How Your 401(k) Is Ripping You Off

Another chapter in Bob Sullivan’s excellent book Gotcha Capitalism explores how Wall Street quietly devours your retirement plan through an array of hidden fees. Bob quotes a Wall Street money manager as saying, “If we had to disclose fees, half the people in this room wouldn’t have jobs.”

Fees are often disguised and given funny names, like “administration fee,” and “marketing fee” (apparently you have to foot the cost of selling the fund to other investors?). Fees are lumped together into the vague euphemism of “expense ratios.” In the chapter, Bob describes how these fees can hit workers investing in their 401(k) plans the hardest as the funds sometimes have trumped up expense ratios because that they include “revenue sharing payments.” This is another euphemism, and it stands for the kickbacks that the funds pay some 401(k) administrator for pushing you towards these funds (ever wonder why there’s often such a limited set of funds to choose from? Sometimes the administration company only wants to steer you towards those funds they’re getting paid off from). How bad can these expense ratios get?

A 2006 study by Congress found that increasing fees by 1 percentage point results in you having 17% less money money when you retire.

In their example, put $20,000 in a 401(k) for 20 years and you end up with $58,000 if the fees are 1.5%. But if they were .5%, you would have $70,500. That’s a lot of money. Increase the time to 35 years and what would be $220,000 drops to $163,000.

If you invest $1,000 at age 20 with an 8% return and 2.5% expense ratio, and just leave it there like that until you’re 85, you will come out with $35,250, while your fund manager rakes in a cool $126,432.

How is this possible? Well we all know how great compounding interest is, right? This is the same thing in reverse, the costs are compounding. Quietly. Rapaciously.

Before putting your money in a mutual fund, especially one in your company’s 401(k) program, do your research. Punch the funds into Google Finance first and, under “key statistics,” and compare the expense ratios. Oftentimes an index fund is the best choice. These funds are managed by computers and track broad market segments. Their expense ratios are low, like .18%. Vanguard is a good place to look at for index funds.

What happens if you find your company’s 401(k)s have high expense ratios? Bob recommends staying away from funds with over 1% expense ratios and says,”Ask about the last time your plan was “put out to bid.” If it’s been a while, encourage your human-resource department to ask for bids again. The industry is getting more competitive, and a new third-party plan administrator might offer cheaper funds.”

(Photo: Getty)

Comments

Edit Your Comment

  1. Xerloq says:

    The commas are revolting!!!!

  2. char says:

    Holy shit, that’s unbelievable. I need to go find my last statement and get my shit fixed.

  3. Toof_75_75 says:

    “you would have $70,5000″

    Wow, well that’s WAY more…

  4. rockstarjoe says:

    Could someone recommend a good index fund?

  5. girly says:

    What I had is how my 401(k) has restricted moving your funds around. When you sell off one fund, you can’t buy back for another 6 months!

    They just don’t want to do the work…

  6. girly says:

    “What I hate” I’m suffering from typos :(

  7. LVP says:

    “But if they were .5%, you would have $70,5000.”???

  8. Toof_75_75 says:

    @girly:

    You and Ben, both.

  9. Ben Popken says:

    @rockstarjoe: Look into Vanguard funds.

  10. @rockstarjoe: any of the vanguard index funds. vanguard’s expense ratios are excellent.

  11. beavis88 says:

    @rockstarjoe: SPY is an S&P 500 index fund. Expenses = 0.12%. My work’s retirement plan, by contrast, has an otherwise identical S&P 500 plan with 0.62% expenses. WTF? It certainly pays to shop around. None of these assholes are primarily in the business of helping you retire. Look out for yourself, and pay reasonable fees to people who can help you get there.

  12. Corydon says:

    @rockstarjoe: Vanguard generally has some of the lowest expense ratios in the business. I have their total stock market fund in my 401k and the expense ratio is 0.06%.

  13. girly says:

    @Toof_75_75: at least he can edit!

  14. Ben Popken says:

    My bad. Fixed the commas and zeros.

  15. ShortBus says:

    Can you get your own 401K without having to go with the company options? I just signed up last week and was somewhat upset that the benefits company is charging $240 just to set up my account. :-

  16. Elvisisdead says:

    Fees are precisely why I pulled all of my money out of Smith Barney and put it in the hands of USAA. Smith Barney was figuratively raping me on a managed account.

