Since we’re on the topic of college tuitions, I have recently adjusted the investment mix in my Ohio CollegeAdvantage 529 Plan. As I’ve mentioned before, I choose a very conservative mix because I think a 20-year or less horizon with a 4-year or less withdrawal period is actually a pretty short horizon. I just want to see gradual but reliable increases in my balances. In contrast, I view retirement as a 30 year horizon with another 20-30 year withdrawal period.
Previous Asset Allocation
My original asset allocation was 100% Treasury Inflation-Protected Securities (TIPS) through the Ohio 529’s Vanguard Inflation-Protected Bond Option which is essentially the Vanguard Inflation-Protected Securities Fund (VIPSX) with a slightly higher expense ratio. Back in 2009, I ran a comparison of the CollegeSure Tuition-Indexed CDs vs. Inflation-Protected Bonds, and picked TIPS. However, back then the real yield was 1.7%, and it is now 0.49%. Accordingly, the fund has a pretty good performance since then.
Updated Asset Allocation
20% Stocks (simple low-cost index option)
40% Inflation-protected bonds
40% Bank CD 10-year initial term, paying 5% APY.
Adding Stocks
The reason I chose to add stocks is that historically, adding 20% of stocks to a portfolio has actually reduced volatility while increasing returns. Here is a chart from my Choosing An Asset Allocation series of posts. As I get closer to college start date, this 20% portion will go down to zero.
Adding a 5% Bank Certificate of Deposit
Right now, a regular nominal 10-year Treasury Bond yields less than 2.50%. The real yield on a 10-Year TIPS bond is 0.95%, so the market is basically predicting inflation over the next 10 years to be about 1.50% annually.
However, the Ohio 529 plan offers a FDIC-insured certificate of deposit with a 10-year term earning 5% APY through Fifth Third Bank. (Heads up via Bogleheads.) That’s quite a big boost in yield. For every $10,000 I put in today, I’m guaranteed over $15,000 in 10 years. Early-withdrawal penalties are steep at half of accrued interest, so I had to be sure I wouldn’t need the money sooner.
As long as the real yield on the TIPS fund stays below 1%, then as long as inflation stays below 4% over the next decade the CD will win out over TIPS. If inflation somehow goes nuts, then the TIPS will keep the portfolio from falling too far behind. (Hopefully the stocks will help out as well.)
Since these are all in a 529 plans, the gains will be tax-free if used for qualified college expenses, which is good because otherwise federal and state taxes on a bank CD would be pretty high for us.
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When will you get a baby?
I’m astonished by that 5% CD!
Is your 529 plan for you or someone else?
Amazing chart and supports exactly how I’ve been feeling. I sure hope that this bubble bursts and students no longer have to pay an absurd amount of money for a college education.
Jonathan-
I hate to bug you, but I cannot seem to post a comment under the SERO thread…..I have a question that I’m hoping that you can help me answer. do u know if you can use the HTC Touch Pro with SERO? Not the TP2, just plain old TP. (heh)
A friend has a TP that has been recoded to use on Verizon’s network, but it was on Sprint originally. I think I can have it switched back over to Sprint and use it on my SERO plan.
Indeed, diversification reduces volatility and improves your returns! I would recommend to diversify further your actual stocks and bonds. If you at all can invest into U.S. stocks and Foreign stocks, you should split that investment. Same goes for bonds, have a mix between U.S., foreign, high-yield, corporate. All of those moves should reduce your volatility as long as they are not correlated to 1, it will reduce your Beta (risk) and therefore your volatility will go down. Also, you do have 20-24 year horizon, that is indeed short.
He mentions the 20-year window for the 529 plan and the 30-year window for retirement. Perhaps planning for some classes on Gerontology to prep for retirement, Jonathan?
On a serious note, do state plans still restrict to use within the state? I recall that being the case when these (or perhaps similar education savings plans) came out in the ’90s.
@bb – I wish I knew :/
@Jenna – We plan to have kids…
@rachel – Yes, I thought I read about lots of people with Touch Pro on SERO.
@Ron – No, you can use any state’s 529 in any other state in general, although several states have special tax breaks only for residents. I like the investment options and low expenses in the Ohio plan, but don’t live there.
Here’s a thought:
In several states you can pre-purchase tuition by the semester at today’s rates. If your child decides not to go to an in-state school at a future date you can generally redeem those semesters at the future average tuition rate of state institutions and spend the cash at whatever college they choose. Essentially that creates an investment that returns the amount of (state) college tuition increase. May be a better alternative to TIPS in light of your prior post’s data on the rapid increase in tuition rates.
@ Andy – Unfortunately, some of these plans have run into trouble and only five (Mass., Miss., Ohio, Texas and Wash.) have a guaranteed refund to participants if shut down:
http://www.smartmoney.com/personal-finance/college-planning/prepaid-tuition-plans-run-into-trouble/
Aside from economic crisis and fund mismanagment, as was done with Social Security on the federal level, I don’t trust state leaders to not use these funds to pay for other obligations.
@Jonathan / That is exciting! I’m just asking because I heard that you can use 529 on yourself, is this true?
@Andy – I googled this too, and ended up finding my own post from last year: Is Your State Prepaid Tuition 529 Plan Really Safe?
https://www.mymoneyblog.com/is-your-state-prepaid-tuition-529-plan-really-safe.html
I don’t know of any prepaid plan that guaranteed a minimum return of whatever the future average tuition rates were in the state. At most, you only get a guarantee getting back whatever you put into it.
@Jenna – Yes, you can have a 529 with yourself as the beneficiary:
https://www.mymoneyblog.com/in-school-and-working-funnel-your-expenses-through-a-529.html
@Jonathan / Cool! Thanks for the information.
I am curious whether anyone invested in the CD has seen a change in their online balance. I could not find any information as to when interest posts (it is compounded continuously). Perhaps it will post quarterly. Just wondering as I like to update my records monthly.
I’m really surprised your 529 is so conservative. For me the college horizon is largely irrelevant until you are very close, since there are other ways to fund college (other savings, cashflow, scholarship, loan). It’s not like retirement, where you are stuck if you get unlucky.
The interest posted one month and one day after the CD was purchased, which makes sense.
That 5% CD has ended… sadly…