Avoid High Fees

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.

Minmize Fees - Maximize ReturnsAn 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.

What Are Investment Fees Really Costing You? [Green Money Stream]

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.

Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.

11 Comments

  1. I never heard about lifecycle funds. Where can I get more info?

    • Investopedia has a nice summary of life-cycle/target-date funds.

      These funds make investing as about as simple as possible, particularly for someone that doesn’t want to spend a lot of time managing their retirement accounts. While I might suggest augmenting a life-cycle fund with other investments, if someone started investing early enough – 20s or early 30s – and they really didn’t want to mess with anything else, one of these would be the way to go.

      Once they chose this as their singular investment vehicle, what would be next? Simply make every effort to maximize contributions and let time/compound interest do their thing.

  2. Reducing the fees in life just makes sense. After all, less $$ going to someone else is more money working for you.

  3. can you explain why I should be concerned with past performance. I understand the low fees, but if the past performance was terrible what makes me think that the future will be that much better?

    • I meant shouldn’t be concerned with past performance.

      • Brian,

        While past performance, particularly over longer time periods (five years or more), can shed some light on how a fund has performed in different market environments, it does not guarantee that performance – good or bad – will be the same going forward. As an example, what if you purchased a health care sector mutual fund two years ago based on how it had performed in the previous 10 years? As it turns out, the health care industry is changing with the introduction of the Affordable Care Act along with other factors. The health care environment over the next 10 years is likely to look very different than the past 10. Moreover, other changes – good or bad – could take place, such as a new fund manager coming on board.

        Would I be more inclined to buy a fund that had performed well in the past (particularly if a lot of the underlying factors have not changed) vice a fund that has performed poorly in the past? Sure. However, when choosing an investment, it is wiser to keep an eye on the future environment and your evolving needs vice what the environment has been like, and what your needs were, in the past.

        I recommend that people not get too wrapped up in what was good (or bad) in the past. As noted by Jack Bogle (founder of the first index mutual fund and retired CEO of The Vanguard Group) recently on The Retirement Gamble (a recent Recommendation here on retirementsavvy.net), “Good markets turn to bad markets, bad markets turn to good markets. So the system is almost rigged against human psychology that says if something has done well in the past, it will do well in the future. That is not true. And it’s categorically false. And the high likelihood is when you get to somebody at his peak, he’s about to go down to the valley. The last shall be first and the first shall be last.”

  4. Leona@allmydollarsandcents.com

    I’m not a big fan of mutual funds and prefer to pick individual stocks–however, this is a wonderful post!!!!

    • Leona, I can appreciate the desire to pick indivdual stocks. I occasionally include an individual stock or two in my Roth IRA. The overall point I try to make to those I speak with is that no matter what your investment vehicle of choice, keep the fees as low as possible. They can really eat into returns! Thanks for the feedback and your complimentary gift certficate for RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit is on the way.

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