You probably know by now that the sooner you start saving for retirement, the better.
That’s largely because retirement savings stored in an account like an IRA or 401(k) are invested and subject to compound interest, which effectively means that the best thing you can do for your money is give it time to grow.
As your savings grow exponentially and the percentage of your assets you pay in fees stays steady, however, a significant amount of money can be diverted from your savings to pay for their upkeep.
In their 2014 report “Fixing the Drain on Retirement Savings: How Retirement Fees Are Straining the Middle Class and What We Can Do about Them,” Jennifer Erickson and David Madland of the Center for American Progress explore how fund management fees can erode retirement savings stored in a 401(k).
Erickson and Madland pinpoint two overarching problems with the fee structure of the investment options offered to most Americans through their retirement accounts: First of all, the fees are difficult to understand, and second, they “are often simply too high.”
They point out that the better Americans understand the fees, the more likely they are to choose low-cost investments for their savings.
To understand how this affects an individual, consider, for example, that a worker has a choice of investing in a mutual fund with a total expense ratio of 25 basis points — 0.25 per cent, which is in line with available, low-cost retirement options — or another with fees of 100 basis points — 1 per cent. While the difference of 0.75 per cent may sound small mathematically, the cumulative effects over time of that difference are huge.
In the infographic below, this calculation is illustrated, showing that the seemingly minor difference in fees works out to over $US70,000 by the time the workers retire. To make up that gap, the worker paying 1% of assets would need to work at least an extra three years.
If the worker opted into a high-fee fund, paying 1.3% of his assets, the difference between his savings and the saver with low-fee investments approaches a hefty $US100,000.
As Vanguard founder John C. Bogle says when talking about index funds, “The more the managers and brokers take, the less the investors make.”
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