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Home Publications Blogs Beat the Press Morning Edition Doesn't Know About Financial Service Fees

Morning Edition Doesn't Know About Financial Service Fees

Wednesday, 30 January 2013 06:14

That's what listeners to a segment this morning on households' lack of adequate savings probably concluded. The piece noted that many households lack the savings needed to support themselves through a period of unemployment or illness. It then talked about various efforts to promote savings.

While it would be beneficial for most people to save more (although it would hurt the economy in the short-run), a major problem is the large fees charged by financial institutions. Fees can eat up as much as one-third of the money in 401(k)-type accounts. It would have been worth at least mentioning the problem of high bank fees as an issue in this discussion.

Comments (18)Add Comment
Fees =ONE-THIRD of 401(k) savings?
written by G Burtless, January 30, 2013 7:03
I would love to see the source for this truly remarkable statement. My understanding is that 401(k) fees are typically less than 1% of assets under management, and usually considerably less than that amount. In our 403(b) plan they probably average about 0.55% to 0.60%. A retirement saver intent on minimizing fees could reduce this to 0.06% if he or she invested in the most economical funds on our menu.

My suspicion is that you are thinking of the total fraction NET REAL long-term RETURNS that can be eaten up by fees in a 401(k) plan with a menu of high-cost mutual funds. But I think it is a hard to find a plan where annual fees eat up one-third of the funds under management.
written by JDM, January 30, 2013 7:25
Here's a source for that statement (took Google and a minute to find):
Bogle talks about this a lot...
written by pete, January 30, 2013 9:08
Fees for funds (much less than 1% annually for passive funds) are less than fees for 401(k)s. Anyways Bogle points out the "30%" thing as a long run cost of using actively managed funds versus passive. I would call this nickle and diming somebody...it adds up over time. Hard to identify it as excessive. Inexperienced investors and so forth, don't they need to pay for access to informed folks? Of course not if they are steered to passive funds. Funny thing is liberal economists like Thaler allowed companies to default employees into 401 contributions, on the premise that young people weren't saving enough.
Problem with the one-third estimate
written by G Burtless, January 30, 2013 9:23
Thank-you, JDM, for the citation. As I suspected, that “one third” number is derived from an estimate of the impact of fees after a lifetime of retirement savings. The net final balance in a 401(k) account can indeed be reduced by a third if the investment is held a long time. The analyst you cite assumes the investment is held for 40 years. Over such a lengthy holding period our retirement saver will see a substantially smaller account balance compared with the situation in which there are no trading costs or management fees. I have no doubt that many retirement savers place their 401(k) savings in mutual funds where one-third of their 40-year account balances may be eaten up by trading costs and management fees.

There is a simple problem with this analysis, however: Most retirement savings are NOT invested for 40 years. Workers who are 30 or more years away from retirement do not save much for retirement. Workers tend to save more for retirement in their late 40s, 50s, and early 60s than they do in their 20s and 30s. Therefore, their 401(k) trading costs and management fees do NOT reduce their final account balances as much as is implied in the analysis cited.

If the management fees and trading costs are 1% per year, then an investment that is held in the 401(k) plan for only a year incurs a total cost of just 1% ... nowhere near the one-third cost cited in the article. The probable costs are even lower than this, however. The average fee on stock mutual funds is 0.79% and that on bond mutual funds is just 0.62%, which is considerably lower than the 1% assumed in the analysis. My guess is that the average fees on dollars invested in 401(k) plans (as opposed to all mutual funds) is even lower than those amounts.

