You probably missed the biggest headline in retirement investing in decades. It’s all about hidden 401k fund fees. What hidden 401k fund fees, you ask? That’s exactly the point: You haven’t heard about them because they were hidden from you.
Let’s start out with a simple story about two friends. Imagine that you and I start a small business. You’re the go-getter, the deal-closer who has the contacts and know-how to bring in business.
Me, I run the shop. It’s not important what kind of business. What matters is our roles: You bring in the cash, I manage the day-to-day.
Every evening, you show up from a long day of sales. Things are going great! We landed business today worth $1,200 a week. I take the money, let’s assume cash, and put it into the till. We close shop and part for the evening.
Every week thereafter, you nail down that $1,200. I do the books and you head back out to find more cash flow for our business. Once a year we review, and every year you admit you have lost track. It’s a constant source of chuckling between us. That’s why I’m in charge of the finances, right?
Little do you know, my day is pretty slow. I dust the fixtures and open and shut the office on time, but not a lot happens. And, at the end of every week, I count out the $1,200 into three piles: $400 in one pile, $400 into another, and a third, also $400.
Then I put one of the three piles of bills into my pocket. The remainder — $800 — goes into the till. You have no idea, but I am taking a third of the money, like clockwork, and putting it into my own account.
Before you cry “embezzler!” remember, you went into business with me voluntarily. You have no one to blame but yourself and little recourse to recover the lost money. All I have to do is pretend that business has been bad, that costs got out of control. How could you prove otherwise?
That, in a nutshell, is the modern 401k industry and the danger of hidden 401k fund fees. Consider this snippet from The New York Times:
Fees on these accounts contribute to a reverse compounding over time. Instead of adding wealth, expenses deplete your nest egg, often compromising a comfortable retirement. These charges can be onerous if you’re among the nearly 50 million employees with a 401(k)-type plan. Your reaction to seeing the extent and impact of these charges may range from shock to confusion, but it’s important to see it through the lens of maximizing your retirement kitty.
According to a study published by the progressive research group Demos, 401(k) fees can cost a higher-income, dual-earner household about $278,000 over a working lifetime. Even if you’ve done well with the funds within your 401(k), fees can consume nearly one-third of investment returns.
Read that again: Hidden 401k fund fees “can consume nearly one-third of investment returns.” That’s exactly what the U.S. Labor Department has been fighting to expose, on behalf of American workers. Workplace 401(k) programs are a great deal, since you can save tax-deferred money. But the hidden 401k fund fees the mutual funds charge are exorbitant and very poorly explained — if they are explained at all.
What Labor has been trying to do is force the fund managers to give consumers a clear warning label on those fees, like the sticker price on the window of a new car or the ingredients list on the back of a can of soup. New rules on hidden 401k fund fees, put into place last month, should help do that.
The mutual funds have resisted mightily, of course. They don’t want you to comparison shop, since that would tip off a price war the big firms would lose in an instant. Mutual fund expense ratios average 1.27%, Demos found, while simple, tax-efficient exchange-traded funds (ETFs) charge fees as low as 0.05%. Individual investors already have moved billions into them to capture the advantage of lower expenses.
We’re talking about small numbers, but consider where the decimal falls. Going from a 1.27% expense down to 0.05% is a decline of more than 96%. Instead of paying $1 for a service in the form of hidden 401k fund fees, you would pay less than 4 cents!
“When plan sponsors and participants have more information about the costs involved with their retirement savings, they are empowered to make more informed choices such as selecting an investment fund provider with better net-of-fees returns or lower-cost retirement service providers,” Phyllis C. Borzi, the assistant secretary for employee benefits security at the Department of Labor, told the Times.
Borzi is fighting the good fight, but it takes consumer demand to make change happen in the marketplace. As generations of pension fund, college endowment, and big insurance portfolio managers know, it’s low-cost, steady-as-she-goes asset allocation that turns savings into wealth over time.