John C. Bogle, founder of the Vanguard Group, had a mantra throughout his long career in the mutual fund industry: “Costs matter.” The amount of fees you pay to a third party to manage your money eats into your retirement savings. That has never been more important, although it is probably not foremost on your mind right now.
Retirees and retirement savers are facing a triple whammy these days. Stock and bond market returns have been clobbered by the coronavirus crisis, and the market will continue to be volatile. Some may see lower balances now and through the end of the year. Millions will tap their 401(k)-type plans for withdrawals or loans, enhanced by incentives in relief-oriented legislation. Jobs have evaporated and might not rebound in a shrinking economy, so contributions could be delayed.
Yet the math for reducing expenses has always made sense no matter what the market is doing: You can increase returns by doing relatively little. In fact, you do not have to take on more investment risk to do it. Online calculators can show you the numbers in seconds, along with the long-term benefits. Costs matter because they allow you to save more every year, and those savings compound drastically over time. The math is elegant and compelling.
Let’s say you had $100,000 in your retirement account, contribute $6,000 a year, were earning a modest 5 percent annually and paying an average 1 percent in total expenses, which is noted in your plan’s “expense ratio.”
What if you reduced those yearly fees to 0.50 percent, which is easy to do with low-cost index mutual funds — baskets of stocks and bonds that are not actively traded? You would have nearly $80,000 extra in your retirement kitty after 30 years, according to 401kfee.com, an online calculator. That is assuming you are 35 now and retire at 65.
Within those savings are some important revelations. You would have had to save an additional $1,400 a year in the more expensive plan to offset the difference between the higher and lower-fee plan. So the decision to reduce fees means more total savings with the same contribution. You get more bang for your buck, aided by the consistency of compounding.
A good first step toward reducing your fees would be to ask your employer how much you are paying in your 401(k), 403(b) or 457 plan. Your employer has to disclose this information annually, but also must explain how much it is costing you personally. Surprisingly, few people ask or have any idea how much they are paying. According to a 2018 TD Ameritrade survey, although 95 percent of 401(k) holders are levied fees, only about 27 percent of those surveyed knew what the costs were.
The Labor Department mandates fee disclosure for retirement plans. Employers must tell you how much is being deducted from your account for administration, money management, legal and record-keeping expenses. Even more detail is provided in quarterly reports that show actual dollar amounts subtracted from your account.
“The importance of fees is that they are like a steady headwind,” said Greg McBride, chief financial analyst for Bankrate.com, a financial information service that provides an array of free online calculators. “Fees always shave total return whether performance is high, low or negative.”
Of course, looking at numbers and percentages without any context can be befuddling. You will have to do a little more homework to see if you are getting a fair deal. You can easily do some benchmarking. Compare apples to apples, starting with the size, or total assets, of the plan you are in now. One good source for benchmarking is BrightScope, which can compare fees by plan size.
Plans with billions of dollars in assets tend to get better deals — and may absorb expenses — but that does not mean you cannot find lower expenses on your own. You can always open your own Roth, Roth 401(k) or individual retirement account with any mutual fund, bank or discount broker offering lower-fee funds to supplement an employer-sponsored 401(k), provided you qualify.
Several free 401(k) expense tools are online now that condense a fee analysis into a few seconds. The Financial Industry Regulatory Authority’s Fund Analyzer is one fairly bare-bones option, but it pulls from a database of more than 30,000 funds. And I like the graphics in the Personal Capital analyzer, although it is embedded in a direct pitch to sign up for a money-management service (you do not have to become a customer to use the calculator).
What can you do if you think you are being overcharged? If you are managing your own money through a self-directed I.R.A., Solo 401(k) or Roth, you can simply transfer your money to a lower-cost fund group. Every mutual fund has to disclose expense ratios, so it is easy to shop.
Once you have done your homework on a company plan, it is time to approach your plan administrator or human relations department. Show them your work and request that they bid out lower-cost vendors. There is intense competition in the 401(k) business, so finding a company with lower expense ratios is not difficult.
“Larger plans generally have lower fees,” Mr. McBride said, “but you can always lobby your human resources or benefits department to send out requests for proposals for new, lower-cost plan vendors.” Generally, you should look for large to medium domestic stocks to be charging well under 1 percent annually; foreign and small-company funds under 1.25 percent.
It is a good time to shop around for lower expenses. Despite the market’s downturn and the pandemic, one long-term positive trend for individual investors is that fund fees have been dropping for years, according to a study by Morningstar. Between 1999 and 2019, the annual (asset-weighted) average annual fund fee fell to 0.45 percent from 0.87 percent. Investors saved nearly $6 billion last year alone because expenses dropped, Morningstar estimates.
On passive index funds, you get a much better break: The average yearly expense ratio was 0.13 percent last year. Competition is so fierce that some fund companies are charging negligible or zero expenses on select funds.
Even if you work for a small or medium-size company, you can request that it search for lower-cost providers. “There are so many small plans that have incredibly high fees,” said Michael Bird, a retirement plan adviser who works with small companies in Bend, Ore. “A 401(k) plan should be reviewed every three years” for fees, he said. “There’s always a lot of room for improvement.”
All told, doing some homework pays off. A 2015 White House study found that 401(k) fees could total tens of thousands of dollars over a lifetime of investing. That lost money could be invested to create a more robust retirement fund.
Working with your employer is an essential first step. You may, though, encounter resistance or flat-out refusal from your company to reduce expenses or change vendors. In that case, another option is to sue your company. Under the Employee Retirement Income Security Act, the federal law governing retirement plans, your employer has a fiduciary obligation to prudently find the lowest-cost plan provider.
Some disenchanted workers, upset over excessive fees, have taken their employers to court in recent years: More than 100 new 401(k) complaints were filed in 2016-17 alone, the most recent years tracked, according to a paper published in 2018 by the Center for Retirement Research at Boston College.
Although he has not updated this study with more recent data, Geoffrey T. Sanzenbacher, a professor of economics at Boston College and an author of the research, said it was possible there would be a new surge in 401(k) lawsuits, mimicking the increase after the 2008 meltdown. He said that the employee lawsuits that had the greatest degree of success were those that involved an imprudent process of fund selection or conflicts of interest.
“A lot of people aren’t aware they are paying plan fees at all,” Professor Sanzenbacher said. “The level of employee engagement is low, even though 1 percent in annual fees means a 1 percent reduction in return. Over time, that’s costly.”
Of course, suing your employer is a time-consuming and difficult journey. It can take years to get a settlement, or the lawsuit may be thrown out. It is usually far easier to work with a willing employer to vet fees and find lower-cost funds.