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Spending for College Can Be Nearly as Hard as Saving for It

NEW YORK (TheStreet) -- Let's see: Should I select one from Column A, one from B and one from C? Or should I take all from Column A?

In a sense, that's the dilemma faced by many families who have amassed significant college savings spread over several accounts. They may have ordinary taxable savings, plus one or more Section 529 plans and perhaps even a grandparents' trust.

So if you have eight semesters to pay for, the question is: Which funds to use when? It's even more complicated if each type of account has a different mix of stocks, bonds and cash. Your choices will depend to some extent on your best guess about factors you cannot control, such as the ups and downs of the stock market. But here are a few guidelines.

First, tax-favored accounts such as Section 529 plans must be used for higher education or you lose the tax exemption on investment gains. Graduate school counts, but if the child is not likely to go on to graduate school, the 529 plan should be used up sometime during the two or four undergraduate years. (Unless you'd consider transferring the balance to another student, but that's another matter.)

Second, potentially volatile holdings such as individual stocks should probably not be held until the student's junior or senior year, because you don't want to depend on a funding source that could plunge in value just as you need it. You'll worry less if you cash out of risky investments such as individual stocks and volatile mutual funds early on -- near the end of high school or in the first year or so of college.

So let's imagine you have a high school senior with college savings divided equally into four parts, each with enough to fund one year: cash, a 529 plan holding a target-date fund, an assortment of individual stocks and a few stock and bond mutual funds.

And let's assume today's market conditions: You're sitting atop fairly healthy gains for the past few years and have reason to hope for decent stock and bond gains this year without especially high risks.

With freshman-year payments due by the end of summer, it's time to start amassing cash. You already have enough cash for the first year, but that can provide a good safety net in case your other investments plunge. So this might be a good time to reduce your overall risk by selling some or all of the individual stocks. Yes, you'd give up potential gains the stocks could produce, but you'd still have the stock mutual funds, a less risky way to profit from a rising market.

For sophomore year, consider unloading the stock and bond mutual funds. By the summer before this second year, you'd really have only two to two-and-one-half years to raise cash for the rest of the college years, so you realistically cannot expect big gains on stock and bond funds.

If the markets plunge over the next year, you could tap the cash account for sophomore year and hope the markets recover before you need the mutual funds to pay for junior and senior year.

If that doesn't happen, stick with the plan and use either the cash or 529 plan for junior year, and whatever is left for senior year. It probably won't make much difference which fund is used when, because by this late date the target-date fund in the 529 will have shifted out of stocks and long-term bonds and into cash or very safe short-term bonds.

The underlying principle: On the verge of college, don't get greedy seeking big returns. Reduce risk, assemble cash ahead of time -- and improve your chances of sleeping well at night.

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