9 August 2022

The Huge 401(k) Hit You Can Avoid

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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:

  • Investing 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 available.
  • 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.


Click here to access the full article on Forbes.

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