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Evaluating Age-Based 529 Plans

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

Morningstar.com has just launched a lot of new data and research about 529 college savings plans. Here to discuss it with us is Laura Lutton, she is editorial director for mutual fund research for Morningstar.

Laura, thanks so much for being here.

Laura Lutton: My pleasure.

Benz: So you and the team have put out a lot of great research, and one area I want to home in on is this category of age-based funds. So these are the 529 plans that get more conservative as your child gets closer to going to college.

I want to discuss how to evaluate those age-based options and how to determine first of all, whether you're better off going with the age-based option or trying to build your own 529 plan with individual static funds. What's your take on that question?

Lutton: Well, there is a lot of choices out there. Many 529 plans have multiple asset allocation choices for you, whether it's aggressive, moderate, conservative, or some plans have even more choices than that.

At Morningstar we were really curious to see, when you put all these options together how do they look? And so one of the new features on Morningstar.com are some graphics that will show you specifically what your choices are in which plan and how they line up relative to the industry norm.

So the typical 529 age-based option has about 80% of its assets in equities when a child is newborn and is close to or almost out of equities about the time that child enters college, but there are a range of choices around that norm that an investor has to sift through in making a decision.

Benz: So if I'm looking at that and say I'm looking at Illinois' plan, one of Illinois' plans. How do I tell, is this within the realm of normal? I can hop on the side and actually see its allocation...

Lutton: The site will show you relative to the norm, and then you really just have to make a gut-check decision. Is holding 10% of my college savings in equities at the time of enrollment, is that okay or is that too risky?

A lot of plans give you more than one choice, so if that does feel too risky there may be an option labeled "conservative" that goes completely into fixed income and cash earlier in your child life. So there are a lot of choices out there.

Benz: There are almost too many it seems.

Lutton: And sifting through them can be a challenge, and so we wanted to provide some tools to make that decision easier and give investors context with which to make that decision.

Benz: So as you've said, there are a number of these age-based plans that actually offer conservative, moderate, and aggressive flavors, and you all are categorizing funds within each age track based on whether its asset allocations is conservative, moderate, or aggressive.

How do I know, though, if I'm a college saver and looking to say for a child at a given age, how do I know whether I belong in the conservative, moderate or aggressive track? What can I do to assess my own ability to tolerate that risk?

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Lutton: Well, that's a tough thing. I mean I think we all had a much different appetite for risk in 2007 than we did at the end of 2008, right.

And I think that parents get particularly emotional about their college savings. This is the money you've put aside for your child to attend college, and I think there has been a broad concern among parents that once they've put the most savings into the 529 plan, that those assets are protected, and so we've seen the industry respond by introducing conservative or less-equity-heavy options that you can choose from to better protect that nest egg in those years heading up to college.

But you as the parent have to weigh what kind of risk am I going to take, am I going to be comfortable seeing a loss potentially in that account when my child is 16, 17, 18. If you are not, then you need to pick an age-based option that has less equity exposure, or most 529 plans have fixed allocation options where you know what the allocation is going to be, it's going to be steady the entire way and not shift like it does in the age-based options.

Another option would be if there is only one age-based track in a plan, and it seems like it's too risky for you, you can always add a bond fund or allocate some of your savings to cash to take the edge off that glide path.

Benz: That sounds like good advice. So one area of concern is for the children who are getting close to going to college, and that was a real problem spot back in '08 where some 529 plan options lost a lot, right at juncture for those kids. How about people who are looking at 529s now, how do they sort of assess that end date of the high school years and asset allocation at that time? How do they see if maybe a fund or an option is tiptoeing too far out on the risk spectrum. What's a good way to evaluate that?

Lutton: Well, this new graphic will show you exactly what the allocation is going to be at any age. So it's easier for you to look at the graphic and say, okay, my child is 16, and this is what the asset allocation or equity exposure specifically is going to be at that given point.

And so then you just go back to the gut check, and you have to think through scenarios. Many years equities do great, and the key is not to kick yourself then if equities do great and you have made a more bond-heavy decision. But I think that it's up to the individual, and all of our appetite for risk is different, and so I think the industry has responded with a lot of choices so that folks can go with something that feels comfortable.

Benz: So, Laura, I just wanted to touch on one other interesting factoid you mentioned to me, the child's age at which most people begin saving for college--it's later than one might think. So say someone is a late-start college saver; they are coming to one of these plans, and their child is 10, 12, 14. What should they do and how can they evaluate asset allocation through that lens that they really have some lost time to make up for?

Lutton: I think with a lot of investing there is, if you are late to the game there may be some temptation to take on more risk or get more exposure to equities and thus give yourself a better chance of growing that nest egg in those final years before college.

The industry would suggest, just based on the way we see the average asset allocation in those age-based options, that you should be more conservative at that point, but the typical 529 account holder has about $10,000 in the account, and when you look at that savings versus what tuition is, there is a big gap there. And so that is going to lead to some difficult decisions, but I think getting started saving earlier is great, but at any point is even better.

Benz: Right. It seems to me that if you are one of those late-start investors maybe you would have to think of some combination of financial aid and loans contributing to funding the college education as well?

Lutton: Yes, it's a difficult equation for a lot of families.

Benz: Absolutely. Well thanks, Laura. I look forward to seeing the research. Thanks for sharing it with us.

Lutton: Thank you.

Benz: Thanks for watching. I am Christine Benz for Morningstar.com.