Before we dive into my Independent Review of The Fidelity Freedom Fund 2020………
the world we live in today requires that I bless you with a few legal disclosures… This is an independent review of the fidelity freedom fund 2020, not a recommendation to buy or sell any product. Fidelity has not endorsed this review in any way nor do I receive any compensation for this review. This review is meant to be an independent review by me- a former hedge fund manager to show my perspective when breaking down the positives and negatives of this particular mutual fund. Before purchasing any investment product do your own due diligence and consult a properly licensed professional should you have specific questions as they relate to your individual circumstances. All names, marks, and materials used for this review are property of their respective owners.
What is The Fidelity Freedom Fund 2020?
The Fidelity Freedom Fund 2020 is a Target date mutual fund designed to provide an all in one solution to investors who are seeking a specific retirement date. Someone planning to retire in 6 years would consider this fund for some or their entire portfolio.
The Composition of the Fidelity Freedom Fund 2020
The money inside the Freedom Fund 2020 as of March 31st 2014 is spread across the following:
The Freedom Fund 2020 is a Mutual Fund made up of several other Fidelity Mutual Funds that contain stocks, bonds, real estate, and cash. In short, the fund is a retirement appreciation tool now and converts to what is supposed to be a safe retirement income tool later. This fund is a perfect example of diversification as it attempts through the use of multiple funds to spread risk across stocks and bonds following the theory that adding multiple securities will reduce risk and smooth out the ride for investors. Unfortunately many of these securities will behave the same during market corrections.
Who Manages the Freedom Fund 2020?
The Fidelity Freedom Fund 2020 is currently managed by Andrew Dierdorf and Brett Sumison. Their job is to choose combinations of other Fidelity funds and fund managers, which ultimately make up the holdings of this fund (I’m not going to list each manager of the sub-funds because it would require most of this page!).
The Good Part About the Fidelity Freedom Fund 2020
Good Marketing. Fidelity designed their Freedom Funds with investor’s wants and desires in mind. The target fund idea was a strong play by Mutual Fund companies… what else do most non- pro investors want to know about their portfolio? Do most people care what holdings are in their mutual fund? Do most people ask how much they pay in fees for their fund? Do most people know how to compare the performance of their portfolio to others with similar objectives? No! Most investors want to know they have a fund or portfolio designed to help grow until retirement and then provide them income! If that’s the case then Fidelity made their Freedom Fund 2020 sound perfect. Most financial advisors preach and deliver diversification and asset allocation solutions to investors. They group your money into various holdings that are very similar to what every other advisor would recommend- a well diversified tactical asset allocation model weighted based on your retirement goals. If you still believe diversification works and will fix all of your investment and retirement fears then you can avoid the BS of talking to a broker who will tell you something very similar to what this and other similar target 2020 funds will deliver. The Freedom Fund 2020 is a diversified asset allocation strategy wrapped up into one fund that in theory could eliminate the hassles and need of meeting with an advisor. If you want to talk to someone…no problem! Fidelity has the staff to answer your questions, the fund manager and analyst to allocate your money according to your objective (2020 retirement), and they have the name and platform that everyone’s is familiar with. This is so simple…not so fast. Better Growth Potential Than Annuities…if the Market Goes Higher and Interest Rates don’t rise. Since 60% of this fund is made up of a variety of domestic and international equity mutual funds it will perform ok as the market rises. The bond holdings and extreme diversification however will weigh on the funds performance in high flying markets as we’ve seen since March of 2009 and pre-2008 recession. Regardless of how a fund or advisor performs, often customers get more value from a feeling or hunch about trust in a company or advisor. Many times this feeling is based on how long a Fund or company has been around. Fidelity has been a big name for a long time in the investment world creating a perception that Fidelity must know what they are doing and because of that will be around ‘for a while.’ Right or wrong when investors call or see concerns they feel better knowing the company they are working with has been through many of the boom and bust cycles the market has so graciously delivered us at least when times are good.
Mutual Fund Fees- Including the Real Fee You Pay to play in the Fidelity Freedom Fund 2020
Before we dig into the Freedom Fund 2020 fees lets explore potential fees someone could pay while invested in mutual funds. Potential Mutual Fund Fees:
- 12b-1 Fees
- Management Fees
- Other Fees/Expenses
- Account Fees
- Exchange Fees
- Redemption Fees
- Sales Loads
- Fees of any other Funds Purchased By the Fund You Own
For more on Potential Fund Fees visit the SEC’s website: http://www.sec.gov/answers/mffees.htm Financial Advisor Fees in addition to your Mutual Fund Fees:
- Flat Fee Regardless of Account Size
- A percent of Assets Under Management
- Performance Only Compensation
- Financial Planning Fees
- All of the above!
