Here’s the latest email from a reader asking for some suggestions on a financial situation.
Please read below and give him your thoughts…
My daughter is about to head off for her first semester in college. About 16 years ago, my wife and I started her 529 fund and contributed $800/mo. during this time. We stopped adding to it about a year ago as I semi-retired from the corporate world to co-found my own business. We kept the money in an S&P 500 fund through the years and the balance has swelled to over $317K.
In February, I got a little nervous about where the market might go and given I was going to have to begin tapping the account in about six months, I moved the money into a CD fund. Unfortunately, I probably cost myself another 20K in gains but it could just have easily gone the other way and I felt like my judgment was sound, even if the result wasn’t. This CD fund only delivers about .3% per year.
My daughter thinks she wants to go to graduate school so we are planning to fund six years of college. I am assuming an average of about $50K per year so the current balance should cover those expenses. Part of me says, we have the funds we need so why risk being more aggressive with the fund but another part of me would like to be a bit more aggressive and let the fund grow a little more. If there is any left over, that becomes a start on a fund for my future grandchildren.
I have several options. One would be to go back to an Index fund but I don’t know if I need to be that aggressive. Two other ideas that seem to make more sense are a fund that is designed for the 18+ age range and a similar fund that is slightly more aggressive for students also in that same age range. The less aggressive age based fund has averaged about 3% per year since inception and the more aggressive age based fund has averaged 5%. These two funds have the following mix:
Age Based 18+ Years Old
- Equity Index 9.45%
- International Equity Index 3.6%
- Emerging Market Equity Index .9%
- Real Estate Securities Fund 1.05%
- Bond Index Fund 17.5%
- Inflation-Linked Bond Fund 5.25%
- High-Yield Bond Fund 5.25%
- Short-Term Bond Fund 40.0%
- Money Market 10.0%
- Institutional Floating Rate Fund 3.5%
- Templeton Global Bond 3.5%
Aggressive Age Based 18+ Years Old
- Equity Index 18.9%
- International Equity Index 7.2%
- Emerging Market Equity Index 1.8%
- Real Estate Securities Fund 2.1%
- Bond Index Fund 27.5%
- Inflation-Linked Bond Fund 8.25%
- High-Yield Bond Fund 8.25%
- Short-Term Bond Fund 15.0%
- Money Market 0
- Institutional Floating Rate Fund 5.5%
- Templeton Global Bond 5.5%
Both of these are clearly better alternatives to the .3% I am getting from the CD fund but they also introduce more risk which, one could argue, I don’t really need to take. I have many other options with various trade-offs of performance and risk but given that we are now using these funds, these seem like the ones that make the best sense to consider at this time.
I would appreciate thoughts on how one might invest these funds going forward, given my situation.
PhD on FIRE says
Can you only have one index fund? Is there an option to get Total Stock Market, total international, bond indexes in a ratio that you are comfortable with? You’ll probably save a bit more on costs if you can do that as well.
529 SOS says
Hi PhD on FIRE, love all your posts on comments! I do have these options you mentioned. TIAA-CREF manages this particular 529 in a state I used to live in. The state I live in now has Fidelity. I’ve considered moving my 529 because I like the options from Fidelity better and I would get more favorable tax treatments on future contributions from the state if I were to switch.
The question comes down to how aggressive I want to be with money I’m beginning to draw down to pay for college. Part of me says, I achieved my goal of accumulating enough to pay for 6 years of college so why risk it. However, the CD ladder is probably too conservative. They do offer a Bond Ladder that YTD is at roughly 3.5%, with a 3-yr average annual return of 2.5%.
The Aggressive 18+ Aged Based is at 6.3% YTD and around 5% since inception. I do worry that at some point over the next 4 years we could see another 2008 in the near term. If that happens and I’m too aggressive, we lose 30% and then have to hold out for another 18-24 months until it recovers.
To your point, it is all about mix and risk and I will find that right balance and make a move back to something that pays a little more and probably pull the trigger by year end.
.3% is silly … my gsbank is at 1.2%.
If you have the funds you need, I’d do a bond ladder and play it safe. You caught some runs to get to $317k. Why risk it?
If the 529 plan you are in doesn’t give you the right fund options, transfer to a different 529 plan.
529 SOS says
I agree, I jumped out right after Trump came into office because I had a lot of concerns on market reaction and felt the market was looking for an easy excuse to correct and I didn’t want money I was about to start drawing out to be at risk. See my comments to PhD on FIRE about my current thinking. Transfer is a possibility as I mentioned in that response.
Thank you for your insights. I always enjoy reading your comments and responses!
