Don’t Let Market Volatility Derail Your College Savings

For many parents, saving for their child’s education is a top priority. And 529 plans offer a tax-advantaged way to reach your savings goals through investing.

But when the market swings, you might be tempted to run away from stocks in favor of safer investments. You’re probably on a rigid timeline, and you may not feel comfortable risking your savings when you need them the most. However, there is no way to accurately predict how the market will behave, so fleeing stocks might make you leave gains on the table if the market comes around. Being too cautious may also put you at risk of not hitting your goals.

Luckily, the most widely used 529 portfolios are designed to expose investors only to as much equity risk as they can reasonably handle as their goal date draws near. These plans will help you stay the course, even when the markets are bumpy.

Age-Based 529s Reduce Your Risk Over Time

Most 529 assets are invested in age-based or target-enrollment 529 plans. These plans follow glide paths that are similar to those used by target-date funds. These 529 tracks start out with a high percentage of assets invested in equities, then gradually sell stocks and increase the allocation to bonds and cash as the child gets closer to age 18 or their enrollment date.

If your beneficiary is early in an age-based track, you have time on your side. Day-to-day market volatility may be unsettling, but it likely won’t hurt returns too much over the long haul—you have more than a decade to recover from stock market shocks.

You have less time to recover from a sell-off when you’re closing in on your 529 beneficiary’s college enrollment, but the age-based track takes care of ratcheting down your stock exposure. According to Morningstar data, the typical 529 investor has about 15% in equities at college enrollment, so most of your savings won’t be affected by a downturn.

Your 529 Should Balance Your Risk Capacity and Risk Tolerance

Age-based 529s follow a glide path that is based on an investor’s risk capacity by investment time horizon. But risk capacity is different from risk tolerance.

If you are saving for a newborn’s future college needs: You have more risk capacity and roughly 18 years to ride out the market volatility that comes along with equities’ higher long-term returns. An equity allocation close to 100% makes sense for the first six years you invest. But if you flinch every time the market drops a few percentage points, your risk tolerance may not be in line with that risk capacity.

If your 529 beneficiary is in high school: Conserving the money in the account becomes a bigger priority as college nears. You don’t have as much time to weather stock market downturns before you will need that money, so your risk capacity is lower. It makes sense that your overall exposure to safer assets like bonds is higher at that stage. This will help protect your savings from getting wiped out in an equity market selloff when you need that money to pay college tuition bills.

If you’re somewhere in the middle: The transition years, when your beneficiary is between the ages of six and 13, can be difficult because you still have some time before college enrollment but not enough that you can weather any storm. Your priorities should be split between aiming for growth and protecting your savings. Your 529 will account for that transition. The average age-based 529 portfolio gradually shifts from around 70% stocks at age six to roughly 40% at age 13.

The chart below illustrates these scenarios during the 2022 bear market using three portfolios from Utah’s gold-rated my529 plan. The 2040/2041 portfolio in red would have likely been for a newborn, the 2024/2025 portfolio in blue would have been for a beneficiary in high school, and the 2030/2031 portfolio in yellow would have been for a beneficiary around 10 years old.

In January of 2022, the 2024/2025 target enrollment track had already shifted to a more conservative 34% equity allocation to preserve assets as enrollment approaches. The 2040/2041 target enrollment track, on the other hand, was almost 100% invested in stocks. The 2030/2031 portfolio was in the middle with around 63% equity.

At their lowest levels, the 2040/2041 portfolio lost nearly 25% of its value, while the 2024/2025 portfolio was down a little less than 15%. As expected, the 2030/3031 portfolio was in the middle with a 19% loss. Keep in mind that 2022 was unique in that both the equity and bond markets floundered. However, the 2024/2025 and 2030/2031 portfolios still managed to reduce their risk compared with an all-equity portfolio.

3 Considerations When Choosing an Age-Based 529

If you opt for an age-based plan, you likely won’t be able to choose your own investments. But that doesn’t mean you don’t have any flexibility to tailor your plan. Here are three things to keep in mind:

1. You don’t have to stick with a plan that aligns with your beneficiary’s age or graduation year. If you want a more aggressive, stock-heavy glide path, you can choose a plan for a younger child or a later enrollment year. Conversely, you can choose a plan for an older child or an earlier enrollment year if you want to take on less risk.
2. Choosing a plan that you’re comfortable with will help you stay invested, even when the market turns. The key is to find the right balance: You want an allocation aggressive enough to give you the best chance of meeting your savings goals but conservative enough that you can stick with it.
3. Try not to play it too safe, especially if your time horizon is long. Taking on too much risk can jeopardize your goals, but being too cautious can make it harder to reach them.

Find the Best 529 Plan for You

Once you understand how your risk tolerance aligns with your risk capacity, it’s time to find the right 529 plan for you. Morningstar’s Guide to 529 College Savings Plans outlines the steps you can take. Morningstar rates 529 plans that represent more than 90% of the industry’s assets, so these assessments can be a helpful resource as you shop around.

Our analysts look for these features in a 529:

• A well-researched asset-allocation approach
• A robust process for selecting underlying investments
• A well-resourced and experienced investment team
• Stable and engaged oversight from the state
• Low fees

Keep in mind that where you live and your tax situation make the “right” 529 plan unique to you.

Morningstar’s 529 ratings do not factor in state-level tax benefits. In some cases, your state’s tax benefits could be worth choosing a plan that doesn’t receive Morningstar’s highest rating.