Why do we pay fees on our 401(k) investments? Why are fees different for different funds? And what are we getting for the fee difference between Fund A and Fund B? These are all great questions that you should ask about the funds in your 401(k) plan.
Unfortunately, discussions about fees can quickly get sidetracked into overstated language that winds up obscuring legitimate questions. I think that’s the case with the recent Forbes piece, The Trouble with Target Date Funds. The writer is so intent on proving you are a sucker for investing in a target date fund (or, as he puts it, “not at a genius level”) that he makes a comparison that doesn’t stand up to a moment’s scrutiny – and then argues that you can do it all better yourself.
Comparing Apples to…Anvils?
Bear with me; this part is going to be slightly technical. The writer begins with the fees for a single share class of a BlackRock target date fund that he claims is “typical of the genre.” Actually, I’d argue that it is not even typical of BlackRock’s target date funds – it’s a ‘C’ share class that is rarely found in a defined contribution plan, which is where most target date fund investments are found.
The writer is aware that funds have different share classes. (He mentions this in the first paragraph.) The ‘C’ class includes 12b-1 fees and additional advisor fees. A more “typical” share class would be the ‘K’ class, which has substantially lower expenses and no 12b-1 fees.
Next, he compares the BlackRock fund to a low-cost Vanguard alternative. Once again, we need to ask about the comparison: the Vanguard fund is index-based, while the BlackRock fund he chose has an actively managed component. Had he been interested in a more apt comparison, he could have compared the Vanguard fund with BlackRock’s index target date fund, ‘K’ class. He would have found the fee difference very narrow, which would have invited an intelligent discussion of the differences between them.
This is not just semantics. There are different share classes, investment approaches and objectives within target date funds, often even within the same fund family. That’s because not every plan sponsor believes the same things or shares the same goals. Do you believe that active management can produce additional return? Do you want more or less diversification, greater or lesser risk? Choices are available and priced accordingly.
Can You D.I.Y?
It’s fair to ask, can you do it cheaper yourself? Well, maybe – if you are incredibly disciplined, have access to sufficient asset classes and don’t lose your nerve. Every investment approach will have its ups and downs, but over-reacting to short-term underperformance can undermine your long-term results.
Research suggests that most of us will not be better off D.I.Y. The Employee Benefit Research Institute has found that do-it-yourselfers tend to take on more risk and do not rebalance their portfolios. Another report found that participants using professional management (including target date funds) have had higher returns across all age groups and market conditions.
So, Getting Back To Fees…
You should be aware of what fees you’re paying and why you are paying them. But don’t fall into the trap of assuming the lowest fee options are automatically the best. Your plan sponsor has a fiduciary responsibility to make choices in your best interests – choices based on realistic comparisons of fees and investment objectives. And it is the job of BlackRock and other providers to offer funds in a variety of share classes, investment styles and fee structures so that plan sponsors can make choices they believe are right for you.
Asset allocation models and diversification do not promise any level of performance or guarantee against loss of principal. Investment in the Funds is subject to the risks of the underlying funds.