I normally write something I feel can help most investors. Occasionally you run across something that just needs to be shared. This eye opening new report from the Demos Organization, authored by Robert Hiltonsmith, is compelling. Highlights below, link to the report at the end.
Though your retirement or bank accounts statements contain no evidence of it, everyone who has an IRA, 401k, or any other individual retirement savings account pays a variety of fees every year. But because these fees are taken “off the top” of investment returns or share prices accountholders generally have no idea how much all of this is costing them.
These fees can be substantial: over a lifetime, fees can cost a median-income two-earner family nearly $155,000 and consume nearly one-third of their investment returns. Worse, these fees are often excessive and financial services companies can get away with charging higher-than-necessary fees for a number of reasons, namely: the savers’ lack of information, the inefficiency of financial markets and individualized investing, and the substantial costs—both in money and time—associated with switching between investment brokers.
This brief sheds light on the hidden costs of 401(k)-type individual retirement plans, details the different types of fees paid by the consumers, and uses an example investment from Demos’ own 401(k) plan to illustrate these fees’ heavy burden on the average account-holder. Using industry data on fees, the brief estimates the high costs of 401(k) fees to a model family over a lifetime of saving for retirement. The brief also explains the causes of the nearly universal excessive fees that investment firms charge to savers, and argues for a wholesale reform of this country’s broken private retirement system.
KEY FACTS
LIFETIME FEES
- According to our fee model, a two-earner household, where each partner earns the median income for their gender each year over their working lifetime, will pay an average of $154,794 in 401(k) fees and lost returns.
- A higher-income dual-earner household, one where each partner earns an income greater than three-quarters of Americans each year can expect to pay an even steeper price: (as much as) $277,969.
OTHER FEE FACTS
- The median expense ratio of mutual funds in 401(k) plans was 1.27 percent in 2010.
- Trading costs vary from year to year, but have been estimated to average approximately 1.2 percent a year as well.
- In the long run, the average mutual fund earns a 7 percent return, before fees, matching the average return of the overall stock market. However, the post-fee returns average only 4.5 percent, meaning that, on average, fees eat up over a third of the total returns earned by mutual funds.
- Smaller 401(k) plans have higher average fees than larger ones. The median expense ratio for plans with less than 100 participants was 1.29 percent, while for plans with more than 10,000 participants, it was 0.43 percent.
TYPES OF 401(k) or IRA FEES
- Expense Ratio Fees: This ratio incorporates the administrative, investment management, and marketing fees charged to savers. Because these fees do not vary much from year to year, they are reported as a static expense ratio and listed both in a retirement plan’s summary documents and the individual prospectuses of each mutual fund in the plan.
- Trading Fees: The costs incurred by a mutual fund when buying and selling the securities (bonds, stocks, etc.) that comprise the fund’s underlying assets. Investment managers of mutual funds pay a fee each time they buy or sell one of the securities that comprise the underlying assets of the fund, and they pass these on to savers via the funds’ share prices. Trading fees vary from year to year depending on the frequency with which fund managers buy and sell the funds’ assets.
Download the report here!
As always, talk to your advisor to find out what you can do to minimize the impact of fees on your retirement nest-egg.
CBlakely CFP®, CTFA 05/2012
Over the next several years the challenges of collecting sufficient income, due to low current interest rates, may be somewhat lessened by taking a more tactical approach to fixed income investing. Current yield is a big component of investing for income investors and there are opportunities available for investors to achieve attractive current and total returns.
The perception for years has been that emerging markets debt as an asset class had been one of high volatility of returns. But look back to the crash of 2008 and remember that emerging markets experienced less of the effect of the crash and moved out of it faster than the U.S. did.
Looking back at 10-year annualized returns for major markets, the average annual total return for emerging markets debt was over 10 percent, while its standard deviation of returns was less than 10 percent. Contrast that with long-term U.S. Treasuries with had comparable returns but with a standard deviation of about 12 percent and Large Cap Domestic Equities with a 10-year average annual return of less than 5 percent but a standard deviation of over 15 percent.*
Another factor is that valuations for this asset class remain attractive. A typical valuation metric for bonds is to look at the yield of the security compared to the yield of a U.S. Treasury security with a like maturity date – called the spread. The median spread of high-yield debt over the past 30 years has been about 500 basis points (five percent). Currently, that spread is around 600 basis points. If the economy recovers, during good economic times that spread generally narrows to 300-400 basis point range. This is positive for the price of the bonds.
Many emerging economies benefit from a younger demographic and a fast growing middle class. Also, many of these countries live within their means and have reached a point where they are self-funding.
Talk to an advisor for detailed information and to see whether adding this asset class to your portfolio makes sense. There are real risks associated with emerging debt, this is not a “set it and forget” it strategy.
CBlakely CFP®, CTFA 05/2012
Source: Morningstar data as of 12/31/2011
Standard deviation is a statistical measure of historical volatility, the higher the standard deviation, the greater the volatility.
The current priority at the Federal Reserve is to keep rates low to help the broad economy, especially housing and the money center banks, get healthy again. However, this has a deleterious effect over the long-term on savers and income investors. With short-term interest rates near zero and the Fed committed to keeping rates low for the next couple of years what is an income investor to do? Do you throw out your risk tolerance parameters and plow into stocks?
The short answer is no. You can maintain your risk profile while adapting to the current environment by embracing creative solutions in small percentages in your portfolio. Many solutions used in the past are probably not the solutions that will serve you best over the coming decade. Remember a successful portfolio funds an investor’s current and or future needs or liabilities, anything short of this is a failure.
For high net worth individuals the use of charitable trusts can create a satisfactory income stream. Tax breaks for some charitable trusts can help high net worth investors divest highly appreciated assets tax-free. The trust income goes to the investor and eventually the remainder goes to the charity. For the majority of investors this is not a prudent option.
There are several opportunities for investors not interested in trusts. First, mortgage backed securities funds are an option. These funds contain AAA/Aaa rated mortgage securities backed by the guarantee of Fannie Mae, Freddie Mac and Ginnie Mae. There are many low cost funds available that offer access to mortgage backed securities. The yields are in the 4.0 to 4.5 percent range.
Next, income investors might consider adding a small percentage of high dividend equities to the portfolio. One example might be adding a select dividend fund or a utility fund to your portfolio for the current income. Both types of funds offer a current dividend yield of 3.5 to 4.0 percent depending on the fund family and fund makeup.
Finally, the fundamentals within the high-yield bond market are strong. That is reflected in yields which are currently around 6.5 percent and approaching historical lows. The main risk to the health of corporate fundamentals would be a meaningful slowdown in the U.S. economy. Base case is that the economy does not come off the rails. The most probable economic outlook is for a slow-growth environment with reasonably steady interest rates. However, the economy is not robust enough, nor are yields high enough, to protect high-yield investors against certain macroeconomic shocks. Macroeconomic driven events - such as, the European debt situation, China's slowing economy, and geopolitical events in other parts of the world - will cause short-term gyrations in the funds value.
If your portfolio is predominately fixed income, adding a small percentage in each of the three types of income investments to your portfolio may actually decrease the overall risk profile through diversification. Minor adjustments can add value to your portfolio.
As always, to see the impact this strategy would have on your investments and cash flow discuss this with your (accredited) financial advisor.
CBlakely CFP®, CTFA, CMFC 05/2012
Sources: Morningstar, iShares
