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401(k) fees: devil in the nest egg

How do you pick the mutual funds in your 401(k)? Do you make a careful attempt to be diversified, to have the proper asset allocation? Maybe you peek at the year-to-date returns and choose funds that are rocketing.

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But do you pay much attention to fees? Apparently, most employees don't. And those who do may find it difficult to get a true idea of how much they are paying to own a particular fund, according to John Rekenthaler, president of Morningstar Associates LLC, a subsidiary of Morningstar Inc.

"The typical provider isn't going out of their way to steer you toward learning more about fees and expenses. Vanguard might because that's their selling point. Everybody else --they don't win business because of their fees and expenses."

Let's take a very basic look at what fund expenses do to your nest egg. In this example, we'll assume a beginning account balance of $25,000, no additional contributions added and an annual return of 10 percent.

Fund Expense5 years10 years15 years
0.5%
$39,356
$61,955
$97,531
1.0%
$38,466
$59,456
$91,480
1.5%
$37,591
$56,525
$84,994
2.0%
$36,733
$53,973
$79,304

Buying shares of a fund that has a 2 percent expense ratio vs. one that charges just 0.5 percent can, over time, eat up more than 18.5 percent of your next egg.

But knowing how much is being charged for a fund doesn't tell you everything.

"Fund expenses are very often just the tip of the iceberg when it comes to plan fees," says Rekenthaler. "Expenses only pay for the portfolio management services because you've hired a mutual fund manager. But there's also a plan in the 401(k) itself. There's a cost to establish the plan, maintain the records, answer participant questions. There's a cost to running the Web site so you can check your balance. None of that is paid for directly by the mutual fund's expense ratio."

Rekenthaler points out that it's quite possible a participant could pay 1 percent in a fund expense ratio and 1 percent in a plan expense ratio, which would amount to 2 percent annually. If you have a bond fund that's returning an average 5 percent per year, you're spending nearly half of your profits.

Figuring out how much a 401(k) costs can be difficult not only for participants, but also for plan administrators.

"Most advisers, plan sponsors -- they don't have a clue who's getting paid for what," says Greg Matthews of Matthews Benefits Group, an independent benefits consulting and plan administration firm in St. Petersburg, Fla. "We dealt with an insurance company, one of the largest providers in the small-plan market. For three years, I tried to get them to explain to me what the fees are so when clients talk to me I could tell them what they're paying for."

If it's that way for sponsors and advisers, what chance do plan participants -- employees -- have to determine fees? Employees may have to work for a company for six months or a year before becoming eligible for the 401(k). A busy human resources director may give a brief rundown on the plan and hand over a packet of information for employees to read when they get a chance.

But the problem with many 401(k) plans starts long before the employee gets any information. Too often, says Rick Meigs, president of 401(k)HelpCenter.com, companies sign up for a plan because the vendor has a Ph.D. in salesmanship.

"The typical person setting up the plan calls a broker, an insurance company, a fund company or a certified public account. As a plan sponsor, you need to understand the motivation of the person attempting to sell you something. Is it in your best interest or because it generates a commission for them?

"I'd go to a fee-based pension consultant versus the commission-based. There are a lot of good commission people, but you want to be sure you're not being sold something based on a commission. Usually it's a bad plan when the sponsor isn't even aware that there are funds with a 2 percent expense ratio."

 
 
-- Posted: Feb. 3, 2004
   

 

 
 

 

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