"Retirement readiness" is one of the major topics in the retirement industry. Developing 401(k) and other retirement plans that help employees identify and work toward their retirement goals is a key goal of many companies. Because many employees choose to roll their 401(k) assets into individual retirement accounts (IRAs) once they retire, extending retirement readiness into IRAs is equally important.
And yet, as recent lawsuits have shown, many retirement plans are failing to prepare workers for retirement due to the excessive fees charged by their investment options. When the issue of investment fees is brought up, plan sponsors and the investment industry often try to downplay the significance of annual fees by saying they're "only 1%."
You may be overpaying for poor returns
The problem with the "only 1%" claim is that it ignores the compounding effect of the annual fees over time. Over a 10- and 20-year period, a fee of 1% reduces an investor's end return by almost 8% and 17%, respectively.
You can more easily recognize the true impact of an annual 1% fee by looking at the fees associated with mutual funds -- specifically, actively managed mutual funds. These are the most common investment options within 401(k) plans and IRAs. While fees vary between each mutual fund, a 1% annual fee is common. According to Morningstar, as of Feb. 6, 2017, the average annual expense ratio of all mutual funds was 1.11%.
Not only do the fees of actively managed funds erode investors' returns, but these funds often underperform passive funds that have lower annual expense ratios. According to the most recent Standard & Poor's Indices Versus Active (SPIVA) report, over the 10-year period ending June 30, 2016, 87% of actively managed mutual funds failed to outperform their benchmark index.
The obvious goal of any retirement savings program is to help employees accumulate as much retirement savings as possible by maximizing their end return on their investments. As these numbers clearly show, minimizing the impact of a mutual fund's associated fees and expenses is critical to accomplishing that goal.
How to find out how much you're paying in fees -- and how to lower them
There are several ways for employees to obtain information regarding the fees charged by their employer-provided retirement plan. The simplest way is to simply request such information from the plan's administrator. It can also be found on the annual report that all plans are required to provide to their participants. The annual report contains information not only about plan fees, but also about the performance of the investment options within the plan.
IRAs present less of a challenge with regard to fees. IRAs are typically held by a custodian, such as a brokerage firm or a bank. The annual fee the custodian charges is usually quite low, in the range of $15-$20. IRA owners can find out how much a fund they hold is charging them by checking the fund's prospectus or searching for the fund on a website such as Yahoo! Finance or Morningstar.
Once you know how much your funds are charging you, you need to decide whether you feel they're worth the cost. Investing icon Burton Malkiel has suggested that investors only invest in mutual funds with an annual expense ratio less than 0.50% and a turnover ratio of less than 50%, as both costs reduce an investor's end return.
IRA owners obviously have greater control over their investment fees, as they have total control over their investments. If you have a work-sponsored plan with excessive fees, then you should discuss this with your plan administrator and ask that the plan include investment options from mutual fund companies such as Vanguard, Fidelity, and T. Rowe Price, which are known for offering funds with good performance records and low expenses.
Retirement readiness is a worthwhile goal for every investor, whether you invest in your employer's 401(k) plan, an individual retirement account, or any other type of account. The cumulative effect of an investment's fees and expenses can significantly reduce that investment's end return. If you want to have a large nest egg to support you when you retire, then one of your first steps should be finding and eliminating any excessive fees in your portfolio.