If you’ve been tracking your 401(k) balance over the past quarter or two, you’re probably feeling a little helpless as the markets contract. And while there’s not much you can do to influence the ebbs and flows of the market, there’s one move you can take to protect your 401(k): negotiate fees that are less than one-percent. For everything.
The sad truth is that many small- and mid-size 401(k) plans are loaded with high expense investment offerings and fees that can shoot participant fees to well over two if not three percent. Unlike other products which come at higher prices with presumed higher quality, the exact opposite is true when it comes to investment expenses. In fact, in a Morningstar study on How Expense Ratios and Star Ratings Predict Success, it was found that “in every asset class over every time period, the cheapest quintile produced higher total returns than the most expensive quintile.”
A simple one percent difference in fees can mean the difference of tens if not hundreds of thousands of dollars over a career of saving in your 401(k). Consider a hypothetical situation of two investors -- John and Alan. Both have $50,000 in a 401(k) plan and never contribute to it again. They are fortunate to both achieve eight percent fixed returns each year. However, Alan’s funds have an average of two percent in fees and John’s only one percent. The effect of the higher costs becomes profound over time.
Over 30 years, John will have saved $372K and Alan will have $274K. That’s $98K more for John than Alan. Extend this another ten years to 40 years, and John has a whopping $242K more than Alan ($727K for John vs. $484K for Alan). That’s a meaningful difference.
Select Low-Expense Funds and Know What Other Fees You’re Charged
Index funds (index mutual fund or ETFs) tend to have the lowest expenses and have historically outperformed 65% to 85% of actively managed mutual funds in a given asset category (e.g. large cap equity funds, mid-cap, international, etc.). In addition, there are a wide range of less-than-transparent fees from sales loads and sub transfer fees to recordkeeping and asset management fees that are often tacked on. Some of these fees are justified to serve your plan and manage it in line with government requirements. You just don’t want these fees to be excessive and some can, and should, be avoided altogether such as sales loads. Keeping your all-in participant fees below one percent is a goal any size plan can achieve with the right due diligence and provider.
How to Occupy Your 401(k) and Lower Your Fees
If you’re an employer, ask your current provider to lower your fees and provide more low-expense funds -- in particular index funds and ETFs. If your provider won’t promptly assist you, it’s probably time to seriously consider looking for a new provider.
If you are an employee with a 401(k) account:
- Select low-expense funds; index mutual funds or ETFs if they are offered in your plan
- Ask your employer for more low-expense funds, specifically index funds so you have access to low expense funds in each asset category
- Ask your employer for a fee summary of your plan and ask how they can be lowered
- Get other employees involved to help drive change for a better 401(k) plan for you and your company
For a greater understanding of 401(k) costs, our educational website may help.