    I was cool with it while a college roommate was managing my money, but he left and then the “fees” started piling up. My buddy was doing it fee-free to up the value of his managed portfolio. The guy he handed me off to had no incentive to make me any money and was a complete dick when I initiated steps to transfer everything out. Almost to the point of trying to block me, and then trying to screw me for a couple hundred bucks in “transfer fees” and “account closing fees”. It took my buddy calling him up and confronting him on it to get him to return the fees. If I was Joe Consumer, I would have simply been screwed.

  17. Toof_75_75 says:

    @girly:

    That’s certainly true!

  18. qwickone says:

    EF! I just look at my 401k and ended up changing about half of it. Turns out the index fund was performing among the best and the expense ratio is 0.10%

  19. @rockstarjoe: I have 0.10% with two different Fidelity Index funds, US index and international index (FUSEX and FSIIX). (I just went and checked the ratios on all the funds in my retirement account after reading this, lol.)

    TIAA-CREF has pretty low expense ratio for actual managed funds (like the lifecycle-style funds). Their ratios on the index funds are a bit higher, tho.

    (I get a choice of TIAA-CREF and Fidelity through my plan.)

  20. dtmoulton says:

    This article just made me call Fidelity for our company’s group account. Thanks!!

    Their retirement plan “2040″ has an .82% expense ratio with no other charges and no front loading.
    The one to watch is their Growth % Income account which has a .68% expense ratio with an added .4% management fee: 1.04% total.

    Not the best, but the company matches half for the first 3%, which offsets more than an index fun with no matching.

  21. Crotty says:

    Vanguard is great, and I use them for my non-retirement investment, but if your employer isn’t using them for your 401K you have to wait until you quit to roll over, don’t you?

    Anyway, I am lucky to be in a Fidelity plan that allows investment in the Spartan S&P 500 index fund with a 0.10 expense ratio — actually better than Vanguard. This is particularly good if you don’t have 100K invested yet, because you need that much to get the low expense ratio through Fidelity outside the 401K.

  22. anatak says:

    @ShortBus: I think what you are looking for is an IRA or Roth IRA, where you can buy any fund in the free market.

    Good article, Ben. After reviewing my 401k, I found one fund to have an expense ratio of just over 1%. A tad troubling, but the real find was that a fund previously closed to new investors was open again. The fund with the high expense ratio was the next best thing. Needless to say, I reallocated.

  23. Pete Venkman says:

    @ShortBus:
    I’m self employed and got setup with Vanguard. Everyone here is right, their fees are very low.
    There were 2 options, put in $1000 and leave it, or put in a minimum of $50 per month.
    Of course you could put in the $1000 and send in a check a few times a year. There is no setup, and any company that wants to charge you for a regular “Average Joe/Jane IRA” doesn’t want your business.

  24. MoCo says:

    While it is true that expenses eat away at earnings, a really good fund manager can be worth the cost of the expenses. A fund that earns 20% and has 2% expenses certainy provides a better return than a fund that earns 10% and has 0.20% expenses.

  25. Maude Buttons says:

    @Eyebrows McGee: I have TIAA-CREF through my work as well. When you say “lifecycle-style funds,” is that where I signed up for a 40-year-plan with the idea that I’d retire when I’m 75?

    Posts like this one make me very anxious because I am very dumb. I know enough to know that one has to do research, but what if one doesn’t even know where to begin said research? Or what questions to ask?

    Ah, Maude: This world was never meant for one as confusable as you…

  26. PeteyNice says:

    TIAA-CREF’s lifecycle ER’s are silly high. The actual ER is masked by “fee waivers” which are discounts against the ER but they can be withdrawn after a certain time so you may be stuck paying the full ER. For example, the ER on their LifeCycle 2040 fund is 0.94% (without waivers) and 0.61% (including waivers). By contrast, the Vanguard LifeCycle 2040 fund has an ER of 0.21%. Huge difference.

    Vanguard FTW

  27. johnva says:

    @crotty: Also, sometimes in a 401(k) you may have access to different share classes that have lower expense ratios if your company is a big account. For example, Vanguard funds often have at least 3 different share classes for their funds, each with different expenses and minimum investments to qualify for. But it’s true, often 401(k) plans suck compared to what you can get independently.

