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Cloudy With a Chance of High Fees

529 plans are tough to analyze and too expensive.

Laura Pavlenko Lutton, 05/28/2010

If you've found it tough to decide on a college-savings plan for your child, you're in good company. It's difficult to evaluate the college-savings vehicles known as 529 plans--those state-administered investments that provide tax breaks for savers. They're complex, opaque, and often expensive. Add extreme ups and downs in the market, higher unemployment rates, and rising tuition costs, and the stakes seem higher now than ever.

Indeed, Morningstar's research into 529s has found that plans have grown more complex in recent years as they have added more investment options to their menus and diversified assets among multiple asset managers. With all of this variety has come variable performance, and investments designed for students nearing their college enrollment have produced a wide spectrum of returns. Finally, there also is a broad disparity when it comes to cost.

Because it's increasingly harder to compare 529s, Morningstar is developing new tools to help investors evaluate these plans both quantitatively and qualitatively. We plan to release our expanded research this fall in lieu of the "Best & Worst" list that we've published in April each year.

Are Four Heads Better Than One?
The market slide of 2008 was a test of any investment thesis, and many 529 plans didn't make the grade. Plans run by Oppenheimer were particularly hard hit because they invested in Oppenheimer Core Bond OPIGX, a fund that was billed as relatively staid but in fact was economically levered up and owned lots of risky bonds that posted huge losses in 2008. This episode highlighted for plan administrators the risk of hiring a single manager to run all of a 529 plan's assets. Some states, including Illinois, now feature managers from multiple firms rather than hire a single manager across strategies.PAGEBREAK

Diversity can be a great thing. After all, few firms are best-in-class managers across all of the asset classes typically represented in a 529 college-savings plan. But now 529 investors are left with the complicated task of evaluating multiple managers across several options within the same plan. Take Wisconsin's two 529 plans--EdVest College Savings Program and Tomorrow's Scholar mix managers from firms such as Columbia, Legg Mason, Mutual Series, Wells Fargo, and Vanguard across 19 fixed-allocation and 10 age-based options. Evaluating the investment merit of each of those options is a tall order.

It's also necessary to compare the various approaches to asset allocation within a plan. Some 529 plans include options for which the asset allocation remains fixed through the years. Others are structured around the child's age and shift the asset allocation from a heavy stake in equities when the child is young to more cash and bonds in the years leading up to college.

There is tremendous variety in the asset allocation of these dynamic, age-based offerings, especially as the child approaches college age. Those aimed toward very young children--ages 0 to 3--tend to be stock-heavy. But among 249 distinct offerings designed for children ages 16 to 18, about 10% have at least half of the assets invested in stocks when the child is 16, while others are stock-free.

That disparity in asset allocation has led to a wide spread of returns among these peer funds over the past three years. One Oppenheimer option lost 8.11% per year on average for the three-year period while more than a dozen bond-heavy 529 plans have gained more than 4% annually on average over the period.

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