Lance @ My Strategic Dollar says
It sounds like it will cost about $300K for her 6 years of schooling, so I’d leave that where it’s easy to access and safe from a declining market. I’d take the remaining $17K and put it in an index fund with a 70/30 split.
529 SOS says
Hi Lance, you make a great point. Isn’t it crazy when we achieve the goal we still want to tinker with the result to try and squeeze out just a little more? There is no doubt whatever I decide will be very conservative and that could include doing nothing. Equities have to take a hit at some point and interest rates also have to start moving higher so bonds aren’t necessarily all that secure either.
I will leave it alone at least through 2017 as I do more due diligence and then decide at that point. I appreciate your feedback!
For what it is worth my thoughts have always been that the equity market is not a place to put money in that you expect to spend in the next few years. Period. This is especially true if you are talking about using the majority or entirety of the equity holding and not a small percentage (like 3 or 4%) since all it would take is 10-20% drop in one year to seriously affect your ability to fund the purpose for the money. IMHO we have been lulled by this long bull market into forgetting the market’s past volatility and foolishly keep believing it has nowhere to go but up versus having a down year every few years. I had money for college in an aggressive fund, with a child graduating in high school in 2009. I got greedy and didn’t begin to transition that money to lock in my gains starting in 2005. I got caught and ended up taking the money to pay for the first three semesters from other areas to give the college savings time to recover. Fortunately I had resources where I could get the money I needed while that fund recovered, but that affected other plans I’d had with the money I used.
So, IMHO the savings is serving it’s purpose. You are focused on what you imagine you are “losing out” on and not what you have gained. What you have gained is fully funding your child’s education with no worries. That is a laudable gift to your child and should bring you peace of mind. I would like to think the gains you can take away will be more along the lines of your child not spending the full $50K a year. They can, and should, look for opportunities to be frugal on their own. Such efforts will help in reducing your burden while giving them more skin in the game.
Sometimes you have to know when to walk away from the table.
529 SOS says
Hi getagrip, your thoughts are worth a lot to me so, thank you. Your comments are exactly why I moved the entire fund out of the S&P Index and into a CD ladder. I guess the second-guessing coming now is about moving from one extreme to the other and I’m spending some time to reflect if it makes sense to come up with something in between that might generate a bit more return without taking on too much risk.
As I mentioned in a previous post, I probably should just be satisfied with achieving what I set out to do and not get too cute with it. I’m certainly going to leave it alone through the rest of the year, mull over my options and then try and make the right decision that doesn’t put the fund in harm’s way. And that may very well be to just leave it alone and thank the good Lord we already have what we need.
Noah Weiss says
I could not agree more with “getagrip”. We have all enjoyed a long run here that may have a bit more room to run before the next downturn, but why chance it for a bit more upside. I look at this the same way that one would if they were retiring and needed to move around some investments to assure a comfortable retirement. If you were still contributing to the fund each month the dollar cost averaging could make sense through whatever downturn is to come, but in this context your flight to safety completes the process you set out to accomplish, funding the education. If your daughter decides she wants to get an MBA after undergraduate, many employers will pay for the part time classes. May take longer, but its at least subsidized (my employer paid for the entire degree, but this may not be as common now as it was 10 years ago).
529 SOS says
Hi Noah, thank you for your comments. I really do appreciate them. I too had an employer who paid for my MBA and my wife’s BS so we were blessed in that way as well. My daughter will need a Master’s degree for her career choice and the goal was to be able to fund both degrees. To your point, it is very rational to look at this and say, “we did it so why mess with success.”
I guess it is just something in our human nature that tempts us to try and reach for just a little more. Clearly, my initial move to safety was triggered by some small voice inside and maybe that is something I need to continue to listen to and just be satisfied we crossed the finish line with what we needed. This is what prompted my email to ESI and I am grateful to you and others for the thoughts and insights!
Quiet Prosperity says
Personally I would do something along the lines of what Lance suggested above. I would construct something akin to a Liabilities Matching Portfolio. Take the $300k that your daughter is expecting to use over the next 6 years and place that in the Bond Ladder. Obviously it would be ideal to stick in some sort of inflation-protected ladder that had alternating 6-month maturities, but my guess is that both 529 plans have limited investment options in this regard.
I would also consider sticking the $300k in the conservative 18+ age based mix that they give. That mix had a max draw-down of around 11% in 2008. Things can always get worse than 2008 over the next 6 years, but I think that is a fair worst-case experience and one that is recoverable in a 6-year total period.
I would then stick the other $17k in a very aggressive mix to be used for grand-children college use in the future since that may be 30ish years away or something.
Whatever you decide, I would lean very conservative with the $300k. 20% or so equities max. I would not personally consider the aggressive 18+ mix as that had close to a 19% draw-down in 2008. No need to keep playing when you have won the game.
