Last weekend, my dad told my mom that their "retirement guy" had called and told them to transfer their assets from one mutual fund to another. Upon hearing this, I asked who "their guy" was and what the fees and performance were for these funds. They didn't know either.
According to Teresa Ghilarducci, a professor of economics and retirement specialist, this is fairly commonplace: "I repeatedly hear about the 'guy.' When I ask how much the 'guy' costs ... or if their investments do better than a standard low-fee benchmark, they inevitably don't know."
Though I actually think my parents will be just fine in retirement, this uninformed approach to retirement planning will be a major crisis in coming years. According to recent estimates, there are 58 million Americans between the ages of 50 and 64. The median retirement savings for this group is only $26,000 per person.
To give you an idea of how scant that $26,000 will be when combined with Social Security and spread out over the rest of one's life, consider this: Almost half of these middle-class workers will be living on a food budget of $5 per day.
According to Ghilarducci, a safe rule of thumb is that you must have 20 times your annual salary saved up by the time you retire. If you earn $75,000 per year, you need $1.5 million saved up to retire with a similar lifestyle.
Even those who are saving are getting screwed
But even if you are doing a great job saving for retirement, there's an insidious, almost undetectable culprit eating away at your savings: mutual fund fees. Whether we are forced into certain plans by our employers or choose them based on our "guy's" suggestions, mutual funds are still a popular vehicle for retirement savings.
A casual glance at a mutual fund's expense ratio might show a seemingly low percentage that you're charged each year. My parents, for instance, had been locked into a mutual fund with an expense ratio of 1% for decades. It seems low, but those fees can really add up over time.
Let's take a relatively simple example and assume my parents' mutual fund earned 9.8% per year -- the S&P 500 average between 1970 and 2011 -- and that they've been putting away $5,000 per year for 40 years. At this point in time, their savings would total about $1.7 million.
Source: Author's calculations.
Of course, these kinds of returns aren't too bad. The problem is that a group of Wall Street "pros" have been getting rich off folks like my parents for years, and not enough people realize it. You see, the 1% charged every year is what the mutual fund's managers charge for their "expertise" in picking winning stocks and sectors.
These days, anyone could just as easily invest in the Vanguard S&P 500 ETF (NYSE: VOO) to get the same returns. The difference is that at Vanguard, stocks are simply bought to mimic the composition of the S&P 500; there's no professional stock-picker trading in and out of stocks on a daily basis. The expense ratio for this fund is just 0.05%--far below my parents' mutual fund.
The effects of this difference, compounded over 40 years, are truly startling. In fact, I had to chart it out to convince them this was the case.
Source: Author's calculations.
After 40 years, my parents would have 33% more retirement money if they used a product similar to Vanguard's. In real dollars, that's a whopping $575,000 difference. With the current retirement picture in the United States, no one can afford to be subsidizing Wall Street at the expense of his or her golden years.
But what if the mutual funds do better?
Of course, if the mutual fund you choose does consistently better than the Vanguard equivalent, then it's obviously worth the money you're paying.
The problem, however, is that the numbers consistently show that actively managed (read: high-fee) mutual funds underperform their stated benchmarks. Standard & Poor's reports that roughly two-thirds of actively managed stock funds underperform the S&P 500 over three-, 10-, 15-, and 20-year time frames.
Some of this is due to the fees themselves eating away at returns. But mutual fund managers are also restricted by both allocation limits and the fact that quarterly statements are sent out every three months. Whether they want to admit it or not, those statements force them to take a more shortsighted outlook on the market than they should.
This leaves you with three options for making the most out of your retirement dollars, each requiring different amounts of time and effort:
- The easiest would be to find a Vanguard (or other low-fee) fund that you're comfortable with.
- If you're willing to put more time in and still want a mutual fund, investigate who the best portfolio managers are and invest with them.
- For the truly Foolish, take your investment dollars into your own hands and start making decisions for yourself.
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