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 as the years go by, your retirement asset allocation ought to become less risky, that doesn’t necessarily apply to all your other savings goals.  Most people fail to consider three other factors- first, the consequences of not reaching your goal, second, that the money may be needed over a range of time rather than all at once, and last that your risk tolerance is higher when you’re investing someone else’s money.

Consequences Differ Greatly by Savings Goal

Consider someone saving up a downpayment for a house.  He may want to buy it in 3 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 he needs in 3 years?  He’s got a couple of other options.  First, he could buy a less expensive house.  Second, he could continue to rent for a few more months or even a couple more years while he saves some more money.  Not that big of a deal. 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 downpayment on a house, for instance, is needed all at once.  Retirement, on the other hand, is funded over a period of decades.  That’s why you don’t have a 100% cash portfolio by age 64.


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 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.  He realizes that he is investing much of his portfolio for his heirs or a charity.  At that point he may start investing that money much more aggressively than the money that is providing the income stream he is living off of.  He might rationally have a riskier asset allocation at 85 than he had at 65.

How does this apply to 529s?

My kids’ 529 accounts are invested 100% in stocks despite the fact that my kids will matriculate in only 11-16 years and the fact that my retirement portfolio is only 75% stocks.  The accounts aren’t that large yet, so there is definitely a need for the money to grow.  But more importantly, those 529 accounts meet all 3 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 seemed to get 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 other organizations who 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 seem pretty minimal compared to eating Alpo during retirement. Therefore you can take more risk.

529 Money Isn’t Needed All At Once

My oldest is 7, so I’ll need to start using that money in just 11 more years.  But I don’t need it all on September 1st, 2022.  She’ll likely go to college for 4, or even 5 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 over an entire decade.  So some of that money might not be needed for 21 years.  That allows the portfolio to recover from a down market that may occur just before she matriculates.

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.

There you go, three reasons to consider having a more aggressive asset allocation in your 529s than in your retirement portfolio.  Agree?  Disagree?  Post it below in the comments.