High fees on investments can really bring a retirement portfolio down over time. Because the time horizon is so long for many retirement portfolios, the bite that these fees can take really compounds over the years.
Unfortunately, many employees who invest in the company 401(k) plan have no idea what their fees actually are. Not only do plan participants pay fees on their investments (the expense ratios), but most also pay an administrative fee for the 401(k) plan.
Incredibly, one study shows that close to 90% of those in a 401(k) plan had no idea how to figure out the fees they are paying. To add to the problems, nearly 45% of those surveyed did not even know if they were paying any fees at all.
How the Fees Work
Most 401(k) plans have fees on their investments and an administrative fee. The fees we pay on investments are listed as expense ratios. It is getting easier to find the expense ratio of a fund these days thanks to all of the great information online.
The expense ratio is an annual fee applied to the balance you have in that particular fund. So if you have $100,000 in a fund with an expense ratio of 1 percent, you are paying the fund company $1,000 per year.
Administrative fees can also take a bite out of your portfolio. Some of these fees are very large and are even just a small dollar amount, regardless of your portfolio balance. But some of the older 401(k) plans have hefty percentage fees that really begin to take a lot of money out of your portfolio as it gets larger and larger.
In 2012 a law was passed that now requires companies to disclose how your administrative fees work. In fact, the company has a fiduciary duty to its employees in that they are supposed to make sure the employees understand their fund choices and their 401(k) fees.
If you are having problems figuring out the fees you pay for your plan, ask the person in charge of the 401(k) plan. If the fees on the investments and/or the administrative fee are too high, lobby to have them change the plan provider.
401(k) Fund Choices
It is usually actively managed funds that are the biggest offender when it comes to fund fees. Actively managed funds can have fees of 1% or more. But if you look at all of the investment funds out there today, you can find many of them (such as through Vanguard) that charge less than 0.1% per year for their funds.
Again, lobby for a better plan at your company if the choices are weak or the fees are high. You should also do the same thing with your financial advisor, if you have one. Check your fees on the funds he or she has you in. If they seem too high, talk to your advisor about putting you in lower-cost funds.
Using Target Date Funds
Times are changing and many companies are now wisely offering target date funds to employees. I usually recommend these funds to people because they usually have lower expense ratios than other choices in the plan.
They also choose your risk level for you based on when you plan to retire and they rebalance your portfolio automatically each year toward less risk as you approach retirement. Lastly, these types of funds have a nice level of diversification among domestic investments and international investments.
Using an IRA
The match that the employer provides is free money. Never let that go to waste. However, most matches stop at a certain dollar contribution value by the employee. At that point it might be best to divert some of your savings to an IRA.
Why use an IRA? Because there will be more choices in terms of investments and you can almost always find lower fees on the funds. This will also allow you to potentially convert the money to a Roth IRA in the future.
Once You Retire, Roll the 401(k) Over to an IRA
Don’t wait on this. The match on the 401(k) is gone once you retire. So you should roll it over to an IRA as soon as you retire. This way you get rid of any administrative fee and you now have all of the fund choices you could ever want.
Doug Carey is president of WealthTrace.