Most financial advisors ask you several questions to help them better understand your concerns and desires. They take your information and try to match it to advice they received from their analyst or asset allocation team (because chances are your financial advisor has little to no trading experience and adds little value outside of spitting out information from financial planning software and providing you service…they are glorified car salesman). In simple terms they take your money and spread it across various baskets of stocks, bonds, commodities, annuities and sometimes real estate through either mutual funds directly or through individual securities. For their work, advisors who are compensated by an asset under management fee will charge you anywhere from .5 – 2% per year. You also may pay commissions, fund fees, or both that range from .3 – 2.5%. In the end, investor fees range from .8% to 4% per year ($8,000-$40,000 per year per million dollars invested). Great now I’m aware of potential Fees Now Much does the Fidelity Freedom Fund 2020 Charge? According to their prospectus, the annual fee to participate in the Fidelity Freedom Fund 2020 is .69%. Whatttttt???? It will cost me less than 1% to participate in this fund each year AND I get a diversified portfolio that automatically adjusts as I near retirement? This sounds amazzzzzzingg…..sign me up! You shut your mouth when you’re talking to me!!! You know better… there has to be a catch somewhere right? I did a little more research for you and found the .69% is very far off the real fee you pay when you play in this fund. Since rules and regulations are always years behind the curve, investors perception of what they pay in fees is often very far from reality. I tried like hell to find the REAL fee in the prospectus..but it took a little more than reading this prospectus to find out how much you really pay for this fund. The big question was: Do investors pay the fee for the Fidelity Freedom Fund 2020 plus a fee for the funds owned by the Freedom Fund or do they just pay the Freedom Fund fee? When I couldn’t find a solid answer in the prospectus I picked up the phone and spoke to a confused but polite customer service rep named Lorne. I asked Lorne if investors pay the Fidelity Freedom Fund 2020 Fee alone or if they also pay the fee from the funds owned by the Freedom Fund 2020? Typical of most home office employees the question was not answered initially and I was circled around with an explanation that was not relevant to my question. So I asked the question again. Finally after a third attempt to get an answer to a question I was certain I knew the answer to he confirmed that a person invested in the Fidelity Freedom Fund 2020 will pay the fee for that fund ANNNNND the fees of the funds purchased by the Freedom Fund. According to Morningstar’s software, the average fee expense for funds inside the Freedom Fund 2020 is .68% ( See the picture below). With that said, it’s safe to say you are paying in the neighborhood of 1.37% per year in fund fees alone when you invest in the Fidelity Freedom Fund 2020. This assumes you went direct to Fidelity. If you own this fund through a broker or 401k chances are there are more fees you are paying which could easily bring the cost of this mediocre fund above 2% (oops did I spill the beans to early?). Buyer Beware: Fidelity Freedom Fund 2020 and other Target Date Mutual Funds can be purchased by a financial advisor on your behalf. If that advisor is also charging you a fee to own this fund ask yourself a few questions such as:
- Does it make sense to pay an advisor to allocate me into a fund that is designed to do that advisors job?
- Is my advisor truly an expert if he feels a target date fund is in my best interest?
If this truly is the fund for you (read my opinion at the end first), don’t waste your money buying this fund through a financial advisor. Instead just create an account at Fidelity, save yourself financial advisor fees, and buy the fund yourself… the team at Fidelity will be happy to assist you free of charge! Or talk to an expert who truly specializes in asset allocation and who offers a truly unique strategy that plans for the unexpected! Fees can make a huge difference in your performance over time and although it shouldn’t be the only factor in your decision it should be part of your consideration. Now that you know the real fees of the Fidelity Freedom Fund 2020 we need to ask:
- How unique is the fund?
- How much would it cost me to diversify across various funds through a financial advisor?
- Is it worth paying ½ to 1 ½ % more to work with an advisor who in theory should be able to build me a more customized model?
- If the market drops like it did in 2008 and or interest rates rise how will my portfolio look if I own this fund?
- How has this portfolio performed against their benchmarks?
- How expensive is it compared to an index fund such as an S&P 500 ETF (if that’s the benchmark)
- Is there a better way to manage risk than using bonds?
- How much risk does the fund take compared to a benchmark like the S&P 500 and how has the result been different?
- If I went back 14 years could a CD or traditional annuity(not EIA) have delivered a similar return?
If you pay an additional 1% to have an advisor you grow to know/trust, speak with regularly, design a portfolio unique to your needs, help answer your questions and help you make non- emotional decisions is it worth it? Only you can decide, but at least evaluate this fund vs. a customized plan and compare your performance and service and risk strategy (the oh shit plan..what if the gorilla comes back in the room) before you decide if the Freedom Fund 2020 is worth your time.
