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Key Factors for 529 Plans

David Falkof

David Falkof: Hi, my name is David Falkof. I'm a mutual fund analyst at Morningstar, and I'm here today with Michael Corr from Vanguard. He is a senior manager in the education savings group.

Mike, I thought we would just start in terms of investors looking at 529 plans, which is sort of the common way to save for college, for a new investor what's the best way to start? What are some of the top considerations they should have?

Michael Corr: There are three really, David. The first thing investors should consider when choosing a 529 plan is to look at their home state's plan. They should look at their home state's plan because various states offer tax deductions for contributions to a 529 plan, and that state tax deduction might be available only to residents of a particular state. So if you live in a particular state, your plan may offer you a deduction for contributions to the plan. Some states even offer a tax credit. So look at your home state first.

Next, cost matters. Look at the cost of a plan. How much are you paying for the program management fee?

And then finally, look at the investment lineup. Know what you want to invest in and the options available to you in a particular plan. So, [three considerations are] home state, price, and investment options.

Falkof: Now, let's say someone chooses a plan, and typically there are a few age-based options as well as static portfolios. The age-based options tend to be more common, and there tends to be a conservative or moderate, and aggressive [strategy], different risk tolerances. How should investors go about deciding which age-based option is suitable for them?

Corr: This is one of the core principles that we look at Vanguard when we educate people on how they should think about investing and [how they should] look at their risk tolerance. If you're more aggressive, you're going to have greater equity exposure. So the aggressive track might be more suitable to you. The moderate and the conservative tracks have less equity exposure.

One of the ways you can determine what your risk tolerance is, is to go on to the Vanguard website or go on to a website that's for your 529 plan that you're looking at. Many of them have investor questionnaires that help you assess what your risk tolerance might be, and based on that you can choose a track that is appropriate for you.

Falkof: Let's talk a little bit about Vanguard's involvement in the 529 space. Vanguard takes a slightly different approach than many other asset management firms. Could you talk a little bit about how Vanguard approaches the 529 world?

Corr: Yes. We believe that investors should have simplicity and choice, and we accomplish this in two ways. First, we have the age-based options that you just referenced that typically use three tracks--aggressive, moderate, and conservative--based on risk tolerance. These are portfolios that shift to a more conservative asset allocation as the beneficiary gets older. And we believe that all beneficiaries, even in the most aggressive track, should be out of equities by age 19 when preservation of principal is absolutely needed to pay for college tuitions at or about the time the beneficiary is going to matriculate.

Also in the plans that we service, we typically have a variety of what we call stand-alone portfolios. These are portfolios that are either multifund portfolios--what might be called a fund of funds--or they are just individual mutual funds contained within a portfolio offered by a 529 plan. The investor then has the option of doing two things. One, he or she could choose the age-based track and one that is suitable for them. That's a kind of a set-it-and-forget-it [strategy], and that provides the simplicity that an investor might need to invest for college savings. Alternatively, they could construct their own portfolio based on the suite of individual or stand-alone options that we provide.

I should add a third, they might choose the age-based option and then wish to overweight in a particular category of asset, whether it be equities or fixed income, by using some of the stand-alone portfolios.

So really what you get when you do this is not only the simplicity--because we believe in a transparent approach to this portfolio setup—but it enables us to provide these options at low cost because really these age-based options are constructed of a total of six different portfolios. That keeps it at a minimum, and it keeps it simple. But it gets you exposure to all the major asset classes that you need for an effective investment program.

Falkof: Thank you so much, Mike. This has been very informative. For Morningstar, I'm David Falkof. Thanks for joining us.