It’s been years since I got to participate in a 401(k) retirement plan. Last time was when I worked at Expedia. I put the amount in that would maximize the employer contribution and didn’t pay much more attention.
The first thing I looked at this time was which investment options were index funds. There’s one index fund option for large-cap funds and one for small-cap funds. Out of 24 options, only two are index funds. That’s deplorable. To illustrate why, I dug around to find the expense ratios for the fund options. It wasn’t as easy to find as I would like, but when I did Fidelity showed it quite nicely.
| Name | Category | Gross Expense Ratio | Shareholder Fees |
|---|---|---|---|
| COMPANY STOCK | Company Stock | — | Commission on stock trades: $0.029 per share |
| MAINSTAY LGCP GR R1 (MLRRX) | Large Cap | 0.87% | No additional fees apply. |
| MFS VALUE R4 (MEIJX) | Large Cap | 0.68% | No additional fees apply. |
| SPTN 500 INDEX INST (FXSIX) | Large Cap | 0.05% | No additional fees apply. |
| ARTISAN MID CAP INST (APHMX) | Mid-Cap | 1.03% | No additional fees apply. |
| ARTISAN SM CAP VALUE (ARTVX) | Small Cap | 1.24% | No additional fees apply. |
| VANG SM GR IDX INST (VSGIX) | Small Cap | 0.08% | No additional fees apply. |
| FID DIVERSIFD INTL K (FDIKX) | International | 0.81% | Short term trading fees of 1% for shares held less than 30 days. |
| DODGE & COX BALANCED (DODBX) | Blended Fund | 0.53% | No additional fees apply. |
| FID FREEDOM K 2005 (FFKVX) | Blended Fund | 0.50% | No additional fees apply. |
| FID FREEDOM K 2010 (FFKCX) | Blended Fund | 0.54% | No additional fees apply. |
| FID FREEDOM K 2015 (FKVFX) | Blended Fund | 0.57% | No additional fees apply. |
| FID FREEDOM K 2020 (FFKDX) | Blended Fund | 0.59% | No additional fees apply. |
| FID FREEDOM K 2025 (FKTWX) | Blended Fund | 0.62% | No additional fees apply. |
| FID FREEDOM K 2030 (FFKEX) | Blended Fund | 0.67% | No additional fees apply. |
| FID FREEDOM K 2035 (FKTHX) | Blended Fund | 0.68% | No additional fees apply. |
| FID FREEDOM K 2040 (FFKFX) | Blended Fund | 0.68% | No additional fees apply. |
| FID FREEDOM K 2045 (FFKGX) | Blended Fund | 0.69% | No additional fees apply. |
| FID FREEDOM K 2050 (FFKHX) | Blended Fund | 0.69% | No additional fees apply. |
| FID FREEDOM K 2055 (FDENX) | Blended Fund | 0.69% | No additional fees apply. |
| FID FREEDOM K INCOME (FFKAX) | Blended Fund | 0.45% | No additional fees apply. |
| MIP II CL 1 | Bond Investments | 0.56% | No additional fees apply. |
| PIM TOTAL RT INST (PTTRX) | Bond Investments | 0.46% | No additional fees apply. |
I’ve highlighted the index fund for large-cap and the option with the next lowest expense ratio, and the same for the small-cap index fund. Those percentages indicate the amount the fund managers skim off the top every year. As a retirement saver, you never even see it because they don’t list this percentage in how much you make. They could do this (examples use a 1% expense ratio for arithmetic convenience):
| Investment | $10,000 | |
| Increase | $500 | |
| Fee | -$105 | |
| Total | $10,395 |
Instead, they do this:
| Investment | $10,000 | |
| Increase | $395 | |
| Total | $10,395 |
Notice in my example, the fee is a percentage of the total, not of the increase. An average fund manager might make the investor $500. An extraordinary fund manager might make $700. The average fund manager charges $105. The extra-ordinary one charges $107. Now, you might think you are getting a steal of $200 for only $2 more, but the real travesty is that the average manager gets $100 for very little work. To see that, look at an index fund.
The small-cap index fund I highlighted uses CRSP US Small Cap Growth Index to benchmark. Compared against their own benchmark, they lose over the last three months but just barely: return of 1.58% vs. the benchmark return of 1.6%. They compare very closely because all an index fund does is buy exactly what’s in the index.
For comparison, the actively managed fund uses Russell 2000 Value as it’s benchmark index. Compared against that, the managers lost 0.28% vs. the index’s gain of 1.78%. These managers are trying to beat the index by picking better investments than the index, charging for their “expertise”, and losing.
Now, that’s a short period of time and perhaps at other times the actively managed fund does better. But over time, index funds have better returns than actively managed funds. There are exceptions, but those options aren’t pertinent to the broad market investments that are available in a 401(k).
So basically, those investment options I have? I’m giving away $60 (for the large cap fund) to $115 (on the small cap fund) every year for nothing (on a baseline portfolio of $10,000). If I’m saving money every year for retirement, that amount grows every year, and cuts into the compounded interest every year.
All of this stuff is pretty well written about all over, but regular people don’t pay attention for a variety of reasons. I’m not naming my employer here, but they really should be doing better by their employees.