A recent episode of PBS’s Frontline that detailed the impact fees can have on retirement savings, has led to a lot of questions.The show, titled The Retirement Gamble, starts out with the usual grim statistics: Half of all Americans say they can’t afford to save for retirement, and one-third have next to no retirement savings.
The documentary explores the invention of the 401k plan in the late 1970s, the meteoric growth of the mutual funds industry in the 1980s, and the demise of the corporate pension plan.
During the 1990s, mutual funds became bloated, with many costing more than 2 percent in annual expenses. But back then, when the stock market regularly averaged double-digit returns each year, no one cared about high fees.
Frontline explored the negative impact today’s excess fees can have on your retirement savings. Here’s an example: $100,000 at a simplified annual return of 7 percent over 50 years vs. $100,000 at a simplified gross return of 7 percent but with an annual expense ratio of 2 percent (netting 5 percent annually) over 50 years.
The investor who paid 2 percent more each year in fees ended up with about 62 percent less value than the investor who pocketed the entire 7 percent. That’s about $2.95 million in retirement savings vs. $1.15 million. Which would you rather live on?
Frontline revealed that the average mutual fund has an annual expense of 1.3 percent. Now, investing is never going to be free, but you can be fee-conscious. My advice is to find an advisor whose fee seems reasonable to you and who employs a strategy you think will meet your goals.
A few things to watch for when considering fees.
Mutual fund fees. Your investment advisor should offer you access to “no-load” funds (those that do not have an upfront or back-end fee) or institutional share classes. No-load funds have no barriers to entry or exit; institutional share classes generally have much lower annual fees.
Mutual fund surrender penalties. Surrender penalties are a tricky way for a mutual fund company to force you to leave your money in their fund to avoid paying a hefty fee to get it out. Penalty fee periods can be eight years or more and cost as much as 8 percent of the value of your investment! Avoid these funds!
Brokerage trading commissions. The days of paying a few hundred dollars to execute a securities trade are over. You can open an online brokerage account and make a trade for less than $15. Independent advisors like Charles Schwab, TD Ameritrade and Fidelity can trade on behalf of clients for as little as $8 a trade.
Internal mutual fund operating costs. Mutual fund managers make their living off the fund’s expense ratio. The charges vary from high-priced, “actively” managed funds that seek to outperform the market (and rarely do) to index funds that passively track the return of the market (and generally outperform the most active funds). Index funds generally have lower fees, in the .07 percent to 0.50 percent range.
Wrap management fees. These management fees (generally a percentage of assets under management) go to the broker and are layered on top of mutual fund fees and account fees.
Mark ups on bonds and new issue securities. Advisors at big banks and brokerage firms can sell bonds and stocks from their firm’s inventory, mark up the price of the bond or other security when they buy it for you – and keep the difference.
12b-1 fees. 12b-1 fees are marketing fees that mutual fund companies pay to advisors and firms that put their clients in the fund.
Remember, when it comes to getting advice a good well respected advisor won’t be free. But doing a little homework, you can find an advisor who can help you maximize your retirement savings without paying exorbitant fees. But you must begin by knowing where the traps are, and asking a lot of questions.
