Pete the Planner: When saving for college, use age-based portfolios

Dear Pete,

My daughter heads off to college next month, and, while I’m thrilled her mother and I have money set aside for college, much of that money is currently down about 30% year to date. The loss on paper is equivalent to nearly an entire year’s tuition. We have some other cash we could make work, if need be, and we also need to consider that her younger brother will be ready for college in five years. How should we navigate this?

—Brian

As if sending your daughter off to college for the first time weren’t hard enough, now you’re navigating an unforeseen sequence of return risks. Don’t panic, though. I’ve got a plan.

But first, I must pleasantly admonish you for the benefit of others. Sorry, Brian, it’s simply the price of admission.

One of the biggest mistakes I see parents make with their college-funding investments is ignoring time horizon. It’s an incredibly common mistake, and it generally happens when investors let their risk tolerance get in the way of prudence. Your penchant for wild swings in the market is rendered silly, when you have only a year or two to recover from paper losses.

My gut tells me your investments were incredibly suitable if the funds had been dedicated to your retirement goals, but the shorter college time horizon rendered those same investments unsuitable. I urge you to take a different path with your son’s college investments.

If you aren’t paying attention, it’s very easy to forget to reallocate your portfolio to less-volatile investments once your child gets to high school. Which is precisely why age-based portfolios were created. Like you, I’m staring at some paper losses in my kids’ college funds, yet the losses aren’t nearly as bad as yours because I’m using age-based portfolios. As my kids get closer to college, their investments automatically shift into less-volatile instruments. It’s rather dummy-proof.

Enough of that. Now to your solution.

If I were in your shoes, I would do what I could to use cash or other less depressed investments to handle the bursar bills until your portfolio recovers, assuming the investments aren’t too speculative. This same strategy is a common one for retirees who happen to retire in or around bad market years. Financial planners prefer retirees have accessible cash to use as income, in order to buy time for a portfolio to recover.

Allow me to oversimplify this. Let’s say you need $30,000 for college this year, and at this time last year, that was equivalent to 30,000 shares of whatever investment you are holding. Now that the investment has fallen 30% in value, each share is worth 70 cents. So, if you were to withdraw $30,000 this year, you’d have to sell 42,857 shares. That’s the problem. Once those 12,857 additional shares are sold, you’re never getting them back. If you allow the share price to recover, you theoretically “save” $12,857.

Your available cash is the better funding option right now, especially when you factor in inflation. While your cash is most certainly valuable for its liquidity, its purchasing power is currently in a tailspin. As long as that cash isn’t your only cash, give yourself a chance to “recover” that $12,857.

What makes this strategy especially attractive for you is the fact that you’ll need money five years from now for your son’s college education. In other words, there’s very little risk of having leftover college money.

There’s one more bonus lesson for you, here, too: Making this same mistake as you approach your retirement years would be even worse. Your risk tolerance is and will continue to be influenced by your experiences, education and outlook on life. For many people, this means an increase in risk tolerance. If this is the case for you and you also continue to ignore time horizon, a disaster is on the horizon. You need a financial adviser for this very reason.

And if you’re willing, spread this gospel to your friends, co-workers and acquaintances. Our kids grow up so quickly that it’s very easy to lose sight of time horizon. Make yourself the poster child for what not to do. I guarantee you will prevent others from making the exact same mistake.•

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Dunn is CEO of Your Money Line powered by Pete the Planner, an employee-benefit organization focused on solving employees’ financial challenges. Email your financial questions to askpete@petetheplanner.com.