Objective information about retirement, financial planning and investments

 

5 Timeless 401(k) Investing Tips

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We have a looming Fiscal Cliff, we have infantile politicians bickering about it, and we have Jim Cramer screaming and ranting about whatever.  In this environment, here are my best tips for 401(k) investors (a hint these are the same tips I would have offered if this was 2011 or 2010, or most any other year):

Stick with it

During the 2008-2009 market decline, many 401(k) participants lowered their deferral rates or stopped salary deferrals altogether. Clearly those participants who stuck with their salary deferrals and their investment strategy throughout are generally happy with the results given the market’s performance over the past three years. The point is that consistent savings and sticking with a plan plays a key role in accumulating 401(k) assets for retirement over time.

Contribute as much as you can 

I’ve read many studies pertaining to retirement success.  Virtually all of them cite the amount saved over one’s working life as the single biggest factor in achieving a financially successful retirement.  At the very least make sure you are contributing enough to earn any match offered by your employer.

View your 401(k) as part of your overall portfolio

Far too many participants view their 401(k) accounts in a vacuum. The better approach is to treat this as a part of your overall portfolio. Your outside investments might include a spouse’s retirement plan, various IRAs, old 401(k) accounts left at former employers, taxable accounts, various individual stocks and bonds, and other investments such as rental property. The point is to view your 401(k) account in light your overall portfolio and allocate your holdings accordingly. 

Don’t ignore your 401(k)

There were many stories during 2008-2009 about 401(k) participants who couldn’t bear to open their account statements. Part of the reason that the participants who stuck with their plan did so much better according to a Fidelity study was due to the fact that they bought shares at lower prices during the market decline and then benefited from the ensuing rally that started in March of 2009. As painful as it is, review your account at regular intervals and rebalance when holdings fall outside the target allocation range you have set. Even better if your plan offers automatic rebalancing, take advantage of it.

Use Target-Date Funds with caution

The concept of Target Date Funds is great.  Invest in the fund with a target date closest to your projected retirement date. The manager adjusts the level of stocks as you get closer to the target date. Participants get professional management of their investments. The reality is that different funds from different families with the same target date often have widely different allocations and levels of investment risk. The quality of the underlying funds differs among various fund families. If this route seems attractive to you, it is vital that you review the Target Date Funds offered by your plan. Don’t automatically default to the fund with the target date closest to your projected retirement, rather look at the allocation of the various funds in the series and pick the one that best fits your situation. Also look under the hood at the fund’s underlying investments and be sure you understand how the fund invests your hard-earned money.  This extends to all aspects of the fund including the fund’s glide path into retirement.  Personally I like Target Date Funds for younger workers who might not have much in the way of outside investments; I’m not a fan for investors within 15 or so years of retirement.  These folks need to have a portfolio and a financial plan that are working in harmony.

Your 401(k) can be a great retirement savings vehicle. Like any other investment, it does take work to ensure that your savings are working hard for your retirement.

Please feel free to contact me with questions about your 401(k) plan and your retirement planning needs.

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Vanguard Target Date Funds – A Look Under The Hood

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I’ve written several posts on Target Date Funds for this blog.  I have mixed feelings about them.  On the one hand TDFs do

Vanguard

provide investors with a professionally managed all-in-one investment solution.  Ideally you invest in the fund with a target date closest to your anticipated retirement date and the fund does the rest.  The manager typically lightens up on equities over time until the fund reaches its Glide Path into retirement, which is a point where the equity allocation levels off and you “glide” into retirement.

This is great in theory, but the reality is that across various fund families TDFs with the same target date can vary widely in their allocations and as to when the Glide Path starts.  Personally I like TDFs more for younger investors versus those who are within say 15 years or so of retirement.  Target Date Funds have become a staple in 401(k) plans due to the safe harbor given to plan sponsors who use them as the default investment choice for those plan participants who do not make an election of their own.

Fidelity, T. Rowe Price, and Vanguard control about 80% of the TDFs assets.  Let’s take a look under the hood at the Vanguard Target Retirement funds.

