Suppose you walked into a restaurant, and they handed you a menu without prices. Would you conclude that:
(1) Everything is free
(2) Something funny is going on
I doubt anyone would choose option 1; it defies logic. Yet, this is how the 401(k) industry routinely operates, and large numbers of people are falling for it. According to a 2018 survey by TD Ameritrade, 37 percent of 401(k) participants mistakenly believe that their 401(k) plans are a free employee benefit—that they carry no fees. Another 22 percent aren’t sure whether or not their plan costs anything. And among the minority who do understand they are paying something, one third don’t know where to find this information. Just 27 percent actually know what they’re paying. In contrast, the survey found that 96 percent of consumers know exactly what they are paying for inexpensive services like Netflix.
This study came to mind yesterday as I read through the investment menu provided by one 401(k) plan. At the top of the page, in bold type, it carried this helpful warning: “Before investing in any mutual fund, consider the investment objectives, risks, charges, and expenses.” That made sense—but the rest of the page looked like that hypothetical restaurant menu with no prices. It listed dozens of investment options but said nothing about their associated costs (not to mention the investment objectives or risks). No wonder so many 401(k) participants end up believing these plans are free.
Of course, fees are always disclosed somewhere, but the disclosure rules don’t require that this information be easy to find. In the case of the menu I saw yesterday, an employee would have had to reference a separate document full of fine print to find all the applicable fees. And even after finding that document, it still wouldn’t be easy. The fees associated with each investment option were mixed into the middle of an 18-column-wide table in 9-point type at the back of the document.
If you’re a participant in a 401(k) or 403(b) retirement plan, here are five tips to help you navigate this landscape of opaque fees:
1. Surface the fees: As the TD survey found, even when people know that they are paying something for their 401(k), often they’re not sure where to find this information. My recommendation: Start by asking your human resources department and/or log on to your benefits website. Keep in mind that retirement plans often carry multiple layers of fees. Depending upon the plan, there might be administrative fees, investment fund fees, investment advisory fees, trustee fees, commissions and sales charges. But the most significant—and the one over which you have the most control—are the fees charged by the funds you select. The term you are looking for is “expense ratio.” Ideally, you’ll find funds that charge 0.1% or less. Even 0.5% is acceptable. If it’s much more than that, skip to #4, below.
2. When in doubt, opt for simplicity: When choosing investments, a good rule of thumb is to look for the simplest option. In general, more complexity simply results in higher costs, without any corresponding benefit. This is especially true if your employer’s plan offers annuities. In my experience, determining the fees on an annuity is like trying to read the newspaper blindfolded. You’re better off avoiding them altogether. And, if an annuity appeals to you, the reality is that you can always purchase one later.
3. Don’t let the tail wag the dog: Research has shown that asset allocation—the mix of stocks, bonds and other investments you hold—is the single most important factor driving results. For that reason, don’t choose based on price alone. While fees are important, if you have to make a choice, it’s usually better to overpay for an appropriate investment than to get a bargain on one that is not appropriate.
4. Make your voice heard: Ironically, but maybe not surprisingly, a number of mutual fund companies have been sued by their own employees. Their objection: high fees in their own funds. If the fees in your plan seem egregiously high, you shouldn’t hesitate to let your employer know—and it shouldn’t require a lawsuit. They do have the ability to switch providers, and there are plenty of fine options out there.
5. Take your money with you when you leave: While some 401(k) plans do offer outstanding investment options, they are the minority. In general, you’ll be better off taking your 401(k) money with you when you leave an employer. Specifically, you’ll want to do a “rollover” to an IRA, where you’ll be able to upgrade your investments. Rollovers are tax-free, and investment changes within an IRA are also tax-free. Alternatively, if your new employer offers a solid plan, then you can do a rollover into that new plan, skipping the IRA. This has the benefit of leaving you with fewer accounts to manage.