How to Build a 529 Portfolio

With age-based accounts depressed in the stock market meltdown, it may be time to consider building your own 529-plan investment portfolio. While building, implementing and monitoring such an approach requires more time than using an age-based plan, it gives you more control over your investment and allows you to craft a portfolio more finely attuned to your individual risk profile. Declines in college savings portfolios are especially painful for parents and grandparents who have to build retirement and emergency funds, so dollars lost to investment declines are hard to replace. Extra pain resulted investors thought they were pursuing the safer course by shifting their money into more conservative investments and away from individual funds. Limits on how often you can change investment options means you have to act with care when selecting 529-plan investments. Because of the market meltdown, Congress is allowing 529-plan custodians to change investment options twice in 2009, but once this year is over, switches will be restricted to once a year. "The issue goes back to choosing your investment options correctly the first time and then staying with your decision and not reacting to what's going on in the market," says Bruce Hagemann, executive vice president and national sales manager for BBVA Compass Investment Solutions, in Dallas. "If you're conservative, you need to be conservative from the beginning," says Hagemann. "If you weren't, and took losses, there's not much you do about that at this point." What went wrong In the recent market meltdown, many investors in age-based plans lost upwards of 20 to 30 percent of their investment ï ¿ ½ in some cases two years in a row. And returns for the last year on an average annual basis remain ugly, despite the recent market uptick. North Carolina's age-based plan performance over the past year is a good example. In the 12 months ending June 30, 2009 the state's aggressive age-based plan lost 24.20 percent; the moderate plan lost 17.64 per cent and the conservative approach lost 11.75 per cent. "The college funds that are age-weighted became too aggressive to make their returns in the past several years," says Christine D. Moriarty, CFP, and president of MoneyPeace, a financial planning firm in Bristol, Vt. "They swayed from their true goals. The old adage 'buyer beware' works with these funds. Know what you are buying. Do not simply buy at face value because of what the product says." The theory behind age-based plans is to invest aggressively when the beneficiary ï ¿ ½ the child who will be going to college ï ¿ ½ is young, then shifting to more moderate investments at age 9 or 10 and finally getting more conservative at high school age. But there's a ton of variation in terms of what is aggressive, conservative and moderate, and even if you've got 10 years before college, a 24.2 percent loss is hard to take. Setting investment goals The key to success in any investment-related endeavor is setting clear goals, says Hagemann. If you know what you're trying to achieve and figure out a sensible way to get there by assessing your risk tolerance, you'll be in better shape to handle the difficulties of the market. Many 529-plan and other investment sites have questionnaires designed to help you make these decisions. If you're unable to tolerate a lot of volatility in your college savings investments, it's better to invest conservatively, especially since you can't change your investment options as often as you can in other types of investment plans, such as retirement plans. On the other hand, if you are willing to take more risk in the hopes that your investments will provide larger returns, you'll likely be more comfortable with more aggressive investment options, at least when your child is younger. Crafting a 529 portfolio If you want to avoid age-based plans, you usually have at least two options in creating and managing your own 529 account: asset-allocation portfolios, which blend several mutual funds together to achieve a targeted mix of stocks, bonds, and money market single-fund options, in which each portfolio is invested in a single mutual fund whether that be a stock fund, bond fund, or money market fund. Typically, if you invest in an asset-allocation portfolio, you'll place 100 percent of your investment in one portfolio, just as you would place 100 percent of your investment in an age-based plan if you wanted to go in that direction. On the other hand, if you pick single-fund options, you'll probably want to choose more than one, so you'll need to decide what percentage of your assets go into each fund. In Moriarty's opinion, there are some rules of thumb to keep in mind when crafting a college-savings portfolio because of the time-limited nature of college savings. "If your child is within two years of college, most of the money should be safely in bonds and cash, she says. "This is not the time because of the age of the child to invest in the stock market," she says. "For years I've said 'If you need money in three years, keep it in cash. If you need money in three to eight years, keep it in bonds. The rest can be in the stock market.' Yes, you may not make as much, but you do not have the time to make up the money if you lose it either." In