Vanguard offers funds with target dates beginning in 2010 and going out to 2060 in five year increments.  Additionally they offer an Income version of the fund for those already in retirement.

Low Cost and Simple

Vanguard’s approach is both simple and low cost.  The underlying funds consist mostly of Vanguard’s low cost index funds.  The overall expense ratio of the funds is a weighted rollup of the underlying funds and currently ranges from 0.17% to 0.19%.  This is far less expensive than either Fidelity or T. Rowe Price and each of the Vanguard funds ranks in the top (lowest expense) percentile of their respective peer categories.

Solid Performance

  • Each of the funds from the 2010 through the 2050 fund received a top ranking from Fi 360 a mutual fund and ETF ranking service that I utilize in their most recent rankings through the quarter ended September 30, 2012.
  • The Retirement Income fund received a score of 6 from Fi 360 meaning that it ranked in the top 6% of the 211 funds in its category based upon the 11 ranking criteria used by the service.
  • The 2055 and 2060 funds do not have enough history to receive a ranking.

Glide Path and Asset Classes

Vanguard uses 7 asset classes in its TDFs; Fidelity uses 11; T. Rowe Price uses 12.  This is not good or bad, but does reflect Vanguard’s more basic approach.

Vanguard’s Glide Path levels off at age 72; Fidelity’s at age 80; T. Rowe Price’s at age 95.  The Glide Path assumes that the investor will hold the fund until death; this may or may not be the case in reality.

Are Target Date Funds the Right Answer? 

As mentioned above, I have mixed feelings.  On the one hand TDFs are often a better solution than simply letting one’s retirement plan assets languish in a money market account.  On the other hand I am convinced that investors who are either comfortable doing their own allocation or who utilize an advisor are generally better served by tailoring an allocation from among the menu of investment choices offered in their 401(k) plan.

As far as Target Date Funds go, I generally like the Vanguard version for their basic, easy to understand approach and their low cost.

Check out Morningstar to look under the hood of Vanguard’s Target Date Funds and to compare them against other alternatives that you might be considering.  Get a  free trial for their premium services.

Please feel free to contact me with questions regarding your investments and your retirement planning issue.

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Target Date Funds – A Look under the Hood

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Asset Allocation on Wikibook

The Pension Protection Act of 2006 made Target Date Funds the default investment option of choice in many 401(k)

plans.  As of March, nearly 25% of all 401(k) participants invest solely in TDFs representing a 6 fold increase in six years according to Vanguard via research for plans they manage.  Vanguard goes on to say that 64% of new plan participants entering a plan for the first time contributed 100% to a single TDF.

When you invest in a Target Date Fund, where is your money going?  Here is a comparison of the TDF series offered by the “Big 3” Vanguard, Fidelity, and T. Rowe Price who control about 80% of the Target Date Fund assets.

Fund Basics

Fidelity

T. Rowe Price

Vanguard

Number of underlying mutual funds

23

19

5

Glide Path end age

80

95

72

Active/passive focus

Active (89%)

Active (85%)

Passive (97%)

Expense ratio-avg.

0.64%

0.70%

0.18%

Information via Lipper and Morningstar

Looking at some of the basics from the chart above:

  • All three families are funds of funds comprised exclusively of their own mutual funds.
    • Fidelity and T. Rowe Price both use a higher number of undying funds as compared to Vanguard.
    • Vanguard’s funds are lower cost due to their focus on passively managed index funds.
  • Vanguard and T. Rowe Price use the same underlying funds that are generally available to investors.  Fidelity has moved in large part to the use of their Series funds, a group of institutionally managed funds designed for use only in their Target Date Funds.
  • Glide path refers to the leveling out of the allocation to equities in the funds as shareholders move into retirement.  All three funds are “through” retirement rather than ‘to” retirement.  In the latter case the glide path would level off around age 65.
  • T. Rowe Price has among the longest glide paths of all TDF families.  As you can see above, Fidelity and Vanguard level off a bit earlier.  A point about the glide path.  The fund companies assume that you will hold the TDFs through retirement and perhaps until death.  You might or might not do this, if you don’t the glide path does not make as much difference.

