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How to select investments in a 529 plan
http://www.savingforcollege.com/articles/how-to-select-the-best-investments-for-your-529-plan-956

Posted: 2016-07-15

by Brian Boswell

There are two types of 529 plans: savings plans and prepaid tuition plans. Savings plans work much like a 401K or IRA by investing your contributions in mutual funds or similar investments. The plan will offer you several investment options from which to choose, and your account will go up or down in value based on the performance of the particular option you select. If, like most college savers, you're using a 529 savings plan, you'll need to choose an investment option at the time that you open your account.

So, which investment option should you choose? To help you decide, let's explore the three main types of investment options offered by 529 plans. Keep in mind that not every 529 plan offers all three options.

1. Age-based portfolios

Age-based investment options, sometimes called target-date portfolios, allow a 529 account owner to "set it and forget it." Once you deposit funds in the portfolio it automatically changes its asset allocation – the unique mix of stocks, bonds, and other underlying investments – to become more conservative as the beneficiary approaches college age.

There are two kinds of age-based options depending on the particular 529 plan you choose. In one, the portfolio itself is actively managed to become more conservative over time. In the other, your money is moved from one portfolio to another automatically. In the industry, how your assets are reallocated over time is referred to as their "glidepath." For the average 529 account owner there isn’t a material difference between reallocation methodologies, and both get you from point A to point B.

One thing you do want to note, however, is how aggressive or conservative the age-based options are. This can vary widely by plan as every manager has its own unique model defining the level of appropriate risk for a given age. Some plans may have a sizable allocation to equities during the college years, the theory being that with a relatively short time horizon the investor needs to be somewhat aggressive to make up for a shortfall. Others go the other way and end up almost 100% in cash equivalents, so you have little if any potential return during college, but much lower risk of principal loss. If you are investing on your own be sure to review the respective glidepath so you are comfortable with the level of risk you would be taking on.

RELATED: Asset allocations in age based portfolios

Lastly, you'll want to take a look at the fees for the portfolios. Every plan is structured differently. While some have dedicated, standalone underlying target-date portfolios, others invest in a mix of funds and charge a fee to conduct asset allocation. You can compare the expenses here.

2. Target-risk portfolios

Target-risk portfolios, also called Static portfolios, maintain a specific asset allocation and adjust that allocation regularly to match its target. They usually have names like "Aggressive Growth Portfolio," "Income Portfolio," etc. An aggressive growth portfolio may invest the majority of its assets in international and domestic equities with a focus on growth. Conservative portfolios will invest in a mix of fixed income and cash-equivalent securities. Depending on the plan, however, the allocation may be more or less heavily allocated to one asset class or another. As a result, you want to review the target asset class mix of the portfolio to make sure its definition of conservative matches your own.

As with age-based options, you'll want to review fees and expenses before choosing a static portfolio. Avoid target-risk portfolios where the plan layers a fee on top of a mix of its other portfolios. You can replicate the asset mix with the individual portfolios yourself and reallocate twice per year- you should be reviewing your accounts at least that often anyway.

RELATED: The 529 plan F-Word

3. Individual portfolios

Individual portfolios are typically mirrors of their underlying investments. For example, The Indiana CollegeChoice Direct Plan has a portfolio called the "U.S. Equity Index Portfolio." It invests 100% of assets in the Vanguard Institutional Total Stock Market Index Fund. If you are more analytically-minded and prefer to customize your investment lineup then these are the options for you.

The majority of plans use exchange-traded or open-ended mutual funds for their underlying investments (there are exceptions such as separately managed accounts and savings accounts). If you really want to dig deep, you can research the underlying investments themselves to look at things such as manager tenure, portfolio turnover, and style drift. However, for most investors this is beyond the necessary scope to make a reasonable investment selection inside a 529 plan.

You could also create your own age-based/target-date portfolios with a combination of individual portfolios. However, it requires diligence on the part of the account owner to maintain a particular investment mix as the value of the portfolios change. Further, you are limited to two investment exchanges per year, so if there is a sudden change in a particular asset class and the account owner wants to make a tactical change, they would need to use one of their exchanges to make it.

Investment option details

You can see the details of the underlying portfolios of a particular 529 plan by visiting your selected plan's details page and scrolling down to the Investment Options section. There you can click on "See Investment Options" to view the portfolio options in any given plan, including information on fees, performance, and more.

A word on fees

As an account owner, you buy units through the 529 plan, which adds a layer of fees to pay for administration and oversight of the plan. The reason for these fees - and you pay them regardless of the investment option – is that when you invest in a 529 plan you purchase portfolio units, rather than the underlying assets themselves. This is because 529 plans are considered municipal securities. From an administrative perspective, the state "issues" the plan, and the account owner buys units of the issue. This layer of fees is typically small to negligible, and getting smaller all the time, but all the same you want to be sure you compare plans to make sure that you are minimizing your expenses.

Fees and expenses can eat away at your investment returns and shrink your savings. Fortunately, many 529 plans have been reducing their fees and there are many low-cost options to choose from. It is always a good idea to compare fees before deciding which 529 plan and investment portfolio to choose.

