Taking
on 401(k) plan fees that take away from you
by
Jon Forman
(published in The Journal Record, January 8, 2007, 6A.)
The stock market had a very good year in 2006, but how did you do? The Dow Jones industrial average was up 16.3 percent, and the Standard and Poor’s 500 was up 13.6 percent. That’s how the stocks did, but most of us don’t own stocks. We own mutual funds, or more commonly, our 401(k) retirement plans own mutual funds.
Unfortunately, mutual fund managers take a big slice out of our profits. They pay themselves first. How did you think that Goldman Sachs Chairman Lloyd Blankfein got that record $53.4 million bonus for 2006?
The bottom line is that if your 401(k) plan invested in the stock market last year, you were lucky if you made 13 percent, after fees. According to a recent report by the Investment Company Institute, the average 401(k) plan charged fees equal to 0.76 percent of assets in 2005, but higher fees are common. To be sure, the Vanguard 500 Index Fund – which tracks the S&P 500 – advertises that it charged an investment fee of just 0.18 percent of assets in 2005 (plus an account management fee of $10 per account).
In general, the more aggressive your fund manager is (that is, the further it gets away from tracking a benchmark), the higher the fees and the harder it is to even know what the fees really are.
In fact, there are many fees associated with 401(k)-plan stock funds. Companies charge fees for portfolio management, fund administration, shareholder service, and other miscellaneous costs. According to a recent report by the U.S. Congress’ Government Accountability Office, these investment fees make up between 80 and 99 percent of all plan fees, depending on the number of participants in the plan. In addition, there are record-keeping fees associated with maintaining participant accounts, processing fund selections, and mailing account statements. These, too, cut into your bottom line.
There are also other fees associated with setting up a 401(k) plan and explaining it to employees, but these are usually paid by the employer.
All in all, investment fees and record-keeping fees can have a very adverse impact on your retirement savings. For example, imagine a 45-year-old employee who plans to leave $20,000 in a 401(k) account until retirement at age 65. If those assets earn a 6.5-percent net annual return – a 7-percent investment return minus a 0.5-percent charge for fees, that $20,000 will grow to $70,500 at retirement. On the other hand, if fees are instead 1.5 percent annually, that $20,000 investment will grow to just $58,400. That additional 1-percent annual fee will reduce the account balance at retirement by about 17 percent.
Fees, especially investment fees, are Wall Street’s dirty little secret. It is extremely difficult for investors to get a complete picture of the fees that fund managers skim off the top. Fund managers rarely advertise how much they make on your money.
Of particular concern, fund managers may receive undisclosed compensation from mutual fund companies in exchange for recommending their funds, and fund managers may receive rewards from stockbrokers in exchange for using their brokerage services. The danger is that your money may be steered toward investment products or services that may not get the best returns and may be subjected to higher fees.
There were 47 million participants in 401(k) plans in 2005, up from just 8 million in the 1980s. More than 90 percent of 401(k) plan participants can choose how to invest their accounts, and nearly half invest in stock funds. That’s a lot of money and a lot of investors.
The U.S. Department of Labor already has some authority to oversee 401(k) plan fees, but it lacks the information that it needs to regulate hidden fees. The Government Accountability Office and the Department of Labor want Congress to amend federal pension laws to require mutual funds and 401(k) plans to provide a summary of all fees that are paid out of plan assets or by participants.
Look for Congress to enact some legislation this year, and look for all investors to benefit. Our capital markets will work better if investors have complete information about all investment and record-keeping fees.
Jon Forman is the Alfred P. Murrah Professor of
Law at the