A look at the asset classes used by each TDF family shows some additional differences

Asset Class Summary

Fidelity

T. Rowe Price

Vanguard

U.S. Large Cap

X

X

X

U. S. Mid Cap

X

X

X

U.S. Small Cap

X

X

X

International Equity

X

X

X

Emerging Markets Equity

X

X

X

U.S. Fixed Income

X

X

X

U.S. TIPs

X

X

X

High Yield Fixed Inc.

X

X

International Fixed Income

X

Emerging Mkts Debt

X

X

REITs

X

X

Commodities

X

X

Source:  Lipper 

As you can see from the chart above, Fidelity and T. Rowe Price have ventured into a number of non-core asset classes.  The allocations to any of these asset classes of course vary based on the allocation of the particular TDF.

Vanguard has chosen to take the approach of building their asset allocation models across the various target dates using a simpler approach with just five funds across seven asset classes.

According to Morningstar both T. Rowe Price and Vanguard are ranked “Top.”  Morningstar uses a five rank system.  Fidelity’s Freedom Funds are ranked as “Average” the middle ranking.  This is as of June 30, 2012.

Target Date Funds are a staple in 401(k) and similar retirement plans.  As mentioned above they are frequently used as the default option for participants who don’t specify an investment choice.

As far as choosing which family of TDFs to use, you generally won’t have a choice in your 401(k).  Understand, however, that TDFs can generally be used outside of retirement plans.  For example all of the “Big 3” actively court rollovers from the retirement plans they manage for participants who are leaving the plan for whatever reason.

Besides the fund of proprietary funds approach used by these three families, there are Target Date Funds out there using ETFs and other vehicles as the underlying investments.

Should you go the Target Date route?  Here are a few factors to consider:

  • Are you comfortable allocating your retirement account from among the other options available in the plan?
  • Are there advice options available to you via your retirement plan?  These might include online options; in-person individualized sessions; or managed account options.
  • Do you work with a financial advisor on your accounts outside of the plan?  If so the advisor might be in a position to provide advice on your 401(k) account.  In any event these assets should be considered by your advisor in the course of the advice they provide to you.

If you decide that the Target Date Fund route is the best route for your situation, here are a few things to consider:

  • Pick the fund that best fits your unique situation; this may or may not be the fund with the target date closest to your anticipated retirement date.
  • Target Date Funds are not a “set it and forget it” option.  There, in my opinion, is no such investing option for your 401(k) or any other account.  You need to monitor your TDF choice and understand how your money is being invested.  Fund companies can change managers, investment philosophies, etc.  You are responsible for your retirement and need to stay on top of it.
  • The use of a TDF does not guarantee retirement savings success.  The biggest determinant here is the amount saved during your working life.  Make sure that you are maximizing the amount you are able to contribute to your plan.
  • TDFs do not lower investment risk; this is a function of how the fund is allocated and the skill of the investment manager.  Just ask holders of many 2010 dated funds back in 2008.
  • You need to understand how the allocation of the TDF you choose will fit with your other investments, whether other funds in the 401(k) or your outside accounts such as IRAs and taxable brokerage accounts.

While I’m not a huge fan of Target Date Funds, they can be a sound alternative for many 401(k) investors.  Make sure you have researched this and all options available via your 401(k) plan to determine if this is truly the best option for you.  Check out morningstar.com to analyze your Target Date Fund choices and all of your 401(k) options, and to get a free trial for their premium services.

If you have a choice of Target Date Fund families remember to look “under the hood” of each because there are differences in approach, the types of underlying investments, and costs.  There are also differences in the allocation and risk of funds from difference families with the same target date.

Please feel free to contact me with any questions you may have about your 401(k) plan or with regard to your overall financial planning needs.

