How to Invest a 529 Account

vitucci-allocating-529-header-imageYoure ready!

Money in hand, youre looking to open a 529 for a child, grandchild, or other family member who you love and have high hopes for.

But the huge variety of options and details might give you pause. Even if you already know which states plan youd like to utilize, you may face a number of choices for how to invest the account.

Making sense of the options

Generally speaking, there are three ways to invest your 529 savings:1

  1. Choose an age-based portfolio
  2. Choose a risk-based portfolio
  3. Allocate across your own selection of mutual funds

There are pros and cons to each, hinging on time, money, and the ability to invest through difficult markets.

Age-based portfolios (target-date funds)

In many 529 plans, the default investment plan involves a pre-allocated portfolio based on the beneficiarys age. As the child gets closer to college, the portfolio is rebalanced to become more conservative, generally reducing equity allocations in favor of bonds.

Age-based portfolios are very similar to the target-date funds that you might have seen in your 401(k). Just like target-date funds, these portfolios are very convenient and you do not need to actively manage them.

However, age-based portfolios do have drawbacks.

Namely:

  • Investment costs can be higher than a self-directed portfolio, depending on the mutual funds chosen.
  • Trading fees can also be higher: These funds also rebalance more often than you might choose to, which triggers fees and expenses that are passed back to you.
  • Risk levels may be higher or lower than you want: The actual allocation in the account at any given time will depend on your specific provider — in other words, the definition of conservativeand aggressivevaries (sometimes widely) from one plan to another.

Risk-based portfolios

Similar to an age-based fund, a risk-based fund will allocate to a portfolio of mutual funds based on your stated risk tolerance. With this account, however, the portfolio will stay true to that risk tolerance level, instead of becoming more conservative over time.

This can be useful if you have a very strong investment philosophy or if you prefer to be the one to decide whether to change the risk profile of your account.

The main drawback, besides the potential for higher costs, is that your preferences might not always align with your goals.

For example, a conservative investor seeking growth needs to decide whether to be conservative or to take a higher-growth strategy — the two are almost mutually exclusive! Similarly, a highly risk-tolerant investor may need to reconsider the implications of losing a great deal of principle right before college starts.

Self-directed portfolio

Finally, a self-directed portfolio means just that: you choose each individual mutual fund in the portfolio and manage the allocation over time.

This can work very well if you like to spend time on your investments on a regular basis and if you can manage market turmoil without losing sight of your long-term strategy.

Part of directing your own portfolio is doing your own rebalancing. Rebalancing is a way of managing risk by keeping your actual portfolio in line with your strategic asset allocation.

For example, if you start with 60% of your portfolio in stocks and they grow rapidly, the proportion of your portfolio in stocks could soon grow to, say, 70%. At that point, youll be working with a completely different asset allocation and risk level. To maintain your original strategy, youd need to sell off some of your equity allocation and invest more in your other chosen asset classes.

On the subject of trading: if you manage your own 529, its very important to remain disciplined. Over-trading is an easy way to rack up expenses, which eats away at long-term performance.

If you find that you struggle to stick with your strategy when the market falls, a self-directed 529 might not be the best solution for you.

For any account

Whatever plan you choose, there are a few key elements you should keep in mind:

First, be sure that the plan youre choosing balances cost with your personal needs. While cost is important — after all, any fees you pay are reducing returns and cant be reinvested — the lowest sticker price isnt necessarily the lowest cost option.

For example, if you manage your own portfolio of cheap index funds but trade anytime the market dips south, you could end up spending more money than someone who buys a nominally more expensive age-based fund.

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Second, check whether your state plan offers a state income tax deduction. Not all of them do, but it could save you a significant amount of money down the line.

Plans also differ widely in their investment options and pricing, so its a good idea to shop around for the one that will offer the greatest benefits to you. Balancing the benefits and the costs of each plan will help ensure that youre giving your 529 — and the loved one benefiting from it — the best possible chance at long-term growth and a well-financed college education.

Let Us Help!

We can discuss this topic and more at a complimentary appointment. As a bay area retirement planning coaches, we can give you a review and make suggestions based on your retirement objectives.

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1 Factual information for this article was drawn from the following sources:
Christine Benz. “How to Allocate Assets for College Savings.” Morningstar, October 21, 2013. http://news.morningstar.com/articlenet/article.aspx?id=615068
Ilyana Polyak. “As Kids Near College, Keep Watchful Eye on 529 Plans.” NBC News, July 18, 2015. http://www.nbcnews.com/feature/freshman-year/kids-near-college-keep-watchful-eye-529-plans-n39438

Important disclosures:

The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by United Planners.

To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.

An investor should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. Most states offer their own 529 programs which may provide advantages and benefits exclusively for their residents and taxpayers. The tax implications of a 529 plan should be discussed with a qualified tax advisor.

Neither diversification nor asset allocation can ensure a profit or prevention of loss in times of declining values. United Planners does not render tax advice.

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