Alamy Everybody knows you should be investing in your company’s 401(k) plan, but here’s something that almost nobody knows: Investing in a 401(k) could cost your three years’ salary.
That’s the surprising upshot of a new study by the financial folks at NerdWallet, whose InvestingNerd division just ran a study concluding that “9 out of 10 Americans (92.6%) dramatically underestimated the total 401(k) fees the average household will pay over the course of a lifetime.”
According to NerdWallet, when posed the question “How much will the average American household with 2 working adults pay in 401(k) fees over the course of their lifetime?” The correct answer is $150,000 to $200,000 — but only 3.3 percent of respondents got it right.
The High Price of a Lifetime of Saving
NerdWallet underlies its findings with a report by public policy organization Demos from last summer, which added the further frightening fact that among folks investing in 401(k) plans, a full two-thirds had no idea they were paying anything at all for their 401(k) (which actually makes all of the folks who guessed wrong in NerdWallet’s poll look pretty smart by comparison).
U.S. Census Bureau figures put the average household income in America today at just a hair over $50,000. Demos’ report, however, shows that over the course of an investing lifetime, an average two-income family in the U.S. could spend as much as $155,000 paying the fees that managers charge for running the funds that make up your 401(k).
How does this happen? It’s quite simple, really. When you invest in your company’s 401(k), unless you keep the money in cash (and with cash yielding less than 1 percent today, good luck with that), what you’re usually doing is buying various mutual funds that are held within your 401(k) account.
The 401(k) industry says expense ratios across all funds averaged about 0.78 percent in 2011. And according to Demos’ calculations, deducting these fees year after year, every year, over the course of an investing lifetime, drags down the returns from investing in 401(k)s by the aforementioned $155,000.
That’s a bit more than three years’ salary for most Americans.
What It Means for You
This hardly seems fair. For years we’ve heard about the imminent demise of Social Security, with workers today paying money into the system — and that money being immediately doled out to retirees today, rather than tucked away to pay back today’s payers.
We all know that corporate pension plans are a thing of the past, as companies all across the country try by hook and by crook to do away with them. Witness Boeing’s (BA) contentious negotiations with its labor unions last year. (By the way, Boeing won, and its workers are slowly shifting to 401(k)s.)
Yet now we learn from Demos and NerdWallet that doing what you’re supposed to be doing — investing steadily in your future by making regular deposits in your 401(k) — could cost you three years’ salary. Unfair!
So how do you cut this cost, and keep more of your money for yourself? Actually, that’s not too hard.
Most funds are “actively managed” by managers who pick and choose stocks for their funds, and the fees for these services add up to about 0.93 percent on average — again, year after year, every year. Putting your 401(k) money in passive “index” funds, which simply and automatically track the returns of major stock market indexes, can cost as little as 0.14 percent per fund — less than one-fifth the average cost.
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Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.