What You Don’t Know Can Cost You, 401(k) Study Shows

Number of the Day: The most relevant or interesting figure in personal finance

Number of the Day

That’s the share of people with a 401(k) plan who don’t realize they pay any fees for the plan, according to a new study by the U.S. Government Accountability Office suggesting more should be done to encourage fee comparisons when making investment choices.

Without properly understanding the investment and administrative fees accompanying a 401(k), participants may be unwittingly undercutting their retirement income, according to the GAO study, released Thursday.  For example, if annual costs and fees are 2%, instead of 1%, you could end up with a return that’s 20% less over 30 years of investment—$80,000 versus $100,000, for instance.

Since 2012, the Department of Labor has required 401(k) retirement plans to provide the more than 87 million plan participants in the U.S. with a comprehensive disclosure of the fees they pay, but a GAO survey in the summer of 2020, weighted and generalizable to all 401(k) participants, showed that many people still do not understand how the fees work, or that they even exist. The explanations required by the department should make the impact of fees more clear, the GAO recommended, and the terms used should be more consistent.

So how do they work and what can you do? The two main types of fees are investment fees, which are the largest component of 401(k) fees and reflect the costs associated with managing the investments made, and administration fees, which cover basic tasks like recordkeeping, legal, and trustee services. 

Generally, actively managed mutual funds charge higher fees because they have an investment advisor who monitors, researches, and actively trades to try to obtain a higher return on investment. Passive funds, whose holdings mirror an index like the Dow Jones Industrial Average to try to match those returns, don’t require as much monitoring so usually have lower fees.

401(k) participants can try to minimize fees by choosing lower-cost funds, but higher fees do not necessarily mean better performance, according to the Department of Labor. Nor is cheaper necessarily better, the department said. Investors should weigh net returns to the risks among investment options and remember fees are only one factor in investing.

Article Sources