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Selling mutual fund shares in order to invest in ETFs or a Target Date Fund?

I Looked at the fees and they are much higher for the Mutual Funds in my 401k VS. a TDF or ETF that I want to inest in outside of my 401k. Does the 1% difference matter?

Apr 25, 2012 by Jane from Rocklin, CA in  |  Flag
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19 votes

The simple answer to your question is that all other things being equal, a 1% difference is huge over time. Now that begs the question, is the 1% that I am paying an active mutual fund manager going to give me better performance than simply uisng an index fund or an ETF. In my experience, I have found that most active mutual fund managers do not be their respective indices. For example most large cap managers do not beat the S&P 500, mid cap managers generally don't beat the S&P mid cap index, and small cap managers do not beat the Russell 2000. Of course there are exceptions as there are many good managers. Studies have shown, and so has my experience, that sector selection is more important than individual stock selection. Thus making ETFs and index funds very attractive. As far as Target Date Funds are concerned, some will have lower fees and others will have jsut as high of fees as any other mutual fund. Vanguard, T. Rowe Price and Fidelity are big players in that market, but the fees vary widely because they are either bundling index funds or actively managed funds.

Comment   |  Flag   |  Apr 26, 2012 from Atlanta, GA

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13 votes

ETF's typically offer lower fees than their open ended counter parts (mutual funds). However, you still have to choose WHICH ETF's to buy. The industry has sold ETF's as the "cure all" to high mutual fund fees. But, investors are still left trying to pick the correct ETF's and all ETF's are not created equal, so be sure to do your research. In our opinion, target date funds are one of the worst areas you can invest. In theory, they sound great. But, in reality, what we've found is that target date funds deliver horrible performance. Take a look at the alpha (a measure of outperformance, or efficiency) on most target date funds and you'll find they deliver NEGATIVE alpha. In translation, this means using them is far less efficient than building your own target date fund using actively managed mutual funds and ETF's.

Comment   |  Flag   |  Apr 26, 2012 from Orlando, FL

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Sean makes some good points Jane. Target Date Funds also have what is called a glidepath. The glidepath is the change in allocation from a more equity oriented portfolio to a more bond oriented allocation in order to make the portfolio more conservative as you age. The problem is that there is no standard for glidepaths. Two TDFs could have the same allocation at their beginning and 15 years later be completely different. So the if you chose a TDF, know what you are getting.

Comment   |  Flag   |  Apr 26, 2012 from Point Pleasant Beach, NJ

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I agree with my colleagues. I have a guide posted that addresses fund hidden expenses; you may enjoy that. To build on Douglas' answer, you can compare TDFs from different fund families and they seldom have the same price fluctuation or allocation characteristics. My own feeling is a TDF can be a fine default option - last resort; the problem, for planning purposes, is assuming everyone who happens to be the same age is also in the same financial situation and has the same risk tolerance and goals. That doesn't happen too often. And, Sean's comments about ETFs are correct. If you can build your own allocation using index funds and ETFs, that might be your best option; but, it would be worth sitting down with a fee-only CFP® - I'm sure you can locate one in your area through this site or the CFP Board - to get some help that's custom-tailored to your specific needs.

Comment   |  Flag   |  Apr 26, 2012 from Moorpark, CA

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Comment   |  Flag   |  Apr 26, 2012 from Port Washington, NY

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