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Tuesday, December 18, 2012

Observations on Fidelity's Freedom 2050 Fund

Mike Piper at the Oblivious Investor answers a really important reader question:  "Should I Use Fidelity's Freedom Funds in My 401k?"  (read this article even if you don't use Fidelity - the applicability is wider ranging).  To answer this question, he hones in on the Freedom 2050 Fund, a target date fund targeted at employees in their mid- to late-20s who plan to retire around 2050.  The expense ratio, as he notes, is on the high side at 0.77% versus .19% for Fidelity's Index funds.  But he also looks at the composition of the fund and raises an important question.

Before looking at the question, it is worth noting that very few employees have the investment savvy to analyze the holdings of a fund.  IMHO, this is a step the plan administrator, who chooses the provider, i.e., Fidelity in this case, should take.

The Freedom 2050 Fund is a fund of funds comprised of 20 different Fidelity funds!  This is a lot of funds.  The interesting question raised is whether the Fund's holdings are structured to the benefit of Fidelity or the 401k participant.  He shows in his post that one fund comprising the Freedom 2050 Fund, a real estate income fund, comprises .06% of the fund!  This obviously will have no discernible impact on performance but will, to the benefit of Fidelity, build participation in the real estate income fund!  One has to admire Fidelity's cleverness in increasing fund size in this manner, assuming this was their intent!  It can also be used to seed participation in new funds.

For completeness purposes, it is instructive to look at the performance of the Freedom 2050 Fund:

Source: Fidelity

CLICK IMAGE TO ENLARGE  As the right-hand column shows, the Fund has underperformed its benchmark by 1.66%/year over the past 5 years.  My reading of voluminous performance data tells me that the 401k participant has about a 20% chance of picking a non-index Fund that matches or exceeds their benchmark. The unlucky 80% of non-index fund holders can pay a hefty price, as in this case.

This particular post also took my thoughts back a few years when I was managing pension fund money and was interested in the process for introducing new funds.  One large well-known provider in the 401k market place allowed employees to present new fund ideas and, if adopted, the fund would run for 1 year with employees' money to get a track record before marketing to the pension funds and the public.  If the track record was poor, the fund idea was dropped, of course.  I often thought that funds with less than 5 years' real experience (not back-tested performance!) should come with a warning label so investors were clear the fund hadn't been around very long.

New funds on the market are, many times, based on what has been successful lately and on what investors are looking for as they look in the proverbial "rear view window."  Today is a good example, with investors desperately looking for yield and finding that new yield funds are the funds du jour.

Disclosure:  Post is for educational purposes. Individuals should do their own research or consult a professional before making investment decisions.


  1. Hi Robert.

    Thank you for sharing the article with your readers! I don't remember when I first looked inside Fidelity's Freedom funds. But I do recall the surprise I felt at the time. I couldn't believe that they would really put together such a portfolio.

    1. Hi Mike,
      You are welcome. The post is really important information. These funds are actually the type that many workers are opted into. Special measures should be taken to structure them appropriately. Understanding what you pointed out will hopefully help a lot of people.

  2. Ah, the old fund of funds trick to extract more fees from the investor. Very interesting, but stupid.