What Banks Don’t Tell You About Your 401k
If you’ve ever worked in corporate America, odds are you’ve had a 401k. Recently, my employer switched 401k providers, and after transitioning to our new provider, we were offered an informational session about the new 401k plans. I attended thinking I might learn something (spoiler alert: it was so boring my eyes glazed over and I love talking money).
Throughout the meeting, I realized that the advisor in charge of “educating” us about our 401k plans only talked about contributions and retirement savings calculators showing that my retirement funds “need attention” (I still don’t know how they decide this without asking me what my expenses in retirement will be). They never once mentioned anything about fees and how they can dramatically affect your account balance.
Translation: they were teaching us how to make them more money.
In this blog, I’m going to tell you some of the ways that banks are profiting off of you, and what you can do to make the most of your 401k account.
Fees
The biggest and most expensive secret your 401k provider is hiding from you is the fees you pay. Unfortunately, some of these are unavoidable, particularly the administrative fees. Short of convincing your HR department to switch providers, there’s not much you can do about these.
But, there is an important fee that you can control. It’s called an Expense Ratio. Every investment has an expense ratio, which is an annual fee that you pay to cover the expenses involved in managing that investment. I’ll get more into these later, but the short version is you want to pay as little as possible. I pay about 0.035% for my investment expense ratio.
2. Rate of return matters
What if someone told you that you could do your exact same job for double the salary? Same work, same responsibilities, double the pay. Sounds amazing right? This is why rate of return matters.
Of course, there’s no predicting for certain what the stock market is going to do in the future. But if you look at the past 5-10 years of performance you can get a pretty good idea of what will happen in the future. By targeting investments that have higher rates of return, you are making more money with the same contributions.
Take this example:
My company auto-invested me into a Target Date Fund. A Target Date Fund has a balance of stocks and bonds, which auto-adjust based on your age. The idea is that it is more aggressively invested in stocks when you’re younger, and more conservatively invested in bonds as you get closer to the retirement age of 65.
The Target Date Fund my company invested me in was 2060, which is nearly 40 years in the future.
Target Date Fund for 2060, nearly 40 years from now, had lower returns than the S&P 500.
Since this Target Date fund “expires” in about 40 years, I want it to be aggressively investing in stocks to get higher rates of return. I have a long time until I retire and I want to take risks to help my money grow more. What’s more, if the market has a bad year, I still have plenty of time to recover.
With half the fees, and a higher return, I choose to invest in my 401k’s S&P 500 index.
The fund I invest in tracks the performance of the S&P 500 (the S&P 500 is often what people mean when they talk about “The Market”). It has higher returns and lower fees than the Target Date fund for my retirement year.
Follow with me for a moment while I do some math. I promise to keep it simple.
Let’s say I contribute $5,000 this year to my 401k. Check out how how the amounts change depending on my investments.
Making a $5,000 contribution with an 8% return will leave you with $5,395.68 - not bad.
Making a $5,000 contribution with a 12% return and lower fees will leave you $5,598.04. Over $200 more than the Target Date Fund.
Difference: $202.36
As you can see, by choosing the index that tracks the S&P 500 index over a Target Fund, you will end the year with $202.36 more in your account with no extra effort! I love free money, don’t you?
In both scenarios you contribute $5,000 of your paycheck, so the amount of money you are putting in is the same, but you have an extra $200 by simply choosing a different investment. Imagine how much more that would be if you continued this process year after year, allowing the extra $200 to gain even more interest.
My point is not that Target Date funds are bad. In fact, they are a great investment for people that just want to set their money aside and forget about it for a decade. But my goal here is to show you that taking a few minutes to look at your investments’ expense ratios and 10 year rate of return really can make a BIG difference in your money. An hour of your time could literally turn into tens of thousands of dollars for your retirement years.
The common industry advice (which I heard several times in my meeting) is to contribute 15% of your salary to your 401k (including employer match). But NO ONE talks about the fees you pay and how they can impact your account balance. Banks profit off of shaming you for not saving enough for retirement. The more money you contribute, the more fees they can charge you. And if you don’t pay attention to what you’re invested in, they’ll happily continue taking your fees.
This isn’t to say you shouldn’t use your 401k. You should definitely contribute to a 401k if you have the option. But, you should make informed decisions about where your money is going. Investing in a fund that has a higher return and lower fees means your money is working harder, growing faster and making you richer.
Whether you’re opening your first 401k, or finally ready to dust the cobwebs off your current one, taking 20 minutes to look at your investments’ expense ratios and 10 year returns is time well invested.
Action Items:
If you have an existing 401k, log on and look at your investments. What are you actually invested in, if anything at all?
Try to find the expense ratios for your investments. If you can’t find them, call your 401k provider and ask. Expense ratios can vary a little, but just for comparison, I pay 0.035% for mine. If you’re paying 1% or more, get out immediately! Fees of 1%+ are considered very high.
Check the rate of return on your investments. This doesn’t involve any math. Most banks will have a little chart under the investment that shows 1 year, 5 year and 10 year returns. Remember, the stock market can go up and down but the average return is about 8%. What’s the rate of return on your investment over the past 10 years? Is it more or less than 8%?
For more info on benefits of having a 401k check out my post: What Types of Retirement Accounts are Available to Me?
All of the information in this article is my personal opinion, and not to be taken as investing advice. If you want specific advice regarding your personal situation, speak with a certified financial planner.
Your life may not be perfect, but it is imperfectly yours. The only way to live it is your way.
