Investor Beware: Don’t Overlook the Cost of Investing
At the start of every year I take a hard look at my 401(k) investments and decide if I want to let them ride for another year. Having just completed that exercise I am astounded (no kidding) at how much you "pay" to invest in these plans. Right now, the lowest cost option in my plan is a large cap ETF from a brand I have never heard of for 85 basis points!
When you stop and take the time to look at the fees involved in 401(k)s it becomes easy to see why rollovers from these plans are a huge source of IRAs. Rollovers are the predominant way that investors open traditional IRAs, according to the Investment Company Institute, and about seven out of 10 new traditional IRAs received rollovers in 2012.
But many investors don't look at the fees or expenses being charged by their 401(k) plan and this isn't a big surprise: These numbers can be very difficult to determine. One easy way to figure out some of the fees that you are paying is to do what I did and look at the expense ratio being charged on your individual investments. But this article in the New York Times outlines the numerous other ways that 401(k) plans can assess fees and expenses, including charging for commission, fund management and plan record-keeping.
While it may be hard to figure them out, fees can add up and take a large bite out of your retirement savings. Take this example from the Department of Labor:
Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions t your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.
I bolded the text to emphasize my point - small fees can really chip away at your retirement savings over time.
For investors who want to take more control over their retirement savings, rolling your 401(k) into a self-directed IRA means you are able to keep the tax-advantaged status of your funds while gaining access to far more investment choices. The average 401(k) plan offers 25 investment choices, of which 13 tend to be equity funds, three are bond funds and six are target date funds, according to the ICI and BrightScope. An IRA can give you access to thousands of funds, stocks, bonds, annuities and, if you open a self-directed IRA, alternative investments like private equity and real estate. At PENSCO, where we custody alternative assets for our clients' IRAs, our clients are invested in more than 40,000 unique asset types.
Part of what participants in a 401(k) are paying for is a fiduciary who takes on the responsibility of screening and choosing the subset of funds that the plan can invest in. When it comes to an IRA, you are taking on the role of the fiduciary and picking investments based on your own criteria, including what might be the best fit your savings profile - whether that's individual stocks or hedge funds or mortgage notes.
At the end of the day, investing is never without a cost. At PENSCO, we believe the fees we charge to custody IRA assets should be transparent and we post them on our website. We also believe that it's crucial for investors to take an active role in their retirement planning and that means knowing how much your investments might cost you.
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This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.