- note numero uno: long term performance should show real performance through booms and busts not just 2009 to present
- note part duex: I would make a small wager that your team can’t provide YOUR average annual term since inception with their firm..not their performance and not your performance YIKES! (put your wallet away I’m not really going to bet..that would be illegal).
How Will the Freedom Fund 2020 Perform During Equity Market Corrections?
Ok so Fidelity Freedom Fund 2020 is designed to meet the objectives of investors who have a retirement date of 2020 in mind, but what does that mean? In other words if I retire in 2020 am I set because I’m invested in this fund? Regardless of what you invest in- annuities, stocks, a program called asset lock, bonds, funds, commodities, tactical allocations or a diversified portfolio containing all of the above and more, you better understand what risks you face. I’m not going to dissect each of those instruments/strategies in today’s blog but I will help you better understand the risk you face if you’re invested or planning to invest in the Fidelity Freedom Fund 2020. As of today the Fidelity Freedom Fund 2020 is invested 60% in stock holdings and 32% in bond holdings (see picture below). 40% of the Equity holdings are in U.S. stocks and 20.38% are invested in foreign stocks. It appears that the manager has discretion to change those allocations as he/she deems necessary but overall the allocation will slide closer to bonds/short term funds as we near and pass the year 2020. See the chart below for its current breakdown.
If the Fidelity Freedom Fund 2020 fund manager (and sub managers) doesn’t make many adjustments to the portfolio and the U.S. equity markets drop 50% as they did between November of 2007 through March of 2009 then you can expect a similar decline in the U.S. Stock portion of your portfolio as the S&P 500 or Dow. That’s no big deal because this fund is diversified and has foreign holdings right? Wrong!
We live in a connected world today people! The world powerhouses are impacted by the good or bad news/policies of each other. When another crisis hits the U.S. it will negatively impact the markets in Asia and Europe and vice versa (Fukushima, Spain, Italy circa 2010-2012…need I say more?). Let’s make the assumption that European and Asian markets have a 50% correction at the same time as U.S. stocks. If this happens you can expect to see 60% of your equity holdings (both the U.S. and Foreign Stock Holdings) follow suit and show losses in the neighborhood of 50%. Since this is 60% of your portfolio we could guess that your stock holdings would look something like this (remember we assume your fund manager just ‘holds on’):
Wait I thought this fund was made for people who are going to retire in 6 years.. isn’t this risk a major problem for someone with those objectives?
What if an investor is taking income at the time their portfolio loses 30%?
The short answer: you might have a problem! I don’t know what will come next in the equity markets and nobody can predict how the fund managers of the Fidelity Freedom Fund 2020 will adjust to unexpected major market movements but we can get an idea of what they may or may not do based on:
- How the benchmarks of these holdings have performed in the past
- What changes they’ve made to their strategy since the last debacle
- Large funds may struggle to offload large equity holdings due to liquidity issues… it would probably take quite a while to move to cash which is not very conducive to say a flash crash as we saw in 2010 when the equity markets dipped 10% in literally 15 minutes.
It’s possible (highly unlikely) that fidelity will make a bold move and force fund managers into cash at the perfect time. Maybe they will try to look at investing differently and use more logical instruments to manage risk. Nobody knows at this point but every investor at the very least needs to know how the fund performed in the most recent crisis and what adjustments they have made or plan to make to avoid repeating their mistakes. Based on the chart below it appears the big risk management solution for this fund is bonds.
When investors are scared they often sell their equity holdings and buy into bonds. This drives bond yields down and the price of bonds up.
Translation: People who hold bonds in this scenario would see an increase in their principal value. In the academic world and the world of major investment institutions bonds and commodities are traditionally how risk is mitigated in client portfolios. Support for this statement is shown in the picture below. The green space below is showing us that as the Fidelity Freedom Fund 2020 gets closer to it’s target year and continues further into retirement, the holdings inside the fund will be allocated nearly 75% to bond and short term funds compared to the current 40% allocation.
Fidelity Target 2020 clearly makes the case that safety and income will come from their bond holdings… should you trust this? Personally I don’t think you should and here’s why. Interest rates have slowly dropped down to almost zero. Last May the 10-year touched historical lows when it touched 1.5%! After running above 3% this year the 10-year is slowly trickling back down to its current level of 2.50%. What does that mean? If rates rise even to normal levels of say 6-7% on the 10 year and you hold bonds be concerned…very concerned.
