Brenden Leese, CFP®
College Saving Amid 529 Declines
If your children are young, you have plenty of time to recover from the current bear market, even if in an aggressive growth portfolio.
You still have options if your child is nearing college age.
There’s no substitute for saving as early as possible in your child’s life. Don’t count on athletic scholarships or merit aid to make up for a savings shortfall.
Just as retirees and near-retirees are especially concerned about the 2022 bear market, so might be some families in their prime college-saving years. In either case, you don’t want to have a big hit to your savings portfolio right before you start drawing on the money, because you might not have time to make up the lost ground. Financial economists call this “sequence risk.” Everyone calls it painful.
Example: Let’s say you have diligently saved for your 17-year old’s college education and had managed to sock away $160,000 as of year-end 2021. If you were in an aggressive growth fund, chances are your account balance would be down over 20% ($32,000) this year, so your child would be starting their freshman year next September with closer to $128,00 in the account. In turn, you’d have closer to $32,000 a year to spend on tuition rather than $40,000 – and would have to look to other sources to close the gap. Whether cashing out stocks (in a down market), tapping home equity (in a higher interest rate environment), or applying for a student loan (with no guarantee of forgiveness), none of those alternatives are ideal compared to tax-free growth and distributions of a 529 plan.
Not since the global financial crisis of 2008 (when the S&P 500 lost over 35%) have college-saving families seen significant declines in their 529 account balances. That means the majority of today’s college savers are first-timers to these kinds of account declines. But the global financial crisis was a big driver of age-adjusted investment options at most 529 plans. With this type of investment option saver’s portfolio gets increasingly more conservative as the child/beneficiary gets closer to entering school. No family wants to see their account balance drop precipitously right before their college-bound child turns 18. The financial crisis also taught families a harsh lesson about moving their entire accounts to cash during the downturn, only to miss out on the huge market recovery that followed. As with stock investing, market timing never works in the college-savings race.
The more conservative investment options contain a higher proportion of bonds and cash and a lower proportion of stocks – even more so as the child ages. Even though this has also been a historically bad year for bonds as well, you can see how the less aggressive options have held up this year at one large state’s 529 plan.
Is it better to make a big contribution all at once, or smaller more frequent contributions?
Studies show a lump sum typically results in greater growth over the long run, specifically in a rising market, but I realize doing so isn’t realistic for many families unless they receive a large upfront gift from grandparents or other family members. Nonetheless, “dollar cost averaging” your savings will greatly lower your downside risk by essentially buying into the market at lower points whenever there is a market decline over the 18+ years you save for a child’s education. Whether you contribute bi-weekly (tied to a paycheck cycle) or monthly (tied to a bill-paying cycle), it doesn’t really matter. Just get on a schedule that is comfortable for your lifestyle.
Should I stay fairly aggressive even as my child approaches college age due to tuition rising even faster than inflation? It depends on your situation. If you plan to continue to contribute to your child’s account through college, and the goal is to pass on unused savings to another child or future generations of your family, then yes, you can continue to have a riskier investment option portfolio (i.e., more stock market exposure) in hopes of achieving higher returns. However, no one knows when the next bear market will come. You could be forced to endure two or even three bad years during your child’s four years in college and it’s very hard to make up lost ground during such a short time horizon, especially when drawing from the account.
Again, that’s why it’s so important to start saving as early as possible in your child’s (or grandchild’s life). No family should be forced to play catchup or tuition roulette with their child’s education at stake. Investing in education follows the same principles as investing for retirement with a few caveats, but you still need to understand time horizon, risk tolerance, and other cash needs.
Advice for families starting late
From time to time, new clients join us who want their 8- to 13-year-old children to attend college, but who “haven’t gotten around” to opening a college savings account. That’s when we have to have tougher conversations about cutting back on other expenses significantly to supercharge the account – or let their kids know that an in-state public school is all the family can afford. Otherwise, both the family and the student will have to take on more responsibility for student loans or perhaps attend school part-time while working. That being said, if a family is coming into the college savings game late, but has large sums of cash available, now may be an excellent time to take some chips off the table and fund a college savings account when asset prices are down.
Don’t count on athletic scholarships.
According to the NCAA, only about 2% of high school athletes receive any sort of college scholarship and the average athletic award is only worth about $5,000 a year. While that package can be supplemented by non-athletic merit aid, only about 0.3% of collegiate athletes receive a full-athletic scholarship and that’s mostly for the two big revenue sports: Division I football and men’s basketball.
Do I have to invest in my home state’s 529 plan?
No. While it’s true you may receive a state income tax deduction for each year’s contributions made to your home state’s 529 plan, having better investment options and lower expenses is sometimes more of a benefit than the state tax deduction. That’s why we recommend the state of Utah’s 529 plan to many of our clients.
Since education financing is a high priority for our firm, we are constantly monitoring investment options, time horizons, and asset allocations for our clients – at no charge. If you or a family member has questions or concerns about 529 plans, please give us a call.
BRENDEN LEESE, CFP® is an Associate Wealth Advisor at Novi Wealth Partners.