For most people, 401k’s are the best option to generate a large amount of wealth. They’re easy to set up and use, and many companies offer a matching contribution that makes it even more lucrative.
I’ve participated in my company offered 401ks since I started working in the corporate world 11 years ago and even though I was a Finance major and always hear about the dangers of high fees, I never really checked what I was paying. When I started my new job a few years ago, I basically selected an allocation that sounded pretty good and didn’t pay much attention after that.
However, now that I’m trying to figure out when we can retire (a later subject for another post), I’m really starting to understand the impact of half a percent! The common number people use when determining the amount they can safely withdraw from their nest egg in retirement (SWR = Safe Withdrawal Rate) is 4%. If you have a million dollars, that means you could pull out $40,000 per year with a pretty good chance of your money lasting 30+ years. However, if you’re paying a financial adviser or other fees of 1%, you’re automatically taking away $10,000 per year away from your retirement.
Anyway, that’s what made me think about my 401k and how much they’re charging. It turns out I was making some dumb decisions. Check out the table below which is the actual investments overview for my 401k. I’ve hidden some things and added the “FEES” column on the table because of course they wouldn’t make it that easy to find. Let’s take a look:
My biggest mistake was contributing to three funds that were charging .35%, .51% and .67%. Why did I even invest in those funds in the first place? After doing a little research, I think I know why. The area that is blacked out in each fund title is my company’s name… and yes, those are the four funds with the highest expense ratios. I probably put money into those funds because I was comfortable with the company name and it felt okay.
Ohhh, but no, it turns out they’ve created these “specialty” company funds so they can make more money off of us! Yes, that’s what really led to the HOLY CRAP moment! Check out the highest fee’d fund (SM/MID-CAP EQUITY) with the rate of .67% and compare to the similar fund (US SMMID CAP EQ IDX) with a tiny .05% fee and it has better returns over one and three years!
It may seem pretty tiny, but let’s see how these little HOLY CRAP fees add up over time. We’ll use two different starting investment amounts, $100k and $1 Million so you really see the impacts. To keep things simple, I used a future value calculator and estimated the value different of going from a .5% fee down to a .05% fee.
Basically, it’s a calculation to see how much bigger your nest egg can be by paying lower fees. I used an investment return of 7% annually. Let’s get to the chart:
HOLY CRAP! Yes, that right columns means if you cut your expense ratio from .5% to .05%, you’d have almost $45k more on $100,000 investment and over $440k more on a million dollar investment! That’s what these innocent sounding little fees will actually cost us! That’s pretty messed up – especially if you have similar funds available with lower fees.
So what should you do?
Log into your 401k or other investment account and check out your fees. You don’t have to make any changes right away, but at least make sure you know how much you’re paying. Then look at the table below and realize how these fees eat away at your investment annually:
Now you might be getting angry enough to actually make a change. Your company determines the funds you can choose from in your 401k, so you should look through your list and investigate the fees on each one. These are still pretty hidden, but you can usually click on the fund name and it should be on that page. If you have any high fees, you should look at changing those investments to fund with lower fees if similar investment classes – you can exchange funds within your account.
If you have a stock account outside of your 401k, you should do the same thing. The best low cost funds are all usually from Vanguard. If you need something right away to put your money into, I’d recommend Vanguard’s “VTSAX” which is their Total Market Index Fund and charges a mere .05% if you have more than $10,000 to invest in the fund.
These little numbers can make a huge different in your retirement nest egg over time. So go on… you can easily do this in a few minutes while your boss gives that boring update in your conference call that you’re not really listening to anyway. If you need more investing help check out my post on how to start investing.