401k - Target Retirement Fund (High Fee) vs S&P 500 (Low Fee)

[dash41]

I have just started to get serious about my financial planning. I am 27 years old. I have been able to invest in my company's 401(k) since January 2016. I originally just put all of my money into the 2055 Target Retirement Fund without even thinking about fees. After reading MMM, I realized this may have been a mistake. I only have 10.5k in the account with only 7.6k of that vested.

I am going to begin maxing out my 401(k). Where should I put the money given my company's limited options?

The 2055 Target Retirement Fund doesn't list out the total gross expense ratio. It only says this: "The current allocation of this model portfolio assumes investment of 5% in the bond fund (Pioneer Bond Fund Class A) and 95% in the stock funds (Putnam Growth Opportunities Fund Class Y, MFS Value Fund Class A, Oakmark International Fund Class I, Invesco International Growth Fund Class R5, JPMorgan Mid Cap Value Fund Class A, Invesco Small Cap Value Fund Class Y, Janus Enterprise Fund Class I, JPMorgan Small Cap Growth Fund Class A). The Rebalance Frequency for this Model is quarterly."

2055 Target Retirement Individual Expense Ratios:
Pioneer Bond Fund: 0.98%
Puntam Growth Opportunities Fund: 0.77%
MFS Value Fund: 0.90%
Oakmark International Fund: 1.05%
Invesco International Growth Fund: 0.99%
JP Morgan Mid Cap: 1.42%
Invesco Small Cap: 0.87%
Janus Enterprise Fund: 0.74%
JP Morgan Small Cap Growth Fund: 1.56%

While I don't know the exact weighting of each fund, I would imagine this fund has fees around 1% total. I don't know how much the quarterly rebalancing is costing me either. While I have read horror stories about worse 401k options, I know this isn't that great. There aren't a lot of other funds to choose from outside of those listed. For example, besides the Blackrock S&P 500 Index, the next lowest gross expense ratio is 0.50% in the Lipper Global Large-Cap Growth Fund. I know Buffet is a big proponent of the S&P 500.

Should I continue to invest all of my money in the 2055 Target Retirement Fund? Or would I be better off investing my yearly $18k into the Blackrock S&P 500 Index which has a gross expense ratio of 0.11%?

[maizefolk]

Two important questions: How long are you planning to work (either generally or at your current employer)? And what is your current marginal tax rate?

Keep in mind that once you leave you'll be able to roll all of that tax deferred money over into an IRA and invest in regular extremely low cost index funds. Unless your marginal tax rate is quite low or you are planning to stick with your employer for decades, the money you save from deferring taxes on your 401k contributions is probably greater than the money you're losing to compounding effects of their ridiculously high fees.

[dash41]

Last year I made 78k gross of which 66.6k was taxable. That put me into the 25% marginal tax rate. This year I am on pace to earn around 108k gross, give or take. If I max out my 401k, I would assume I would still barely be in the 25% marginal tax rate. However, I could easily fall into the 28% marginal tax rate if I get a raise later this year.

Your first question is hard to answer. I work in professional sports where stability isn't a strong suit. However, the team I work for is actually stable. I could probably stay with them for at least the next 5 years or so. Predicting anything after that is hard to do with any confidence in sports. If I got a better opportunity with another team, I would have to consider leaving though. Because of the limited number of teams, it is hard to predict when and where that would happen. Regarding how long I plan to work, I love the job I am at considering it is my dream job. However, I am not married with kids right now. The lifestyle may be hard on them if I ever do get a wife and kids. Let's say I plan to work for at least the next 20 years for purposes of the question.

Thanks for your help!

[Nothlit]

If I understand correctly, the Blackrock 500 fund is available within your 401k? (I think maizeman might have missed this detail.) If so, I probably would switch to that if indeed the target date fund has a 1% expense ratio. If you don't want to be 100% in stocks, you could always balance that out by buying a low expense bond fund in your IRA or taxable account (perhaps a tax-exempt bond fund in that case).

