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.”