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How Should I Invest My Child's 529?

May 31, 2014

College savings plans typically offer pre-mixed portfolios that you can select based on the date your child is likely to start college. For those who don’t want to worry about how to invest, these set-and-forget “age-based portfolios” are a perfect solution. They tilt toward stocks for growth when the child is younger and shift toward bonds as the child approaches college age, and the money needs to be more secure. You may have the choice of age-based funds that are aggressive, moderate or conservative.

Besides the age-based funds, you may also have choice of a few regular mutual funds.

Whichever path you choose, the most important thing is to select low-cost funds—meaning an expense ratio below 0.4%—since decades of research shows that low-fee index funds generally outperform competitors. A few other guidelines, based on the age of the person you’re saving for:

When your child is younger than 13

Choose an aggressive fund. The longer you have until you plan to spend your college savings, the more equity or stocks you should hold. After running thousands of simulations, Vanguard found that families who put $6,000 a year into an aggressive fund that started with 100% equities and tapered down to 20% stocks would have an 89% chance of building up enough to fully pay for a private college after 17 years. If they put that money instead into a conservative fund with only 50% in stocks, however, they’d only have a 53% chance of fully funding that private education.

Calculator: How much should I be saving for college?

When your child is older than 13

The standard advice is to shift towards bonds as the child ages, getting down to about 10% in stocks by age 19. But this misses an important wrinkle. Funds invested in long-term bonds tend to drop dramatically when interest rates rise. So to protect your savings, by the time your child is 17—when tuition bills are about to come due—shift that year’s withdrawal to a fixed-rate cash-like product that has very few long-term bonds. (Such as California’s no-fee “Principal Plus Interest” option that was paying 1.2% in 2014.) Alternatively, if you’re pretty investing savvy, opt for a fund that is primarily invested in short-term bonds or other safe assets that won’t suffer if interest rates rise from their current low level. You can look up the percentage of the fund that is in bonds on, then click on the “Bond Style” tab on the Morningstar page for your fund. Multiply the “duration” times the percentage of the fund in bonds, and you’ll have a rough idea of how much the principal would fall if interest rates rise by 1 percentage point.

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