This month's scenario: Client is a single mother with a five-year-old son. She wants to start a college savings account and can invest $250 each month to start and should be able to double that amount in a few years.
She has read about mutual funds and 529 plans but has no experience with investing. She believes she is willing to accept moderate volatility in order to earn returns above current CD rates.
What research tools do you use to identify prospective funds for clients?
Morningstar Principia Pro allows for screening of mutual funds based on performance and expense. We would only recommend using exchange traded funds (ETFs) or no-load mutual funds for these investment purposes. As a Registered Investment Advisor on the Fidelity platform, we are also provided continuous research and alerts to investment and economical trends.
For 529 plans, some online sources have excellent tools for identifying and selecting the most beneficial plan for investors based on their state, investment preference, and expense threshold.
What specific fund categories would you recommend for the client's consideration and why?
Starting a college savings account doesn't necessarily mean parents need to put money in 529 plans. Given her lack of experience with investing, we would suggest a healthy mix of equity and bond funds, with a higher percentage in bonds.
Considering that her child won't be using these funds for at least 13 years, we favor value stock funds for the equity portion of the education account.
For the bond portion, given the tenuous interest rate environment, we would recommend a floating rate mutual fund. With interest rates expected to rise in the near future, these variable rate investments should perform better than the typical bond fund.
Depending on the client's tax bracket, we may also consider using municipal bonds as well. Again, we would want to take the interest rate environment and her state income tax rate into account.
Probably the easiest course of action would be to use a target date fund to start, possibly within a 529 plan depending on the rest of her financial planning profile.
What specific funds and allocations would you recommend within those categories?
As part of the equity portion of the education account, we would allocate up to 15% to the Yacktman fund (YACKX). We consider it the strongest of the large value funds in terms of performance and expense.
For a floating rate mutual fund, we would invest up to 10% in the Fidelity Floating Rate High Income fund (FFRHX).
If the client is in a high tax bracket, we would consider allocating up to 20% in municipal bond funds, such as the Vanguard Intermediate Tax Exempt fund (VWITX), which has over 90% of it's holdings rated in the 'A' category.
For target-date funds, it's easy to find a suitable fund within the T Rowe Price family to allocate 100% of invest funds.
If the 529 plan is a suitable vehicle, we use the Fidelity age-based funds within the U Fund College Investing Plan (Massachusetts) or the UNIQUE College Plan (New Hampshire), but others may be suitable depending on the client's home state.