3 Tips for Investing Wisely in a 529 Plan
By Joe Messinger, CFP®
October 23, 2015
Fans of ESPN’s College Game Day know the familiar “not so fast, my friend” from Lee Corso. Sometimes we come across articles that cause us to say those very words. While the information is true, we might not 100% agree. We had a “not so fast” moment when reading an article from CNBC about 529 savings plans. The article made some suggestions that may be the right fit for more savvy and experienced investors but not for all—especially if you are a more hands off “do it yourself” investor. (To their credit they do acknowledge this in the article briefly towards the end.)
If you are a DIY 529 investor, here are 3 quick tips for you:
1) Carefully review your investment choices. 529 plans can be set up in a variety of different ways, but they are typically invested in mutual funds. In most plans, you can choose to invest in a combination of the plan’s individual investment options, in a ready-made risk-based portfolio, or in a ready-made age-based portfolio. One popular method is the age-based funding strategies. Here is how it works: If your child is young, your funds will be invested in more aggressive choices. As your child gets older, the assets are automatically transferred to more risk averse investments. The CNBC article suggests you NOT choose the age based method. We would say “not so fast”.
Like any investment, you want to make sure your asset allocation is appropriate given your risk tolerance and time horizon. Just because family A and family B both have 10 years until their kids go off to school does not necessarily mean they should be invested the same way. Some people may be willing to forgo the potential of higher returns to know their downside risk is limited. Others may be the opposite being more comfortable with something a bit more risky in exchange for the potential of higher returns.
2) Review your goals and asset allocation strategy regularly. The only thing constant in life is change. As your goals and time horizon change, so should your investment strategy. Your strategy is of particular importance with a relatively short investment runway for college. One important tenet in investing is rebalancing your portfolio at least annually to align with your goals. So, what is rebalancing?
Rebalancing is the process of buying and selling portions of your portfolio in order to set the weight of each asset class back to its original target amount. In addition, if an investor’s investment strategy or tolerance for risk has changed, they can use rebalancing to readjust the weightings of each asset class in the portfolio to fit the new asset allocation. Frankly, most investors don’t do this, unless they have an attentive advisor.
The whole idea behind age based investing is to essentially set it and forget it. These plans are not perfect, but for the hands off DIY investor they can serve them very well by systematically making the portfolio more conservative and less risky as college approaches.
If you are working with an advisor and/or pay close attention to your portfolio, you certainly may be able to create a more customized portfolio. However, many investors are just trying to sock away as much as they can and outsource the asset management for a reasonable fee. If this sounds like you, the ready-made age-based option is something you should strongly consider.
3) Fees matter! You will incur lower expenses with direct-sold 529 plans. Broker-sold 529s generally have higher annual costs and may include sales charges of anywhere from 1% to 5.75% of your contributions. Also, many of the direct-sold 529s invest in index funds with low expense ratios.
The vast majority of our clients are Ohio residents. As such, we typically advocate families use the College Advantage direct 529 plan with the Ohio Tuition Trust Authority. For starters, Ohio offers a state income tax deduction to Ohio residents on the first $2,000 you contribute to the plan for each beneficiary, per year. They also offer a variety of passive low cost index funds. The high fees of many broker sold plans can eat up any potential of having a bigger pot of money at the end of the rainbow.
If you are going the do-it-yourself route, make sure to put in the time and effort to invest and research all of your alternatives and set the plan and other investment goals that are important to you.
The next time you read a financial article, make sure to take a step back and see how it applies to you and talk to your advisor if you have questions. We see articles every day that make us say “Not so fast, my friend”.