If you are not able to hold your bonds to maturity or if they default or if you get scared because of the losses you see on paper or if you are in a mutual fund and your fund manager is forced to sell bond holdings you will experience a significant amount of pain… potentially similar pain as equity holders felt in 2008. To help you better understand where we are in terms of interest rates and the risk you face if holding bonds.. look at the chart below back to 1962:
Charts don’t always tell the truth, but in this case we know the limit of interest rates. Rates can’t fall below zero so the worst-case scenario is a measly drop of 2.5% from where we are today! When rates reach zero they can only do two things:
- Go Negative
Again when rates rise bond holders will show losses….So why would anyone invest in bonds right now? Good question I wouldn’t and I wouldn’t for my clients either. I would rather seek income from other sources. The argument I constantly hear from people and advisors sounds like this: as long as you hold a bond to maturity you won’t lose anything. This is only partially true, and would be 100% untrue and create a big problem for someone relying heavily on bonds for their retirement income. My point? There is meaningful downside risk in corporate bonds and bond funds. The bond holdings in the Fidelity Freedom Fund 2020 may help, but they could also hurt the portfolio if some very real scenarios arise. A few scary scenarios for bond holdings in this fund: A Run on a Bond (or a fund with large bond holdings) Mutual Fund: What if your bond exposure is through Mutual Funds? If you have a Mutual Fund(s) holding bonds…especially funds that heavily weight bonds it’s not always your decisions to sell or hold on that matter. A few situations that could hurt you that you can’t control in this or any fund :
- Your fund manager may sell bond holdings at his/her discretion
- Other investors flee the fund forcing the fund managers to sell bond holdings scaring investors potentially creating even more selling
- Managers are forced to sell holdings at the wrong time losses can wrack up pretty quickly… when big funds start wracking up losses entire markets can spiral out of control creating a panic selloff across the board
Pain may force an emotional decision for managers and individuals…what is your pain threshold: How much pain can you tolerate in your fund holdings? Since funds are portfolios of numerous individual securities whose prices fluctuate based on prevailing market conditions, their values can experience significant volatility. In 2008, the fidelity investment grade bond fund lost nearly 9% in a 3-month period! If interest rates rise faster than we think or if clients flee their mutual funds unexpectedly the loss in 2008 in this and many other corporate bond funds could be minor compared to the potential pain in the future. This would lead to unexpected losses for clients who thought their Fidelity Freedom Fund 2020 was a great place for their investments/ retirement savings. Default: Bonds are safe and never default right? WRONG! The following are just a few big name municipalities that either defaulted or were at the brink of default in the recent past:
- Stockton California
- Bear Stearns
- Harrisburg Pennsylvania
- Jefferson County Alabama
- Professional Athletes (not funny?)
Rising Rates Showing Principal Losses: It shouldn’t be a secret by now that if interest rates rise bond values decrease. What isn’t known to many people is how much value could be lost when rates rise. Getting into the exact numbers at this point wouldn’t make sense but a scenario you should consider before investing or staying in the Fidelity Freedom Fund 2020 is a principal loss on your bond holdings that could be 15-40%. Will your income still come in? Maybe. But will you be able to tolerate the fluctuation of your overall principal in this fund? Will you want to hold onto your holdings when you can get 6% FDIC insured at a bank? See: Indexed Annuities: 3 Things I Love and Hate About Them
Fidelity Freedom Fund 2020: Mutual Fund Returns
The majority of equity and balanced mutual fund returns in 2008 were scary at best. The Fidelity Freedom Fund delivered -32.12% to investors beating the S&P 500 but underperformed its second benchmark. The target 2020 fund was around during the last crash, but many of the mutual funds inside the target fund 2020 did not exist in 2008. Mutual fund returns as a whole suffered during the last correction and from what I can see it’s difficult to find funds that changed their risk management approach. As we discussed earlier we have no way of predicting the future performance of the Target Fund 2020 but I would be comfortable betting that a quick turn down in the equity markets and a quick rise in interest rate would have an investor sitting in a very uncomfortable position.
Is this Fund considered one of the Safe Investments We Can Trust?
Please read my analysis on the potential pitfalls of this fund. I’m extremely concerned about rising interest rates and an equity market correction. If you agree with my analysis then I would look for other safe investments that may offer less pain potential and less opportunities for you to make an emotional decision. Safe investments are a topic I could and likely will write an entire blog about… but for today I’ve spoke my peace.
Pros and Cons of the Fidelity Freedom Fund 2020
When this fund might work out well for investors: Rising equity markets and declining or stagnate interest rates. Either of those scenarios should leave investors in this fund relatively happy. When I would run from this fund: As witnessed by owners of this fund in 2008, this fund won’t likely save the day and in fact will probably disappoint you if we see rates rise, the market correct, or both. If you have questions ask me! There is a form below this blog where you can make comments- fill it out…that form is not shared with anyone but me and my team. Investments are boring and confusing for most people… yet they are the most critical piece of our financial future! Get the facts not just the sauce so you don’t end up making a decision that you regret. Decisions people regret come in the way of surrender penalties, unexpected losses, and selling at the absolute wrong time!
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