The Real Cost of Long Term Money Management

Could you use an extra $200,000 or so?

How about $1,000,000?

Then lets examine what high expense 401(k) and 403(b) plans are costing plan participants.

A primary or secondary school teacher who invests for retirement through a typical 403(b) plan pays expenses of about 2 percent a year for a variable annuity. This may cost $500,000 in retirement assets.

Fidelity Investments is the nations’ largest 401(k) plan provider. The nine most commonly used Fidelity funds have average annual expenses of 0.77 percent. If you add their U.S. Equity Index fund, which has an expense ratio of 0.18 percent, the average expense drops 0.71 percent. A lower cost plan could mean an additional $300,000 at retirement for plan participants.

            Expenses wouldn’t be an issue if portfolio manager performance offset the costs. But research has shown most managers can’t beat an index. Currently, for instance, the average domestic equity fund with a track record of at least 15 years trails the S&P 500 index by 1.93 percent annually over the last 10 years and 2.20 percent annually over the last 15 years, according to data from Morningstar.

To explore the impact of costs I built a lifetime accumulation model and tested how expenses affect what a worker has at retirement. The model assumes a 30 year old worker with a starting salary of $40,000, an inflation rate of 3 percent, annual raises of 4 percent, and a 401(k) plan in which the employee saves 6 percent of salary with a typical 50 percent employer match. The model grows the income and savings until the worker retires at age 67.

In a100 percent equity investment program with an 11 percent annual return our saver would put aside $309,000 and see it grow to $2.6 million. That’s a lifetime gain of $2.3 million if no money was lost to management fees.

If the same investment is executed through a plan that has costs of 0.75 percent a year, the growth drops to $1.9 million. About $420,000 is lost to the impact of fees.

That’s 22 percent of all growth.

With a 2.0 percent expense burden the accumulation plummets to $1.7 million. Net growth is only $1.3 million. You’ve lost nearly $1 million of growth or 72 percent of the money you might have had. (Comparative figures for a 100 percent equity plan are shown in the table below.)

The Career Cost of Investment Management- 100% Equities

 Sources: Author accumulation model; Ibbotson Associates

            According to the Employee Benefit Research Institute 401(k) plan participants have been investing with a 70/30-equity/fixed-income mix. Without costs, their expected return would be 9.29 percent a year. An annual cost of 0.75 percent takes nearly 24 percent of all possible growth. A 2.00 percent annual cost takes 75 percent of all growth— and costs the employee more than $600,000.  (See table 2 below.)

The Career Cost of Investment Management- Typical 70/30 Portfolio

Sources: Author accumulation model; Ibbotson Associates

            Most participants in the nations 401(k) and 403(b) plans will experience such losses unless management costs are reduced.

            How much reduction is possible?

            Here’s a hint. Using index units from Barclay’s Global Investors, Exxon-Mobil delivers investment options to its employees that cost as little as 0.01 percent to manage.

            Yes, you read that right.

            One-one hundredth of one percent.

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: cottonbro

(c) Scott Burns, 2022