Rightfully so, 401(k) fees are coming under increased scrutiny lately. Back in late April, PBS Frontline presented “The Retirement Gamble” (in the Recommendations section) which noted that retirement is big business in America as there is a lot of money at stake. High management fees for mutual funds can put a serious dent in investor’s retirement accounts.
Now, Yale University professor Ian Ayres has gathered data regarding plan costs of nearly 50,000 companies and intends to publish his research in spring 2014. Every indication is that the report will be damning to the mutual fund industry. There is a good story on the furor over Professor Ayers’ research at MarketWatch.
An index fund is a specific type of mutual fund. These types of mutual funds are designed to track the performance of a stock market index (e.g. Russell 2000, S&P 500, Wilshire 5000, NASDAQ Composite, etc.). Advantages of these types of funds is that they offer investors broad exposure to the markets and most importantly, expenses that are typically lower than traditional mutual funds due to their passive, vice active, management.
Regarding expenses, I recommend that you seek funds that have an expense ratio (the operating costs, including management fees, expressed as a percentage of the fund’s average net assets for a given time period) that is less than 1%. The more money you have working for you, and not going to fees and other expenses, the more you can leverage the power of compound interest.
Along with fees, another consideration as you conduct your research is past performance. Note that past performance is not a reliable indicator of future performance. While past performance can help you assess a fund’s volatility over time, do not become too enamored by the previous year’s returns. In the case of investing, the past is not necessarily prologue.
Another good option, which is relatively new, is lifecycle funds. Lifecycle funds are an easy way to manage investments during your working years. They consist of a series of target retirement date funds in five or ten-year increments and you select the fund nearest your anticipated retirement date. The underlying idea of lifecycle funds is that they are low-cost, as the management is fairly passive (like index funds), and their weighting with regards to equities and bonds; and volatility and risk are adjusted to become more conservative as you get closer to the target date, near your date of retirement.
The bottom line for the SavvyReader: Do not become too enamored with past performance and generally, your best bet for minimizing fees are index funds and lifecycle funds.