<FOOLISH FOUR PORTFOLIO>

Financing an Education
With help from Uncle Sam

by Ann Coleman (TMF [email protected])

Reston, VA (January 12, 1999) -- In a fit of bridled generosity, Congress gave us the Education IRA a few years ago. There was a lot of grumbling at the time about the contribution limit of $500 per student per year, and certainly with all the dire predictions we've heard about the escalating cost of higher education, $500 per year, even with tax-free compounding, isn't going to send anyone's kid to Harvard.

(Educational Individual Retirement Account? That's a name only Congress could have come up with. I suppose they think college is some kind of golden years where you don't have to work, you can stay up late partying, no one tells you what to do anymore, and all you have to do is learn stuff. Oh. Now, I get it.)

Let's see if it is really worth the trouble. First, click the link above to make sure that you qualify for it. (If you qualify for the Roth IRA, you will probably qualify for the E-IRA.) We will look at two scenarios: Today we will take the worst case (a 15-year-old kid already collecting college catalogs), and tomorrow we will look at the best case, a newborn. (Forget about starting any earlier than that. The account beneficiary has to have a social security number, so you can't start saving for eventual children.)

If you have children who are already calculating the male/female ratio at their schools of choice, this plan is not going to help you all that much, but it's not totally useless either. Like any kind of investment, time is the single biggest factor in its success. Five hundred dollars invested each year for five years at any realistic rate of return is not likely to make the difference between the Ivy league and your local community college.

These days, though, four years of college is not that much. In many fields, the really good jobs require a master's degree. Depressing though the thought may be, your child may be in college for 6 or more years -- which is good because to make my point, I really need about 10 years to work with. Also, it's not unthinkable that a kid may want to take a year or two off to work, do the Peace Corps thing, or bum around the Caribbean on a banana boat. Those experiences can be highly motivational, and they buy you more time for those dollars to compound.

So even though it might not be very useful for freshman tuition, an E-IRA can be part of your ultimate college plan even if your kids already have most of their adult teeth.

Try this on for size: You have a 14-year-old kid who is either the Peace Corps type or obviously headed for grad school. Starting today, you invest $500 at the beginning of each year. You can contribute until he turns 18, but the money can continue to compound tax free until he turns 30. For the first two years you just concentrate on saving and you accept the 5% interest you get in your broker's money market account. When the account is a healthy $1000, switch to the Foolish Two, the top two of our Foolish Four stocks. Assume that your Foolish Two (formerly the RP2) strategy compounds at 20% per year (a very conservative estimate when compared with past performance, but I don't want to get carried away).

Whoa! In 10 years, by the time Josh or Jenna is a senior or working on his or her masters, that lousy $500 bucks a year for four years ($2000 total) has grown to over $8,500! That will fund a quarter or two of tuition at most state schools with a bit left over for a book or two, and it's $1,000 more than you would have had in a regular brokerage account where you had to pay capital gains taxes. Is it worth it? I'd say so.

By the way, I am suggesting the Foolish Two, at least for the early years, for two reasons. First, it keeps commissions down (even so, you will want to find a very low cost broker if you are going to try this), and second, it is a higher risk/higher return strategy. In the early years it's easier to justify the additional risk. As your account grows and you get closer to the time where you will need your cash, you might want to switch to the less risky Foolish Four.

Regular readers are undoubtedly jumping up and down about now, grabbing their mice to fire off an email reminding me of my advice a few days ago that money needed sometime in the next 5 years should be in something safe -- not stocks. I haven't forgotten. I guess it depends on your definition of "needed." (Everyone's into definitions, these days!)

In this scenario, we assume that the money is something of a luxury -- an early ticket to grad school or a way to avoid working summers the last two years. I am assuming that you already have other plans in place for college and that the $40 a month that the E-IRA requires is not being diverted from those plans. If that's just wishful thinking, then you would want to use a much more conservative approach with all of your college savings.

Keep in mind that the E-IRA money is controlled by the parent. To avoid taxes, it has to be used for educational expenses, but you can transfer the money to a different beneficiary if young Joshua decides to stick with banana-boating.

Fool on and prosper!

Today's Stock Lists | 1998 Dow Returns

01/12/99 Close

Stock Change Last -------------------- CAT -2 1/4 50.75 JPM -2 5/8 111.81 MMM - 13/16 77.75 IP + 9/16 46.50

Day Month Year History FOOL-4 -1.73% 7.50% 7.50% 9.10% DJIA -1.51% 3.19% 3.19% 2.78% S&P 500 -1.92% 0.84% 0.84% 2.23% NASDAQ -2.67% 5.84% 5.84% 7.29% Rec'd # Security In At Now Change 12/24/98 24 Caterpillar 43.08 50.75 17.80% 12/24/98 22 Int'l Paper 43.55 46.50 6.77% 12/24/98 9 JP Morgan 105.51 111.81 5.97% 12/24/98 14 3M 73.57 77.75 5.68% Rec'd # Security In At Value Change 12/24/98 24 Caterpillar 1034.00 1218.00 $184.00 12/24/98 22 Int'l Paper 958.12 1023.00 $64.88 12/24/98 14 3M 1030.00 1088.50 $58.50 12/24/98 9 JP Morgan 949.62 1006.31 $56.69 Cash $28.26 TOTAL $4364.07 </FOOLISH FOUR PORTFOLIO>