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Summary FFTWX offers investors a high expense ratio to go with a needlessly complex portfolio. By incorporating an enormous volume of other mutual funds the target date fund incorporates a higher expense ratio. If the fund needs exposure to the total U.S. market, they can ditch the complicated combination of funds and just use FSTVX. Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Fidelity Freedom® 2025 Fund (MUTF: FFTWX ). What do funds like FFTWX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of FFTWX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of FFTWX. Expense Ratio The expense ratio of Fidelity Freedom® 2025 is .70%. That expense ratio is simply too high. Investors using a target date fund need to keep an eye on those expenses. It is possible to create a very efficient portfolio using only a few funds. Ideally the funds selected for building the portfolio would be selected for offering excellent diversified exposure at very low expense ratios. At the most simplistic level, an investor is looking for domestic equity, international equity, domestic bonds, and international bonds. If any of those had to be left out, the international bond allocation is the least important. In my opinion, there is no need to use both growth and value indexes. There is no need to individually use large, medium, and small-cap allocations. For instance, the Fidelity Spartan® Total Market Index Fund (MUTF: FSTVX ) has a net expense ratio of .05% and offers exposure to the vast majority of the U.S. market. If you were building a target date fund from Fidelity funds, you could simply use FSTVX and eliminate all other domestic equity funds. This method would provide investors with a low expense ratio on the underlying domestic equity position and excellent diversification. That is precisely why I am including FSTVX as a holding in my portfolio. The Vanguard Target Retirement 2025 fund has an expense ratio of .17%. Just so investors have a healthy comparison of how much it costs to run a very efficient target retirement fund, the Vanguard expense ratio gives a pretty clear indication. Holdings / Composition The following chart demonstrates the holdings of Fidelity Freedom® 2025: If you were making a target date fund, how many allocations would you need? Hopefully it wouldn’t be that many. Note that the holdings chart above simply showed the equity funds. There is another long list of funds for bond exposures. There is simply no need for a portfolio to be this complex. Volatility An investor may choose to use FFTWX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. (click to enlarge) When we look at the volatility on FFTWX, it is dramatically lower than the volatility on the SPDR S&P 500 Trust ETF ( SPY). That shouldn’t be surprising since the portfolio has some large bond positions. Over the last five years it has significantly underperformed SPY, but that should be expected given the much lower beta and volatility of the fund. Investors should expect this fund to retain dramatically more value in a bear market and to fall behind in a prolonged bull market. Even adjusted for the beta, the returns on this portfolio were pretty weak. They were slightly over half the rate achieved by SPY. For comparison, one way an investor can achieve precisely half of the returns on SPY with precisely half the volatility is to buy SPY with half of their portfolio and leave the rest sitting in the account. That would have resulted in slightly lower returns, but it would also have resulted in a dramatically reduced max drawdown. For a fund designed for people that are retiring only a decade from now, having had a max drawdown that was almost as large as if the entire portfolio had been invested in SPY is a pretty poor performance. Opinions The first change I would want to make here is to see a lower expense ratio and a dramatically simplified portfolio of holdings. There is no need for a large complicated portfolio. To drive annualized volatility down while using Fidelity funds, I would favor using the Spartan ® Long-Term Treasury Bond Index Fund (MUTF: FLBAX ). The fund has a very high weighted average maturity (around 25 years), over 99% of the portfolio is in treasury securities (low credit risk), and an expense ratio of only .1%. That is a good solid mutual fund and using it in a target date portfolio fund with regular rebalancing allows investors to automatically take advantage of the negative correlation that long term treasuries have with the domestic equity market. Comparison Portfolio I used Invest Spy to put together a portfolio from Fidelity funds that I believe is dramatically superior to FFTWX. That portfolio is demonstrated below: (click to enlarge) This portfolio simply combines their total domestic market index (expense ratio .05%) with their long term treasury ETF (expense ratio .1%). The resulting expense ratio of the two underlying funds at a 50/50 weighting should be about .075%. This hypothetical portfolio had a max drawdown of only 7.3% and an annualized volatility of 7.2%, which is dramatically lower than the 10.4% reported for FFTWX. Of course, investors should not rely on historical results as predicting future results. The example is simply to demonstrate that a portfolio of domestic equities and long term treasuries has been capable of maintaining fairly low portfolio volatility due to the historical negative correlation of the two asset classes. Conclusion When an investor takes on an expense ratio that is even .3% higher and pays that ratio for 20 years, they are looking at losing 6% of the value of the portfolio without accounting for compounding. If investors account for the benefits of compounding and assume annual returns are positive, the potential value lost is even greater than 6%. FFTWX is an expensive option for investors looking for a simple “set it and forget it” retirement plan from their employer sponsored retirement accounts. The volatility of the fund is not a problem and the total exposures are not unreasonable. The problem comes down to two issues. One is that the fund has needlessly complicated the portfolio holdings and the other is that the expense ratio is simply too high when compared to similar products offered by competitors. There are some great funds offered by Fidelity and I have positions in a few of them. Unfortunately, this fund just falls short of the mark. Scalper1 News
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