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By Christine Benz | 10-22-2010 01:36 PM

How to Pick a 529 Plan

Morningstar senior fund analyst Josh Charlson outlines how to use Morningstar's new ratings, data, and analysis to find reasonably priced plans with bright prospects.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

What are the key factors to look at when evaluating a 529 plan? Here to discuss that question is Josh Charlson. He is a senior mutual fund analyst with Morningstar.

Josh, thanks so much for being here.

Josh Charlson: Sure, nice to be here.

Benz: So Josh, you and the team have recently come out with a lot of new data and research to look at 529 plans. I wanted to discuss one thing: So you're providing a rating at the plan level, and then also the individual options within a given 529 plans are getting a rating as well. Can you discuss the different types of rating systems that you're using for each--both the plan and the individual funds?

Charlson: Sure. The ratings that we're using at the option level are similar to the traditional Morningstar star rating. So for every option in the plan, we have created a specific 529 star rating. Those are quantitative measures looking at risk-adjusted performance within the Morningstar category, and for this new data launch, we've created Morningstar categories for every 529 category. So that's a new innovation.

At the plan level, we have a more holistic qualitative Morningstar analyst rating, and those look at a bunch of different factors. They are looking at performance. They're looking at the price, which incorporates both the expense ratio and the state tax benefits. They're looking at the portfolio, the underlying quality of investments. And then two factors that go into our Stewardship ratings: parent, looking at the corporate parent, and people, which is the quality of the people managing the money, running the programs, managing the underlying investments.

Benz: Okay. So it sounds like one way to think about it is that as with the star rating, those option ratings are a quick snapshot of how a fund has balanced risk and return in the past. The plan level ratings are actually meant to be somewhat forward-looking and meant to give investors kind of a thumbs up or thumbs down?

Charlson: Yes. That's a great way of putting it. I mean we're really trying to put all of our analyst resources into evaluating the plan, looking at it from a lot of different angles, and it's really trying to say, "how well do we expect this plan to perform relative to peers in the future over the long period that you may potentially be investing in this."

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