Please check out our Resources page for tools and services that you might find useful. 

Photo credit:  Wikipedia

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Guaranteed Income Does Not Guarantee Retirement Success

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Retirement

I suspect in part as an outgrowth of the stock market meltdown of 2008-09, guaranteed income products (annuities) in 401(k) and other retirement plans are a major topic of discussion. The Treasury Department recently gave the go ahead for the use of annuities in retirement plans. As a practical matter the widespread use of these products is still a bit off into the future.

I wrote an earlier post in this blog and one for US News about my thoughts and concerns surrounding annuities in retirement plans. A good idea in theory, the reality of the implementation concerns me.

Saving for retirement is still the key to success

Let me focus on one additional area of concern. While a guaranteed income product that the participant would purchase as part of their investment in the plan would provide a guaranteed lifetime income stream, there is no guarantee that this stream of income would be sufficient to guarantee the retirement lifestyle the participant seeks.

Said another way, the inclusion of a guaranteed income option in a retirement plan does not absolve the participant from determining how much they need to save for retirement and how they need to allocate their investments. Even the use of a Target Date Fund or a managed account option requires the participant to ensure that the fund manager is investing their money in a fashion that fits their retirement accumulation needs.

Besides concerns such as the fees tied to these options and the selection and monitoring of an insurance provider for these products, the prospect of these products providing retirement plan participants with a false sense of security in terms of their retirement readiness concerns me greatly. A guaranteed income option might be a good tool for a retirement plan participant, but it is in no way a substitute for good old fashioned financial planning. At the end of the day, participants still need to accumulate a sufficient amount in their retirement plan accounts in order to be able to generate a meaningful monthly income stream if they choose to go the annuity route.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner.

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What Does My Fidelity Freedom Fund Invest In? – An Update

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In February of 2010 I posted “What Does My Fidelity Target Date (Freedom) Fund Invest In? “ It is time to update this analysis.

Using the same methodology as the last post, I combed through each of the individual Fidelity Freedom funds and made a list of their underlying holdings. The Fi360 Toolkit which rates funds based on an 11 point criteria was used to review the underlying funds:

• Fund inception date (at least three years)

• Manager Tenure (min. 2 years)

• Minimum fund size

• 2 measures relating to fund investment style and asset composition

• Expense ratio

• 2 measurements of risk-adjusted return

• Trailing 1,3,5 year returns

Of the 23 non-money market funds used inside the Freedom Funds (all rankings as of June 30, 2011):

• One of the funds received the highest ranking of 0. This means no deficiencies, they passed all criteria.

• An additional three funds earned a score ranging from 1-25 indicating that they passed most of the criteria. This would indicate that these funds rank in the top 25% of all funds in their peer group with enough data to be ranked.

• Three funds had scores ranging from 26-50 indicating that they did not pass in a couple of areas but overall rank in the top half of their respective peer groups based upon the ranking criteria.

• Three of the funds had a ranking in the 51-74 range indicating that they were deficient in several of the criteria and overall place in the lower half of their peers with enough history to be ranked.

• One fund had a score in the bottom quartile of the ranking meaning that it was deficient in most areas and ranked in the bottom 25% of its peers. A ranking in this range indicates that strong consideration should be given to replacing such a fund.

• Twelve of the funds did not have enough history to be ranked. These funds are all Fidelity Series funds. This appears to be a new group of funds that Fidelity has designed for use in their Freedom Funds. These may ultimately prove to be good funds over time, but as an advisor I am generally loath to invest client money in new, untested funds unless there is a compelling reason to do so. In looking at the returns posted by these unranked funds, the results are middling at best.

• Noticeably absent from the underlying funds within the Freedom Funds are any of Fidelity’s low cost core index funds covering areas such as the S&P; 500; total domestic stock market; international equities; or their total bond market index fund. These are by and large solid, low cost holdings. Also absent are several top Fidelity funds such as Contra, Low-Priced Stock, and others.

