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Bonds are lower risk, but not risk-free

Last updated on 23/09/2020

Bond investors can find themselves in this situation when interest rates rise. That’s because bond investing comes with interest rate riskwhen interest rates rise, bond prices fall.

If this happens while you’re saving for a child’s future education expenses, what should you do?

If you invest in an age-based portfolio

Most people investing in a 529 plan account at Vanguard 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 portfolios, 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.