It’s a well-known fact that defined-benefit pension returns
regularly outperform 401(k)s. Hands down. These old-style pensions, which are
rarely offered to employees anymore, were are managed by outside professionals.
But in the ownership society of 401(k)s, you are supposed to know as much as
professional managers, make prudent choices and get the economies of scale that
they do. You’re started off wearing lead slippers and your hands tied behind
your back. No wonder millions aren’t saving enough for retirement.
In a recent study by the Center for Retirement
Research at Boston College, returns on 401(k)s and IRAs were compared to
defined-benefit pensions. Individuals managing their own retirement money
consistently lagged the pros. Pension returns topped 401(k) performance by 0.7
percent from 1990-2012, according to the center. And pension returns were
double those of IRA investors during that period. While that doesn’t sound like
a lot of money, in the retirement investing world, it’s a dramatic gap.
Let’s say you had $100,000 and invested $1,000 a year at 5%
annual return. You’d have about $400,000 at the end of 30 years thanks to the
miracle of compound interest, according to the Bankrate.com return
calculator. That’s what a professional could probably do without much effort
given current rates of return. On your own, you’d do much worse. Investing in
your IRA, getting a 2% net return, you’d have only $205,000 after three decades
— nearly half as much with the pension. That’s often the difference between a
comfortable and undignified retirement.
Why is there such a gap between pensions and self-investors?
The pros can manage a lot of money cheaply. Every one of their costs is at at
institutional rate. They get lower commissions on buying/selling securities and
can manage for much less. In the 401(k)/IRA world, money managers are charging
you “retail” and often overcharge for sales, management and securities
commissions. That’s why your net return is so paltry.
“Investment fees, which typically account for 80 to 90
percent of total expenses, are the most likely reasons,” 401(k)s underperform
pensions, the Center stated. IRAs and mutual funds usually invest through
mutual funds, which have layers of fees that professional pensions don’t have.
What You Can Do
There is a silver bullet to boost returns in personal
retirement investing. Costs matter, so find the lowest-cost provider in every
retirement fund you have, particularly in your 401(k). That means:
through passive index mutual- or exchange-traded funds. You can find funds
that invest in entire markets for 0.04% annually — or less.
- Ask for
institutional-class funds in your 401(k). These are the lowest expenses
- Ask for
separate managed accounts. These bypass the expensive mutual fund world
with rock-bottom costs.
- Ask your
employer to dump any fund company that charges commissions (loads), 12b-1 fees
or revenue sharing. This is money that goes from your retirement fund
straight into the pockets of middlemen.
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