When I started my first 401k about three years ago, I was boggled by the fund choices given to me. I ended up picking the Fidelity Freedom 2040 Fund (FFFFX), probably for the reason most people do – it looked simple and had tons of funds with great sounding names in it. Disciplined Equity? Value? Growth and Income? They all sounded pretty good to me. Who doesn’t want some discplined investing, value, or growth?
But what are you really buying? If you read its information page you see that this fund of funds includes 17 different stock funds and 6 different bond funds:
Equity Funds
Fidelity Growth & Income Portfolio 11.15%
Fidelity Blue Chip Growth Fund 10.06%
Fidelity Equity-Income Fund 10.04%
Fidelity Disciplined Equity Fund 10.03%
Fidelity Mid-Cap Stock Fund 6.44%
Fidelity Growth Company Fund 6.44%
Fidelity Europe Fund 5.55%
Fidelity OTC Portfolio 5.12%
Fidelity Overseas Fund 4.13%
Fidelity Diversified International Fund 4.10%
Fidelity Value Fund 3.80%
Fidelity Fund 3.55%
Fidelity Japan Fund 1.74%
Fidelity Small Cap Independence Fund 1.40%
Fidelity Southeast Asia Fund 0.82%
Fidelity Small Cap Growth Fund 0.35%
Fidelity Small Cap Value Fund 0.35%
Fixed-Income Funds
Fidelity Capital & Income Fund 4.96%
Fidelity High Income Fund 4.93%
Fidelity Investment Grade Bond Fund 1.84%
Fidelity Government Income Fund 1.70%
Fidelity Intermediate Bond Fund 1.17%
Fidelity Strategic Real Return Fund 0.28%
While you do get a good amount of diversification in a simple package, I would note that these are all actively-managed funds, there is not one index fund in the bunch. Some of these funds have good track records, and some don’t. I would pose that Fidelity possibly sneaks in some of their more profitable funds (does having 0.28% of any fund really matter?). The actively-managed funds, although no-load, lead to an annual expense ratio of 0.76%. Not good, but not atrocious.
There is also a certain amount of overlap between all the funds. If you use Morningstar X-Ray, it is revealed that the overall breakdown is approximately
65% US Stocks (primarily Large Cap)
20% International Stocks
15% Bonds
What about past performance?
I don’t usually put too weight on recent performance, but Fidelity has made it’s own comparison index called the Fidelity Freedom 2040 Composite Index which is made up of unmanaged indices like the Wilshire 5000. Note that the actual 5-year performance (3.94%) lags the index performance (4.88%) by 0.94%, about the same as the expense ratio which in previous years has been at about 0.90% (higher than now).
This is exactly what a lot of academic research has shown – over time, actively managed funds lag the corresponding indices by the exact amount of their expense ratio. Thus, the most important thing is to work to minimize that expense ratio!
Roll your own?
One great thing about 401ks is that you (usually) don’t have to worry about low-balance fees. You could have $24 in a fund and you’d be fine, because across all the 401ks in your company, Fidelity has enough money pooled together so they don’t care. That’s one drawback of an Self-Employed Solo 401k – you do have balance requirements to maintain.
So what if you just modelled your portfolio after the asset allocation of this fund, using the index funds available to you? Sure, you’d have to rebalance yourself, but you can use the Freedom funds as a guide, and you’d only need to do it once every one or two years.
Here’s a quick possiblity using the index funds available in my wife’s 401k:
50% Fidelity Spartan US Equity Index Fund (FUSEX)
15% Fidelity Spartan Extended Market Index Fund (FSEMX)
20% Fidelity Spartan International Index Fund (FSIIX)
15% Fidelity US Bond Index Fund (FBIDX)
Using Morningstar X-Ray again, one can see that this breakdown gives a similar asset allocation mix to the Fidelity 2040 Funds, but has a combined annual expense ratio of only 0.13%, thanks to the super-low expense ratios of Fidelity’s index funds. That’s a difference of 0.63%, which if that is the amount that it will outperform FFFFX annually in the long run, is a big difference indeed.
Added: If you take the 5-year performance of the above mix of index funds and do not rebalance (for simplicity since I don’t have the performance for each individual year), you get a 4.78% return, beating FFFFX and which is .10% off of the 4.88% theoretical index return, very close to the 0.13% expense ratio.
