How to Stop Retirement Account Fees from Eroding Your Portfolio's Profit
Everyone hates investment fees. Like termites, they gnaw away at your returns, often too small to be noticed. Yet the cumulative effect of all that gnawing may be enormous.
So who pays the most? And what can we do about it?
Let's find out.
The calculus of retirement fees
One-percent doesn't sound like much, does it? Certainly not enough to make a serious financial difference.
That attitude, which is far from uncommon, is one of the reasons most of us are so complacent with regard to fees. Given the tiny percentages involved, we assume the damage is limited.
Unfortunately, that's not the case.
A study by the Center for American Progress has some surprising things to say about retirement fees. Assume you're an average American worker with a 401k. Your fees equal roughly one-percent. Not too bad, right?
Wrong. Over the course of a four decade career, that one-percent will cost you roughly $70,000, in comparison to less expensive options.
That's a scandal. Higher fees do not correlate to better performance. That means you're potentially throwing away tens of thousands of dollars in fees over the course of your career.
Who is paying too much?
So now that we've established the portolio eroding nature of account fees, let's take a look at who is paying them.
In short, workers employed by smaller companies. FeeX, a company that tracks retirement account fees, conducted a study that showed that large plans have lower fee ratios. The largest plans (more than 100,000 workers) averaged a mere 0.27 percent. Smaller plans (fewer than 100 workers) average 0.87 percent.
Again, a difference of six tenths of a percent seems small. Yet that seemingly marginal difference has a stark impact. It can cost you tens of thousands of dollars, long term.
Why the disparity between small and large? It's fairly simple. Smaller companies don't have the leverage necessary to negotiate better terms. They also can't spread out the costs of managing a plan among thousands of workers.
Those working at smaller firms face other obstacles. Owners of companies with 50 or fewer employees are about half as likely to offer a 401 match, compared with large firms. Small companies are also far more likely to offer no retirement plan at all.
Action Plan: Changing investor behavior
A study conducted by Harvard researchers a few years ago delivered a surprising result -- even the most well-educated investors failed to minimize fees. Lowering fees ranked very low in their list of investment priorities.
That's alarming, as a reduction in fees is the one thing we can do that is guaranteed to improve our returns. We can't control market performance -- yet we absolutely can influence our fees. Here are some things we can do:
- First, investigate your expense ratio. A 2011 study by AARP showed that 70-percent of 401k holders didn't even realize they were paying fees. Two-thirds of those who did had no clue how much in fees they were paying.
- The federal government has strengthened fee disclosure rules. Yet this information is still tough to track down. You can find fee disclosures in your fund statements, but be warned -- they are often just a few lines in an otherwise complex and confusing list.
- If it doesn't arrive in the mail, you can find your statement online.
- If you're paying too much, switch to a low cost fund.
- What if you're employed by a small firm with an expensive plan? You still have options. Consider an IRA. You can contribute up to $5,500 (or up to $6,500 if you're 50 or older) in tax-advantaged dollars.
- A movement to establish state-based retirement plans is underway. Illinois, Washington and Oregon are expected to roll out their state-based plans in 2017. Another 20 or so states are considering similar measures. While this option is still a couple of years away, it bears watching.
Failing to minimize account fees costs investors millions of dollars every year. Why line the pockets of plan managers? Instead, follow the advice listed above and maximize your portfolio profits.