Change Your 529 Plan Strategy

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Posted: Apr 02, 2009 12:01 AM
Change Your 529 Plan Strategy

Body text: It's not just stocks, bonds and real estate that declined sharply in value in 2008. Section 529 College Saving Plans lost substantial amounts of money, too. And parents are worried.

Written in a frantic e-mail to me, "My daughter is a junior in high school, and her 529 plan has lost half its value. I don't know how it will recover before she heads off to college!"

If you're one of those parents who has worked hard to save for your child's education and are now worried because you've just seen many years of diligent savings evaporate in a matter of months, here's what to do.

If your child is a high school sophomore, junior or senior, or already in college: It's time to alter your strategy. Not your investment strategy, but your withdrawal strategy. Many parents have been planning to begin using the funds they've accumulated in their 529 plans as soon as their children enter college. Because most don't have enough money saved to pay for the entire degree, they've assumed that they'll need to obtain student loans for the last year or two of college. In response to market conditions, let's simply switch the strategy: Use student loans for the student's freshman and sophomore years of college so you can leave the 529 account untouched for several more years. Instead of spending the money in just another year or two, you can effectively double the amount of time in which the account can grow, dramatically boosting its chances of recovering from recent losses.

If your child is 12 or younger: Congratulations! It just got a lot easier to save for college. With stock prices down so low, you have the opportunity to buy shares that are 30 percent to 50 percent cheaper than they were just a year ago. You should consider this to be the sale of the century! Most parents are saving regularly for future college expenses, and that means you're taking advantage of the concept known as dollar cost averaging: A $100 monthly investment today buys far more shares than it did a year ago. By continuing to invest regularly as you've been doing for years, your college savings fund will be able to obtain the "average lowest cost" of shares -- dramatically boosting the odds that you'll enjoy profits by the time your child graduates from high school.

Say you have $100 and you buy a stock that costs $10 per share. That means you buy 10 shares. Next month, you save another $100, which you place into the same fund, only now the shares are just $5. Thus, you buy 20 shares. What's the average price of all your shares?

If you said $7.50, you're wrong.

You invested $200 ($100 per month over two months) and you own 30 shares (you bought 10 shares, then 20). Divide $200 by 30 shares and you'll find that the answer is $6.67. Why did you think the answer was $7.50?

Because you used the arithmetic mean ($10 + $5 divided by 2