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When A Bear Market Chews Up College Savings Accounts

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The current financial downturn has many boomer parents in a quandary as their children are poised to enter college or are already in school. The problem: many college savings plans have lost 20% and more of their value as the stock market plunged this year.

Mark Kantrowitz, a college financial aid expert who publishes, Cranberry Township, Pa., notes that many parents have set aside funds for their kids’ higher education in Section 529 plans. Those who have used these plans’ automatic asset-allocation feature may have seen little or no drop in asset value, because this kind of arrangement gradually invests funds more conservatively as college years approach.

“If they were following recommended strategies, they’d be 80% or 90% in bonds or money market accounts,” he says.

Parents of younger children may not have too much cause for concern because their 529 plans have time to recover from recent losses. Kantrowitz, for instance, says the 529 accounts he holds for his 2 children, age 3 and 5, are mostly invested in stock funds. Although these have fallen in value 20% to 30%, that doesn’t alarm him because the funds have years to recover before his children enroll in college.

For the children of many boomers, however, college is imminent and savings have often sagged for those who haven’t chosen to automate allocations.

“If their 529 has lost money because they had too much in stock funds, they can avoid taking a distribution when their child is a freshman,” he says. “If they can, they should wait until junior or senior years, because if they’re like most people, they probably haven’t saved enough to pay for all 4 years anyway.”

Meanwhile, the parents can be advised to borrow from Sallie Mae for the first year or two of college and hope their 529 will regain its lost value, he says.

On the other hand, if it seems unlikely the plan won’t recover in time, the investor might prefer to take a distribution from the account.

“That will lock in losses but prevent the account from going down further,” Kantrowitz says. “They can put the funds in a money market account until needed.”

For investors with a little time to save for college, advisors can explain the advantages of dollar-cost averaging, in which monthly contributions buy more and more fund shares as the stock market declines.

Dollar cost averaging assures that at least some shares will be purchased when the market hits bottom, Kantrowitz notes.

“This works best when the market is extremely volatile,” he says. “If it’s going down, each contribution buys more shares. If it turns up, contributions buy fewer shares, but they’re appreciating.”

As college approaches, investors who have not selected automatic allocations based on age need to start moving their 529 funds into conservative investments, Kantrowitz says. He thinks 529 investors with a longer time horizon should be in a broad indexed fund that tries to capture the performance of the stock market as a whole rather than an individual sector.

The best 529 plans to recommend usually are the ones offered by the investor’s home state, if it is one of the 32 states that allow an income tax deduction for residents’ contributions, Kantrowitz says. Otherwise, look to states with the lowest fees.

“You want plans where fees charged by the manager are under 1%,” he says. “That’s going to leave more cash to build savings and less to padding the pockets of the company that’s managing the fund.”


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