SUPPOSE YOU WALKED into a restaurant and they handed you a menu without prices. Would you conclude that: (a) everything is free; or (b) something funny is going on?
I doubt anyone would choose the first option. It defies logic. Yet this is how the 401(k) industry routinely operates—and large numbers of people are falling for it. According to a 2018 survey by TD Ameritrade, 37% of 401(k) participants mistakenly believe that their 401(k) retirement plan is a free employee benefit—that it carries no fees. Another 22% aren’t sure whether or not their plan costs anything. And among the minority who understand they’re paying something, one third don’t know where to find the information. Just 27% of all participants actually know what they’re paying. By contrast, the survey found that 96% of consumers know exactly what they pay for inexpensive services like Netflix.
This study came to mind recently as I read the investment menu provided by a 401(k) plan. At the top of the page, in bold type, it carried this helpful warning: “Before investing in any mutual fund, consider the investment objectives, risks, charges, and expenses.” That made sense—but the rest of the page looked like that hypothetical restaurant menu with no prices. It listed dozens of investment options, but said nothing about their associated costs, investment objectives or risks. No wonder so many 401(k) participants believe these plans are free.
Of course, fees are always disclosed somewhere, but the disclosure rules don’t require that this information be easy to find. In the case of the 401(k) menu I saw recently, an employee would have needed to reference a separate document full of fine print. And even after finding that document, it still wouldn’t be easy. The fees associated with each investment option were mixed into the middle of an 18-column-wide table in nine-point type at the back of the document.
What to do? If you’re a participant in a 401(k) or 403(b), here are five tips for navigating this opaque corner of the financial world:
1. Find the fees. As the TD survey discovered, even when people know that they’re paying something for their 401(k), often they’re not sure where to find this information. My recommendation: Start by asking your human resources department or logging on to your benefits website, and perhaps both.
Keep in mind that retirement plans often carry multiple layers of fees. Depending upon the plan, there might be administrative fees, investment fund fees, investment advisory fees, trustee fees, commissions and sales charges. But usually the most significant cost—and the one over which you have the most control—is the fee charged by the funds you select. The term you’re looking for is expense ratio. Ideally, you’ll find funds that charge 0.1% or less. Even 0.5% is acceptable. If it’s much more than that, skip to No. 4 below.
2. When in doubt, opt for simplicity. As you select investments, a good rule of thumb is to look for the simplest option. In general, more complexity simply results in higher costs, without any corresponding benefit. This is especially true if your employer’s plan offers annuities. In my experience, determining the fees on an annuity is like trying to read the newspaper blindfolded. You’re better off avoiding them altogether and buying other investments in your retirement plan—assuming that’s possible.
3. Don’t let the tail wag the dog. Research has shown that asset allocation—the mix of stocks, bonds and other investments you hold—is the single most important factor driving results. For that reason, don’t choose based on price alone. Yes, fees are important. But if you have no other choice, it’s usually better to overpay for an appropriate investment than get a bargain on one that isn’t right for you.
4. Make your voice heard. Ironically, but maybe not so surprising, a number of mutual fund companies have been sued by their own employees. Their objection: high fees in their own funds. If the fees in your plan seem egregiously high, you shouldn’t hesitate to let your employer know, and it shouldn’t require a lawsuit. Your employer has the ability to switch providers—and there are plenty of fine options out there.
5. Take your money with you when you leave. While some 401(k) plans offer outstanding investment options, they’re in the minority. You’ll usually be better off taking your 401(k) money with you when you leave an employer. Specifically, you’ll want to do a rollover to an IRA, where you’ll have far more investment choice, including investments that likely have much lower costs. Both rollovers and investment changes within an IRA are tax-free. Alternatively, if your new employer offers a solid plan, you can skip the IRA and do a rollover to your new employer’s plan. This has the benefit of leaving you with fewer accounts to manage.
Adam M. Grossman’s previous articles include Private Matters, Don’t Overthink and B Is for Bias. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.