Savings accounts, CDs, and money markets can offer stability for parents of future college students.
For parents, one of the scariest aspects of investing in a 529 plan, a college savings account with tax benefits, is taking a risk with money used to fund their child’s education, experts say.
That explains why a portion of investments are generally invested in cash products: savings accounts, bank certificates of deposit (CDs), and money market accounts. While other investments within a 529 plan have more potential for growth, the money in cash accounts won’t lose value, says Chadderdon O’Brien, a certified financial risk manager and certified financial planner with Lassus Wherley.
However, not all cash investments are completely safe. O’Brien and Mackey Advisors President and CEO Mackey McNeill assessed the following cash investment vehicles in terms of investment stability.
[Learn how to select mutual funds within 529 plans.]
Savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC), an insurance program where the United States backs up to $250,000 in a cash account with the full faith and credit of the U.S. government. No matter what financial troubles a bank has, your deposits are safe, O’Brien says.
But 529 plan investors stashing cash in savings accounts have one risk: falling behind in college fund growth because interest rates earned can’t keep up with inflation, O’Brien notes. Last year’s average money market or savings account within a 529 plan earned a tenth of a percent, according to the Financial Research Corporation.
Each savings account’s rate, however, can vary. The Utah Education Savings Plan, for instance, earned over a 0.6 annual percentage rate in August after deducting fees charged.
[Learn more about 529 plan prices.]
Bank certificates of deposit
CDs are also FDIC insured for up to $250,000. But the difference is that savings accounts accept multiple deposits per year and funds can be withdrawn at any time. A CD requires a single deposit and then the amount is held for a set period of time of the purchaser’s choosing, such as 60 days, 6 months, 1 year, 5 years, or 10 years, McNeill says.
Generally, the interest earned increases within the time frame the money is held. Bankrate.com shows the current national average for CD rates at 0.31 percent for one year and 1.01 percent for five years (rates from Sept. 18, 2012).
CDs are only risky if the purchaser wants to cash in before the specified time period ends, McNeill says, as a penalty will likely be charged. But she adds that this isn’t typically a problem because parents choose CD investment schedules based on the time period between the investment and their student’s first day of college.
For instance, if a student starts college in two years, parents could invest in one-year CDs for the first year and then renew them for sophomore and junior years.
For senior year, parents can invest in a five-year CD. When interest rates are low, parents may want to choose 60-day CDs so they’re not locked into a lower rate if interest rates rise, McNeill notes.
Money markets are considered a safer investment than most stocks or bonds but aren’t FDIC insured. The safety aspect is that they contain extremely short-term investments maturing in days rather than months, O’Brien says.
If investments within money market accounts lose value, there is a risk the individual’s account can also drop in worth, he says. A penny or two lost per dollar invested is a 1 or 2 percent decrease in the value of the account.
Parents shouldn’t be too alarmed about investing in money markets, because drops in value don’t happen often, though O’Brien recalls a money market fund losing value in 2008.
“If the goal is to hold pure cash, then a savings account is a more appropriate and safer method,” O’Brien says. “While a money market fund may offer a higher yield than a savings accounts (and this is not always true), the higher yield comes with higher risk.”
Reyna Gobel, frequently quoted as an expert on student loans and college costs, is the author of “Graduation Debt: How To Manage Student Loans And Live Your Life” and “How Smart Students Pay for School: The Best Way to Save for College, Get the Right Loans, and Repay Debt.” She has appeared on PBS’s Nightly Business Report and speaks regularly at CollegeWeekLive.