529 SOS says
Hey QP, great thoughts. I was just looking at both the 18+ and 18+ Aggressive and considering the risk/reward of each. I think your comments are spot on and I appreciate that reinforcement!
When both my sons were attending college at the same time, there was a lot being pulled out of there 529. Basically we wiped them out during those two years and cash on hand filled the gaps. I did not have all the money saved in a 529 but the rest was in safer investments that can easily be liquefied when needed. Mostly in a money market account that I kept feeding.
Treat the funds like a retirement plan as you will “need” the money over the next 6 years, be cautious in invest it for the long run for better returns. The 6 years will go quick along with the money.
529 SOS says
Thanks Coop, very sound advice. She just started so it also probably makes sense to get a feel for all the expenses in the first year so I kind of see what the run rate looks like. Either way, I don’t plan to do anything crazy that could hurt us with this. It’s one thing if I put myself at risk for more gain but quite another when someone else you care about is involved.
Jeff O. says
I think the asset allocation between money market and more aggressive allocations are a personal decision considering the short investing time frame.
Two areas of advice from my experience, especially given your significant gains:
1.) Keep good records of what you spent the money on when you withdraw.
2.) When possible, have the withdrawal sent directly to the institution. Try to avoid having the money going to you (owner) or your daughter (beneficiary) to reduce inquiries from the IRS.
A few years ago, I was not able to have the payment go directly to the university. I received a distribution for tuition, rent, books, supplies, etc. I kept meticulous records on a spreadsheet where the total matched my withdrawal.
I received a letter/audit inquiry from the IRS with a proposed settlement for the gains on the withdrawal because I received the distribution. Luckily it was easily resolved because of my thorough records. My lesson was to reduce the potential for this in the future by distributing as much as possible to the institution.
529 SOS says
Hi Jeff, great advice on the record-keeping. Unfortunately, my 529 does not send the money directly to the university so I’ve decided to only use it for the things that are easily matched with the tax forms I will receive from both the 529 and the university. In other words, I’m only using the 529 for the tuition, room & board and meal plan expenses because those are published by the university and will match exactly with the tax forms that are provided from the 529 and the university bursar’s office. Books aren’t enough of an expense to worry about taking out of the 529 because she is renting them rather than buying them.
Like you, I will keep the semester invoices outlining all the charges I’m taking that match to the 529 withdrawals, just in case the IRS comes knocking at my door. I will also have my CPA provide the documents in each year’s return so they already have it and hopefully won’t even need to reach out to me about it.
Thanks for weighing in with your thoughts because it is a good reminder for me to be sure and stay on top of this!
Great question and thanks for sharing your story. I would invest 15% in money market, 25% in short duration bond fund such as Vanguard Short Term Corporate Bond fund or ETF and the remaining in Vanguard Wellington Fund, which is a great, low-cost, excellent performance 65/35 fund. That way you have cash for needs, short term bonds that won’t greatly fluctuate but will provide higher return than a CD, and some in a balance fund for growth. Also rebalance monthly or quarterly.
529 SOS says
Thanks Michael, I do have to invest within the confines of my available options in my current 529 which is managed by TIAA-CREF but they have similar index funds to some of the ones you mentioned. If I focus more on your ideas for a proper mix vs. the actual funds themselves, your ideas are certainly worthy of consideration.
Thanks again for taking the time to comment and help!
I love the expression: “When you have won the game, stop playing.”
I would go pretty conservative for the next few years (bonds) and then perhaps
as she heads into year 4, reconsider her plans, balance, etc.
529 SOS says
M, that is actually a great point. By the end of year 3, we will be halfway home, assuming she is still on track to attend grad school. At that point, we will have a good idea about how much we have left and of the costs yet to come. We will also have a better feel of where the market is at that point. This would be an ideal time to consider any adjustments we want to make.
Thanks for your great thoughts and willingness to share them with me!
Great job putting away a good chunk of change for college. Like most things in finance, if you start early enough, time has a way of solving a lot of problems.
We have put 2 kids through college and have one currently in. One aspect of college tuition that I found worth planning around is taxes. I have used 529 accounts to pay the bulk of our kids college costs but have always paid some out of current income in order to maximize tax benefits through the various tax breaks that exist. If your income allows you to qualify for the tax breaks, to me, that outweighs the potential for having leftover money in a 529 account. This focus also takes some of the pressure off of trying to time the market just right with your 529 investments.
529 SOS says
Mark, that is an awesome perspective and something that I have not given any thought. The whole tax implication and leveraging to your advantage wherever possible makes a lot of sense. Thank you for bringing it to my attention. I definitely will work with my CPA and make it part of the plan going forward!