Greg H. Carver, The Daily Record Newswire
Over the lifetime of a typical median-income two-earner family, 401(k) fees can total nearly $155,000 and consume nearly one-third of their investment returns. For earners who have a salary higher than the average American, the fees increase sharply. This is according to the Demos report “The Retirement Savings Drain: Hidden & Excessive Costs of 401(k)s.”
Why am I telling you this? Because if you don’t want a large portion of your hard-earned retirement savings ending up in somebody else’s hands, you need to look at your current 401(k) plan now and take action if needed.
How did this happen?
A little background, 401(k)s have become the premier retirement savings vehicle in recent years. Accounting rules and government regulations have encouraged the 401(k) plan to be the favored choice over the more traditional defined benefit (pension) plans. The idea was to put the responsibility for our retirement savings in our hands and out of the hands of our employers and out of the hands of the government.
As a principle, I think this is a great development as I am all for personal accountability. However, a funny thing has happened along the way, people are not taking any responsibility for their 401(k)s and are being taken advantage of in the process. The effect of all of these fees is causing some to run out of money during retirement versus having a nest egg to pass along to your family.
Why is this happening?
The reason this is happening is because the fees they are taking from your retirement savings are deeply hidden. As a somewhat real world example, let’s say you had a stack of 100 $1 bills locked in the drawer of your desk. You step away from your desk to meet with the boss and Milton comes by with the key and takes one dollar bill from your stack, are you going to notice that when you get back to your desk? Probably not.
Is this way oversimplified? Definitely. But the point is that money that you have earned is being taken from right under your nose, except that the amount of money that is being taken is astronomical.
The median expense ratio of mutual funds in 401(k) plans was 1.27 percent in 2010. Trading costs can vary from year to year, but they are estimated to average 1.2 percent a year. The yearly return that you see on a mutual fund report does not include the expense ratio, nor does it include the trading costs, which are also passed down when managers trade funds within a mutual fund.
According to the Demos study, the average mutual fund earns a 7 percent return, before fees, which matches the overall stock market. However the post fee returns average only 4.5 percent, meaning that on average, fees eat up over a third of the total returns earned by mutual funds.
What can you do about it?
Hopefully, you are somewhat depressed by now, and for that I am sorry. However, there is one thing you can do to reduce the pain.
Move your investments to lower cost index or exchange traded funds (ETFs). The index and ETFs are relatively new and can have expense ratios anywhere from .30 percent to as low as .08 percent. These funds typically buy and hold the stocks of major asset classes and do not have frequent trading activity.
Mutual fund managers are trying to beat the market with their investment choices, and you are paying them for this expertise. However, with the expenses mentioned previously and the thousands of mutual funds out there, do you think they all beat the market? There is plenty of research out there to show that over the long haul, the overall stock market outperforms managed funds.
You can check the expense ratio of your current investments by looking at you current 401(k) plan documents, for each investment there should be a fund fact sheet or something similar that will show you what the current expense ratio is of the fund that you are invested in.
Unfortunately most 401(k) plans lack a quality selection of low cost index funds and ETFs as investment options. The reason for this is that there are large financial incentives for 401(k) plans to offer certain investments over others, and most of the time the investment choices in a plan are included as part of a kickback arrangement with your plan provider or investment advisor, and are not for the best interest of the 401(k) participant.
It’s not all bad news though; there are many 401(k) plans with lower cost funds available. If your current plan does not have these lower cost funds, ask your employer why and ask that they be included. And get your coworkers on board too because the more of you that speak, the greater chance that changes will be made.
Most companies also have a committee to review the 401(k) plan activity and actually select investment options, ask to join that committee or at least attend meetings. If your company does not have such a committee, encourage them to start one. It is up to you to force the change and to take responsibility for your hard earned retirement savings.
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Greg H. Carver, CPA, is a manager with Mengel, Metzger, Barr & Co. LLP and may be reached at gcarver@mmb-co.com.
