How To Reduce 401K Fees Through Portfolio Analysis
Do you know how much in mutual fund fees you are paying a year? I didn’t, so I ran my 401K portfolio through Personal Capital’s 401k fee analyzer and I’m absolutely shocked by the results! I always figured that from a percentage point of view, my mutual fund fees were small. But, when you take a small percentage multiplied by a big enough number, the absolute dollar amount starts adding up!
As you can see in the picture above, I’m paying $1,748.34 a year in fees across four mutual funds! In 20 years, I will have paid roughly $84,000 in fees based on only this amount. In the second chart, you’ll see how much I will pay in fees if my funds actually grow.
I’ve got another fund worth about $22,000 as part of my 401K which does not show a fee, because it is a hedge fund whose fees are baked into the performance. Typical hedge fund fees are 2% of assets under management and 20% of upside. This is called 2 and 20, which is egregiously high, but it’s the only way I can get short exposure to hedge my bets.
I’ve been wanting to do a 401K/mutual fund fee analysis for the longest time, but was too lazy to do the analysis until I realized I didn’t have to do the calculations myself. As the new year arrives, I want my portfolio to be as optimized as possible.
ANALYZING YOUR 401K FOR EXCESSIVE FEES
* Huge spread in expense ratios. The cheapest expense ratio is 0.19% for the Vanguard IT Index Fund and a whopping 0.74% for the Fidelity Blue Chip Growth Fund. 0.74% is almost 4X greater than 0.19%, supposedly because they’ve got to pay the fund manager and analysts for providing alpha and outperforming the S&P 500 index. If the fund manager(s) can indeed outperform the S&P 500 index by more than 0.5% a year, then their fee is on par with my cheapest Vanguard Index Fund. If not, I’m wasting my money.
* Fees add up over time. In 20 years, I will have paid ~$87,000 in mutual fund fees if I keep my existing portfolio. I don’t know about you, but that seems a lot, even if my 401k does grow to $1,500,000 as my 401K savings guide estimates. Just doing the math here, 67% or $58,290 of the $87,000 in fees will come from my Fidelity Growth Fund alone. Meanwhile, the Fidelity growth fund only accounts for 39.5% of total assets. Long term growth has a way of compounding into great returns for consistent investors and savers, however it sure does a number on the total amount of fees as well.
* Understanding tax cost ratio. The Tax Cost Ratio measures how much a fund’s annualized return is reduced by the taxes investors pay on distributions. The range is usually between 0%-5%, the lower the better. For example, if a fund had a 1.5% tax cost ratio for the three-year time period, it means that on average each year, investors in that fund lost 1.5% of their assets to taxes e.g. a 10% return is really only a 8.5% return. It’s good to see my highest fund with a 0.74% expense ratio have only a 0.11% tax cost ratio! One can simply combine the two to figure out their total expenses. The Fidelity Growth Fund is therefore 0.85% vs. 1.94% for the Vanguard Precious Metals fund! The Vanguard IT Fund is the lowest 0.31%.
* Big fan of index funds. The Vanguard family of funds have some of the lowest, if not the lowest fees in the mutual fund industry. The reason is because of their scale and also because they run passive index funds. There’s no team of analysts to pay. There are no business trips to expense to go kick the tires of the companies they hold. The index is rebalanced usually once a quarter, or whenever there is a big index addition or subtraction to reduce variance risk. Three out of four of my funds are by Vanguard. After I finish typing this post, all of my funds will be by Vanguard!
* You can create a portfolio of index speciality funds. About 60% of my entire 401K allocation is invested in three speciality index funds: Energy, Metals & Mining, and Technology. If I wanted, I could create a portfolio of 20 speciality index funds if I wanted to. In other words, you don’t have to buy one fund that asset allocates across the industrial board. If you have conviction in particular industries which you think will outperform, there is an index fund for you. We can discuss investment decisions in a future post.
401K PRO FORMA ANALYSIS OF LOST RETIREMENT OVER TIME
This is the chart that really kind of makes me sick. Let’s say I continue to max out my 401K like I have been doing for the past 13 years, get a full employer match (I was getting more due to profit sharing), and assume an annualized return of 5.8%. After 30 years, I will have paid $489,014 in fees and lost out on 2 years worth of retirement income!
The funny thing is, my blended expense ratio is 0.43% compared to Personal Capital’s target benchmark of 0.5%! The public is paying a tremendous amount of mutual fund fees over our lifetimes, and we don’t really know it until we do the analysis. To put it differently, if you want to make big bucks in your life, you should consider a career in money management. It’s all about leverage. A fund manager can run $1 billion dollars under management as easily as he can run $10 billion dollars under management.
CONCLUSION – TAKE SOME ACTION TO SAVE
It’s important to not only look at the expense ratio, but also the tax cost ratio to see how much your performance is getting reduced by each year. Look to invest in lower cost index funds instead of actively managed funds who have shown a poor track record of performance. There are plenty of studies showing that the large majority of actively managed funds underperform their benchmarks.
Personal Capital helped me realize that I am paying at least $1,000 more a year in mutual fund fees than I should by investing in the Fidelity growth fund. I wouldn’t have been able to see what an outlier the fee is without the 401K fee analyzer that aggregates all the data and provides a side by side comparison. Not bad for a free online financial management huh? I suggest everybody take a hard look at their finances to see where they are paying unnecessary fees.
Step By Step Instructions To Reduce 401K Fees
If you want to figure out how much in fees you are paying in your 401K, do the following:
1) Spend one minute to sign up with Personal Capital. It’s free and secure.
2) Click the “+” button on the top left to add/link an account. For my Fidelity hosted 401K, I typed in the search box “401k.com” since the Fidelity pre-populated button just linked to my Fidelity rollover IRA.
3) After your 401K account is linked, click the “Investing” tab on the top right then choose “Investment Checkup”
4) Select the “Cost” link to have Personal Capital evaluate your portfolio.
5) To bring up the second chart in the post, click the “401K Fee Analyzer” link under the Investment tab and play around with the assumptions. It’s best to use three assumptions: conservative, base case, and blue sky to have a feeling of where your 401K will be when you want to retire. I have a feeling you are going to be as surprised as I was about how much you are paying in fees. After writing this post, I’m exchanging my Fidelity Fund into a Vanguard Large Cap fund.
About the Author: Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 35 largely due to his investments that now generate over six figures a year in passive income. Sam now spends his time playing tennis, spending time with family, and writing online to help others achieve financial freedom.