When it comes to investing for retirement, the obvious goal is to accumulate more. But along the way, the principles of doing and spending less can make achieving that goal a lot more attainable. A great example is the all-exchange traded fund (“ETF”) 401(k).
Less Spent in Fees = More Money Invested for Retirement
Until recently, most Americans were in the dark when it came to understanding the fees in their 401(k) – in fact, many weren’t even aware they were paying any.
But thanks to fee transparency laws put into effect in 2012, 401(k) providers are now required to disclose their fees more clearly. With this transparency, investors are coming to understand the impact fees can have on long-term savings. Many are also learning that ETF-based 401(k)s are, on average, much less expensive than more traditional plans that invest in actively-managed mutual funds and insurance-based investments.
Consider two hypothetical 401(k) plans:
- The first plan is comprised of low-expense investments such as ETFs, and all-in including administrative and other typical costs, has 0.75 percent in fees.
- The other is a plan comprised of more expensive investments that are common with actively-managed mutual funds and the fees all-in are 1.75% -- just one percent more than the first plan.
- An employee in the first plan contributes $4,800 a year and achieves a 7% annual return before fees, and an employee in the second plan contributes the same amount and also achieves 7% in annual returns before fees.
Over a 40-year career, the employee in the more expensive second plan would pay roughly 98% more in fees (or $77K) than the employee in the low-expense first plan. Even worse, the employee in the second plan would have $200K less in their 401(k) account ($829.2K vs. $628.9K) at retirement due to the fees paid and the resulting drag on the investment performance. Quite simply, for every dollar paid in fees, that’s one less dollar invested in the markets, which can make a big difference come retirement.
History is on the Side of the Index Investor
While fund managers have made a lot of money charging fees to predict and beat markets, their clients haven’t usually received the benefits.
The indices such as the S&P 500 have historically outperformed the vast majority of actively managed funds over the long-term. ETF-based 401(k) plans take a diversified indexing approach to investing. While ETFs and other index mutual funds do carry expenses, they are typically much lower than actively managed funds and insurance products.
Of course, there are no guarantees when it comes to investing, but the prudent investor will pay less in fees, keep more invested, and we believe be in a better position to achieve greater returns (along with a better nest egg) in the long-run.
In 2014, investors can expect to see a wider exploration of how less can produce even more return on investment in 401(k)s and even greater adoption of all-ETF 401(k) plans.
