Is your 401(k) a good deal?
We always talk about saving in 401(k)s, but in general far less ink is spent on the nature of the retirement asset management industry and whether it's really good for investors.
And as it turns out, that industry doesn't exactly have your best interests in mind. Here's what you need to know and what you can do to minimize the damage.
Fees, fees, fees
Sixty-five percent of 401(k) participants don't know that they pay fees, according to an AARP survey, and 83% don't know the basics of what those fees are. This is not an insignificant issue. The progressive think tank Demos determined that the "ideal" household, which earns the average American salary and saves 5% to 8% of it from ages 25 to 65, would end up spending about $155,000 in fees over the course of a lifetime. And as if that didn't sound bad enough, this adds up to a breathtaking 30% of the account's pre-fee balance at retirement.
Those fees come from several sources: the mutual funds you invest in; your employer, who might be passing fees on to you; and the plan record-keepers, who do all the administrative work involved in running a 401(k). With so many players and a lack of competition among them, it's easy to see why fees end up getting so high.
Am I paying too much?
The difference between plans is remarkable. The largest plans tend to be cheaper to employees than small plans -- Demos reports that, on average, they pay less than a third of what the smallest plans pay in expense ratios.
But the craziest part of all this is that it's hard to really tell if you as an individual are being overcharged in your 401(k). A New York Times piece concluded that it would take an independent audit by a fiduciary capable of comparing plans to really determine whether yours is too expensive.
That's how complicated 401(k)s are.
More than fees
But it's not just fees that cost you. It's the fact that you're going it alone.
When comparing 401(k)s to their dwindling predecessor, the defined benefit pension plan, 401(k)s cost employees about 9.4 percentage points more when expressed as a proportion of employee salaries. To ensure an "adequate level" of retirement income, the cost is 23% for 401(k)s, on average.
The reason? Lower returns, less balanced portfolios, and the benefit of risk-pooling that you get from defined benefit plans.
So what do I do?
Demos argues that getting fees under control would require a wholesale overhaul of the system. That's because the problems we're talking about aren't superficial -- they involve not only a lack of information but also a lack of competition.
That being said, it probably doesn't make sense to head for the exits, either.
Congress' General Accounting Office found that IRA fee structures are even worse. You could just revert back to your taxable brokerage account, but then you'll miss out on a host of other benefits, like an employer match and the tax-advantaged status of your 401(k).
Here's what you can to minimize the damage:
Be as aggressive as possible about reducing fees in your 401(k) investments. I'm a big fan of index funds, and most plans will offer at least a handful of them. Their expense ratios are lower and they only trade when the index changes, which further reduces fees.
For your part, try to avoid trading as well -- even if you never see the expense, you might be responsible for these kinds of transaction fees.
And finally, get the most that you can from your employer. If they match up to a point, try to reach that point. It'll at least give you a bit of a return to make up for the potentially high cost of the plan.