It really shouldn't be so complicated. Recently I helped Jess sign up for her 403(b) plan at work, and it wasn't nearly as straightforward as it should have been.
The current wisdom for anyone investing in financial markets is to buy index funds
. There have been so many studies and books written on this subject, I think we should finally accept that owning individual stocks and trying to time the market is a waste of effort and money, and that paying someone to do so for you (in the form of an actively managed mutual fund) is no better.
The next step after recognizing that you want to invest in index funds is to determine how much of each type of index fund you should own. There are lots of online asset allocation calculators
to help you figure this out. Fortunately, many financial service companies offer target retirement funds that do this for you. Unfortunately, some of them charge way more than they should.
Jess' retirement plan only offers a select menu of Fidelity funds to choose from, which was disappointing because I tend to prefer Vanguard's funds. I thought Fidelity's target retirement fund, the Fidelity Freedom 2045
, would be perfect... that is until I discovered the expense ratio on the fund is a whopping 0.83%! Now, this might not sound like much, but consider that $100k invested for 40 years at 8.00% yields $2.17m, while the same $100k at 7.17% yields $1.60m, or a difference of nearly $600,000 ($15,000 / year)! That's right: after 40 years, you'll have paid Fidelity $15,000 per year to hold onto your money for you.
I'm not saying you'll ever be able to find a fund that doesn't charge any expenses. I'm just saying that 0.83% is not as negligible as it sounds. For comparison, Vanguard's Target Retirement 2045
charges 0.21%, which would leave you with $2.01m after 40 years. The best target fund family I've seen is the Federal Thrift Savings Plan L Funds
, which charges only 0.03%
but, as far as I know, is only available to federal employees.
In the end, I decided to take a DIY approach and buy the components individually. Long story short (chorus: too late!) my intention was to buy 50% Spartan 500, 25% Spartan Extended, 20% Spartan International, and 5% Emerging Markets, but Jess' plan didn't have Spartan International as an option, so I settled on the Diversified International managed equity fund as a replacement. The resulting average expense ratio is 0.30% (which corresponds to $1.94m in our example). Had the Spartan International Index Fund been available, I would have gotten the average expense ratio down to 0.14% ($2.06m).