  28. Schlarg says:

    @rockstarjoe: Have a look at these solid, low expense ration index funds: VIGAX, VVIAX, FUSEX, FSIIX

  29. TWSS says:

    So, um, is 1% bad? Because that’s about what I’ve got with FDIVX (.7%) and BARAX (1%) right now. The index fund (FUSEX) is at .07%. Of course, it’s kind of a moot point since I just switched jobs and I want to roll that 401(k) into my IRA anyway.

    This has also got me thinking about the mutual funds in my non-401(k) accounts. I’ve been ignoring them and trusting my investment guy for a long time. I trust him, but this is a good reminder that as a consumer, I need to keep track of this kind of thing.

  30. johnva says:

    @MoCo: This is completely true, but it’s often quite hard to figure out which actively managed funds will beat the market. Past performance doesn’t necessarily indicate that they will do so in the future. And what’s worse is that the performance of actively managed funds often suffers once they become well-known for doing well. This is because lots of people start pouring money into them, and it’s harder for the managers to invest the much larger amounts as efficiently and well as they did in the past. Index funds don’t usually suffer from this effect, because they are based on a simple formula instead of a potentially complicated trading strategy.

  31. bustit22 says:

    If you have the option of a “brokerage account” with your 401(k), you can often buy a low cost index fund (such as Vanguard) that way. My company allowed this but charged a $75 fee for the transaction. That sucks, but that was only a 0.15% ONE-TIME fee on the total amount.

  32. TWSS says:

    @MaudeButtons: Maude, I’ve used Morningstar.com’s ratings before, but I’m not sure how reliable they are. At the very least, they’re a good introduction to what the terms mean.

  33. johnva says:

    @TWSS: Yes, 1% is pretty bad, all other things being equal. Of course, it’s hard to determine whether all other things are equal. But just quickly looking at BARAX it doesn’t look like it has done much different over the past 10 years from VTSMX (Vanguard Total Stock Market Index), which has an expense ratio of 0.19% or less. So I’m not sure you’re getting anything worthwhile for paying 5x more in fees every year. When you’re evaluating expense ratios, you really need to look at whether you think you’re getting something that is worth paying that much more for. Even if it’s slightly better, it needs to be quite a bit better to beat the cheaper option.

  34. m4ximusprim3 says:

    Good article. One of my fidelity funds was at .97%, and I wasn’t really happy with it anyway. Time to move!

  35. MoCo says:

    @johnva: I agree!

  36. ironchef says:

    My beef with Manulife…they have “Proprietary funds”

    Once you put your money it it…no one else can buy it. They relabel stuff like Vanguard funds…call it a new manulife name…then they charge you for it.

    The sad part of it is…you must LIQUIDATE the funds if you decided to transfer out. There they charge you special fees for liquidating their private label funds.

    That’s SLEEEZY.

  37. manbeast7 says:

    Can anyone explain what “Expense Ratio after Reductions” is? For instance, I have a fund that has an Expense Ratio of .92% and an Expense Ratio after Reduction of .87%. Does that mean that I am “only” paying .87%?

  38. laserjobs says:

    A simple solution is to dollar cost average into SPY or even BRK if you want to go long in the markets. BTW: I am an investment advisor and probably should not be telling you how simple it is.

  39. johnva says:

    @laserjobs: Of course, if you’re going to DCA into an ETF on a frequent basis, you should carefully compare the effect of transaction costs to the effect of a higher expense ratio in an equivalent index fund without transaction costs, especially if you are investing relatively small amounts at a time. Either that, or find one of the deals where you can get a certain number of free trades per month or whatever. I’m sure you know this, but people really need to do the math themselves to figure out what’s best for their situation and assumptions.

  40. barty says:

    If the person setting up the 401(k) at your employer is worth anything, most people should have zero to no account fees and should have plenty of investment choices with little to no load.

    Generally, I’d avoid anything with an expense ratio of more than about .5% in a 401(k). If you don’t have access to a 401(k), your’re probably going to be looking at choices between 1-3%.If your employer’s 401(k) is filled with a bunch of high load investments, it might be time to talk to your boss and rattle some cages in HR to find out what the hell is going on. They’re either being paid some commission by the investment house or they’re fairly ignorant and just fell for the investment houses’ marketing BS.