[dash41]

If I understand correctly, the Blackrock 500 fund is available within your 401k? (I think maizeman might have missed this detail.) If so, I probably would switch to that if indeed the target date fund has a 1% expense ratio. If you don't want to be 100% in stocks, you could always balance that out by buying a low expense bond fund in your IRA or taxable account (perhaps a tax-exempt bond fund in that case).

Correct. Sorry if I didn't make that clear enough. The Blackrock S&P 500 Fund is an option within my 401k. It by far has the lowest gross expense ratio.

[MDM]

Two important questions: How long are you planning to work (either generally or at your current employer)? And what is your current marginal tax rate?

Keep in mind that once you leave you'll be able to roll all of that tax deferred money over into an IRA and invest in regular extremely low cost index funds. Unless your marginal tax rate is quite low or you are planning to stick with your employer for decades, the money you save from deferring taxes on your 401k contributions is probably greater than the money you're losing to compounding effects of their ridiculously high fees.

+1 to this.

See To 401k or not to 401k? That is the question. for more details.

And yes, the S&P 500 is likely your best choice.  But see also Tax-efficient fund placement - Bogleheads for context.

[maizefolk]

Yup, I did miss that detail. Whatever else, definitely do switch to the lower cost fund. (I looked it up online, does it really only have a 0.11% expense ratio? If so, problem solved, just put your money there.)

Here's the math I was going to do, assuming 1% ER was the best you could get in your 401k:

Assuming a 25% marginal rate, if you decided not to max out your 401k ($18,000), you'd have $13,500 to invest post-tax. Let's say the expense ratio on this would be 0.05%. The yield drag from paying taxes on 2% dividends is .3%. CAGR of the stock market is 9.1% (not correcting for inflation). So your money would grow at about 8.1% (9.1-8.1) in the 401k and 8.75% in a taxable account. Given all that it'd take about 48 years for the taxable account to catch up (assuming you manage to not pay taxes in retirement). If you're paying taxes at a 15% marginal in retirement, the break-even point is 21 years.

[dash41]

Yup, I did miss that detail. Whatever else, definitely do switch to the lower cost fund. (I looked it up online, does it really only have a 0.11% expense ratio? If so, problem solved, just put your money there.)

Here's the math I was going to do, assuming 1% ER was the best you could get in your 401k:

Assuming a 25% marginal rate, if you decided not to max out your 401k ($18,000), you'd have $13,500 to invest post-tax. Let's say the expense ratio on this would be 0.05%. The yield drag from paying taxes on 2% dividends is .3%. CAGR of the stock market is 9.1% (not correcting for inflation). So your money would grow at about 8.1% (9.1-8.1) in the 401k and 8.75% in a taxable account. Given all that it'd take about 48 years for the taxable account to catch up (assuming you manage to not pay taxes in retirement). If you're paying taxes at a 15% marginal in retirement, the break-even point is 21 years.

Thanks for doing the math on that. I am definitely maxing out my 401k. Doubtful I won't be able to roll over my 401k into an IRA in the next 21 years.

https://www.blackrock.com/investing/products/251378/

Due to the 0.11% expense ratio, I think I will switch over to investing all of my 401k money in that. What does everyone think of putting additional money into a low expense bond fund into an IRA or taxable account like Nothlit recommended? I will be 100% into the S&P 500, but I am not far off of what Buffet recommends at 90% into the S&P 500. Do I need to diversify more?

[maizefolk]

If you're going to buy bonds, it makes much more sense to buy them either in an IRA or in your 401k than in a taxable account because more of their return is in the form of interest which would be taxed at your regular marginal income tax rate (either 28% or 25%) which reduces the power of compounding, while for stocks a lot of the return is capital gains (no tax until you sell), and the remainder is dividends (taxed at a lower rate than your regular marginal tax rate (either 0%, 15% or 20% but regardless lower than what you'd pay on bond income at the same income level).

Tax exempt bond funds get around the tax rate issue, but tend to have lower rates of return than non-tax exempt bonds as a result. (Also some of those tax-exempt bond funds are or were heavily invested in Puerto Rican debt, which could still have a very unhappy ending, we'll have to wait and see).