Short version
My opinion remains that Fidelity’s Freedom Funds are an “okay” place for people who have a Fidelity 401k and really don’t want to think about their investments and just want one fund to do it all for them. It is automatically rebalanced as you age and the expense ratio of 0.76% is below industry average.
However, with just a little bit of do-it-yourself gusto, you can imitate the Freedom fund but still get a significantly lower expense ratio and an equal (if not greater) amount of diversification using Fidelity’s low-cost index funds.
The question is – Can you spare the extra hour (if that) a year to rebalance?
(The third option, as always, is to do some reading and make your own portfolio decisions.)
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I enjoy reading your blog, thank you. This entry is similar in many ways to columns by one of my favorite financial writers. Scott Burns’ columns are syndicated in papers across the country, but his home paper is Dallas Morning News (http://www.dallasnews.com/business/scottburns/).
Burns has some older columns on this same topic, and he has previously called the idea “Couch Potato Investing”. He suggested picking a few low-cost index funds to get a balanced mix and then hold it over the long term to minimize costs and unnecessary risks, while making a decent return. Either way, I think this approach has clear value and am glad you are discussing it here.
I’m not impressed with any of the Retirement XXXX funds offered by anyone.
I’m not sure about rebalancing every year, but I think with a bit of effort the average person can do better than these funds.
This is retirement we are talking about. Pass or Fail and not much chance to correct if big money is lost. One should spend a several hours per year working on this given the time horizon.
I’m a fan of the Vanguard Target Retirement funds. The holdings are much simpler, and are composed entirely of index funds. For example, the Target Retirement 2035 fund has the following allocation:
Vanguard Total Stock Market Index Fund: 70.4%
Vanguard Total Bond Market Index Fund: 12.5%
Vanguard European Stock Index Fund: 10.1%
Vanguard Pacific Stock Index Fund: 4.8%
Vanguard Emerging Markets Stock Index Fund: 2.2%
Now you can argue about whether those are the appropriate allocations, and of course you can pick a longer term or shorter term fund based on your personal preferences, but it is a reasonably diversified and fairly low cost basket of funds.
Unfortunately this fund isn’t offered in my 401k, so I use it for after-tax savings.
I have FFFFX in my 401k too and invest in it – the expense ratios of the other available funds >.75.
Would you feel differently about your decision to do it yourself if it was Vanguards 2040 with an expense ratio of .21?
Samer/Geoff – My favorite Target XXXX fund is Vanguard’s, as it is already comprised of low-cost index funds, so you can’t replicate it with something better. I think it is good (maybe not perfect, but good) choice for lots of people.
Geoff – you have access to FFFFX but no other Fidelity index funds? I’d talk to your HR dept 🙁
Don – I totally agree that people “should” spend more time researching their options, but the fact is that many people don’t and that partially is why these funds are so popular.
Have you ever seen that TV game show “Street Smarts” or something where they ask the public trivia questions? I highly doubt most people would know the difference between a Growth and Value fund, or even what an Index fund was…
I don’t really consider retirement as pass or fail. Let’s face it, lots of people are going to get C’s! 🙂
Good topic. There are so many options out there these days that it’s easy to get overwhelmed with information.
I’m not keen on funds like you’ve mentioned, as I think you can do a little better with ETF’s. Just my opinion of course, and I think everyone’s situation and level of market understanding is different.
-Grant
it said fidelity is closing their good funds- low price stock, contra, diversified international….greta fund…too bad u didnt get in them prior
Just retired after being held captive by metlife annuity for 5 yrs. I have taken a crash course and decided Vanguard funds are where my IRA future lies. I like reading your comments because it confirms my decision-making process. I look at the consistency of management tenure along with consistency of performance. Their Windsor II Fund has done very well for me. I wonder who these pie charts were invented for. They serve no purpose for me.
The problem with getting into the spartan index of funds is that the minimum initial investment is 10,000 dollars. I’m a new investor and i dont exactly have 10,000 dollars falling from my pockets. With the fidelity freedom fund, this allows you to slowly build up your wealth until you can purchase the spartan index funds (well that’s my plan anyway).