I completely agree that retirement savers should be offered low-cost mutual funds in their 401(k) plans. It is a scandal that some profit and non-profit employers only offer their workers high-cost plans. But it is incorrect to suggest that it is common for excess fees and trading costs to soak up to one-third of worker's 401(k) savings. That can certainly happen in the case of investment savings held in a high-cost, poorly managed plan for a long period of time. But a quick glance at the Vanguard Total Stock Market Index - Signal Class - prospectus shows its management fee is just 0.05%. The net return to shareholders over the past five years has slightly EXCEEDED the total return on the U.S. stock market index (which implies that Vanguard’s trading costs were negligible). That investment option is one offered to me and my colleagues in our 403(b) plan. My suspicion is that it is also offered to millions of other 401(k) and 403(b) retirement savers.
I was referring to outliers
written by Dean, January 30, 2013 9:32
Come on Gary, there are good low cost funds. (I tell everyone to buy Vanguard.) There are also ripoffs and people who are less informed are more likely to end up with the ripoff funds. If we want people to save more we should be able to assure them that they will not be victimized by high cost funds.
Inmates in Poorhouse Told to Save More
written by leo from chicago, January 30, 2013 10:28
'Inmates in Poorhouse Told to Save More' -- that's what I got out of the segment.
written by PeonInChief, January 30, 2013 11:18
More important than the cost of saving is that the median income in the US provides for a budget where there can be no savings for college, retirement or an emergency fund. But the ability to do simple arithmetic is not an expected part of the NPR reporter skill set.
written by liberal, January 30, 2013 11:39
pete wrote,
Hard to identify it as excessive. Inexperienced investors and so forth, don't they need to pay for access to informed folks?

LOL. If you have access to "informed folks," you're probably paying someone who makes money off of sales or some other scheme where the conflict of interest is a mile wide.
written by liberal, January 30, 2013 11:45
Dean wrote,
I tell everyone to buy Vanguard.

Tell that to my wife, who's nervous that we have all our non-retirement assets there (my doing of course).
Yes, 401(k)s can cost 33% for many
written by Wells Fargo Must Die, January 30, 2013 2:26
The average expenses for a 401(k) is 1.33%. If you project a 6% return for the stock market and 4% for bonds which is probably generous for both, you would pay roughly 25% of your returns in fees. For roughly half of 401(k) participants, whose fees are closer to 2%, it would be roughly 33%.

How much you pay depends on your projections on returns for the future. Many 401(k) participants also pay an administration fee on top of fund expenses. This fee is typically 0.75% or so.

Even at 1%, 401(k)s are expensive. A person will forfeit roughly 15 to 20% of their earnings. It is also not possible for people to choose Vanguard funds with their 401(k). The employer decides on the 401(k) option and many go with the least expensive option for the company which have the highest costs for the participants.

Given a long-term likely return of 5% on a 60/40 portfolio, it is quite likely the majority will pay 33% in fees. 401(k) seemed great when returns were 15% per year. Not so great in the single digits.
Average expenses for a 401(k) = 1.33% ?
written by G Burtless, January 30, 2013 4:16
The estimate shown in the title, and offered by "Wells Fargo Must Die," seems to me implausibly high. First, it greatly exceeds the average fee collected by mutual funds on an average dollar invested in mutual funds (stock, bond, or hybrid). Second, it is my impression that 401(k) plans typically offer a menu of investment options with below-average mutual fund costs.

Finally, an observation on "... 401(k) seemed great when returns were 15% per year. Not so great in the single digits." There are two main saving alternatives to 401(k) savings plans: Traditional defined-benefit pensions, and saving outside of employer pension plans in regular bank and mutual fund accounts. Both these alternatives also incur costs, and often the costs are higher than those obtainable in a standard 401(k) plan. The right counterfactual for thinking about management fees is "How much would it cost me to save in a plausible alternative to my 401(k)?" It is not "How expensive is my 401(k) compared with a savings account without any trading or account management costs at all?" My 403(b) menu includes three investment options that have management costs below one-tenth of 1% per year. So does my wife's (she works for a different and much smaller employer). My guess is that the same can be said for the 401(k) and 403(b) plans offered to tens of millions of U.S. employees.

Bottom line: Fund costs rarely eat up 33% of our retirement account assets, even over fairly long investment horizons. They CAN eat up a sizeable share of our expected returns if (a) our employer offers a terrible line-up of investment options; or (b) we unwisely choose to invest in high-cost options in a line-up that contains excellent, low-cost alternatives.
written by denise, January 30, 2013 4:55
The NPR piece included a low-income woman who managed to put away $200 month, then said how lucky it was that she did because she got sick and used it to pay her rent. If she hadn't saved, she would have been homeless.

