Free Asset Management In Some Target Date Funds

Bevan Goldswain/E+ via Getty Images You’re aware that Fidelity and others offer zero fee mutual funds. But it should surprise you to learn that some target date funds (TDFs) waive the cost for their underlying funds, so they provide free asset management in TDFs. They do so in both their mutual fund and collective investment trust (CIT) TDFs. It’s a great bargain. It should also surprise you that these free funds are not advertised – they’re a “secret.” They’re quietly used to reduce total TDF fees to compete in the race to the bottom on TDF fees. Here’s how to find free funds in TDFs. A race to the bottom in TDF fees At $4 trillion and growing, TDFs are the most popular Qualified Default Investment Alternative (QDIA) in 401(k) plans. Due mainly to the success of excessive fee lawsuits, there’s been a race to the bottom in target date fund fees, as shown in the following Morningstar TDF fees have halved in the past decade. Were they too high to begin with? Successful lawsuits say they were. Now fees are top of the list of criteria for choosing a TDF, so fund companies are motivated to come to market with their lowest fee. Note that Morningstar “Excludes zero-fee share classes” in the above table, so the average fees are lower than shown. Some fund companies have waived the fees for their underlying funds in their TDFs. You can see this in fee disclosures like the following that list zero as the cost for underlying funds. Target Date Solutions Big Savings You would think that there’s some sort of “gimmick” in these free funds, but there doesn’t appear to be. For example, one provider’s TDF underlying funds are “Z funds” with no expense – they’re free – and most are expensive when purchased outside their TDFs, so the fee that is waived is substantial. Target Date Solutions Conclusion Free underlying funds in TDFs are a great bargain. Or is it? What do you think? Can you make up for zero fees with volume? How can fund companies profit when they waive fees?

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