Reader: I would like to hear your ideas about college student portfolios. I have a sophomore in college and a junior in high school. Therefore their savings need to be very safe. However, the high school student has almost 5 years before the last of hers will be used, while the college student has less than 2 years before its no longer needed. Interest rates are falling and look to fall further if the Fed reduces its rates again. Would you recommend bonds or cash for the very short term, and what would be your recommendations for funds slightly longer term?

funds-newsletter: I appreciate your suggestion that I give more information for people saving for shorter-term goals, such as for funds for college.

Although my newsletter hardly ever refers to specific goals, such as retirement, buying a home, or funding a college education, I do usually point out that my advice usually covers investments at least over the next year or two, and likely even longer term. So, I would expect that if your children have funds set up to last for roughly 2 yrs thru 5 yrs., my portfolio suggestions in my Jan. newsletter would work for them.

Of course, anyone investing for periods as short as these, and needing to be almost absolutely sure that the investments were not going to be in negative territory when needed, should as you imply be focused almost exclusively on bonds and/or cash, not stocks.

Since I expect interest rates to be falling for a while, it appears to be a good time to invest in bonds as opposed to cash. Bonds usually have a higher dividend than money market funds, plus the more interest rates drop, the more certainly will yields on money market funds get smaller than they are now. But even more important is the fact that as interest rates drop, one's total return from bonds almost always will increase. This is because bond prices rise as interest rates fall. So, if the Fed drops interest rates say 1 to 1.25 from their current level, and all bonds also start to reflect the same drops, one's return on a short-term bond fund could easily grow by 2-3%, on a intermediate bond fund by 5-6%, and a long-term bond fund by 10% or more! This gain is in addition to the dividend payments. So, a bond fund paying 4.5% now, if interest rates drop, could easily return 6.5-7.5% or more.

However, just as with stock funds, no return for a bond fund can ever be a sure thing. If you invest in a bond fund, and interest rates wind up going up over the period you hold the fund, you could do worse than a money market or even have a negative return. If you must be absolute certain of making at least a small positive return, currently around 4% but likely to go lower, then you must choose cash. If however you are quite confident, as I am, that interest rates will continue to go down, then it makes sense to put most or all of these savings into a short or perhaps an intermediate bond fund.

Over the next say 3-6 mos., if you start to read that interest rates are now going up, you would want to reconsider, and likely put the money strictly in cash. I think this is highly unlikely. But at some point, perhaps over the next year or 2, this is certainly possible. That is why it is so important whether interest rates are going down or up. As long as they are going down, or even stable, short and possibly intermediate bonds are a very safe place to be; when they are going up, and you will need the money soon, I would certainly go into the safety of cash.

The money for the child who has close to 5 yrs before it is needed is, in my opinion, pretty safe in bonds for a while. The money for the child with less than 2 yrs. til needed seems to be safe as well, provided you keep you eye on what the Fed does with interest rates as stated above. Make sure the bond funds you invest in are high quality bonds as opposed to low rated bonds. That is, certainly do not invest this college money in "junk" or "high yield" bonds.