College savings funds can include a variety of investments, such as stocks, bonds, and money market accounts.

How to Select Mutual Funds Within 529 Plans

Experts offer tips for choosing specific investments within colleges savings plans.

College savings funds can include a variety of investments, such as stocks, bonds, and money market accounts.
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529 plans, named for the section of the Internal Revenue Code under which they were created, are considered education savings plans with tax benefits.

However, that may be a misnomer: Unless a parent or grandparent chooses to solely invest in savings accounts, 529 plans are actually investment accounts comprised of a variety of investment types, from mutual funds to savings accounts to money market accounts. 

The majority of investments not in a cash portion are mutual funds, a collection of stocks, bonds, or other assets purchased in shares. While most plans offer a predetermined mix of investments designed to automatically reduce mutual fund investments as children age or to maintain parents' or grandparents' desired risk levels, 529 plans vary in qualities such as price, portfolio management strategies, and investment options. 

Parents and grandparents have a choice of more than 100 plans across the country, notes Michael Conrath, 529 program director at J.P. Morgan Asset Management. 

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There are 529 plans available in both active and passive investments. Passive may seem like a "set it and forget it" plan chosen based on the child's age; however, the term passive doesn't usually refer to a way of choosing a plan, says Chadderdon O'Brien, Certified Financial Planner® at New Providence, N.J.-based Lassus Wherley. Instead, the term refers to certain investments—such as mutual funds based on an index, a collection of stocks that represent a sector of the economy. 

The S&P 500 Composite Price Index is comprised of stock from 500 large companies; there are also indices for mid-sized company funds, smaller company funds, and foreign companies. Indexed funds are generally less expensive to operate and thus cost less for 529 plan investors to own, because the investment manager always invests in companies based on who's in the index, O'Brien says. 

Active funds generally have a goal of beating an index by a certain percentage rate or taking less risk, O'Brien says. The goal is always stated in the mutual fund prospectus, the required disclosure documents for shareholders. Search for prospectuses at the Securities and Exchange Commission's website, as well as tips on how to read them

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Another way to find out is to ask the plan administrator about the goals of the fund O'Brien says. Or, get information on websites such as as to whether mutual funds are meeting goals over time, he says. Parents and grandparents can also get mutual fund information at U.S. News & World Report's Best Funds site.

A benefit to actively managed funds is that portfolio managers can change which companies are invested in within the fund to either take advantage of positive economic changes or reduce risk, J.P. Morgan's Conrath says. An indexed fund investment manager sticks with the market index no matter how individual companies or the economy as a whole is performing. 

Whether a plan manager chooses active or passive investments, or a combination of both, investors want a variety of mutual funds in their portfolios because it's unknown when one group of companies will do better than another, Conrath says. This is because even the strongest companies have bad years, he notes. 

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"In the past decade, the S&P 500 index has been one of the worst-performing asset classes," Conrath says. "Selecting a wide variety of investments within a 529 plan is crucial." 

In addition to the variety of active and passive investment mutual funds, O'Brien says it's important to consider the performance record for the active investment managers relative to their benchmark, fees, inflation protections, and years until your child will need the money for education expenses. You can compare more than a dozen factors, including investment managers, on sites such as the College Savings Plan Network, which represents all 50 states' 529 plans.