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How Have 529s Performed Since the Downturn?

Christine Benz

Christine Benz: Hi, I'm Christine Benz for has recently launched some new data and research about 529 college-savings plans. Here to discuss the new features with us today is Laura Lutton. She is director of editorial research for Morningstar.

Laura, thanks so much for being here.

Laura Lutton: Thanks for having me.

Benz: So Laura, I want to discuss performance from these 529 plans. A lot them got a black eye during 2008, some of them had poor performing individual investment choices. Some had overly heavy equity allocations. What have you seen from this group generally since that time?

Lutton: Most 529 investment options are still in the red from 2008. The average option lost 24% of its value in just that year alone. So, that's a lot of ground that these options have to make up, and many of them have done better certainly since then, but they're still in the red and have ways to go to make it up.

Benz: So Laura, you know that you and the group have done some great work in which you have categorized 529s much as we do with mutual funds. So, now you can compare them on an apples-to-apples basis, which is really helpful.

What do you see, though, when you step back and look at 529 performance, so the performance of investment options within a given 529 category versus mutual funds in that same category?

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Lutton: We did do a comparison. You know, logic would suggest that the 529 plan options would outperform at similar mutual fund category, because anybody can launch a mutual fund, but you have got to be a pretty decent investor to win a 529 contract.

And that's exactly what we found that even though 529 plans tend to have higher fees than mutual funds, they actually have outperformed over some three- and five-year periods.

Benz: So, that's encouraging for 529 savers--that you're not necessarily suffering from those extra layers of costs that you may do just as well as investing in funds.

Lutton: Right. Especially, when you layer in the income tax savings that a lot of 529 savers get on the way in when they invest in the 529 plan, and then of course the proceeds, when you withdraw them, when your child enters college are also not taxed. So, that's another advantage that isn't specially baked into the expense ratio, but investors should keep that in mind when they're evaluating performance relative to other investments in their portfolio.

Benz: So, I wanted to discuss another issue with you, Laura. A lot of the assets in these plans are in so-called age-based options--the ones they get more conservative as your child gets close to college. Have you seen any trends among those age-based options? Some of them were too equity heavy, arguably, for kids who are 15, 16, 17 years old.

Lutton: Right.

Benz: Have they backed off of those equity heavy stances? Have you seen an overall rise in conservatism in the management of these funds?

Lutton: Yes. We have seen a number of 529 plans introduce investment tracks that are aimed at kids based on their age or their enrollment date, that have less exposure to equities, the whole way through. So starting when your child is an infant all the way to the enrollment date, and in most 529 investment options that are age-based are out of equities at the enrollment date, and many of them are out, even when a child enters high school. So, there has definitely been a trend towards more conservative asset allocation or less equity allocation in the 529 plan universe as a whole. And we've even seen plans introduce more cash-type options, more than a dozen plans have FDIC insured 529 plan options within the plan. So, if you really are concerned about protecting that nest egg, you can go that route as well.

Benz: So, let's talk a little bit, though, about the risks of being too risk adverse. If you are a college saver and you have a young child. It seems to me that you are really not in a great place, if you're earning just 1% or 2% on your cash investments, and you're trying to save these huge sums that you need to say for college.

Lutton: Yes. College gets more expensive every year. Tuition has been going up at about 6% a year. So, if you're barely earning anything on that college investment, keeping up with those tuition increases is a challenge. But there's also the flipside that you've put this money away for your kids and you want to make sure it's there when they need it, and so I think a lot of investors have to wrestle with that. How much market risk am I comfortable taking on, and to what extent do I want to sure that those college savings that I've put away are protected from market action.

Benz: So lastly, Laura, I want to discuss the strides you think the industry has made, the 529 industry has made. And also whether you think there is still work to do in some areas. Could they be even better than they are now?

Lutton: I think the industry as a whole has been very responsive to criticism. Morningstar and other organizations have been very quick to point out when we don't like the quality of the investment that's included in the plan. Several states have included new clauses in their contracts with money managers that give them outs if an investment is underperforming. So, they're not stuck with something that they think is not doing its job on behalf of a college saver. So, I think that's great.

You know, where there may be room for improvement, I would say, is on the fee side. There are still 529 investment options that I look at and think, "Oh my goodness, that's way too expensive," and particularly, when you compare it to a similar strategy on the mutual fund side. So, we've seen a lot of fees come down over the last year. More than 30 plans have cut their fees since last summer, which is fabulous. That's more of your investment you get to keep. But we still see a lot of plans that could be cheaper.

Benz: And it sounds like the new data that we have provides a little more clarity on all-in fees for 529s, which is great.

Lutton: Yes. I think one of the huge challenges to investing in a 529 plan is because they're offered state by state by state. It's hard for you as a consumer, investor, to feel confident that you are buying something that's going to be a strong investment. So, I think what's a great step forward for investors is having the data all in one place through Morningstar to compare returns, fees, asset allocation. All these data points that are relevant to making a good choice with your college savings.

Benz: Well, Laura great research. I look forward spending more time with it. Thanks for being here.

Lutton: Thanks.

Benz: Thanks for watching. I'm Christine Benz for