In the past, we've been able to laud the 529 industry for lowering fees, improving investment options, and closing down poorly structured plans. Unfortunately, the past year hasn't been so rosy in the college-savings universe. Several plans had maintained too-aggressive asset allocations for students nearing or in college, while other plans were hamstrung by their allegiances to floundering investment options.A Major Player Stumbles
OppenheimerFunds is the poster child for how badly some 529 players went awry in 2008. Over the past few years, the company had firmly established itself in the 529 college-savings universe. The firm currently manages nine separate college-savings plans, both advisor- and direct-sold, in five states. Unfortunately, all of those plans had exposure to one of the worst bond-fund blowups in 2008. Oppenheimer Core Bond
(or separate accounts managed in the same style), a fixture in those Oppenheimer-managed 529s, lost more than 35% in 2008 due to management's bets on nonagency mortgages. In particular, management gained exposure to the battered commercial mortgage-backed securities market through derivatives that had a leveraging effect on the fund, amplifying losses. But it didn't stop with just Core Bond. Many of the Oppenheimer plans also had exposure to Oppenheimer Limited-Term Government
and U.S. Government
, two other troubled fixed-income funds that were run by the same management team as Core Bond. Government bonds were the only pocket of strength in 2008, but these funds managed to finish last year in the red despite their focus on that asset class. The reason? The funds owned mortgage-related securities and derivatives that weren't backed by the U.S. government, including commercial mortgage bonds that dropped precipitously last year. (Like most government funds, these two have the ability to invest up to 20% of their assets in nongovernment securities.)
In fact, one of those nine Oppenheimer-managed plans, Illinois' direct-sold Bright Start College Savings Plan
, made our best list last year. The previously named "Active Portfolios" were caught up in Oppenheimer's fixed-income fiasco. The losses were so unprecedented that in mid-January 2009 Illinois' State Treasurer Alexi Giannoulias indicated that he was preparing to file a lawsuit against OppenheimerFunds. At the same time, the state also reacted by no longer offering the three troubled Oppenheimer fixed-income products, but existing shareholder money is still tied up in them. All told, the plan still holds plenty of appeal; its untainted "Index Portfolios" are still the cheapest nationally available Vanguard options.
The worst part for investors in these plans is that the Oppenheimer portfolios positioned closest to college were the ones holding the largest positions in these bond funds. Thus, even though fixed-income investments are typically considered more conservative than equities, the plans' bond options didn't provide the ballast that one might have expected--far from it. For example, Texas' direct-sold College Savings Plan's "Blended Age-Based 15 - 17 Years Portfolio," which had half its assets in Core Bond, fell nearly 30% in 2008, compared with less than half that amount at many peers in a similar age-band. A similar pattern of losses can be found in the same age band at nearly every Oppenheimer-managed 529 plan.Risky Age-Based Options
Unfortunately, the Oppenheimer-managed plans weren't the only ones with problematic age-based options. Age-based options are designed to transition from mostly equities in a younger child's account to more conservative investments--bonds and cash--as the beneficiary approaches college. There's not a strong consensus on the exact amount of stocks, bonds, and cash to hold for a particular time horizon, but it's clear to us that some plans didn't move out of equities fast enough and were courting far too much risk given that they were geared toward students getting close to matriculation. After all, most students deplete their 529 assets in the space of four years, leaving little time to recover from a serious market downturn like 2008's.
The most striking example of an overly aggressive asset allocation comes from one of Utah's
five age-based options. That plan's "S&P and Bonds" age-based option stashes 65% of assets in equities for a college-enrolled beneficiary. This is dangerously bold, in our opinion. It's important to note, however, that this best-in-class plan features four other age-based options with much more sensible structures.
An overly aggressive asset-allocation framework becomes a more serious issue when investors are offered only a single age-based choice. For example, Oregon's OppenheimerFunds 529 Plan
has just one age-based option, and until March 30, 2009, the plan's "1-3 Years to College" portfolio had 40% devoted to equities, with more than 5% in foreign stocks. Additionally, New Jersey's direct-sold plan
has just one age-based option that can have as much as 35% in equities--including up to 12% in international and 6% in smaller-cap fare--for a beneficiary already enrolled in college. The critical lesson for investors is to pay particular attention to the latter stages of a plan's age-based option, and be sure you are comfortable with the risk your plan is taking.Our Methodology
The terrible performance of some 529 plans in 2008 clearly illustrates that, now more than ever, investors can't afford to invest in anything but best-of-breed college-savings plans.
To arrive at our annual list of the best and worst 529 plans, we've combed piles of 100-plus page plan documents, talked with several plan sponsors and used our own tools to evaluate these plans. There's an enormous amount of data to review, but the critical features we focus on are asset-allocation schemes, fees, flexibility, and the overall quality of the underlying investments.
We like to see plans that have sensible allocations among stocks, bonds, and cash that are appropriate for the age of the beneficiary. We like to see plans that are not only well-diversified across the major asset classes, but are also exposed to such areas as foreign bonds, real estate investment trusts, and Treasury Inflation-Protected Securities for added diversification benefits.
