Now, I can already hear the question: What fees?
All 401(k) plans charge fees, whether you realize it or not, and the lion’s share goes toward investment management. Until recently, you never saw a separate line-item specifying the fee for “investment management.” That’s because the fee is expressed as a ratio, typically a percentage per $1,000 invested, and it is deducted from the mutual fund’s gross return. What you see on your statement is a net return after the fee is subtracted.
Let’s put this in perspective. If a mutual fund you’re invested in generates a 7 percent return for the quarter, you will not be credited for the full 7 percent. The investment management fee is deducted first, and the net gain will be credited to your account. So, if the expense ratio is 1.5 percent, you will be credited 5.5 percent. If the expense ratio is .90 percent, you will be credited 6.10 percent. The average 401(k) plan has an expense ratio around 1.25 percent.
Not sound like much? Consider the following scenario: Bob earns $4,000 per month and contributes 3 percent of his pay towards his 401(k). Bob’s employer also matches 3 percent. Over a 35-year career, and assuming an average return on investment of 8 percent, Bob will have saved over $550,000 for retirement. However, let’s say his investments only average 7 percent. If all other variables remain the same, Bob will have saved just over $432,000 for retirement. ONE percent cost Bob $118,000 – or 21.5 percent!
Almost makes you sick to the stomach, right? Well, all is not lost. Like I said, the good news is you’re your 401(k) is required to disclose fees going forward. It is up to you to use that information to your advantage, so pay attention. Here are a few ways that you can use the new fee disclosures to boost your retirement savings:
1. Compare fees within your plan
It is likely that you are captive to your plan’s investment options. So, if you realize you’re paying an exorbitant amount in fees, look at other funds within your plan and see if there are similar options with lower costs.
2. Keep your entire portfolio in mind
Your 401(k) is (or should be) just part of your overall retirement strategy. You may have taxable accounts, IRAs, whole life insurance or annuities. While it’s important to diversify your investments, there’s no reason why each account has to be a paradigm of diversification. So, if you’re faced with limited low-cost options within your 401(k), do not hesitate to go heavy in those funds, so long as your accounts as a whole are properly diversified. Note: This action may require you to reallocate your other investments to take into account your new 401(k) positions.
3. If high fees are unavoidable, contribute the match
I have always told my clients, especially those with limited options in their 401(k) plan, to contribute up to the amount their employer will match. It’s the easiest 100 percent return on your money that you will ever make. Invest the difference in an IRA or Roth IRA. By doing so, you will have thousands of options from which to choose – including low cost Exchange Traded Funds (ETFs). Note: ETFs are almost always lower in costs than stock mutual funds.
4. Ask your employer to consider other providers
Most companies offer plans that are high in costs and low in options. In fact, the General Accountability Office recently stated that there were an “alarming number” of employers who were unaware that the 401(k) plans they offered had fees! So, it is likely that as you become aware of your options, your employer is too.
5. Move your old 401(k)’s
If you’re still employed, there’s little you can do with your current 401(k). But if you have older 401(k)’s out there, roll them over into an IRA. As I mentioned earlier, you will have more freedom to choose your investments. Note: It’s best to initiate a direct rollover to avoid penalties and taxes.
Derek Burcham, a 2001 graduate of Trigg County High School, is the founder and principal owner of Cornerstone Wealth Advisors, an independent Registered Investment Advisor based in Louisville. The firm offers financial planning and investment management to individuals and businesses. If you like to learn more about their services, please visit their website at www.cswadvisors.com, or send an email to firstname.lastname@example.org.