“I’m sorry, but your education fund has halved!” It is October 2008. Just a few months before David and Ruth’s first daughter was meant to go to university. David and Ruth were devastated. Years’ worth of savings were gone in an instant. The timing could not be worse. The couple decided to sell what was left and keep it in a safe cash account. They were not going to compromise their daughter’s education fund any further.
David told me this story - during our December holidays - a few years after it had happened. The sad part - David and Ruth had done all the right things over many, many years. They opened an education fund briefly after their daughter was born. They invested in a low-cost, well diversified index fund. They put aside a small amount of money into this fund every month. They did so consistently. They never missed a month. On several occassions - such as birthdays - some family and friends even contributed towards the fund. Albeit small, their consistent contributions meant that the fund grew into a sizeable investment. It was not evident at first, but with time, the largest part of the fund's value could be attributed to sheer growth and dividends from the underlying investment rather than David and Ruth's contributions. So despite the fund enduring several market crashes - the Asian financial crisis, Russia's sovereign debt default and the tech bubble bursting - each time, it was able to recover . That is, until the 2008 crash. This time the fund was unable to recover. More than half was gone. In a flash! And there simply was no time for the education fund to recover such a devastating loss.
What can I learn from David and Ruth's story? This is it. For my daughter's education fund, I will need to adjust the amount of investment risk as time goes on. The closer I am to her needing the money saved for her tuition, the less risk the fund should be exposed to.
Early on, it makes sense for the education fund to be fully exposed to the greatest growth engine in the world. The stock market. Even if market crashes come along - and they will - the fund is able to recoup those losses. Time is the stock market's greatest friend. If there is plenty of it, the stock market remains the greatest vehicle for growing the education fund.
However, as the time horizon lessens & the need for the tuition money becomes closer, I will need to adjust the risk in the education fund. I can do this, by dialling down the exposure to the stock market and increasing exposure to less risky assets such as bonds and cash. Thus with about seven years left until university starts, a “High Equity” fund becomes the more appropriate vehicle. A “High Equity” fund still has a large part invested in the stock market, but also invests in less risky asset classes. There are numerous funds in this space. A couple of examples would be the Sygnia Skeleton 70, 10X High Equity or the Allan Gray Balanced fund.
This path of taking on less risk should continue. With about five years left, I will need to again adjust that risk dial and switch to a “Medium Equity” fund. Example Sygnia Skeleton Balanced 60 Fund, 10X Medium Equity or the Coronation Capital Plus fund.
At about three years, I will dial it down further to a “Low Equity” fund. Nedgroup Investments Core Guarded Fund, 10x Low equity or Coronation Balanced Defensive. About two years or less I should dialit down even further. An “Income” fund is more appropriate, where there is little to no stock market exposure; such as Coronation Strategic Income, Nedgroup Investment Flexible Income Fund. Finally, with one year to go, I will put the investment into a money market account.
For my daughter's education fund, I want to employ a risk adjustment strategy. This involves starting out with full blown stock market exposure early on. It will give our education fund its best chance to maximise growth whilst time is on our hands. As time passes, I will dial down the exposure to the stock market, by switching into less and less risky funds until the fund is a mere money market account. This way, I will give the fund the best chance to grow, but not be decimated by a market crash shortly before we need the money. These are lessons I want to take from David and Ruth's story.