There is a story getting considerable coverage this week about a study that finds that an average family may end up having 30% less in total lifetime accumulated wealth in their 401(k) plans due to high fees and expenses. The study inspiring all of this attention is titled “The Retirement Savings Drain” and published by policy research firm Demos.

The Demos study estimates that the all-in costs of a 401(k) plan, (including fund expense ratio, trading costs and administrative fees) average 1.56% of assets per year. This figure is based on asset-weighted average expense ratios for mutual funds and assuming trading costs that are pretty reasonable. The all-in cost estimates are fairly consistent with other estimates that I have read. Participants in large low-cost plans may pay less and participants in small company plans tend to pay more, but this number seems to be a reasonable baseline.

Checking the Numbers

I have often performed this type analysis as a standard demonstration of Monte Carlo simulation for portfolio planning.

To follow the general structure of the Demos analysis, I assume that an investor buys and holds a portfolio that is 50% allocated to an ultra-low-cost S&P 500 fund (SPY) and 50% allocated to an aggregate bond fund (AGG).  I then assume that the investor continuously contributes to a 401(k) plan over his or her entire 40-year career (age 25 to age 65) and increases the annual contribution to keep up with inflation.

I then calculate the investor’s total accumulated wealth at age 65, including their contributions and capital gains, assuming that all dividends and bond yields are reinvested. (Note: I realize that this is the ‘best case’ scenario.) I then add a 1% additional expense to both the stock fund and the bond fund to see how much a 1% increase in cost will impact lifetime wealth.

Here’s Why Every Percentage Point Counts

So, how much does just a 1% increase in costs reduce our model investor’s lifetime accumulated wealth?  I come out with a 20% reduction in lifetime accumulated wealth. And if I add a 1.56% additional fee (to match the Demos example), the lifetime reduction in accumulated wealth is 28.3%.

My results are very consistent with those produced by Demos. The two main differences between my assumptions and those used in the Demos study are:

  1. They use last 40 years of historical market data, while I use forward-looking risk and return simulations.
  2.  The Demos researchers look at a couple who each earn an average salary for their age and gender through this 40-year period. In my calculations, I simply assume that the investor’s wage growth follows a 3% annualized increase to keep up with inflation and that their contributions also increase 3% annually (so that inflation-adjusted contributions are constant).

Same Numbers Very Different Interpretation

While my calculations agree with the Demos study, my interpretation of the results is quite different. Here’s why: Demos is citing this 30% reduction in lifetime wealth as if it is entirely avoidable but mutual funds and ETFs will always have a cost, and administering and managing a 401(k) plan will always have a cost.   There is no way to have a costless solution.

Comparing the average lifetime cost of a 401(k) plan to an unattainable zero-cost solution is like pointing out that a car could get an infinite number of miles per gallon in a frictionless world. This may be true, but it is simply irrelevant.

I have previously estimated that it is possible to create a well-diversified investment portfolio in an IRA for an all-in cost of 0.56% per year. (Note that this is for an IRA and not a 401(k) and a 401(k) will incur additional costs for administrative and advisory services.)

If a 401(k) plan’s costs can be reduced by 1% per year in just fees and expenses, this would save plan participants 20% of their lifetime accumulated wealth.

This is an enormous amount. Based on a range of data, there are plans where it should be possible to create this level of cost reduction. To focus on the 30% number calculated by Demos without looking somewhat deeper is an oversimplification, and to make a zero-cost plan the basis of comparison is simply not very useful.

Employers and their employees should look closely at the costs of their retirement plans. There is nothing to lose (and potentially a substantial amount to gain) for all involved if  the costs of having a retirement plan can be reduced.


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