Reviewing the overall performance of the 12 Freedom Funds compared to their peers in the Fi360 rankings:

• One fund received 0 the highest score available

• Three of the funds received scores ranging from 1-25 placing them in the top quartile of their peer group.

• The rest of the eight funds earned a score in the 26-50 range, placing them in the second quartile of their peer group of funds.

Note these ranking are in line with Morningstar’s evaluation of the Freedom funds as of June 30 in which they ranked this group of funds as Average. Morningstar ranks 20 Target Date families each quarter.

Target Date Funds are typically funds of funds that are managed towards the target retirement date in the fund’s name. Fidelity, for example has target date funds with dates that range from those currently retired out to the year 2050. Target Date Funds are a staple of 401(k) and other defined benefit retirement plans.

All too often a retirement plan sponsors will default to the suite of Target Date Funds offered by the platform used by the plan provider. In fact, plan sponsors need to perform the same level of due diligence on the Target Funds they offer in the plan as with any other investment choice included in the investment menu.
Target Date Funds have been marketed as a one-decision set it and forget it investment option. In my opinion, there is no such investment option.

Investors considering a Target Date Fund need to do their analysis of the fund(s) they are considering to determine if this is an appropriate investment for them. Further investors should not feel compelled to invest in the fund with the target date closest to their projected retirement date, but rather should pick the fund that best matches their investment objectives.

Please feel free to contact me with questions about Target Date Funds or to address your investment and financial planning advice needs. 

Do-it-yourselfers check out morningstar.com to analyze your investments and to get a free trial for their premium services. Check out our Resources page for links to a variety of tools and services that might be beneficial to you.

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Target Date Funds-A No Brainer?

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When they were introduced, Target Date Funds (TDFs) were touted as a no brainer investment. Much of the education presented by fund companies to 401(k) participants portrayed these funds as a place where participants can “set it and forget it.”

In my opinion, no such investment exists. I’m not knocking TDFs. Rather 401(k) participants need to understand what they are investing in and whether or not these TDFs are right for their unique situation. Is the fund nearest their probable retirement date too heavy or too light on equities for their goals and risk tolerance? 

Further, 401(k) plan sponsors also need to perform their due diligence. Just because their plan is with the likes of Fidelity, Principal, or the American Funds doesn’t mean that any of these provider’s TDFs are right for their participants. It is incumbent upon plan sponsors to “look under the hood” of these funds. What are the fund’s underlying investments? Are they too heavy or too light in equities in the various target years? What does each group’s glide path into retirement look like? Do their participants tend to leave their money in the plan at retirement or do they tend to roll their money out of the plan? Plan sponsors need to perform the same level of due diligence with the selection of TDFs as they would with any other investment choice. 

JP Morgan has a tool called Compass that compares the makeup of various near-dated TDFs (currently the 2010 funds). The range in equities among the 40 funds shown in the JP Morgan analysis was from about 20% to almost 75%. The recent Congressional hearings on TDFs illustrated that two funds with the same target date might have radically different investment allocations and levels of risk.

My bias would be for plan sponsors to offer their participants access to qualified unconflicted advisors. These advisors are able to offer each participant specific advice as to how to allocate their accounts from among the investment options offered by the plan. Perhaps the recently passed Financial Reform Bill and the pending Advice Provisions of the Pension Protection Act (PPA) will help plans to move in this direction. Participant education is fine, but plan participants are better served by direct, live investment and retirement planning advice.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner.

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What Does My Fidelity Target Date (Freedom) Fund Invest In?

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Fidelity is one of the largest providers of 401(k) plans and like many fund company platforms it is common for their plan sponsor clients to offer several or all of Fidelity’s Target Date funds known as the Fidelity Freedom funds. These funds have target dates from 2005 every five years out to 2050 with an even shorter-term Retirement Income fund. The premise behind these and other Target Date funds is that a plan participant will choose a fund with a date close to when he or she might retire, invest their contributions and let the fund manager do the rest. The funds typically lighten up on equity investments as the target date draws nearer, at some point they go to a “glide path” into retirement typically at the target year. This means the fund at that point is geared to the typical life expectancy of someone retiring in that year, the allocation allows the fund shareholder to “glide” into retirement.

