Wednesday, 15 April 2009

Investing for Children: Getting the Goal and Timing Right for Education

A successful plan to invest for a child's post-secondary education must address:
  • the cost of the education
  • the timing of the studies to determine when funds will be required
  • the variability of various types of investments and their respective returns in the short and long term - stocks do best over long periods but may suffer severe ups and downs in the short term
Total Cost of Education
Develop an estimate of how much you will need to save using the excellent Calculator, where you can enter many variables such as: number of children, current age, duration of post-secondary program, age to start post-secondary studies, live at home or in residence with or without meal plan with actual recent costs for tuition for both college and university and room and board by province. You can select to add in or not the Canada Education Savings Grant.

Timing of Spending
18 years is the usual youngest age when post-secondary education starts, but it can be delayed which may warrant keeping more of the investment assets in more volatile stocks longer. This is a difficult call since young people can change their minds quickly and decide suddenly that they do want to go back to school after all. Such delightful news to a parent should not be marred by discovering that the stock market is in a downturn and the required funds are less than a year previous. There does come a time when the education goal, having not yet been pursued, becomes unlikely and it is best to shift investment goals.

Higher education lasts two to four years, perhaps longer if higher, higher education is pursued. The cash needs to be made available over that span, so investments that mature in time with each new school year make sense.

The Time-to-Spending Asset Mix
The longer there is before the funds will be needed, the greater the proportion of the investment asset mix should be in stocks, which provide higher long term returns than bonds, GICs, money market funds or plain old cash earning interest. One critical caveat - if a large lump sum (like an inheritance) sufficient to fully fund any higher education comes along, then merely protecting that capital against loss and inflation may well be the wisest approach. Most people do need to take advantage of higher stock returns (e.g. 4.5-7% for stocks vs 2-4% for bonds vs 0-2% for T-bills; see these summaries of past and future expected returns at CanadianFinancialDIY and the Bogleheads forum)

Example Asset Mix Over a Childhood
Birth: 80% Equity & Other, 20% Bond
Age 13-14: Child still headed for higher education?
  • Yes - shift to 40% Equity, 40% Bond, 20% Cash (incl GIC, Money Market Funds, T-bills)
  • No - maintain asset mix to serve different long term goals (e.g. house purchase)
Ages 15-18, assuming still headed for higher ed
  • Shift another 10% a year into Cash till it is 100% Cash

Variations of the percentages and ages of shifting are possible but the idea is that as the time for spending approaches less and less should be in riskier, more variable investments and more in the stable, safe, liquid investments.