Are you currently invested in a 401(k)? If so, I would naturally assume that you’re invested through your employer. This is by far the most common way that people start to invest in their future.
While many employers offer the 401(k) option (which is great) and some of them even match your contributions (which is even better), very few of them educate their employees on how to invest.
Beyond this, very few employers make any mention of the fees that are tied to each mutual fund that’s offered in the 401(k) package. And, since many people just don’t talk about finances, these expenses eat away at your investments without you ever realizing it.
Now that you know there are fees that are continuously taking money out of your account, it’s time to learn how to identify them and ultimately, how to avoid them in your future investments. Remember, this is mistake #2 of the most common 401(k) mistakes — so pay attention!
As you may have guessed, you are being charged fees because of administrative tasks. These expenses cover the everyday costs of your 401(k) fund — things like record keeping, accounting, and legal costs.
To be honest, these costs make sense. You want to be able to see the historical data of your fund, and you certainly don’t want your fund to experience any legal trouble with their operations (this could be very detrimental to your investment).
These costs are often taken from the plan’s overall assets, but they may also show up as a flat fee from your account.
Did you know that your fund is managed by a whole team of people? Of course there’s a manager of your fund, but oftentimes there are hundreds of people that are employed to be experts in a given industry.
Let’s say your mutual fund is largely invested in family restaurants. One of the employees might focus solely on KFC and report back everything there is to know about that restaurant. How busy are they? How is their food? Do they appear to be profitable? How was the service? How satisfied are the customers? How is their marketing plan? Are they attracting new customers? And so on and so forth. If the KFC has a problem with their biscuits, the mutual fund employees will know about it before anyone else.
So why does the manager have all of these people running around and doing studies on all the intricacies of the industry? It’s for your benefit as the investor. If there is something good coming out, they’ll quickly invest. If there is an issue, they’ll lighten the load of those shares. Your investment fees go directly to these tasks, which keeps you ahead of the overall market.
Typically, these are the highest fees that you’ll incur. You’ll see this money coming out of your account each month and it is normally a set fee that you can see on each one of your earning statements. With most mutual funds, you’ll see this range from 0.5% to 2.0%.
Quite a few plans have additional fees for special features and options. For example, if you decide to take a loan against your 401(k), there is most likely a fee tied to this, either as a single lump sum or a percentage during the term of the loan. Some 401(k) plans even charge a 401(k) rollover fee.
Getting into the Specifics
The three types of fees above are the general categories for fees that you’ll incur, but most likely, you’ll never see the term “investment fee” on your earnings summary. There are a few other fees that pop up often, and before you invest in a particular fund, you want to be sure that you don’t see the terms “front-load” or “back-end load.”
Just as you may have guessed, these fees happen either when you initially invest in the fund, or when you decide to sell the fund (at the front, or at the rear). If you are comfortable with the fees, then you can go for it and invest, but just be aware that they are there. Many people are not prepared for the fees they incur when they sell a back-end loaded fund. I don’t want you to be surprised either.
So How Do You Use This Information on 401(k) Plan Fees?
Now that you have all of this knowledge in regards to fees, how do you use your newfound knowledge? The solution is not to try to avoid fees entirely, because what’s your goal with investing? It’s to make the most money possible, not to skimp out on your costs.
Let me expand on this with an example. Let’s say that historically, your fund has earned an average of 9% over the past 10 years and only has investment fees of 0.09%. The other fund that you’re prospecting has average earnings of 16% over the past 10 years, but has remarkably high investment fees of 2.3%. Both funds expect to earn their historical growth in the future and have no fees other than the investment fees. Which one do you go with?
The typical cheapskate would immediately look at the costs of each fund and since the second option has some of the highest fees he’s ever seen, he decides to take the first option and earns a very comfortable 9% (8.91% after fees).
You, however, are a little more wise, and you decide to look into the complete “take-home income” of each investment. While the second option has a high fee, it also has very high historical earnings, which are expected to continue in the future.
If you take the 16% yearly growth and subtract the 2.3%, you are still left with an overall earnings of 13.7%, which is much better than the 8.91% of the first option. Therefore, even though the second option has a large fee, you would want to choose that one for your investment of choice! Take a careful look at all of your investment options in terms of growth and fees, and choose what’s best for you.
What are your thoughts on 401(k) plan fees? Do you feel your company is competitive when it comes to plan fees?