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TRUTH HAS A FUNNY way of punching you in the gut. I received my punch thanks to the 2022 decline in the stock market, which put a dent in the “funded” status of the 529 college-savings plans for my two sons, ages 16 and 14.
Buy and hold is all well and good if you have an infinite investment time horizon. Strict adherents will argue that mark-to-market gains and losses are just noise. Time will smooth out the ripples. But what if the funds are earmarked for an upcoming goal, like college costs or retirement?
Already, parents in my shoes are aghast at nearly $80,000 a year for tuition, room and board at private colleges in the Boston area. A 20% drop in a fully funded 529 plan with, say, a $320,000 balance means a $64,000 loss. My sons, of course, may go to one of the excellent public universities here in Massachusetts, where tuition is lower. But I want them to have a choice.
Responsible investors manage risk. Target-date funds, available in some 529 college-savings plans and most retirement plans, achieve this with a “glide path.” These funds automatically shift a portfolio’s asset allocation away from stocks as the target date approaches, reducing the prospects not only of stock-like losses, but also stock-like gains. As a prudent financial advisor would counsel, don’t risk what you can’t afford to lose.
Well, here’s another truism: There’s no return without taking risk. I still feel like I need investment growth. Instead of getting out of the stock market, I’m staying fully invested, while managing risk with my own homegrown downside protection.
The 529 plans for my sons remain invested in stocks. But at the same time, I’m spending some of the money that would otherwise have gone into their accounts to buy put options. Those put options pay off if the S&P 500 plunges in value. What if, instead, the S&P 500 rises? The options will expire worthless.
To be sure, the cost of hedging is a drag on performance. But I think of the option premiums I pay as similar to insurance premiums. Yes, I’m giving up some of the gains in a rising stock market. But in return, I have the peace of mind that the options will keep my boys’ college funds intact when the market declines. Sometimes the best offense is a good defense.
Philip Sun, a former portfolio manager, is co-founder and CEO of Adaptive Investment Solutions, LLC, a provider of one-click portfolio downside protection solutions. He also teaches finance and data analytics at Boston University and Hult International Business School. An amateur violinist, Philip is a devotee of Bach and gypsy jazz. In the early mornings, you can find Philip training for sprint triathlons in the western suburbs of Boston. Contact Philip via LinkedIn and follow him on Twitter @Adaptive_Invest.
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Thanks for the article and sharing this particular strategy of playing defense, among others.
It seems to me that investment strategies for college funds are an under-discussed financial issue given their importance to both students and parents. So I thought Mr. Sun’s article interesting.
Folks who invested in stock within education funds over the 11 years prior to 2022 did very well. But as the investment horizon shortens for these funds, allocation decisions are more difficult because, as 2022 reminded us, market volitility in the short term can be a real problem. Even folks heavily weighted toward bonds in those funds at the beginning of 2022 didn’t escape.
Put options are perhaps a bit more sophisticated strategy than many people would consider, and they likely work better for folks who have high fund balances than low balances. Nevertheless, the idea of options under short-term horizons has enough merit that it warrants thinking about. Even if the idea is not something you pursue, sometimes understanding why you’ve choosen not to do something is quite valuable and pondering the pros and cons of a previously unconsidered option costs you nothing. Thinking about ideas, after all, is free (once you finish paying college tuition, anyway).
I appreciate the themes in this article, 529 accounts and hedging, but a couple of observations.
1) A $320,000 balance in a 529 Plan is such a huge sum that when seeing it, made me recoil. I’ve recovered, but I can imagine that balance would alienate a lot of readers.
2) I know little about put options but find them interesting. Rather than tying this theme loosely to 529 downside protection, I would have preferred a more thorough examination of put options pros/cons. Appreciate the link, but a future article from you on the pros/cons, and evidence that this strategy is worthwhile for everyday investors, would be appreciated.
Right now Vanguard brokerage CDs are paying 5.15% for one year and up. Seems like a simpler and safer way of offsetting potential stock losses. And I would not have a fund I was going to need in the near to mid term 100% in stocks in the first place.
I also agree with Nate, and would add that courses taken at a community college can usually be transferred for credit to a four year college.
I hate to sound skeptical, but it seems a bit suspicious to me that this article was written by the CEO of a company that specializes in guarding against market downturns.
Since this post is somewhat about education, I’ll again ask about much cheaper alternatives: WGU charges $4000/term for 6 month terms and you can transfer in credits for even cheaper if someone wants an accredited 4-year degree. (Also other options out there)
There are many HVAC, plumbing, electrician, nursing, and other certifications that could be had for 2-years or less with an apprenticeship.
Unless someone is going to Harvard or the like, it might be better to get a much cheaper/faster degree (or route) to earning money.
Our middle son recently graduated from a well regarded 2 year nursing program at a California community college. No debt when he graduated. He moved out here to Georgia and was offered several RN positions. He’s making $35 an hour during training. Then about $90,000 after that. So yes, there are much cheaper alternatives depending on what one’s goals are.
I couldn’t agree more. The world of higher education is changing rapidly right now. Students–and parents–are becoming more aware of what is happening at higher education institutions and are starting to look for viable alternatives.
Coding bootcamps are one popular alternative to earning a degree in computer science. Companies like Google, Microsoft and Apple offer certificate programs to fast track students into high demand–and good paying–jobs.
The medical fields are also changing the way they educate students. Some pharmacy programs no longer require a student to have a four-year degree prior to being admitted into pharmacy school. At least one new medical school is offering a tuition-free education to their students: https://medschool.kp.org/admissions/tuition-and-financial-aid
And, of course, there are trade schools and apprenticeships. Mike Rowe started a foundation a few years ago with the idea of helping recruit more young people into the trades. In 2022, his foundation awarded $1.5 million in scholarships to men and women who wanted to learn a trade. https://www.mikeroweworks.org/scholarship/