One of my biggest concerns as a financial advisor is not a market crash or missing out on Bitcoin level bubbles. My biggest concern is the increasing push by government to play a larger role in managing and holding your investment dollars. For example, an investment in a 529 plan encourages states to ignore real fiscal emergencies and play money manager.
Michael Glennon of Wirepoints, a media site that covers Illinois economy and government, recently published an article showing despite the common belief that 529 plans are run largely with sound investment approaches by professionals, the State Treasurer of Illinois has been actively using the fund to promote and coerce companies to act in certain ways.
The Problem With 529 Plans
The obvious problem here is state plans and treasurers can utilize funds for their own benefit, rather than for the sole benefit of the investor, whether that means advancing their political party, their careers, or local companies. Many investment advisors default to an investment in a 529 plan for college, and it could be said advisors initially were responsible for building the 529 industry through their recommendations. The use of their clients' money to become activists should now give every investment advisor pause before recommending a fund that increasingly may be used for political purposes.
When the state takes a role in investing your money, there are devastating effects on savers and citizens.
Investors Invest in Funds With Unknown Risks
Savers invest in funds with unknown risks or benefits. Investing is taking known risks. Giving money to a manager to pick winners and losers is speculating when done with professionals, and it is gambling when done with amateurs. Hiring a bureaucrat to be your investment manager is a massive gamble. I have always suggested a 529 plan is not an investment since the state can and has changed managers.
Potential Conflicts of Interest
The state treasurers have significant conflicts of interest in the stocks and program managers. Already, many state plans are run by local or regional firms. It is difficult to believe there is no quid-pro-quo today between the firms they choose as these politicians seek higher offices. It is impossible to believe that a politician who dictates what companies these managers invest in will not further abuse that power for donations and other purposes.
The Illinois Treasurer is a life-long bureaucrat, not an investment manager. Illinois is one of several states considering running retirement accounts. Oregon recently began a retirement account program that forces their state employers who do not offer retirement plans to become enrollment agents for a state-run account that charges more than 10x the going rate for a S&P 500 index fund investment. This makes it hard to believe states are concerned with their fiduciary duty to the citizens of their state rather than finding ways to raise money. Glennon also has written about how Illinois is paying high costs for unpaid bills while earning little on cash balances. (For related reading, see: Duties of Fiduciaries.)
Elimination of Competition and Choice
States may be lobbying to eliminate competition and choice. Initial proposals for tax reform included eliminating free-market Education Savings Accounts (ESAs) and handing that money over to state-run 529 plans. ESA growth has been hampered over the last generation by increasing benefits given to state-run 529 plans with no corresponding benefits given to savers who want to keep the government out of their investment holdings. Where ESAs give the investor total control over costs, risk, and investment provider, 529s have only been more successful due to the uneven playing field they have in terms of higher contribution limits and the use of state funds to market awareness.
Absence of a Long Enough Time Horizon
Investing involves a time horizon of at least five years, though ideally over 10 years. For that reason alone I have always been hesitant to recommend state 529 plans. Yes, investors generally have this time horizon, but only for a limited time. While many college investors start with a long enough period to invest, they quickly reach a point of not being able to risk their college funds. States are conflicted when it comes to accepting an investment from someone who should not be investing, and have no ability to provide that advice in the first place.
I believe the concept of higher education will change over the next 18 or even five years—we will see more online and apprenticeship programs, and as traditional colleges adapt, we will see more support in tax subsidies and credits—which makes the concept of investing with a singular college goal a losing proposition.
Lack of Cost or Risk for States
States have a massive advantage over private and professional investment managers. Your fiduciary investment manager has significant and increasing costs to comply with regulatory bodies and disclosing risks to clients. Your state "investment manager" has no such cost or risk.
No Recourse for Mismanaged Funds
Investors have no recourse against a state mismanaging funds. And, they will mismanage the funds as can be seen by just about every state-managed pension fund. State-run prepaid 529 plans have failed and been closed, and there is concern today about those states who still run prepaid plans. Investors who trusted the state when they took out investments over a decade ago will just be out of luck when it is time to collect on poorly run plans. (For related reading, see: 4 Smart 529 Plan Alternatives to Consider.)
While states like Illinois are going bankrupt and there is significant concern regarding their management of prepaid 529 plans and pension investments, their treasurer is playing active investment manager. If the vast majority of full-time professional, politically unconflicted investment managers should not be engaging in active management, it is hard to believe the Illinois Treasurer can do so effectively. Investors should not hire someone to actively gamble with their money. It is highly concerning that some states are already taking this approach with your college funds, and many are looking to do so with retirement accounts as well.
Consider all of your investment options and opportunities prior to believing a 529 plan will be a sound option over the coming years.
(For more from this author, see: 3 Equity-Indexed Annuities: A Comparison.)