A client recently came to see me about saving for his newborn son’s education.
My client lives on a fixed income -- his wife is currently at home with their child, and he was nervous that he couldn't afford to save for both his retirement and his child’s education.
But I knew a solution for his special circumstance, one that allowed him to save while generating income.
But first, I explained to my client that he was making the right decision to discuss his options, because saving for a child’s education is the best investment that he could ever make. Education is not available to everyone, and it is imperative to start saving as soon as possible.
But saving wasn't enough. My client needed income, too. That's why we decided to invest in dividend-paying stocks and mutual funds; They provide a steady stream of income with the potential for some capital gains in the long term. It provides a perfect balance of regular income and moderate growth for long-term investors.
This is exactly what my colleague Amy Calistri recommends to readers of her 'Daily Paycheck' newsletter. And if my client had wanted to magnify his earnings, there is a way to do that -- another trick Amy recommends. It's simply this: Reinvest the dividends into purchasing more stocks.
For example, take a $35,000 investment in a stock that trades at $35 and has an annual dividend of $1.80. With 5% annual stock and dividend growth, that investment would turn into $207,735 in 18 years. That's an annualized return of 10.4%.
Even without reinvestment, my client would still enjoy $53,170 in dividends paid for a total return of $137,400, or a 7.9% annualized return.
You won't see impressive returns overnight -- or even in a year or two. But in the 18 years it takes my client's son to grow, he should see rewarding returns in the money invested.
Investing for your child’s education is kind of like being stuck between a rock and a hard place. On one hand, you want your investments to grow over the next 15 or 20 years until your child goes to school, but on the other hand, you want your investment to be stable because you don’t want to take the risk of losing the money for your child’s education.
Investing in the right dividend-paying stocks can solve both of these problems, something my client realized.
The Investing Answer: One nice thing about reinvesting your dividends is that you can do it in a 529 savings plan, improving your savings even more.
A 529 savings plan is designed for parents (or other relatives) to save for a child’s post-secondary education. The money saved in the account can be used by the future student towards education related costs such as tuition, room and board, fees, books and computers.
My client wanted to save for his son’s education but he wasn’t convinced that a 529 savings plan was the way to go. He wanted to invest in a regular savings account just in case his son decided not to attend a post secondary school. This way he could use the money for something else if his son decided not to pursue his studies after high school.
But the interest, dividends and capital gains earned in a 529 savings plan are not subject to federal and (usually) state taxes if the money is used for qualified college expenses, making it worth your while to consider.