Muscular Investing

Improve a 'Bad' 529 College Savings Plan - part 4

Brian Livingston

Brian Livingston


Some 529-type college savings plans are so restrictive that no more than two portfolio changes per year are possible. • If you’re willing to do a little extra footwork, you may be able to adapt your portfolio to market conditions a bit more often — without market timing. Here are the details you need to maximize the gain of whatever your educational investment program may be.


• Parts 1, 2, and 3 of this column appeared on Dec. 6, 10, and 11, 2018. •

College savings plans can be some of the most restrictive tax-free investment programs out there. In the US, 529-type plans that provide tax-advantaged contributions, growth, and withdrawals for permitted purposes usually don’t allow more than two portfolio reallocations a year. But there are alternatives. If you want to realize the greatest gains possible in a 529 plan, you need to determine the limits and possibilities of the program you’re in — or considering investing in.

As described in a Wall Street Journal article, the twice-per-year limit doesn’t count portfolio changes you make when you change the name of a 529 account’s beneficiary. Also, a 529 account can have only one owner (an adult) and one beneficiary (an extended family member), but you’re allowed to open more than one 529 account, as long as your contributions remain within certain dollar limits. We’ll see how these facts interact in the three scenarios below.

Question: Why do we want to change our portfolio allocation more than twice a year? Gradual changes in your portfolio, required no more than once a month, are the way you maximize your gain while eliminating heart-stopping crashes (declines of more than 30%). The S&P 500 loses that much every 10 years, on average, adjusted for dividends and inflation.

Economists have proved in hundreds of studies over the past three decades that asset classes that have risen in the past 3 to 12 months are likely to continue rising for the next one month or more. This trait is called momentum. Nobel Prize winner Eugene Fama has recently written: “All models that do not include a momentum factor fare poorly.” (For evidence, see my Muscular Portfolios summary.)

The following scenarios make use of the free ETF ranking tables at MuscularPortfolios.com. The rankings are updated every 10 minutes during market hours. But don’t check that often! Making sure your portfolio stays in the top-ranked asset classes requires looking no more than once a month.

Figure 1. The free ETF ranking tables at MuscularPortfolios.com show which asset classes have the best odds of rising (and, just as important, not crashing) in the month to come.


Scenario 1: A reallocation twice a year is it, period

After you’ve examined your existing 529 plan — or every plan you might be thinking of investing in — you may reach a dead end. It looks to you like there’s just no practical way to change the allocation in your account more than twice a year. In that case, your best strategy is to use the so-called Baby Bear Portfolio. (Go to MuscularPortfolios.com and click “Baby Bear” in the menu.)

The Baby Bear is a “clone” of a portfolio that’s been recommended publicly for more than two decades by Vanguard founder Jack Bogle. It’s known as a 50/50 portfolio: you hold half of your money in the entire US stock market and the other half in the entire US bond market. (Investors outside the US may prefer to buy index funds that track their own country’s stock and bond markets, although the results will differ.) Followers of Bogle’s recommendation never change their holdings, except for one transaction near the end of each year: rebalancing their funds back to a 50/50 split. (Even that minor alteration is only recommended if either position is more than 5% off its ideal dollar weight.)

Surprisingly, the 50/50 portfolio delivered almost exactly the same return since 1973 as a much riskier 100% investment in the S&P 500. In 43-year simulations (see Chapter 1 of the book Muscular Portfolios), the S&P 500 returned 10.0% annualized, while the 50/50 portfolio returned 9.8%. That’s a statistically meaningless difference.

The diversification benefit provided by holding both asset classes gave investors a stronger return than the simple average of stocks and bonds. The synthesis allowed the 50/50 portfolio’s balance to run ahead of the S&P 500’s in two-thirds of the months during the 43-year period. Yes, the S&P 500 zoomed ahead during bubbles, but it fell behind the 50/50 portfolio during equity crashes. The index was down more than 50% in the 2007–2009 financial crisis, while the Baby Bear Portfolio fell only 29%. That was a bad stumble, but smaller losses like these are more tolerable than losing half your life savings. (All figures include dividends.)

