Fire Your Broker and Earn 25% Higher Returns

Do you know how much money your 401(k) is costing you?

If you’re like most Americans, this might seem like an unusual question. Most of us associate investment accounts with making money, not spending it.

The fact is: your IRA or 401(k) is a financial product. And just like any product in the market – from milk to a Lexus – there’s a price tag. And you may be paying much more than you’d expect to fund your retirement.

Financial products are paid in fees. For example, loans charge interest. Even free checking accounts make money on overdraft fees.

Of course, it’s easy to understand your mortgage statement. You owe an amount in principal and another amount in interest. And if you make the minimum payment, you can expect to pay off your loan on a specific date.

It’s not so simple to understand a 401(k) plan. An AARP survey [1] showed that 65% of 401(k) contributors were completely unaware they were paying fees to begin with.

Perhaps one reason is because financial service providers don’t post fee information in the expected places. 401(k) fees come “off the top,” which means they aren’t documented in your monthly statement.

You’ll have to dig a little bit deeper if you want to find out what is really stunting the growth of your nest egg. A good place to start is by requesting a “fee audit” from your company’s 401(k) plan administrator.

Buyer beware: If you’ve ever felt like your 401(k) should be making more than it actually is, that’s a red-flag that you’re paying too much in fees.

Here’s what you need to watch out for…

3 fees that can shred your 401(k) returns

Below are the three most common fees that brokers charge. These are only the basic fees, but some plans charge “advertising & marketing fees” as well as others. As you’ll see, some fees are necessary. Others exist for the sole purpose of making the financial service industry more money while draining your retirement.

Fee #1: Administrative Fees

Every company has overhead expenses such as office management, book keeping, and customer service. And mutual funds are no exception.

These fees generally range from .2% to .4% annually. [2]

Administrative fees are unavoidable because without capital an investment fund can’t keep operating. And since most brokers don’t invest in their own funds (more on that below), they aren’t making money off their own investments.

Even the lowest fee funds will assess some administrative costs. Though, you’ll want to make sure you’re not paying more than you have to.

So far, no real harm. Fund managers and their employees have to make a living too, right?

As it turns out, administrative fees aren’t the only way funds cover payroll. And it’s the next type that really starts killing your returns…

Fee #2: Asset Management Fees

In active professionally managed funds, investment researchers and broker-dealers make some of their money through asset management fees. Many brokers also receive commissions from companies whose stock they recommend to clients (more on that below…)

Asset Management Fees generally range from .5% to 1% annually. [2]

That sounds like a small amount. How much of a difference could half a percent really make?

Let’s take the median Administration Fee (.3%) and add the median Asset Management Fee (.75%) and add them together. That’s 1.05%. Now let’s compare returns over thirty years with and without the asset management fees.

Let’s say, for argument’s sake, that you and your employer are contributing $7,500 of your paycheck to retirement yearly.

With an average annual fund return of 7% and an initial investment of $50,000…

With Asset Management Fees, you’d earn:

Yr 1 – $50,000                       Yr 5 – $111,503         Yr 10 – $193,613       Yr 15 – $303,237

Yr 20 – $449,592                   Yr 25- $644,987        Yr 30 – $905,853  

Now look at the SAME portfolio without Asset Management Fees:

Yr 1 – $50,000                       Yr 5 – $114,896         Yr 10 – $204,646      Yr 15 – $328,771

Yr 20 – $500,436                   Yr 25 – $737,849       Yr 30 – $1,066,193

Do the math: that’s $160,340 in extra fees.

Now, you may be thinking: “OK, but don’t I need a professionally managed portfolio to get the best rates of return?” It’s a good question, because high enough returns could outweigh the cost of fees.

But the surprising answer is “NO.” For reasons you’ll soon understand, actively managed portfolios almost NEVER consistently beat the market with a large enough margin to justify the fees. That’s almost always true, even when your employer is chipping in with a matching contribution.

But Wall Street can’t make money by encouraging you to put your money into safe investments with modest, consistent returns.

No one makes much money on index funds, where rates of return are based on the average growth of an entire market (like the S&P 500 companies). There’s no risky betting involved there. Either the average of the S&P companies grows from last quarter, or it doesn’t. And since the larger market almost always grows over time, putting your money in an index fund is a relatively safe move. And the fees are low, which means an affordable investment for you.

But most brokers would have you think otherwise…

Fee #3: Trading Fees

Here’s how the investment slaughter house goes in for the kill.

Trading fees are charged each time your broker buys and sells the securities (e.g. stocks and bonds) in your fund. Actual fee amounts vary from broker to broker. All told, it’s not unusual for fees to exceed 1.6%

How does your broker know when and which stocks to buy and sell? Well, that depends on who you ask.

Brokers are quick to make the argument that experience and knowledge of the markets puts them at an advantage to earn you the highest possible returns.

But that explanation doesn’t exactly hold water.

While it’s true that individual investors are less likely to beat the market than professional traders, professional traders are less likely to beat non-managed funds.

According to the S&P Indices Verses Active (SPIVA) scorecard, non-managed funds outperform actively managed funds most of the time. [3] That means that a professional investor has little chance of beating the market during any given year, much less year after year.

And there’s something else your broker doesn’t want you to know. Client fees aren’t the only way to get paid as a broker-dealer. Another way is to earn commissions from the publically traded companies they recommend.

Just as drug companies solicit medical doctors to proscribe their medications, publically traded companies are competing for your mutual fund dollars. And your broker is forced into a situation where he (or she) cannot represent your best interests.

Unlike a financial advisor who has a legal fiduciary duty to act in your best interests, most broker-dealers are salespeople who profit from selling stocks that pay the highest commissions.

So, Exactly How Much Can Your Broker Take?

Let’s run our 30-year experiment again, this time comparing an actively managed fund with Asset Management and Trading Fees versus a low-cost index fund.

Actively managed fund with 1.6% fees:

Yr 1 – $50,000                       Yr 5 – $109,069         Yr 10 – $185,906      Yr 15 – $285,852

Yr 20 – $415,861                   Yr 25 – $584,973       Yr 30 – $804,950

Passive index fund with .3% fees:

Yr 1 – $50,000                       Yr 5 – $114,896         Yr 10 – $204,646      Yr 15 – $328,771

Yr 20 – $500,436                   Yr 25 – $737,849       Yr 30 – $1,066,193

For a whopping total of: $261,243 in fees, or 25% lost returns!

[1]  http://assets.aarp.org/rgcenter/econ/401k_fees.pdf

[2] http://www.demos.org/publication/retirement-savings-drain-hidden-excessive-costs-401ks

[3] http://us.spindices.com/indices/strategy/sp-500-high-beta-index