529 Plans and Risk Management

The last few years, 529 Plans became a preferred method for financing college. They offered the ability to have money growing in a tax-advantaged fashion for children and grand children. I never bought one for my kids and I never sold one to a client. Never.

Mark Boucher’s story in his book “The Hedge Fund Edge” always stuck in the front of my brain -

“Recounting a personal experience may be the best way to explain why risk should be of paramount importance to investors. In the early 1970’s, when I was nine years old, my father died of cancer. He had struggled to try and leave me a trust fund with enough money to finance my future college education. Since I had at least a decade to go until reaching college age when my father set up the trust, he put it into stock funds managed by a bank.

From the end of World War II to the late 1960’s, stocks had been in a wonderfully profitable bull market. The public was participating in stocks to the highest degree since 1929, and the prevailing wisdom was that if one just hung onto stocks over the long run, they showed a better return than nearly any other type of asset. (This type of environment should sound familiar to investors of the late 1990’s (and again in the late 2000’s)).

Things did not go according to plan beginning in 1972. From 1972 to 1975, the value of that trust fund declined by over 70 percent along with the decline in U.S. and global stock prices of a commensurate amount (the S&P and Dow dropped by around 50% during the period, but the broader market dropped by much more than that). By the time I started college in the early 1980’s, even the blue chip indexes had lost more than 70 percent of their 1972 value in after-inflation terms.

While my trust had recovered somewhat from 1975 to the early 1980’s, it was nowhere near the level it had been before my father died. In the early 1970’s, he believed he had provided enough funds for me to go to an Ivy League school – but a decade later, the diminished trust led me to opt for UC Berkeley instead. In no way could the trust have covered the cost of an elite private school.”

My concern with 529 Plans is that if you are using them to finance the education of young kids, then the plans will be extremely aggressively invested. They will own lots of Small Stocks and International Stocks. These are extremely volatile asset classes. So if you have young children and you fund this plan, and the markets tank, you have no method for managing the risk in the account. They buy risky stocks and you are along for the ride.

As the child ages, these plans sell stocks and buy bonds. So if your child is near age 18, then you can’t buy stocks if you want, because the plan will force you into bonds. Then you can’t play offense if you want to.

So the worst case scenario would be that you have a young kid and the markets tank and sit around for a few years. Then the markets rally, but by then your accounts are in bonds and you do not participate…

Now the media is picking up on the topic –

http://www.citytowninfo.com/career-and-education-news/articles/families-exploring-new-college-savings-options-09111101

“Families whose 529 college savings plans took a beating last year are now looking into safer ways to save for higher education. As a result, banks and financial advisers are beginning to offer more conservative college savings options.”

There is a method top my madness. I sold my house in 2005 (I am trying to buy it back right now at a 49% discount to my sale price – holy cow). I stayed up nights in 2007 reading Money Market Fund Prospectuses to make sure that the funds clients owned had no holdings in Lehman or Bear Stearns. I avoided Corporate Bonds and sold my stocks in early 2008. I avoided 529 Plans because of lack of control. I started buying Gold, long before you were hearing about it on CNBC.

I am humble in the face of the market. If prices fall, I am wrong and I try to get out quickly. If prices go up, then I try to add to what is working. Markets lead. I follow.

I’m a top down kind of guy – is the market going up? Then I am interesting.
Which Sectors have the most strength? Which Industry Groups are getting the focus of buying from the big boys?
Which stocks have the characteristics of the great leading stocks of the past?
Is there a point on the chart where I can buy then, know I have a good chance at success and still have an exit strategy if prices start falling?

The rules set up by the likes of William O’Neil work. Is it a matter having the discipline to follow them and the expertise to customize portfolios to potential risk.

My goal is to manage risk. I define risk as falling prices and falling purchasing power via Inflation and a falling US Dollar. I will make money when the gettin’ is good and then hide when the stuff hits the fan.

I think others are making promises of returns that are not possible or are being achieved at undisclosed risks. I think that selling products like 529 Plans, illiquid Limited Partnerships or Bond Funds that are loaded up on Mortgages and Bank Bonds is unconscionable. The stuff will hit the fan again and you had better have the ability to play defense – because the next unwind will make 2008 look like a picnic.