When you start shopping for a 529 plan, one of the first decisions you’ll face is whether to use an age-based option or customize the plan with your own investment choices.
For buyers who prefer a hands-off, “set it and forget it” approach, age-based plans can be appealing.
Generally speaking, the asset mix in an age-based plan starts out more aggressively when the child is younger. In other words, the allocation for a beneficiary who is, say, 5 years old or younger will be heavily tilted toward stocks, with little exposure to bonds.
As the student gets older and approaches college age, the objective is capital preservation rather than growth. That means the asset mix shifts toward an increasingly conservative portfolio that’s more heavily allocated to bonds and cash. The allocations are done automatically, at certain ages, so the plan owner doesn’t have to worry about steering the portfolio.
With a static option, the asset choice remains the same unless the plan owner decides to reallocate.
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Aaron Vasil, an investment advisor at North South Capital in New Lenox, Illinois, specializes in college financing. He opens about two or three 529 accounts each month and says the majority of clients prefer the automated features of an age-based plan.
“Most clients who come in for 529s are not that investment savvy,” he says. “If it’s for a child, for an 18- year plan at birth or a 14-year plan at age five, the age-based definitely covers all the asset classes. They get exposure to all the markets, and they don’t have to worry about managing it.”
For clients who are not interested in choosing their own investments or don’t want to worry about changing allocations over time, Vasil recommends age-based tracks.
He says only about 20 percent of his 529 clients opt for a customized, or static, plan. Some of those account owners are savvy, experienced investors, but many are simply risk-averse.
“Grandparents come in and say, ‘We just want to put money away, and we don’t want a lot of risk.’ At that point, they’ll just buy a bond fund or a balanced fund,” Vasil says.
But it’s possible to take too little risk with 529 investments, according to Hank Mulvihill, principal at Mulvihill Asset Management in Richardson, Texas.
“This may shock you, but inevitably, self-allocators are too conservative,” he says. Interest rates make a difference when choosing an allocation, he adds. Mulvhill forecasts yields on the 10-year Treasury note to remain at 3 percent or lower for the next decade. “That blows away the whole traditional bond allocation element. If you’re compounding at 2 percent a year, why bother with a 529 at all?”
[Read: What is a 529 Plan?]
Mulvihill advocates starting a 529 savings plan early in a child’s life to take advantage of growth and the magic of compounding. However, he believes age-based plans do not take enough risk in a beneficiary’s younger years.
“An age-based plan will have a growth component, but unfortunately it will also have a bunch of bond funds,” he says. “These are not suitable if you are shooting for a target date of 18, 19, 20 or 21 years old. If you start with a portfolio for a child who’s 2 or 3, you have a long time to grow some money. If you have a defined objective that’s that far out in time, take more risk.”
As the child reaches his or her late teens, the account owner can then shift to a less aggressive portfolio, either custom or age-based, and designed for capital preservation, Mulvihill says.
Parents and grandparents evaluating 529 plans should understand that all age-based programs are not the same. An account owner has to evaluate his or her own risk tolerance when choosing an age-based plan. For example, Vanguard’s plan offers aggressive, moderate and conservative options for every age group, from newborn through college age. The aggressive model for a child of 5 years and younger contains 100 percent stocks. In that age bracket, the moderate portfolio is allocated 75 percent to stocks and 25 percent to bonds, and the conservative portfolio contains 50 percent stocks and 50 percent bonds.
When it comes to static or customizable plans, Vasil says these are more appropriate choices for people with more investing experience and greater understanding of financial markets.
[Read: Do Prepaid 529 Plans Ever Make Sense?]
“We’ve seen people come in who know what they are doing, and they literally come in and say they want to buy one particular fund idea,” he says. “But those situations are unusual.”
Vasil cautions that owners of a custom plan have to take responsibility for making decisions about allocations even if they work with a financial advisor. That can be a risky proposition, especially if investors panic about day-to- day market moves or try to predict how asset classes will perform based on news events.
“If you’re chasing returns, and you say, ‘I heard something on the radio, now I want all mid-cap,’ that’s great until we go through another 2008, and you’re down 40 percent,” Vasil says.
Although there’s no universal course of action for every 529 buyer, it’s crucial to consider your own objectives, the number of years before your child or grandchild attends college, your personal risk tolerance and your interest in playing a more active role in managing the plan investments.
Finally, regardless of what type of plan you choose, carefully analyze fees and expenses before you invest. These vary widely from plan to plan and can make a big difference in your returns.
As Mulvihill says, “Some of the state plans — they’re just an insult to anybody who can think. The fees are so high.”
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529 Plans: Should You Choose Static or Age-Based? originally appeared on usnews.com
