401(k) Plan Optimization: How To Calculate 401k Fees And Stop Overpaying
If you’re putting money into a 401k, you’re already ahead of the game in comparison to many Americans. A recent study by the Pew Charitable Trust found that 28% of employees who have access to a retirement plan at work don’t contribute. So, if you have a 401(k) account at all, it might be tempting to pat yourself on the back and call it a day.
But do you have any idea what’s actually going on in there? Sure, you probably look at the balance every now and then, but did you know you are paying 401k fees with your investments? And that there are super simple changes that can help you grow your 401k even faster?
I’d be willing to bet most folks have a fuzzy picture of how their funds are allocated, how much they pay in fees or whether they’re even on track to cover our expenses when they retire. Most people only think about what to do with their plan when they first start contributing or when they’re changing jobs and need to figure out how to rollover a 401(k) to a new provider.
Sound familiar? If so, this is the “How To” for you 🙂
What's we are covering
In this post we’ll talk through easy steps you can take to:
- Ensure you’re not paying high investment fees that can cost you BIG in potential growth
- Make sure your asset allocations are in line with your risk tolerance
- Determine if all your nest eggs are in one basket when it comes diversity of your portfolio.
Ready? Let’s get started!
What are 401(k) fees?
401(k) fees are paid within your retirement portfolio for various administrative reasons, like the management of investments. According to a study by TD Ameritrade, only around 27% of Americans know how much they are paying in 401k fees.
When it comes to your 401k, how much you pay in fees matter. If you are a working with a financial advisors, they should proactively disclosure this information to you. That's because there are fiduciary rules in places that dictate they must act in the best financial interest of their clients.
You may only pay a few hundred dollars a year, but it can cost you big on long-term retirement savings. This is because you have less money to receive the benefit of compound interest . The good thing is, there are really only two types of fees. The first, an administration or plan fee, which is charged by your 401(k) provider . The second type of fee is charged by the individual mutual funds in your portfolio.
In this this article we will focus on the second type since administrative plan fees are the harder to reduce without moving your portfolio which is not always an option.
So what can you do about those fees charged by your funds? You reduce them by selecting a lower expense fund which suits your needs, but first you need what the cost actually is. The good news is they are pretty easy to find by checking their expense ratios.
What types of fees are they?
The good news is, there are really only a few types of 401(k) fees.
- Administrative fees: This is a fee that is charged directly by your provider, and pays for their overall business operating expenses.
- Service charges: These are for specific services your plan may offer. An example would be when you taking out a loan, they may charge you a "processing fee"
- Investment or advisory fees: Actively managed funds are operated by analysts who monitor the market conditions, and buy/sell individual investments in the fund on your behalf.
- Commissions or "Loads": If you are working with a financial advisor, you'll find some mutual funds are referred to as "loads" or "no-loads". This is an upfront commission which is typically charged in lieu of ongoing investment fees. 401(k) plans typically don't have these.
In this this article we will mostly on investment fees, since administrative plan fees are the harder to reduce without moving your portfolio. So what can you do about those fees charged by your funds? You reduce them by selecting a lower expense fund which suits your needs, but first you need what the cost actually is. The good news is that it’s pretty easy to figure out by checking their expense ratios.
How do I find my 401(k) fees?
The first place you should look is in the annual statement provided by your 401(k) administrator. The Department of Labor requires plan administrators to provide an annual fee disclosure to individuals enrolled in their plans.
Within that document you will find a "fees disclosure" which identifies the administration fees. Sometimes they will identify the operating fees charged by the mutual funds, but not always. That's because many of these are indirect fees which are hidden within the individual mutual funds operating expense. The good news is there are not hard to find on your own.
First, find out how the operating expenses of your mutual funds
Let’s take a look at two different funds so you can compare costs:
- Vanguard Total World Stock Index Fund Institutional Shares (VTWIX)
- Northern Small Cap Value Fund (NOSGX)
First, search for VTWIX and you’ll find an article by Morningstar which has great insight into the economics of the fund.
Once that opens, you’ll see a little dashboard with a bunch of information, including “Expenses”, which lists “.09%” as your expense ratio.
But you want to find out how much it’s actually costing you a year, so multiply that % by the amount of money you have in the fund itself (not the whole portfolio) and that will tell you the annual amount you pay.
For easy math, let’s say you have $100,000 worth of VTWIX. That would mean you are paying $90 a year in fees. For comparison, NOSGX has an expense ratio of 1%, so the same amount would cost you $1000 a year.
That’s over a $900 annual difference between the two funds. This doesn’t mean one is better than the other, but it does mean you are charged 10x in fees.
Starting to see how this can add up?
Second, determine what’s the right mix of assets for you
Now that you know how to figure out what the different funds are costing us a year, you should determine the right asset allocation, i.e. the mix of stocks and bonds in your portfolio. The quick thing to know about stocks and bonds is that stocks tend to have higher returns with higher risk, and bonds have lower returns with lower risk. This is not an absolute definition, but a fair generalization.
Many 401(k) ’s provide something called a “target date fund” which changes your allocations to be less risky the closer your get to your target retirement date. Something to check out if you are looking to set it and forget it.
If you want to be a bit more active in your invest, you can try using a stock allocation rule like the “110 rule” . With the 110 rule you subtract your age from 110, and the remaining percentage is used to determine your allocation of stocks.
For example, if a 36 year old was using the 110 rule they would their an allocation of 74% stock and 26% bonds.
Finally, identify what options you have for diversifications, and rebalance your portfolio
At this point you know how much you're paying in fees, and what a reasonable asset allocation should be. Now you need to diversify your investments across multiple funds so that you if one is impacted by a market shift, they others may not be . In my case I spread 74% of my money across several different stock-based funds that cover large-cap, small-cap and international interests, and I invest the 26% in different bond funds. The actual funds available to you is driven by the investment options offered by your 401(k) .
Make sure you are comfortable with your choices
Remember that personal finance is personal, and my tolerance for risk is different than yours. The key is for you to feel informed and comfortable with your decision. Also make sure you are analyzing each funds expense ratios to identify fees, and then select the right mix for you based on your target asset allocation and diversification strategy.
Recently, Last Week Tonight with John Oliver did a segment on just how important understanding your 401(k) plan is. It's a very well done piece which was not only funny but incredibly informative.
If you want to make it easy check out the our review of Blooom. They are a robo advisor who provide a free 401(k) fee analysis tool. Their tool will show you what fees your are paying in your401(k). In addition, they will also give you some ideas to diversify your portfolio further. Why not let them do a lot of the heavy lifting for you?
So now that you have the right knowledge and tools to grow your 401(k) , what’s stopping you? Go dig into your investment account and learn what you've been paying in 401(k) fees. If you don't like what you see, take action. Or if you'd prefer a slightly easier method, I'd recommend giving a service like Blooom a try.