529 college-savings plans are growing up quickly, but like a lot of teenagers, they have some awkward qualities.
These state-based savings plans have made significant strides forward over the past 18 months. Thirty of the nation's 82 529 plans have cut their fees, which is an immediate benefit to shareholders. Also, states have been relatively quick to get rid of unsuccessful investment options within 529 plans. These signs of maturity, however, are offset by a few less-desirable features. Fees at many plans could be lower, for example, and many investment choices fail the best-in-class test.
Morningstar's seventh annual study of 529 college-savings plans is based on months of research into more than 50 of the largest 529 college-savings plans that together represent 94% of the industry's $119 billion of assets. Morningstar's mutual fund analysts studied detailed comparisons of the plans' asset allocations, underlying investments, returns, fees, stewardship practices, and tax incentives. The team also discussed investment strategies with the plans' program managers and talked with the states' representatives to determine how they oversee, market, and administer their 529 plans.
From this work, Morningstar developed a new Analyst Rating for 529 plans, and it has been assigned to each of the 52 plans the analysts studied most closely. The Analyst Ratings are Top, Above Average, Average, Below Average, and Bottom. Investors can use these ratings to quickly identify which plans are the industry's best and worst, as well as where plans fall in between.
To earn a Top rating, plans must harness the industry's best practices. Specifically, Top plans have strong investment options run by talented management teams. Those managers typically work for asset-management companies that are good stewards of capital. Top 529 plans charge fair fees for their investment strategies and, in Morningstar's view, are likely to deliver strong long-term performances.
Five 529 plans received Top Morningstar Analyst Ratings and thus make Morningstar's Best 529 Plan list for 2010. These plans are the hands-down best choices for local residents, but they're also contenders for those willing to leave home for a best-of-breed plan. Among the college savers most likely to benefit from an out-of-state plan are those living in states with no tax incentives to stay put and those who intend to save tens of thousands of dollars in a 529 plan. (In-state tax benefits shrink in importance as one's nest egg grows larger.)
Here's what made each of the Top plans stand out:
T. Rowe Price College Savings Plan and Maryland College Investment Plan
Thoughtful Management: Both of these plans are sold directly to college savers (not through a financial advisor) and are run by T. Rowe Price. They feature nearly identical asset allocation and underlying funds. These are two of the few direct-sold 529 plans that emphasize actively managed funds, rather than index funds. As a result, college savers pay more than they would for an indexed-only plan, but they're getting a strong set of funds run by experienced managers. T. Rowe Price has used this lineup well elsewhere, including in the firm's target-date funds, which also earn Morningstar's Top Analyst Rating.
CollegeAdvantage 529 Savings Plan
Low-Cost All-Star Team: This 529 plan, managed by the Ohio Tuition Trust Authority, mixes sought-after money managers from a number of firms. Vanguard runs a set of age-based indexed options, while another track of investments mixes active managers from PIMCO, Vanguard, Oppenheimer, and GE, along with some Vanguard index funds. Morningstar has found it's usually more expensive to offer multiple firms' strategies in a single 529 plan, but this plan's total expenses are among the lowest for their respective strategies.
The Vanguard 529 College Savings Plan
Cheap Indexed Options: The cost of buying index funds in 529 plans went way down in 2010 when Fidelity first announced steep fee cuts within the plans it manages, particularly among indexed options. Vanguard--the industry's leader in indexing strategies--has followed suit, though not for every plan it manages. The Vanguard 529 College Savings Plan, sold through the state of Nevada, features an expense ratio of 0.25% on its age-based options, making it a top choice for college savers. If the $3,000 minimum investment for this plan is too steep, New York's 529 College Savings Program (Direct), another Vanguard-run, direct-sold suite of indexed options, charges the same but requires just $25 to get going. The New York plan, however, lacks international exposure in the age-based tracks.
CollegeAmerica
Steady-Eddie Investments: This Virginia-based plan is the nation's largest, and it's no wonder why. American Funds, a broker-sold family of funds known for its patient, risk-aware investing style, offers its complete lineup here for advisors to mix for their clients. Many broker-sold 529 plans are significantly more costly than their namesake mutual funds, but these are barely higher, and the funds' long-term records are enviable.
Some Plans Have Shortcomings
Not surprisingly, the plans that didn't earn passing marks from Morningstar--those with Below Average and Bottom ratings--fall short where the best plans excel. Two of the three plans earning Below Average ratings are mostly indexed options that now look too expensive relative to the now-lower fees on indexed options from Fidelity and Vanguard. Georgia's Path2College 529 Plan is run by TIAA-CREF and charges nearly twice as much as The Vanguard 529 College Savings Plan's 0.25% per year. The same is true of The Upromise College Fund 529 Plan, which also hails from Nevada and is a clone of The Vanguard 529 College Savings Plan but charges double.
The other plan with room to improve is Tomorrow's Scholar College Savings Plan, one of two broker-sold plans based in Wisconsin. It's rated Below Average because the plan's investment options, which are mostly from Wells Fargo, together have turned in some of the worst risk-adjusted performance relative to similar peers. The plan's asset-weighted expenses are also high.
The only plan to get Morningstar's Bottom rating, CollegeBound fund of Rhode Island, also has a poor long-term track record, but of greater concern is personnel turnover at program manager AllianceBernstein. The firm was hard-hit during the 2008 market downturn. Since then, investors and AllianceBernstein's own personnel have voted with their feet. Many of the funds have been in net redemptions, and key personnel--including several chief investment officers--have left the firm. There are a few bright spots in the organization, but they're not enough to instill confidence that the firm is back on solid footing.
by Laura Pavlenko Lutton | 2010-12-31-
Laura Pavlenko Lutton is an editorial director in Morningstar's fund research group.