    Personally speaking, I’ve yet to have worked at a larger company that didn’t have good investment choices in their 401(k) plan. Everything I’ve been involved in the past 6 years or so has been managed by Fidelity, which is one of the highest rated firms out there.

  41. rhambus says:

    Weird that this should come up now. My 403(b) (the same thing as a 401(k) but for nonprofits, like where I work) is with TIAA-CREF, so I am more or less OK there. Where I had trouble was that I wanted to invest in some index funds as normal investments (not retirement or tax-deferred). All my research, both reading articles and crunching numbers, led me to 2 things:

    1. Almost no fund beats the S&P 500 over the long term. It’s depressing that almost every actively managed fund (where people make decisions, not just slavishly follow an index) will end up worse over 10 years than the S&P 500. Basically, mutual fund managers don’t know any better than you what stocks are going to do. The S&P always averages around 10% and you simply can’t reliably do any better than that. Short term, you can get lucky with a fund that might go up 33% but you could just as easily go down 33%, and over medium term or long term you will virtually ALWAYS do better with an index. Like I said, I find this depressing.

    2. I wanted to just constantly invest about $200 a month (for now) into the index funds. There are three practical ways of doing this if you don’t want to pay exorbitant fees (and as this article says, you REALLY REALLY DO NOT WANT TO).

    a. Go with a Vanguard index fund. Lowest costs possible except for Fidelity Spartan funds, which are similar. About .10-.20 ER max. It does not get lower. Problem: if it’s not for retirement, the smallest initial investment in a Vanguard index fund is $3000(!). I don’t have that. Successive investments have to be a minimum of $1000. Yipes! That would not work for me.

    b. Buy ETFs like the Vanguard VIPERS (just Google it, Vanguard has a good webpage for them) or the aforementioned SPY. There is also DIA for the Dow and QQQ for the Nasdaq. These are like mutual funds but are traded like stocks. This is cool but TD Ameritrade, my broker, charges $10 a trade. This is cheap but you do not want to pay it every month for just $200, that’s like a 5% fee! There goes your money. So forget that. It would work if you go with someone like Zecco, which gives you 10 free stock trades a month, but I have heard bad things about their customer service. If you are willing to deal with it, this is probably the cheapest route. But you have to work on it every month and also, the prices go up and down, so you can’t just buy $200 worth every month.

    c. The only alternative that I found would work for me was T. Rowe Price. You can buy funds there with no initial investment as long as you put at least $50 in a month automatically though your bank. They have 5 index funds with expense ratios from about .25 to about .45. Not the cheapest but I don’t have to come up with mucho cash up front, and they are lower than a lot of index funds (and actively managed funds). I am putting $100 a month into the S&P index fund, $50 in an international index, and $50 into the S&P completion index which brings in some small companies that aren’t in the S&P 500. Overall, not bad. I think they do charge you like $10 a year per fund for a maintenance fee, but that is not much, really. I think $30 a year is reasonable for all the paperwork they have to send me and the IRS, etc.

    I hope this helps someone! It took me days to figure this out so I hope I can help someone else through this super long comment.

  42. tycho55 says:

    @rhambus: You should note that while Vanguard does require a $3k initial deposit, subsequent deposits need only be $100. I’ve got a Vanguard Target Retirement account, DCA weekly, and have been very happy.

  43. laserjobs says:

    @rhambus: Nice plan you have going!!!

  44. @MaudeButtons: yes, that’s exactly it. The Lifecycle-style funds are sort of a set-it-and-forget-it type of investing, and are tailored for people who don’t know a lot about investing, or don’t want to mess with it. They basically allocate the fund in pretty standard ways, chasing a larger proportion high-risk, high-growth stocks when you’re young, and settling into more stable, less-exciting investments as you get closer to retirement.

    You can feel pretty confident in the Lifecycle-style funds from any of the major fund houses. They’re popular, they’re well-scrutinized, the brokerage isn’t going anywhere. They may not get you the best possible return, but they’ll give you a nice, steady, broad-market investment over your working life that you don’t really have to mess with much. (And for a lot of us, just investing in the broad market over a long period is really the goal — your money SHOULD increase over that long haul basically no matter what.)

