I recently met up with an old high school friend of mine. He’s the smartest person I’ve ever met. When a teacher would explain a new and difficult physics concept, he would shrug his shoulders and say under his breath, “Of course it works that way. How else could it be?”
My friends and I thought, this guy could cure cancer someday.
[ad#Google Adsense 336×280-IA] Instead, he crunches numbers for a financial institution. I’m sure he makes good money doing it. Brains like his usually get paid well.
Investing can be incredibly complex. And that’s not an accident.
The harder it is to understand, the more you need paid experts to guide you. All that advice and service and all those complex products cost money, big money.
But you can cut your investment costs with a few simple steps. And save yourself hundreds of thousands of dollars.
Last week, Mark Ford wrote about why he prefers to let someone else manage his money, even if it means paying him $50,000 per year in fees. To him, it’s worth it because it frees him up to do other things instead of spending time on his portfolio.
My parents do the same. They’re not particularly interested in the markets. It’s worth it to them to pay the 1% per year fee to have someone else handle their investments.
And if you’re like them and you don’t have the time or desire to manage your own money, you’ll sleep better at night letting someone else do it for you. Even if you have to fork over a substantial amount in costs.
But if you’re reading Investment U, you certainly have the interest to do it yourself. So it would be nuts to pay anyone thousands of dollars per year to do something you can probably do better yourself.
Hope You Didn’t Need an Extra $155,000
How much would a broker who charges 1% a year cost you?
Let’s say you have a portfolio worth $250,000 and that portfolio grows by the market average of 7.48% per year. Over the next 10 years you’ll pay out over $36,000 in management fees.
A recent study by think tank Demos showed that an average two-earner household pays $155,000 in 401(k) management fees over their lifetime. And if you’re a higher-income household, you shell out almost $278,000.
Sometimes, there’s not much you can do about it. I once had an employer whose benefits manager knew nothing about investments. She selected a 401(k) program whose fees were exorbitant. When I complained, she asked me to provide her with some lower-fee alternatives.
I did. And she did absolutely nothing about it.
If your 401(k) fees are too high, talk to your benefits manager. Maybe she’ll be more on the ball than mine was.
Let me be clear. If your employer matches any of your contributions, you should invest in a 401(k), whatever the fees. That’s free money. You’ll still come out ahead.
You also get a nice reduction in your taxable income. If you make $100,000 per year and contribute $10,000 to your 401(k), your taxable income is now $90,000. So not only are you saving for retirement, but you are no longer paying taxes on the money you save. If you’re in the 28% bracket, that will save you $2,800 on your federal taxes.
But there are some steps you can take to lower the amount you’re paying your 401(k) manager if the fees are too high.
Consider an IRA. After you’ve maxed out your employer match (again, it’s free money, so take it), consider investing in an IRA with lower fees rather than in the 401(k).
In an IRA, you can choose very low-cost index mutual funds such as the Vanguard Total Stock Market Index Fund (Nasdaq: VTSMX), which has an ultra-low expense ratio of just 0.17%. Compare that to American Century Equity Growth C (Nasdaq: AEYCX), another fund in its category. In the American Century fund, you’ll pay 1.68% per year. Not surprisingly, the fund performed more than a full percentage point worse per year over 10 years than the Vanguard fund.
If you had invested $10,000 in the American Century fund 10 years ago instead of the Vanguard fund, today you’d have $2,500 less to show for it.
Find the lowest expense ratio funds in your 401(k) offerings. In my own 401(k), I have two choices in the small-cap category.
I can go with the Principal Small Cap S&P 600 Index R5 (Nasdaq: PSSPX), which has an expense ratio of 0.42%. Or I can go with the Fidelity Advisors Small Cap A (Nasdaq: FSCDX) and its 1.06% expense ratio.
Guess which one I own? If you said the Principal fund, you are correct. And the returns of the Principal fund have beaten the Fidelity fund over the past three and five years.
Be sure to talk with a tax advisor before making any modifications to your retirement investing, as the changes could have important tax consequences.
You work too hard for your money to give it to someone who likely won’t do as good a job as you can. And I’m sure you can use an extra $155,000 in retirement. If you don’t need it, I’m sure my smart friend will find some ways to take it from you.
Source: Investment U