Your 401(k) retirement account is being eroded by fees. Those fees are dramatically impacting how much money you will have upon retirement. American investors lose an average of $155,000 due to such fees over their lifetimes.
At least, that’s what FeeX.com is claiming. FeeX.com is a relatively new company. Their mission is to help people minimize the investment fees that they are paying on their investments. The folks at FeeX.com refer to themselves as “The Robin Hood of Fees.” Essentially, their mission is to make people aware of the expenses involved in investing, and to provide this information to the general public, free of charge.
Regardless as to whether or not FeeX.com’s claim of a $155,000 lifetime cost to your portfolio is accurate, the sentiment is spot on; many people are paying considerably more in fees than they need to.
Principally, there are three different types of fees that are charged by investment companies on retirement accounts: plan administration fees; investment fees; individual service fees. Some of these fees are not be in your control. The administration fees are determined by negotiations between your employer and the investment management firm. Other fees may be in your control.
The plan administration fees are the fees that the 401(k) plan administrator charges for the day-to-day running of the plan. Those administrative services usually encompass things like record keeping, accounting, legal, and trustee services and responsibilities. Most 401(k) plan operating expenses are paid from plan assets. This means that the fees to run the plan are paid by the plan’s participants. The costs for these services are usually paid by investment fees which are deducted from investment returns, so they are seemingly invisible to most investors. The plan administration fees may also be charged separately as a charge against the assets of the plan, and billed to you separately.
The individual service fees are usually fees related to loans which participants may or may not take against their retirement investments. It is strongly advisable that you avoid borrowing against your retirement account if at all possible. In the long run, it would be far more advisable to let that money grow until you need it for retirement rather than to borrow from it. Unfortunately, there may be circumstances where you have no other option but to borrow this money. Your employer’s HR department will have the specifics regarding the fees associated with 401(k) loans should you need them. Remember that borrowing against your 401(k) account may have a sizable negative impact to your retirement nest egg as your money will not have the opportunity to compound over as many years as it would have had you left it alone. If you have no other choice but to borrow against your retirement funds, then you should obviously do so. However, you would be much better off maintaining a separate emergency fund and leaving your retirement funds alone.
There are those fees that you may have control over. You might be able to impact your retirement account investment fees. The investment fee expense is the largest fee expense that most people pay for their investments. This is commonly referred to as the expense ratio of the fund. Typically these fees run about 0.5% to 1.5% of your total investment. While this may sound like a small number, these seemingly insignificant expenditures can really add up.
Assume that you are a 30 year old employee with 35 years to go until you reach your retirement. Let’s assume that you have been putting money into your 401(k) account each year and that you have amassed a balance of $25,000. A reasonable expectation is that the returns on these investments will average seven percent annually over those 35 years until your retirement. This would amount to $267,000 at retirement age, assuming you didn’t invest even one additional penny. Of course, there are always fees associated with investing. The key is to be aware of what you are paying and minimize those fees where possible.
If the fees and expenses in your account were to reduce your average returns by 0.5% per year, your account balance will grow to $227,000 when you reach your retirement age. If the fees and expenses in your account were to reduce your average returns by just one additional percentage point annually (for a total of 1.5% per year), your account balance will only grow to $163,000 when you reach your retirement age.
That additional one percent in fees and expenses would have a dramatic effect on the long term performance of your investment. It would reduce your account balance at retirement by an astounding 28 percent. Obviously, the amount that you pay in fees can have a considerable impact on your retirement account. Controlling the amount you pay in fees is vitally important, but you may not have the ability to control how much you are paying in fees.
Where you work may have a sizable and direct impact on the amount of fees that you pay on the investments in your 401(k) retirement account. Most people are limited to a specific handful of funds which comprise their employer’s retirement account.
CNN Money has a calculator which shows how much you will pay in fees as a result of investments in the funds that employers offer. While the calculator does not list every employer, it’s fairly likely that your employer is included in their database. The calculator estimates how high the fees will be on your investments. You simply select your employer (if they are included in the study), your current salary, and your current age. The calculator will estimate how much you will lose to fees.
For example, a 25 year old earning $50,000 will retire in 40 years. (The calculations assume a 3% annual salary growth, a 10% annual investment, a 4.1% inflation-adjusted annual return on investment and a retirement age of 65.) Here are the projected average fees that our 25 year old might incur over those forty years at several large employers:
|The Walt Disney Company||$78,000|
|The Coca-Cola Company||$105,000|
|Blue Cross & Blue Shield of Minnesota||$133,000|
This is just a sampling of the companies included in the CNN calculator. As you can see, the amount that you might pay in fees by investing in 401(k) retirement accounts at companies can vary wildly. The fee estimates are based on the average fees (expense ratio) for all of the plan’s investment options offered by each employer. An employer may have both low fee funds and high fee funds, so even though your employer’s expenses might appear high, you might be able to mitigate some of the fees by only investing in those funds with lower fees.
To see how your employer’s retirement plan investment fees measure up, here’s a link to the calculator on CNN Money’s website: http://money.cnn.com/calculator/pf/retirement-fees/.
The calculator on CNN Money’s website is provided by FutureAdvisor. Like FeeX.com, FutureAdvisor provides information that can help you to determine the optimal low-fee investment options within your employer’s plan. These websites will link to your employer’s account. If you do not want to share this information, FutureAdvisor allows you to enter your specific investments manually. Typically the investment recommendations will include index funds.
Investing in index funds is usually the least expensive approach. Many index funds offer expense ratios of 10 basis points or less; that’s one tenth of one percent, which is virtually negligible. If you employer’s retirement plan offers index funds as part of their lineup, consider yourself fortunate. If they do not, you still might want to consider those funds with the lowest expense ratios.
The information provided here is not only appropriate for employer sponsored retirement accounts; you can also use this information to minimize the expenses on your other investing accounts, like your IRA accounts or any non-retirement investing accounts you may have.
Minimizing fees on your investments will go a long way towards maximizing your returns and providing you with a financially comfortable retirement.