401K Fees Are Too High. Here’s What to Do.
For being one of the richest countries on the planet, it’s rather puzzling as to why Americans can’t manage to save any of their money. Ask any American about their savings, and you’ll probably get some response which includes the word “401k”. For our international readers, a 401k is a retirement plan that any American who showers before going to work is likely to have. You contribute some of your paycheck before taxes into an account, then choose from a pre-selected list of funds to allocate your monthly contributions towards. This is where the problem starts. Most people who have a 401K are paying too much in investment fees. We’ll tell you why, and how to fix it. First, the why.
The people that usually coral these 401k plans together are the Human Resources (HR) department. (Think about that for a second. You’re entrusting your entire financial future with some of the most inept people to be found in any organization.) Part of setting up a firm’s 401K plan is determining which selection of investment products to offer the employees. While this is often the decision of external 401K providers, the options often contain high-fee products or even something horrible called “load funds”. According to Investopedia:
A load fund is a mutual fund that comes with a sales charge or commission. The fund investor pays the load, which goes to compensate a sales intermediary, such as a broker, financial planner or investment advisor, for his time and expertise in selecting an appropriate fund for the investor.
Many 401k participants out there are paying for someone’s “time and expertise” in selecting a bunch of high-fee funds instead of taking that money and allocating it immediately to low-cost options. How do you know which options are the low-cost options? You need to read the fact sheets for each fund, or use this quick tip that will save you a lot of money.
If anything in your fund list says “Vanguard”, it’s probably a safe bet you’re not getting swindled on fees. Sometimes referred to as the “low-cost king“, Vanguard offers some of the lowest fees in the business because of a little thing called “economies of scale”. How do they do it? By having $5.1 trillion in Assets Under Management (AUM) and being the world’s largest fund provider. If they charged just 0.10% to manage that money, that would mean yearly revenues of over $5 billion. Of course most fund providers don’t charge 0.10%, they charge 6X that amount as seen in the below chart courtesy of the Investment Company Institute (ICI):
That downward trend is a good thing, and reflects the average fees based on what people are actually paying. In other words, the slow move of investment dollars from high-fee funds to low-fee funds is what is causing the downward trend, not just that fees are being lowered across the board. Now, the above chart only represents equity funds (funds that contain stocks only). Since that’s where the majority of 401K investment dollars are placed at the moment, that’s where we’re going to focus on.
After you’ve checked to make sure you have Vanguard selected as an investment option, the next thing to do is go see if any of your funds are “active funds”. These are funds which try to beat a benchmark, and fail miserably at it while still getting a paycheck. This means you’re probably better off allocating those dollars to passive funds (funds that track a benchmark) – but only if Exchange Traded Funds (ETFs) are not an option.
ETFs are essentially funds that can be bought and sold just like a stock, and are known for having lower fees than passive mutual funds. What’s the point of a high-fee passive mutual fund if instead you can invest in an ETF which charges on average 0.44%? All the major index-tracking ETFs charge a whole lot less. The popular Nasdaq ETF tracker, (QQQ), charges 0.20% and the even more popular S&P500 tracker, (SPY), charges just 0.09% with assets under management of $62.8 billion and $255 billion respectively. Why on God’s green earth do people keep handing over their hard earned money to mutual fund providers, when there are excellent low-fee ETFs available like these two examples?
That’s because if we asked a sample of 401k participants if they could recite the names of their 401k funds and the investment fees each one incurred, probably a fraction could. Let’s not be so quick to blame HR or those greedy fund mangers for the 401K fee debacle so quickly. 401K holders need to be accountable for their own financial future, but we all know that’s easier said than done. You’re busy people with families you love, jobs you hate, and you just want someone to sort this out so you can spend some “me time” reading about how Bey and her middle-aged cohorts, slayed it at #Beychella a few days ago. One quick fix which is gaining a lot of momentum is a company we’ve talked about before called Blooom.
Founded in 2013, Kansas-based Blooom has taken in $13.2 million in funding so far to develop a service that charges you $10 a month to optimize your 401K, no matter how big your account is. While a traditional robo-advisor has their own investment vehicles, Blooom uses your existing 401K plan and selects which funds in the plan are best to allocate your money towards, especially when it comes to investment fees. Like a robo-advisor, they obviously pay attention to the whole “asset allocation” thing and make sure that people who are closer to retirement have more fixed income exposure. Boring stuff like that gets sorted for you automagically. Just choose your 401K provider from the list and the system will get to work telling you how much in investment fees you’re being milked for with your current allocation settings:
You can read our last article on Blooom which talks about the process, but we want to talk more about how successful they’ve been since then. According to a press release issued earlier this year, Blooom has already doubled assets under management to over $2 billion less than six months after reaching the $1-billion milestone, and a full year faster than it took popular robo-advisors Betterment or Wealthfront. Over 46% of people who took Blooom’s free 401k analysis signed up as clients which has led to more than 16,000 people using the system today. 16,000 is a pretty good sample size, and here’s what they found out:
- 79 percent of 401ks were racking up too much in hidden investment fees;
- 53 percent of 401ks were not properly aligned to retirement goals; and
- 39 percent of 401ks were invested in one or more target-date funds with an average fee of 45 percent higher than alternative investments.
There’s a 79% chance you’re giving away your savings to some third party. Stop for a second and think just how crummy it is that your human resources department doesn’t care about you enough to offer 401k optimization as a service. If they did, then maybe Blooom wouldn’t have already amassed over $2 billion in assets under management (AUM) becoming the fastest growing robo-advisor there is today. Of course back of the napkin math doesn’t make the Blooom business model seem that lucrative. At $10 a month from each of their 16,000 401K participants, that’s a run rate of only $1.92 million a year. But that’s because they’re just getting started. Bloooom has only captured a minuscule fraction of the potential market. According to ICI, 401K plans held an estimated $5.3 trillion in assets at the end of 2017. This means Blooom has only captured 0.04% of the possible market, meaning there is tremendous upside for their business model provided they can scale quickly.
You can probably guess who else is benefiting from Blooom’s efforts. Companies that offer low-cost funds like Vanguard. Unfortunately, you can’t buy shares in Vanguard because they’re a privately held company. While you could invest in other providers of low-cost products like Blackrock, or any other asset manager out there, you need to be aware of the impact that robo-advisors like Blooom will have on these firms that have been raking in money hand over fist from mutual fund investment fees. Take for example, T. Rowe Price (TROW). We’re shareholders as part of a diversified dividend growth investing strategy, and T. Rowe is one of the four financial firms we’re holding, largely because they’ve managed to increase their dividend every year for 62 years in a row. That’s a remarkable accomplishment, but what happens when everyone starts flocking to low-fee investments because of companies like Blooom? Maybe that’s why T. Rowe published a 50-slide investor deck a few months ago to assure investors they have a plan to address the 16-year downward trend of lower fees.
If you are regularly contributing to a 401K and you’re not interested in actively managing your own investments, then letting Blooom take over is your best option. They will do everything and you pay them $10 a month to do it. If you have a 401K sitting there and you’re not contributing to it, roll it over to a robo-advisor like Betterment which we’ve talked about before. And the next time you talk to your “local Human Resources generalist”, ask them why they ever let this situation happen in the first place.
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