A Case for the TuitionMAR
May 28, 2007
As Money Management Executive launches this year's set of State Tuition Index and Datasheet reports, a new paradigm for evaluating college savings plan is introduced. With MME's TuitionMAR (minimally acceptable return) statistics, a set of core absolute return benchmarks is now available to assist mutual fund companies, 529 plan sponsors and financial planners in evaluating the ongoing success of a college savings plan investment.
Updated annually and a core element of MME's 529 Risk-Adjusted Performance (RAP) Report series, these benchmarks create a framework for the ongoing evaluation of minimum target rate returns required by parents faced with saving enough for college.
Some call the MAR an investor's hurdle rate, but due to their specificity of purpose and applicability to the college savings plan model, we refer to an absolute benchmark created specifically for the college savings industry as the TuitionMAR.
The application of MARs is common in many investment sectors, including pension funds where a targeted ongoing payout remains a goal in the burgeoning world of hedge funds where the measurement of downside risk below a fixed, given return is often the most important evaluation metric.
For retail investors, though, performance evaluation against strict, sector-neutral benchmarks remains fairly uncommon. Yet due to the non-correlated nature of college savings investment returns (what is achieved by the investor) and tuition inflation rates (what is required by the investor), successful out-performance against relative return benchmarks such as the S&P 500 index provides little information concerning the overall effectiveness of a college savings strategy.
After all, exactly how successful can one consider a college savings strategy where even though the portfolio outpaced its benchmark by 3.5%, it still managed to underperform the tuition inflation rate by 4%.
With the release of MME's State Tuition Index and Datasheet reports, the college savings industry is provided detailed, in-depth analysis of each state's unique tuition trend patterns, cost breakdowns and individually calculated TuitionMAR statistics. Along with a normalized TuitionMAR value, the reports highlight predictive values based on tuition/tuition, room and board rates growing faster than normal, and also slower than history has indicated within each state.
Much more than a state's average long-term tuition inflation rate, each TuitionMAR value is based on an analysis of 2,500 different data points, encompassing 17 sequential years of tuition data between 1990 and 2007. Bootstrapping this data, a common practice in quantitative finance when using limited data sets, helps us understand not only what actually occurred with a state's historical tuition costs, but what could have occurred given similar circumstances.
Also, bootstrapping the data provides the added benefit of smoothing out our expected values given statistical outliers and/or anomalies in the smaller, original data set.
As such, MME's TuitionMARs provide college savings strategists at all levels with statistically meaningful data points for the ongoing evaluation of investment performance against tuition trends in each state.
TuitionMARs at Work
Development of MME's TuitionMAR statistics does bring to light one unique industry-specific theme. Parents residing in different states may, in fact, require different investment risk profiles in order to successfully fund a child's future college education.
Consider a given asset allocation model with an expected average return of 6%, and two different families. One residing in Virginia, the other in Texas. Each set of parents expects to send their child to an in-state, four-year public university. Each family chooses similar portfolios, and thus should expect similar investment returns, as well. Yet, who will achieve greater success at funding their child's future college costs?
Assuming a TuitionMAR for tuition, room and board of 5.45%, the probability that the family from Virginia achieves a return equal to or greater than their state's future tuition inflation rate remains fairly healthy. But for the parents from Texas, who are faced with a TuitionMAR of 7.35%, achieving funding success may require a modification in their investment allocation strategy-one that accepts a slightly different risk profile in order to increase the probability of success.
Overall, the introduction of MME's State Tuition Indexes and Datasheets provides a new barometer for shaping and evaluating a college savings plan strategy. The TuitionMARs, in particular, give the industry a core set of absolute benchmarks to be used for evaluation purposes. Tailored and customized at the state level, the data sets and reports provide insight into the challenges parents face when building a college savings plan along with a core set of absolute-return benchmarks instrumental to the college savings strategy evaluation process.
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