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The Flaw of Averages
Should you Ignore the Advice of the World's Wealthiest Man?
Did you select the table on the left?  Perhaps you were reluctant to, given that there was a 45% loss in the last year as opposed to the three consecutive gains at the end of the period for the table on the right.  This is something of a behavioral finance issue and research has shown that most investors dislike losses over twice as intently as they enjoy gains - we are by-and-large, risk-averse.  Perhaps more of us should keep that in mind when it comes to saving for - and then paying a date-certain-expense (summer before college starts), tuition.  Let's add money to the tables above and see how they did:
Year
Performance
1
40%
2
10%
3
5%
4
20%
5
-45%
Concept Two: "The Flaw of Averages"

From the columns below, which investment performance would you prefer? 
Both series of numbers AVERAGED 6% annually.
Year
Performance
1
-5%
2
-50%
3
40%
4
20%
5
25%
Year
Start
Performance
End
1
$100,000
40%
$140,000
2

10%
$154,000
3

5%
$161,700
4

20%
$194,040
5

-45%
$106,722
Year
Start
Performance
End
1
$100,000
-5%
$95,000
2

-50%
$47,500
3

40%
$66,500
4

20%
$79,800
5

25%
$99,750
Wait, what?!  The investor on the RIGHT averaged 6% annually?  Is she as happy with her investments as the investor on the left?  We'd guess not.  Yet their "Wall Street reported" average annual return performance was identical!


Actually, NEITHER investor should be particularly thrilled!  The one at left, the "better performance" investor, averaged 6% ANNUALLY but only has about 6% more MONEY at the end of five years!  Brutal.  Well, not as brutal as the "6% investor" at right but still...

You cannot spend "averages" - you can only spend dollars.  And if your 529 Plan loses money at the wrong time (i.e. shortly before college) or has a bad five years, your child's college education is in jeopardy.  If your time horizon is 15 years, 529s are probably not a bad idea.  If your horizon is one or two years - as in, you have a junior or senior (or a recent high school
graduate) - you are adding a great deal of risk to your college plan.  And that is Concept 3: Holding Period Risk

Let's look at actual 529 Plan performance, here, for one of the most widely-sold 529 fund options.
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