My friend John had a….holy cow, I’m about to say it….grandchild….this morning. (Side note: Is 8:47 too early in the day to crack open your first beer?)
Don’t get me wrong, I’m happy for John…and you would be, too, if you knew him. Just so you know, both mom and baby are fine. It’s a boy, so before we know it, John’s going to be bringing along another little runner on our long training runs, I’m sure…..but here’s the deal: I’m 45 years old. I’m still young and sexy….and my buddy’s a grandfather.
Yeah, I’m feeling old today. Why do you ask?
John and I haven’t talked about investments for the grandchild. Often, at this point, grandparents begin thinking about some nice gift that the baby can use in the future, like seeding a college fund. In many cases, people settle on savings bonds. When you ask them why they’d buy junior a savings bond, they say, “It’s safe, and that’s what everybody does.”
Enough prelude. Let’s go ahead and start the blog post:
3 Reasons A Savings Bond Is a Rotten College Fund
1)     The current interest rate on a EE Series savings bond, according to TreasuryDirect.gov, is 0.2% While you aren’t losing money, you’re losing purchasing power….which is the same thing in the long run. If the price of bread inflates at a 3.5% rate next year, John’s grandchild would be able to by 3.3% less bread with his savings bonds a year from now than today. Inflation kills low interest rate investments. Forget about bread in this case….college costs are currently inflating at a rate of between 6 and 7 percent according to college planning website FinAid.Org.
2)     Savings bonds in a child’s name give you a tax exemption, but so what? How much interest will you have on 0.2% interest? Let’s do the math:
A $500 savings bond gift at birth, with compounding interest for 18 years = $518.31
$18.31 would have been taxable. If the child has any earned income at all, it’ll be at the 10% tax rate, meaning that you avoid $1.83 in federal tax by using it for college.
At the same time, $500 worth of college expenses rose to $2,358.56
3)     Competing gift ideas, such as 529 college savings plans, have a much better track record. The Ohio 529 plan, called CollegeDirect (I have no affiliation with this plan….just wanted to pick a random state), offers many options for college savings. Only one option that’s existed for more than five years shows an average annual return lower than savings bonds: the Vanguard Developed Markets International Stock Index Fund (-.54 percent). Were you really going to place all of your money in an international fund? The other funds in the account have returns between 5.6 and 8.76 percent. While these returns don’t all outpace inflation, at least you’re in the ballpark.
There are countless other reasons why EE savings bonds are a rotten idea for a college savings fund. If you’re becoming a parent or grandparent, aunt or uncle, explore other choices such as 529 plans for better results.
In Other News
Thank you to Matt at MomandDadMoney for mentioning my post: My Wife Is Pregnant – Is It The Right Time To Buy Life Insurance? on his Cool Stuff Around the Web piece. Matt has an interesting discussion on Peer-to-Peer Lending that you should check out as well….it might take the shine off this hot investment area a little….
The Plutus Awards have a cool tool that allows me to send you directly to the categories we’re hoping you’ll use to nominate us! If you like us in humor, use this link to vote. If you think our podcast should be on the list for multimedia, try this link to reach the right Plutus Award category. Thank you!
Today’s Workout: 8 mile tempo run
Days I’ve Run In a Row: 352
On my iPod: Natalie Sisson’s interview with Jaime Tardy on The Suitcase Entrepreneur
Photo: Phillipe Put
Interestingly enough, I just found a savings bond a few weeks ago that my grandmother gave my daughter ten years ago and I did the very same calculations that you’ve done here, with the same result of course!
Yeah, it’s pretty ugly, Mike. I can’t imagine why someone would buy them. If you felt obliged, why not just by the I bond instead?
My wife and I had a talk about this on the way home, as we’re always wondering whether we have the right mix of investments as we’re saving for our rental property. It’s currently 50% cash, 30% total bond fund, 20% total stock. I suggested going with less cash if our purchase timeline moves out, but she’s hesitant about the risk facing bonds and the possibility of an adjustment in the stock market, and wants to keep the cash where it is. But there’s an inflationary risk, as you noted. Over time, it can be significant. There really is no truly safe place for our dollars. Everything’s got some sort of risk and the best we can do is find a diversified balance.
I think you balance your thinking with your time frame. If the rental property is 3 years away, I’d be leery of the stocks and pile more in cash.
Nice run-through Joe. We opened a 529 for our son as soon as he was born. We haven’t been able to put a ton of money in there yet, but it’s nice to know we’ve got regular contributions in there. I’m with you that it’s a much better option than savings bonds. And of course, thanks for the mentions. Enjoy the weekend old man!
Don’t feel bad, Joe. Lots of the girls I went to high school with had kids before age 18, so there are several grannies from the class of ’92! Just think,if you had a kid at 15, and your kid had a kid at 15 and so on, you could be a great grandpa by age 45! That wasn’t the point was it? My parents are way too smart to buy savings bonds. They got my daughter a whole life policy. They were so proud, just had to nod and smile. What can you do?