Schwab Challenges Fidelity and Vanguard September 9, 2016 Adviser Fund Update Print Schwab Takes Aim at Fidelity & Vanguard’s Target-Date Investors Last week, Charles Schwab Corp. announced a new suite of target-date retirement funds (TDFs) whose lowest-cost share class charges 0.08%, undercutting similar options from Vanguard and Fidelity by 0.02%. The least expensive shares are only available through defined-contribution plans, but retail versions of the same funds charge 0.13%, also offering savings over comparable investor-share TDFs from the two fund giants. While two-hundredths of a percent may not seem like a big deal, it gives Schwab an edge in the lucrative, $6.8 trillion defined-contribution retirement savings marketplace, where target-date funds have been widely adopted. According to the Investment Company Institute, as of year-end 2014 (the most recent data available), 72% of 401(k) plansA 401(k) plan is a retirement account that a company sets up on behalf of its employees. Both the participant and the employer can contribute to the account. There are two types of 401(k)s, traditional and Roth. Income invested in traditional 401(k)s isn’t taxed while it’s invested, but is taxed when it’s withdrawn. Income invested in a Roth 401(k) is taxed before it’s invested, but no tax is paid when it is withdrawn. offered target-date funds, 48% of 401(k) investors owned one and 18% of all 401(k) assets (approximately $830 billion) were invested in TDFs. You’ve heard us mention the lengthy and ongoing fee war between Vanguard and Fidelity to provide investors with the lowest-cost passive management. We’ve covered it at length. With this move, Schwab has fired a shot across Vanguard’s and Fidelity’s bows, taking the lead in offering the TDF marketplace’s lowest expense ratios. Vanguard Institutional Target Retirement funds and Fidelity Freedom Index funds, the two companies’ analogous passively managed TDFs, each carry 0.10% expense ratios. Feeding the competition to be a low-cost—if not the lowest-cost—TDF option is the host of lawsuits filed by retirement plan participants against their plan providers over the last year for offering sub-par or expensive options, which they claim harmed their retirement savings—this summer, a group of U.S. universities faced such litigation. In conjunction with the new Fiduciary Rule, which goes into effect in April 2017, legal firms will have strong motivation to pursue more of these class actions, and lawsuit-conscious employers and plan sponsors are sure to take notice as they periodically review and revamp their plans. Fund companies that can point to low-cost solutions will likely have a strong advantage when employers attempt to build better plans and avoid the lawyers. What Are Target Date Funds? As a refresher, target-date, or “lifecycle,” funds usually own baskets of other mutual funds (in Schwab’s case, the underlying investments are exchange-traded fundsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index.), and the fund name will include a year that corresponds with the shareholder’s planned (or actual) retirement date. The funds periodically rebalance along a “glide path,” slowly shifting allocations from stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. to bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. as the date nears. Once the date passes, the glide path generally continues to slide down to a bond-heavy portfolio focused on preserving assets and providing income. Our view on target-date funds is that they are acceptable choices for an investor with limited options in their retirement savings plan, or for someone who is just beginning their investment career, but in general, they represent the lowest common denominator of hands-off investment management. TDF funds don’t take your risk toleranceThe amount of loss an investor is willing to absorb in their investment portfolio. or investment goals into consideration (other than your desired year of retirement), and not all lifecycle funds are created equal, either. Each fund family offers its own interpretation of how aggressive or conservative the mix of underlying funds and glide paths should be, so expenses are not the only consideration when choosing a lifecycle fund. For uninformed or starter investors, we can see the appeal of target-date funds. With their low minimums and set-it-and-forget-it design, they provide entry-level retirement savings to just about any investor under the sun. Plus, when combined with a defined-contribution plan, they put the power of tax-deferred or tax-free compounding and dollar-cost averaging to work, which can pack a fantastic investment punch over time. Even though we typically do not recommend these funds to our clients, we see it as a good thing for the retirement savings landscape that they are available at rock-bottom expenses and get people investing for their future. We’ll be watching to see if and how Fidelity and Vanguard respond to Schwab’s challenge. About Adviser Investments Adviser Investments is a full service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994, and have more than 3,500 clients across the country and over $6 billion in assets under management. Our portfolios encompass actively managed funds, ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index., socially responsible investments and tactical asset allocation strategies, with particular expertise in Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. Our minimum account size is $350,000. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868. Disclaimer: This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations, personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed. Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged. Past performance is not an indication of future returns. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. We do not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation. The Barron’s rankings consider factors such as assets under management, revenue produced for the firm, regulatory record, quality of practice and philanthropic work. This award does not consider client experience and is not indicative of future performance. Editors at the Financial Times bestowed “elite” status on 300 firms in the U.S., as determined by assets under management, asset growth, longevity, compliance record, industry certifications and online accessibility. © 2018 Adviser Investments, LLC. All Rights Reserved.