RELATED: 529 Fee Study

There are two types of 529 plans: savings plans and prepaid tuition plans. Savings plans work much like a 401K or IRA by investing your contributions in mutual funds or similar investments. The plan will offer you several investment options from which to choose, and your account will go up or down in value based on the performance of the particular option you select. If, like most college savers, you're using a 529 savings plan, you'll need to choose an investment option at the time that you open your account.

So, which investment option should you choose? To help you decide, let's explore the three main types of investment options offered by 529 plans. Keep in mind that not every 529 plan offers all three options.

1. Age-based portfolios

Age-based investment options, sometimes called target-date portfolios, allow a 529 account owner to "set it and forget it." Once you deposit funds in the portfolio it automatically changes its asset allocation – the unique mix of stocks, bonds, and other underlying investments – to become more conservative as the beneficiary approaches college age.

There are two kinds of age-based options depending on the particular 529 plan you choose. In one, the portfolio itself is actively managed to become more conservative over time. In the other, your money is moved from one portfolio to another automatically. In the industry, how your assets are reallocated over time is referred to as their "glidepath." For the average 529 account owner there isn’t a material difference between reallocation methodologies, and both get you from point A to point B.

One thing you do want to note, however, is how aggressive or conservative the age-based options are. This can vary widely by plan as every manager has its own unique model defining the level of appropriate risk for a given age. Some plans may have a sizable allocation to equities during the college years, the theory being that with a relatively short time horizon the investor needs to be somewhat aggressive to make up for a shortfall. Others go the other way and end up almost 100% in cash equivalents, so you have little if any potential return during college, but much lower risk of principal loss. If you are investing on your own be sure to review the respective glidepath so you are comfortable with the level of risk you would be taking on.

RELATED: Asset allocations in age based portfolios

Lastly, you'll want to take a look at the fees for the portfolios. Every plan is structured differently. While some have dedicated, standalone underlying target-date portfolios, others invest in a mix of funds and charge a fee to conduct asset allocation. You can compare the expenses here.

2. Target-risk portfolios

Target-risk portfolios, also called Static portfolios, maintain a specific asset allocation and adjust that allocation regularly to match its target. They usually have names like "Aggressive Growth Portfolio," "Income Portfolio," etc. An aggressive growth portfolio may invest the majority of its assets in international and domestic equities with a focus on growth. Conservative portfolios will invest in a mix of fixed income and cash-equivalent securities. Depending on the plan, however, the allocation may be more or less heavily allocated to one asset class or another. As a result, you want to review the target asset class mix of the portfolio to make sure its definition of conservative matches your own.

As with age-based options, you'll want to review fees and expenses before choosing a static portfolio. Avoid target-risk portfolios where the plan layers a fee on top of a mix of its other portfolios. You can replicate the asset mix with the individual portfolios yourself and reallocate twice per year- you should be reviewing your accounts at least that often anyway.

RELATED: The 529 plan F-Word

3. Individual portfolios

Individual portfolios are typically mirrors of their underlying investments. For example, The Indiana CollegeChoice Direct Plan has a portfolio called the "U.S. Equity Index Portfolio." It invests 100% of assets in the Vanguard Institutional Total Stock Market Index Fund. If you are more analytically-minded and prefer to customize your investment lineup then these are the options for you.

The majority of plans use exchange-traded or open-ended mutual funds for their underlying investments (there are exceptions such as separately managed accounts and savings accounts). If you really want to dig deep, you can research the underlying investments themselves to look at things such as manager tenure, portfolio turnover, and style drift. However, for most investors this is beyond the necessary scope to make a reasonable investment selection inside a 529 plan.

You could also create your own age-based/target-date portfolios with a combination of individual portfolios. However, it requires diligence on the part of the account owner to maintain a particular investment mix as the value of the portfolios change. Further, you are limited to two investment exchanges per year, so if there is a sudden change in a particular asset class and the account owner wants to make a tactical change, they would need to use one of their exchanges to make it.

Investment option details

You can see the details of the underlying portfolios of a particular 529 plan by visiting your selected plan's details page and scrolling down to the Investment Options section. There you can click on "See Investment Options" to view the portfolio options in any given plan, including information on fees, performance, and more.

A word on fees

As an account owner, you buy units through the 529 plan, which adds a layer of fees to pay for administration and oversight of the plan. The reason for these fees - and you pay them regardless of the investment option – is that when you invest in a 529 plan you purchase portfolio units, rather than the underlying assets themselves. This is because 529 plans are considered municipal securities. From an administrative perspective, the state "issues" the plan, and the account owner buys units of the issue. This layer of fees is typically small to negligible, and getting smaller all the time, but all the same you want to be sure you compare plans to make sure that you are minimizing your expenses.

Fees and expenses can eat away at your investment returns and shrink your savings. Fortunately, many 529 plans have been reducing their fees and there are many low-cost options to choose from. It is always a good idea to compare fees before deciding which 529 plan and investment portfolio to choose.

RELATED: 529 Fee Study

 

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