college savings 101

How Safe is Money in a 529 Plan during a Pandemic?

529 plans, like other investments in the stock market, can lose money. Investing in the stock market is never really safe. But, stock market investments generally grow to a greater extent than other investments over the long term. 

During an economic downturn, such as the one triggered by the coronavirus pandemic, investments in the stock market will drop significantly, but only temporarily. 

For example, the S&P 500 dropped by a third from February 19, 2020 to March 23, 2020, but has since increased by 43% off of the bottom. As of July 14, 2020, the S&P 500 is just 5.9% short of a full recovery.

(For reference, the S&P 500 closed at 3,386.15 on February 19, 2020, 2,237.40 on March 23, 2020 and 3,197.52 on July 14, 2020.)

Investing in the stock market is like riding a roller coaster. It has its ups and downs, and watching it too closely can cause nausea. 

See also: What to Do With College Savings in a Volatile Market

The best advice is to remain invested. Set up a direct-sold 529 plan with automatic investment and don’t pay too much attention to the ups and downs.

If you are invested in an advisor-sold 529 plan, follow their advice to stay the course. Pulling out of the stock market will just lock in losses and cause you to miss out on the economic recovery. Trying to time the market, especially during a period of increased volatility, just doesn’t work very well.

See also: Should You Dip Into Your 529 Plan in Case of Coronavirus?

If you can’t handle the stress of stock market gyrations, 529 plans offer many investments that are safer, with a lower risk of investment loss. Several 529 plans offer FDIC-insured investment options and money market accounts. All 529 plans offer age-based asset allocations, which shift to a lower-risk mix of investments as college enrollment approaches. 

Consider what happens to an age-based asset allocation that starts off with 80% invested in stocks when the baby is born and gradually shifts to 20% in stocks when the baby is a high school senior. 

  • If the stock market were to drop by 30% when the baby is one year old, the 529 plan will experience a 24% loss. But, there will be very little money in the 529 plan, so the losses are the equivalent of just three months of contributions. You also have 16 years to recover from the losses.
  • If the stock market were to drop by 30% when the baby is a high school senior, the 529 plan will experience just a 6% loss, which may be partially offset by gains in the low-risk portion of the portfolio. That’s not too bad. Although that’s the equivalent of about 1-2 years of contributions, there’s a good chance the stock market will recover before you need to use most of the money. You also have the option of borrowing to pay for college costs while you wait for the stock market to bounce back, and then using the 529 plan to pay off the student loans.

See also: How Will Coronavirus Impact Your College Savings?

Of course, if you invested all of the money in the 529 plan in an all-stock fund, all bets are off. Such a 529 plan will follow the performance of the stock market as a whole, without any attempt to manage the risk of investment loss. The stock market has at least three corrections and one bear market in any 17-year period. A stock market correction is a drop of 10% or more. A bear market is a drop of 20% or more.You may also wish to avoid 529 plan portfolios that are too heavily weighted in real estate or foreign stocks, as these can increase volatility and do not recover as quickly as domestic stocks. 

college savings 101

Is It Safe to Get Back into the Stock Market?

After the stock market started dropping on February 19, 2020 due to the coronavirus pandemic, some investors pulled out of the stock market. Other investors remained invested, but shifted their asset allocations to a more conservative mix of investments. When is it safe for these investors jump back into the stock market?

The stock market is never really “safe,” but the recovery began on March 24, 2020, about a month after the start of the bear market. 

Pulling out of the stock market just locks in losses and causes you to miss out on all or part of the recovery. It is better to remain invested than to try to time the market. 

If you blink, the recovery will have already happened and you will miss out on the opportunity to regain some of your losses. If current trends continue, the S&P 500 will be fully recovered in two more weeks and the Russell 2000 will have fully recovered in about a month. 

It took about a month for the stock market to drop by about a third. It will have taken about three months for the stock market to fully recover from the bear market. It always takes longer to recover from a bear market than it takes for the stock market to drop. 

This chart shows the change in investment returns as compared with where the stock market was at the beginning of the year. It graphs the performance of the S&P 500, Russell 2000, the MSCI EAFE Standard Index (Foreign Stock) and the MSCI US REIT Index (Real Estate).