Assessing Investment Risk in a Coverdell Education Savings Account
Whether you’re investing in stocks or bonds in your Coverdell Education Savings Account (ESA), an element of risk is involved. Here are some points to keep in mind when pondering the level or risk to take:
Never put all your eggs in one basket. No matter how confident you are that something will take off, invest part of your money in other ventures just in case.
Most people assume that buying stocks is riskier than buying bonds, and to some degree, that’s true. In a worst-case scenario, where a company goes bankrupt, a bondholder has some opportunity to recoup his investment, because he’s a creditor of the company. A shareholder in that bankrupt company, however, knows to kiss the value of his investment good-bye; as a partial owner in the company, he’ll receive money only after all creditors have been paid in full.
However, some companies’ financial situations ensure they’re still going to be around tomorrow or next year and may represent a less risky investment than investing in junk bonds.
Doing some research helps you to assess the risk of a particular investment. Bonds and mutual funds carry creditworthiness ratings; check the ratings. Moody’s Investors Service and Standard & Poor’s are the best-known bond rating organizations. They judge bonds from highest quality (S&P = AAA, Moody’s = Aaa) to those in default, with recovery unlikely (S&P = D, Moody’s = C).
The higher the quality of the bond, the lower the stated interest rate is likely to be, but the higher your chance is of actually collecting that interest.
No investment is absolutely risk-free. Your bank may go belly up (although your bank deposits, but not your investment accounts, are protected by deposit insurance). The United States Treasury may start defaulting on its loans. Your house may float away, taking all the savings you’ve stitched into the mattress down the river with it. There is no such thing as a sure thing.
Any discussion about stocks and the stock market inevitably includes the terms “growth” and “value.” Here’s what those terms mean.
Growth stocks: Growth stocks are shares in companies that still are experiencing, or anticipate experiencing, significant earnings growth.
Value stocks: Value stocks are shares in companies who already have an established product line or service, a product or service that generates steady income for the company. Usually, the current share price of the company is well below the actual value of the company if it were sold or otherwise liquidated.
Every Coverdell ESA has some sort of money market option; make sure that any cash sitting in your account is swept daily into the money market funds. Even though the interest that you earn on this money won’t pay for much on its own, over time, it will help to improve your overall investment result.