“While you do get a good amount of diversification in a simple package […]”
Do you, really? It’s hard work to tell how much diversification you’re really getting out of these funds-of-funds, because of the significant overlap between the component funds. Diversification is not measured in the number of funds that your portfolio has; it is measured in the diversity of the underlying investments held by your funds. Vanguard’s Target Retirement series, for example, puts your money in fewer funds than Fidelity does, yet are certainly better diversified than the Fidelity Freedom funds. And cheaper. And, very important, way simpler.
It gets worse. Since the underlying funds for the Freedom series are actively managed funds, they will likely at times use market timing; either by keeping some amount of money in cash, or by investing a significant amount of money in asset classes other than the ones the fund is supposedly for. This means that the Freedom funds can actually have significant difficulty sticking to their asset allocation models.
There’s also what the fund selection for the Freedom funds seems to say about Fidelity. It gives a very nasty impression that the funds were designed to give money to every fund in the company that asked to be given money, instead of serving investors’ interests.
samerwriter: yeah, Vanguard’s allocations are arguably not ideal, but the most important thing about Vanguard is that they’re not trying to rip you off with their funds. They’ve put together something that’s (a) not stupid, (b) simple and effective, (c) very low in the expenses side.
Alex: I have FSTMX in my 401(k), and there I can buy it without any minimum amount; that’s nice, yeah. Anyway, Vanguard lets you get started with $3,000 in nearly all of its funds, and their low expense ratios are kept up throughout the family, not just for a handful of teaser funds run at a loss (e.g., FSTMX), designed to entice you into the fund family, just to recoup the loss elsewhere…
Great advice. I myself previously had my entire 401(k) in the 2035 Freedom Fund — while the expense ratio of ~0.8% looks low, when summed up over 10 years it ends up costing an investor close to 10% of what they contribute. YIKES.
Interestingly, I chose the exact same 4 funds listed for your wife’s 401(k)! Getting that expense ration down just half a percent makes one HELL of a difference in fees over 25 years.
For the last 3 years I have fully funded my IRA and it is all in the Fidelity Freedom Fund 2045.
Thanks to you guys, I now realize that the expense ratio of .76% could be a lot lower if I manage it myself. My question is, when the market is low like it is now is it a good time or a bad time to move it into something like what your wife has to get the expense ratio of .13%?
I’m not even sure how to go about making a move like that. Would I be taking the loss of the market right now or getting a good deal on the new fund? Also, it sounds like vanguard could be a good way to go. Would it be a good move to take all of my money to vanguard? My balance is over $10,000 so maybe I can avoid their fees? I’m so confused. If anyone has any tips they would be greatly appreciated :). I love your blog! I feel like I am learning more everyday.
I hate these Freedom Funds and all their ilk. You can do much better just doing a bit of research and picking your own diversified mutual funds.
I also would like to point out that a lot of managed 401(k) plans are now eliminating a lot of their investment options and moving everything into these target date funds. Do you really think they are doing this because they are better investment options? They are doing it because it is costs them less. That should be a red flag right away.
It only takes a few hours a year to hand pick your own mutual funds. As TD Ameritrade states in their commercials “…you can do this…” Roll over that old 401(k) account into your own IRA and take charge of your retirement.
I have used this fund in a different sort of way … One of my accounts had grown more that the others & it threw my mix off so I took $1000 and dumped it into this account & the price at the time of the transaction was less than 7 dollars so I am going to let this account sit there & do its own thing & I can see how the performance ranks compared to other funds. My company switched over to Fidelity from another provider which had given a GREAT return on my investment & sadly only one offering is the same so I am still trying to get an over feel for the fidelity options & amount of growth.
Jonathan,
Way back when you posted this, I took your advice and replaced my Fidelity Freedom Fund with a combo of Spartan Index Funds in my 401 to reduce costs.
Well, more than four years later I now get an e-mail from my HR department announcing that they’re replacing the Fidelity Freedom funds with the new, lower cost Fidelity Freedom K Funds.
The attached list of improved expense ratios range from 0.42% to 0.62%. Still nowhere close to the roll-your-own solution of 0.13% with the index funds!
@Dan – Ha, glad to hear that you are happy with your low-cost DIY solution. I should perhaps do another performance comparison if I get the chance and can find the data.