Some of the biggest potential news for individual investors in quite some time is coming and you probably haven’t heard a word about it. The information is currently being passed around behind the scenes, but will be revealed to consumers by the end of August.
What is the big news and why isn’t anyone talking about it? The answer is 401k fee disclosure requirements.
Full Transparent Disclosure of 401k Fees
The Department of Labor has introduced new rules that require businesses to provide full disclosure as to the fee structure of their employees’ 401k plans.
This is huge news.
Right now when you log in to your 401k account you probably have the ability to see your total balance, what percentage of your salary is invested each paycheck, and what mutual fund options you have. In the section your mutual fund choices is an explanation of the charges associated with investing in that mutual fund, but the information isn’t easy to find.
Plus, mutual fund expense ratios aren’t the only costs of having a 401k plan.
Why are Transparent 401k Fee Disclosures So Important to Individual Investors?
The transparent disclosure of these previously hidden or hard-to-find 401k fees should lead to better plans and lower costs. When you can compare your retirement plan to your friend at another employer, only to discover your plan has an extra 1.5% in administrative fees, you might get upset. (In fact, 401k providers and employers have known this law was coming and have been cleaning up their plans to make sure they look good when everything is revealed to consumers.)
Imagine going to a bank (or online bank website) and seeking out a savings account. How would you react if you couldn’t easily find information on fee structure or interest rates? What if they never told you how much it would cost you to have your money deposited at the bank, instead choosing to secretly take it out of your balance and hope you don’t notice.
That is what has been happening with your 401k plan. You can find the expense ratios — sometimes easily, sometimes not — but finding out the total percentage cost of having the account is nearly impossible.
That all changes within the next two months. Mutual fund companies had to provide the data to employers by July 1st. Employers have until the end of August to disclose that information to plan participants in a simple, clear, and understandable format. (No more 10 page document in 3.5 font that details out how they are fleecing you.) Each year the same information in the same clear format must be delivered to plan participants.
How Much Does My 401k Cost Me?
Want to see how large of a difference high fees have on your retirement nest egg?
Let’s say you put $10,000 per year into your 401k starting at age 25. You invest the same amount each year for 35 years until you hit age 60. During that time you receive a consistent 8% return. When you reach your retirement your nest egg would be worth about $2 million.
Compare that amount to if you received a 7% return — or earned an 8% return but lost an extra 1% to fees. Your total drops from $2 million to $1.6 million. You just lost $400,000.
That’s why it is so important to focus on fees in your 401k. Here are the two types of fees to look out for:
Investment Fees and Expense Ratios
A mutual fund is a great investment. It combines a little bit of money from a lot of people to buy little chunks of shares in a lot of companies. It provides a large amount of diversification versus buying a few stocks with what little money you have.
However, as we all know, mutual funds are not free. They have expenses involved with running the company, paying the analysts and managers of the funds, transaction fees, profit, and so on. These costs are totaled up and charged on an annual basis; they are expressed as a percentage of the total amount of money you have invested. The lower the percentage, the less money they take from what you give them to run the fund. All things equal, a fund with a lower expense ratio will provide a better return over the long term than one with a higher expense ratio. (Again, assuming all other things like investment results are the same. That’s incredibly difficult except when comparing index mutual funds.)
So what should you look for? The average is about 1%, but personally I think that is a bit high. You can build a portfolio of index funds in the 0.10% to 0.40% range. You’d be saving anywhere from 0.6% to 0.9% in fees over the average which, again, will save you a ton of money in lost fees over the next 30 years.
The 401k are administrative fees are usually more difficult to find than the mutual fund expense ratios. These are the fees the 401k company or plan administration company charges to actually run your employer’s 401k. While your employer may pay some of these fees out of their own pocket, a lot of times these are snuck through the backdoor into each employee’s 401k.
The only problem is there is no easily found “expense ratio” for these administrative fees, making it difficult, if not impossible, for employees to truly gauge the performance of their investments and compare their plan to other 401k plans. That’s what these new 401k fee disclosure requirements will provide, and we’ll all soon found out whether we have a great 401k plan or a mediocre one.