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University of Portland graduates celebrate with a beach ball during the beginning of their commencement ceremony at the Chiles Center.

(Rob Finch/The Oregonian/file)

Eric Hutchinson has been saving for his daughter's college education for a dozen years. But in April, the Tigard resident decided to take advantage of the Oregon College Savings Plan's tax break.

He put $5,000 in the plan's Age-Band 16 portfolio for 16-year-olds, which will automatically adjust his investment into more conservative holdings as his daughter Noelle gets older.

So, he was a bit surprised when he looked at the account balance just after New Year's and found it held $4,980. Hadn't it gained anything from the year's run-up in stocks?

"I was just stunned," said Hutchinson, 57. "If that's the performance we're going to see out of the fund, is that worth the tax advantages."

It is. We'll get to why in a moment. But he's right to expect more of the plan. Its oversight board made moves in November to address the issue.

Oregon College Savings Plan age-based portfolios' performance in 2013.

Things could've been worse, as they were in other states' 529 plans across the nation. Oregon's portfolio for beneficiaries 18 & over actually lost nearly 2 percent of its value last year. The Age Band 17 Portfolio also lost money.



New York's 529 College Savings Program's Income Portfolio for college-age students declined more than 3 percent in value last year. Vanguard-managed portfolios for 19-year-olds in Nevada, Iowa, Missouri and Colorado were down as much as 3.6 percent.

Unfortunately, investors in these and other states have learned yet again about the risks of investing in age-based funds. Like target-date or glide-path funds, these mutual funds automatically shift money toward more conservative holdings as the beneficiary nears college, or, in the case of retirement plans, age 65. As the plan's disclosure statement says, these moves are made "to preserve capital."

They're supposed to be a safe way for investors to save without worrying about whether they've got their mix of stocks and bonds correct. But one fund family's decision about what's conservative usually differs from another, and it might differ from yours, too. The losses in bond funds last year caught many investors by surprise.

"Many parents think of those investments as their safe money that's going to grow at a steady rate," said Laura Lutton, director of 529 plan analysis at Morningstar, which rates mutual fund performance. "But they are susceptible to losses."

During the financial crisis, target-date funds in some cases lost more than near-retirees expected because they had stock exposure.

The fund mix underlying Oregon College Savings Plan's age-based portfolios.

But in 2013, at least among college savings plans such as Oregon's, the opposite happened. Oregon's age-based portfolios have a very conservative tilt in its teen-age band. At age 16, 85 percent is invested in bond funds, and by age 18, 100 percent is invested in bond and money market funds.

Well, last year, bonds took it on the chin. The value of bond funds drop when interest rates increase, and interest rates began moving up mid-year. Barclay's U.S. Aggregate Bond Index, a measure of the entire domestic bond market, declined 2 percent in 2013.

All of Oregon's age-based portfolios hold between 10 and 20 percent of TIAA-CREF's Inflation-Linked Bond Fund. That fund invests mostly in Treasury Inflation Protected Securities, which are supposed to protect investors from inflation. But when the bonds are held in funds, the value of the fund itself will go down if interest rates bump up. That's what happened to TIAA-CREF's bond fund. It fell 9 percent for the year.

Hutchinson's returns might've been worse had the plan not invested a substantial amount of in Vanguard's Short-Term Bond Index Fund. Short–term bonds aren't affected as much by interest rate spikes as, say, bonds held for intermediate or long periods -- 10, 20, or 30 years.

"I don't think what you're seeing in the Oregon plans is all that unusual," Morningstar's Lutton said.

But they could've been better. The MFS Oregon 529 Savings Plan, sold by investment advisers, has a conservative allocation fund for teens ages 15-18 that gained nearly 2.5 percent last year after sales charges. That's because about 36 percent of the fund is invested in stock-like holdings, which means it's susceptible to losses when the more volatile stock market declines. Through Thursday, it was already down nearly 6 percent for 2014.

The MFS age-based fund for beneficiaries 19 or older is invested in MFS' Limited Maturity Fund, which also lost money. After sales charges, it dropped 2.14 percent in 2013.

