If you don’t already have a 529 plan opened, you should start with the instructions for opening a 529 plan before worrying about which investments you use. Trust me, when I tell you, as a former financial planner, that the biggest drag on saving money for college isn’t choosing the wrong investments, it’s taking too long to get started.
This is not an offer buy or sell securities. This entire article is for general informational purposes only and is not specific recommendations for you to buy, sell or invest. Only you understand your individual situation. Consult an investment or tax professional for advice specific to your needs.
529 Plan Investment Options
Every 529 plan has different investment options. Even within the same state, different plans will have different investment options. We’ll continue using the Colorado 529 plan Direct Portfolio option here as our example, but the concepts apply to any 529 plan option from any state. If you are curious about a specific stat’es 529 plan investments, leave a comment below, preferably with a link to the plan you are talking about, and I’ll take a look.
Like many 529 plans, the Colorado 529 Direct Portfolio offers different investment options including an age-based investment option.
Before we make a choice on this screen, notice the rules that you have to follow for choosing investments in this 529 plan. You can choose up to five total investment, and each investment must have a minimum of 5 percent allocation, and you can only use whole percentages.
Age-Based Option versus Choosing Investments in a 529 Plan
There are two main choices here. Beyond this screen there are more choices as well. The concept of age-based portfolios may be familiar if you have a 401k plan with age-based (or retirement date based) options. The idea is that with an age-based investment you can set it and forget it. As your child gets older and closer to college, the plan will automatically make your investments more conservative by increasing the amount of bonds in the portfolio.
Of course, I’m not a fan of forgetting about your money or investments, no matter how much autopilot you can use. However, if the investment part is stressing you out, just go this route. Again, you’ll lose a lot more ground by not getting started than you will by picking the wrong investments.
If you select Age-Based Options on this screen you’ll see three sub-options. You can be aggressive, moderate, or conservative. You can click the little “i” in the circle to read up on the choices. Typically, most experts will tell you that age-based investments are usually too conservative in the first place. Also, remember you are really going to need the investment growth to keep up with the rising cost of college unless you can contribute a lot of money to your child’s college savings.
In this case, the conservative option starts you at a 50/50 mix of bonds and stocks when your child is under age 5. That’s WAY too conservative to get you anywhere investing wise. Stick with Moderate or Aggressive. Frankly, the only way you really have a shot of getting enough investment gains to make it worthwhile is with Aggressive. Don’t worry, it gets more conservative the closer your child gets to college. If you just must have a safe portfolio for piece of mind, the conservative portfolio probably isn’t conservative enough. There will still be plenty of ups and downs even with that allocation. If you need safety, click the next button and select Money Market Portfolio for your funds. You won’t get any growth, but you won’t lose any money either.
If you select Blended and Individual Portfolios on this screen, it will expand to show the individual portfolios. You’ll notice you can also still use the age-based options just like a regular investment choice by allocating a percentage. In this way, you could do half age-based, and half-regular investment options just by making the percentages do what you want to do.
Choosing Your Own 529 Plan Investments
In this case, you’ll notice that the good people who run the Colorado 529 plan have decided to go all out in the cause of simplification. Your only investment choices are:
- Aggressive Growth Portfolio
- Stock Index Portfolio
- Growth Portfolio
- Moderate Growth Portfolio
- Bond Index Portfolio
- Conservative Growth Portfolio
- Income Portfolio
- Money Market Portfolio.
While these are simple names, they hide what is really going on. To find out, click the little i in the circle. In the little pop-up window, you’ll notice a section called “Investment Strategy.” This tells you what you are actually investing in. In the case of the Aggressive Growth Portfolio, the actual investment is 80% in Vanguard Total Stock Market Index Fund and 20% in Vanguard Total International Stock Fund. The Stock Index Fund invests only in the Total Stock Market Index Fund (no international). And so on…
What Investments Should I Use for My 529 Plan?
Using the information form the descriptions, you can put together a portfolio based on your own risk tolerance and situation.
Now, as a former financial advisor, what I know, is that most people do not know what their risk tolerance is. They like risk when it leads to higher returns; they hate risk when it means they are losing money. Asking someone what their risk tolerance is, is like asking someone how important safety is to them. In the abstract, the answer is worthless.
Should you wear a helmet when riding a bike? When skiing? When driving? — Each yes represents a different risk tolerance. You would be safer in your car if you wore a helmet, and a five-point harness like race car drivers. Yet, you probably do neither. Don’t you care about your safety? Didn’t you say above that safety was very important to you? Of course you want to be safe, but it’s a real world choice you make based on what is going on at the time. Just saying you are safe, very safe, or extremely safe is all but nonsensical.
