529 decision

I was aware that my content had been minimal since Owen was born, but I didn't realize it had been so lame even before he was born (only a handful of posts in January and February--I really thought I was a little more productive than that). And I've been putting off the "new father" post for five (!) weeks--missing 8 personal deadlines (weeks 2-7, one month and 50 days (yesterday)). But instead of finally addressing that, I'm going to follow up on my 529 post from January, since it's now easily fundable since Owen is here.

In retrospect, that post, while a nice summary, didn't really contain any content not easily obtainable from many other sources. I will rectify and maybe provide some alternate considerations.

After that post, I had settled on West Virginia's DFA plan, despite the higher expense ratio associated with the portfolio, because of DFA's allure and the structure of the all equity fund. Now that it's crunch time, there's some waivering between it and the Ohio College Advantage plan, which has a number of Vanguard offerings for one to get to a reasonably good self selected allocation, rather than something fixed (this is what put Ohio over Illinois. IL is cheaper, but there's fewer and less flexible options).

IN trying to decide between the two, a couple of questions have come up that I think are important to clarify how one will invest in a 529:

1. Is the 529 considered its own portfolio, or is it simply a component of our overall portfolio?
2. Are contributions to the 529 the full extent of the planned contribution to college, or do we expect to spend more outside of it?

These two questions speak to the risk (or lack of) that one can/should take in selecting a plan. To respond "own portfolio" and "all contributions" might mean one takes more risk early, and a lot less as college approaches. For Owen, the plan is to treat it as part of our overall allocation, but we don't plan on the 529 being the extent of our contributions.

What are the ramifications of that decision? For starters, it means finding a 529 that offers the asset classes we're already invested in. Not a problem--many plans have Total Market, S&P Index, International Index, Bond funds, etc. So then it becomes a matter of placement. One option I considered for a bit was "transferring" our REIT allocation to the the 529 by opening up a Virginia VEST account, which has a REIT option. This would allow us more tax deferred space and a straight forward approach to filling a gap of our allocation, but some of the costs of making that switch didn't quite appeal to me, not did splitting the allocation into different accounts. So then I started looking at Bond options--the Ohio plan offers a TIPS (Inflation protected securities) and Total Bond fund for a low ER. And I almost convinced myself that that was the way to go, until I remembered that a 529 is similar to a Roth in that all earnings are tax free, so we're better off investing for growth in the 529 to take advantage of that.

Which leads to the second part of whether the 529 is the extent of our contributions to Owen's education, which I find to be unlikely. This means we'll be using other assets outside of the plan. This is another reason to go for growth (equities) in the 529, rather than using bonds. As was mentioned in the exchange I had with Jot in the comments of the original post, you can borrow for college, but you can't borrow for retirement. So if the extra risk in the 529 doesn't work out, since it's part of one's overall allocation, that means there was even less risk (ie, more bonds/fixed income) in the retirement accounts. That means a more stable growth in a 401k/IRA. The two extreme scenarios are: (1) a lot of growth in the 529 to better pay for college, but less growth in the 401k/IRA (which isn't all bad, as that will all be taxed as regular income when the day comes) or (2) the 529 unfortunately doesn't take advantage of the tax advantages, since equites dropped. but because there were more bonds in the 401k, retirement is better accounted for. Sounds reasonably win-win to me.

The above isn't to say I plan that we'll have the 529 in 100% equities until Owen is done with school, but by treating it as part of our overall portfolio, it provides more flexibility in terms of how to structure our account, the risk that we can take (since risk elsewhere in the portfolio will be reduced), as well as taking greater advantage of the tax benefits of the 529.

This brings us back to the two main contenders. The DFA/West Virginia all equity option is 40% large cap; 35% small cap, 25% international, with a heavy value tilt. This doesn't quite fit our equity allocation (2x, 1x, 2x), but it is made up of 8 component funds that are constantly rebalanced so that minimizes risk to a small degree (not as much as it could since there seems to be increasing correlation of returns between different equity classes). The ER for the all equity plan is 0.88%

The options in the Ohio plan are broad Vanguard Indexes that can generally match our allocation. The only minor issue is that Extended Market and International Developed Markets don't quite fit the allocation areas I'd like to hit (small cap and a broader international index such as the FTSE all world index), but these same limitations are in my 401a/403b and that doesn't stop me from using them there. A mix of S&P INdex/Extended Markets/International similar to our overall allocation would have an ER of .29%. Splitting it into 4 funds (the 3 mentioned and either Total Bond or TIPS) would cause little change to the ER.

Based on the write up, it should be a clear Ohio is the proper option, but I still am compelled to strongly consider WV because of DFA's structured approach and strategies. But to use it, I'd have to either disregard that its stock allocation doesn't quite match our own, or break down the numbers (not a big deal with a properly set up excel sheet) to have it match our allocation plan. And then there's the potential rollover to another plan in 12-15 years. Another point not in it's favor is that the 529 is never likely to be more than 5% of our portfolio (or at least not for a while), so any super outsized gains that may be derived from DFA really wouldn't have a large impact.

But, then again, when it comes to college, every little bit helps, right?