The risk from declining bond fund values will continue to hover over 529 plan investors using age-based options. Interest rates are likely to go up again. It's just a question of when. And lots of plan investors will be impacted.

More than one-third of the Oregon College Savings Plan's 106,000 accounts -- and nearly half of plan's $950 million in assets -- are invested in age-based portfolios. Nearly half of plan beneficiaries are 12 years old or older.

The proposed changes in the funds underlying Oregon College Savings Plan's age-based portfolios, shown above in red, were approved in November by the plan's oversight board. They should take effect in February, plan director Michael Parker said.

The Oregon 529 College Savings Board addressed this issue in November when it voted to replace TIAA-CREF's TIPS fund with three other bond-based funds. The main substitute was Vanguard's Short-Term TIPS Fund (VTSPX). This fund still invests in TIPS, but the bonds are coming due, on average, in 2.4 years. Even so, the fund lost 1.5 percent last year.

The board is also adding two other funds -- Vanguard Total International Bond Index Fund (VTIFX) and Fidelity's Strategic Real Return Fund (FSRRX) – to help increase diversification in all of the age-based portfolio bond holdings.

"We want to hedge a bit against inflation, but we don't want that intermediate (bond) exposure anymore," said Michael Parker, director of Oregon's plan.

The changes go into effect next month, he said, encouraging investors to be patient. "While we never ever like to see any negative performance, we do look at this over time to manage the risk."

Investors should always judge investment results over several years, not just over a one-year time frame. No one knows what the bond market will do this year. But, there are things you can do on your own right now if you're concerned:

1. If your child is about to enter college, or already there, you can move money yourself into the Oregon plan's Principal Plus Interest portfolio. That fund, invested in a mix of insurance instruments and bonds, guarantees to return your original investment, plus some interest.

Right now, that interest rate is low – 1.3 percent – and it will likely drop again April 1, when TIAA-CREF adjusts its 12-month rate. But it's better than losing money, and it's a better return than you can find in most bank CDs.

Be careful, though. Plan account holders can only move money among portfolios once a year. Be sure you know what you want to do before you access your account. You won't get another chance to make a move for 12 months.

2. You can invest in other vehicles outside the Oregon College Savings Plan, as Hutchinson does. Roth IRAs are a good place to do it, too. You can always withdraw your contributions from a Roth. You can also withdraw earnings to pay for education-related expenses without paying a 10 percent early-withdrawal penalty, provided you've held the Roth for five years. You will pay tax on any withdrawn earnings, though, unless you're age 59.5 and have held the Roth for five years.

3. You can invest in other state 529 plans. The Utah Educational Savings Plan might offer the best solution to the bond problem. It actually offers aggressive, moderate and conservative age-based paths. In other words, investors can choose to have greater stock exposure all the way through college age by choosing the aggressive age-based path.

As beneficiaries reach college age, Utah invests more money in federally insured savings accounts. Its age 19+ or College Enrolled investment options put most or all money in a federally insured savings account at Zions Bank. Its 2013 return through Nov. 30 ranged between 0.34 and 0.76 percent, based on whether one invested in the conservative or aggressive age-based option.

Investors in Utah's plan can also customize their own age-based allocation, choosing from 22 different underlying funds. The plan then automatically reallocates the investments to more conservative holdings as the child ages.

But if you go to Utah, or any other state, just know that you're giving up an Oregon tax break that actually becomes more valuable as your child nears college.

Let's use Hutchinson's investment as an example. He appears to have lost $20. But by April, he'll be able to deduct $4,455 from his Oregon taxable income (the deduction would be $2,225 if he were single).

At a tax rate of near 9 percent, that will put about $390 in his pocket come April that he wouldn't have received investing in another state's plan. He can plunge that money right back into the plan this year, erase that $20 loss and end up with an effective $370, or 7 percent, gain on his $5,000 investment.

Not bad for a conservative investment. You're going to be hard pressed to find a similar return elsewhere without taking risks you shouldn't if your child needs the money in the next few years.

-- Brent Hunsberger is an Investment Adviser Representative in Portland. For important disclosures and information about Brent, visit http://ORne.ws/aboutbrent. Reach him at itsonlymoneyblog@gmail.com.