The same thing happens with investing risk. People say they are aggressive, then panic when they have a 20 percent loss. Other people say they are conservative, and then get angry when they have a 5 percent return in a year when more aggressive investors have a 15 percent return.
My official advice, is to figure out what is right for you while realizing that with time, the market always eventually recovers, and that most investment losses come from pulling out when the WORLD looks scary, not from when your risk tolerance changes.
Cheatsheet for 529 Investing
Right about now, you probably feel gypped. It said I was going to help you step by step and now I’m telling you to figure it out for yourself. You’re right. I have to. Otherwise, someone would sue, or something.
That being said, what I would tell a good friend (Not you, of course, you are a stranger. I would never make a specific recommendation to you. Of course, I can’t help it if you read along too…) is that you should be aggressive when your child is young. As long as you never withdraw your money, or change your investments in response to the market, you have plenty of time to recover.
Remember the super-duper Great Recession? Remember when Wall Street and sub-prime lending, and banking crisis, and so on and so forth led to the market taking a huge drop? Remember when the world was ending, and we would all never get our money back? Remember PANIC?!?
The time from when the drop started in about September, 2007 to when the S&P 500 made all its money back, about February, 2013 was a total of 5 1/2 years. In other words, in the biggest bust of our time if you left your money where it was, you got it all back in five years. Imagine how much shorter it could have been if Congress had actually helped. If a kid is four years old, that’s plenty of time to recover from a market drop.
The key is to leave your money. The way people lose money is by pulling out when it’s down. That locks in your losses.
If you not only never took your money out, but you kept putting money in, you broke even a lot sooner, and were way ahead after 5 1/2 years. Why? Because you were buying low, below that line, all that time. That’s what it means to not time the market.
So, what I would tell a friend is, that they should use the Aggressive Growth Portfolio for 80% or more (even 100%) for their child’s 529 plan investment from age 0 until age 12. The rest should go in Growth. Then, they should switch to more in the Growth Portfolio (which is 75% stocks and 25% bonds) until they are 15. Then, switch to 50% Growth Portfolio and 50% Money Market. When you withdraw money, take it from the Money Market.
It would look like this when my friend signed up their 3-year old.
What I really, REALLY emphasize to both you and my friend is that what will really matter over those years is consistently putting money in, every single month, or year, or whatever. In fact, the most important thing you can do for your 529 plan is to setup the automatic monthly investment direct from your checking account. Set it for the day after you get paid, or right when you pay your bills.
$100 a month for 15 years is worth a lot more than getting the investment allocation just right for some lower amount of inconsistent investments.
That gives my friend a solid chance to earn actual money on your investments over time while still dialing about the risk when it comes time to use the money.
Here is the most important advice I can give you about investing for your kid’s college, or anything else. When I was a financial planner, I had two kinds of clients. The kind that signed up with me while the market was going up, and the kind that signed up with me when the market was going down. The former always thought I was doing a good job, even when the market did eventually go down in later years. The latter took much longer to ever trust me. Many left.
The reason is that when you start doing something and it goes up, it feels good. You will remember that, even when things start getting back. When you sign up for something and it starts going down, it feels bad. You will feel like you are doing it wrong, or like your new advisor is doing it wrong. Even when it comes back, you will have issues for a long time about it.
If you are lucky, your investments will increase in the first few years. By the time you start losing money, you’ll have the confidence that comes with losing your earnings, and not your principal. If that happens, great. You’ll be fine.
If you are not so lucky, you will start putting money in and it will decline in value. You’ll look at your statement and see that you put in $600, but it’s only worth $400. You’ll feel like this was a mistake. There will be an enormous temptation at this time to change your investments, or worse, stop investing, “until things get better.” This is the wrong move. Keep saving. Stick to your plan. Remember your time frame. Eventually, your returns will be higher, and you’ll be miles ahead for having kept saving than for pausing or quitting.
Either way, remember your time frame. That little one will keep getting bigger. When they start driving, re-evaluate. Start applying for loans and grants and scholarships. Help them out with that as well. Who knows, maybe you’ll be one of those very rare people who has to figure out what to do with left-over money in a 529 plan.
Next, unless you are contriubting a sizable lump sum, you’ll need to setup automatic 529 plan contributions if you want to be really successful.