Part 2 of “Financial Follies: Common Retirement-Planning Mistakes and How to Avoid Them,” a recurring series about the best savings “levers” to pull depending on where you are in your career and your life. Read Part 1: The Cost of Waiting a Year.
Isn’t it a little strange that we never have to pay our investment managers? When we hire a plumber or an electrician, we pay them an agreed upon amount once they’ve satisfactorily completed the work. Why don’t we ever get a bill from the folks who manage our retirement accounts? This is because for most retirement accounts, fees are deducted from your account balance automatically. Most investors don’t know what management fees they are paying or where to look for that information.
If you happen to be contributing to the PERAPlus 401(k) or 457 Plan, then you’ll be glad to know that you can find out what fees you are paying at any time. You will pay a $1.00 per month administrative flat fee for each plan to which you contribute. Additionally, you will pay a Plan administration asset-based fee of 0.03 percent on each PERAdvantage Fund you invest in. That fee is built in to the total asset-based fee for each fund.
If you have other retirement accounts outside of PERA, you might be surprised to learn just how much you are paying in fees. Over the course of your career, your retirement income could be eroded significantly just due to fees.
In Part 1 of this series we met Brenda, who started her career in 1984 at age 30 and saved 10 percent of her salary for her entire 35-year career. For simplicity, we will assume that Brenda chose to participate in the PERAPlus 401(k) Plan and solely invested in a low-fee fund like the PERAdvantage Large Cap Stock Fund which currently charges 0.08 percent (in reality, she should diversify her assets). Upon reaching age 65 in 2018, she decided to retire. By then, her 401(k) account had grown to $860,864.50.
Now suppose Brenda’s friend, Bonnie, had done the exact same thing, but she didn’t pay attention to investment management fees. Instead, Bonnie participated in a different plan and invested in a fund that charged 1 percent of her accounts’ value as a management fee each year. This amount was deducted from Bonnie’s account balance, so she never actually saw it. Her investments were earning up to 12 percent on average, so paying even a sliver of that in investment management fees couldn’t hurt that much. Could it?
At the end of 2018, with exactly the same contributions and earning the same return as Brenda, but having a higher management fee, Bonnie’s account grew to just $703,323. This is $157,542 less than Brenda’s retirement account. Why the huge difference? The management fees had invisibly eaten into her investment returns year after year. Simply by ignoring the fees, Bonnie had lost about 20 percent of her potential retirement savings. While a 1 percent fee seems like a small amount in and of itself, when you compare it to Brenda’s 0.08 percent fee, you can see that Bonnie paid quite a bit more to invest the same amount of money.
Knowing that reducing investment management fees can yield tremendous savings can be very empowering for the individual investor. So what’s the takeaway? Pay very close attention to fees and compare all your options when you invest.