Bonds can be a great investment for your MOST Missouri 529 Education Plan account if you're looking to balance the volatility of stocks in your portfolio and lower your overall risk of loss. But what happens if bonds fail to produce a positive return?
Bond investors can find themselves in this situation when interest rates rise. That’s because bond investing comes with interest rate risk—when interest rates rise, bond prices fall.
If this happens while you’re saving for a child’s future education expenses in MOST Missouri’s 529 Education Plan, what should you do?
If you invest in an age-based portfolio
Most people investing in MOST Missiouri’s 529 Education Plan choose a conservative, moderate, or aggressive age-based portfolio. With these options, Vanguard's investment management specialists predetermine the amount invested in stocks and bonds in the portfolio at any given time. So, if you invest in an age-based portfolio, you have a mix of stocks and bonds that's appropriate for the amount of time you have left to invest for your child's education.
While the bond portion can at times lose value (as any investment can), bonds still offer more stability than stocks. And most importantly, by having a diversified portfolio, you are lowering your overall risk because gains in one area can help to offset losses in another.
If you don't invest in an age-based portfolio
If you're not investing in an age-based portfolio and have invested a lot of your savings in bonds, you may feel nervous if you see rising interest rates having a negative effect on your balance. Just keep in mind that downturns in bonds are generally not as severe as downturns in stocks. If you move from bonds to stocks, you could be worse off if stocks begin to fall.
The best action is often no action
Trying to time when to move in and out of stocks or bonds is very tricky, which is why it's usually better to stay the course with your investments. If you're considering making a change, be sure to base your decision on your risk tolerance and the amount of time you have to invest, and not emotion.
Lastly, if you're interested in more stability, the plan offers an alternative that doesn't invest in stocks or bonds. It's called the Interest Accumulation Portfolio, and it owns funding agreements issued by one or more insurance companies, as well as shares of Vanguard Federal Money Market Fund. The funding agreements are interest-bearing contracts structured to preserve principal and accumulate interest earnings over the life of the investment.
While the Interest Accumulation Portfolio does offer stability, it comes with a trade-off: lower return potential. That lower return potential is why the portfolio is generally only used when the child is close to needing (or currently needs) the money to pay for education expenses. Investors with younger children have more time and therefore may want to wait out a downturn.
All investing is subject to risk, including the possible loss of the money you invest. Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer's ability to make such payments will cause the price of that bond to decline. In a diversified portfolio, gains from some investments may help offset losses from others. However, diversification does not ensure a profit or protect against a loss.
Vanguard Income Portfolio and Vanguard Interest Accumulation Portfolio both invest in Vanguard Short-Term Reserves Account, which, in turn, invests in Vanguard Federal Money Market Fund. Vanguard Short-Term Reserves Account's investment in Vanguard Federal Money Market Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of the investment at $1 per share, it is possible that Vanguard Short-Term Reserves Account may lose money by investing in the fund.