What if I told you that 12 minutes of your time could save you $60,000 or more over your lifetime?
Believe it or not, one easy tweak to your 401(k) could help you save tens of thousands of dollars -- and it doesn't involve putting more money in. That's the beauty of it: no extra savings needed.
I won't keep you in suspense. You can save this money by checking what funds your 401(k) is invested in and switching from an actively managed mutual fund to an index fund or exchange-traded fund, or ETF, with a lower expense ratio.
It's easy to review your funds' expenses. Many 401(k) providers have a helpful table showing you the expense ratios for every fund you could invest in. Check that table and consider going for the lower-priced options (which should take you about two minutes). And then there's a little more research required (which should cost you perhaps 10 minutes -- more on that in a moment).
I'll show you how this could be worth $60,000 to you -- or more.
Let's talk expenses
As of 2014, the average mutual fund has an expense ratio (an annual fee that all fund shareholders must pay) of 1.33%. So, for a hypothetical investment of $10,000, you'd pay $133 each year to invest with that fund. Now compare that with an ETF. The SPDR S&P 500 ETF has a 0.09% expense ratio (or $9 for every $10,000 invested), while the Vanguard 500 Index Fund Admiral Shares' charges a minuscule 0.05%.
You may reasonably be asking: What's a percentage point either way?
Over a long-term investor's career, it makes a surprising difference.
Let's look at an example. The Dreyfus Natural Resources Fund has a 1.35% expense ratio, which is more or less average for an active mutual fund. We'll compare it with the Vanguard 500 Index Fund Admiral Shares, with its 0.05%. Let's assume a $25,000 initial investment in both funds, with no additional contributions. Assuming a 7% annual return before expenses (which assumes that both funds track the market's historical return), after 30 years the Dreyfus investment would be worth about $126,580. Not a bad chunk of change.
The Vanguard 500 Index Fund Admiral Shares? About $187,472.
So in this example, that 1.3% fee difference was worth more than $61,000.
The numbers I've provided assume, by the way, that you didn't have to pay the upfront sales charge on the Dreyfus fund, which is up to 5.75% of your investment and would have made for a bigger difference in returns, as the Vanguard fund doesn't carry sales charges. So that $60,000-plus difference may actually be conservative.
And when you look at 10-year performance, the Vanguard fund has returned 7.88% annually, compared with the S&P 500's 7.89%. The Dreyfus fund hasn't done so great returning an average of 5.8% annually (or 5.17% if you include the maximum sales charge).
But don't you get what you pay for?
Maybe it didn't work out in that example, but that expense ratio has to be worth something, right? The logic would go that if you're paying more for something, there must be some quality difference to make it worth the extra money.
However, with mutual funds, that's simply not the case. Last year, the average mutual fund returned 11.5% before fees; the average index fund returned 14.5% before fees. And that losing streak has been continuous since 2008. Last year, 86% of large-cap actively managed mutual funds failed to outperform their benchmarks, extending a multiyear losing streak.
Put differently, many people who are invested in mutual funds pay extra for the privilege of losing to the market.
This isn't to say that all actively managed mutual funds are underperforming money pits; there is that other 14% of large-cap funds that didn't fail. But the overall statistics on actively managed mutual funds just aren't in your favor.
Go a little further
Of course, if you're moving from one fund to another, you should do your due diligence. Check the index fund's historic returns (five- and 10-year) with a simple Internet search. If you're putting your money into one index fund or even just a couple, it's a good idea to seek diversified funds so that you aren't heavily exposed to a particular sector of the market. You don't want to be unknowingly putting all of your eggs in one basket. Review the prospectus briefly (also available online) and check the fund's major sectors and holdings. After all, for the massive amount of money your 401(k) could hold, it's worth the 10 minutes to check.
Far too many 401(k) savers are unknowingly overpaying for mutual funds that consistently underperform the market. Switching to a low-cost index fund or ETF is a simple way for you to keep more of your hard-earned savings ($60,000 or more). And it takes only 12 minutes, plus a long investing horizon, to keep that extra cash for your retirement.