Fees are another important item to consider. Morningstar and others have consistently found that costs are the best predictors of a mutual fund's long-term success, and one can safely extrapolate those findings to the 529 universe as well. Expenses are especially important for the growing number of index-centric plans, which have little else besides expenses to distinguish them.
Flexibility is also an essential ingredient to a 529 plan. In addition to multiple age-based options with differing levels of risk, we also like to see a few fixed-allocation offerings (that is, the level of stocks, bonds, or cash does not change over time) and a good selection of single-fund options for do-it-yourself investors or for advisors looking to tailor-make a portfolio for clients. Finally, the quality of the underlying investments is an important consideration. We look for funds that have experienced managers, a history of good stewardship, and sensible strategies.
Using those criteria, we've ferreted out what we believe to be the five best and five worst college-savings plans in the country. It's important to point out that, although we tend to put newcomers at the top, we don't rank plans within each list. This year's Best and Worst lists are a good deal different from last year's lists--with two newcomers on the Best list, and three on the Worst list.The Best 529 College-Savings PlansOhio CollegeAdvantage 529 Savings Plan
Ohio is in an interesting position. The state has two plans at opposite ends of the quality spectrum, with this direct-sold plan
securely in the "best" camp. One of the most important features of this plan is that the Ohio Tuition Trust Authority not only created the plan, but it also manages it directly. (Most 529 plans, by contrast, use mutual fund companies as program managers.) This setup is rare in the 529 universe and it gives the OTTA more freedom to choose from a variety of mutual fund families, such as Vanguard, PIMCO, GE Asset Management, and Fifth Third Bank (for CD options). We like the flexibility here, too. The plan offers four distinct age-based options--all with sensible asset-allocation schemes--with a choice between active and index strategies. Additionally, it offers a bevy of individual fund options--both active and passive. Finally we like the low fees of this plan. Total expenses are 0.23% to 0.47% for the age-based options, 0.24% to 0.46% for the static options, and 0.23% to 0.91% for individual fund options. And the deal is sweetened for in-state residents who can deduct up to $2,000 of contributions. (Excess contributions can even be deducted in later years.)
Indiana CollegeChoice 529 Direct Savings PlanThis direct-sold plan
is a newcomer to Morningstar's 529 Best list. Upromise Investments--a subsidiary of the popular Upromise rewards program--took over this plan from J.P. Morgan in the fall of 2008 and upgraded it to a best-in-class choice for investors. This plan keeps it simple, but it gets kudos in a number of areas. First, the plan is built with solid underlying funds from the likes of Vanguard, Dodge & Cox, and Western Asset. The underlying holdings cover all the major asset classes and even include exposure to Treasury Inflation-Protected Securities as a single-fund option. The plan also offers sensibly constructed age-based portfolios and six individual fund options for those who want to customize their portfolios. Fees are very reasonable, ranging from 0.35% for a total stock market index fund to 0.95% for a single-fund international portfolio, while costs for the age based options hover around a modest 0.51% to 0.53%. To top it off, Indiana residents receive a 20% tax credit, up to a maximum of $1,000 per year, on contributions.The Utah Educational Savings Plan Trust
For those who want a tax-sheltered way to save for college using Vanguard index funds, this is the plan. Utah's 529 plan
has long been a favorite of ours and remains a strong choice for its low costs, flexibility, and tried-and-true Vanguard index funds. The plan's fees are a rock-bottom 0.22% to 0.35%, making it one of the cheapest plans in the country. The plan offers plenty of flexibility with five distinct age-based choices, which gives investors a good deal of choice to match the options with a level of risk they are comfortable with. (Even the most risk-tolerant investors should steer clear of the aforementioned "S&P and Bonds" option, however, which has nearly two thirds of assets in equities for college-aged beneficiaries.) Investors also have the option of three individual funds and a few static options to augment the age-based options or build their own portfolios. We'll admit it's not an exciting option, but as this market has demonstrated
, it's tough to argue with the merits of a passive, low-cost approach.Virginia Education Savings Trust (direct-sold) and Virginia CollegeAmerica 529 Savings Plan (broker-sold)
The final two plans are the only carryovers from last year's Best list. The Education Savings Trust
has a lot in common with Ohio's direct-sold plan. Similar to the Buckeye plan, Virginia not only sponsors the plan but it also manages it (instead of using a mutual fund firm). So it's not a big surprise to see plenty of diversification across different mutual fund families. The plan's age-based portfolios offer a compelling mix of solid actively managed and index offerings from such shops as Vanguard, Templeton, and Capital Research (advisor to the American Funds). We also like the plan's sensible mix of static-blend options and a smart selection of single fund options that not only cover the three core asset classes, but give investors access to real estate investment trusts and TIPS. The plan also offers residents generous state income tax breaks up to $4,000 of contributions per year--doubling last year's limit and still retaining the benefit that excess contributions can be deducted in later years. Finally, a nice price tag that ranges from 0.31% to 0.54% rounds out the appealing package here.
The state's other topnotch choice, the advisor-sold CollegeAmerica plan
, remains a favorite for its large selection of mostly first-rate American Fund mutual funds that give investors access to a broad array of asset classes, including emerging markets, small-cap foreign stocks, and foreign fixed-income securities. Fees are attractive, too, as most of the plan's A-share options are below 1.00% in total annual fees.