New Study Again Cites Importance of Low Fund Fees
It is widely regarded in the modern world that the earth revolves around the sun.
Now, it is time for more investors to understand that the fees charged to manage your mutual funds in a 401(k) and elsewhere all reduce your net investment returns. There is a direct connection: the more you pay in fees to investment companies, financial advisors and 401(k) administrators, the less money you will have in your own account.
While managing money requires expertise, there is a balance between what fees you are paying for this expert service and what you get in return. All-in fees (including 12b-1 and the other 18 or so possible fund fees designated by the U.S. Department of Labor and SEC) in the 1.3% to 1.5% fees considered in the average range for mutual funds are acceptable, provided your returns exceed an established benchmark, such as the S&P 500 or MSCI EAFE Index. Expert advisors and companies deserve to be compensated for their talents.
The problem is when uninformed investors pay fees that benefit investment professionals and firm more rather than you, the investor. Surprisingly, many 401(k) participants think they are not paying any fees in the 401(k) plan. This is a big mistake. It is one that costs investors hundreds of thousands of dollars over an investing lifetime.
New Study Shows the “Destructive Impact” of Fees
In a study conducted by Craig Israelsen in the July 2017 issue of Financial Planning, Israelsen analyzed the impact of a hypothetical $1 million portfolio over 23 rolling periods of 25 years each in a portfolio compared to seven standard indexes to gauge the impact of fees. Fees were comprised of fund expenses and manager fees. He also accounted for required minimum distributions for people with IRAs over age 70 ½.
Using different scenarios of total fund fees ranging from 50 basis points (bps) and average annual withdrawals over the 25-year-period, he found the following changes in account balances in a portfolio starting out with $1 million:
- If you are paying total portfolio fees of 1% (100 basis points), over 25 years, you will have an average account balance of $2,428,629, and will be able to withdraw $146,853 per year over the 25 years. This gives you an average total amount to withdrawal over each 25 year period of $3,671,335.
- If you paid 2% in fees (200 basis points) over this same period, your average account balance would be $1,905,338 and you could withdraw an average of $126,426 annually during each 25 year period.
- If you want to pay even more in fees, say 3% (300 basis points), your average ending account balance over 25 years drops to $1,491,240 and you only get to withdraw $109,104 annually for a total of $2,727,594 in withdrawals over the 25 years.
This is a lot to digest, but Israelsen said the impact of fees is “huge.” He also says: “
Think of it this way: if a portfolio had a total cost of 100 bps and by using lower-cost products or reducing the advisory fee the total portfolio cost could be halved to 50 bps, the retiree could withdraw $11,554 more from the portfolio each year and her ending account balance would be higher by roughly $288,850 after 25 years.”
These are powerful calculations that can make a big difference to your quality of life in retirement.
Impact of Fund Fees Over Time (Source: SEC)
Fees vs. Privatized Social Security
But fees also play a huge role in the political battle over the future of Social Security.
Republicans have already announced plans to privatize all or part of Social Security using the cover story that government has no role in private lives. But the bigger reason is that investment companies, which rank among the largest lobbing forces in Washington, have been engaged in pushing for privatization of the multi-trillions in Social Security for decades. And the goal of privatization is, you guessed it, the huge potential revenues generated by charging fees.
Fees also play a huge role in generating revenues for banks, credit card and student loan companies. Nor are excessive fees just restricted to individuals. The numbers are even worse for unsuspecting or poorly managed institutions. The North Carolina state teachers’ pension fund in 2014 invested in about 300 hedge funds. The net result was that the fund saw that “fees have skyrocketed over 1,000% since 2000 and have almost doubled since (2008) from $217 million to $416 million,” former SEC investigator Ted Siedle wrote, adding that “annual fees and expenses will amount to approximately $1 billion in the near future.”
It was no surprise that the North Carolina fund underperformed the average public plan by $6.8 billion, according to Siedle.
This large public fund (at the time the nation’s seventh largest public fund) was managed and overseen by a team of highly-paid managers and consultants, and they still made serious mistakes. Unsuspecting individual investors make these same mistakes every day.
So Here is the Bottom Line
When you buy a mutual fund you pay fees.
When you pay fees, you often pay for many services that do not boost your investment returns.
When you pay for services you don’t need, you pay for people who don’t help you make more money.
When you don’t make more money, you can’t retire.
When you can’t retire, you end up working longer and eating dog food.
So learn about the mutual fund fees you are paying.
Learn how to save more retirement money by paying less in fees.
Learn more by buying this book: