I’m the proud father of an eight-year-old second grader who’s thriving in our local public elementary school. I see a bright future for this kid, and her mom and I and her grandparents have been saving for her college education since the day she turned one. In this era of higher ed inflation, it feels like you can’t start that process soon enough or save aggressively enough to keep up, but at least we have something!
Because the state of California doesn’t offer any tax benefits for using our “local” 529 program, we chose Nevada’s plan, which is operated by Vanguard. It’s inexpensive, easy-to-use, and has served us well.
When we signed up for the plan, I selected a "target-enrollment" portfolio that’s a 529 version of a target-date fund; it’s designed to adjust its asset allocation to reduce volatility as our little beneficiary approaches her college enrollment date. (Note that 529 assets can also be used for K-12 tuition and some other non-traditional-higher-ed purposes, so your time horizon may vary.)*
Where does that asset allocation sit today, 10 years out from her anticipated matriculation at The U of Somewhere Not Too Far From Mom and Dad? Roughly 68% diversified stocks, 32% diversified bonds. Moderate. Sensible. Totally fine. Given our time horizon, we aren’t necessarily trying to maximize our rate of return on these assets. Naturally we’d like to see positive returns and we love the advantages of tax-free compounding, which is simply one of the best things there is in personal finance. But I don’t plan on exposing these assets to max-volatility at this point in the process.
Nevertheless, as I’ve watched our 529 account balance creep higher while the stock market sprints up the mountainside, it’s difficult not to sense that our moderate portfolio has held us back a little. Still, I’m not going to chase performance by going all-in on stocks after they’ve gained so much ground. So where does that leave us? And what can we learn from this situation that applies more broadly to portfolio management and financial decision-making?
Here's what I’ve done: I’ve left the accumulated assets in the target-enrollment portfolio at 68% stocks, 32% bonds. But I’ve updated our ongoing contributions to be invested in a mix of a few Vanguard index funds that give us 100% diversified exposure to global stocks.
And here’s what I think I’ve achieved by taking this step…
First, knowing that the time horizon on the full body of our 529 assets isn’t the day our daughter enrolls, but the day we write the last checks for her to finish school (in other words, more like 14 or 15 years, not 10), I feel like we can absorb a decent amount of short-term volatility with at least a chunk of this account.
Second, we’ve positioned ourselves to “win” whether stocks go up or down in the near term. If stocks rise, we’re incrementally improving our current rate of return by increasing our exposure to appreciating assets. If stocks fall, we get to acquire more shares at lower prices, thus improving our future expected returns. (All else equal, the future expected returns on a given asset are inversely related to the price paid to acquire that asset.)
Third, we’ve done this without exposing the entire account balance to high volatility and greater uncertainty. The historical reality is that stocks can tread water for a decade or more, and the statistical reality is that mediocre returns are, all else equal, more likely in the aftermath of the sort of remarkable bull run we’ve enjoyed since March of 2009 when we bounced off the lows of the Great Financial Crisis.
I love this solution. I think it’s elegant, nuanced, pragmatic, and confidence-inspiring. Among other benefits, it allows me to spend exactly zero hours per month worrying about this particular account.
And here’s what it isn’t: It isn’t “all-or-nothing,” where we feel like we have to (get lucky to) get this exactly right in some objective sense. This solution is one that accepts and embraces uncertainty, diversifies our opportunities, manages risk, and still, more likely than not, improves our expected outcomes with these assets.
It's a sensible shade of gray, not black or white. This topic came up this week in a discussion with new wealth management clients who hold a substantial position in a highly-appreciated tech stock in a taxable account. I sold about 10% of that position to reduce risk on the margin (without netting out any taxable gains), but we plan to leave the rest of the position in place for the foreseeable future. That’s gray, and it’s beautiful.
These decisions don’t have to be all-or-nothing, and most shouldn’t be. Find a middle ground that makes sense, feels right, and works relative to your specific goals.
From time to time I receive calls or emails from 401(k) participants who are concerned about the stock market and want to move entirely to cash. My counsel is always the same, focusing on time horizons, risk management, and the biggest problem with sell everything: Even if you get the exit “right,” how and when will you jump back in? That’s the hard part, and market history is littered with examples of investors wildly underperforming by buying high, selling low, and waiting too long to re-enter. The math of that sequence gets ugly in a hurry.
For workplace plan participants, modern recordkeeping systems (for Interlake’s plans, those are PCS, T. Rowe Price, Vanguard, and Vestwell) allow you to choose one mix of investments for your current assets and another for your future contributions. Shades of gray are right there for the taking.
This subtle approach becomes more relevant as time horizons shorten. For young participants with very long time horizons, there’s no need for gray in their retirement accounts: The answer is to buy diversified baskets of stocks hand over fist, not worrying at all what they’re worth today. This is just pure, powerful accumulation.
When the date of distribution approaches, however, we need to start thinking in more nuanced ways about how we can maximize our chances of (adequate) success while minimizing our chances of (abject) failure.
If you’re at that point in life, or in some part of your financial life, drop us a line and we’ll talk it out until we come up with an approach that works for you, one that avoids all-or-nothing thinking in favor of pragmatism and practicality.
As I type this, we’re approaching Easter Sunday, when our daughter will rightly and gleefully put all her eggs in one basket. But she’ll grow up learning that that’s pretty much the only time she should do that. Some here, some there. It’s a handy, timeless metaphor for so many dimensions of our financial and personal journeys.
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*Here's something new and awesome about 529 accounts worth (foot)noting: SECURE 2.0, which became law in late 2022, now enables account owners to roll unused 529 assets into Roth IRAs in the name of beneficiaries. Annual contribution (currently $7,000) and lifetime (currently $35,000) limits apply, but this is a game-changer for 529 account owners. It's hard to imagine a better setup to get kids off to a great financial start by combining low-to-no debt for higher ed and the potential for very long-term compounding of retirement savings with 529-to-Roth assets starting in their late teens or early 20's. If you'd like to read a little more on this, here's a useful review from SavingForCollege.com.