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Ignoring fees in your 401(k) can sap savings

Bet if I asked, the odds are good that many people could tell me to the penny what they just paid for a gallon of gas. So how much did it cost you to invest in your 401(k) last year? I don't know myself. Likely you don't know either.

Over the years, most of us have heard that if we just start saving a few hundred dollars a month in our 20s, we can retire a millionaire. Compound interest is your best friend.

But what about the fees in a 401(k)?

"I don't think they go out of their way to explain the consequences of what seems like a small, innocent fee," said Martin Smith, the correspondent for "The Retirement Gamble," produced for PBS's Frontline.

Fees create what some call a reverse compounding and reduce your nest egg over time. The higher the fees, the greater the hit.

The Frontline piece took a hard look at how 401(k) savings are falling short for many people. One expert pointed out that the 401(k) is one of the only products that Americans buy without knowing the price of it.

The focus on fees in 401(k)s is relatively new. Francis Vitagliano of the Center for Retirement Research at Boston College compares the lack of discussion to the time when food companies first had to put ingredients on labels. It took awhile before people started reading food labels and being concerned about sugar and salt, he said.

"Expenses are a very important factor in the return on investments over a very long period of time," Vitagliano said. "My guess, in a year or two or so, we'll be a little bit more sensitive to it."

Take 2 percent in fees. In the Frontline episode, Jack Bogle, the founder of Vanguard, said that during 50 years of investing, the consumer with a 401(k) packed with 2 percent in annual fees — and a gross annual return of 7 percent — would lose almost two-thirds of what he or she would have had.

But the 2-percent-fee example, industry experts argue, is an extreme for the 401(k) universe.

Sean Collins, senior economist for the Investment Company Institute, a mutual fund trade group, said the weighted average expense ratio was 0.63 percent for 401(k) assets in equity funds and 0.50 percent for bond funds in 2012, the most recent data available. And the trend has been heading downward.

Vanguard gave me an example that shows that during a 30-year run, an investment of $100,000 could build to $532,899 — under a low-cost scenario in which annual costs are limited to 0.25 percent.

By contrast, the investment would end up at $438,976 under a higher-cost scenario in which the annual costs were 0.9 percent.

That's a cost of almost $94,000 in 30 years. Or you'd end up with a nest egg that's reduced by nearly 18 percent if you opted for higher-cost funds.

Robert Hiltonsmith, policy analyst for a public policy group in New York, said some investors may mistakenly believe that higher-fee funds are going to give them higher returns. But a fee structure doesn't offer a clue to future returns. Lower-cost index funds can be just fine for many 401(k) investors, he said.

Susan Tompor is the personal finance columnist for the Detroit Free Press.

Ignoring fees in your 401(k) can sap savings 05/05/13 [Last modified: Sunday, May 5, 2013 5:40pm]
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