Have you looked at your 529 plan recently?

Don’t.

If you do take a look at your 529 plan, you may be shocked at how the value has changed so far this year. This can cause you to panic and make changes you’ll regret later. For example, if you pull out your investment, you will lock in your losses and may miss out on the economic recovery.

All of the major stock market indexes, including the S&P 500, NASDAQ and Dow Jones Industrial Average, are in bear market territory this year. Even bonds are down by a lot, in correction territory.

A bear market involves a drop of 20 percent or more. A correction involves a drop of 10 percent or more.

Although bond yields have increased as interest rates have increased, bond prices have dropped. Yields and prices move in opposite directions.

Increases in interest rates also cause stock prices to drop because the increase in the discount rate reduces the present value of future revenue.

The Federal Reserve Board has increased interest rates by a total of three percentage points so far this year, in an attempt to control inflation. They may continue to increase interest rates. But, it’s not possible to predict when they will stop increasing interest rates.

Inflation is caused when supply is out of sync with demand. The current high inflation rates are being driven by supply chain problems, not just by an increase in demand. Increasing interest rates is a blunt instrument for influencing demand and isn’t very effective at controlling inflation. But, when the only tool you have is a hammer, everything looks like a nail.

Eventually, inflation will start decreasing on its own, regardless of whatever the Federal Reserve does. Inflation rates have already dropped to 8.3 percent in August 2022 after peaking at 9.1 percent in June. Every time the Federal Reserve increases interest rates, the stock market gets spooked.

How Families Typically React to Market Downturns

During previous economic downturns, most families did not react to stock market losses. They do not change their asset allocation and they don’t stop new contributions to their college savings plans.

However, some families suffered above-average losses. These families were more likely to decrease contributions and adopt a more conservative mix of investments. This is especially true of families who had a very high percentage invested in stocks. Families who were invested in age-based and enrollment-date asset allocations were less likely to take negative actions.

Very few families liquidated their 529 plans, because doing so often results in a tax liability and comes after the losses have already been incurred.

How to Handle a Market Downturn

Here are a few tips for families seeking advice on how to manage their 529 plans during a bear market.

Don’t Panic

Panicking leads to an overreaction. It can also lead to an attempt to time the market. Market timing does not work very well for 529 plans. Instead of buying when prices are low and selling when prices are high, panic-selling yields the opposite. Remaining invested in the stock market is much more important than picking the best time to buy or sell. It is very difficult to predict when the stock market will reach a bottom or top. Studies have shown that missing even just one great day a year is enough to have a big impact on overall investment performance.

Continue Contributing

Families should continue contributing regularly to their 529 plans. When stock prices are lower, the same dollar contribution yields more shares. This is a form of the advice to buy low and sell high.

Dollar-cost averaging, where you invest the same dollar amount every month, works the same regardless of whether the stock market is going up or going down. Only the perspective has changed. It is more frightening to watch your investment value decrease when the stock market is dropping.

But, the stock market is like an elevator. What goes down will eventually come back up. You just have to be willing and able to wait.

Set It And Forget It

Thus, the best approach with a college savings plan is to set up an automatic transfer from your bank account to the 529 plan. You set it up and forget about it. That way, you continue investing in good times and bad.

Strategize to Minimize Risk

For your investment strategy, you should choose an age-based or enrollment-date asset allocation that bottoms out in low-risk investments, such as money-market accounts or CDs, so that the exposure to high-risk investments, such as stocks, decreases as college approaches.

There is at least one bear market and three corrections in any 17-year period. So, market downturns are unavoidable. Instead, you use a dynamic asset allocation strategy to appropriately balance the risk and return.

Delay Distributions

If the 529 plan beneficiary is currently enrolled in college, you can delay taking a distribution by borrowing student loans. Later, when the stock market has recovered, you can take a distribution from the 529 plan to repay the student loans.

The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) lets you use a qualified distribution from a 529 plan to repay up to $10,000 each in student loan debt of the beneficiary and the beneficiary’s siblings. (It can also be used to repay Federal Parent PLUS loans by changing the beneficiary to the parent.) The $10,000 limit is a lifetime limit per borrower.

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