ByABC News
January 11, 2012, 8:55 PM
— -- Q: Aren't 529 college savings plans terrible for people investing for college, since they can go down when the stock market falls?
A: Hopefully this statement isn't going to surprise anyone: You can lose money on 529 college savings.
You read that right. If you invest in a 529 college savings plan, and that plan puts your money in a variety of investments as most do, you can lose money. That's because these investments, ranging from stocks to bonds, can go down in value.
It's just like your retirement accounts. These accounts are also often invested in stocks and bonds. And as investors have found out these past 10 years, the value of stocks and bonds can go down. And when the value of stocks and bonds go down, the value of retirement accounts that own stocks and bonds falls, too.
Seeing the value of a college savings plan fall is painful. With college costs soaring, rising 7% or more a year in some states, not getting any growth or losing money in a 529 is not going to help pay those mounting tuition fees. Some investors, who have been mechanically contributing to a college savings plan, are understandably upset if the value of the account falls or doesn't go up by much.
But does the fact that stocks can fall and drag down the value of 529 accounts, mean these accounts are a bad idea? Absolutely not. 529 accounts are still one of the things all investors planning to pay college costs should consider. It's just that investors need to keep a few things in mind when it comes to 529 accounts, including:
• Investing is one of the only ways for investors to keep up with college inflation. I understand how disappointing the last 10 years have been for stocks. Had you put money in a 529 plan that was all invested in large U.S. stocks you would have only earned 0.4% a year on average. Clearly that's not enough to keep up with soaring college costs.
But putting money under your mattress would generate 0% interest, which isn't going to cut it either. And even if you put your money in a high-yield savings account, rates on those accounts have fallen to about 1% now. That's not much better.
• Diversification can be your friend. When you open a 529 account for a newborn, your mix of investments will be the most aggressive. You'll usually have a large percentage of assets in stocks.
However, and this is an important point, most 529 plans have a recommended option that will dial back your exposure to risk as your child nears college enrollment. Most 529 accounts will automatically shift money from riskier assets like stocks into bonds over time. And doing this would have saved some major pain.
Consider that while stocks have done very little over the past 10 years, five-year global government bonds have returned nearly 5% a year on average over the past 10 years. Investors who shifted away from stocks and into bonds as their child aged would have gotten some decent returns in the last few years.
• Saving taxes is huge. Don't overlook the greatest power of the 529: Tax savings. If you take money out of a 529 plan to pay for qualified education expenses, you don't pay any taxes on the withdrawals. This is a huge advantage that cannot be ignored.