    Another very easy way to invest is the index funds (as everyone’s said here), especially S&P500-trackers. You could split your portfolio between a Lifecycle fund and an index fund and feel pretty good about it as a simple, stable portfolio for a novice investor.

    (My retirement account through work, where obviously I’m limited in choices, is 50% lifecycle fund, 25% US market index fund, 10% international index fund, 10% contrafund, and 5% real estate fund. — basically 75% dull and 25% in investment strategies I’m interested in.)

  45. johnva says:

    @tycho55: Plus I think you can do even less ($50?) in subsequent investments with Vanguard as long as you set up an automatic investment plan. I believe the $100 limit is only for manually initiated transactions (though it’s possible they’ve raised the limit for automated investments too since I set mine up). Vanguard also charges a $20 per year account maintenance fee for each fund with a balance under $10,000, but they will waive this if you agree to electronic statement delivery (making them even cheaper).

    If you can’t make the $3000 initial investment I suggest just setting up a savings account and putting some money aside until you can. Personally I wouldn’t make a decision about which company to go with based only on that. Fidelity is another good choice, and I believe they will let you open an IRA account even if you can’t make the minimum for their mutual funds (so you can still get the tax benefit while accumulating money towards that minimum investment).

  46. missjulied says:

    Ugh, I’ve been bumming over this lately too – my husband’s company has their 401(k) through Kibble and Prentice – and their fees are ridiculous! Not only that, but the participant website is so awkward to use it makes seeing what activity actually occurred very difficult. We’re past the point of contributing to Roth IRAs, so our 401(k)s are the best vehicle we have right now, both for retirement and to bring our taxable income down. I know we’re lucky to be where we are, but it still kills me how much they suck from his account. We’re moving his money out of there the *second* he changes jobs!

  47. Notsewfast says:

    @Elvisisdead:
    Agreed! I worked for (what is now called) Smith Barney for a short time right out of college. It did not take me long to realize that what was occurring was basically distracting clients with good personalities while screwing them. I have since moved out of the commission business (bonused on aggregate gains from the company’s coffer now), and I’m in investment banking. A good tip is to make sure that you are not paying HUGE fees (2%+) to a “broker” who is only investing in mutual funds. If your financial adviser can’t actively manage stocks and bonds, you should probably consider managing your own accounts. I generally don’t take accounts under $1.5mil, so your needs may be different, but if your guy spends more time on the golf course than in the office, or you can’t find him at his office during trading hours, you may want to be suspicious.

    My mother just inherited quite a bit of money from her father’s estate and I have given her the same advice.

    @TWSS:
    Morningstar ratings are very reliable

  48. smashirony! says:

    @Secret Agent Man:

    Added to this – unless you’re a true high net worth client, an alarming proportion of fee-based brokers will stick you in model portfolios and effectively do nothing at all to earn their percentage. They’ll create an investor profile on you, punch in a retirement date, and some computer will pump out an asset allocation and recommended set of funds to populate each asset class. Then they set their auto-rebalancing schedule and crack a beer. Great scam, eh?

    Morningstar ratings are good for some things, bad for others. A good practice is to look at the Lipper averages (quantitatively sound measures which the industry uses) and the Morningstar ratings (valuable but essentially a consumer-friendly quant-lite thing.) Incidentally – all these firms who provide consumer-friendly ratings also provide systems like those describe above to help brokers bleed you – caveat emptor.

    If you really want to play this rigged game, find some good ETFs and/or closed end funds (Vanguard has great ones and Barclays’ iShares has some that are better than others for more exotic asset classes / styles). Google “core-satellite portfolio management” too, there is a lot of sense in that approach.

    Otherwise stick your fucking money in the mattress.

    There are even fewer gains to be had from active investing than ever before, now that huge quant trading systems have taken over and is eating every last arbitrage opportunity alive. Basically, Skynet is eating your retirement.

  49. tk427 says:

    @MaudeButtons:

    Look for an “investment basics” or “education” type link on your investment company website and read it all. Read the prospectus online (or order them in the mail) from the funds they are offering. Then start goggling the different terms and phrases you see and you will find plenty of good advice from reputable companies and publications. Look on other investment company websites and request free brochures. Take notes; draw pictures if it helps you.

    This is your money so keep looking for answers until you have no more questions.

  50. JPropaganda says:

    So Fidelity runs my company’s 401(k). Is fidelity ripping me off?

