Your 401(k) is a Cannibal

Written By Jimmy Mengel

Posted June 3, 2013

There’s a ravenous cannibal on the loose…

But it’s not a blood-smeared tribesman or a crazed Hannibal Lecter. No, this is a different kind of monster, lurking in plain sight. And it’s eating your retirement alive.

The monster feasting on your retirement comes in the form of 401(k) fees.

Did you know that over a lifetime, these fund fees cost an average American household $154,794?!

If you are a higher income earner, you could be bleeding up to $277,969. That’s almost one-third of your hard-earned savings.

All told, 401(k) fees eat up $25 billion of Americans’ savings each and every year.

Here are just a few things you could be buying with that pilfered cash:

1) Four years of tuition at an ivy league college

2) An exotic retirement home in South America

3) Both your childhood dream car and a brand-new model 

Instead, that money is being siphoned right into the pockets of money managers who can barely even beat the market.

I guarantee you’ll be able to save thousands a year on fees and statistically have a better chance of beating the returns of these bloodthirsty funds after reading this…

And if you are shocked at these numbers, don’t feel bad. You are not alone. A recent AARP survey showed that 71% of people believed they paid no 401(k) fees at all!

And that’s exactly how these guys want it.

We’ll show you how to slay this cannibal once and for all. But first, let’s have a look at the breakdown of hidden fees…

The total percentage of fees is rolled up into your “expense ratio.”  

Here’s what they’re spending your money on:

  • Administrative Fees
    This is a pretty typical expense that covers customer service, record keeping, and ensuring regulatory compliance. Fair enough.

  • Asset Management Fees
    Your money is going to the portfolio managers and investment researchers who act as the architects of your retirement plan. If you aren’t doing it yourself, someone has to put together your investments… and you can expect to pay them something. 

  • Marketing Fees
    Here’s the one that really burns me. We’re paying so you can advertise your product to other people? That’s like a fee on your monthly car payment to buy ad space for the next year’s model of the car you bought. What kind of madman would have the cojones to do that? (The 401(k) cannibals — that’s who.)

One sneaky fee is conspicuously absent from your expense ratio, and that’s the Trading Fee. 

This fee can add up to massive costs for you, especially if you are in an actively-managed fund that makes a lot of moves. On average, the trading fees can run you another 1.2% on top of your expense ratio. 

So, how can you subvert this 401(k) tyranny?

It is simpler than you might think…

All you have to do is open up an IRA account and load it with simple and effective ETFs. You can cover the same exact bases with a expense ratio of a hell of a lot less.

Considering 401(k)s average a return of between 5.5% and 8.5% — which basically mirrors the broader market — you really just need to find low-cost funds to match what your 401(k) was doing anyway.

Get an IRA cracking and start using ETFs to build a long-term portfolio.

Matching Allocations, Maximizing Returns

The first step to building a parallel account that isn’t being pilfered is to match the allocation you use in your account.

Some people tolerate more risk, some prefer growth over bonds, but it is easily done.

For comparison, here is how the average person in the United States Allocates funds in their 401(k) through 2011, the last year data was available from the EBRI…

Balanced funds are typically 60% stocks and 40% bonds; 60% of the 21% in balanced funds, plus the 39% in pure equity funds and 8% in company stock, comes to about 59% equities for the average 401(k).

To build a similar allocation using ETFs, you can easily use ETFs from three categories:

  • One will match the performance of the S&P 500, Dow Jones Industrial Average, or another index.
  • One will capture dividends from a basket of stable large-cap corporations.
  • Finally, the last one will pull in steady income from a broad selection of bonds.

You can easily use several ETFs in each category, but you’ll want at least one from each to build an ideal portfolio for some stability and growth potential.

Trading the Market

The best place to start will be with the ETFs that are based on large benchmark indices.

All three sport low expense ratios and rarely have bid/ask spreads above a penny.

Vanguard Total Stock Market ETF (NYSE: VTI) – If you want to get really broad coverage of the market, it doesn’t get better than VTI. The index it tracks represents 99.5% or more of the total market capitalization of all of the U.S. common stocks regularly traded on the New York and American Stock Exchanges and the NASDAQ over-the-counter market. The market cap is an impressive $240 billion, and the expense ratio is a mere 0.05%. 

There are a couple of other popular options that you should be aware of:

SPDR S&P 500 ETF (NYSE:SPY) – This was the first S&P 500 ETF and is by far the largest, with a market capitalization of nearly $130 billion. The expense ratio is 0.09%.

SPDR Dow Jones Industrial Average (NYSE: DIA– Once again, this is your best bet to track the Dow, although it would be pretty redundant if you are holding SPY. DIA holds about $12 billion and the expense ratio is 0.16%

Pump Up the Dividends

No retirement account is truly complete without a healthy selection of dividend stocks.

Instead of trying to pick and choose a dozen stocks, this ETF makes your job a whole lot easier.

SPDR S&P Dividend ETF (NYSE:SDY) – The S&P High Yield Dividend Aristocrats Index is comprised of the 50 highest dividend-yielding constituents of the stocks of the S&P Composite 1500 Index that have increased dividends every year for at least 25 consecutive years.

These stocks have both capital growth and dividend income characteristics, as opposed to stocks that are pure yield, or pure capital oriented. The expense yield is set at 0.35%. Dividends are collected by State Street and distributed quarterly. The dividend yield is 2.69%, which is essentially an average of its 86 holdings. 

Bond ETFs

When it comes to bonds, one name comes to mind…

Bill Gross is the founder of PIMCO and known as “the king of bonds”. He manages $1.9 trillion in securities for his company.

Normally, it would take a pretty hefty chunk of money to open an account with him. However, he introduced the PIMCO Total Return ETF (NYSE:BOND) back on February 29th, 2012. It quickly attracted $50 billion in investments.

The ETF holds a large number of bonds, 958 as of the date this report was published, with an effective maturity of 6.73 years.

Bond income distributions are paid monthly. The distribution yield is variable, but is currently at 2.1% annualized. You may choose to reinvest in BOND with the distributions or cash them out.

The expense ratio is far better than what you’d pay for your own bond specialist at 0.55%

The View from the Crow’s Nest

This is but a small sampling of the many ways you can take control of your retirement.

You don’t need to watch helplessly as cannibalistic 401(k)s eat up a third of your retirement funds...

That’s why we’re launching The Crow’s Nest in the coming weeks.

In the days of naval conquest, explorers were only as good as their lookout. Perched atop the crow’s nest, the lookout could see for miles and identify hazardous waters, storms, or traps well before they threatened the ship.

Not only did he spot the dangers, but a good lookout could spy land and opportunity to safely guide the captain to safety and prosperity.

The world of personal finance is filled with tricks, traps, fees, and scalawags — only instead of Blackbeard coming for your booty, you have bankers, money managers, and government officials with their beady eyes fixed on emptying your pockets.

We are your own personal crow’s nest, at your service and ready to steady the turbulent seas of finance.

The Crow’s Nest will demystify your finances and arm you with the knowledge and research you need to save, grow your money, and prosper all on your own.

We’re almost ready to set sail… We hope you’ll join us.

Jimmy Mengel

Jimmy Mengel for Outsider Club
Follow Jimmy on Twitter @mengeled