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