Wednesday, February 15, 2012

Fidelity Freedom Funds Aren't "Free" But Are "Dumb"

Fidelity Investments is known as "Fido" on Wall Street. Maybe it's because their target date retirement funds are dogs?  Fido is known for its actively managed stock mutual funds.  Peter Lynch became famous as the index-beating manager of the Fidelity Magellan fund. And while Magellan has struggled since Peter retired some 20 years ago, Will Danoff and Joel Tillinghast have quietly carried the torch since Peter departed.

Fido still sports a few funds with long impressive track records. Of course, they should have at least a few good track records since they have 259 funds. Exactly 12 of Fido's funds (or less than 5%)  have earned a 5-star rating from Morningstar.  I could see how it would be an easy sell for Fidelity to convince investors to plunk money into their Fidelity Freedom line of target date retirement funds.  Just pick one Freedom fund and Fidelity will allocate your money among the many good Fidelity funds for you.  Unfortunately, Fidelity does not do that.  Instead, Fidelity abuses the Fidelity Freedom target date mutual fund shareholders by using their money as seed money to start new and untested funds with expense ratios much, much higher than the Fidelity Spartan Index Funds.

I've always wondered, "how Fidelity could possibly grow to 259 mutual funds?"  I never could figure out why anyone would invest in a new and untested Fidelity fund when you could place your money with Will Danoff in the Fidelity Contrafund or Joel Tillinghast's Fidelity Low-Priced Stock Fund.  Both gentlemen have managed their funds for more than 20 years and both sport  impressive index-beating track records.  Or better yet, why not put your money in the very low cost Fidelity Spartan Index Funds?  Then, you won't have to keep tabs on Will and Joel's own retirement plans and can focus on your own.

I have finally figured out Fidelity's dirty little secret for funding the launch of new and untested mutual funds.  The Fidelity Freedom target date funds allocate money to Fidelity's new funds.  I took a close look at Fidelity Freedom 2035 Fund and was shocked to discover:
  • Money is allocated among 20 different Fidelity funds.
  • No allocation to the impressive Contrafund. 
  • No allocation to the impressive Low-Priced Stock Fund.
  • No allocation to the low cost Spartan Index funds.
  • 19 out of the 20 funds are high cost active management funds. 
  • Only 1 of the 20 funds has a 10-year record that beats an index fund!  
  • Only 3 out of 20 have even been in existence for 10 years!  
  • Only 5 out of 20 are more than 5 years old.  
  • Half of the 20 funds are less than 3 years old!
  • 5 out of the 20 funds are less than 1 year old!
  • The 3 largest fund allocations go to funds that are just 3 years old.
  • 70% of the fund is allocated to funds that did not exist prior to 2008!
  • Freedom 2035 only owns 1 fund rated 5-stars by Morningstar.
If your 401(k) includes Fidelity funds, I urge you to avoid using the Fidelity Freedom target date funds even though their expense ratios are slightly lower than average at 0.77%.  You can build a better portfolio for about a third of the cost (see below).

If your 401(k) is with Fidelity, I recommend building a low-cost portfolio with the following excellent funds:

Fidelity Spartan 500 Index Fund
Fidelity Spartan Extended Market Index Fund
Fidelity Spartan International Index Fund
Fidelity Spartan US Bond Index Fund
Fidelity Spartan Long Term Treasury Bond Index Fund
Fidelity Four-in-One Index Fund
Fidelity Inflation-Protected Bond Fund

All of the above funds have very low expense ratios (0.07% to 0.23%)  except the Inflation-Protected Bond Fund which is a bit higher at 0.45%.

If you don't know how to allocate your money among the excellent funds listed above, spend just 15 minutes with my book, "The 401(k) Cookbook" to create an investment recipe that works for you.

Also, don't be confused by the "Fidelity Income Replacement" dated funds.  These funds are for folks already retired and the dates are NOT retirement dates.  For example, the Fidelity Freedom 2035 fund is allocated 80/20 in its stock/bond split, while the Fidelity Income Replacement 2034 fund is allocated 55/45 in its stock/bond split.  

Fidelity also has a series of asset allocation funds called "Fidelity Asset Manager," but with  expense ratios around 0.84%, they are even more expensive than the Freedom funds.


  1. Great research Ron. That is really shocking. Does the expense ratio for the target date fund include the fees on the funds within it, or are those fees just buried?

  2. Fidelity does NOT charge an additional fund management fee for the Freedom funds. In other words, the 0.77% expense ratio for the Freedom 2035 Fund is the "all in" expenses and made up only by the expense ratios of the underlying mutual funds held by the Freedom 2035 fund. So, compared to industry averages, 0.77% is below average.

    However, Fidelity investors can do much better by creating their own portfolio using Fidelity's Spartan Index Funds and avoid having their money used as a funding/training tool for untested Fidelity actively managed funds.

  3. Great article. I also bought and enjoyed your cookbook. Having a bit of trouble mapping the categories from the recipes in your book to the Fidelity funds you list above.

