This post first appeared on Forbes.com.
This summer, you have one of the best opportunities to fine-tune your portfolio. In fact, you could potentially add tens of thousands of dollars to your 401(k) and IRA balances come retirement time.
The catch: You must be willing to step up and pay attention closer attention to the fine print. Your 401(k) is now required to disclose the investment and administrative fees you pay to participate in your plan.
I can hear the question in your head: What fees? You’re not alone. An AARP survey found that 70 percent of 401(k) participants weren’t aware there are fees embedded in their 401(k) that are reducing their net performance. If it makes you feel any better, the General Accountability Office did its own survey of the folks sponsoring 401(k) plans – your employer – and also discovered an alarming lack of awareness of fund fees.
That’s a potentially costly lack of awareness. All 401(k) plans charge two broad sets of fees. The biggest chunk goes toward investment fees. The thing is, you won’t ever see a line-item “investment expense” in your 401(k) statements. The way it works is that these fees are bundled into what is known as an “expense ratio” – a percentage of a fund’s net assets – that is deducted from every mutual fund’s gross returns. What you see in your 401(k) statement is net returns after subtracting that fee.
So for example, let’s say a fund you’re invested in generates an 8 percent gross return. You won’t have 8 percent credited to your account. First the expenses are deducted. If the expense ratio is 1.2 percent, the net gain credited to your account will be 6.8 percent. If the expense ratio is 0.50 percent, the net gain credited to your account will be 7.5 percent.
Sound like small potatoes? Well, if you’ve got $100,000 today that will earn an annualized 6.8 percent for the next 25 years you’ll end up with about $518,000. If that $100K compounds at an annualized 7.5 percent you’re looking at having close to $610,000. That’s nearly a six-figure pick up solely because you paid attention to fees. Not exactly small potatoes, right?
The good news is that your 401(k) is required to do a better job showing these fees. But all they have to do is disclose the information. It’s up to you to use that information to your advantage.
Unfortunately, it seems many people aren’t taking notice. Some 401(k) plans that already share this information with participants report there hasn’t been much response. That’s not exactly shocking – inertia is one of the most prevalent enemies of investors – but it is incredibly disappointing.
Given the endless stream of surveys reporting how worried Americans are about their retirement security, it seems to me you can do yourself a great favor. Pay attention to the new fee disclosures required of 401(k) plans. Here are a few ways to use the new fee disclosure to boost your retirement balances:
1. Size up what you’re paying
One of the disclosures you will receive is a laundry list of the charges for the investments offered in a plan. Yes, you’re captive to the funds offered in your plan, but if you discover one or more of the funds you’re investing in is a fee hog, time to rethink.
2. Focus on the low-cost options
While it’s vitally important that your overall long-term retirement portfolio be well-diversified, there is no reason that your 401(k) has to be a paradigm of diversification. If you have other retirement accounts – IRAs, rollover IRAs, taxable accounts you will use for retirement — the goal is that all those pieces mesh together into one cohesive allocation strategy. Don’t worry about the diversification within each piece. That means you could take a look at your 401(k), find the lowest cost option and load up on that asset within your plan. Then adjust your other retirement accounts accordingly.
3. Keep investing even if it’s a fee dog
Okay, if you discover your 401(k) plan lacks any low cost funds, keep contributing if your plan gives you a matching contribution. Set your contribution rate to capture the maximum match, but don’t contribute more. Then after you’ve received the max match — or if your plan doesn’t offer a match – focus on saving in an IRA. The maximum IRA contribution this year is $5,000 if you are under age 50; older workers can contribute $6,000 this year. The advantage of an IRA is that you set it up at any mutual fund or brokerage firm where you can choose among thousands of investment options, including low-cost exchange-traded funds.
4. Look for low-cost index funds.
Reams of research show that the majority of funds that are actively managed fail to consistently beat index funds that simply aim to track a market benchmark. Sure there will be outliers that manage to thump an index for maybe a year or two or three.
But today’s hot hand typically cools over time. Moreover, your portfolio is no doubt comprised of a handful of funds focused on different asset classes. You really think you can nail the outlier four or five times? C’mon. Low-cost index funds should be the core of every 401(k) account. (I’d actually love to see more funds add exchange traded funds — ETFs — which can be even cheaper than index funds.) And those funds should have expense ratios below 0.50 percent. There are plenty of index funds charging less than 0.10 percent, so I am being generous with a rule-of-thumb of 0.50 percent. Broad market index funds charging 1 percent are just a flat out bad deal you should howl about. Which brings me to my next point….
5. Let H.R. know you’re on the case
Let’s face it, the folks running your company are probably more focused on growing revenue than fine-tuning the 401(k). That said if enough of you speak up that can spur change. And keep in mind that GAO report I mentioned earlier: plan sponsors didn’t exactly show a whole lot of comprehension about how their plan worked.
The new federal regulations require plans to get better disclosure. Chances are your employer may be learning a ton along with you. That’s an opportunity to chime in about what changes you want. You might want to slip in the phrase “fiduciary duty” into the conversation. That’s the fancy way of saying that every 401(k) plan must be run for the benefit of the participants. Low(er) fees certainly qualify as one way a plan can fulfill its fiduciary role.
6. Get out of old expensive 401(k)s
While you are a captive participant in the plan of your current employer, any 401(k) from a prior job can be moved to what is known as an IRA rollover. If you are voluntarily still investing in an old 401(k) with costly funds, move the money ASAP to a fund company or discount brokerage. There’s no tax due when you make the move—assuming you follow some basic rollover rules every financial institution will be happy to help you with. Once the money is in your Rollover IRA account you can then invest in any funds, or stocks or ETFs you’d like. You are free to put together a solid low-cost portfolio. That’s one of the few slam-dunk ways to boost your account balances come retirement time.
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