Fri, 12 Oct 2012
Morningstar's Laura Lutton details the new ratings system used for 529 college-savings plans, what analysts look for in the plans, and improvements in the 529 industry.
Adam Zoll: I'm Adam Zoll for Morningstar. 529 plans have become many investors' college-savings vehicle of choice, and this week Morningstar released its updates to its annual ratings of state-sponsored 529 plans. Here to talk about this year's changes is Laura Lutton. Laura is the head of Morningstar's 529 plan research team. Laura, thanks for being here.
Laura Lutton: Great to be here. Thanks.
Zoll: So Laura, what's new for this year's 529 plan ratings?
Lutton: Well, this year we have a new rating scale. It's consistent with the rating scale that we introduced for mutual funds about a year ago. These are the Morningstar [Analyst Ratings] for funds that we recommend. They get Gold, Silver or Bronze. And then investments that we think are going to [have a similar performance to that of the overall market], we give a Neutral rating. And then we also have a negative rating for investments that we don't think are as well-suited or are going to be successful over the long term. So, we've applied the same scale to 529 plans. We used to assign ratings of top, above-average, average, below-average, and bottom, and we've replaced that scale with those three medals plus Neutral and Negative.
Zoll: And the medal rating applies to the entire plan as a whole, as opposed to specific tracks within the plan, is that correct?
Lutton: That's correct. So, we look across all of the investment options within the 529 plan. There are usually a lot of choices, such as age-based options, where the asset allocation shifts over time, or individual-investment options that you can chose, as well. So, we look at the whole gamut, and we decide whether we think these investments are likely to be successful over the long term or not. We layer in things like whether there is a tax benefit locally. We spend a lot of time on fees to see if these plans are a good deal. And that's how we arrive at that rating.
Zoll: On the whole, how are you finding the ratings? Do the ratings seem to be going up, showing improvement overall with plans, or are they holding steady? What are you finding?
Lutton: You know, we found that the 529 industry has made tremendous gains in the last few years. The days of plans being chock-full of poor investments that were really expensive are over. For the most part, we see that the plans are strong and the investments within them are proven and are priced fairly reasonably, particularly when you consider all the tax breaks that come along with 529 plans.
Zoll: How did the ratings break down this year?
Lutton: Overall we identified 27 plans as medalists. These are plans that we think are going to outperform over a full market cycle, when you consider the tax benefits and all those add-ins. We had four Gold, four Silver, and the rest Bronze, and I think the fact that we have so many of these medalists really reflects these improvements that we were talking about in the 529 industry.
And the Gold and Silver plans are plans that we had rated highly in the past. Those are plans like the Vanguard 529 plan out in Nevada and the Utah plan. These are proven plans in our view and certainly deserving of those top medals.
The Negative plans, we had four of them. We've identified those as the weaker players in the industry, at least among the 63 plans that we rated this year. And in those cases, weaker performance or more expensive options were really the reasons that we labeled them Negative this year.
Zoll: Do you have any sense of how many plans moved up or down one bracket from last year to this year?
Lutton: We did have some plans last year that were on our below-average list that we moved up to Neutral. The TD Ameritrade plan out of Nebraska would be an example. We were concerned about some of the fees on its investments and some overlap in investment strategies among its options, and the managers did a nice job over the past year cutting fees and improving some of the quality of the lineup there.
So that would be an example of an improvement story. Then plans out of Maine also moved up this year. Again lower fees [helped the rating], and that's really important to us, particularly in the 529 space.
Zoll: Aside from fees and the lineup of investments, are there other factors that go into analyzing a plan and assigning it a rating?
Lutton: Yeah, we look at the stewardship practices of the parent firms that are involved in running the 529 plan, so that would be the program manager, the asset manager like Fidelity, American Funds, or Vanguard--names that are familiar to fund investors. But we also talk with the states and talk with them about how they are administering the plan and what their priorities are for creating the investment lineup and governing the 529 plan. So that plays in, as well.
Zoll: For visitors to Morningstar.com who want to see the latest 529 plan research and ratings, where should they go on the site?
Lutton: So we have a 529 Center that's got a map of the U.S. There, you can click on your state or if you have a loved one in another state you can check out the plans there. It lists the plans that we follow there. We've got all sorts of data, including star ratings on 529 options. And if you're a paid subscriber to Morningstar.com, you can read our commentary or analysis that goes along with the rating, and that will help you understand where we think the plans' pros and cons are.
Zoll: Great. Well, thank you very much, Laura for being with us today and talking about the latest 529 ratings from Morningstar.
Lutton: Glad to be here. Thanks.
Zoll: From Morningstar, I'm Adam Zoll. Thanks for watching.