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By Adam Zoll and Kathryn Spica, CFA | 05-28-2014 11:00 AM

Fund Returns Put 529 Plans to the Test

Traditional mutual funds tend to outperform 529 plans, but tax incentives and high-quality investments can offset the college-savings vehicles' lagging returns.

Adam Zoll: I'm Adam Zoll. Morningstar's annual 529 survey has just been released and here to talk about some of the key findings is Kathryn Spica. She is a senior fund analyst here at Morningstar and a co-author of the report.

Kathryn, thanks for being here.

Kathryn Spica: Thanks for having me.

Zoll: In your analysis, you compare the performance of 529 portfolios versus comparable traditional mutual funds. What did you find with regard to how they compared?

Spica: It's an really important comparison to make because as a college saver those are the investment vehicles you have available to you. You can choose a 529 option in most cases or an open-end mutual fund, for example. So looking at those two categories and their differentials in performance can really be insightful.

We looked across the categories of static 529 plan investments, such as large plan, conservative allocation, large value, et cetera, and compared them with the open-end categories, and we saw a pretty big gap across some of the categories.

Zoll: Which categories in particular seemed to lag when you invest via a 529 plan?

Spica: The majority of them did. The larger gaps were in the large-value categories and the conservative-allocation category.

Zoll: You mentioned that these are for static portfolios. Those are the portfolios that never change and keep the allocation set. What about the age-based portfolios? These are the portfolios that change as the beneficiary ages, so they may be stock-heavy when the beneficiary is younger, more bond-heavy as they approach college age. What did you find with regard to performance there?

Spica: Exactly. So it's another good point. A lot of investors are choosing these age-based options. They're a little bit of an easier default investment. They're kind of like a target-date fund in that they change their allocation as they mature. With these assets they also trail their counterparts.

We don't have analogous open-end categories to compare them with, but we can look at blended benchmarks. So, in our study, we looked at two different benchmarks. One, just an allocation of stocks, bonds, and cash at appropriate allocations, and then we also looked at blended benchmarks from Morningstar. So within both cases, 529 plans also fell short.

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