ZERO-COUPON BONDS
U.S. Treasury zero-coupon bonds are securities that are sold at a deep discount from their face value and do not pay interest. The return on a zero-coupon bond comes from the difference between the purchase price of the bond and its value at its maturity date.
Some investors prefer zero-coupon bond to save for specific goals, such as retirement or a child's college education, because they can estimate in advance approximately how much these investments will be worth when they mature. However, there is no guarantee the fund shares will reach their anticipated value at maturity.
For example, if you had $5,000 to invest for a particular goal in the year 2020, you might allocate around $1,000 to zero-coupon bonds with a face value of $5,000 at maturity. You could invest the remaining $4,000 in a stock fund or other securities.
No matter what happened to your other investments, your initial investment of $5,000 would be returned when the zero-coupon bonds matured.
Interest on these bonds is deferred until maturity, when it is paid in a lump sum. It's important to understand, however, that you do have to pay income tax on the interest as it accrues each year the bond is held. You should set up these bonds so that they mature successively, in every year of a child's college career.
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