When it comes to managing your 401(k), most people aren't aware of how much they are actually paying in fees. Over time, the loss of this revenue can amount to thousands of dollars.
To illustrate this common lack of awareness consider this: when meeting with a Chief Financial Officer at a company several weeks back, we told him that he was paying Wall Street 5.75% on every dollar they were contributing to the company's 401(k). He was shocked at this revelation. If an expert in the field of finance, who is a CFO, is not aware of the hidden fees, how could the average investor know?401(k) Fees: How Much are you Actually Paying?
There are some things you can do to avoid these costly 401(k) fees. First, it's important to understand how much you are actually paying in 401(k) fees because it will dramatically impact your investment returns over time. Annual operating expenses, sales charge, and investment manager fees are key fees you need to be aware of. The Fund Analyzier below, from the FINRA (Financial Industry Regulatory Authority) website, illustrates the fee structures that are embedded with hidden costs. On the left is the Fidelity Advisor Freedom 2025 Fund (a 2025 target date fund) and on the right is American Funds Growth Portfolio.
There are two expense areas to pay particular attention to. The first is the annual operating expenses; this is the operating expenses of the mutual fund itself. You'll notice that the Fidelity Fund has an annual operating expense of 0.95% and the American Funds annual operating expense is 0.75%. Additionally, you'll notice the front end loaded sales charge schedule, which is what most people are NOT familiar with. Take note that every dollar you contribute to the 401(k) has a sales charge (some call it a commission) of 5.75%. This is true for both the Fidelity and American Funds below. It is possible that your company may have negotiated a lower fee structure with the mutual fund companies, however.
Additionally what you won't find in the screen shot are portfolio managers cost (or management fees). Typically, these fees range between 0.25% and for smaller plans you may be charged an additional 1.5%. These fees are also known as investment advisory fees. For example, for every dollar that you contribute to your 401(k), the fee can cost you anywhere from 6.5% to 8.0%. So, if the stock market has a good year and goes up 8% on the year, for that year you're basically at breakeven.
401(k) Fees Can Add Up!
As you can see, it's important to be aware of all the different fees within your 401(k). Otherwise, the fees will reduce your overall performance and the amount of money you'll have available to you when you need it the most during your retirement years.
How to Reduce or Eliminate Fees
Below is a screen shot of the S&P 500 index value for the past 50 years from 1964 through 2014. The beginning value of this hypothetical example is $10,000. The grey line represents the growth of that $10,000 over the 50 years with no management fees. That total is $242,938. The red line however, is what most people experience with the growth of $10,000 in a typical 401(k). Please note that this red line has a 2% management fee which reduces its value over 50 years to $88,471. The difference in account value between the two is approximately $150,000. This begs the question, "Where did the $150,000 go?" Hint, that's the banks money – the pension you're helping build for Wall Street. Think about it, you're providing 100% of the money, taking 100% of the risk and only receiving 35% of the profits.
Here's how you can reduce some or all of your 401(k) fees and keep more of what you make. First, check within your existing 401(k) on your investment options and find funds with the lowest expense ratio. You can check expense ratios at http://www.finra.org and click on "Fund Analyzer". Look for the lowest expense ratio funds, and reallocate your positions to those funds. Typically, look for funds with no front end load fees and expense ratios below 0.50%.
If your 401(k) does not offer funds with low expense ratios then you may want to consider transferring your existing balance (the balance that is vested) into your own IRA. Once you have your IRA established you'll be able to choose from a variety of low cost funds and ETF's. The more you understand how the financial system really works, the more empowered you will be to make financial decisions that benefit you, not Wall Street.
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