How to compare investment options for HSA

Question

I'm having some trouble comparing ETFs or other index funds. I have some money in a Health Savings Account which I would like to automatically invest and use when I'm old and in need of care. One suggestion made by my HSA investment platform is to select a Target Date Fund (e.g. Fidelity Freedom Index 2055 fund or Vanguard Target 2055 fund) which automatically reduces risk the closer I get to the target date. Another option is to pick a single diversified fund, e.g. (Fidelity Asset Manager® 70%).

My question is how I would go about choosing between any of these options. I'm not looking for opinions, but for a more systematic approach that allows me to make a proper comparison. What sources should I consult? There's different articles that discuss how to compare ETFs (e.g. nerdwallet) but these articles remain rather superfluous (e.g. compare expense ratios, etc).

Just to take a concrete example. The Fidelity® Blue Chip Growth Fund Class K fund has a expense ratio of 0.71%, but reports 10yrs historical growth of 22.37%. In comparison, the Fidelity Freedom® Index 2055 Fund Institutional Premium Class has a significantly lower expense ratio (0.08%) but has a much lower 10yrs growth performance of 11.60%. Finally the Fidelity® 500 Index Fund which tracks the S&P500 index has an expense ratio of 0.015% with a 10yrs growth performance of 16.54%. Just judging from these numbers, it seems that the Blue Chip fund, while being the most expensive, gives the highest return value. Is this a reasonable comparison? And if not, what other factors should I take into account? Any resources/references are welcome.

Answer 1

You're spot on regarding the issues with a lot of these personal finance website when it comes to picking funds. They overemphasize expenses but don't really talk about the big picture.

What you are trying to do here is portfolio construction (something professionals get paid hundreds of thousands of dollars a year to do).

A simple way to look at portfolio construction is through a three-step top down process - figuring out objectives and thereby your goal and risk tolerance; allocating asset classes accordingly; and lastly choosing the vehicle through which you gain exposure to these asset classes.

As you can see, comparing funds is really the last step. It simply doesn't make sense to do that without figuring out the first two parts first.

Objective

Setting objectives are the most personal part of this. How do you plan to use your HSA fund? Do you expect regular reimbursement aka withdrawals? Or do you treat it like a 401k i.e. retirement fund? Would you lose sleep if your HSA fund lose 20% in two months? These determine your risk tolerance and investment horizon.

Asset Allocation

Now you can compare your objectives to the broad asset classes - equity, bonds, mmf/cd, REITs, crypto etc, and see which combination can match your goal. These are big building blocks of your portfolio that give you very different investment profile (risk vs return). They exhibit different correlations with each other. Many of them have a lot of subclasses that can also show very different traits. This is where things get complicated. To be able to make an informed decision, you need to have at least a basic understanding of what they are and why they behave the way they do. It's frankly a daunting task for an average investor, but luckily as an US investor, you could take a shortcut and start with US equity.

The reason why US equity is a good starting point is because not only does it have a great track record, fundamentally it is built upon the success of the biggest economy in the world, as well as a very efficient market, supported by good law and order. And presumably as a US resident it is also easy for you to feel comfortable formulating a view on the overall wellbeing of the economy through the exposure of your daily life. That being said, given how equity works, it is subject to more volatility than say US corporate bonds. In some periods it's quite noticeable (e.g. early March this year) In short, US equity has great returns with a certain level of volatilities, a great candidate for a retirement fund.

(BTW this is an example of "basic understanding of what they are and why they behave the way they do")

Once you have a decent understanding of US equity, you can apply that knowledge to the subclasses (e.g. large cap vs. small cap, growth vs. value) and other classes like EM equities, corporate bonds, govt bonds and treasuries, etc etc. The underlying mechanics of the investments might be different but you still use the same standards to judge them (risk vs. return). And when you're done, you should be able to come up with a brief allocation of how much money goes to which class.

Picking Names

This is the easy part. Given an asset class, you quickly narrow down the candidates to dozens. In fact for an HSA platform, unless you are doing self-directed investment, likely you have just one or two choices. It then usually just boils down to expenses and how well the funds historically track its benchmark. Expense is straightforward. Tracking entails how well a fund manager can keep up with the benchmark. Possibly there's also the active vs. passive decision, which is itself a whole other topic.

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If all of this sound overwhelming, there is always the choice of going to those target date funds. These are fund of funds and their job is to do all of this for you. But obviously it won't be as personal, and you have no control over the allocations.

I suggest googling "asset allocation" and read a couple primers to start.

Answer 2

If the plan is to invest the money and not need it for decades, then the investment choice could be whatever you are comfortable with for your other retirement funds. They have a similar accumulation profile.

Some people want the ease of the target date funds, others are 100% stocks all the way until retirement age.

One thing to consider is that there is a chance you may need those funds earlier than you expect, if you are faced with a huge medical expense that would drain your other liquid funds. In general, the older you are the more likely that major medical expense will happen. I don't think that would pick a more conservative investment choice just because of the chance of needing it sooner, unless I knew that the chance of needing it sooner are almost guaranteed.

One good thing about the investments in the HSA: if you want to switch investments there are no tax obligations when you do so. So you can change your mind as the years go by.

Answer 3

Generally, the market for large index funds like these is quite efficient, which means that any of these funds exists reasonably close to an optimal performance. The differences in returns that aren't due to luck of the draw are then primarily to different risk profiles: a growth-oriented fund will exhibit better returns in hot periods for the market, but often collapse faster than a more conservative fund in a negative period. In general, more risk means higher expected rewards, as long as it doesn't all go wrong.

Thus all you can really do is decide how much risk you're willing to take on, and choose investments on that basis. Nobody is going to be able to give you a reliable way to assess one fund as better than another in a global, objective way–if they could, then investors would all be in that fund instead of the other one.