Fidelity Investments has created target date investment plans so that you may save for college for your children, family, friends, or yourself. These plans allow you to invest your savings in the hopes of benefitting from their auspicious investment management expertise, so that through their guidance, your contributions will be available to you when they are needed for college. You may choose to invest your funds based upon a target date that your child will enter college, and these portfolios are currently based upon 3 year time frames with the first target date portfolio set at 2009.
The following outlines how you probably think of a 529 plan.
Once you have contributed to the accounts the manager of the plan invests your contribution into the underlying mutual funds based upon an asset allocation tied to the date you have chosen to retrieve your funds. The mutual fund managers then take your contribution (I call it a contribution based upon what happens while it is there) and invest your contribution into individual equities, bonds, and cash or cash equivalents. The manager of the fund makes a determination of what to buy or sell based upon their own personal bias or prescience. In any event you now have your money with some of the most skilled professionals that Fidelity could find.
This is when you should start to get uncomfortable based on what’s coming.
In these target asset allocation funds, there may be no less than 15 individual mutual funds. So what! That will mean that I have 15 of the finest managers on the planet insuring my success! Well…..these individual managers don’t sit around a table and discuss the little tike’s college fund, they have more pressing needs on their minds. You see the Blue Chip Growth manager is managing for ALL of his shareholders based upon the prospectus that guides his asset allocation. By the way, you’ll see that the Blue Chip Growth fund must invest at least 80% of its assets in equities, AT ALL TIMES. But no need to fret, the Disciplined Equity fund must invest at least 80% of its assets in equity securities, AT ALL TIMES. In fact, of the 9 Fidelity mutual funds shown in the Fidelity mutual fund guide for year-end 2008, 8 of the equity funds listed on P.478 that allocate contributions for the plan, are required to have at least 80% of their assets invested in equities, AT ALL TIMES. Only the Growth Company fund does not have this requirement. The College Investing Plan Fact Kit is quite an interesting read. It can be found at: http://personal.fidelity.com/planning/pdf/ma_cit.pdf and it outlines these facts. So while you are off running errands and looking after dinner for the family, and the market is crashing, no one is trying to make sure your money isn’t. Why? Because the equity funds are suppose to have at least 80% of your assets invested, AT ALL TIMES.
Let’s say you just sent in a contribution to your 2012 target asset allocation plan. You probably expect that the 529 plan manager will invest your 529 contribution for you. You are probably thinking that Fidelity determined which funds to purchase, and that they are placing a small percentage of your contribution into an assortment of many Fidelity mutual funds. Right? Well not exactly. The money goes into a giant pot that is called the 2012 target asset allocation 529 plan (or trust). The manager (trustee) of the plan makes the decision which mutual funds to use in the plan and the portfolio allocations. The decision of which funds to use seems to be somewhat static. By the way, the state of Massachusetts is making that decision, not Fidelity, and least I forget, they take 15 basis points per year, on the assets in the accounts, as the fee to trustee this operation. (Some might call that a tax but I won’t, besides, I’m sure that the trustees are finding ways to spend the money to foster more money going into 529 plans) However, the state of Massachusetts does not back the investments in the account, nor do they promise that the account will increase or won’t decrease.
This is when you should start to sweat profusely. (I’m pretty sure that you thought Fidelity made that decision)
There is an eventual allocation of the giant pot into the 15 various mutual funds so that everyone that owns the 2012 target asset allocation 529 plan is invested in the underlying funds. However, you will find in the Participation Agreement for the 529 Plan that you actually own units not shares, even though your statements say shares. No big deal, it just makes the accounting a whole lot easier and reduces the expense of trying to deal with so many people wanting to invest in the 2012 target asset allocation 529 plan. One thing you should know though, the units are not registered with the SEC or any other state securities commission, and oh yeah, the portfolios are not mutual funds. You see each portfolio is like a fund of funds. Thus it reduces costs and those savings are passed on to you. (Really?) So instead of worrying about everyone, they can manage one giant pot of money devoted to the 2012 target asset allocation 529 plan and then just make accounting entries for you to see your portion. You see these plans are custom strategies, or so says Fidelity’s 529 College Planning Group. So they have developed this custom strategy for the little tike. Heaven knows what all the rest of the $400 million that’s in the pot is for!
Finally, let’s get back to the decision that the state of Massachusetts makes in making sure the right funds are in the plan. For brevity’s sake we’ll only look at the funds that are invested in equities. According to Fidelity’s Mutual Fund Guide of Year End 2008 there are 9 Fidelity equity funds in the 2012 plan. The following chart displays their Morningstar ratings and their asset levels over different time frames.
Morning star Rating Assets in 2003 Assets in 2008
Blue Chip Growth 3 stars $22.3 BB $8.6 BB
Dividend Growth 2 stars $18.1 BB $5.3 BB
Equity Income 2 stars $23.5 BB $17.3 BB
Equity Income II 2 stars $12.2 BB $5.1 BB
Disciplined Equity 3 stars $3.9 BB $9.0 BB
Growth Company 4 stars $22.6 BB $21.5 BB
OTC 3 stars $7.9 BB $3.2 BB
Small Cap Independence 3 stars $949 MM $1.20 BB
Lg Cp Core Enhanced Index N/A N/A $862 MM
Of the 9 funds only 1 has a rating of 4 stars or higher, and if you don’t know, the highest rating is 5 stars. Of the 9 funds, 3 have shown increases in assets since 2003. This would be fairly remarkable given the market’s plunge, however, one of the funds is new and has a majority of the different 529 plans money as its primary investment. The other 2 funds have negative returns for the 5 year period 2003 through 2008 according to the mutual fund guide from Fidelity for year-end 2008. The average rating on funds, for those funds that have ratings, comes in at a resounding 2.75 stars, not exactly “stellar.” Are these the best managers that the state of Massachusetts could find? Hey! So when do we talk about returns?
Here is where you start breaking things.
Fidelity offers many different types of plans. Some are conservative, some are aggressive, and some involve money markets or treasuries. There are 26 different plans to chose from so you would think that one might be the custom fit that you are looking for, but wait, 16 of the 26 different plans are showing negative returns since inception! This means that on those sixteen plans Fidelity and the state of Massachusetts were paid from your contributions to watch over your investments while the contribution that you made lost money. http://personal.fidelity.com/global/search/inquira/resultsindex.shtml?question=529%20Plans
In essence this is a passive management program masquerading as an actively managed, customized, tax deferred, college savings plan. It is passive for it does not make decisions to reduce the asset allocation until time passes. As long as the market is going up you win, they win, life is rosy! However, when the market retreats, and the allocation to equity securities falls only to a minimum level of investment in equities, you lose, your intended beneficiary loses, and Fidelity and the state of Massachusetts receive their fees.
So what do you do?
Here is an excellent article from Bankrate.com that might help you at least secure some tax advantage if you have had tax losses from your investing in 529 plans. http://www.bankrate.com/finance/college-career/529-plan-moves-to-make-now.aspx. More importantly, you should rethink the process of investing for college. Meet with a financial planner and have them educate you on costs, investment options, tax liabilities, and alternatives for saving for college. Make sure that the financial planner is a CERTIFIED FINANCIAL PLANNER. If you use them they have a fiduciary responsibility to you. This is an important distinction that is to your benefit.
529 Plans might be the way to go for you even considering the information above. But for many, they are finding out too late that what they thought was a “smart move” turned out to be just that, just not for the intended beneficiary.
Some other articles of note that you should consider:
http://www.bloomberg.com/apps/news?pid=20601103&sid=afmB.7qR9z2M&refer=us
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