The high fructose corn syrup in your 401(k)

There are only a handful of moments in life when you learn something that changes you forever.  Years ago, I saw a documentary about diets and nutrition that changed my perspective on food, agriculture, the foodservice industry and how they are intertwined with our government.  It shook me to my core,  motivated me to learn more and to take immediate action in my life.  I’ve since seen a boom in nutrition and health related documentaries, books, social groups and other forms of media shedding light on the impact of diet to long-term health.  Despite widespread financial illiteracy, I firmly believe that a similar revolution is brewing in the financial world.

Today, people want to know how the sausage and the money is made.  

Signals of this shift can be seen in the breakout popularity of films like The Wolf of Wall Street, The Big Short and the fairly recent skit on John Oliver’s Last Week Tonight where he lampooned the hidden costs in retirement accounts.

But long before these flashes in the pan, Jack Bogle has been screaming from the rooftops of The Vanguard Group office in Valley Forge, PA.  He is credited as the pioneer of index fund investing and shining a wary spotlight on the “tyranny of compounding cost”.  The essence of his position can be summarized simply as.  Only two things impact the long term value of an investment portfolio over time:

1. How well the stock market performed
2. The cost of your investments

Since NOBODY can predict the stock market, as everyday investors, it’s critical that we understand the one lever you can control; cost.  Unfortunately, it’s been proven time and time again that the vast majority of investors have no clue how much their investments cost or that it costs them anything at all.  If you are one of those people, allow me to explain.

The costs associated with mutual funds vary but by and large, they are referred to as the expense ratio.  That number, typically expressed as a percentage, is the holding cost/fee for a mutual fund and is tucked into your fund prospectus like high fructose corn syrup in your…everything.

For example, if fund ABCDE has an expense ratio [fee] of 1%, then for as long as you hold that fund, at least 1% of your holdings will go to the brokerage firm.  The vast majority of mutual funds have an expense ratio below 2% and most people will look at that and say; “that’s not bad“.  Nothing could be farther from the truth.   According to the 2013 study published by the US Department of Labor

“Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent”.  

In other words, the difference between a single point in an expense ratio equated to about ⅓ of the potential balance.  Today, the average expense ratio hovers around 1.25% meaning, on average, most people are forking over 1/3 of their retirement funds and don’t even know it.  Think about that for a moment.  Let that sink in.
You’re doing everything right by investing and planning for the long term but by simply not paying attention to the fine print or by relying on your advisor to make decisions for you, it could cost almost a third of your savings over your lifetime.  Put another way, the same people who shop at Sam’s Club, Costco, eat at McDonalds and coupon shop to save money, turn around and invest that savings at a super-luxury premium price unknowingly.  If this is news to you and you are infuriated then CONGRATULATIONS.  You’ve taken a huge step towards increasing your understanding of personal finance.  Secondly, I challenge you to carve out an hour of time to do these  four things-

1. Log into your 401K, IRA or other investment accounts
2. Jot down the funds you are invested in and their corresponding expense ratio.  You can find this by easily googling the “ticker symbol, expense ratio“. (e.g. ABCDE, expense ratio)
3. Now, do a quick Google search for popular stock index funds.  Or choose from these model portfolios by three investment gurus
4. Compare the cost of the fund you choose in step 3 with your fund’s cost by plugging it into the calculator in this article on NerdWallet

If you’re happy with what you see, then stop right here and go back to blissful ignorance. But if your funds expense ratio is greater than 1% then you’ve bought into some pretty expensive mutual funds.  Even if the performance of those funds are comparable, you’re losing a lot more to fees that otherwise would’ve gone back in your pocket.  If performance is not comparable, then I offer you a fifth step. 

5.  Set up some time to speak with your financial advisor about ways to optimize your investments and lower the cost of your portfolio

We did this about a year ago and it was one of the most uncomfortable interactions I’ve ever experienced.  After providing our financial advisor with a list of funds that I wanted to invest in,  he told me that he simply wasn’t allowed to make the transaction.  His boss wouldn’t let him.   Today, he is still a close family friend, mentor and confidante but he is no longer my advisor.   Knowing what I know now, I simply couldn’t swallow such a high price tag to manage my money.  For the record, I don’t blame him, his firm or any financial advisor for doing their jobs.  He wasn’t doing anything deceptive or illegal. It was me that changed.  After watching that health documentary years ago I vowed to avoid certain foods.  Similarly, after learning about expense ratios and other costs to investing,  I refuse to outsource my financial advice at such a high cost.

Bottom Line I get it, financial lingo can be intimidating and making these decisions on your own can be tough but I assure you the fundamentals of investing require elementary school math skills.  Thats it.  Plus, the alternative is working your entire life, saving what you can, thinking you’re ahead of the game, only to realize that you unknowingly let thousands of dollars disappear into thin air.  Below are some recommended readings to help you along the way.