Should I raise my 401(k) contributions even if fees are too high?
I currently contribute 5% to my 401(k) while my employer gives me a 4% match. I am 37 years old and in the 25% tax bracket. Unfortunately, my employer uses a poor brokerage as its 401(k) provider. I would like to start contributing 15% to my 401(k), but the fees are too high. The growth fund that I am currently in has an expense ratio of 1.33 and I would have to rebalance over time. Does it make sense to raise my contribution to 15%? If not, would it be better to change my investment fund to a retirement target date fund with a 1.25 expense ratio? All of the firm's funds are too high but I would like to contribute 15%.
As a Participant, don’t get too hung up on the expense details regarding 401k plans. Investment fees are but one part of the fee structure to pay for the administration of an employer sponsored retirement plan. Often revenue sharing from those fees are paid to recordkeepers, administrators, custodians, etc., to provide services to the plan. Talk with your firm’s management about when they last reviewed other plan providers, it might be time....
I think you have a decent idea of using lower cost funds that are available in the plan, if you can augment that investment with outside investments that give you a well-rounded overall portfolio. At 37 years of age and a 25% tax bracket, contribute as much as you can, and if your plan offers a Roth 401k contribution option you should seriously consider it. Money you put away now has a long, long time to grow!
Hope this helps.
I know it sucks to have to get stuck with higher than needed fees, but don't let that deter you from saving for retirement. A few pieces to this answer.
1) 100% you need to contribute enough to get the full company match. The employer contribution will be more valuable than lower fees. (at least while you work here.)
2) Consider a ROTH IRA or Traditional IRA that you manage directly. This of course is dependend on your income and eligibility to contribute. This will allow you to find cheaper investments on the open market.
3) Not sure of your income but at 15% you very well may need to save more info the 401k beyond the money you are putting in to get the company match and a Traditional IRA (Contribution limit of $5500). Put the remainder into the 401(K) plan. I think saving the money versus spending it, and getting a tax deduction will put you ahead even if the fees are higher than average in the 401k plan.
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DAVID RAE, CFP®, AIF® is a Los Angeles-based fiduciary financial planner with DRM Wealth Management, a regular contributor to Advocate Magazine, Huffington Post, Investopedia not to mention numerous TV appearances. He helps smart people across the USA get on track for their financial goals. For more information visit his website at www.davidraefp.com or the Financial Planner LA blog.
The #1 way to retirement success is contributing systematically to your retirement savings through either a 401k plan or a taxable investment account. I would suggest that you increase your 401k contribution rate to 15% to save for retirement—and decrease your overall income taxes. There are also a few steps I would recommend that you take. The first is to determine whether your current growth fund option is worth the fee. You should also explore investing in other U.S. equity funds that could help diversify your portfolio. An additional step you can take is to contact your HR person to request that low-cost options be made available within your employer’s 401k plan.
Research your fund’s performance and fees vs. its peers
First step: I would suggest reviewing all of the funds that are available to you. The 401k platform that you use should have a quarterly investment performance report available to view online. The report should list the investment options by asset class: All of the U.S. equity funds should be listed together, all of the international equity funds should be grouped together, etc.
Next: Compare how each of the U.S. equity funds have performed. You should compare each against its benchmark. I would suggest investing in both U.S. Large Cap and U.S. Small Cap funds, as well as in growth and value funds. Each different category can outperform the others for years at a time. I also like to invest in multiple managers in each category: If one manager underperforms for whatever reason, you could still have several other managers in any given asset class represented in your portfolio that turn in a better performance.
A growth fund with an expense ratio of 1.33 is a little high. Are they “earning” those fees? You can compare the fund with a U.S. growth index to determine if the fund manager is doing better than low-cost alternatives. In researching funds, I like to use Morningstar’s free online website to gather information. You can find out how each fund is invested, along with its performance and fees. In terms of performance, you’ll be able to see how a fund has performed by calendar year. Most performance reports only show performance by the most recent quarter, along with the most recent one-, three-, five- and 10-year periods. A bad performance year from four years ago can distort the five-year performance number, so I prefer to see performance by calendar year against a benchmark to give me a better perspective.
You can google the fund name and then include “Morningstar” after the name; google will provide the Morningstar page for that fund. For example, if I want to review how the Vanguard 500 Index Admiral Share fund has performed, I would type “Vanguard 500 Index Admiral Share fund Morningstar.” The fund is typically listed as the first search result, though that doesn’t happen 100% of the time. You need to look for Morningstar in the web link. After clicking the correct link, I suggest clicking on the performance, portfolio and fee tabs.
Once you do your Morningstar search for the growth fund, you have a decision to make. Do you compare this fund with a measure of the overall stock market like the S&P 500 or Russell 1000, or do you compare it with a Growth index? To become more knowledgeable, I’d suggest using both comparisons. But apples-to-apples is your key metric. Ask any investment advisor: You should compare a growth fund with a growth index.
Explore diversification options
Investing in value, growth and blended funds will help you diversify your portfolio so that, as an investor, you are not relying on just one investment style. You can conduct the same type of Morningstar analysis with retirement target date funds. It’s important to look at the underlying portfolio of a target date fund to see how it is invested in U.S stocks vs. international stocks. Some target date funds are heavily weighted to U.S. stocks; others have a more even distribution between the two asset classes. If you invest in the target date fund, the individual investments within the fund are designed to create a diversified portfolio.
At the outset, I suggested you contact your HR person to request that low-cost investment options be added to your 401k plan. Depending on how the retirement plan is organized and who is involved, this request may not be implemented right away. But you certainly have a strong case to make if the current active, higher-cost funds are underperforming.
In summary, increasing your contribution to 15% is a great move. This will help you on your path to retirement and decrease your taxes. You can research how each of the funds within your investment options perform against one other and against benchmarks. You can gather information about their portfolio compositions. You can determine which funds are managed well—and which merit the fees they charge. Using multiple funds within each category will help you create a well-rounded portfolio.
If your employer does a 4% match, then only put in 4%. Maximize your Roth contributions for yourself and for your spouse, 5500 each or 11 thousand combined (your wife doesn't have to work to contribute). Also contribute the family maximum to an HSA each year which is currently 8750 and might be increased by Congress, since those funds can be subtracted from your income and unlike a 401(k) you get tax-free withdrawals once you reach age 65
Also try to convince your employer to switch to a lower-cost provider.
Avoid target-date funds and stock funds since the U.S. market is too dangerous. Stick with very conservative choices.
This is an extremely smart question to be asking! I'll lay out my thoughts in order:
1. I'm guessing the answer is no, but do you have any index funds in your 401k plan?
2. If the answer is no, I would approach your employer or HR and express your disappointment with the high fees in your plan. This may not fix the problem immediately, but from the limited information I have, it appears that you have been given poor choices to work with.
3. If it were me, for the time being, I would not raise my contributions. If you qualify, in addition to taking advantage of the match, I would max out contributions to Roth IRA.
4. When the time comes that you have better 401k fund choices, then increasing contributions there would be a great move.
Best of success to you!