529 plans, like other investments in the stock market, can lose money. Investing in the stock market is never really safe. But, stock market investments generally grow to a greater extent than other investments over the long term.
During an economic downturn, such as the one triggered by the coronavirus pandemic, investments in the stock market will drop significantly, but only temporarily.
For example, the S&P 500 dropped by a third from February 19, 2020 to March 23, 2020, but has since increased by 43% off of the bottom. As of July 14, 2020, the S&P 500 is just 5.9% short of a full recovery.
(For reference, the S&P 500 closed at 3,386.15 on February 19, 2020, 2,237.40 on March 23, 2020 and 3,197.52 on July 14, 2020.)
Investing in the stock market is like riding a roller coaster. It has its ups and downs, and watching it too closely can cause nausea.
The best advice is to remain invested. Set up a direct-sold 529 plan with automatic investment and don’t pay too much attention to the ups and downs. If you are invested in an advisor-sold 529 plan, follow their advice to stay the course. Pulling out of the stock market will just lock in losses and cause you to miss out on the economic recovery. Trying to time the market, especially during a period of increased volatility, just doesn’t work very well.
If you can’t handle the stress of stock market gyrations, 529 plans offer many investments that are safer, with a lower risk of investment loss. Several 529 plans offer FDIC-insured investment options and money market accounts. All 529 plans offer age-based asset allocations, which shift to a lower-risk mix of investments as college enrollment approaches.
Consider what happens to an age-based asset allocation that starts off with 80% invested in stocks when the baby is born and gradually shifts to 20% in stocks when the baby is a high school senior.
- If the stock market were to drop by 30% when the baby is one year old, the 529 plan will experience a 24% loss. But, there will be very little money in the 529 plan, so the losses are the equivalent of just three months of contributions. You also have 16 years to recover from the losses.
- If the stock market were to drop by 30% when the baby is a high school senior, the 529 plan will experience just a 6% loss, which may be partially offset by gains in the low-risk portion of the portfolio. That’s not too bad. Although that’s the equivalent of about 1-2 years of contributions, there’s a good chance the stock market will recover before you need to use most of the money. You also have the option of borrowing to pay for college costs while you wait for the stock market to bounce back, and then using the 529 plan to pay off the student loans.
Of course, if you invested all of the money in the 529 plan in an all-stock fund, all bets are off. Such a 529 plan will follow the performance of the stock market as a whole, without any attempt to manage the risk of investment loss. The stock market has at least three corrections and one bear market in any 17-year period. A stock market correction is a drop of 10% or more. A bear market is a drop of 20% or more.
You may also wish to avoid 529 plan portfolios that are too heavily weighted in real estate or foreign stocks, as these can increase volatility and do not recover as quickly as domestic stocks.