Expenses continue to shrink, but mutual funds are still cheaper.
While the gap is shrinking, the costs of 529 college savings plans continue to create a tough hurdle when compared with traditional mutual funds.
As part of its annual study of the 529 college-savings-plan industry, Morningstar's team of analysts dug into the costs associated with 529 plans. Because of many factors, including smaller asset bases and costs associated with state-level administration and marketing, 529 investment options typically carry more-expensive price tags than comparable traditional open-end mutual funds.
Fortunately for college savers, costs across the industry have come down in recent years. Since Morningstar began tracking the movements in 529 investments' fees in 2010 through the end of 2013, the cost gap between the average 529 category expense ratio and that of the analogous open-end mutual fund category has shrunk to 21 basis points from 40 basis points.
The lower-cost trend is due to a number of factors, including a growing use of low-cost passive mutual funds and exchange-traded funds for age-based and stand-alone investment options. In addition, several plan sponsors and program managers have aggressively cut administration and maintenance costs. For example, Fidelity is the program manager of four direct-sold plans and, along with its state sponsors, cut fees at each of the plans' index-based options below most peers'.
Costs have decreased on average, although all but one of Morningstar's 529 categories still cost more than their respective open-end category. The largest gap is among aggressive-allocation investments, in which the typical 529 aggressive-allocation option costs 35 basis points more than the typical open-end mutual fund. The only category to reverse this trend is large blend, in which the average 529 option costs 5 basis points less. The large-blend category is home to index funds that track prominent U.S. stock indexes, such as the S&P 500, and passive investments cost less than most category peers. As passive investments have taken up a prominent position in many 529 plans, it makes sense that this category carries a generally lower price tag.
The Method Matters
To better compare 529 expenses across plans, Morningstar divided 529 age-based options into groups based on their distribution channel and underlying investment types. After dividing the age-based options by whether they are direct- or advisor-sold, Morningstar categorizes the options into one of three groups: actively managed, passively managed, or a blend of the two. (The "blend" groups are defined as having between 20% and 80% in active management.) Morningstar then determines the average total expense ratio for each age-based track.