Few, if any, other investments can match the long-term record of the stock market. Therefore, putting some savings into equities makes sense for most college-fund investors during the early, wealth-building years of a long-term savings plan.

What Are Common Stocks?

Only a small portion of the hundreds of thousands of companies in the U.S. are bought and sold by the public in the stock market. The two big data services on stocks, Moody’s and Standard & Poor’s, report sales, earnings, and other information regularly on about seven thousand of these publicly held companies. However, shares of only about five thousand companies trade actively.

An investor for college bound students probably would want to focus specific shares for the college fund in companies with a solid history of earnings and dividend growth and with a healthy share of the markets in which they do business. When investing in an aggressive-growth stock fund, the shareholder is an indirect owner of shares in a somewhat wider group. In either case, the shares represent ownership of the fair portion of a company’s assets and of whatever flows to the company’s “bottom line” (net income). The value of the shares will be determined by these fundamentals and, equally important, by how much others want to own those assets and earnings.

The Pros & Cons Of Using Stocks For College

Once it has been determined that stocks deserve a role in building up a college fund, the three key guidelines to successful stock investing are:

  1. Develop a disciplined approach to selecting stocks. Understand the basic criteria used when making a choice.
  2. Do as little short-term trading as possible. Do not leap into a declining market because it is about to turn right around; leave those decisions to traders.
  3. Keep an eye on the proportion of stocks in a college fund in relation to returns available from alternative investments (“asset allocation”).

There are as many currents affecting the stock market as there are wind and ocean currents affecting the weather. They include general economic and industry ups and downs, interest rates, currency flows, technological changes, government regulation, international events, competitive challenges, good and bad management, taste and fashion, and the law. There is no way for to make stock selections based on taking even a few of those factors into account systematically.

The stocks in a college fund have one function: to generate fairly reliable growth at a rate somewhat better than can be achieved by Treasuries and other fixed-interest investments.

Here are some tips for investing in stocks:

  1. Forgo searching for a “killing.” For the most part, look for companies that already have a good track record of success available at a fair price. Those with a taste for a bit more risk, might consider putting some part of the college fund’s assets into a growth fund.
  2. The savings that have been set aside for a child’s future should never be invested in a “tip,” or in an “idea” that is not fully understood. Take time to be methodical and make long-lasting decisions that can be lived with.
  3. When considering an individual stock suggested by a broker or one that an individual has researched, ask what is expected from the issue: Reasonably steady growth? Good dividend income? A sharp rise in price over the next one or two years?
  4. Check expectations against the company’s actual performance. Look at a company’s net income per share, and, perhaps, at the five- or ten-year record of such earnings in the annual report. This gives an idea of whether the company’s earnings are steady or erratic.
  5. Look in the company’s annual report for:
  • Total debt load – On the balance sheet find the figures for long-term debt, short-term debt, and shareholders’ equity. Calculate the percentage of total debt represented by short-term debt and whether that percentage is increasing from quarter to quarter or year to year. That trend could make the company vulnerable to higher interest rates. Add the long-term debt and shareholders’ equity figures together (the total is long-term capital). Then divide long-term debt by long-term capital. If the result is 50% or less, the company probably has additional borrowing capacity, which could be, essential to take it through a period of exceptionally fast growth, or an earnings falloff.
  • Sales slowdowns – Figure out the rate at which inventories are rising. Compare that rate to the rate at which sales (on the profit-and- loss statement) are rising. If inventories are going up faster than sales, the company may already be producing more goods than it can sell.
  • Increasing costs – This is a matter of increased concern now that competition can come from anyplace in the world. Figure out the annual rate of increase in costs and expenses (on the company’s profit-and-loss statement and compare that to the rate of increase in sales. Costs may be getting out of line if expenses are going up faster than sales, and that could spell trouble for a fast-growing company.
  • Company management – Get some sense of whether management is honest in dealing with negative business conditions. Do not ignore the chief executive’s letter that usually leads off an annual report. Look at the latest letter and the one in the previous year’s annual report. If optimistic projections were made earlier, have they been borne out by results since? If they were not, does management explain what happened and offer information on what is being done about it? Be wary of a management that does not acknowledge any problems at all in the year’s operations.

All in all, investing in stocks as a long-term strategy for funding a college education may offer the best opportunity to keep ahead of both inflation and the rising cost of college.