By Dr. Jim Dahle, WCI Founder
One of the dogmas of financial planning is that the shorter the time period between now and when you need the money, the less risk you can afford to take. While it is true that your retirement asset allocation ought to become less risky as the years go by, that doesn’t necessarily apply to all your other savings goals. That includes taking more risks with a 529 account.
Most people fail to consider three factors when deciding whether to take risks.
- The consequences of not reaching your goal.
- The money may be needed over a range of time rather than all at once.
- Your risk tolerance is higher when you’re investing someone else’s money.
Consequences Differ Greatly by Savings Goal
Consider someone saving up a down payment for a house. This person may want to buy it in three years, so the traditional advice is to not take much risk with the money. But what are the consequences of not having exactly the amount the homebuyer needs in three years? They’ve got a couple of other options.
- They could buy a less expensive house.
- They could continue to rent for a few more months (or even a couple more years) while they save more money.
Not that big of a deal. That’s much different than not having enough money to retire.
The Longer the Withdrawal Period, the More Risky Assets You Can Have
The other factor rarely considered is whether a lump sum is needed or a stream of income. A down payment on a house, for instance, is needed all at once. Retirement, on the other hand, is funded over decades. That’s why you don’t have a 100% cash portfolio by age 64.
More information here:
6 Ways to Increase Your Risk Tolerance
It’s Easier to Take Risk with Someone Else’s Money
Financial advisors find it much easier to tolerate market ups and downs than their clients do. They spend a great deal of time in volatile markets “holding their clients’ hands” so they don’t panic and sell out. Psychologically, it’s hard to watch the money you were counting on to provide you security disappear. But sometimes in personal finance, you’re not actually investing for yourself.
Consider an older investor with a large nest egg. They realize that they are investing much of their portfolio for their heirs or a charity. At that point, they may start investing that money much more aggressively than the money that is providing the income stream from which they are living. They might rationally have a riskier asset allocation at 85 than they had at 65.
Should I Take More Risk with a 529?
My kids’ 529 accounts have been invested 100% in stocks even though my retirement portfolio is only 60% stocks. When I originally wrote this piece in 2012, the accounts weren’t that large, so there was definitely a need for the money to grow. But more importantly, those 529 accounts meet all three of the above criteria.
Consequences of a Small 529 Account
Guess how big my 529 account was when I started college 18 years ago? That’s right, zippo. I got through both college and medical school pretty much without loans too. There are lots of options they can take if the 529 doesn’t cover all the costs:
- Go to a less expensive school
- Get scholarships
- Work full-time in the summers
- Work part-time during the year
- Join the military or another organization that will pay for school
- Have a lower lifestyle in college (no car, for instance)
- They can take out loans
- You can take out loans
- Use your current earnings
Those consequences of a smaller 529 seem pretty minimal compared to eating Alpo during retirement. Therefore, you can take more risk.
529 Money Isn’t Needed All at Once
When I last updated this post, 
my oldest was 16, so I needed to start using that money just two years later. But I didn’t need it all on September 1st, 2022. I figured that she’ll likely go to college for four, or even five years. She may take a year or even more off. She may go to grad school or even medical school. It’s possible she’ll be withdrawing from that 529 over an entire decade. So, some of that money might not be needed for nine years or more. That allows the portfolio to recover from a down market that may occur just before she matriculates.
More information here:
How to Use Real Estate to Pay for College
Despite Our Student Loan Debt, Here’s How We’re Filling Our Kids’ 529s
It’s Really Not My Money
Psychologically speaking, this is money I’ve already spent on my kids. I’ve mentally divorced it from the rest of my portfolio. Since I don’t have to deal so much with the consequences of it performing poorly, it is far easier for me to tolerate its volatility. I hardly even look at it.
That allows me to invest it aggressively without feeling a need to bail out in a down market.
Should you have a more aggressive asset allocation in your 529 than in your retirement portfolio? Or are you playing it safe with your kids’ college fund? Comment below!
[This updated post was originally published in 2012.]
