It’s time to examine my mom’s 401(k) plan. The first thing that I wanted to do was to get an idea of what kind of fees she was paying. There are three basic types of fees, according to the Dept. of Labor:
- Plan Administration Fees – Like the description states, this is for things like record-keeping, mailing statements, and other accounting duties.
- Investment Fees – Often the largest and most hidden, these are fees that are wrapped into the investment options that you are given.
- Individual Service Fees – These are for specific things like processing loans or for self-directed investments.
Smaller companies often can’t afford a top administrator like Fidelity or Vanguard, which can absorb most administrative costs. Instead, they must find a cheaper firm (at least for them). Guess where the costs get shifted to? The workers. Thankfully, my mom isn’t subject to any administrative fee, at least that I could find. But investment fees…
Types of Mutual Fund Investment Fees
Investment fees for a mutual fund are usually broken down into
- Front-end loads – Also known as sales charges or just front loads, this fee is charged when you buy a share of the fund. For example, if you have a 5% load and put in $1,000, only $950 worth of shares is actually purchased. Essentially a sales commission, the $50 goes to the salesman (in this case, the plan administrator). Avoid whenever possible!
- Back-end loads – Also known as deferred loads, this is essentially the same setup, except that it is charged when you sell.
- Expense Ratio – Also known as annual management fees, these are ongoing fees charged by the mutual fund company for running the fund. It is usually expressed as an annual percentage of fund’s net asset value (NAV), although the fee is subtracted a little bit each day. The expense ratio may also include a sales portion, called 12b-1 fees.
- Early Redemption Fees – Supposedly to deter market timing, such fees are usually the same as back-end loads, unless the money is direct back into the fund itself and split amongst the shareholders (instead of going to the fund managers).
What is sneaky about all these fees is that they are usually not marked on your account statements as a fee, and in the case of 401k’s I bet many investors are never told about them and how they can seriously hurt your potential returns.
Do You Know What Share Classes You’re Buying?
Now, of course by law they must give you the prospectuses for each fund. You know, those thick booklets that most people file away, never to see it again. But if you don’t know, dig them up and read them! For one, one mutual fund may have several different shares classes, with different combinations of front loads, back loads, and annual expense ratios. Don’t just assume you are buying the cheapest class, either.
For example, the only Real Estate option my mom’s plan is the AIM Real Estate Fund, Class A Shares (IARAX). I was sad to see that this has a fat 5.50% front load and a 1.29% expense ratio. The Investor Class shares of this fund (REINX) had no loads and 1.27% expense ratio. I don’t know how happy she’ll be to find out that 5% of every dollar she put in was being taken away instantly.
I still have to sort through the other details of the funds like investment objectives and asset classes, but by better understanding the fees, she can already start to choose between her available options more wisely. For instance, your 401k might offer a great International Fund with reasonable expenses, and an S&P 500 fund with horrible expenses. If so, you can buy the better fund in your 401(k) and find a good alternative for the bad one in your other brokerage accounts.
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Good post. 401k fees can be bad, yes. Its a problem most people don’t know much about. My 401k is with American Funds, so I know I’m buying load funds and have to make 6% just to break even. Still this should not keep people from contributing.
The first reason to contribute is matching funds from the employer. If that happens then you can consider the fees taken care of plus some. Yeah, maybe the deal isn’t as sweet as you thought, but…
The contributions are pretax and the growth is tax deferred. That advantage will beat any other low cost mutual fund out there invested after tax in a non-sheltered account.
Plus the contribution limits and catch up limits are higher than any other vehicle. Where else are you going to put this much away with these benefits?
Finally it has been said by people smarter than me that asset allocation is the most important thing when it comes to portfolio performance. Picking funds just because of the fee may not be the best idea without considering the big picture. One should not be penny wise and pound foolish when it comes to fees.
This is one of my financial pet peeves – disclosure of fees, etc. for 401(k) plans. Having the fees taken out of the NAV is just so wrong! Also with my husband’s 401(k), there are “Plan Administration Fees” (they call Separate Account Charges) which are in a 6-point footnote (seriously) a supplimental form that shows the Fund Performance for the plan (they have to show a separate fund performance than the prospectuses, because they have to show performance net of the fees you will be paying, which is different for each plan). These fees, which are a % of assets, are also taken out of NAV, so we would never see them, and would 0.05%-0.75% to the mutual fund expense ratio.
