As the summer winds down, going back to school becomes a front and center topic for many parents, and there is no bigger issue or responsibility than saving for college expenses. If you are a parent trying to save money for your child’s college education, then you realize how daunting a goal it is to save and invest for these large expenses. One of the most effective ways parents can save for college is by establishing an education savings account like the Michigan Education Savings Plan, or more widely known as the MESP.
The MESP has been around for many years, and it offers tax advantages and other benefits that make it an attractive vehicle to save for college, but these benefits will not be the topic of this article. You can visit their web site at www.MISaves.com for more information on its features and benefits. The focus of this blog will center on the MESP investment options and helping people assess those options as a way to understand them better.
The MESPs investment options are broken down as follows:
This option seeks to match the risk level and return opportunities based upon certain age bands, which start at infant through the time the child reaches age 18. The risk level automatically shifts down as the child ages, which is called the “Glidepath.” They have three levels of Age-Based options: Conservative, Moderate and Aggressive. The Glidepaths for each risk-profile are different in terms of how much each age band has in stocks and fixed income. These options are similar to “Target-Date” funds that have become popular in many employer retirement plans like 401(k)s.
This option includes specific static allocations in four sub-allocations such as the International Equity Index (100% Equities), Global Equity Index (70% U.S. Equity Index/25% International Equity Index/5% Emerging Markets Equity Index), Balanced (60% Equity/40% Fixed Income), and 100% Fixed Income. These options go from very aggressive to conservative. The 100% Fixed Income option is categorized as conservative, but it can fluctuate depending on the direction of interest rates and/or the economy. This is unlike the Guaranteed option, which will not fluctuate.
This option includes only one style of investment, which is the most aggressive option available, since it is entirely dependent on one market index–the U.S. Equity Index. While this is the most aggressive option, it may be the riskiest since it focuses entirely on one market—U.S. large cap stocks. If they do well, then this fund will perform well. If they struggle, then this fund will struggle.
This option is the most conservative and seeks to provide maximum capital preservation and a fixed return. The current fixed yield is 1.6%. This would be a good option for people that want no fluctuation in principal, but want to earn some income. Of all the above options, this is the most conservative. This may not be an appropriate option to use past three years since it will not generate sufficient appreciation. However, it could be combined with a more aggressive option like the 100% Global Equity Index and/or U.S. Equity Index. In a period of rising interest rates, I would expect this option to hold up better than the 100% Fixed Income option, which will have more fluctuation due to changes in interest rates.
Obviously, there is no single best investment option in the MESP, because choices should be based on your risk tolerance and individual situation. The Age-Based options are advantageous if you do not want to be actively involved in managing the account since they make changes automatically based upon the age of the child. Account holders need to understand these accounts will become conservatively positioned once the child attains age 16+.
If the goal is to maximize returns, then selecting either the 100% Global Equity Index and/or the U.S. Equity Index may be preferable. I prefer the Global Equity option since it includes domestic and foreign stocks. However, having 100% equity exposure as your child approaches college-age may be too volatile. The Balanced Option is a viable option since it includes static exposure to global stocks and fixed income in a 60%/40% mix. You can find the historical and inception returns of each option on the MESP website.
In the end, I believe that having a diversified investment portfolio during the applicable time horizon is important and makes sense.
If you are having a difficult time making a decision, then contact an advisor for further help.
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