I'm actually a little bit embarrassed to admit this -- OK, a lot embarrassed, being a Seeking Alpha contributor and all -- but up until today I held a target date fund in my Roth IRA. I met with a Fidelity financial advisor back in 2008 who couldn't say enough good things about my target date fund and how diversification is important in this day and age, and I caved. Boy, have I learned a lot since then. This particular fund, the Fidelity Freedom 2050 Fund (MUTF:FFFHX) boasted:
a combination of underlying Fidelity domestic equity, international equity, bond and short-term funds using a moderate asset allocation strategy designed for investors expecting to retire around the year 2050.
Eventually the fund becomes more and more conservative as I age until it merges with the Fidelity Freedom Income Fund (MUTF:FFFAX). Sounds pretty good, right? Isn't it nice to have someone watching over your assets, making sure you're in good hands, guiding you through this treacherous sea of confusion Benjamin Graham aptly referred to as "Mr. Market"? Sure sounds good to me...
Only, wait, upon checking my account balance the other day, I noticed FFFHX has underperformed the S&P 500 by not only a small but a rather wide margin. How could this be? Here's the run-down:
|FFFHX Return %||S&P 500 Return %||Delta %|
Adding insult to injury, FFFHX's expense ratio is 0.80%, when compared to the SPDR S&P 500 (NYSEARCA:SPY) expense ratio of 0.10% and SPY has a positive alpha of about 9% over a five year time horizon when compared to FFFHX. In just about any market scenario you run over the last three to four years with S&P 500 comparisons, I've lost out by being invested in my target date fund. While speaking to a Fidelity representative today, he was sympathetic: "I can see your point, Mr. Shadzi. When compared to the overall market, our fund has been a disappointment. I'll be sure to pass this on to upper management."
So what's there to like about target date funds, then?
Target date funds are often touted as a "smart and lazy" way to invest for your future. However, while paying significantly higher expense ratios for a lower return, I can't help but expect more. Sure, I understand FFFHX and other target date funds include cash, stocks, bonds and other investment vehicles, but if this is the case, shouldn't they have at least performed better during our last market crash? FFFHX also underperformed the S&P 500 by 0.48% during our market meltdown between May 30, 2008, and February 2,0, 2009. So much for running for safer havens.
While I understand the concept of target date funds, allowing a "hands-off approach" to investing, I can't help but argue rebalancing a concise portfolio of low cost index funds is not difficult at all. In fact, I think my cat could probably even do it and certainly a caveman could.
"So why did you hold on for so many years, then, if you knew target date funds wouldn't fit your investing lifestyle?"
It's a good question, and I'll provide two answers. First off, I was always taught that funds which underperform have a better chance of overperforming in the future. I now know this isn't necessarily true. Second, many of Fidelity's funds that I actually did want to be in have account balance limits. Fox example, the Fidelity Spartan Total Market Index Fund (MUTF:FSTMX) has a $10,000 minimum account balance limit. At $416 a month distributions into my Roth IRA, it takes a bit of time to reach that $10,000 sweet spot.
Just to be thorough and not throw the baby out with the bathwater, I decided to take a look into target date funds from other Fidelity competitors in order to see how they stack up.
The TIAA CREF Lifecycle 2050 Retirement Fund (MUTF:TFTIX) also underperformed the S&P 500 with an expense ratio of 0.46% and Vanguard's Target Retirement 2050 Fund (MUTF:VFIFX) also significantly underperformed the S&P 500 for the last five years with an expense ratio higher than that of SPY.
Learning is a natural part of the process as us younger investors inch ahead towards retirement. Though my target date funds are a rather small percentage of my portfolio allocation, I truly believe low cost index and mutual funds are a more safe and productive way of investing your hard earned cash. You live and you learn!