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College Investing Primer

Learning the ABCs of investing can move you to the head of the class.

If there's college tuition in your future, you need to create an investment strategy to cover the cost. The longer you delay putting a plan into place, the greater the likelihood you'll face the prospect of having to borrow large sums or limiting your child's college choices.

AN INVESTMENT PRIMER They're not quite as simple as ABC, but here are some frequently suggested ways to approach investing for college. Remember, though, that investment returns are not guaranteed and your account could lose as well as gain value.
  1. Establish education accounts, separate from any other investment accounts. Putting money into 529 college savings plans and/or Coverdell education savings accounts (ESAs) for individual beneficiaries allows you to use tax-free withdrawals to pay qualifying expenses. You may want to use taxable accounts as well.
  2. Add money to your accounts in a lump sum or on a regular schedule. You may qualify for state tax deductions in some states if you're a resident who puts money in the state's 529 plan.
  3. Choose investments based on your children's ages. One popular approach is stressing investments with the potential for growth in the early years and those with a reputation for safety as the child gets closer to 18.


There are a number of investments that don't usually work very well as ways to invest your college savings, either because they're too aggressive or not aggressive enough. Or they may be hard to cash in when you most need them. They include:

  • Any investment that doesn't pay enough interest to beat the rate of inflation, including savings accounts, short-term bond funds, money market mutual funds, and similar investments
  • Any investment that's not easily liquidated, such as real estate, unit investment trusts, and limited partnerships
  • Any speculative investments that expose you to greater than average risk of losing principal


Investments that have the potential to grow in value — stock, exchange traded funds, and mutual funds in particular — may be the most appropriate choices for meeting expenses that are constantly increasing. You can get all the advantages of long-term equity investing by starting a college fund when each child is born. You can minimize current taxes by making investments you intend to hold in your portfolio for a number of years. And qualifying dividends are taxed at your long-term capital gains rate.

The risk of equity investing, though, is that growth is not guaranteed. Your account could lose value in a market downturn or if individual investments didn't meet your expectations.

TIMING IT RIGHT There are some investments you can time, like the dates when your CDs and zero-coupon bonds come due. Since you'll need a cash transfusion, usually in August and January when the new semesters start, you can plan to have the money available then. Colleges usually require payment in full when students register, though you may be able to arrange a monthly payment plan to spread the cost over the academic year.

When you're buying zero-coupon bonds, it's especially important to buy those that mature during the four- or five-year period that you'll need the cash. If you have to sell them before they're due, you may take a real beating on the price as they tend to be volatile in the secondary market. If you're buying US Series EE or Series I savings bonds to pay college expenses, remember that you have to keep them at least five years to collect the full interest.
As an added bonus, if your income in the year you redeem savings bonds is less than the amount established by Congress, interest on those bonds is tax free if you use them to pay qualifying college costs and meet certain ownership requirements. You can check the website of the Department of Education ( or the site describing savings bonds ( for more information.
When your children are young, you'll probably want to consider investing primarily in equities, such as stocks and stock mutual funds or exchange-traded funds (ETFs). If you reinvest all the earnings or use them to make similar investments, the value of your portfolio has the potential to grow over time.
As they get older you may want to begin switching some of your portfolio into more price-stable investments, including equity income funds and intermediate-term Treasury bonds. If stock prices increase sharply, you might also sell some of your investments to protect your gains. But you still may want to invest for some growth.
As your child gets closer to college and actually enrolls, you may want to include more income-producing investments, and continue to transfer part of your equity assets gradually into more conservative investments. The schedule should be dictated by when your tuition bills come due, not by what you think the market's going to do. But, if the stock market goes way up at any point in this period, you may want to take advantage of selling when the prices are high. In other words, you may want to speed up — even if just a bit — the shift from stocks and funds to less volatile investments.
THE NAME ON THE ACCOUNT Should you put investments earmarked for college in your child's name instead of your own? There are two arguments in favor of this - that you'd be less apt to spend the money for something else, and that your child might owe less tax than you on any money the investments earned. But there are also several potential drawbacks to this practice:
  • Children under 19, or 24 if they are students, pay tax at their parent's rate once they earn more than a minimum the government sets, so there is no tax advantage for children younger than this age if the investment is producing major earnings
  • Once you put money in a child's name, you give up the right to use it yourself, except for the child's direct benefit. At 18, 19, 21, or 25 (depending on the type of account and the state) the child can spend it as he or she wishes
  • If you are planning to apply for financial aid, a child is expected to contribute a higher percentage of his or her assets than you are of yours (approximately 20% vs. 5.65%)
CHECK IT OUT Earnings in Coverdell education savings accounts (ESAs) - and 529 college savings plans - can also be withdrawn free of federal and sometimes state income tax to pay qualifying education expenses for children in grades K-12. The only drawback is cutting into the amounts you've set aside for college.


One way to take advantage of your child's potentially lower tax rate after he or she turns 19 or 24 is to make a gift of stocks or stock mutual funds to the child before they're sold to pay college or graduate school tuition. Since your child, not you, is selling the investment, the taxes on the profits will be calculated at the child's capital gains rate, which could be as low as 0%. And you won't owe any gift tax if the value of the stock or stock fund at the time of the gift is less than the tax-free annual gift amount. In 2021, that's $15,000 per recipient, or $30,000 if you're married and file a joint return.

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