College savings in 529 plans may be worth less than hoped

Reuters, September 20, 2017

CHICAGO (Reuters) – (In this Sept. 20 column, corrects penultimate paragraph to say that the duration of the average 529 fund for 19-year-olds is 4.32 years instead of 4.32 percent, and that many of those funds have a duration of close to six years instead of close to 6 percent.)
Parents who are counting on savings in 529 plans to pay for college this year or next could be in for an unpleasant surprise.
Right when they need the money most to cover costs for tuition and dormitory rooms, they could find their 529 stash has dwindled.
The reason: Bonds.
Most 529 money for students about to go to college is placed in bonds by fund managers. The idea is to avoid the volatility of the stock market and keep money safe in bonds so families can rely on their savings at the crucial moment when the college bills must be paid. But, while bonds are safer than stocks, there are times when bonds can present losses. And that time could arrive soon if the Federal Reserve raises interest rates as expected this year and next.
As expectations for a stronger economy and rising U.S. interest rates arose during the last quarter of 2016, the average mutual fund that invested in a variety of bond types lost 2.89 percent, according to Lipper.
Because most 529 plans hold small portions of stock and cash in addition to bonds, these accounts did not lose that much. But with bond funds dominating “age-based” 529 portfolios for students at age 18 or 19, the average lost 0.57 percent in the last quarter of 2016, and many lost about two percent, according to Morningstar.
The 529 plans are offered by states and have become a popular way to save for college because parents can put away a little at time for children routinely as they grow up, and money used for college isn’t taxed. Of these, parents tend to prefer the so-called age-based approach to investing, in which fund managers invest heavily in stocks to grow money when the children are young. As students approach their college years and can’t afford a loss in the stock market, managers pull away from stocks and invest heavily in bonds and some cash.
A 0.57 percent loss, or even a two percent loss in college savings, would be nothing to keep a parent awake at night if their child was young. But when parents are sending a child to college every penny is precious.
According to research by Sallie Mae the average family had saved only $16,380 for college in 2016, which wasn’t enough to cover even a single year. Last year parents said their average cost of college was $23,757, and many colleges now run more than $30,000.