There has been much controversy as to whether Target Date funds work as advertised. My purpose in writing this post is not to comment on these issues one way or the other. Rather I want to take a look at how the Fidelity Freedom Funds actually invest shareholder’s money.

The Freedom Funds like many Target Date funds are funds of funds. Each Freedom Fund has its own mutual fund ticker symbol. Unlike many mutual funds which make direct investments into individual stocks or bonds, the Freedom Funds invest in a variety of Fidelity mutual funds. Which funds and the percentage held of each fund will vary by Freedom Fund. I made a list of their underlying holdings using Morningstar’s Advisor Workstation. I then used the Fi360 Toolkit to rate these funds based on their 11 point criteria:

• Fund inception date (at least three years)
• Manager Tenure (min. 2 years)
• Minimum fund size
• 2 measures relating to fund investment style and asset composition
• Expense ratio
• 2 measurements of risk-adjusted return
• Trailing 1,3,5 year returns

All funds are rated relative to other funds in their peer group.

In looking at the 26 Fidelity mutual funds that I found as holdings of the various Freedom Funds I found the following for the ranking period ending 12/31/09:

• Three of the funds received the highest ranking of 0. This means no deficiencies, they passed all criteria.
• An additional four funds earned a score ranging from 1-25 indicating that they passed most of the criteria. This would indicate that these funds rank in the top 25% of all funds in their peer group with enough data to be ranked.
• Four funds had scores ranging from 26-50 indicating that they did not pass in a couple of areas but these funds overall rank in the top half of their respective peer groups based upon the ranking criteria.
• Five of the funds had a ranking in the 51-74 range indicating that they were deficient in several of the criteria and overall place in the lower half of their peers with enough history to be ranked.
• One fund had a score of 87 meaning that it was deficient in most areas and ranked in the bottom 13% of its peers. A ranking in this range indicates that strong consideration should be given to replacing such a fund.
• Nine of the funds did not have enough history to be ranked. These funds are all Fidelity Series funds. This appears to be a new group of funds that Fidelity has designed for use in their Freedom Funds. The funds all have anywhere from a month’s worth of history out to about a year. They would flunk the inception date test for the amount of time the fund has been around. These may ultimately prove to be good funds over time, but as an advisor I am generally loath to invest client money in new, untested funds unless there is a compelling reason to do so.
• Noticeably absent from the underlying funds within the Freedom Funds are any of Fidelity’s low cost core index funds covering areas such as the S&P; 500; total domestic stock market; international equities; or their total bond market index fund. These are by and large solid, low cost holdings. Also absent are several top Fidelity funds such as Contra, Low-Priced Stock, and others.

In their defense of the 11 numbered Freedom Funds, 10 earned a score of 0 for the most recent ranking period and the other one earned a top quartile score of 20. Keep in mind; however, these rankings are within the target date peer groups via Morningstar. All of these groupings have a small number of funds and there is not a lot of history in some cases. A really good or really bad quarter or two can skew a target fund’s relative ranking. Additionally the peer groupings have changed and been revamped at least twice in the past several years.

Should you invest in these funds? As a plan participant you need to understand the fund’s investment philosophy, the glide path concept, and the fund’s underlying investments. Remember just because a particular fund has a target date closest to when you might retire, you can go with a closer date fund if you want to be a little less aggressive or a longer-dated fund if you want to be a bit more aggressive.

Plan sponsors it is incumbent upon you to monitor the Target Date funds in your plan as closely as you would review any plan investment choice. In the case of a Fidelity plan you may or may not be limited to the Freedom Funds.

Again I am not saying the Freedom funds are good or bad. Clearly they did well relative to their peers in 2009. Participants and Sponsors need to understand these funds and what they can and cannot offer.

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