Morningstar, the global investment research firm has published its annual list of the best and worst 529 plans – when it comes to earning long-term returns for college savers – and the overall opinion smacks of optimism. Some of the worst plans from years past have folded up and gone away, while others continually strive to improve.
Here are the criteria that separate the best plans from the worst:
- Flexibility. As Morningstar points out, no savings plan is one-size-fits-all. Investors differ by risk tolerance, by the time until the college funds are needed, and by the amount of principal available to invest.
- Fees. Fees come directly out of returns, so higher fees mean lower returns. Morningstar has long maintained that, when it comes to college savings plan fees, it is not true that you get what you pay for. Since most plans are based on "similarly constructed index funds," it is safe to go with an otherwise quality plan that also has low fees.
- Diversification. Funds that rely heavily on one segment of the market could lead to high volatility and low returns, depending on the performance of that sector.
- Underlying funds. Morningstar looks for seasoned managers, shareholder friendliness, and sensible strategies.
Four plans made this year's best list:
Illinois Bright Start College Savings Program. This is a fund that Morningstar says has undergone a Cinderella-style transformation, by switching to a stronger program manager (OppenheimerFunds, Inc.), charging "rock-bottom fees," and giving investors better choices, between all-index funds and age-based funds (that is, funds that grow more conservative as future college students gets closer to college age).
Maryland College Investment Plan. This low-fee plan offers a good mix of strategies that emphasize value and others emphasize growth, and that include mid-cap and small-cap exposure. Investors can also choose to customize their plans based on five static portfolios.
Virginia Education Savings Trust and Virginia College America 529 Savings Plan. Both of these low cost plans represent the best in class, according to Morningstar. The VEST offers excellent management, proven index offerings, or alternatively, several single fund options that investors can use to diversify, such as international funds and REITS. The College America fund offers a wide assortment of quality American funds over many strategies and asset classes.
Colorado Scholars Choice College Savings Program. This broker sold plan is a continuing favorite for Morningstar. It offers a sensible split between growth and value strategies. Or, investors can use static portfolios that can be customized. Besides reasonable fees, this plan also offers an impressive array of proven managers.
Also deserving of mention are two more plans that did not make this year's list: the College Savings Plan of Nebraska, and the Utah Educational Savings Plan (which made last year's list). Both are still high-quality, but were bumped by plans with lower fees.
Three plans made this year's worst list:
Mississippi Affordable College Savings Program and Mississippi Affordable College Savings Advisor Program (broker sold). These plans, managed by TIAA-CREF, offer limited options, are inflexible, rely too much on index funds, and charge excessively high fees which don't seem to be justified by the performance of the programs. Morningstar does point out that some state plans include attractive tax deductions for contributions to the plans, but the negatives of the plans may outweigh the tax benefits.
New York 529 College Savings Program. This plan is troubling because it lacks diversification and offers no exposure to international markets. That means investors will not be able to take advantage of gains in foreign markets, and overexposes them to risk when U.S. markets turn down.
Nebraska AIM College Savings Plan. This plan returns to the worst list for the second year in a row. It has made some changes but still charges fees that are too high and tilts too far towards growth portfolios. Investors are advised to check out the state's two direct-sold plans for better options.
Three other plans didn't make the official list, but deserve what Morningstar calls a "dishonorable mention." Iowa's Advisor 529 Plan is based on solid underlying funds, but lacks diversification and includes layers of fees. The Kentucky Education Savings Plan Trust is inflexible and gives investors few options for customization. Alabama's Higher Education 529 Fund has improved its equity line-up and made its fees more competitive. But the state's practice of taxing the earnings of out-of-state plans effectively twists the arms of investors to adopt the state plan. Morningstar would like to see Alabama adopt tax standards that are closer to the industry norm.