Of course, this just demonstrates how absurd it is to think that people making $11/hour can ever accumulate anything. Every time they put some money away, some unexpected expense comes along and they are wiped out and have to start over. Yet we are supposed to think that if only they are disciplined and thrifty they will somehow end up with a real financial cushion.
written by liberal, January 30, 2013 5:23
G Burtless wrote,
First, it greatly exceeds the average fee collected by mutual funds on an average dollar invested in mutual funds (stock, bond, or hybrid).

So? The average dollar isn't limited to all-too-often crap funds picked by an employer.
written by Wells Fargo Must Die, January 30, 2013 5:35
G Burtless, you continue to say that you believe that 401(k) participants have access to low-cost funds. This is solely a guess on your part and like most guesses, it is completely wrong. People who have low-cost plans assume everyone has one. But they don't.

The average cost is actually 1.26%. It is 1.11% for people in large company plans and 1.33% for people in small company plans.

The reality is that most employers go with the lowest cost alternative which puts a great many people in plans offered through outfits like The Principal which are very low cost for the employer but very expensive for participants. Small company plans are almost exclusively these types of arrangements.

You like 401(k) plans and are resistant to the idea that they might not be favorable to everyone. The reality is that plans are very expensive for the average participant. And yes, they will eat up roughly 1/4 to 1/3 of their earnings. That's a great deal for the providers but not for the participants which is why they'd love to get their hands on some of that SS privatization money.

You present a fairly good counterfactual and for the average person, investing outside of a 401(k) is a far better option because:
1) Investment expenses are within your control by choosing your own investment provider; 2) Most people will retire in a higher income tax bracket, therefore, the 401(k) offers almost no advantage in the long term except for the matched contributions.

Defined benefit plans are much better because they have far lower expenses and do not make money managers out of people who should not be trying to invest their way to retirement swimming with sharks. Unfortunately, they are not transportable.

401(k) plans are an expensive way to go for most people and they will fail miserably in the end. It is true that 401(k) plans will not eat up 33% of your retirement savings in total but 25-33% of your earnings ought to be enough.
written by jd, January 30, 2013 7:52
Wells Fargo: I agree 100%

G. Butless: I suggest you read Allan Roth" How a 2nd Grader Beat Wall Street
written by watermelonpunch, January 31, 2013 12:44
My spouse told me about hearing this story this morning. But his main interest point about the story was that it's now essentially normal for people not to have any savings cushion & not even any rainy day fund put away.
That surprised him.
I do not find it surprising at all.

I didn't bother to look up the story myself to hear it, because stories like this inevitably make me angry for another reason... already addressed by Denise's comment.

I think leo from chicago sums it up pretty well with "inmates in the poorhouse told to save more".

And for what it's worth, "Fees can eat up as much as one-third", was pretty clear to me, and I'm no expert. ;o) Worded fine in my opinion. (And I'm a grammar nitpicker!! ha)
written by watermelonpunch, January 31, 2013 12:54
It would have been worth at least mentioning the problem of high bank fees as an issue in this discussion.

Come to think about it... high bank fees for 401ks... Forget that.
What about the stinky rates for standard savings accounts?
And the fact that the ordinary working joe wouldn't find it worth it to have a standard savings account for the simple fact that they might go under the required balance at some point, and get slapped with a fee that would wipe out 3 years worth of puny interest they'd earned.

I'm not knocking the point about the 401k fees.
BUT, I think the issues of the standard savings account these days would be of more direct interest to at least 50% of that reported 44%.
written by liberal, January 31, 2013 8:10
Wells Fargo Must Die wrote,
Most people will retire in a higher income tax bracket


Defined benefit plans are much better because they...

The problem with defined benefit plans is that they're often looted by the sponsoring companies at bankruptcy. 401(k) assets, OTOH, belong to the account holder.

I think 401(k)'s would be great were it not for the fact you point out that employers choose crap plans, plus most people not understanding how to prudently pick funds.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.