NEW YORK ( TheStreet) -- Faced with steep tuition bills, investors have been pouring money into 529 college savings plans.
In 2012, assets in the plans grew 25% to $166 billion, according to Morningstar. Under the savings program, parents or friends of a child can invest in a fund and owe no taxes on the earnings, provided the money is used to pay tuition bills.
The 529 program can be a valuable resource for people who face tuition costs. But investors must shop carefully. Many of the investment choices are expensive and have delivered uninspiring returns.
According to Morningstar, the average 529 investment has underperformed conventional mutual funds. During the five years ending in January, the average mutual fund in the conservative allocation category -- which holds a mix of stocks and bonds -- returned 4.3% annually, compared to 3.7% for comparable 529 funds.Part of the reason for the weak showing is that 529 plans charge extra layers of fees, says Morningstar analyst Kailin Liu. In a typical arrangement, a 529 fund invests in a portfolio of conventional mutual funds. So an investor must pay the expense ratios of the mutual funds. In addition, the 529 plans charge administrative fees. While the average moderate allocation mutual fund charges an expense ratio of 0.99%, a comparable 529 fund charges a total of 1.22%.
States sponsor the plans, and the fees vary considerably around the country. Among the lowest-cost plans is New York's 529 Program, which charges 0.17%, a total that includes administrative fees and expense ratios on the mutual funds in the portfolio. Near the high end of the spectrum is Iowa Advisor 529 Plan, with a total expense ratio of 1.74%. The plans follow a variety of investment strategies. Among the most popular choices are conservative portfolios that keep a relatively static asset allocation. You start with most assets in bonds, and the allocation stays that way until the child enters college.