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)
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Wow I’m one of those youngings who didn’t look into expense ratios. I’ll need to check that. Thanks Consumerist
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.
@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.
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.
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.
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!
@rhambus: Also, some funds will let you set up an automatic investment with a minimum of $25 per deposit.
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…
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!!!
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.
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!