Is the Risk Really Being Managed in your 529 College Savings Plan?

As our kids get within a few years of going off to college the desire to make more money in their 529 college savings plan should be replaced by the need to protect what you have.  If you’ve done a good job planning you should be at, or very close, to your goal.  The benefit of a few dollars more is far outweighed by the risk of not having enough if the investments were to decline in value.

Managing the Risk in your 529 Plan

Since many of us don’t have the financial background necessary to manage investments and financial risk, the companies that sponsor the 529s give us the choice of having them manage the risk through the use of Target Date Funds (TDFs). The premise of the TDF is that as you get closer to the date you need the money (the target date in the fund name), the manager reduces the risk in the fund.  Conventional wisdom tells us this means moving out of stocks and into bonds.  We all grew up being told that stocks are risky and bonds are safe(er), right?

If you’ve been paying attention you probably know that there are three things that really grind my gears when it comes to investing:

  1. Black box investments that have become popular only because we (and the financial media) buy into the advertising propaganda of the big financial firms
  2. Conventional wisdom that’s usually wrong and only accepted because we (and the financial media) just don’t do at least a sniff test
  3. The shock and surprise we suffer when things go bad because of #1 and #2.

As I’ve discussed in a previous article (read it here), I really don’t like Target Date Funds.  Mostly for the three reasons above.  They are designed with good intentions.  Let the pros manage your risk.  I actually like that idea.  Unfortunately, by trusting the black box we unknowingly subject ourselves to risks we think are being managed.

What risk is hidden in your College Savings Plan?

After reviewing the 529 plans for some of our clients I noticed that more of the plans are invested in TDFs.  While this may be acceptable when kids are young, there is a real risk if they are within a few years of college.

Even though we are all led to believe that bonds are safer investments, they are still instruments that are subject to market forces.  If interest rates rise the price of the bonds will fall.  That’s finance 101.  With interest rates at historical lows it is only a matter of time before we see rates begin to rise.  Even without an interest rate hike the returns on bonds should be low.

Some in the market feel that when interest rates do rise that there will be a strong (probably unwarranted) reaction in the bond market.  This would cause a sharp drop in the price of the bond funds that are there to reduce risk ultimately cutting the value of your kids 529 just when the funds are needed.  Will this happen?  I have no clue!

What I do know is that as college gets closer the money in the 529 should be truly protected – not just in theory but in reality.  We could be faced with a situation where there is little potential upside to the bond funds (due to the low interest rates) but an unknown potentially high risk due to the potential rise in interest rates.  This is definitely not a good formula for investing.

What should you do to reduce the risk in your 529 Plan?

You need to review the investments in your kids 529s to understand the real level of risk you have.  Regardless of the investments, if your kids are going to college next year it may be time to eliminate some risk all together.  Giving up some potential interest is probably far better than the alternative of a big loss.  Remember the fine print at the bottom of all the financial advertising.  There is a risk of loss in investing.  Even in bonds.

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Until next time…..