State Farm Mutual Funds: Alternatives to Its High-Fee Funds
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State Farm may be a great insurer, but is a poor choice in the investment management industry. Investors should read the fine print before buying State Farm Mutual Funds in a 401(K) plan or IRA, as its funds are frequently loaded with fees that will all but guarantee poor performance.
The list below shows some of its common mutual funds. Below, I'll discuss some better alternatives for each fund.
Data source: Fund prospectus. Expense ratios do not include upfront sales fees, also known as loads, which can be significant.
What you should know about State Farm Mutual Funds
State Farm is primarily in the business of selling mutual funds that are managed by other investment firms. For instance, its LifePath funds are managed by BlackRock (NYSE: BLK), while its State Farm Equity Fund is managed by BridgeWay Capital Management and Westwood Management. You can think of it as a fund distributor or marketer rather than a fund manager, as only one of its funds we'll discuss -- its bond fund -- is actually managed by State Farm.
This makes State Farm something of a middleman in the investment management business, resulting in additional costs which are passed on to investors in the form of fund fees. Virtually every fund it sells can be purchased elsewhere, or replicated with similar funds, at a lower price.
State Farm LifePath Funds
Most people want nothing to do with managing their retirement account, fearing that they lack the expertise or the time to make decisions about how to invest their money. So-called target date funds like LifePath funds seek to make retirement as easy as selecting a retirement year.
LifePath funds come in intervals of five years, designed to match the investment needs of an investor who wishes to retire at any given point in time. The LifePath 2050 fund is designed for investors who expect to retire in or around the year 2050, for example.
The basic rules of retirement planning say that you should invest most aggressively when your retirement date is decades away and invest more conservatively as your retirement date nears. These funds do that for you, automatically reducing risk as you age.
The chart above shows how these funds differ. The 2050 and 2055 funds hold 94% of their assets in riskier stocks, while the 2020 and 2025 funds invest more in lower-return, lower-risk bonds. That's consistent with the advice that virtually any retirement planner would give you.
BlackRock's LifePath funds are fine funds, but investors should be very careful if they choose to buy these funds from State Farm. State Farm has a financial incentive to sell the highest-fee LifePath funds, to the detriment of your retirement account.
Take the LifePath 2050 Fund as an example. If you buy it through State Farm, you'll pay up to 5% of your original investment in upfront fees, in addition to annual expense ratios equal to 0.94% to 1.04% of the fund's value.
The exact same LifePath 2050 Fund is available in many 401(k) plans in the form of low-cost Institutional Shares, which carry an annual expense ratio of 0.64%. Similarly, the Class R shares of this fund are available from most online brokerages, and carry an expense ratio of 1.09% per year. Neither the Institutional Shares nor the Class R shares carry upfront sales charges like State Farm's share classes.
Other target-date funds may be even better. Fidelity's Freedom Funds are roughly as expensive as LifePath funds, but certainly less expensive than the State Farm variety. Vanguard has a full line of target-date retirement funds, all of which have annual expense ratios under 0.20%, and do not carry any sales charges.
State Farm S&P 500 Index Fund
The State Farm S&P 500 Index Fund is simple in design, seeking only to track the S&P 500 Index. The S&P 500 is made up of roughly 500 stocks that together compromise about 80% of the total value of all stocks listed on exchanges in the United States.
Index funds can be excellent. Even Warren Buffett -- the world's best investor by a country mile -- plans on leaving 90% of his wealth to his wife in the form of an S&P 500 index fund. But State Farm's S&P 500 Index Fund is an egregious fee trap, carrying sales fees equal to 3% to 5% of your investment, plus annual expense ratios ranging from 0.56% to 1.36% per year.
Competitors offer funds that do the exact same thing as this fund at a fraction of the cost, and do not charge upfront or deferred sales charges for investing in them. The Vanguard 500 Index Fund(NASDAQMUTFUND: VFINX) carries an annual expense ratio of just 0.16% per year, which falls to just 0.05% for investors who meet the minimum investments to buy the fund's Admiral Shares. It does not charge upfront or deferred sales fees.
Similarly, the BlackRock S&P 500 Index Fund (NASDAQMUTFUND: BSPAX)carries annual expense ratios of 0.11% to 0.36%, and does not have any upfront or deferred sales charges. The Fidelity 500 Index Fund (NASDAQMUTFUND: FUSEX)carries expense ratios ranging from 0.045% to 0.09% and does not charge any kind of sales fee, making it easily one of the best S&P 500 funds, and one of Fidelity's best mutual funds.
Quite frankly, any financial advisor who sells this State Farm fund to his or her clients is doing them financial harm in order to generate a bigger commission check on payday. S&P 500 index funds are excellent, and can serve as the bedrock for a diversified retirement portfolio, but State Farm's funds carry such high fees that they will perform poorly for their investors.
Over the 10-year period leading to the end of 2015, State Farm's S&P 500 Index Fund returned 5.5% to 6.2% per year, on average, falling far behind the 7.3% return on the S&P 500 due to its heavy fee burden. Because all S&P 500 index funds all track the same index, the best choice is the one that costs the least.
State Farm Bond Fund
Any diversified retirement account should include stocks and bonds, typically through stock and bond mutual funds. The State Farm Bond Fund offers a convenient way to own lower-risk bonds in your retirement account. Unlike the others on this list, the State Farm Bond Fund is managed by State Farm Investment Management Corp.
Unfortunately, this fund is loaded with upfront and deferred sales charges equal to 3% to 5% of your investment amount, plus annual expense ratios ranging from 0.55% to 1.05% per year. While these fees would be high for any stock mutual fund, they are sky-high for a bond fund. By their nature, bonds offer lower returns than stocks, thus fees eat up a greater share of the expected returns over time.
At the end of 2015, the fund reported that it returned 2.06% to 2.24% per year, on average, over the recent five-year period, compared to the 3.25% average annual return of its fee-free benchmark. Again, fees played an important role in its underperformance.
You can't get a perfect match for this bond fund, but you can get pretty close with lower-fee funds from other fund managers. Splitting your investment between Vanguard's Short-Term Bond Index Fund (NASDAQMUTFUND: VBISX) and Vanguard Intermediate-Term Bond Index Fund (NASDAQMUTFUND: VBIIX) would result in a mix of bonds that isn't extraordinarily different, and costs no more than 0.16% per year in annual expenses. Vanguard has a number of low-fee bond funds that rank as some of the very best.
In 2015, the average bond index fund carried an expense ratio of just 0.10%, according to the Investment Company Institute, or 80% less than the least-expensive shares of State Farm's bond fund. You don't need to look very hard to find a better bond fund at a lower price.
Why does anyone buy State Farm mutual funds?
It's been said that some financial products and investments are "sold, not bought," referring to the fact that no one would go out of their way to buy high-fee funds. With sales loads frequently topping 5%, investors who use these funds are effectively paying $50 in unnecessary fees for each $1,000 invested, in addition to above-average fees every single year thereafter. That's no good.
The truth is that State Farm isn't doing any illegal, as fees are within the limits set by regulators. Nor is it necessarily doing anything out of the norm, as many other companies sell similarly high-cost investments that are almost certain to underperform. And, to be completely fair, State Farm's high fund fees enable its salespeople to justify spending time on smaller accounts that wouldn't be economical to service if it weren't for high fees.
But it is doing its clients a disservice. The simple fact is that expenses are the single best predictor of any fund's future success; lower-fee funds are substantially more likely to outperform their benchmarks than higher fee funds. State Farm's high-fee funds virtually guarantee that investors will experience poor returns by investing in them.
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