portfolio. The advantage of investing for your children’s education using 529s is that many states don’t have a minimum initial investment limit so you could even start with the checks and money that comes from baby showers assuming you have their diapers and baby necessities covered. For many new parents welcoming babies home saving for college probably isn’t even on their radar, but it should be. It can give you a leg up and watching the investments grow is exciting!
Some states have initial minimum investments, annual fees, or even limited investment options. If you live in a state that with limited or poor options, you can invest through another state’s plans. Morningstar has some good reviews and rankings of 529 options available.
How we Outperform the S&P 500 – Our Kid’s College Savings Plan:
- Choose the which state’s 529 option you will invest in. This is your bucket.
- Choose which individual funds you’ll put in your bucket. These are your tools.
For our kid’s college savings plans we made a list of all the possible investment funds we were considering including their statistics. Using this information we highlighted the funds with reasonable expense ratios. We also compared each fund to the S&P 500 as a baseline. Dividing the potential investment funds into the risk categories we easily put together a diverse portfolio. Your state may offer different fund options.
I share our choices because I was shocked that there really are funds that consistently outperform the S&P 500. We are not financial advisors and you must do your own research, this is what we do but its not financial advice. You need to research additional items such as:
- Who the top 10- 20 primary members in the fund
- Size of the companies or geography of the businesses and their industry
What do you need to get your kids’ college funds started?
Ultimately, you’ll be doing your children a favor by saving for college as early as you can. You can always reevaluate the asset allocations in the future. If you haven’t already, open a 529 college savings plan for your child today, they’ll appreciate you saving for college later! All you need is their social security number, some basic information and a little cash to get started today. Some states don’t even have minimum investments so you could literally start one with your $5 lunch money!