Providing for college education in the 21st century. (Personal Financial Planning)by Person, Stanley
As we approach the 21st century we see our clients more concerned than ever about how to provide funds to give their children the best possible start. Reflecting on current worries about the economy, globalization, low rates of return on investments, and rising costs of education, it is easy to understand their feeling. Is it possible that as we anticipate the new century that financial planners will need to change their usual approach in creating education plans? Should investment aggressiveness be the keynote in the 1990s?
Ideally we make our clients aware of future education funding needs when their children are 5 to 7 years old. Parents looking ahead will need to depend a great deal on the economic situation of the next few years. As this point, here seem to be many problems that work against accumulating funds to achieve financial goals. If traditional and conservative approaches are used, the objectives may fall short. In addition, the ever changing tax laws with promises of help in one year and higher rates the next continue to play havoc with the best of plans.
Consider the following--it is estimated that the Roberts family with 3 children, age 3, 5, and 7 in 1991, will need $370,000 for basic undergraduate education of their children using the following assumptions:
* Annual tuition of $15,000 in 1991 dollars for a medium-priced private school.
* Annual increase in tuition cost of 5%.
* The first child begins college in 2002.
In order to provide $370,000, the family will need to have a fund of $302,000 by 2002. The balance will come from the earnings of the fund at 6% per annum while it is being drawn down to pay for three tuitions between 2002 and 2009.
The Roberts family started with a combination of zero coupon bonds, nontaxable municipal bond funds and other investments currently worth $101,000 and earning about 8% to 9%. The bad news is that if the family uses very traditional funding methods, they may not be able to have the $302,000 accumulated by 2002. They will probably fall short about $100,000.
The conservative methods that were generally recommended to families such as the Roberts revolved around the types of instruments that would produce standard returns. Combining expected returns with highes taxes negates that planning. Though the use of programs such as non-tax zero bonds and U.S. Saving Bonds will help with taxes, they will not necessarily answer the problem of the needed investment return levels. Therefore, the field has to be opened to more aggressive approaches.
Over the past 15 months, our firm has studied alternative ways to safely generate, over a reasonable amount of time, an investment return that could outpace the declining returns of the more conservative treasury bills, CDs, non-tax zero coupons, etc.
Our experience has shown that financial planners and most of their clients should avoid direct selection and purchase of securities in the search for enhanced returns on investments. Given limited investment funds, it is difficult, even with the use of investment advisors, to make the right selections. On the other hand, our experience has confirmed the importance of having aggressive growth represented in order to build a successful plan.
We have found that the use of broad-based mutual funds that have shown good returns over an 8- to 15-year period should be aggressively used. We are not necessarily referring to the purchase of specific funds even if they have an outstanding long-term record, but rather to a slightly different approach. There are many funds that invest in other mutual funds--so called "funds of funds." The strength of these plans is that they have had relatively attractive performances while being pretty safe. Their basic operating philosophy is to reduce risk by diversification and to be able to move funds quickly.
At various times, these funds will be invested in stock, government issues, commercial bonds, cash funds, among others. They attempt a balanced approach and/or allow the investor to designate the type of funds that best meet thei goals (i.e., income, equity growth, balanced, etc.). Out recommendation has been to use the balanced approach, which has substantially decreased risk but has resulted in good and steady returns that will enable families to fulfill their planning goals. The long-term returns have also been good enough to cover taxes on the earnings. This type of fund generally has not suffered big losses, even in times of market upheavals.
A major consideration in using mutual funds of any type, which we highly recommend, is the availability of proven management. For example, at the start of the Soviet Union's problems, astute funds had about one-third of customers' investments in cash funds directly or through other funds. They were then able to make investment purchases after the initial shock was over.
Financial planners should be aware of the possible necessity to be registered as investment advisors. A case can be made that the recommendation of long-term, well-managed mutual funds lessens the advisor's risk, but it is not eliminated.
In summary, we believe that the use of mutual funds, whether balanced- type of specific, will enhance the performance of clients' financial planning and help them achieve their goals, particularly in education plans that reach out 12 to 15 years. Obviously, different times require different approaches. For the present we feel that investment aggressiveness is needed during the 1990s if the objectives set beyond 2000 are to be realized.
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