Our annual review of the 529 college-savings industry.
Editor's note: We've updated our best and worst "529 Travel Guide" map from the Summer 2008 issue of Morningstar Advisor magazine to reflect this year's picks. This map tracks every plan listed since 2004; the plans that have landed on the best lists are still deserving of investors' money, while some on the worst list have improved. Other plans have closed or are now defunct.
It's a dismal scenario: As college tuition continues to shoot up at an alarming rate, investors brave enough to open their 529 college-savings account statements have likely seen a precipitous drop in assets.
In the past, we've been able to laud the 529 industry for lowering fees, improving investment options, and closing down poorly structured plans. Unfortunately, the past year hasn't been so rosy in the college-savings universe. Several plans had maintained too-aggressive asset allocations for students nearing or in college, while other plans were hamstrung by their allegiances to floundering investment options.
A Major Player Stumbles
OppenheimerFunds is the poster child for how badly some 529 players went awry in 2008. Over the past few years, the company had firmly established itself in the 529 college-savings universe. The firm currently manages nine separate college-savings plans, both advisor- and direct-sold, in five states. Unfortunately, all of those plans had exposure to one of the worst bond-fund blowups in 2008. Oppenheimer Core Bond
In fact, one of those nine Oppenheimer-managed plans, Illinois' direct-sold Bright Start College Savings Plan, made our best list last year. The previously named "Active Portfolios" were caught up in Oppenheimer's fixed-income fiasco. The losses were so unprecedented that in mid-January 2009 Illinois' State Treasurer Alexi Giannoulias indicated that he was preparing to file a lawsuit against OppenheimerFunds. At the same time, the state also reacted by no longer offering the three troubled Oppenheimer fixed-income products, but existing shareholder money is still tied up in them. All told, the plan still holds plenty of appeal; its untainted "Index Portfolios" are still the cheapest nationally available Vanguard options.
The worst part for investors in these plans is that the Oppenheimer portfolios positioned closest to college were the ones holding the largest positions in these bond funds. Thus, even though fixed-income investments are typically considered more conservative than equities, the plans' bond options didn't provide the ballast that one might have expected--far from it. For example, Texas' direct-sold College Savings Plan's "Blended Age-Based 15 - 17 Years Portfolio," which had half its assets in Core Bond, fell nearly 30% in 2008, compared with less than half that amount at many peers in a similar age-band. A similar pattern of losses can be found in the same age band at nearly every Oppenheimer-managed 529 plan.
Risky Age-Based Options
Unfortunately, the Oppenheimer-managed plans weren't the only ones with problematic age-based options. Age-based options are designed to transition from mostly equities in a younger child's account to more conservative investments--bonds and cash--as the beneficiary approaches college. There's not a strong consensus on the exact amount of stocks, bonds, and cash to hold for a particular time horizon, but it's clear to us that some plans didn't move out of equities fast enough and were courting far too much risk given that they were geared toward students getting close to matriculation. After all, most students deplete their 529 assets in the space of four years, leaving little time to recover from a serious market downturn like 2008's.
The most striking example of an overly aggressive asset allocation comes from one of Utah's five age-based options. That plan's "S&P and Bonds" age-based option stashes 65% of assets in equities for a college-enrolled beneficiary. This is dangerously bold, in our opinion. It's important to note, however, that this best-in-class plan features four other age-based options with much more sensible structures.
An overly aggressive asset-allocation framework becomes a more serious issue when investors are offered only a single age-based choice. For example, Oregon's OppenheimerFunds 529 Plan has just one age-based option, and until March 30, 2009, the plan's "1-3 Years to College" portfolio had 40% devoted to equities, with more than 5% in foreign stocks. Additionally, New Jersey's direct-sold plan has just one age-based option that can have as much as 35% in equities--including up to 12% in international and 6% in smaller-cap fare--for a beneficiary already enrolled in college. The critical lesson for investors is to pay particular attention to the latter stages of a plan's age-based option, and be sure you are comfortable with the risk your plan is taking.
The terrible performance of some 529 plans in 2008 clearly illustrates that, now more than ever, investors can't afford to invest in anything but best-of-breed college-savings plans.