Do you know how much in mutual fund fees you are paying a year? I had no idea, so I ran my 401K portfolio through Personal Capital’s 401k fee analyzer several years ago and was surprised by the results. I always figured that from a percentage point of view, my mutual fund fees were small. But, when you take a small percentage multiplied by a big enough number, the absolute dollar amount starts adding up.
As you can see in the picture below, I was paying $1,748.34 a year in fees across four mutual funds totaling about $385,000. Paying 43 basis points in mutual fund fees is not too bad, but I wanted to optimize the figure even lower. If I continued with just the existing portfolio and amount, I would end up paying $84,000 in mutual fund fees over 20 years. The Fidelity Blue Chip Growth Fund clearly stood out as a fund that needed changing. As a result of this analysis, I sold FBGKX and replaced the entire position with the S&P 500 ETF, SPY with minimal fees.
ANALYZE YOUR INVESTMENTS FOR EXCESSIVE FEES
When analyzing your investment portfolio(s) for fees, think about the following:
* Huge spread in expense ratios. The cheapest expense ratio is 0.19% for the Vanguard IT Index Fund and a whopping 0.74% for the Fidelity Blue Chip Growth Fund in my example above. 0.74% is almost 4X greater than 0.19%, because they’ve got to pay the fund manager and analysts for trying to outperform the S&P 500 index. If the fund manager(s) can indeed outperform the S&P 500 index by more than 0.5% a year, then their fee is on par with my cheapest index Fund. If not, I’m wasting my money and so are you if you are in a similar actively managed fund. Studies have consistently shown that active fund management cannot outperform passive fund management over the long run.
* Fees add up over time. In 20 years, I will have paid ~$87,000 in mutual fund fees if I keep my existing portfolio. I don’t know about you, but that seems a lot, even if my 401k does grow to over $1,500,000 as estimated in the 401k By Age post. Just doing the math here, 67% or $58,290 of the $87,000 in fees will come from my Fidelity Growth Fund alone if I did not make a switch. Meanwhile, the Fidelity growth fund only accounts for 39.5% of total assets. Long term growth has a way of compounding into great returns for consistent investors and savers. But the opposite is true if fees go unchecked.
* Understanding tax cost ratio. The Tax Cost Ratio measures how much a fund’s annualized return is reduced by the taxes investors pay on distributions (pertinent to portfolios in non-tax advantageous accounts). The range is usually between 0%-5%, the lower the better. For example, if a fund has a 1.5% tax cost ratio for the three-year time period, it means that on average each year, investors in that fund lost 1.5% of their assets to taxes e.g. a 10% return is really only a 8.5% return. One can simply combine the two to figure out their total expenses. The Fidelity Growth Fund’s total expense is therefore 0.85%, while the Vanguard Precious Metals fund has a total expense of 1.94%.
* Additional layers of fees. The tricky thing about 401ks is that you have to pay additional fees over and above expense ratios, which vary based on whatever the plan that your employer has set up. According to a 2012 study by the Government Office of Accountability, other fees include marketing and distribution fees (12b-1 fees), sub-transfer agent fees, trading or transaction costs, wrap fees, trustee fees, legal fees and audit fees. Pretty amazing right? The bottom line is that there can be fees on top of expense ratios that can add up, especially for small companies, where all-in fees approach an alarming 2% – on average. Because 401ks always have at least some layer of extra fees, Personal Capital recommends always rolling over your old 401ks to IRAs.
* Focus on ETFs or index funds. When you run an index fund, there’s no team of analysts to pay. There are no business trips to expense to go kick the tires of the companies they hold. The index is rebalanced usually once a quarter, or whenever there is a big index addition or subtraction to reduce variance risk. Consider low cost index funds, ETFs, or Smart Indexing with Personal Capital where we build a custom portfolio that is consistently rebalanced.
401K PRO FORMA ANALYSIS
Below is the chart from Personal Capital’s 401k Fee Analyzer tool that really made me feel ill. Let’s say I continued to contribute $17,000 pre-tax to my 401K per year from a couple years ago when the limit was lower, continued to receive a full employer match every year, and continued to return 5.85% a year for 30 years, I will have paid $489,014 in fees and lost out on at least two years worth of retirement income.
TAKE ACTION TO SAVE BIG MONEY OVER TIME
“The greatest trick the Devil ever pulled was convincing the world he didn’t exist,” said Verbal Kint in classic movie, The Usual Suspects. The mutual fund industry and the brokerage community have purposefully made their fees opaque in hopes they can quietly earn outsized income off unsuspecting retirement savers. With Personal Capital’s 401k/Portfolio Fee Analyzer tool, we hope to shine a spotlight on portfolio fees to help empower the individual investor.
Personal Capital helped me realize that I’m paying at least $1,000 more a year in mutual fund fees than I should be paying. I suggest everybody take a hard look at their investment portfolios to see where they are paying unnecessary fees. If you are looking for professional financial advice, you can always arrange a free consultation with a Personal Capital advisor to build a customized portfolio for you.
Step By Step Instructions To Minimize 401K Fees
1) Sign up with Personal Capital and link your 401k account by clicking the “+” button on the top left. My 401k was with Fidelity, so I simply typed Fidelity in the search field.
2) After your 401K account is linked, click the “Investing” tab on the top right then choose “401k Fee Analyzer.”
3) Play around with the contribution, employer match, growth, and additional fee assumptions to develop a pro-forma analysis of your retirement account.
4) Research alternative ETF or index fund substitutes for your high cost actively managed mutual funds.
5) Link other portfolio accounts that you’d like to analyze. The 401k Fee Analyzer analyzes various investment portfolios.
Photo Credit: Wellies on MorgueFile