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Should I Use Fidelity’s Freedom Funds in My 401k?

A reader writes in, asking:

“I know you like Vanguard’s target funds, but my 401-k is run by Fidelity. Are their ‘freedom funds’ a good choice? I like the idea of something that I don’t have to manage.”

The short answer is, “it depends.”

  • If we’re talking about Fidelity’s Freedom Index funds, then yes, I like them a lot. They’re an easy way to build a low-cost diversified portfolio.
  • If, however, we’re just talking about Fidelity’s Freedom funds (i.e., no “index” in the name), that’s a different story. They’re a hodgepodge of actively managed funds with significantly higher costs. (Fidelity Freedom 2050, for example, has an expense ratio of 0.77% as compared to Fidelity Freedom Index 2050’s expense ratio of 0.19%.)

Unfortunately, the Fidelity Freedom Index funds are less common in employer-sponsored plans than their non-index counterparts, and they’re not available to retail investors at all (e.g., in an IRA or regular brokerage account).

What Does a 0.06% Allocation Get You?

In addition to having higher costs, Fidelity’s Freedom funds give me the distinct impression that they were created with Fidelity’s goals in mind rather than investors’ goals.

Let’s again use Fidelity’s Freedom 2050 fund as an example. Take a look at the fund’s current holdings:

  • 12.27% Fidelity Series All-Sector Equity Fund
  • 10.59% Fidelity Series Large Cap Value Fund
  • 8.32% Fidelity Growth Company Fund
  • 7.43% Fidelity Series 100 Index Fund
  • 5.65% Fidelity Disciplined Equity Fund
  • 3.92% Fidelity Blue Chip Growth Fund
  • 2.06% Fidelity Series Small Cap Opportunities Fund
  • 1.21% Fidelity Small Cap Value Fund
  • 1.17% Fidelity Small Cap Growth Fund
  • 0.72% Fidelity Series Real Estate Equity Fund
  • 9.50% Fidelity Series Commodity Strategy Fund
  • 8.44% Fidelity Series International Value Fund
  • 8.22% Fidelity Series International Growth Fund
  • 5.22% Fidelity Series Emerging Markets Fund
  • 1.70% Fidelity Series International Small Cap Fund
  • 3.13% Fidelity Series Investment Grade Bond Fund
  • 9.26% Fidelity Series High Income Fund
  • 0.10% Fidelity Series Floating Rate High Income Fund
  • 0.97% Fidelity Series Emerging Markets Debt Fund
  • 0.06% Fidelity Series Real Estate Income Fund

If you were given a clean slate and asked to create a portfolio using Fidelity mutual funds, what would have be going through your mind in order for you to build that?

There are four holdings with allocations of less than 1%. The idea that a fund could merit inclusion in the portfolio, yet not merit even a 1% allocation (or, in the case of the Real Estate Income Fund, not even a 0.1% allocation) seems absurd to me. What can an investor possibly hope to achieve with a 0.06% allocation to something?

If I had to bet, I would bet that the goal for including those funds was not to improve the Freedom funds in any meaningful way, but rather to give Fidelity an easy way to get some money into their new funds. (If you look, you’ll find that each of the funds with an allocation of less than 1% was started in 2011.)

 Why You Might Want to Use Them Anyway

In short, I think Fidelity’s (non-index) Freedom funds are a mess. Still, depending on what’s available in your 401(k), it’s possible that there’s nothing better.

Before using the Fidelity Freedom funds, I’d suggest checking for less-expensive funds that can be used as any of the major pieces in a portfolio (i.e., U.S. stocks, international stocks, and bonds). In a plan run by Fidelity, you’ll especially want to check for their “Spartan” index funds, which are super low-cost and easy to use to build a diversified portfolio.

If you do decide to use a target-date fund — from any company — it’s important to make your choice based on the fund’s underlying allocation rather than just the date in the name. You might find that the fund that best matches your risk tolerance is one intended for people significantly older or younger than you.

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  1. Mike, I also found that although the “top” or holding fund had a reasonable expense ratio, the underlying funds all had expense ratios too. Adding expenses on top of expenses made “Funds of Funds” too expensive for me. moving to a single layer Index Fund made a huge difference in my returns.

  2. Chris,

    The stated expense ratio of the “fund of funds” is the actual expense ratio that an investor pays. At Vanguard at least (and I believe at Fidelity), the “fund of funds” doesn’t add an additional layer of costs per se.

    That said, there is often still some room for cost savings — at Vanguard, for instance, via their Admiral shares, because the “funds of funds” hold Investor shares.

  3. Mike, I agree that this particular Fidelity fund looks like an over-complicated joke that creates the impression of diversity but may just have a lot of duplication. Coincidentally regarding mutual fund fees, another blogger just today posted a comment where he referred to the tax cost ratio, or “how much a fund’s annualized return is reduced by the taxes investors pay on distributions.” I have not heard of that before and wonder where I can find such information, or what it signifies. This person also mentioned “Personal Capital’s 401k fee analyzer,” an apparently free web service, but I’m skeptical of anything apparenly free. Your thoughts on these matters?

    Fortunately our 401(k) offers Fidelity’s Spartan Total Stock and Total Bond, which are my only two funds within the plan.

  4. Larry,

    Tax cost ratio can be found by looking a fund up on Morningstar, then clicking over to the “tax” tab.

    The idea is to show, if an investor held the fund in question in a taxable account, what percentage of his holding would he lose each year to taxes. (In other words, it’s like an expense ratio, but with taxes.) This document explains how the calculation is done. Most importantly, it assumes that the investor is in the highest tax bracket at all times.

    I’m not familiar with the Personal Capital 401(k) Fee Analyzer either.

  5. Are you saying that the tax cost ratio is irrelevant to tax-deferred accounts?

  6. Yes.

  7. DIY Investor says
  8. Wow, I didn’t even know there were such a thing as Freedom Index Funds offered by Fidelity. How long have they been around? My SIMPLE-IRA is administered by Fidelity and contains the actively managed Freedom funds as choices.

  9. Tom,

    It looks like they’ve been around since late 2009. I believe, however, that they’re only available to employer-sponsored plans rather than to retail investors. (And I do not know if there are requirements the plan must meet in order to be able to use them.)

    Morningstar has some information about them:

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