Age-based plans function similarly to a 401K retirement account. Just as retirement accounts are set up to maximize risk and earnings earlier and taper to safer investments as you near retirement, age-based 529s follow the same premise leading up to college age. The risk is greater the younger the child, and as the child nears college age the funds are more securely distributed.
Age-based options are set up so that your money is dispersed in different ways depending on your child’s age. If your child is between the ages of 0-5 you have quite a bit of time to let your money do the work for you. The younger the child, the more the investment emphasis is placed on stocks because there is time for short-term fluctuations and long-term growth potential. As college grows closer money is transitioned into more bonds and secure savings in order to ensure adequate funds when you need them. Even though it’s best to start saving as early as possible, it’s never too late. Even if your child is in high school, you can still reap the tax advantages and investment potential of a 529 plan. Your investments will start off more conservatively since you will need the money soon.
In addition to your child’s age, another factor that plays a key role in deciding upon the right plan for you is your level of risk tolerance. As with any investment tool, the more risk, the greater chance for reward (or loss). If the thought of losing money terrifies you, take a more conservative approach in which at least half of your money is more securely invested in bonds as opposed to a far more aggressive approach in which funds are invested in more volatile stocks. Or perhaps you are feeling adventurous, but also want to ensure some stability. Yet another advantage of 529 plans is that you can set up more than one account for your child. You may want to try one conservative and one aggressive plan in the hopes of off-setting any major losses.
Keep in mind that once you choose a plan you are not locked in. Once you decide on your risk tolerance, there is still a lot of flexibility within each category. You can create your own age-based plan by picking your own stocks, bonds, and reserves within your portfolio, or you can pick a managed fund that does the work for you. You can always change your plan to be more or less aggressive or move funds around to suit your needs.
Remember, these types of plans are designed for long-term investing. In a bear market, it is not always advisable to pull money out if you still have plenty of time for it to recover. If your money takes a downturn and your child is more than 10 years away from college, it is generally okay to leave it alone and ride it out. Chances are the market will recover in that time. Alternately, if your child is nearing college age and you will need the funds soon, it is advisable to move money to more secure funds.
Below is an example of an age-based plan adapted from the Vanguard 529 Plan Age-Based Option. It illustrates how money is allocated depending on the child’s age and your risk tolerance. All of them start out more aggressive earlier and become safer as college approaches.
Best of luck on the next step of your investment adventure!
Are you happy in an age-based 529? Made the switch to something else? Let our readers know! And check out FreshmanFund.com for an easy way to increase your 529 savings.