A great website to see the effect of different share classes (loads, fees, etc):
http://apps.nasd.com/Investor_Information/EA/1/mfetf.aspx
To find current yield for bond funds: Yahoo finance
To get morningstar ratings, see performance of fund within category: I use a search function within my Schwab brokerage account
One more useful tip: I need to use Yodlee (via Fidelity web site) to see a record of each transaction (or at least the last month of transactions) from the plan administrator… even our 401k plan website does not list out how many shares were purchased each time (just your running total), which makes it nearly impossible to really know what is going on. Yodlee shows the shares transacted, but muffs the share price… which I can get from the plan web site. We definitely need legislation for better disclosure with 401k plans!!!
Good advice on the class you are buying. I couldn’t for the longest time find the right ticker for the funds in my current 401k. Then finally I got a prospectus from one of the firms and realized that I should use the institutional investor ticker since the 401k administrator was holding my funds for me. Or at least I think that is the way it’s working since that is what most closely matches what the plan reports to me.
Got any comment on that?
Any thoughts on what a good expense ratio is? I avoid funds with fees, but my only rule on expense ratio is “less than 1.5%.” But I don’t recall whether I got that from anywhere and if so where.
If the plan only has a select number of available funds… what can you do? Are you forced to use the funds available?
NCN
mapgirl – It all depends on the administrator. Hopefully the prospectus will at least supply you the ticker symbol, which tells you if you have the institutional share class or not. Otherwise I’d bug the appropriate HR person.
Josh – the overall average mutual fund expense ratio is somewhere around 1.3-1.5%. Obviously, the lower the better, but different asset classes have different standards. For example, there is really very little reason to be paying 1.5% on an S&P 500 index fund when you can get one for 0.10-0.20% on the open market. But for an micro-cap or emerging markets mutual fund, 1.0% might be relatively good.
So, I’m not trying to say that you should buy just the cheap funds, but you should buy the relatively cheap ones that you can get in the 401k.
Simplified analogy: You need both apples and oranges. In the company store, apples are 40 cents and oranges are $1. At Wal-mart, oranges and apples are both 50 cents. Logically, you should by apples at work and oranges at Wally-world.
NCN – Most of the time, yes. Some plans let you buy external stocks/ETFs and pay a commission, which may or may not be worth it.
Thanks for the reply Jonathan. I will double check with the plan administrator at HR and the company.
My pet peeve as well. I wish this topic would be as prominent as universal health care, it’s rooted in the same place, dependence on employers for administering retirement plans.
The plan administration company offers a package of funds for a certain price to the employer. The price is subsidized by inflated expense ratios. You’ll find almost no index funds with the exception of S&P500 with 1% expense ratio. That’s the reason fund selection sucks with most employers.
The employer pays the administration $100-200 per employee annually. On top of that, the employee is saddled with average expense ratios at 1.5%. Just how much work is involved in administering these plans?
How hard could it be to make this like IRAs, where you can open up the account anywhere? The contributions would simply need to sent in by your employer. You might need to get rid of 401k loans, but I think that would be reasonable.
Thanks Jonathan for this article–it has inspired me to more closely examine my 401k (about 1 yr old only) and see if I had my head screwed on straight when I was picking my funds. I sure didn’t! I think a lot of people don’t understand their 401ks, and it is a shame. I refuse to be one of them anymore!
My job doesn’t provide a 401k but the company is thinking about having “something” for retirement soon. I was looking into SIMPLE-IRA plans and they sound pretty good. What’s the disadvantage of something like that over a 401k?
I was on the 401k selection committee for a former company. None of the plans offered were very good. When we selected a plan provider and I insisted that a simple S&P 500 index fund be included in the list of available funds the salesman looked at me like I was asking him to kill a kitten.
Some 401K plans do waive loads on investor class shares that normally charge funds. The literature I got from our 401K provider stated “no load funds from American Funds, Vanguard, etc.” Since I know American Funds normally charges loads, I decided to make a small contribute as a test and sure enough, no load. I think American Funds is probably being paid from the admin fees. Or it could be because we went online and completed the setup/fund selection ourselves so there’s no salesman to pay.