Don’t Give Up on 529 Plans in Down Market

It always amazes me that people stop investing in down markets.

I maintain a newsletter about saving for college and 529 college savings plans. When someone unsubscribes, they can leave a comment about why they are leaving. Here are some recent comments:

“I don’t think it’s smart to invest with what’s going on in the stock market.”

“I’m waiting for the stock market to rebound before investing money.”

What’s wrong with these statements? It’s the typical buy high, sell low mentality. These same people were interested in investing in the stock market when the DOW was at 14,000, but wouldn’t dare touch it at 8,000.

What’s more concerning is that people confuse investing for college with saving for college. There are ways to take advantage of the tax benefits of 529 savings plans without taking on market risk. I don’t recommend avoiding market risk altogether, but the option is there. So people shouldn’t throw the entire idea of 529 plans under the bus without considering the alternatives.

First, let’s talk about those options with less risk.

In part because of the downturn, many 529 plan operators are adding options for investing your 529 funds into FDIC insured mechanisms – basically certificates of deposit and other savings vehicles. They will only earn a couple percent a year, but that’s what you get when you aren’t willing to take on risk. If the money is earmarked for college, you may as well put it in a 529 plan instead of your local bank. The federal government won’t tax you on the interest you earn when you withdraw it from a 529 plan, assuming you spend the money on qualified education expenses. Also, many states offer upfront tax benefits that could give you a tax credit now on money you contribute.

Second, let’s explore the idea of not investing in the stock market right now.

Yes, the stock market is risky. People forgot that up until a year ago when the market fell 50% peak to trough. It can take a long time to recover.

That’s why you shouldn’t invest money in the stock market that you need to tap in the next 5 years (or perhaps 10). And you need to understand you can lose money. It’s not 8% earnings per year no matter what. So if you child or grandchild is heading to college in the next 5 years, your 529 plan investments should be conservative. (Conservative doesn’t necessarily mean bonds; bonds have market risk, too).

My child is 2, so we’re 16 years off. My latest 529 plan statement shows we have about 30% less in our account than we’ve contributed over the past two years. It hurts, but we have 16 years to make up the difference. (Actually, more time since we won’t spend all of the money her freshman year.) We keep contributing the same amount each month, so we’re dollar cost averaging in a down market. If she was headed to college soon we wouldn’t take this approach. That’s why each individual needs to consider their own situation.

But don’t give up on saving for college just because it’s a down market.