Do you know how much you’re paying in fees on your investments?
If you’re like most Americans, the answer is no. And recent evidence that fund fees are going down doesn’t necessarily mean that more mutual fund companies are acting in your best interest. Rather, more investors are taking steps on their own to get off the high-fee treadmill.
A recent Morningstar study found that the asset-weighted expense ratio across all funds (including mutual funds and exchange-traded products) was 0.64 percent last year, down from 0.76 percent five years ago. That drop in the expense ratio — which represents the percentage of assets in a fund deducted each year for expenses like management and administrative fees — was largely driven not by funds cutting fees, but by investors increasingly seeking out funds with lower fees.
During the five-year span, researchers noted that 63 percent of the fund share classes and exchange-traded products that existed in both 2009 and 2014 did reduce their expense ratio, but not by much — less than a quarter cut their fee by more than 10 percent. But over the same period, there was a massive influx of investor money into passive funds that carry lower expense ratios. The asset-weighted expense ratio for index funds was just 0.20 percent in 2014, for example, compared with 0.79 percent for actively managed funds.
An encouraging trend
The promise of lower fees isn’t the only reason investors have been moving more money into those funds. Overall, passive funds, which track indexes, have also been outperforming actively managed funds.
A separate Morningstar analysis found that higher-cost funds are more likely to underperform and ultimately go under than lower-cost funds. And an exclusive analysis run by online portfolio tracker SigFig for CNBC.com found that across more than 220,000 households, passive index funds still beat actively managed funds for the year ending in October, even with the recent market volatility. Index fund returns were down less than half that of active funds (-0.6 percent vs. -1.3 percent), while charging about two-thirds less, on average.
Nearly two-thirds of active large-cap managers underperformed the benchmark (S&P 500, 7.42 percent) during the one-year period ending in June, according to SPIVA U.S. Scorecard data from the S&P Dow Jones Indices. And over the past decade, about 8 in 10 large-cap managers failed to meet their benchmarks, it found.
“Low-cost funds have been attracting far more inflows than their more expensive peers,” noted Morningstar in its report, pointing out that estimated net inflows in 2014 to index funds totaled $392 billion — nearly six times the flows into active funds. And the large inflows into passive funds appear to be continuing this year.
That’s an encouraging trend, said Tony Robbins, author of the best-selling book “Money: Master the Game.”
“Looking at fees as part of the process of choosing investments can be the difference in being able to retire or not,” he said. “It can’t be overstated.”
The expense ratio is only the most obvious fee. “Most people believe the expense ratio is what you pay to own a typical actively managed mutual fund. Not true,” said Robbins. “When a fund manager is buying and selling stocks, attempting to outperform the market, he is also incurring transaction costs that quickly add up and subtract from your account.”
Jack Bogle, who founded Vanguard, has estimated that those additional costs can add another 1 percent or more to the “all-in” fees you’re paying. “You are probably paying even more than you think,” Robbins said.
You may not be able to do much about high 401(k) administrative costs beyond complaining. But picking lower-cost funds (whether in your retirement account or regular investment account) can yield substantial savings, said Yoav Zurel, CEO of FeeX, a service that calculates the fees in retirement plans. He cited one large tech employer for which the expense ratios on its 401(k) target-date fund offerings differ by nearly 0.70 percent. Fees tend to vary widely among plan providers and can add up to several hundred basis points. So it’s worth taking the time to ask questions and read through the disclosures.
“We see so many different fee disclosures, ranging from six to 20 pages or more,” Zurel said. “People really have no idea how much they’re paying.”
The company, which currently tracks 40,000 accounts on a monthly basis, estimates investors lose up to one-third of their potential retirement savings over their lifetime to fees. That may seem high, but even a difference of 1 percent in fees can translate to tens of thousands of dollars over time.
Over the last few years, at least a half-dozen free services like FeeX and SigFig have emerged to help investors decipher what they’re paying now in fees and even look at lower-cost alternatives. Other comparison sites include GuardVest, Personal Capital and Brightscope.
“Looking at fees as part of the process of choosing investments can be the difference in being able to retire or not.”
Advisors recommend asking brokers and 401(k) plan administrators a lot of questions about all the fees associated with the funds you’re investing in — not just in 401(k) plans but any investment accounts — as well as fees associated with managing and maintaining your account.
Expenses associated with employer-sponsored retirement plans aren’t as inscrutable as they were before 2012, when the Department of Labor instituted new rules for the disclosure of fees and expenses by 401(k) providers. But the additional costs, which can range from management to record-keeping fees, can be buried deep within several pages of disclosures.
For example, the Securities and Exchange Commission points out that if you have a $100,000 investment portfolio that grows a conservative 4 percent annually, a 1 percent ongoing fee would add up to almost $28,000 lost to fees over two decades. And there’s the opportunity cost as well: If you’d been able to invest that $28,000, you could have earned an additional $12,000 over that time period.
The key is to take the time to look, Robbins said. A small investment in time now can yield a big difference in your account balance later.