Sav­ings accounts, CDs, and mon­ey mar­kets can offer sta­bil­i­ty for par­ents of future col­lege stu­dents.

repost­ed from U.S. News & World Report
by: Rey­na Gob­el, Sep­tem­ber 19, 2012

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

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.

[See what a fresh­man bud­get and sopho­more bud­get look like.]

Mon­ey mar­kets

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.

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