    Would the percentages of the the mid and small cap categories be combined and put into the Fidelity Spartan Extended Market Index Fund? Or does the Fidelity Spartan Total Market Index Fund (FSTMX) cover all categories (large, mid, and small) enough to be the sole domestic stock fund?

    What about the intermediate and long term bond categories?

    Alternatively, could a reasonable index portfolio be constructed by just following your recipe allocations but using the same funds that Fidelity uses in their Fidelity Four-in-One Index Fund (FFNOX)?

  4. RH - you are on the right track - combine the small and mid cap allocations from my recipes into the Spartan Extended Market Index Fund. The Spartan Total Market Index Fund is a good fund too and could also be used as the large cap allocation (it is roughly 85% large cap and 15% small/mid cap stocks). The recipes in my book are intended to give everyone a tilt or over-weighting to small and mid cap stocks (they will beat other stocks over a long period, but are also more volatile). Here is a mapping of the Fidelity funds to the recipes in my book:

    Fidelity Spartan 500 Index Fund (Large Company Stocks)
    Fidelity Spartan Extended Market Index Fund (Mid-sized Company Stocks AND Small Company Stocks, combined)
    Fidelity Spartan International Index Fund (International Stocks)
    Fidelity Spartan US Bond Index Fund (Intermediate-Term Bonds AND Short-Term Bonds, combined)
    Fidelity Spartan Long Term Treasury Bond Index Fund (Long-Term Bonds)
    Fidelity Inflation-Protected Bond Fund (Inflation-Protected Bonds)

    Fidelity Four-in-One Index Fund (This fund could be used as an all in one fund for those folks just starting out with small amounts of money to invest. This fund could be especially useful if you are subject to the fund minimum investment rules. Most 401k plans waive the minimum investment rules for individuals. This fund is roughly 85% stocks and 15% bonds, but does not include any inflation-protected bonds. So, if someone starts out by owning just the Four-In-One Index Fund, they should consider pairing the Fidelity Inflation-Protected Bond Fund with it.)

    You noticed that I recommend the Fidelity Spartan Extended Market Index Fund for the small cap and mid cap allocations. Fidelity does have separate index funds that focus on only mid caps and small caps, however these index funds have high expense ratios of 0.35% compared to the Spartan Extended Market Index Fund expense ratio of just 0.10% currently.

    For similar reasons, I recommend avoiding the Fidelity Short-Term Bond Fund, whose expense ratio is 0.45%. The Spartan US Bond Index Fund has an expense ratio of just 0.11% currently, and includes short-term bonds in the fund.

    1. IRA also can make the portfolio from those above list fidelity funds? Thanks

  5. Ron, just came across this article. i had $10.000 i a rollover IRA that i moved to the fidelity spartan extended market index fund. my 401k is in a 2040 freedom fund. would you recommend that i move all that money over to a mutual fund? can i move it over to the same one as my IRA? and what happens 20-30 years from now, do you leave your money in the same mutual fund or do you move it elsewhere? thanks.

  6. I came across your article. I recently rolled over my 410K to Fidelity and would loike to invest for longish term 10-15 years. Would you recommend the same portfolio listed above? I was seriously considering the Freedom Fund until I read your article. Many thanks.

  7. Dennis, yes you can create a much cheaper portfolio for your 401k by moving out of the Freedom Fund and creating a portfolio of Fidelity's low-cost index funds as I outlined in the article above. When constructing your portfolio, consider all of your investments together (such as the IRA you mentioned). Good move with your IRA but use different mutual funds that I listed in the article above for diversification.

    If you need help figuring out how much to put in each fund, you can figure that out by spending about 15 minutes with my book, "The 401k Cookbook." In about 15 minutes you will have your own personal recipe. Just insert the Fidelity funds above into the recipe (see my answer to a previous question).

    In regards to your question about 20-30 year from now, the book will show you how to modify your portfolio a bit every 5 years as you age. Thus, you will be properly allocated 20-30 years from now (including any changes to your risk tolerance over time).

  8. Anonymous from April 13, yes you should consider avoiding the Freedom Funds and construct a lower cost, better performing portfolio, using the excellent Fidelity funds I listed above.

    Sorry to keep pushing my book, "The 401k Cookbook," but that is the quickest way to determine how much you should put in each of the funds I listed above. The book starts with a quick 12 question quiz. The score from that quiz will determine which portfolio recipe you should use. This recipe will tell you exactly how much to put into each of the mutual funds I listed above. You don't have to read the whole book. It is designed like a Cookbook. You will have a recipe in 15 minutes and can be done with it.

  9. After meeting with a Fidelity representative, I chose not to use the fee based Adviser service of 1% per year. I have now purchased your cookbook and have diversified into six index funds based on age 50. I have always heard of index funds, yet could not get the recipe correct. I will review and balance each year. Thank you. FYI.. I was all in with the contrafund worth 485K. I now have peace of mind for the long term.