April was a scary month for the big dogs in the financial services industry. After decades of hiding the true cost of 401(k) plans, Congressman George Miller got some movement for H.R. 1984. Otherwise known as the 401(k) Fair Disclosure for Retirement Security Act of 2009, the bill would set new standards for expense disclosure. In the same month, “60 Minutes” correspondent Steve Kroft brought home the devastation the market crash has brought to millions of near-retirees.
The industry thinks things are just fine, thank you.
But they aren’t.
We may focus on the market losses of the last year, but the greater danger isn’t the ups and downs of markets. It is the unrelenting high costs of many plans. As I pointed out in my previous column “Is Your Employer Match Being Wasted?” some plans would require a 50 percent employer match just to overcome the high costs of the plan.
How much should a 401(k) plan cost? Investment manager David B. Loeper believes that anything over 0.75 percent a year is excessive. Indeed, he calls 0.75 percent the “maximum fair total expense.” In his book “Stop the Retirement Rip-Off: How to Avoid Hidden Fees and Keep More of Your Money” (John Wiley & Sons, $19.95), he shows exactly how much the ongoing rip-off means with a menu of consequences.
By his calculations, a 30-year-old worker with an 80/20 (equity/fixed-income) portfolio who saves $2,500 a year in a plan that costs 1.75 percent a year can compensate for the additional cost by:
- Increasing annual savings by $1,600 a year, or
- Delaying retirement by 6 years, or
- Reducing annual retirement income by $4,100.
Those are major consequences. Do you really want to work another six years just to feed the financial services industry? The same higher cost also increases the risk of outliving the money accumulated by a whopping 91 percent, Loeper estimates.
In fact, it is possible to manage 401(k) plans for well under 0.75 percent. I’ve written about it for years. It can be done by any worker who invests in index mutual funds or exchange-traded index funds. It can be done following William Bernstein’s directions for “the coward’s portfolio,” Bill Schultheis’ instructions for his “coffee house portfolio” or by building my Couch Potato Building Block portfolios. (You can read about them, their trailing time period performance, and their history at www.assetbuilder.com.)
You can, for instance, build the most basic Couch Potato portfolio (50/50 total domestic equity market/TIPs) using Vanguard mutual funds with a starting investment of $6,000. Its annual expense ratio will be less than 0.20 percent. And there will be no commissions to pay.
But suppose you want more inflation protection? Is there a simple, low-cost way to build such a portfolio--- a way you can use an account at Fidelity, Schwab, TDAmeritrade, E-Trade, Bank of America, USAA, or any other discount brokerage platform?
Combine equal parts:
- Vanguard Total Stock Market ETF (ticker: VTI), expense ratio 0.07 percent. This fund allows you to buy the entire domestic stock market.
- iShares TIPS ETF (ticker: TIP), expense ratio 0.20 percent. This fund gives you ownership of an inflation-protected portfolio of U.S. government securities.
- iShares MSCI EAFE ETF (ticker: EFA), expense ratio 0.34 percent. This fund allows you to buy the entire equity market of the developed economies.
- SPDR Barclays International Trust Bond ETF (ticker: BWX), expense ratio 0.50 percent. This fund gives you broad ownership of international government bonds.
- Vanguard REIT ETF (ticker: VNQ), expense ratio 0.10 percent. This fund tracks a broad index in domestic real estate investment trusts.
- SPDR Energy ETF (ticker: XLE), expense ratio 0.21 percent. This fund tracks an index of major energy companies.
Put more in the pot each year. Rebalance as necessary. Simmer for as long as possible.
The average expense ratio of this portfolio is 0.24 percent. With 6 transactions a year at $20 each, your all-in expense would be 0.75 percent for a portfolio of $24,000. With commissions of $12, your all-in expense would be 0.75 percent for a portfolio of only $14,000. The more you have put away, the lower your average expense--- with 0.24 percent being your lowest limit.
The difference is money in your pocket and your retirement.
Next week: Part 5--- Measuring the Difference Fees Make