I failed to move my daughter's college fund into safe investments. Now she's starting college. Do I sell at a loss?

QUESTION: I'm a bit embarrassed to admit that I didn't follow everyone's advice and move my daughter's college funds into safer investments two years before she needed them. Now she's starting college. Should I start cashing in her big losers, or sell some of her winners? She only needs about 15% of her funds this year. Do I hope the funds that have lost money come back, or let the winners run?

— Dale Terrell


ANSWER: So you tried to race time — and lost. "The thing that makes stock investing so great is time," says certified financial planner Ross Levin, president of Accredited Investors in Edina, Minn. And when time's lacking, stock investing isn't so great. "As your big expenses approach, you have less ability to recover," Levin says.

All right, well, clearly you've learned your lesson. So let's move on to how to make the best of this situation. Chances are, you're going to want to sell both winners and losers. Why's that? Tax management. As you may know, if you sell holdings that have lost you money, you can take a tax loss of up to $3,000 a year against ordinary income. But if you have more than $3,000 in losses, you can also hock some of your winners, using those additional losses to offset their gains, says Don Cassidy, senior research analyst at Lipper and author of the 1997 book, "It's When You Sell That Counts." Alternatively, you can postpone additional losses to use as a tax write-off in future years. (For all the nitty-gritty details on how that works, see our Capital-Gains Guide.)

Before you sell anything, however, you need to distinguish your winners from your losers by calculating the tax basis of your shares. After all, while some of your funds may have fallen dramatically over the past year or so, that doesn't necessarily mean you have an overall loss. In fact, if you bought these funds in the mid-1990s, you probably still have gains. Likewise, if you bought shares of the same fund at different times — some of those shares may represent a loss, while others may have gains. By strategically choosing which shares to sell you can dramatically reduce your tax liability. (Our story will give you all the goods.)

Now that you're selling shares to pay for your daughter's freshman year, this is also the time to be thinking about freeing up funds for the remainder of her studies. That means that you should probably move additional assets into more conservative investments, says CFP Sue Stevens, Morningstar's director of financial planning. One idea, she says, is to give all of your holdings a "haircut" by selling, let's say, 10% or 25% of each. Then place the money for the first two years of school in a money-market mutual fund or a similar highly liquid vehicle, suggests CFP Norman Boone, president of Boone Financial Advisors in San Francisco.

Junior-year tuition could be placed in a short-term or intermediate-term bond fund (i.e., something that will offer slightly more upside than, say, a money-market fund). If you're a bit short on funds, Boone stipulates, you may want to be somewhat more aggressive with that money — but obviously not as aggressive as you've been over the past few years. So consider instead a balanced fund. This might also be a good option for senior-year tuition.

For more on allocating your college funds, check out our College Portfolios section, which gives a recommended asset allocation based on the age of your child.