Wednesday, November 12, 2014

Many 401(k) Participants Upon Retirement Will UNWITTINGLY, UNNECESSARILY and UNKNOWINGLY Leave Several Hundred Thousand Dollars on the Table

In a recent post, we wrote about the problems associated with the vast majority of employees' ignorance about how their 401(k) plans operate. The post was titled "401(k) Fees ... Vastly More Expensive Than Commonly Believed."

So today let's dig a little deeper to see how all this ignorance is costing participants lots of money that we could otherwise put to very good use.

But before discussing plan fees and expenses and how they may negatively impact the participant's ending balance by ~$200,000, let's consider how a participant's investment decisions may cost our participant another ~$200,000, or a total of ~$400,000 or more. 2% for fees and 2% for investment returns equal 4% of the total, and that's not chump change, whatever the dollar figure.

For example, over 40 years (i.e., age 25 to age 65) and due to compounding (the rule of 72), $10,000 invested initially at a 9% rate of return (historical average of stocks) will grow to twice as much as a blended investment of 50% stocks (9%) and 50% bonds (5% for our assumption). And it will end up being four times as much if the typical plan's management fees and expenses are included.

Thus, in an actively managed self directed account or a passively managed S&P 500 index fund, we could reasonably expect that $10,000 to grow to $320,000 at 9% instead of the 'normal' $80,000 at 5% (5% is the blended 50/50 stock/bonds return of 7% minus the 'normal' 2% in management fees and expenses).

When it comes to 401(k) investing, ignorance is not bliss.

Most employees have 401(k) plans to which they and their employers contribute in order to supplement Social Security payments during retirement. So far, so good.

But not many employees, and for that matter, employers, know what's happening under the hood. Taken as a whole, expenses often amount to 30% of more of the nominal returns generated. That's right --- 30%. And not the average 1% that's generally believed to be the cost. {See prior post.}

Over a career, the total overcharge to the individual may range from ~$150,000 to ~$300,000, or enough to buy a nice house.

Finding, and Battling, Hidden costs of 401(k) Plans has the story of one man's attempt through litigation to get his money back and then some:

"LIKE millions of retirees who assumed their companies had taken care of them, Ronald Tussey never thought that his retirement plan might be flawed. He trusted his company so much he kept his money in his 401(k) long after he left.
Having worked as an engineer for 37 years, ultimately at ABB Inc., where he retired 11 years ago, Mr. Tussey said he never paid much attention to the fees in his retirement plan and “assumed the company was looking out for my best interests.”
But after seeing a television program on the negative impact that 401(k) expenses can have on retirement savings, he hired a lawyer, who filed a class-action lawsuit in 2006 against ABB and plan administrators. . . .
Like many employees, Mr. Tussey, now 70, was told that his retirement plan was “free,” even though middlemen were deducting expenses from his savings.
In many retirement plans, a significant amount of future retirees’ funds are devoured by fees. According to a 2012 study published by the progressive think tank Demos, high 401(k) fees can drain $155,000 from an average household over a lifetime. Higher-earning households can lose even more — up to $278,000. . . .
Despite a federal requirement that plan fees be disclosed and numerous reports on 401(k) plan flaws, few employees question how much they are being charged . . . . there are lessons here for current and future retirees.
At the heart of the suits are a raft of obscure fees and services that few employees will be able to discern. Unless employers absorb all of the expenses, you must pay the bills for plan record-keeping, administration and fund management.
Most fund expenses not covered by employers are deducted from plan assets — the money pooled for your retirement — and show up in an “expense ratio,” which is expressed as an annual percentage of what you have invested. If your plan charges 1 percent on $100,000 invested, you are paying $1,000 annually in fees. . . .
A St. Louis lawyer who represented Mr. Tussey and plaintiffs in other 401(k) suits, said there were some common elements in plans that could indicate lofty expenses and conflicts.
Even though no extra service may be provided, record keepers may reap higher compensation just because total assets increase from year to year. This number can be hard to find and even tougher to examine. . . .
Also look at revenue sharing. This is an often complex arrangement where a fund manager “shares” some of the fees it receives from fund expenses with other service providers, such as brokers. This practice, though declining, is particularly insidious since it provides little or no value to employees. It is derisively referred to as a “kickback” by 401(k) critics. . . .
And keep an eye out for unnecessary fees that may be eating up your nest egg. These include commissions, also known as “loads,” 12b-1 marketing fees, insurance-related charges, “wrap” fees and transaction expenses. . . .
Except for fund management fees, it’s not easy to spot a blatant overcharge. . . . most employees “are not aware of these fees and don’t learn much from their plan statements.”
Summing Up

Got your attention yet? If so, good. Then consider a few suggestions for your long term financial health and well being.
In addition to a passive low cost S&P 500 index fund, a self directed 401(k) investment approach is another excellent low cost way to materially enhance stock market returns over a working career.
By so doing, the employee can avoid that $150,000 to almost $300,000 lifetime earnings shortfall resulting from the typical plan's many unnecessary and largely hidden above described charges. Throw in an all blue chip stock portfolio compared to a 50/50 blend and the difference is probably going to be twice that $150,000 to $300,000 differential.

And that's not chump change, whatever the case. So when investing in a 401(k) plan, do yourself a favor and use MOM (my own money) rules, because the doctrine of Caveat Emptor (let the buyer beware) is in full force and effect.
It's well worth the effort to take the time to learn the basic facts about 401(k) plans and investing. Your financial future depends on it. 
That's my take.
Thanks. Bob.

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