Many Americans’ only participation in the stock market is through their employer’s 401(k) plan. Those with a company retirement plan have watched the stock market soar to record territory, and opened their account statements with anxious relief. Yet, when they look at the numbers, something just doesn’t seem right. As the market pushes farther and farther into record territory, their 401(k) statements are underperforming.
The better you understand how your 401(k) plan works, the farther ahead you’ll be when it’s time to retire.
Despite new laws requiring the disclosure of fees, many are unaware that their hard earned savings are being siphoned off by high plan-management fees. The math is devastatingly simple — suppose someone in his or her mid-30s puts $20,000 in a 401(k) and changes jobs, not adding any more to the account. If the account earned 7% average return with 0.5% in fees, at retirement that account would be worth $132,000. If the plan management fees were 1.5%, the yield drops to $100,000. That’s a lot of money to lose in fees. The really infuriating part is that even when the plan loses money, they still collect their fees from your account. What a deal.
It’s hard to know when you’re paying too much if you don’t know what’s typical. According to the Investment Company Institute, a trade organization for investment houses, the industry average is around 0.78%, a figure which includes both the plan fees and management fees charged by the individual funds. Employees of a company with a large fund should be well under 1 percent in total plan fees — ideally 0.5 to 0.75%. A few of the bigger plans are all the way down in the 0.38% range. If you have a plan like that then you owe your boss a high five.
If you work for a larger company, you can expect to have lower overall plan management fees. There is a certain level of fixed costs when it comes to managing a company 401(k) plan, and the bigger the company, the larger the pool of employees and the more people splitting the check on the fees. Small companies are going to pay proportionately higher fees as there are fewer people contributing. A smaller company will also miss out on volume discounts available to larger plans.
To find the biggest reason your 401(k) is underperforming you may not need to go any further than the nearest mirror. A study by University of Virginia law professor Quinn Curtis and Yale law professor Ian Ayres analyzed data from over 12,000 plans and discovered that, many times, individual employees were choosing funds with high fees relative to other options in the plan. In fairness, the same study indicated that many of the management companies were including a preponderance of high fee funds in their selections, something that was worse in smaller companies.
Several high-profile lawsuits have been filed in recent years by groups of employees who felt their retirement investments were not well managed. Many of those decisions came out in favor of the employees.
It’s wise to periodically review your plan fees and the options available. If your plan fees are in the range of 2%, that’s going to take a significant bite out of your investment savings, and it will be well worth your time to look for better options.
Taming The Fees
You may even need to consult a third-party investment adviser to help you through the confusing jargon of the plan prospectus. It may be the law that fund providers have to disclose the information, but that doesn’t mean they have to make it easy to figure out. You can also seek out online resources like Kiplinger’s Fund Finder to search for funds with lower expense ratios.
I know most of you put wading through the insanely dry language of a fund prospectus right up there with going to the dentist, but the better you understand how your company 401(k) plan works, the farther ahead you’ll be when it’s time to retire.