Investment fees can shrink retirement assets, but for 401(k) investors, plan fees have been declining steadily. Investors pay an average expense ratio of 0.41 percent in 2017, down from 0.52 percent in 2013, according to NEPC Investment Consulting.
“Regulatory pressure and a rash of high-profile class-action lawsuits alleging excessive fees, and plan designs that were not in the participant’s best interests have been the driving force behind the continuous drop in overall 401(k) plan fees,” says Daniel Milan, managing partner of Cornerstone Financial Services in Birmingham, Michigan. Additionally, low-cost passively managed investments have replaced some actively managed funds in many qualified plans.
Fees are expected to continue falling as employers look to reduce costs in workplace retirement plans. Fewer fees mean more opportunity for growth in your portfolio. “An investor may not think that the difference between 0.1 percent for a fund and 0.5 percent for a similar fund is significant, but in a 30-year savings window, the difference this can make given comparable fund performance could cost the investor hundreds of thousands of dollars,” Milan says. Here’s what investors can do to take advantage of the drop in 401(k) fees.
[See: 10 Mistakes You’re Making in Your 401(k).]
Know how much you’re paying. It’s easy to overpay 401(k) fees when you don’t know what your plan charges. In a NerdWallet survey, roughly 92 percent of Americans said they had no idea what they were paying in retirement plan fees. A lack of transparency with fees can be a big problem for investors, says David Walters, client service and portfolio manager with Palisades Hudson Financial Group in Portland, Oregon: “401(k) plans vary and there’s no single explanation of what a participant is charged and why.”
Generally, participant fees fall into two categories: the plan’s expenses that the administrator or custodian charges and fees from the underlying investments. Although some employers pay the plan’s expenses, many pass these costs on to employees, Walters says. Plus, some investors may be charged individual services fees associated with optional features in their 401(k), such as choosing self-directed investments.
The primary fee to be concerned with is the fund’s expense ratio, a portfolio management fee that’s charged per dollar of assets managed. In a company 401(k) plan, investors are essentially captive consumers because some plans have a limited selection of mutual funds, Walters says. If those funds carry high expense ratios, you’re stuck.
Furthermore, expense ratios can be layered depending on the type of fund. A target-date fund may include a management fee as well as other management charges from the underlying mutual funds it invests in. “It can be difficult to tease these interwoven fees apart,” Walters says, but that knowledge can help you make better decisions about how to invest money in the account.
Consider your investment options. Moving from actively managed to passively managed funds in your 401(k) is one way to leverage falling fees, as the latter tends to be more cost-efficient. That doesn’t mean, however, that all passively managed funds are the same.
Index funds and target-date funds are common 401(k) options. Index funds are structured to track the performance of a stock index, such as the Standard & Poor’s 500. Target-date funds feature an asset allocation customized to your target retirement date. The average asset-weighted expense ratio for index funds was 0.09 percent in 2016, compared to 0.51 percent for target-date funds, according to the Investment Company Institute.
[See: 7 Tips for Finding the Best Target-Date Retirement Funds to Buy.]
Based on cost alone, index funds may seem like the better option, but your risk tolerance also plays a role in that decision. “Index funds are a good choice if you’re fee-conscious,” says Robert Baltzell, president of RLB Financial in Los Angeles. If you don’t have a plan to rebalance your portfolio, however, you may want to consider target-date funds instead. Although these funds often charge higher fees, Baltzell says you may be better off paying them because your investments will be rebalanced to reduce risk as you get older. “Taking on too much risk can be much more damaging than the fees associated with a balanced fund or a target-date fund,” he says.
Nathan Boxx, director of retirement plan services at Fort Pitt Capital Group in Pittsburgh, says that if you’re gravitating toward target-date funds, make sure you understand the fund’s holdings and glide path. “Some target-date funds have proprietary active funds as underlying investments, and if you’re just looking for low-cost index funds, it may not be the right choice for you.”
Along with cost, fund performance also factors into your decision. Compare index funds to mutual funds across multiple sectors to find funds with a good balance between fees and performance, Milan says. You should also choose different fund types, including growth, income, international and sector funds. “Mixing up your funds allows your investments to work together as a team, lowering your risk when the market is down without sacrificing growth potential when the stock market is riding high,” he says.
Don’t fall into the trap of chasing performance. “Unfortunately, most employees only look at the choices and the returns for the past one-, three-, five- and 10-year periods as required,” says Stan Corey, managing director at United Capital in Great Falls, Virginia. “The problem is that those reported returns don’t necessarily reflect how the investment did during different investment environments.”
The returns of the plan’s best-performing investments may not be sustainable, either. A low-cost fund with a consistent rate of return may offer better overall performance than switching to another fund to generate higher earnings.
Let your plan’s automatic features work for you. Automatic rebalancing can take the guesswork out of maintaining the right investing allocation in your plan, which can help minimize costs.
[See: 10 Long-Term Investing Strategies That Work.]
When 401(k) fees are low, you may want to consider increasing your contribution rate. Automatically escalating your contributions annually could allow you to cash in on declining fees in years to come.
“Assuming your plan offers auto-escalation, you absolutely should not opt out,” Boxx says. “It’s a great way to help easily increase your contribution rates over time, as most people lack the discipline to do so on their own.”
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How to Capitalize on Falling 401k Fees originally appeared on usnews.com
