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Asset Allocation for 529 Plans (and other similar scenarios)

In a post a couple weeks back, I asked readers their thoughts (and provided my own) on asset allocation, specifically:

  • At what point should you begin shifting your allocation away from stocks? and
  • How gradually or suddenly should you do so?

In the comments, Neal brought up the fact that in the article I was making the (unstated) assumption that a person’s investments were intended exclusively for retirement, when clearly that’s not always the case.

So today the question is: What should a person’s asset allocation look like when the investment portfolio is intended to pay for a specific cash outlay at a known time in the future? (Example: A 529 plan intended to pay for college in X years.)

What guideline could an investor use as a starting point (which then, of course, must be adjusted for personal factors such as volatility tolerance)?

My own thoughts

My own attempt at a generalized guideline (for a cash outlay X years from now) would be something to the effect of:

Stock allocation = 4x – 10 (with all negative values considered to be zero, and possibly with a cap at, say, 90%), thereby yielding the following allocations:

  • 1 year: 0% stocks
  • 5 years: 10% stocks
  • 10 years: 30% stocks
  • 20 years: 70% stocks
  • 30 years: 90% stocks

Thoughts from the Bogleheads & David Swenson

I asked over on the Boglehead forums for their thoughts on the matter. One of the replies brought up the method suggested by David Swenson (in his book as well as in this interview), which is essentially to have two separate portfolios:

  1. A long-term portfolio, in which you maintain an (unchanging) equity-oriented asset allocation, and
  2. An extremely low-risk portfolio, such as a money market or online savings account, possibly with some TIPS thrown in.

And, as the date of the expenditure draws nearer, simply shift money from the first portfolio toward the second. This would provide an asset allocation as follows:

  • More than 8 years from expenditure: 70% stocks, 30% bonds
  • 6-8 years: 52.5% stocks, 22.5% bonds, 25% cash
  • 4-5 years: 35% stocks, 15% bonds, 50% cash
  • 2-3 years: 17.5% stocks, 7.5% bonds, 75% cash
  • Less than 2 years: 100% cash

What do you think?

What guidelines would you use as a starting point for consideration when developing an asset allocation (and glide path) for a portfolio that’s intended for a specific expenditure in the future?

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Comments

  1. Dave C. says:

    Mike,
    I setup a 529 plan for my young niece with DC College Savings Plans (http://www.dccollegesavings.com/) which purchases shares from Calvert. It automatically changes allocations in the portfolio based on age-levels, 0-5, 6-10, 11-13, 14-16, 17-up. Here is a link that shows allocations: http://www.dccollegesavings.com/dcinvestmentoptions_DC529AgeBasedFunds.html

  2. Rhianni says:

    Why not treat everything on the timescale of retirement?
    The closer you get to needing to spend your money on whatever it is you shift from stock to bonds or other safer things.
    So if you need college money in 10 years act like you are 55 years old and you are retiring at age 65.

  3. Hi Rhianni. Thanks for stopping by to comment.

    It seems to me that the problem with that plan is that there’s a big difference between retirement (where you spend the money over an extended period) and something where you spend the money all at once.

    In other words, college 10 years from now (meaning the money will be completely spent within 14 years) is very different from being 55 (at which point we sure hope the money isn’t gone in 14 years).

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