Morningstar’s Approach to 401(k) Fund Selection
I’ve been on Morningstar’s 401(k) committee for over 25 years, where I’ve worked alongside colleagues to pick and monitor the funds offered to our employees. While the selection of 401(k) options has expanded over the years, our fundamental approach has remained: we prioritize highly rated, low-cost funds for the long haul.
As the size of Morningstar’s plan has increased, I’ve been able to access cheaper share classes, and, well, the selection has certainly gotten a bit broader since I first started. We aim to encompass the key areas for a well-rounded portfolio, recognizing that different investors will need different choices. Overlap is built in, of course; no one expects employees to invest in every single fund.
Changing 401(k) lineups isn’t a quick task, so we focus on proven funds backed by strong teams that are likely to endure over time.
Morningstar also understands that some employees might not know how to build a portfolio, so we offer a couple of straightforward options for those who might feel overwhelmed. We provide Vanguard target-date funds and Morningstar-managed portfolios, allowing allocation experts to select funds tailored to employee profiles.
Now, let’s go through the lineup. While we feature fund tickers included in the Morningstar 500, there are actually various institutional stock classes available that are less expensive. Just to clarify, I own many of the funds listed here.
Large Cap
Dodge & Cox International Stock DODFX stands out as a well-managed value fund, with a dedicated management team collaborating with talented analysts to create a diverse portfolio of foreign stocks. The stability comes from employees needing to sell their own shares when they leave the company. This fund is definitely in my top five 401(k) picks. I really believe Dodge & Cox can keep this fund on the right track.
Another choice, Harbor Capital Appreciation HACAX, contrasts nicely with Dodge’s focus. Managed by Jennison’s growth team, it seeks out fast-growing companies with strong R&D. Key holdings include tech powerhouses like Nvidia and Amazon. This fund is also in my top five—it’s essential to cover crucial economic drivers, and Jennison’s research capabilities are impressive.
Then there’s Oakmark Select OAKLX, a flexible value fund that looks for stocks expected to grow—provided they’re priced attractively. Manager Bill Nygren is in his 60s, so his retirement might not be far off, but we feel confident about the team ready to step in when he does.
The Vanguard Developed Markets Index VTMGX provides a simple way to invest outside the U.S. (excluding emerging markets) and charges just 0.05%. Its returns over the five-, 10-, and 15-year periods generally rank in the upper third of its category.
Vanguard FTSE Social Index VFTAX is an ESG-focused large-cap index. Interestingly, despite the controversies around ESG, its returns are fairly close to our S&P 500 fund, Vanguard Institutional Index VINIX. The S&P 500 has a slight edge over the five-year mark, while the ESG fund has outperformed over 10 and 15 years.
Speaking of the S&P 500, Vanguard Institutional Index offers it for merely 4 basis points, while Vanguard 500 Index VFIAX, the retail version, has a 0.04% fee.
Another active fund, Vanguard International Growth VWILX, has a low fee of just 0.25%. Baillie Gifford manages two-thirds of it, with the remaining third managed by Schroders. Its 10-year annual return of 9.64% beats the benchmark rate of 6.00%.
Small and Mid-Cap Stocks
DFA International Small Company DFISX is mostly passive, but with a twist. It doesn’t track a specific index and targets foreign small-cap stocks. Instead of exploiting the traditional buy-sell price spreads against investors, it trades in a way that benefits them. This fund has become more accessible, though it’s not available on all platforms yet, so check your options.
Primecap Odyssey Aggressive Growth POAGX brings a bolder small-cap approach. We rely on deep fundamental research to find companies with lasting advantages, often leaning heavily into biotechnology. This one’s also in my top five; Primecap has a strong track record across various market caps, and I want my aggressive fund to be more than just about trends.
Lloyds Small Cap Special Shares RYSEX is a defensive option, ideal for weathering market turbulence. Charlie Dreyfuss and his team invest in companies with clean accounting and solid valuations. It’s not the option for chasing huge returns during market rallies, though.
Vanguard Selected Value VASVX takes a unique approach by employing three sub-advisers to provide affordable exposure to small and mid-cap value stocks, each bringing their own take on the concept.
Vanguard Small Cap Index VSMAX simplifies small-cap investing, with costs as low as 0.05%.
Wasatch Small Cap Growth WAAEX offers a well-rounded approach to small-cap growth investing, focusing mostly on stable producers while including early-stage, higher-risk stocks. Due to the retirement of its longtime manager JB Taylor, we lowered the fund’s People Rating to “Above Average.”
Emerging Markets
We have three emerging market funds available. In truth, you probably only need one, but they each operate quite differently.
American Fund New World NEWFX is appealing, with a strong management and analyst team, paired with low expenses. This fund doesn’t just focus on companies based in emerging markets; it also includes businesses generating significant revenue from these markets. It’s a savvy strategy, leading to better performance when developed markets do well. This fund is among my top five holdings because it tends to have lower volatility than typical emerging market funds.
Vanguard Emerging Markets Index VEMAX provides exposure at just 0.13%. The downside is that these markets can be inefficient, so long-term returns are rather average. Its 10-year return sits at 5.6% annually, which is lower than the New World Fund’s 7.5%. Still, it’s better than the 3.5% from our third emerging markets fund.
Invesco Developing Markets ODMAX has had a rough patch. Although historically it has performed well, many recent macro investments haven’t played in its favor. Invesco has replaced Justin Leverentz with a UK-based emerging market team, which is promising. The new team scores an ‘Above Average’ rating from us, and they’ve shown skill in other funds, so we hope they can achieve similar success here.
Inflation Hedges
We offer three distinct inflation hedges; owning all three is an option since they serve different functions.
The Vanguard Short-Term Inflation-Protected Securities Index VTAPX just joined the Morningstar Plan recently. We previously had Pimco Real Return PRTNX. The switch to Vanguard was due to preference for a TIPS fund with lower interest rate risks. Inflation often leads to spikes in interest rates, which can hurt long-term TIPS investors. With a shorter duration of 2.4 years, this Vanguard fund fared better than the Pimco fund’s 7.0 years during 2022.
Pimco Commodity Real Return Strategy PCRAX offers commodity exposure along with some TIPS. Commodities typically surge with inflation, so they can make for decent hedges. But I always caution to keep commodity allocations small due to their volatility. The A shares have a Neutral rating, while institutional shares in our 401(k) are rated Silver thanks to lower fees.
Vanguard Real Estate Index VGSLX provides diversification along with an income stream. This sector is undergoing significant changes, especially with shifting demand for office versus data center real estate. For further diversification, Vanguard also has an international real estate fund.
Bonds
Dodge & Cox Global Bond DODLX allows for regional and currency diversification. This fund focuses on corporate bonds, leveraging deep company research for impressive returns.
Pimco Total Return PTTRX showcases Pimco’s strengths across a variety of fixed-income funds. Under Mohit Mittal’s leadership since 2022, it’s become a bit more aggressive and exceeded benchmarks after a period of mediocrity. It’s also one of my top five picks in my 401(k).
T. Rowe Price High Yield PRHYX is a solid high-yield option, combining good risk management with superior yields.
Loomis Sayles Bond LSBRX takes a bolder approach, mixing high yields with currency plays and government bonds. Just expect a bit of volatility here; it aims for a target profit dividend by 2026.
On the other end, the Vanguard Total Bond Market Index VBTLX offers a more conservative option. With significant exposure to government debt, it tends to carry lower credit risks compared to many peers in its category—great for covering the foundation of a fixed income portfolio while permitting more adventurous investing in other areas.
