College Savers Rebound from Stock Market Drop with Target Funds

Posted on: 11 June 2020

The price of a college education has just risen for many families. Following the missed winter college semester, students face additional college expenses while their entry into the workforce full time is likely delayed. Yet after the loss in value in 529 college savings funds because of the coronavirus stock market decline, your college financial planning of many families risks falling short.

Diversified target funds are helping college savers recover from the decline in their investment portfolios just in time for college. 

1. What are 529 college savings plans and how are they affected?

A state 529 college savings plan provides tax-deferred capital gains and distributions when the money is spent on higher education expenses. When choosing 529 financial investments, target-date funds are an increasingly popular way to save for college.

As tuition rises faster than inflation, college savers are investing in stocks to increase returns. Target funds allocate more to higher returning, yet higher-risk stocks in the early years. Over time, asset allocation gradually shifts to lower-risk investments. Closer to college, the portfolio becomes more conservative as more money is allocated to bonds. This age-based investment strategy is helping many college savers recover from the recent stock market downturn. 

2. Will target funds recover the lost equity value?

Historical stock market performance shows that the market, and college portfolios by extension, will recover. Although the COVID-19 shutdown may be an unprecedented economic event, stock market corrections are not. A correction is a 10 percent decline from a 52-week high in a major stock index. Of the 26 market corrections from 1945–2018, the average recovery took four months. In a bear market, when the market falls 20 percent from its high, the average recovery time has been two years. 

3. But will the recovery be in time for college?

If your children are about to enter college, more of your target fund asset allocation will have already shifted to the lower end of the risk spectrum into bonds. Investment-grade bonds have had positive returns this year. The higher bond allocation means you should have less lost ground to cover.

529 funds did indeed fully capture the downside of the stock market decline. An 18-year-old about to enter college can recover with a 3.5 percent return over the next year. Over the past nine years, the stock market has delivered an average annual return in excess of 3.5 percent.

Investing in target funds remains sound investment advice. Even in the current volatile stock market, they are proving to be resilient investments that help preserve the value of college savings portfolios. If you or someone you support is trying to save for college, consider reaching out to financial planning services for more assistance.