Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

Q: With all the volatility in the market right now, I am getting nervous having all the money I saved for my kids’ college education at risk. My 529 plan has a money market option; should I move my balance there until things improve?

A: It is always tempting to take shelter in safer assets when markets whipsaw, but timing moves into and out of stocks will probably just prove costly. In the short term, there is no way to accurately predict how the market will behave.

It is hard to tell from the question how close he or she is to paying college tuition, but the good news is that many 529 plans are designed to expose investors only to as much equity risk as they can reasonably handle as their goal date draws near.

The lion’s share of 529 assets are invested in age-based 529 plans. These plans follow glide paths that are similar to those used by target-date funds. Age-based 529 tracks start out with a high percentage of assets invested in equities—sometimes as much as 100%, but the average is around 80%—and they gradually sell stocks and increase the allocation to bonds and cash as the child gets closer to age 18.

If your beneficiary is early in an age-based track, up to age 6, you have time on your side. Day-to-day market volatility may be unsettling, but it likely will not hurt returns too much over the long haul; you have more than a decade to recover from stock market shocks. For instance, the stock market lost nearly 40% in 2008. Equity investors felt that pain acutely. But in the ensuing 10 years, the S&P 500 has gained more than 260%, about 15% per year. Hindsight is 20/20, but history keeps teaching us that when it is most painful to be an equity investor it is the best time to buy more stocks.

If you are closing in on the 529 beneficiary’s matriculation day, you have less time to recover from a sell-off, but the age-based track has taken care of ratcheting down your exposure to equities. The typical 529 investor has about 15% in equities at college enrollment, according to Morningstar data. Even if we experience another year where the market loses 40% of its value, as it did during 2008, most of your savings will not be affected.

Dial Down the Risk (a Bit)
One lever you have at your disposal is to fine-tune the aggressiveness of your 529’s allocation. All the age-based tracks follow a glide path that is based on an investor’s risk capacity by investing time horizon, but you can choose a more or less aggressive age-based track that best suits your risk tolerance.

Bear in mind, risk capacity and risk tolerance are different concepts, and they can be out of sync with each other. If you are saving for a newborn’s future college needs, you have a large capacity for risk—you have 18 years to ride out the market volatility that comes along with equities’ higher long-term returns. An equity allocation close to 100% could make sense for the first six years you invest. But if you cringe every time the market drops a few percentage points, your risk tolerance may not be in line with that risk capacity.

On the other side of the coin, if the 529 beneficiary is in high school, you have an interest in conserving the money in the account. You do not have as much time to weather equity market downturns before you will need that money. It makes sense, then, that your risk capacity is lower, and your overall exposure to safer assets like bonds is higher. This will help protect your savings from getting wiped out in an equity market sell-off when you need that money to pay college tuition bills.

Finding the Best Fit
As you go to establish a 529 plan, you may encounter a questionnaire that asks you to describe your attitudes toward gains and losses. These types of surveys focus on gauging how loss-averse you are and attempt to pair you with the most suitable asset allocation among that plan’s different 529 products. A common question is “What would you do if your college-savings portfolio declined X% in a year?” The answer choices include options like “Stay the course,” or “Move into a less risky portfolio.”

We recommend that you consider these questions carefully with your financial advisor, trying to imagine the scenario
described and answer honestly. Ask yourself: If we were to see a repeat of 2008’s market, could you bite the bullet and stick with your 529 plan? If your answer is no, consider going with an option that is not 100% equity at inception, but is not as low as 50% either. Find a balance: You want an allocation aggressive enough to give you the best chance of meeting your investing goals, but conservative enough that you are comfortable sticking with it.

 

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