The rout in the stock and bond markets has been especially rough on people paying for college, retirement or a new home. Our columnist has some advice.
The stock market has been painful if you have been looking at it closely.
So don’t look. Set up your investments, then take a deep breath.
After that, what should you do? In a word: nothing. Get on with your life.
I’ve been suggesting this approach for quite a while, and follow a modified version of it myself. I can’t ignore the markets entirely. My work compels me to study them.
But after years of practice I am able to separate work from my personal investments, which are mainly in low-cost, diversified index funds. I’m adding to my holdings, even in this nasty market, and intend to continue until I need to draw on the money.
I’m not risking anything I need now or in the next year or two, and recommend the same caution for just about everybody else. Always, always pay the bills first.
That’s easier said than done, though, when big bills are coming in the not-too-distant future and you are counting on declining investments to pay for them.
Nobody wants to be in this position, but it is precisely the situation faced by many of the millions of people who have been saving and investing for a child’s education using tax-sheltered state plans, known as 529 plans. Every state offers them.
Nor are college savers the only investors in this predicament. People about to retire, or in the early stages of retirement, face a similar quandary. And so do those investing in the hope of buying a house, only to see their down payment melting away in a market downturn.
I’ll focus mainly on the problems confronting the people who use 529 plans, but these issues are relevant for many others.
Setting and forgetting
The most popular choices for both the New York State and California direct college savings plans that I examined are set-it-and-forget it investments, similar to the target-date funds that have become a staple of workplace retirement accounts.
They are generally fine for the long haul but don’t offer much protection in years like this one.
“Of course, nobody wants to lose money,” said Julio Martinez, executive director of the ScholarShare Investment Board, which runs California’s ScholarShare 529 plan. “This is a bad year, unfortunately. Sometimes, there are very good years and you luck out.”
These widely selected 529 plan options are preset mixes of low-cost stock and bond index funds, just the kinds of long-term investments that I think make sense for most people. You can put away money steadily and avoid any attempt at picking individual stocks or timing the market. When the markets rise, you prosper.
Much like the target-date funds in retirement accounts, they are intended to become more conservative as you approach the moment when you need the money.
The problem is that what looks conservative in theory may not seem that way in practice. Bonds in recent decades have usually risen in value when stocks declined, but not this year, and that has led to losses for stock and bond portfolios of all kinds.
“We’ve tried to build the best lineup we can for account owners,” said Jeremy Rogers, who runs the 529 programs of New York State, with more than one million active accounts. “Long-term investors have done well, but the problem is your time horizon. If you need the money this year, it can be tough.”
The ugly numbers
Consider the age-based options offered by New York’s 529 program. You can start putting money in when a baby is born. It’s up to you to decide whether you want a “conservative growth,” “moderate growth” or “aggressive growth” path. Vanguard runs the underlying funds, which are solid but entail risk that may not be obvious when you sign up for them.
I used this plan for my son, and the records show I chose “aggressive growth.” That choice must have been excruciating in 2008, when the S&P 500 lost 35.5 percent, though I don’t remember the pain. It’s possible that I followed my own advice and just didn’t look; more likely, I’ve repressed the memory. Because the stock market came back smartly, my aggressive choice worked out by the time we emptied the account in 2016.
When the stock market rises, the aggressive plan goes up more than the others. But for the last year, anyone using it is facing a double-digit loss. How much depends on the age of the person for whom the investments are made. Remember, the portfolio for a 1-year-old has more stock than one for a 19-year-old in this plan.
These are one-year returns through August, the most recent available:
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0 to 4 years old, –16.1 percent.
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13 to 14 years old, –13.5 percent.
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19 and up, –12.1 percent.
Less aggressive plans did better because they contained less stock. But they weren’t great either. It has been that kind of year.
Here are selected one-year returns for the “moderate growth” age-based plan in New York:
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0 to 4 years old, –15.4 percent.
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13 to 14 years old, –12.6 percent.
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19 and up, –6.5 percent.
And these are the “conservative growth” returns:
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0 to 4 years old, –14.1 percent.
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13 to 14 years old, –6.5 percent.
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18 to 19 years old, +1.4 percent.
Note that the only positive number here is the conservative option for people 18 to 19 years old — those who may already need the money. That return is better because the portfolio is held in a money-market fund, which is a good place for short-term money but won’t keep up with inflation.
On the other hand
Over the long haul, taking on greater risk has been worth it.
At my request, New York State calculated the annualized returns of these 529 plans from Aug. 1, 2003, through Aug. 1, 2022 — representing a 15-year investment of a lump-sum contribution. The returns were excellent:
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6.9 percent, annualized, for the aggressive option.
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5.9 percent for the moderate option.
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4.7 percent for the conservative one.
In other words, even with recent losses, you are ahead if you used any of these plans over those 15 years. Knowing that may help you cope with the immediate pain.
The California ScholarShare plan has provided similar ballpark returns, and its short-term performance numbers are clearly visible. That’s not the case for the New York plan: You need to hunt for those numbers, if you are trying to figure out which may be best for you.
“This is supposed to be a simple and easy-to-use plan for people who are novice investors,” Patricia Oey, a senior analyst at Morningstar, said of the New York plan. “But when the website is complicated, and when it’s difficult to find performance data, it isn’t aligned with those goals.”
California uses a college enrollment date model instead of an age-based one. It’s similar in principle. The closer you get to the target enrollment date, the more conservative the investments become. All of these options are in the red this year, much like the New York plan, but all have had long-term gains.
Both California and New York offer a variety of other 529 investments, including portfolios that you can build yourself. But the standard, set-it-and-forget-it plans are the most popular, and most people using them have been losing money lately.
No simple solution
It’s reasonable to accept losses in the stock market in 2022 if you believe, as I do, that you are likely to earn them back, and more, in the years to come. That belief isn’t a sure thing, but it’s well grounded. It assumes that the economy is likely to grow ultimately, even if it stumbles now, and that you will share in the profits.
It also assumes that you are a long-term investor, which I’d define as having a horizon of at least a decade and preferably much more. If you are investing for a goal that needs to be realized before then, you are taking on a sizable risk if you are counting on the stock market. Offsetting stock holdings with bonds, as these 529 funds do, is a good idea as you come closer to needing the money, even if the strategy hasn’t worked well this year.
Certainly, by the time you are five years from your goal, it’s worth checking whether you are comfortable with the risks you are taking, and readjusting if you are not.
My only real quibble with the 529 plans is that I don’t think most people realize how high their risk of losing money is, even when their choices are labeled “moderate” or “conservative.” In fact, whether it’s a 529 plan, a retirement plan, a fund for a house or any other important purpose, I’d cut back on risk-taking if I couldn’t afford to lose my nest egg.
For those whose accounts are down but need the money soon, I’m afraid I don’t have great answers. Your options are limited.
You can gamble that the stock market will rise in the next six months or so, but that may not happen. It may well fall further.
Investing in the stock market for decades makes sense to me because the U.S. market has always risen over 20-year periods. But for the short term, it has been much more hazardous.
That’s why, in the end, I believe that money you really need shouldn’t be in the stock market.
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