Question: How Do I Invest My Kid’s 529 College Savings Plan?

Question: How Do I Invest My Kid’s 529 College Savings Plan? Photo (cc) by laffy4k

If you’ve got a kid heading for college, hopefully you’ve got a 529 college savings plan to help. These plans, operated by states or educational institutions, are designed to help you set aside money for college. They offer income tax benefits (the name “529” comes from that section of the Internal Revenue Code) and great flexibility with the investments you choose within the plan.

Which brings us to this recent reader question:

I have a Junior in high school and have invested his money in the Aggressive Growth option in the Wisconsin 529 Plan. I am regaining some of the money (last two months) that was invested over the past few years. When do you think is a good time to move the allocation from the Aggressive to the Moderate or Fixed ? We will need to start withdrawing in two years.

Thank you,
Todd

Here’s your answer Todd: right now is a good time to move from aggressive to moderate or fixed.

On July 6, 2010, I wrote a column called Why You Should Buy Stocks and Houses Now. At the time the Dow Jones Industrial Average was 9,686, and I predicted it would hit 12,000 within two years, for a gain of more than 20%. Well, here it is just three months later and the Dow is just over 11,000 – 13% higher.

I mention this because Todd also apparently read that column and agreed with it. In a subsequent email exchange regarding his question, he added “I, like you, believe the market will rise 20 % in the next two years.” That’s obviously why he’s chosen to invest aggressively.

But here’s a rule that overrides all others in investing: when you’re investing money for one specific purpose – say, for retirement, a new house, or in Todd’s case, college – you don’t want to take too many chances as your target date approaches. There’s a simple reason for this rule – because the stock loves to wait until you’re just about to need your money, then go down about 50% so you can’t have it.

Stock market risk is inversely proportional to the amount of time you can leave your money invested: the longer you have, the lower the risk. But as the date approaches when you’ll need your money, you’ve got to put the brakes on risk – period. It doesn’t matter if safer alternatives are paying squat. It doesn’t matter if you, me and fencepost is convinced the market’s going higher. Anybody who advises investing aggressively with money that absolutely, positively must be available 24 months from now is a fool.

Granted, Todd’s son isn’t going to need all of the money on day one of college – some of that money might not be needed for five years or more. So here’s what I’d do – and I consider this relatively aggressive: depending on the rate in the fixed plan, I’d put half of Todd’s 529 money in that right now. Then I’d put the other half in the moderate fund. If I felt I could make up the balance if I’m wrong, I might try half in fixed, 1/4 in moderate, 1/4 in aggressive, but that’s definitely as much as I’d be willing to gamble.

Whether you’re investing for retirement, college, or just for fun, the way to succeed is not to over-reach. You’ve heard the expression: bulls make money, bears make money and pigs get slaughtered.

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