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Question About Target Funds
Old 03-16-2009, 02:15 AM   #1
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Question About Target Funds

My son has 401K administered by Fidelity. He doesn't know anything about investing, and feels that he should spend his time on his job skills, not trying to be an investor.

He chose one of their target date retirement funds- I think target 2040. This is a fund of funds. My question is about expenses in this type of fund. It appears to me that an investor in one of these pays fees at 2 levels- the level of the target date fund, and the level of each underlying investment.

I think the Target Date Fund has a ratio of about 0.67%. The underlying funds vary, but for the most part they are higher than this. To make it simple, I assumed that the fee at both levels is 0.65%, meaning that each year, at each level he has 99.35% working for him, and 0.65% working for Fidelity. But it seems to me that these piggyback on one another, so that in total he is only keeping 0.9935*0.9935 , or 98.70% each year, and Fidelity gets 1.30%. This seems to be a ridiculously high expense ratio for something that could be synthesized in one hour.

Is there anything wrong with this analysis? If I mention this to him, I have to be correct.

He can chose other funds, to avoid this layering approach, so this problem is not inescapable. He would just need to avoid funds of funds.

Any comments?

Ha
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Old 03-16-2009, 03:28 AM   #2
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I looked at the target funds my Megacorp was offering. It was a fund of fund of funds and the total expenses came out to 2.5% a year so it sounds worse than what he is being offered. I followed the same logic you did so it sounds correct to me.

I would point this out and then see if they has some index funds available. The same package offered some at .6%, while not great, is better than the 2.5. Tell him he can also leave the money in the Index fund until he retires.
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Old 03-16-2009, 04:00 AM   #3
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im not 100% sure but i think one set of fees is waived in the target funds... i remember fidelity posting some thing about that
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Old 03-16-2009, 07:40 AM   #4
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The net fees of the target funds are around 0.8%. The Fidelity 401(k) plans are usually filled with their freedom funds, a bunch of actively-managed funds and a few index funds. The actively-managed funds funds are usually not fidelity funds and are decoy funds. They usually have higher expense ratio than the other funds and are simply used by fidelity to say "We pick the best funds, not just fidelity funds. We are good because we are looking out for your best interests." Of course, that makes the 401(k) super complicated and hides the low-cost index funds.

So even with freedom funds, one should pick the index funds with their 0.1% to 0.2% expense ratios.
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Old 03-16-2009, 07:52 AM   #5
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My last employer's 401K was pretty expensive in fees and fairly limited in selections etc.. And no matching. Yet it was still less of a headache to invest through them than not at all, or trying to be a financial whiz, which I am not.

After I left rolled the funds over to Vanguard.
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Old 03-16-2009, 11:02 AM   #6
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I have the bulk of my investments in a Vanguard TR fund. According to quick research on Google finance, my fund has an expense ratio of 0.18%, which doesn't seem too outrageous to me.

However, the ER is probably all over the map depending on which TR funds you pick.

In addition, I have the impression that Fidelity's TR funds are some of the less impressive in the category, but I don't know this to be the case for sure.

I have also noticed a rather dramatic shift in sentiment concerning TR funds on the Internet since the current unpleasantness started. Prior to the meltdown, the common feeling seemed to be that TR funds were underweighted in terms of equities. Since the meltdown, the common feeling seems to be that TR funds are underweighted in terms of bonds. I guess reality has a way of making people re-evaluate their tolerance for risk.
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Old 03-16-2009, 11:07 AM   #7
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I may be wrong but it is my understanding that the ER of underlying funds are already factored in the ER of the fund of funds. So the ER quoted for the fund of funds should be all inclusive.

P.S. I don't like Fidelity TR funds (too many -managed- underlying funds, too expensive, etc...). In my wife's 401K, we have bypassed Fidelity's TR funds completely and created our own "TR fund" using Fidelity Spartan index funds instead (ER around 0.1%).
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Old 03-16-2009, 11:13 AM   #8
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One thing to look at with Target funds is whether the listed expense ratio is inclusive of the fees of the underlying funds.

I have a Fidelity 401K and I'm looking at Freedom 2040, which is one of our options. When I look at Morningstar (FFFFX), it says the ER is 0.78% -- including underlying expenses. So I think 0.78% is the entire expense ratio.

As to whether or not this is a good place -- for someone just starting out and has neither the account size nor the inclination to want to roll their own AA and rebalancing routine, it's a pretty decent place. It would also depend on what funds he has available in the plan. If most of the other stock funds in the 401K are crappy, I'd be even more inclined to stick with the lifecycle fund.

(For what it's worth, I historically used Freedom 2030 as my parking place for new contributions over the course of one year and then rebalance into other funds offered in my plan.)
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Old 03-16-2009, 11:26 AM   #9
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Quote:
Originally Posted by ziggy29 View Post
One thing to look at with Target funds is whether the listed expense ratio is inclusive of the fees of the underlying funds.

I have a Fidelity 401K and I'm looking at Freedom 2040, which is one of our options. When I look at Morningstar (FFFFX), it says the ER is 0.78% -- including underlying expenses. So I think 0.78% is the entire expense ratio.

As to whether or not this is a good place -- for someone just starting out and has neither the account size nor the inclination to want to roll their own AA and rebalancing routine, it's a pretty decent place. It would also depend on what funds he has available in the plan. If most of the other stock funds in the 401K are crappy, I'd be even more inclined to stick with the lifecycle fund.

(For what it's worth, I historically used Freedom 2030 as my parking place for new contributions over the course of one year and then rebalance into other funds offered in my plan.)
Thanks for looking this up, Ziggy. This is the fund he uses. So 0.78% is better than I feared.

I think I'll stay out of it at this point. It does strike me that the fixed income portion is pretty high for something that has 30 years to run. But it would be easy for me to be wrong suggesting a higher equity exposure and then having the bad luck to get another market downdraft. This is something a father tries to avoid.

Ha
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Old 03-16-2009, 11:39 AM   #10
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It does strike me that the fixed income portion is pretty high for something that has 30 years to run. But it would be easy for me to be wrong suggesting a higher equity exposure and then having the bad luck to get another market downdraft. This is something a father tries to avoid.
Historically I would have said that you probably don't need bond exposure with that time horizon. But the last 18 months have convinced me otherwise unless someone has ice running through their veins and the constitution of a Sherman tank.
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