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Given the importance of saving for college and the nearly $40,000 in debt the average student has upon graduating, 529 plans have become a go-to vehicle for many families looking to defer the cost of higher education.
However, 529 plans aren’t all created equally. There are many moving parts and those that use mutual funds in their master portfolios offer some very unique advantages for savers. Understanding how they can be used to craft portfolios for college savings is key.
Click here to learn more about mutual funds.
When savers invest in a 529 plan, what they are really doing is buying into a so-called master portfolio. These master portfolios can be tied to various allocation or age-based strategies or seek to invest in a certain segment of the market. 529 plan program managers select the underlying investments in each portfolio. Mutual funds offer several benefits in this selection.
For starters, many 529 plans that use mutual funds in their master portfolios have access to the cheapest or institutional share classes. This provides lower expense ratios than other share classes. For example, the Vanguard Growth Index Portfolio 529 Plan option uses the Vanguard Growth Index Fund Institutional Shares (VIGIX) as its sole holding. This provides a rock-bottom expense ratio of just 0.04%. The same is true for many allocation 529 plans as well. The Pennsylvania Aggressive Growth Portfolio 529 Plan portfolio uses the Vanguard Institutional Total Stock Market Index Fund (VITSX) and Vanguard Total International Stock Index Fund (VTSNX) to build its portfolio. Again, these institutional shares provide lower costs for savers. Lower costs mean more money compounding for college savings.
The second place where mutual funds can shine is in active management. While many 529 plans using mutual funds – and all plans using ETFs – are indexed, there are some that take advantage of active management. Active management takes a very different approach and provides a very different set of return expectations. Active managers can potentially boost returns as well as limit losses in down markets.
Meanwhile, they can potentially enter different asset classes not readily available in indexed 529 plan options. A prime example would be the American Funds suite of College Target-Date plan options. Here as part of their allocation strategies, the master portfolios invest in the American Funds Mortgage Fund (MFAAX). This provides exposure to MBS and commercial mortgage bonds. That’s an asset class not readily available in many plans.
Finally, one of the main flaws with mutual funds is overlooked in 529 plans. Capital gains and dividends can provide some tax headaches and inefficacy. However, since 529 plans are tax-deferred vehicles, these payouts from mutual funds aren’t taxed when the master portfolio receives them. Investors never feel the brunt of the tax liability.
This is what we hope to do at 529s.com. We plan on building out the site as a one-stop hub for investors looking at direct-sold and advisor-sold college savings plans. This includes the latest data on the various master portfolios using mutual funds – both active and passive – as well as tools to help screen, compare and analyze investment options. This way savers can feel comfortable about the mutual funds and master portfolios they place their savings in.
Moreover, 529s.com will be the place to find the latest news related to everything in college savings plans. This includes everything from new regulations and withdrawal methods to using mutual funds in order to build a custom college savings plan that’s right for you.