If you’re like most people, an employer-based 401(k) plan is probably at the top of your list when it comes to saving for retirement. Hopefully, your employer offers to “match” a portion of your contributions and you’re able to contribute the maximum allowed amount every year. Perhaps you’ve even taken the time to pick investments that make sense for your age, risk tolerance, and preferences. But have you ever thought about operating expenses when choosing which mutual funds to invest in?
Operating Expenses Of Your 401(k) Plan
As it turns out, the operating expenses of your 401(k) funds are very relevant in the sense that they can eat up thousands of dollars over the years. In other words, they’re an important factor in determining how to allocate your portfolio.
However, a recent study showed that 85% of people with 401(k) plans didn’t know what the operating expenses were for their funds, and another study revealed that 65% thought these expenses were zero. Since there’s a pretty good chance you fall into either category, read on to discover the facts about operating expenses and the effect they have on your bottom line when saving for retirement.
The Numbers
Besides contributing as much as you can to your 401(k), finding funds with low operating expenses is the single most effective way to maximize your savings and growth. Annual operating expenses can range from nearly zero for funds like ETFs, to upwards of 2.5% for heavily managed funds and annuities. Though these fees may not sound like much, when totaled over many years, the bite into your 401(k) can be significant.
For example, assume you’ve saved $50,000 and contribute $15,000 per year to your 401(k). If your investments earn 7% annually and your operating expenses are 0.5%, you’ll have almost $1,125,000 in 25 years. However, if your operating expenses are a mere 1% more (1.5%) the value of your 401(k) will drop to $958,000. That’s a decrease of $167,000, which isn’t exactly chump change.
The Shell Game
In the past, determining the operating expenses of 401(k) funds was hit-or-miss at best. But, fortunately, that’s changed.
The Department of Labor now requires 401(k) plans to annually disclose operating expenses on mutual funds. Specifically, your plan is required to give you a breakdown of operating expenses for each fund you own – this is known as the expense ratio. Use this number as a benchmark to compare your funds, as it will indicate which ones are more expensive than others. However, since this information is only provided for funds you own, you’ll need to do a little extra work to determine expense ratios on all available funds.
How To Find the Truth On Operating Expenses
In order to get the truth on expenses, the best thing you can do is look at each fund’s prospectus. This is a document with detailed fund information that you should have received for each fund you own. However, since many fund companies will have prospectuses available online, you can search for these to find information – including expense ratios – on funds you’re not invested in.
You can also check with your human resources department for expense information on all the funds offered in your 401(k). However, if you work for a larger company, just getting through to the right person can be an issue.
The key is to be persistent. I recently called my HR department for this very information and they seemed irritated that I even asked. In fact, I’m still awaiting their reply. If your HR department treats you this way, it’s time to take matters into your own hands and follow the steps above to get the information you need.
Final Thoughts
In general, there are a wide array of 401(k) fees worked into your plan and the funds within it. Some are “direct” fees which are disclosed, while others are considered “indirect” and are more difficult to access. Your funds’ operating expenses are just one of these fees, though, and perhaps the most important.
You could visit your HR department to peruse a copy of your plan’s summary annual report in order to get an idea of administrative expenses and the portion you pay. With that said, keep it simple to start. Determine the expense ratios for your current funds, and look into other fund options to see if you can save money.
Though determining operating expenses for your 401(k) can be trying, it’s not a point to be ignored. The difference could mean thousands or even hundreds of thousands of dollars for your retirement.
Have you tried to get information on the operating expenses of your 401(k) plan? What did you find out?
David Bakke writes about managing money, investing for retirement, and smart spending on Money Crashers Personal Finance.
I saw a post on ObliviousInvestor.com today that mentioned this study that found just how much people lose on average:
That’s a lot of money to lose to costs!
It’s an interesting study, isn’t it?
Honestly, I think the study’s assumptions might overstate the cost of the funds for many investors. On the other hand, the study doesn’t account for the costs of the 401k plan itself. I’ve seen many plans that charge plan participants an administrative fee not included in the listed expense ratios of the funds.
I think its always better to go with index mutual funds in your portfolio, as their expense fees are lower, and the performance isn’t all that different from the actively managed mutual funds.
There’s a level of expenses in the 401(k) which combined with the fact that withdrawals are ordinary income (as opposed to capital gains, which may or may not last) negate the tax benefit over time. Simplest example – a fee that’s 1% higher than you’d get in your IRA will cost you about 10% over ten years. So the deposit pretax saves you 25%, you lose 10% along the way, and pay 15% at withdrawal? This is the elephant in the investing room for those 401(k)s with fees over 0.5%.