COLLEGE SAVINGS 101

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How Dollar-Cost Averaging can protect your 529 savings during a stock market slump
http://www.savingforcollege.com/articles/how-dollar-cost-averaging-can-protect-your-529-savings-during-a-stock-market-slump-830

Posted: 2015-8-24

by Matthew Toner

A 529 college savings plan invests your contributions in mutual funds or similar investments, which are made up of securities such as stocks and bonds. That means the value of your account will go up or down based on the performance of these underlying investments. If you find that your 529 plan is performing poorly, you generally have a few different options: you can stay with your current plan but switch to another investment option, roll the funds into a different 529 plan, withdraw the money and pay a 10% penalty and income tax on the earnings portion of the account or simply do nothing. Before you decide, be sure you first understand the reason for the decline in performance.

If you feel the plan itself is being poorly managed, maybe it is time to roll the funds into another 529 plan with a more reputable investment manager. Federal tax law allows you to roll over your entire plan balance (or just a portion) from your current plan into a different one, but only once in any 12-month period. Keep in mind that if you’ve been claiming a state tax deduction or credit for your contributions you may be subject to a recapture tax if you roll over to another state’s plan.

RELATED: When should you switch 529 plans?

Or maybe your plan is heavily weighted in U.S. stocks and the Dow Jones Industrial Average (which is made up of domestic equities) suddenly takes a steep dive. After you see your account value drop, you might be tempted to take a withdrawal – even if you have to pay the taxes and penalty. But is that really the smart thing to do when you have a long-term savings goal?

If you’ve been making regular contributions to your 529 plan, the answer is “probably not”. Whether you know it or not, you’ve been taking advantage of a strategy called Dollar-Cost Averaging. Each time you make a contribution to your 529 account, you are essentially buying shares of the underlying securities. So if you make equal contributions every month, you’ll buy less shares when the market is up and more shares when the market is down, regardless of the price. So when the market does come back, your account will benefit from having bought a larger amount of cheaper shares. This can reduce the risk of a volatile market.

Dollar-Cost Averaging also provides peace of mind for new investors and college savers. The strategy eliminates any regret you may have about investing at the wrong time and gets you into the habit of regularly putting something away for college each month. The easiest way to take advantage of this method with a 529 plan is to enroll in the plan’s automatic investment option, where the funds will be electronically transferred from your bank account on a monthly basis.

Here’s an example of how Dollar-Cost Averaging works:

RELATED: 10 things we love most about 529 plans

Month Amount
Invested
Price Shares
Bought
Total
Account
Value
Jan $1,000.00 $10.00 100 $1,000.00
Feb $1,000.00 $12.00 183 $2,200.00
Mar $1,000.00 $14.00 255 $3,566.67
Apr $1,000.00 $8.00 380 $3,038.10
May $1,000.00 $9.00 491 $4,417.86
Jun $1,000.00 $12.50 571 $7,135.91
July $1,000.00 $8.00 696 $5,566.98
Aug $1,000.00 $8.50 814 $6,914.92
Sept $1,000.00 $7.50 947 $7,101.40
Oct $1,000.00 $10.00 1047 $10,467.00

A 529 college savings plan invests your contributions in mutual funds or similar investments, which are made up of securities such as stocks and bonds. That means the value of your account will go up or down based on the performance of these underlying investments. If you find that your 529 plan is performing poorly, you generally have a few different options: you can stay with your current plan but switch to another investment option, roll the funds into a different 529 plan, withdraw the money and pay a 10% penalty and income tax on the earnings portion of the account or simply do nothing. Before you decide, be sure you first understand the reason for the decline in performance.

If you feel the plan itself is being poorly managed, maybe it is time to roll the funds into another 529 plan with a more reputable investment manager. Federal tax law allows you to roll over your entire plan balance (or just a portion) from your current plan into a different one, but only once in any 12-month period. Keep in mind that if you’ve been claiming a state tax deduction or credit for your contributions you may be subject to a recapture tax if you roll over to another state’s plan.

RELATED: When should you switch 529 plans?

Or maybe your plan is heavily weighted in U.S. stocks and the Dow Jones Industrial Average (which is made up of domestic equities) suddenly takes a steep dive. After you see your account value drop, you might be tempted to take a withdrawal – even if you have to pay the taxes and penalty. But is that really the smart thing to do when you have a long-term savings goal?

If you’ve been making regular contributions to your 529 plan, the answer is “probably not”. Whether you know it or not, you’ve been taking advantage of a strategy called Dollar-Cost Averaging. Each time you make a contribution to your 529 account, you are essentially buying shares of the underlying securities. So if you make equal contributions every month, you’ll buy less shares when the market is up and more shares when the market is down, regardless of the price. So when the market does come back, your account will benefit from having bought a larger amount of cheaper shares. This can reduce the risk of a volatile market.

Dollar-Cost Averaging also provides peace of mind for new investors and college savers. The strategy eliminates any regret you may have about investing at the wrong time and gets you into the habit of regularly putting something away for college each month. The easiest way to take advantage of this method with a 529 plan is to enroll in the plan’s automatic investment option, where the funds will be electronically transferred from your bank account on a monthly basis.

Here’s an example of how Dollar-Cost Averaging works:

RELATED: 10 things we love most about 529 plans

Month Amount
Invested
Price Shares
Bought
Total
Account
Value
Jan $1,000.00 $10.00 100 $1,000.00
Feb $1,000.00 $12.00 183 $2,200.00
Mar $1,000.00 $14.00 255 $3,566.67
Apr $1,000.00 $8.00 380 $3,038.10
May $1,000.00 $9.00 491 $4,417.86
Jun $1,000.00 $12.50 571 $7,135.91
July $1,000.00 $8.00 696 $5,566.98
Aug $1,000.00 $8.50 814 $6,914.92
Sept $1,000.00 $7.50 947 $7,101.40
Oct $1,000.00 $10.00 1047 $10,467.00
 

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