Education account investment strategies

When invested properly, a 529 Plan can be a powerful vehicle to use to save for a child’s or grandchild’s college education. The main benefit of investing in a 529 Plan is that the earnings grow free of income tax if they are used to pay qualified education expenses.

A lot of investors are currently concerned about future performance of the stock markets in light of attractive returns these past several years. Higher valuations will likely lead to more muted returns over the next market cycle.

Given many investors are currently focused on market risk (and stocks carry more market risk than bonds), it is important for investors to remember there are several other types of investment risk. The underlying investments in a 529 Plan need to generate a sufficient return over time to provide adequate funding for the beneficiary’s education needs. Given the current risk-free return is essentially zero, this involves taking on some level of market risk. Having too conservative of an investment strategy increases the risk that the funding objective will not be met. Therefore, perhaps the biggest investment risk concerning a 529 Plan is not taking on enough market risk.

In general, riskier investments outperform more conservative investments over longer periods of time. 529 Plan beneficiaries who have a longer time horizon will likely benefit from having a larger portion of their account invested in stocks. While taking on more market risk generally equates to earning a higher rate of return over time, blending in more conservative investments helps protect the account value during periods when the stock markets are falling. Also, maintaining adequate global stock diversification helps reduce market risk over time.

529 Plan investors need to maintain a proper balance between riskier and more conservative investments over the time horizon of the beneficiary. As a beneficiary gets closer to needing the funds, investments should be positioned more conservatively. Moreover, amounts needed to cover education costs within a year or two should be held in cash or cash equivalents.

-John Petrie is director of investment advisory and principal at Aspiriant in Milwaukee.