Scenario 2: Make your contributions using momentum

This is an enhancement for anyone who is following Scenario 1. Even if you can’t find a way to make portfolio changes in a 529 plan more than twice a year, nothing prevents you from making your monthly contributions into a different asset class each time.

If your 529 plan has a decent set of funds to choose from, you can direct, for example, $100 into bonds in January and $100 into a real-estate investment trust in February. Just before whichever day of the month you make your 529 contribution, you choose whichever asset class has the best momentum.

The best way to determine which asset class has the best momentum is to look at the ranking table for the Mama Bear Portfolio, shown above in Figure 1. The Mama Bear is cloned from a diversified asset-class strategy developed by Steve LeCompte, CEO of the CXO Advisory Group, which he and many others have followed with real money for years. (Don’t buy the top-ranked fund in the sample image! Use the live rankings on the website.)

You’ll need to determine which investment option within your 529 plan is closest to the asset classes that are ranked at MuscularPortfolios.com. Fortunately, the best 529 plans offer a set of index funds that should be very similar to the nine asset classes that the Mama Bear ranks, such as stocks, Treasurys, and money-market funds.

Your plan sponsor may or may not offer emerging-market equities, and it almost certainly doesn’t offer any commodity or gold ETFs, as the Mama Bear does. (Two 529 plans that do support these asset classes are described in Part 3 of this column.) If one of the asset classes that your 529 is missing happens to rank No. 1 on the Mama Bear Portfolio page, simply direct your contribution that month into any of the three top-ranked asset classes in the rankings.

It’s most important that your account tilts toward asset classes that are in the top half of the rankings (“the attic”) and reduces its exposure to those that are in the bottom half (“the basement”). The exact ranking is not crucial. It’s impossible to predict precisely which asset class will outperform every other in the coming month or any time period. Just try to stay in the attic and keep out of the basement!

Even if every asset class is the world is crashing, money-market funds — similar to the SHV exchange-traded fund that’s shown on the Mama Bear page — will still be rising, if only a little. Money-market funds will therefore rise to the top of the rankings, even in the worst global financial panics.

Twice a year, you can use your two permissable portfolio changes to reallocate your 529 account to whichever asset classes are ranked as the top three on the Mama Bear page. That time lag will not produce the same gains as shifting your portfolio into the three best asset classes once a month, so consider using Scenario 3.

Scenario 3: Use the rules to reallocate whenever necessary

The best return possible — without delving into S&P 500 market timing — really requires checking your portfolio once a month for possible tune-up opportunities. The book’s two true Muscular Portfolios, called the Mama Bear and the Papa Bear, don’t actually require 12 changes a year. On the average, the portfolios require a change in 9 months out of 12. This schedule is easy for any individual to follow. But nine times a year is more than twice a year, so Scenario 3 lets you follow the regulations to the letter while enabling monthly tune-ups.

Both the Mama Bear Portfolio (which ranks nine asset classes), and its bigger alternative the Papa Bear Portfolio (13), far outperformed the 50/50 strategy and the S&P 500 from 1973 through 2015 in simulations. While the 50/50 strategy returned 9.8%, the Mama Bear returned 14.3% and the Papa Bear returned 16.2%.

The healthy returns from the two Muscular Portfolios are certainly not guaranteed to continue in the years ahead. But the monthly check-ups these portfolios require do deliver huge advantages, even if you ignore the raw gains. The two portfolios make gradual course corrections — called “asset rotation,” as distinct from the all-stock vs. all-cash duality of market timing — which helped them lose no more than 18% or 25%, respectively, in the worst bear markets. Drawdowns below 25% are tolerable, even by skittish investors, when the S&P 500 is crashing 30%, 40%, 50% or more. (All drawdown percentages are measured between month-ends.) Keeping your losses small in bear markets is the crucial key for outperformance over the long term.

