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It can be difficult to navigate 529 plan investment strategies.
College and retirement plans often include dynamic investment strategies, such as age-based and enrollment-date-based asset allocation for 529 college savings plans and target-date retirement funds.
You initially invest a high percentage in risky but high-yield investments such as stocks and gradually shift the investment mix to a less risky asset allocation over time.
In most cases, dynamic investment strategies use a linear glide path where the percentage invested in equities decreases by a fixed amount each year. For example, a typical asset allocation for target-year funds bases the percentage invested in equities at 100 minus the investor's age.
Although this immediately reduces the proportion of equity investments, it also means exiting a risky investment mix too early.
A new patented dynamic investment strategy corrects this flaw by delaying the start of reducing the proportion invested in stocks for several years. This can significantly improve your return on investment without significantly increasing the risk of investment loss.
Weighing up investment risk and return
When saving for college or retirement, the risk of investment losses is unavoidable.
Large declines in the stock market are called corrections and bear markets. A correction is a short-term decline of 10% or more, and a bear market is a longer-term decline of 20% or more.
Corrections and bear markets are largely unpredictable and therefore inevitable.
During the 17 years from birth to college enrollment, the stock market experiences at least three corrections and at least one bear market.
During the 45 years from college graduation to retirement, the stock market will experience at least ten corrections and at least four bear markets.
You can't expect to time the market to avoid corrections and bear markets. Instead, investors must employ strategies that maximize returns on capital while reducing the negative impact of investment losses.
Dollar-cost averaging
An example of such a strategy is the dollar cost averaging effect. With dollar cost averaging, you invest a fixed amount every month. If share prices rise, you buy fewer shares. If share prices fall, you buy more shares.
Rebalancing
Another example is adjusting asset allocation as investments increase. When necessary, the investment portfolio is rebalanced to shift it to a lower-risk investment mix. Over time, this reduces the proportion of investments invested in stocks and increases the proportion of investments invested in bonds, certificates of deposit, money market funds and cash, thereby locking in gains.
Investors can afford to take higher risks initially because there is less money at stake and more time to recover from investment losses.
As the goal approaches, shifting the portfolio to a less risky investment mix can lock in gains and reduce the risk of investment losses.
Tax-advantaged accounts
Specialized savings plans such as 529 plans, 401(k) or IRA allow the accumulation of income and capital appreciation on a tax-free basis. Investors can sell investments within these college savings and retirement plans without paying capital gains taxes. As a result, investors are less hesitant to rebalance their investment portfolios due to large unrealized capital gains.
The long-term return on capital of an investment portfolio depends largely on asset allocation rather than on investing in specific stocks or bonds.
Glide paths for delayed-start investments
An investment glide path describes how the percentage of a portfolio invested in risky assets changes over time.
The glide paths for age-based and enrollment-date-based asset allocation for the College Savings Program and target-date retirement funds begin reducing the percentage invested in stocks too early.
Instead Glide path for delayed-start investments delays the start of the reduction in equity holdings for a certain number of years. This can increase the overall return on an investment without significantly increasing the long-term risk of investment losses.
The initial investment in stocks is maintained at a higher percentage for a longer period of time and subsequent reductions in that percentage are compressed to match the remaining investment period.
Assuming an investment horizon of 17 years, delaying the start of a transition to a more conservative investment mix by up to 10 years can increase the annualized return on investment by up to a full percentage point without significantly increasing the overall risk of investment loss.
The improvement in annual return on investment is approximately 0.1 percentage points for each year of delayed commencement, up to a maximum of 10 years. So, a five-year delay in commencement increases the long-term annual return on investment by half a percentage point. However, delaying commencement by 11 or more years leads to a significant increase in investment risk and diminishing returns.
Assuming an investment horizon of 45 years, delaying the start of a transition to a more conservative investment mix by up to 30 years increases the annualized return on capital by up to 1.4 percentage points without significantly increasing the overall risk of investment loss. The investment risk only increases significantly after a delay of more than 30 years.
For more informations
These results are based on US Patent 11,288,747 (Method, system and computer program product for developing, evaluating and validating investment glide paths).
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