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Financial Life Advisor
College or Retirement Savings?
My children are 5 and 8. I have a 529 plan for them and a 401K for my retirement. The market's going down and college tuition is not. So one question I have is how I should allocate investment income - in their 529 or my retirement? I realize that's based on future performance and kind of hypothetical, and if I read 3 sources I may get 3 different answers.
R.C. from Austin, TX R, I hate to break the bad news, but I am just one more source and one more opinion. I make no claim to be an all knowing sage. Based on my financial planning experience, I can tell you that you are facing a very common dilemma of parents. You are trying to balance saving for your kids’ college education with trying to make sure you can retire comfortably someday. There are several questions we must address to walk through the decision-making process for college versus retirement funding.
I am guessing that you are using mutual funds in your 401(k) and for your children’s college education. This most likely means you have exposure to the stock market. Over the long run, the stock market has provided a return above inflation, but in the short run, the stock market can move up or down dramatically. This movement will affect both your college savings balance and retirement accounts alike. You must trust that in the long run, stocks will outperform safer investments like bonds and money market accounts. That trust is crucial because stocks have and most likely will go up and down quite a bit in the short run,so just because the market has gone down recently doesn’t mean it will continue to go down, nor does it mean that because it just went down, it will now go up.
The next issue requires that you make a personal decision as to what is fundamentally more important to you, retirement or children’s college tuition? Many parents feel an obligation to pay for college for their children. Many parents either had their education paid for by their own parents, did not receive one because of the cost or simply had/have a crushing debt load from paying for their own education. Most people fall into one of those three categories and feel it is to be expected that as parents, they should provide for their kids whole education cost.
In my economics classes in college, I learned that there are an unlimited number of needs and wants in society, but finite resources to fulfill those wants and needs. This dynamic is called scarcity and is the basis for the study of economics. We will assume all parents want to provide for both their children’s college and their retirement, but paying for both are in direct competition, and for many people, fully funding both is not possible. So how is one to decide the best way to allocate their scarce resources between the two?
This decision is largely a personal one. The way I look at it, you need to prioritize which of the two goals is most important. To help you visualize, think about these outcomes, remembering the subject of scarcity. If you had to retire early, but had been saving for your retirement, you’d be in good shape. This might mean that your children would be partially/completely on their own for college. I would argue that if someone gets to retirement age, especially if they retire due to health concerns, that their options to continue to save and earn an income are very limited. On the other hand, if a student graduates from college with school loan debt, they ostensibly have their entire career to pay that back.
To put it another way, if you asked me who is in a better financial situation, a 70 year old in failing health with no savings or a recent college graduate with $100,000 in student loans I would tell you the 70 year old is in worse shape. There are also many ways to go to college. Students can receive grants, scholarships, or work through school. If money is a paramount concern, then a two-year junior college and finishing at an in-state public four year university is a drastically less expensive option than four years at a private university. These are the reasons why I feel retirement savings have precedence over college savings. Ultimately, though, the decision is a personal one.
Once you have decided how much money to allocate to retirement or college savings, you need a plan to invest the money wisely. When deciding how to allocate investments, you need to pay close attention to the time horizon for the money you are investing. Your eight-year-old should be going off to college in ten years. The stock market has almost always been positive over a ten- year period of time. As you approach the actual time to load up the car and deliver your baby to college, you should slowly be reducing the equity exposure. Ultimately, by age 18, there should be no equity exposure. It would be quite the shock if in 2007 you told your high school child they had college paid for, and in 2009 after the latest market crash, they have half of college paid for. The easiest way to do this is to use an age based portfolio, which is a common option in 529 plans. They automatically lower the risk as the child approaches college age.
Retirement is a completely different time horizon. If you have twenty years to retirement, you can be fairly aggressive with your portfolio. Even when you are ready to retire, you should still have significant equity exposure. You should not be 100% in equities at that point, but your time horizon is usually over ten years in retirement. Oftentimes, retirement can last 30 years or more, and you will need some equities to keep up with inflation.
You can also see my blog post from another soon to be parent about 529 plans, retirement savings and how much you might need to save to pay for college.
Posted by Ben Gurwitz on 21st August, 2009 | Comments | Trackbacks
Tags: College Savings, Investments
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