Many families expect to continue to support their adult children through college and often beyond. The norm is to pay for their tuition, rent, utilities, food, cell phone, and even some entertainment expenses through college. Ideally that would all end with graduation, with perhaps a brief visit home before starting off for a new job and a life of independence. The new norm, however, is getting to be to continue that support until your son or daughter is 30 or even older.
The issue is that many college students are graduating with enough student loan debt to amount to a car or rent payment each month. This makes it difficult for them to start an entry-level job and pay for both their loan payments and their living expenses while they gain the experience needed to get enough money to be fully self-sufficient. They are also much happier living at home in a spacious home with free meals, particularly if their mom still does their laundry, while they are gaining that experience than they would be in a cramped efficiency apartment.
My parents did things somewhat differently for my sister and I than the norm, and it seemed to work well (if your definition of “working well” is to launch your kids out on their own after college). From the time we were about 14 my parents started depositing money in a brokerage account for each of us and worked with us to pick investments and manage the accounts. They were able to do this tax-free because their contributions were always under the gift tax allowance (currently something like $28,000 for a married couple to each son or daughter per year). By doing this for a number of years they were able to build up a sizeable starter portfolio for my sister and I before we went to college.
Once at college, instead of calling Mom and Dad each time I had a bill, I would just use cash from interest and dividends on the investments or sell shares of stock as needed. Because I was living very modestly and on scholarship, I was actually able to cover most of my bills from just the interest and dividends I was receiving from the investments. I therefore had a reasonable portfolio to help pay for graduate school expenses after I completed my undergraduate degree. With the portfolio, thrifty choices on schools (I went to UC Berkeley, where I got in-state tuition paid for by the grant for my graduate work instead of Stanford where I would see tuition bills of $20,000 per year), and some side jobs along the way, I was able to make it through school loan-free and still have enough in the portfolio to serve as a good emergency fund after graduation.
This worked out very well for my sister and I, but things could have gone really badly. Since the money was put into a custodial account, once we turned 18 the portfolio was ours and our parents had no legal say on what we did with the money. One of us could have blown the money on parties and junk, leaving us without the money needed to go to college. It probably would have served us right to then need to drop out of college and get a regular job to earn the money to go back, but it still would have been a disappointment for our parents to see their hard-earned savings wasted. Of course, there are also students who spend six or seven years in college on loans and never get a degree. They then have both loans to pay back, often with help from their parents who may be consignees on the loans, and no degree to show for the money.
There are many advantages to using this method of college/early life funding rather than paying for expenses as they occur:
1) You can help your son or daughter learn how to manage a portfolio of investments while still under your roof.
2) When your students go out on their own and start earning money from their portfolio, they will (possibly) be paying taxes at a lower rate than you since their total income will be a lot lower, so it may be better for them to be earning the money in their portfolio than for you to earn money in your own portfolio and then send the money to them for expenses.
3) When it is your student’s money, they will usually tend to want to save it rather than spend it, so they may be more thrifty with their college choices and spending while at college.
4) It will force you to save the needed money for their college before they go rather than hoping you’ll find the money somehow when they get there.
5) It allows you to tell them they’re on their own and that the choices they make are now theirs without worrying about them not having the money for rent the first month and ending up on the street. There is security in having enough money to have a few unfortunate events without becoming destitute.
6) If they work a job in college, they may be able to fully fund an IRA with their wages since they’ll have the money needed for living expenses from the portfolio.
Still, giving them all of the money when they are 18 may not be the best option. While legally adults, people make some pretty bone-headed decisions when they are 18-23 or so. It is good to be able to give them a second chance if they screw up early but then learn their lesson and mature. A second plan would therefore be to give part of the money when they head off to college, but then give the rest of the money as they mature and prove they can handle the wealth. For example, maybe give enough for them for living expenses for the first two years of college before they turn 18, then continue to give them money through the gift tax exemption for the next four years after their sophomore year if they prove that they can handle to money and are making good progress in college. This unfortunately will make it less likely that they will be able to pay for most expenses using just interest, but it does help protect the parents from spendthrift students (and gold-digging relationships).
Now one final “disadvantage” of starting your children with a portfolio is that it may well hurt their chances of getting financial aid. Really, though, this should not be seen as a disadvantage at all. Why is it that middle and upper-middle class families who have plenty of money to spend on cable packages, kitchen upgrades, Caribbean cruises, and big data packages for their phones need to go begging for charity when it comes to college? Maybe it is time for families to put first-things-first and not accept public charity when they can pay their own way through better choices.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
