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529 E-ditorials

00-21: The Balance Beam Effect
Joe Hurley
Monday, November 20th 2000

Watching the development of asset allocation models used in state 529 plans reminds me of the balance beam competition in the Olympics. Years ago, the competitors on the beam would perform their graceful cartwheels and pirouettes, and produce high scores even though they almost always had at least one hand or foot in contact with the apparatus. Sure they might fall once in a while, but they usually landed feet first.

Now look at what the gymnasts are doing. Back flips, front flips, springs into the air; all on a piece of wood four inches wide! It’s truly incredible. The competitors certainly seem to be at greater risk of falling off the beam, and the prospect of serious injury appears to be much greater. Because of the constantly increasing degree of difficulty, a winning routine from 20 years ago would hardly be a warm-up today.

Only three years ago the states began to compete on the “529 beam” with age-based investment programs that would shift from mostly-equities to mostly-fixed income as a child grew from pre-school to college age. These programs were graceful and intuitive, with a gradual shift of their asset allocations over time, designed to produce good “scores” for the participants without taking on a lot of investment risk. But as the stock market roared to ever higher levels, many people judged these programs to be “too conservative” in their make-up. And so the states, “coached” by the investment companies managing their programs, started coming up with riskier routines designed to produce higher scores in the face of increasing competition.

So what are we seeing now? We’re seeing new age-based programs that weight their portfolios more heavily in equities. We’re seeing more international equity exposure. We’re seeing programs with more than one age-based option, perhaps an aggressive version and a moderate version. We’re seeing some allocation models that stay heavily invested in equities until shortly before college and then, like a cliff, drop abruptly to a more conservative fixed income posture.

Back flips, front flips, springs into the air ….

Families now have a marvelous assortment of age-based programs to choose from and more will be coming along in the future. And there is an ever-increasing amount of life-cycle investment theory backing the design of these plans. But like the balance beam, the amount of investment risk is increasing for many participants who depend on the age-based plan as the state’s “core” college investment program. The uncertain stock market we are witnessing these days should serve as fair warning that an aggressively-invested college savings account can fall off the beam every once in a while. For the unprepared, that can be painful.

» 05-4: The 529 marshals have arrived - 08/30/05
» Our 5.29th-year anniversary - 06/29/05
» 05-2: 529s and the new Bankruptcy Act - 04/28/05
» 05-1: Reform or Deform? - 02/27/05
» 04-6: Perspectives on the 529 debate - 12/28/04
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