  51. Kounji says:

    Wow I’m one of those youngings who didn’t look into expense ratios. I’ll need to check that. Thanks Consumerist

  52. AndyFromTucson says:

    Large portions of the financial industry are predicated on the fact that most people don’t bother to learn about managing money and therefore they can be talked into anything, including mutual funds that are a rip off because of fees. Invest some time in learning about money and investments.

  53. johnva says:

    @JPropaganda: Probably not, but you need to read about the specific fees associated with your plan. I don’t think there is a standard set of fees for all 401(k) plans offered through a single broker; instead, it’s probably negotiated based on the size of your company.

  54. jtaylor555 says:

    The real rip off is not in the mutual fund fees. These at least are easy to find and compare. The real rip off is in ‘asset fees’(Nationwide) AMC (John Hancock) etc. All of which are added on in addition to the mutual fund management fees! To find out if and how much you are paying you should request a sign up package from your employer, then you must look for either an addendum or footnote and some oddly named charge.

    This is how the plan administrator and broker are paid. These expenses are in addition to mutual fund expenses and are usually charge to all plan participants.

    This is where the real rip off is.

  55. jmackowi says:

    First off, an expense ratio of 1% is no big deal. It’s high for an index fund. If you’re investing in a small cap fund or an international fund, then you’re going to pay more, as the underlying investments are not as widely traded and may have less information available. Marketing fees (aka 12b-1 fees) are not a terrible thing, either, unless the fund is large and they have not decreased that fee over time. In response to the poster that compared Morningstar and Lipper ratings, they are designed to do the same thing: compare a fund against its peers.

    There are arguments to be made for indexing and arguments to be made for active management. There is nothing wrong with a fee based advisor putting clients in a model portfolio based on their risk and goals. A good advisor is going to put a lot of effort in to designing the portfolios he or she uses. It also makes monitoring everything much easier for them. Would you prefer they work with several hundred different funds and not know much about them or work with 20-30 and know them inside and out?

    Bottom line is that people can do their research, but at the end of the day, if you’re not an investment professional, it is a good idea to pay someone to assist you with your retirement. Find an independent advisor who you trust. Ask for referrals.

  56. rhambus says:

    RE: Vanguard, I know I read somewhere that there was a $1000 minimum subsequent investment, but that may have been some specific fund (or it might just be wrong). Remember I am not talking about IRAs here, I just mean actual, taxable, sell-anytime-and-take-the-money investments. One person suggested just waiting until you have $3000 and then buying a Vanguard fund – this is not bad but the problem is that while you are saving the money, you are missing out on whatever investment income you could otherwise earn. Also, remember if you want two Vanguard funds to get some more diversity in your portfolio, that’s $6000, and so on. I am not running down Vanguard here, seems to me they are the best choice but as so often is true, it seems you have to have money to make money.

    With regard to retirement, I think you have to invest there (obviously) but you should also have normal investments that you can get to for stuff you might actually need to buy. You do have to do a lot of living before 65, after all!

  57. jmackowi says:

    @rhambus: Also, some funds will let you set up an automatic investment with a minimum of $25 per deposit.

  58. Squeaks says:

    Wow, even the default money market has an expense ratio of .94%. Some of my funds even go above 2%. I think I’ll send an email to hr…

  59. BridgeTea says:

    Avoid getting too excited about no-load index funds. An index is not well diversified and you could suffer from downturns in a particular sector (like Financials for the S&P 500) more so than you would in a fully diversified investment. Talk to a professional about diversification and asset allocation… make sure you know where your money is going!!!

  60. Hateshopping says:

    Don’t forget about the part where the fund manager buys a whole honking load of the company’s stock (thank you very much Mr. CEO for giving us this plan management!). So not only is your income tied to this company, but your future as well. Ask any Enron or Worldcom employee what happens when their 401K has a significant portion of the plan in their employer’s stock.

  61. Anonymous says:

    Why not just completely ditch a risky and high cost 401k plan and set up a 7702 Private Plan instead? In a 7702 Private Plan there are no hidden fees, and properly structured there is the opportunity to earn market based gains without market risk. Finally a 7702 Private Plan eliminates future tax risk because unlike a 401k, income from a 7702 Private Plan is 100% tax free!