Earlier this week I received a notification from my employer disclosing the administrative fee I will be charged each year for my 401(k) going forward starting in July. Most likely, this notification was prompted from the Department of Labor’s new rule, called the Fiduciary Rule, which went into effect last Friday, June 9. Specifically, the conversation on the Fiduciary Rule, and more broadly on 401(k) investing costs, is very timely with its focus on consumer protection. So in this post, I want to go over, first, what are the fees you pay for your 401(k); second, what’s the Fiduciary Rule; and third, how you can lower your 401(k) investing costs?
What are 401(k) fees?
To begin with, and to recall, your employer will partner with a plan administrator, such as like Fidelity, Morgan Stanley, etc. to provide you the 401(k) plan and run the day to day activities of your plan. For example, you will enroll in your 401(k) with the plan administrator, and it is with them that you will select your contribution rate and which investment funds to contribute to. Smaller and mid-sized companies may also have a separate plan advisor in addition to the plan administrator. The plan advisor may help with enrollment and/or manage your 401(k), for a fee. Larger plans may provide access to professionally managed services, where you get a team of professionals behind the scenes who help design and manage your 401(k), for a fee, too.
Knowing that your plan is managed by a third party, naturally there are costs associated with this work. These costs can be grouped mainly into the three main categories of 401(k) fees:
- Expense ratio. This is the cost of the investment funds you select in your plan for overall operating expenses, expressed as a percentage of the fund’s total assets.
- Advisor fee. These are the fees you’d pay if you elect to hire a plan advisor or professionally managed services to design and manage your 401(k). Fees can be high.
- Administrative fee. These are fees paid to the administrator for recordkeeping, compliance, communication with participants and transactions process.
There are other costs, but these are the main general expenses. Costs are lower for the largest plans, such as those provided by publicly traded companies, think like Goldman Sachs and Apple, where the company can negotiate with the administrator on lower fees and access to cheaper classes of fund, such as index funds. Smaller and mid-sized companies typically have more expensive plans because there is less scale to distribute the costs among its participants. Employers generally will not cover these administrative fees and pass them onto plan participants.
What’s the Fiduciary Rule?
The rule essentially looks to limit potential conflicts of interest between plan advisors and plan participants. Practically what this means for your 401(k) is that the fees that you pay for your plan need to be more transparent and communicated to you. Previously, I had no visibility into what the administrative fee was that I was paying for my 401(k). Going forward, the administrative fee associated with my plan will be fulfilled in quarterly installments. So, with the fiduciary rule in place, I will now see the fee clearly on my account statement every quarter. Without going into the political debate of it all, more transparency and less conflict of interest seems like a good thing for the investor. You should know what you’re paying for behind the scenes. Additionally if your plan has an advisor, he or she will need to act more in your best interest instead of promoting products in the plan that best suit them but recommend products aligned to your goals, risk tolerance and investing time horizon. If you want more information you can check out this article here on Investopedia.
How can you lower your 401(k) costs?
Knowing that your costs will be more transparent, what can you do to minimize your investing costs? As an investor, you can’t control short term market returns. (Although recall that the long-term stock market return is 8%.) But you can contain the costs that you pay in your 401(k). When you minimize your investing costs, you can get a higher overall investment return. For each of the three 401(k) expenses here’s how you can minimize costs:
- Expense ratio. Choose low cost index funds over actively managed funds (if offered in your plan). Actively managed funds can have expenses ranging from .5% to 2.5%, whereas Fidelity’s S&P 500 index fund’s expense ratio is 0.015%.
- Advisor fee. Select to DIY your 401(k)! Don’t elect to have a plan advisor or professionally managed services design and manage your 401(k). In my upcoming book on DIY 401(k) investing I’ll show you how to do that, offsetting the costs for an advisor.
- Administrative fee. Unfortunately, you have zero control over this fee, and you will have to pay what your plan administrator charges you.
So, in sum, select low cost index funds (if your plan offers them) and avoid the plan advisor/professionally managed services to lower your overall investing expenses.
Stay tuned! To get this blog started, I’ll be taking inspiration from my upcoming book, From Millennial to Millionaire: DIY 401(k) – 5 Do-It-Yourself Steps for the Digital Generation to Design and Manage their 401(k), to write blog posts. My new book should be available in eBook and paperback on Amazon by summer 2017.