Fidelity Freedom Funds: Convenience Comes at a Cost

What if planning for retirement could be as simple as buying one mutual fund? Fund companies including Fidelity are increasingly trying to make that a reality.

Fidelity Freedom Funds are target-date funds, which are designed to be maintenance-free investments that automatically rebalance toward safer investments as you reach retirement age. Also known as lifecycle funds, Fidelity Freedom Funds are available in five-year intervals so that investors can select their expected retirement date with some precision.

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Source: Fidelity Investments

How Fidelity Freedom Funds work

Fidelity Freedom funds automatically rebalance toward safer investments as investors reach their target retirement date. The funds follow what is known as a "glide path," or the plan for reducing the fund's risk over time by reducing its holdings of aggressive investments to buy more conservative investments.

Consider the 2015 and 2060 Funds as an example. The 2015 Fund invests more of its assets in bonds and less in stocks compared with the 2060 Fund. Risk is also reduced by adjusting exposures within asset classes. Riskier small-cap stocks make up a smaller portion of the 2015 fund than the 2060 fund.

Target-date funds accomplish their objectives by investing in other mutual funds, making them simple funds of funds. The 2060 Fund invests in 27 different Fidelity mutual funds, from stock index funds to bank loan funds, with the goal of creating a complete and diversified portfolio.

Pros and cons of target-date funds

One of the biggest advantages of a target-date fund is convenience. Most investors don't want to think about how to allocate their investment portfolio, nor do they want to log into their accounts to rebalance their stock and bond exposure each year. Target-date funds do all that for you.

The disadvantage to convenience is that it comes at a price. Fidelity's Freedom Funds carry relatively high expense ratios ranging from 0.64% of assets, all the way up to 0.78% of assets. Higher fees are typical of target-date funds, though fund fees have come down over time. 

Note that although Fidelity offers a full line of low-cost index funds, its Freedom Funds primarily invest in Fidelity's higher cost actively managed funds. As an example, the 2060 Fund had about 65% of its assets in U.S. stock funds at the time of writing. High fee active funds made up about 61 percentage points of that, while low-cost index funds made up the remaining 3.5 percentage points.

Fees and expenses are a disadvantage that is easy to spot, but others aren't so apparent. One potentially problematic issue with target-date funds is that they build their portfolios for the average person. Fidelity's Freedom Funds assume you will retire between ages 65 and 67. It also assumes that the fund is your only retirement investment, just as most target-date funds do.

The amount of income you can expect to receive from a pension, annuity, and/or Social Security are all important variables of making a proper retirement plan. A target-date fund cannot take these personal matters into consideration, as it is designed to create a portfolio for tens of thousands of people who all wish to retire around a specific date.

Fidelity Freedom Funds vs. alternatives

Investors should carefully weigh the cost of investing in any target-date fund. Fees are especially important for investors nearing retirement age, when a target-date fund will be invested most conservatively. A 2020 or 2025 fund will have more money invested in lower risk, lower return investments, but may continue to charge stock fund-like fees even as the portfolio shifts toward safer assets. 

Fidelity Freedom Funds tend to be on the higher-end of the expense spectrum. The table below compares expense ratios for 2020, 2040, and 2060 funds from three leading asset managers. 

Source: Fidelity, Vanguard, BlackRock.

Keep in mind that fund fees can vary dramatically by share class. BlackRock's LifePath funds can be relatively inexpensive if purchased through an employer-sponsored retirement account, as many qualify for low fee "institutional" share classes. On the other hand, the same fund's Class A shares sold by a financial planner will carry a higher annual expense ratio in addition to upfront fees and expenses that can tally up to 5.25% of the amount invested.

Of course, picking a fund isn't just about bargain shopping, but it is a simple fact that expenses are the most reliable, albeit imperfect, indicator of a fund's future success. All else equal, investors who pay 1% in annual fund fees will retire with considerably less savings than peers who paid average fund fees of 0.5%, or even 0.1%.

Fidelity Freedom Funds may be worth a look for investors who put a high value on convenience, but higher expenses increase the likelihood that the funds underperform less expensive peers.