Like death and taxes, some fees are unavoidable. After all, those highly-paid fund managers have to make a living, as does every customer service rep and call center employee — and let’s not forget those executive bonuses. That house in the Hamptons isn’t going to pay for itself!
The money supporting all that overhead, including the bonuses, comes out of your pocket. In a sense that puts you and your investment broker at odds. Most of the time your broker is making it on a piddling 2% of your investment cash, which doesn’t sound like much — until you realize Americans had $6.4 trillion dollars in IRAs in 2013. Imagine being able to collect 2% of that by doing little more than converting oxygen to carbon dioxide, and you get an idea of what’s at stake.
While 2% doesn’t sound like much, it can make a huge cumulative impact on your returns over time. Let’s take a simple investment scenario: $10,000 invested for 10 years at 6% yields $17,908 in returns, but cut the yield to 4% and the return drops to $14,802. Now multiply the $3,106 difference by every $10,000 you have invested, and that’s how much you’re worth to big banks and investment houses. The goal for you then is to minimize the fees you pay.
IRAs Versus 401(k) Plans
First it should be pointed out that there is a big difference between an IRA and an employer-managed 401(k) when it comes to your ability to control fees. According to research, the average cost basis for administration of 401(k) plans is 0.72%, yet one in ten 401(k) plans charges administrative fees in excess of 1.72%, a serious hit on your returns. For a company-managed 401(k), it may be necessary to talk to Human Resources to get the exact expense ratio, or look to a site like BriteScope.com to find your plan rating. The 401(k) plans aren’t required to disclose their management fees, except in aggregate at the end of the year, and even then that may not include all the fees deducted from your personal account. That probably explains why the amount of money in IRAs dwarfs the amount in company-managed 401(k) plans.
Managed vs. Passive Funds
Managed funds almost always have higher fees than index funds, which can be managed by a computer algorithm. The problem with paying fees on managed funds is you’re almost always paying for the fund manager’s past performance. The more years a fund manager can string together better than market performance, the more you’ll lose in management fees the years he or she underperforms the market. Broad-based index funds focused on large cap stocks have lower trading costs and typically boast lower fees. Passively managed funds typically have expense ratios below 1%.
Administrative and Annual Fees
These fees will almost always be listed somewhere on your fund statement, but that doesn’t mean they have to make them easy to find. There’s usually a section labeled “Fund Performance,” although many now have a separate section for fees. Interestingly, there is little correlation between fees and fund performance. In other words, you don’t necessarily get more for paying more. It’s also not unusual for passive index funds to routinely outperform managed funds that typically have higher fees.
Early Withdrawal Fees
These are fees and penalties incurred for funds that have a minimum holding time or a specified withdraw window. Most of the time, that minimum holding time will be disclosed before you put in an order for the fund, and is most common on NTF or No Transaction Fee funds. The holding times vary, but industry competition has corralled most of them to around 90 days, though some can be as high as six months. Rolling money in and out of funds too quickly is like setting your money on fire.
Knowing what fees are common, and how to compare them, is the first step to getting control of expenses in your retirement account.