|Should I invest a lump sum, or is there a way to use dollar cost averaging when investing in a college savings plan?|
If you want to contribute to your college savings plan and use dollar cost averaging at the same time, you can simply invest a fixed amount in your account at regular intervals (e.g., $100 a month). One way to do this may be to arrange for automatic payroll deductions or bank account debits to be invested in your college savings account. But assuming you have a lump sum of money to invest, is dollar cost averaging better than making a single large contribution? That's a more difficult question, and the answer depends on your particular circumstances.
According to the experts, the benefit of dollar cost averaging is that it helps you ride out the ups and downs of the market--you buy more shares when the prices are low, and fewer shares when the prices are high. But your decision may be more complicated than it seems. Let's say you have $100,000 that you'd like to invest in your college savings plan over time using dollar cost averaging. Where will you keep the money in the meantime (e.g., money market fund), and how does your expected return on that investment compare with your expected return on your college savings plan? If you expect to do better with the college savings plan, it might make more sense to invest the lump sum. Remember to compare after-tax return figures, since college savings plan investments grow tax free.
Other factors may also enter into this decision. Fees imposed by your college savings plan may decrease as you contribute more money, so investing a lump sum may save you fees over the long run. But a lump-sum contribution may have gift tax consequences that could be avoided by gradually investing the money. However, under special rules unique to 529 plans, you can make a lump-sum gift of up to $65,000 ($130,000 for joint gifts) and avoid gift tax if you elect to spread the gift over five years.
Gradual investing might also help you better diversify your college savings plan holdings, since many plans let you direct new contributions to a different investment option. However, the IRS has given states the discretion to allow you to change the investment option on your existing (lump-sum) contribution once per calendar year. (For 2009 only, states may permit 529 college savings plan investors to change the investment options for their existing contributions twice per year instead of once per year.) Check with your specific plan for more information. Also, be sure to consult a financial professional before making this decision.
Note: Dollar cost averaging does not ensure a profit or protect against a loss in a declining market. You should consider your ability to invest continuously when the market is down.