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SDec 4, 2013

If You Are Still in School, Keep Your Investment Powder Dry

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Q. I am an 18-year-old college freshman. I have been fortunate enough to receive a very large sum of money in scholarships at my university, such that I have a surplus of a few thousand a semester. I am allowed to spend the money however I wish.

Rather than allowing the money to depreciate during my four years in college, I would like to invest it. I'm planning on investing in an index fund, but I'm not sure if I want to make my investment in a Roth IRA or in a traditional account, or some sort of split.

I may need some funds for graduate school in the future, but I don't have any idea about how much that will end up costing, or how much support I will get. I would like to complete graduate school without taking out any debt so that I can start my career debt-free and financially sound. However, getting some money in a retirement account now when I am not paying any taxes is also an attractive opportunity.

I appreciate any investment advice you can offer a young person like me. —M.D., by email        

A. Congratulations! The best answer to your question requires a short lesson in what's called "the life cycle hypothesis," the idea that won the late Franco Modigliani a Nobel Prize. The idea is that we try to even-out our consumption throughout our lives, attempting to avoid sharp drops by saving—first as a cushion and second to replace our earning power as we get older. Basically, we try to replace our human capital (something you have a lot of because you are both young and smart) with financial capital during our work life.

In that context, saving in a Roth IRA isn't a good idea right now because (*see correction below) you won't be able to access the money until you are 59 1/2 without penalty. More important, you've got opportunities to further augment your human capital that require money even beyond graduate school.

Having some accessible savings, for instance, can help you make a good decision when you seek a job. It may allow you to pursue opportunities that your highly indebted classmates won't be able to pursue because they're looking over their shoulders at major debt service. Having access to liquid savings will also make you a better (read stronger) salary negotiator.

Bottom line: For the near future, limit your risk and stay liquid. You might, for instance, consider one of the short-term inflation-protected Treasury securities exchange-traded funds, such as the iShares 0-5 Year TIPS Bond (ticker: STIP).

Q. My mother in law is 93 years old. When she was in her late 70's her husband passed away and she decided to buy a Long Term Care insurance policy. Her account is now worth $146,000. Her intent was noble— she did not want to depend on anyone when she was aged and infirm. That’s the good news.

She has been pretty much incompetent since this spring. She suffered a stroke three years ago, then developed fractures in her vertebrae. This year she has slipped to the point that she cannot take care of herself. My wife and her sister have been trying to get some of the money
from the insurance to defray the care costs since May. This company has put obstacle after obstacle in their way with delays and demands for paper work. In the event they ever break the logjam, the max payout is $2,400 per month. So this could last 5 years. I think the chance she will survive another 5 years is pretty remote.

In retrospect, she would have been much better off investing the money, so that when she needed it she could have control and if she did not use it, the remainder would be part of her estate. I cannot imagine that we are the only ones going through this. I hope you
can alert folks to this problem. —T.W., by email

A. When the sale is being made, agents talk about prompt payment of claims. I'm hoping your experience is unusual; so let's see what other readers have experienced.

*Correction: The limitation cited applies to Roth IRA conversions from traditional IRAs, not directly opened Roth IRAs. This has no effect on how the money should be invested.

Filed Under: Financial Planning