Personal Finance

The Average American Is Paying Too Much in 401(k) Fees. Are You?

It's been widely suspected since at least the mid-1960s that actively managed mutual funds generally underperform passive, low-fee broad-market indexes. Fees are one of the main reasons for this, but even excluding the depressing effect of fees on a fund's returns, the funds that charge higher fees tend to perform worse than funds that charge low fees. A seminal 2009 study on the relationship between mutual fund fees and performance found "a puzzling negative relation between before-fee risk-adjusted performance and fees in a sample of U.S. equity mutual funds: funds with worse before-fee risk-adjusted performance charge higher fees."

Needless to say, this pivotal finding shows the importance of knowing how much your 401(k) plan charges in fees.

Do you know what you pay in fees?

Figuring out what you pay in fees seems easy in theory, but it's unfortunately more complicated in practice.

First of all, the variety of fees tends to mask their cumulative impact. There are plan administration fees, investment fees, and individual service fees, among others. Secondly, 401(k) administrators often couch their explanation of fees in long-winded and esoteric language; plan disclosures routinely exceed dozens of pages.

It's up to you to figure out your 401(k) plan's expense ratio. You can do this by adding up all of the fees assessed against your account in any given year and then dividing them by the value of the account's holdings. According to the 401k Averages Book , this ratio should fall between 0.31% on the low end and 1.88% on the high end.

The table below illustrates the impact fees have on the value of a hypothetical 401(k). It shows what happens over 25 years to a one-time $10,000 investment that earns 10% before fees under three different fee scenarios.

Expense Ratio Scenario Value of $10,000 Invested for 25 Years at an Average Annual Growth Rate of 10%
0.00% $108,347
0.31% $100,966
1.88% $70,413

Source: Selena Maranjian, If Your 401(k) Plan Is Doing This, You're in Trouble.

As you can see, fees matter a lot when it comes to the long-term value of your 401(k). It isn't unreasonable to conclude that they can spell the difference between retiring in comfort and having to scrimp in save later in life.

What can you do if your plan's fees are too high? You can explore your plan's alternative offerings and choose the lowest-cost options, typically broad-market exchange-traded funds. Or, if there aren't sufficiently attractive alternatives, you can minimize your 401(k) contributions and redirect that money to an IRA or other type of retirement account. Either way, you'll thank yourself later by locking in a much more comfortable retirement.

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The article The Average American Is Paying Too Much in 401(k) Fees. Are You? originally appeared on Fool.com.

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