How can you make nine changes per year in a 529 account without running afoul of the twice-per-year limit? There are at least two different ways:

Change an account’s beneficiary. Every time you amend the beneficiary of a 529 account, you can reallocate the asset classes in the portfolio without using up one of your two changes per year. The beneficiary doesn’t have to be your child, but it does have to be what the IRS calls a “qualified family member.” That includes children, parents, spouses, siblings, first cousins, nieces and nephews, and aunts and uncles, according to an article by Adam Nash, the CEO of Wealthfront. The beneficiary can even be yourself, the IRS says in a Q&A on 529 plans. (In other words, you’re a qualified family member.) If you open 529-type accounts for two children, it’s easy to switch the beneficiary names between them. If you don’t have two children, you can alternate between any beneficiary and yourself. When a student finally enters college, you can reallocate the correct number of dollars to that beneficiary’s account. Be sure to check that your 529 plan sponsor has no special limitations on beneficiary changes.

Open more than one account. If you open three 529 accounts, for example, you could hold a different asset class in each program. You might select three of the plan sponsors described in Part 1 and Part 2 of this column — or any other plans you like. Let’s say you hold a bond fund in one 529 account, but the Papa Bear page shows that the momentum of bonds is now lower than small-cap stocks. No problem! You sell the bond fund in whichever 529 account it may be in and replace it with a small-cap fund. That would use up one of your twice-a-year reallocations in that particular account, but there would be no need to change a beneficiary name that month.

What if none of the three top-ranked asset classes on the Papa Bear page are offered by your 529 plan? In that case, your best best is to buy a 10-year Treasury fund or other sovereign government bond fund that has little or no chance of default. A 2013 whitepaper by Mebane Faber — co-author of The Ivy Portfolio, and the creator of the portfolio that’s “cloned” in my book as the Papa Bear — shows that 10-year Treasurys have always outperformed cash, even during periods of sharp interest rate hikes.

As if things weren’t complicated enough...

It’s important to be aware of legal and tax issues. Always consult a tax professional about the details of your situation and the laws of any state that may sponsor a 529 plan you own.

Lifetime contribution limits. It’s perfectly legal for you to own different 529 accounts, whether they are sponsored by a single state or several different states. However, US law prohibits you from saving in a 529 account more than is necessary for the most expensive educational expenses possible. Each state’s sponsor sets its own limit, which varied in 2018 from $235,000 to $520,000. If you open multiple 529 accounts, the combined total per beneficiary must remain beneath the limit.

Annual contribution limits. You can contribute as much to a 529 account each year as you wish, but contributions to a beneficiary of more than $15,000 per individual ($30,000 per couple) may incur US gift taxes. However, there is an exception. Any individual can make up to five years’ worth of contributions in a single lump sum (for example, $75,000). The donor then reports this on the next five tax returns as one $15,000 contribution per year. Donating a lump sum takes the whole dollar amount out of a person’s taxable estate upon death. This may be an important consideration for grandparents who are contributing to their grandchildren’s education. The lifetime and annual contribution limits are described in more detail in a Saving for College article.

Penalty for nonqualified withdrawals. If the IRS determines that a withdrawal was not for qualified expenses, the percentage of the withdrawal that represents gains in the account is liable for federal and state income tax plus a 10% penalty. (The sum of your own contributions can be withdrawn tax-free at any time.) Changing your portfolio allocation more than twice in one year counts as a nonqualified withdrawal, unless you carefully follow one of the legitimate techniques described in Scenario 3. However, you can make withdrawals without tax or penalty if the beneficiary (a) is permanently disabled, (b) received a tax-free scholarship, or (c) attended a US military academy. More details on permissible withdrawals are provided in a Zacks.com analysis.

Whew! What a complicated program. All of that is a lot to digest. But I’ll bet that you want the maximum gains in your 529 account(s) with the smallest possible drawdowns and not too much work (no more than one tune-up per month). If that’s true for you, the extra effort can give you a larger ending balance and, ideally, no tuition shortfall — or, eventually, a smaller college loan to pay off. Enjoy!


With great knowledge comes great responsibility.

—Brian Livingston

CEO, Muscular Portfolios

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Brian Livingston
About the author: is a successful dot-com entrepreneur, an award-winning business and financial journalist, and the author of Muscular Portfolios: The Investing Revolution for Superior Returns with Lower Risk. He has more than two decades of experience and is now turning his attention directly on the investment industry. Based in Seattle, Livingston is now the CEO of MuscularPortfolios.com, the first website to reveal Wall Street's secret buy-and-sell signals, absolutely free. He first learned computer programming on an IBM 360 in 1968 at age 15. Learn More