John Bogle, the late founder of Vanguard, was fond of saying “costs matter.” When he said that, he was usually citing the impact of high costs on how much investors could expect to accumulate for retirement.
Can you say HUGE?
You can get some idea of just how huge by looking at how much a Texas teacher’s retirement assets decline as investment fees rise. (See table below.)
Costs Really Do Matter |
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| This table shows how much spendable, after-tax money you will accumulate in a 403(b) plan if you save $100 a month for 30 years, a total of $36,000 in pre-tax contributions. The figures assume a pre-expense return of 8 percent and a tax rate of 15 percent. | |
| Expense
Ratio |
After-Tax
Spendable $ |
| No cost Ideal | $126,681 |
| 0.05% | $125,402 |
| 0.10 | $124,438 |
| 0.25 | $120,433 |
| 0.50 | $114,532 |
| 0.75 | $108,961 |
| 1.00 | $103,698 |
| 1.25 | $ 98,775 |
| 1.50 | $ 94,025 |
| 1.75 | $ 89,583 |
| 2.00 | $ 85,384 |
| 2.25 | $ 81,413 |
| 2.50 | $ 77,657 |
| 2.75 | $ 74,104 |
| Source: Scott Burns calculations | |
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Flying blind in Texas
Until September 1, investment products for Texas 403(b) plans had to register with the Teachers Retirement System. They also could not charge fees higher than 2.75 percent a year. That wasn’t much of a limitation, but the Texas Legislature thought it would be good if registration were eliminated along with the cap on fees. That means, as I wrote last week, that Texas teachers are now flying blind. Vendors could actually put in new products with higher expenses.
When Texas teachers have friends like the Texas Legislature, they don’t need enemies.
High expenses work for them
Sales people will happily tell you that expenses of 2 percent and more are typical for what they sell. That’s because many of them work for an insurance company. The insurance industry has yet to respond to the reduction in annual expenses that has been under way since 401(k) plans came to life more than 30 years ago. While mutual fund companies have been forced to reduce fees as assets under management have grown, insurance companies have ignored reality.
Why? High fees work for them and their sales force.
Follow the “advice” of one of these folks, and a $100-a-month contribution for 30 years could be only $74,104 rather than the $124,681 it could be if you took a low-expense option. Whatever your actual contributions, the difference won’t be minor.
Finding your way to the low-cost alternative
But isn’t it difficult to actually find low-expense investment funds and put money in them?
No, it isn’t.
Exxon Mobil, which committed to index investing decades ago, now offers a 401(k) plan with expenses under 5 basis points, or 0.05 percent. Texas Instruments has a similar plan. This is what large companies with far-sighted HR departments can do.
Smaller companies don’t have size on their side. So their expenses tend to be larger. Since 403(b) products are sold to individuals, they tend to be burdened with the highest expenses.
That’s the way it is. And the Texas Legislature has voted to make it worse, if possible.
So what can you do? Is there a work-around?
You bet there is.
Don’t be sold a product.
Search out an investment source and buy it. That means looking for a firm that offers a selection of low-cost index funds. Do that and you have a good shot at having expenses well under 10 basis points, or 0.10 percent. The most common way to do this is to invest with a firm that offers exchange-traded funds.
Then you invest in the broadest and lowest-cost funds, such as a total U.S. stock market ETF and a total U.S. bond market ETF.
Trust me, you can do it. As I’ve told readers for years, if you can fog a mirror and divide by 2 with the aid of a pocket calculator, you can be a Couch Potato investor.
Here’s how, step by step
—Need some really specific directions? Read “How to build the basic Couch Potato portfolio anywhere, for next to nothing.”
—Need to know why? Read “The Simplicity Manifesto” and it’s linked columns.
—Need to know the supporting facts? Read “The Lessons of Couch Potato Investing.” While that column is from 2016, the data continues, year after year after year, to show that the vast majority of professional managers can’t beat the index they are measured against, as reported here in March.
Related columns:
Scott Burns, “An alternative to 403(b) plans for Texas teachers,” 10/14/2019 https://scottburns.com/an-alternative-to-403b-plans-for-texas-teachers
Scott Burns, “How to build the basic couch potato portfolio anywhere, for next to nothing,” 09/12/2018 https://scottburns.com/how-to-build-the-basic-couch-potato-portfolio-anywhere-for-next-to-nothing/
Scott Burns, “The simplicity manifesto,” 3/31/2019 https://scottburns.com/the-simplicity-manifesto/
Sources and References:
Bob Pinsani, “Active fund managers trail the S&P 500 for the ninth year in a row in triumph for indexing,” 03/15/2019 https://www.cnbc.com/2019/03/15/active-fund-managers-trail-the-sp-500-for-the-ninth-year-in-a-row-in-triumph-for-indexing.html#
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo:
(c) Scott Burns, 2019 A view from St. Julien de Lampon, France