a portfolio offered by a 529 plan, the plan puts several funds together to achieve a particular investment purpose. For example, a conservative portfolio might have a stock fund, a bond fund and a money market fund. An aggressive portfolio might have a US stock fund and a foreign stock fund. The number of single-fund options depends on the plan, but you typically want to mix and match at least three or four funds to have a diversified portfolio. When selecting among single-fund options, aim for some diversity - if you're looking at putting a stock portfolio together, you could pick a growth fund, an international fund and a value fund to give you exposure to different sections of the market. Managing your 529 portfolio Once you set up your account, whether it's composed of single-fund options or an asset allocation portfolio, you should check it on a yearly basis to ensure it is accomplishing the initial goals you set and decide if any changes are needed as your child gets closer to college. Look at performance, investment objectives and fees. See if your underlying funds have performed as well as or better than a market index during a particular period. You can generally find performance information on the Website of your 529- plan sponsor and in reports mailed on a quarterly basis. With an asset-allocation portfolio, you want to make sure the funds included in the portfolio have not been changed, and if any have they should be as similar as possible to the old ones in terms of investment objective. You don't want an international stock fund, for example, replaced with a bond fund. As for costs, the lower the better ï ¿ ½ if either the percentage of your assets charged for fund operations or any fees charged by the 529 plan itself rise significantly, you may want to make a change. As your child gets older, you may want to change your investments so that you don't lose a large sum of your investment a few years before you need to spend the money on tuition, room, board, fees and other college expenses. Remember that you can only change investment options once annually (after 2009), so consider setting up a specific date each year to review your objectives and the plan to decide whether to make any changes. "The restriction on changing investments once a year was set up, I think, to keep parents from moving in and out of the market," says Hagemann. "This is like any other investment, where you need to look at your risk tolerance versus the length of time before you need the funds. The tendency can be to be more aggressive with investing, but I think with college funds it makes sense to be more conservative." Posted August 7, 2009 With age-based accounts depressed in the stock market meltdown, it may be time to consider building your own 529-plan investment portfolio. While building, implementing and monitoring such an approach requires more time than using an age-based plan, it gives you more control over your investment and allows you to craft a portfolio more finely attuned to your individual risk profile. Declines in college savings portfolios are especially painful for parents and grandparents who have to build retirement and emergency funds, so dollars lost to investment declines are hard to replace. Extra pain resulted investors thought they were pursuing the safer course by shifting their money into more conservative investments and away from individual funds. Limits on how often you can change investment options means you have to act with care when selecting 529-plan investments. Because of the market meltdown, Congress is allowing 529-plan custodians to change investment options twice in 2009, but once this year is over, switches will be restricted to once a year. "The issue goes back to choosing your investment options correctly the first time and then staying with your decision and not reacting to what's going on in the market," says Bruce Hagemann, executive vice president and national sales manager for BBVA Compass Investment Solutions, in Dallas. "If you're conservative, you need to be conservative from the beginning," says Hagemann. "If you weren't, and took losses, there's not much you do about that at this point." What went wrong In the recent market meltdown, many investors in age-based plans lost upwards of 20 to 30 percent of their investment ï ¿ ½ in some cases two years in a row. And returns for the last year on an average annual basis remain ugly, despite the recent market uptick. North Carolina's age-based plan performance over the past year is a good example. In the 12 months ending June 30, 2009 the state's aggressive age-based plan lost 24.20 percent; the moderate plan lost 17.64 per cent and the conservative approach lost 11.75 per cent. "The college funds that are age-weighted became too aggressive to make their returns in the past several years," says Christine D. Moriarty, CFP, and president of MoneyPeace, a financial planning firm in Bristol, Vt. "They swayed from their true goals. The old adage 'buyer beware' works with these funds. Know what you are buying. Do not simply buy at face value because of what the product says." The theory behind age-based plans is to invest aggressively when the beneficiary ï ¿ ½ the child who will be going to college ï ¿ ½ is young, then shifting to more moderate