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Is Your 529 Plan a Lemon?

Christine Benz

Christine Benz: Hi, I'm Christine Benz from Morningstar. Morningstar has just come out with its annual study of the Best and Worst 529 Plans. I am here today with the study's author, Greg Brown. Greg, thanks for being here.

Greg Brown: Sure, sure.

Christine Benz: Well, Greg, we just spent some time talking about some of the problems specific to the plans that had been managed by the Oppenheimer family of funds. But, let's face it. All 529 plans suffered in 2008, a terrible year for stocks. How do I know if my plan is a lemon, even if it wasn't managed by Oppenheimer Funds? How do I know if I've got one that, maybe, I should do something about?

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Greg Brown: Sure, sure. One of the key things that we look for is flexibility. What this year has shown us is age based options, some age based options, may just be too risky. It's important to have more than one age based option to match a particular investor's risk tolerance.

The other thing in terms of flexibility is to have a good number of single fund options for do it yourself investors that want to build their own asset allocation or even augment the age based options.

Also, in addition to the age based and single fund, there's also what we call stack blend options that are sort of a fixed allocation between equities, cash and bonds. You want to have, at least, sort of the major asset classes covered there. So, you can have a good flexibility among all those options.

Christine Benz: I know another thing you like, Greg, is those plans that have several different investment providers so they kind of pick and choose best of breed. Maybe, they have PIMCO running fixed income, some of the better equity managers running the equity sleeves and so on. So, you like the flexibility that it gives to the participants.

Greg Brown: That's sort of that open architect that I think the industry is moving towards and has been. I think some of the earlier players are like Ohio's College Advantage Drexel Plan which has a good number of mutual fund families represented. Virginia's Drexel Plan is also managed by the state, its program manager.

It just gives them more freedom to add any kind of mutual fund they want, any mutual fund that wants to be in the 529 space, and then quickly get rid of the options they don't want. It's just good to have. There's enough market risk. There is no need to have this kind of firm risk.

Christine Benz: Right.

Greg Brown: If you're always using the same mutual funds.

Christine Benz: Now, I know another thing that you tell people to look for, and it's possibly something you want to look out for if you have one of these plans, is fees. High fees can really cut into your take down return, whether you are investing in a mutual fund or a 529 plan. How do you go about checking up on fees, and what do you think is a reasonable range for fees?

Greg Brown: Fees are very important. Anyone familiar with Morningstar is familiar with how we focus on low-cost mutual funds. Since 529s are built with mutual funds, the same logic applies. You want to focus on low fees. The typical act of management fee for 529s, you know, anything for a Drexel plan, anything less than one percent or 0.9 percent. That's a reasonable fee range. Costs are particularly important for index oriented plans.

Christine Benz: Right.

Greg Brown: That's something that index funds are already well represented in the 529 space. What I've seen this year is there's been an even bigger push towards index funds. A lot of the Oppenheimer funds were replaced with index funds. Even before that, some of the Oppenheimer equity funds were replaced with index funds.

Fees are particularly important with an index plan because usually the lowest cost index fund is going to be the winner. With index plans, you simply want to choose costs are really, really critical in index oriented plans. Utah's is one of the lowest cost kinds of index centric plans.

It's a good idea, anything under 40 basis points is reasonable for an index plan. Sometimes, the index funds have the underlying fund has 10 basis points or one tenth of a percent which is extremely inexpensive. Then, you've got program management fees and state administration fees of 60, 70 basis points. That's six times the cost of the underlying fund, and that's a problem. Investors should stay away from those options.

Christine Benz: OK. So, if you've got a plan with high fees that's going to be an impediment to strong future returns and, maybe, that's the kind of plan you might want to think about replacing with a lower cost plan.

Greg Brown: Certainly, certainly.

Christine Benz: Thank you, Greg. That's helpful advice.

Greg Brown: Sure, sure.

Christine Benz: Thanks for joining us. I'm Christine Benz from Morningstar.

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