Should I Add Bonds to My Kids' College Account?

You'll need a lot more growth than bond funds can offer to cover college costs for your three children.
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I'm 40 years old and have three kids (ages 9, 6 and 2). Most of their college fund is in a very mediocre blended fund that a financial adviser sold me six or seven years ago. It amounts to about $15,000. I've finally decided to learn about mutual funds and move the money. I've researched and picked a few growth funds that seem to make sense ( (WOGSX) - Get Report White Oak Growth, (RBCGX) - Get Report Reynolds Blue Chip Growth and (DTLGX) - Get Report Wilshire Large Company Growth). I see the value of picking my stock funds so I diversify with respect to holdings, size, etc. Most of the things I've read tell me that, given the age of my kids, I should also put 30% or so in bonds. Since I'm pretty risk-tolerant and am not interested in income from this investment, should I really look at bonds? Or would adding a growth-and-income or blended fund make more sense? -- Steve Beckman

Steve,

It's clear your college savings plan could use a makeover. Congrats on taking matters into your own hands.

Based on your question, I'm assuming the money you are saving is pooled in a single account for all three children. While this approach gives you greater flexibility when the children reach the age of majority and makes it easier to qualify for supplemental student loans, it doesn't offer the same kind of tax breaks you'd get if the money was in each child's name.

At some point, you may want to consider individual education IRAs to supplement savings. If you are married and file a joint return with your wife and your modified adjusted gross income is below $150,000, you can make a nondeductible $500 contribution per child annually. (The adjusted gross income limit is $95,000 if you're single.) Withdrawals to pay for the beneficiary's college costs are tax free.

Modified adjusted gross income, by the way, is determined by adding back certain excluded items to your adjusted gross income, and it is not a simple calculation. So check with your tax adviser to make sure you qualify.

But for now, let's focus on your one account with $15,000 for all three children.

"With the cost of college increasing about 8% per year, on average, you'll need to rev up this portfolio," says Rick Applegate, a certified financial planner with

Strategic Capital Concepts

in Allison Park, Pa. "Bonds just aren't going to cut it," he says. "You've got to be more aggressive and use growth-stock funds."

"Given that you state you are pretty risk-tolerant and that your oldest child is nine years away from college, bonds may not make sense in your portfolio," agrees David Maffuid, a certified financial planner with

Financial Solutions

in Glastonbury, Conn. "Stick with growth funds."

Maffuid recommends you dollar-cost average into just two funds. That is, invest a set amount of money at regular intervals, say, each month. The funds you researched on your own are all quality, large-company growth funds. But rather than rely solely on these, both planners suggest greater diversification.

Maffuid recommends you begin with about 60% of the portfolio in one of the funds you named. For the highest octane, he likes the focused approach and low turnover of White Oak Growth. "It's the most volatile, but probably has the greatest potential for the best return," he says.

To this, Maffuid would add a good growth-and-income fund for the other 40% of the portfolio. Rather than recommend a specific fund, he suggests you do your own research, focusing on funds with low expense ratios (the average for a growth-and-income fund is 1.3%, according to

Lipper

), low turnover and a manager who has at least five years' tenure with the fund.

Should you decide to throw individual education IRAs into the savings mix, Maffuid suggests you place your most aggressive growth vehicle -- perhaps a fund with some small-cap exposure -- in these.

Applegate would like to see at least some small-cap exposure here as well.

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