investments at age 9 or 10 and finally getting more conservative at high school age. But there's a ton of variation in terms of what is aggressive, conservative and moderate, and even if you've got 10 years before college, a 24.2 percent loss is hard to take. Setting investment goals The key to success in any investment-related endeavor is setting clear goals, says Hagemann. If you know what you're trying to achieve and figure out a sensible way to get there by assessing your risk tolerance, you'll be in better shape to handle the difficulties of the market. Many 529-plan and other investment sites have questionnaires designed to help you make these decisions. If you're unable to tolerate a lot of volatility in your college savings investments, it's better to invest conservatively, especially since you can't change your investment options as often as you can in other types of investment plans, such as retirement plans. On the other hand, if you are willing to take more risk in the hopes that your investments will provide larger returns, you'll likely be more comfortable with more aggressive investment options, at least when your child is younger. Crafting a 529 portfolio If you want to avoid age-based plans, you usually have at least two options in creating and managing your own 529 account: asset-allocation portfolios, which blend several mutual funds together to achieve a targeted mix of stocks, bonds, and money market single-fund options, in which each portfolio is invested in a single mutual fund whether that be a stock fund, bond fund, or money market fund. Typically, if you invest in an asset-allocation portfolio, you'll place 100 percent of your investment in one portfolio, just as you would place 100 percent of your investment in an age-based plan if you wanted to go in that direction. On the other hand, if you pick single-fund options, you'll probably want to choose more than one, so you'll need to decide what percentage of your assets go into each fund. In Moriarty's opinion, there are some rules of thumb to keep in mind when crafting a college-savings portfolio because of the time-limited nature of college savings. "If your child is within two years of college, most of the money should be safely in bonds and cash, she says. "This is not the time because of the age of the child to invest in the stock market," she says. "For years I've said 'If you need money in three years, keep it in cash. If you need money in three to eight years, keep it in bonds. The rest can be in the stock market.' Yes, you may not make as much, but you do not have the time to make up the money if you lose it either." In a portfolio offered by a 529 plan, the plan puts several funds together to achieve a particular investment purpose. For example, a conservative portfolio might have a stock fund, a bond fund and a money market fund. An aggressive portfolio might have a US stock fund and a foreign stock fund. The number of single-fund options depends on the plan, but you typically want to mix and match at least three or four funds to have a diversified portfolio. When selecting among single-fund options, aim for some diversity - if you're looking at putting a stock portfolio together, you could pick a growth fund, an international fund and a value fund to give you exposure to different sections of the market. Managing your 529 portfolio Once you set up your account, whether it's composed of single-fund options or an asset allocation portfolio, you should check it on a yearly basis to ensure it is accomplishing the initial goals you set and decide if any changes are needed as your child gets closer to college. Look at performance, investment objectives and fees. See if your underlying funds have performed as well as or better than a market index during a particular period. You can generally find performance information on the Website of your 529- plan sponsor and in reports mailed on a quarterly basis. With an asset-allocation portfolio, you want to make sure the funds included in the portfolio have not been changed, and if any have they should be as similar as possible to the old ones in terms of investment objective. You don't want an international stock fund, for example, replaced with a bond fund. As for costs, the lower the better ï ¿ ½ if either the percentage of your assets charged for fund operations or any fees charged by the 529 plan itself rise significantly, you may want to make a change. As your child gets older, you may want to change your investments so that you don't lose a large sum of your investment a few years before you need to spend the money on tuition, room, board, fees and other college expenses. Remember that you can only change investment options once annually (after 2009), so consider setting up a specific date each year to review your objectives and the plan to decide whether to make any changes. "The restriction on changing investments once a year was set up, I think, to keep parents from moving in and out of the market," says Hagemann. "This is like any other investment, where you need to look at your risk tolerance versus the length of time before you need the funds. The tendency can be to be more aggressive with investing, but I think with college funds it makes sense to be more conservative." Posted August 7, 2009