When I opened my latest retirement fund statement, everything seemed like it was going just fine.
In the five years I’ve been working here at Outsider Club, my 401(k) has grown into a nice little nest egg. If I were to look at the simple chart of my account returns, I’d think my broker is doing a great job. There is a nice, sturdy upward trend since I started the account.
Psychologically, it seems like everything is going peachy… mainly because every time I dare to look at it, there is more money in the account. It’s easy, it’s stress-free and I can go about my day without rending my clothes and tearing my hair out thinking about how much money I’ll need to save.
One reason for this is that the money is taken — sight unseen — out of my paycheck and plunked into some vanilla mutual funds. It keeps growing every time I look at it, which is very rarely. And I’m not alone — most people treat their 401(k) or IRA as a “set-it-and-forget-it” situation.
Even Vanguard founder Jack Bogle — whose company has around $3 trillion in assets under management — seems to agree with this head-in-the-sand approach.
“You’re gonna get a statement every month,” says Bogle. “Don’t open it. Never open it. Don’t peek.”
While psychologically, this makes sense: if you don’t look, you aren’t tempted to try and beat the market by making hasty, short-term mistakes. Financially, however, it is a very dangerous approach. Though Bogle recommends you don’t look at your account, he also went on to include a warning for those that dare to sneak a peek…
When you finally open it, he warns, you may want to have a cardiologist on hand. After looking into my own account, I know exactly what he means.
When I dug down into the actual returns of my funds, I started getting heart palpitations.
7.4% annualized returns.
That was my average return for the past five years. Now, I don’t normally sneeze at a 7% return. In all honesty I would be completely comfortable getting 7% every year until I retire. It sure beats having it sit in a bank account with no interest, or stuffing my mattress with a stash of cash that is losing value each and every year.
However, this 7% return came as the stock market was having a historic bull run.
Something didn’t add up.
Once I dug a bit deeper, I realized that not only am I leaving money on the table, I’m literally being robbed…
While I was collecting a 7% return, the market was scorching. Check out what the S&P was doing while my retirement account was sputtering along…
That’s a 95% return over the exact same time frame.
So, how in the world did the broad market beat my professional money manager 13 times over? Well, it had some help…
That massive gap in performance and return can be blamed on one insidious factor: FEES. Big, fat, dirty fees.
My 401(k) custodians charged me an arm and a leg to deliver that tepid 7% return. The total percentage of fees is rolled up into your “expense ratio.”
Here’s what they’re spending your hard earned money on…
Administrative Fees
This is a pretty typical expense that covers customer service, record keeping, and ensuring regulatory compliance. Fair enough.
Asset Management Fees
Your money is going to the portfolio managers and investment researchers who act as the architects of your retirement plan. If you aren’t doing it yourself, someone has to put together your investments… and you can expect to pay them something.
Marketing Fees
Here’s the one that really burns me. We’re paying so you can advertise your product to other people? That’s like a fee on your monthly car payment to buy ad space for the next year’s model of the car you bought.
One sneaky fee is usually absent from your expense ratio, and that’s the Trading Fee.
This fee can add up to massive costs for you, especially if you are in an actively-managed fund that makes a lot of moves. On average, the trading fees can run you another 1.2% on top of your expense ratio.
You are shedding a certain percentage of your money each and every year you have your 401(k) rolling.
If you didn’t realize how much you were spending on these fees, don’t worry, you’re hardly alone. A recent AARP survey showed that 71% of people believed they paid no 401(k) fees at all!
And that’s exactly how these guys want it.
“Well, a couple percentage points doesn’t sound like much for expert money management,” you may be thinking.
You’d be wrong. It amounts to an absolute ton over time. The Wall Street Journal just laid it out like this:
An investor who had $200,000 in a mutual fund would pay $2,500 based on the average annual fee, while the same sum in a broad-stock-market index fund could cost as little as $80. Over 30 years, with fees and returns compounded annually, that gap alone would cost the higher-fee investor about $570,000, if both investments return 8% a year before fees.
If the professionals can’t beat the market — or at least keep up with it — then why in the hell are we paying them these extravagant fees in the first place?
I’d argue that you shouldn’t…
Most traditional retirement accounts invest in mutual funds that act as proxies for the market at large. But with so many exchange-traded funds available to you, it seems downright silly to have some overpaid money manager pushing around stocks all the time — and charging you each time they do.
You can easily replicate the market with a low-cost index fund. So instead up paying up to 3% on your retirement account, why not replace it with a broad market index fund that only costs a mere fraction of that?
Take Jack Bogle’s own index fund, the Vanguard Total Stock Market ETF (NYSE: VTI). This ETF basically apes the investment return of the overall stock market.
Here are the top ten holdings:
1. Apple Inc.
2. Exxon Mobil Corp.
3. Microsoft Corp.
4. Google Inc.
5. Johnson & Johnson
6. General Electric Co.
7. Wells Fargo & Co.
8. JPMorgan Chase & Co.
9. Berkshire Hathaway Inc.
10. Procter & Gamble Co.
Not exactly rocket science. You’ll see most if not all of these companies making up the bulk of your own 401(k) mutual fund — I certainly did while looking at my fund prospectus. Again, I was returning around 7% a year.
Here’s the return for VTI those same five years:
That’s a 98% return — I’d have about doubled my money if I chose VTO over my 401(k). But we haven’t taken fees into account yet.
Quick question…
Considering the 2.5% average for 401(k) fees, how much would you wager you’ll be paying Vanguard for its expert selections? Surely choosing a basket of stocks that has doubled in the past five years should demand a fair chunk of change, right?
2%? Maybe even half that — say, 1%?
Not even close. VTI has an expense ratio of 0.05%.
If we stick with that average annual return of 8%, before fees and taxes, in 30 years I would have saved up almost a million dollars with an ETF like VTI.
If I stuck with my current mutual fund, however, I would have pulled in around $700,000.
So, which retirement would you rather have?
