Playing Defense

Philip Sun

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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