When I was an inexperienced investor, I spent a lot of time researching potential company stocks and index (or mutual) funds. In retrospect, most of the performance indicators I paid attention to were important for evaluating a purchase. However, expense ratio (a.k.a retirement savings account fees or expenses) was one element I wish I had taken more seriously.

I didn’t even know about compounding when I made my first stock purchase back in 2009. And once I learned about compounding, I didn’t know that fees also compound while my savings compound. Even after I became aware of expense ratios, it didn’t occur to me right away that I needed to learn what those fees are or read about their potential impacts.

That was, until last year. Those sayings that go like, “You don’t know what you don’t know.” and “You don’t know how little you know until you start learning.” are so true in this case. To this date, every day, I’m still finding out I have a lot to learn on investing, growing and protecting my money.

In this article, I bring your attention to retirement account fees and their potential impacts when left ignored. These fees are typically a small percentage of your account balance, making it easy for uninformed investors to ignore or overlook. Yet, the fees can slowly eat away your investment returns over 5, 10, 15 or 20 years time span.

Using research studies on 401(k) plans and number examples, I shared below how retirement savings account fees can dramatically affect your ability to retire and how much money you have during retirement.  The contents and messages are also applicable to IRAs and any types of individual retirement savings accounts where someone (or an entity) is involved in helping you manage your money.

Did You Know?

According to a 2010 AARP survey, seven in ten (71%) of over 800 401(k) plan participants ages 25 and older were not aware that they paid fees to their plan administer to maintain their account. When told of these fees, six in ten (62%) were not aware of the amount they paid in fees.

Since that study, the Department of Labor implemented a new 401(k) rule that went into effect in year 2012. This rule required all 401(k) administers (or sponsors) to give plan participants basic explanations of each fund’s average annual returns over one, five, and 10 years; the comparable returns of a benchmark fund; and average annual operating costs as a percentage of assets and as a dollar figure per $1,000 invested.

Despite such efforts, there’s evidence that 401(k) plan participants’ awareness of what and how much they pay continues to lag and only increased slightly over the past several years.

With pension plans fading away, many of you are probably relying on your 401(k)s (and/or other similar accounts) to fund your retirement lifestyle. Considering all the tax benefits you might get from contributing pretax money to these accounts and how substantial such account(s) can become for some of you over the years, it’s very unfortunate that many plan administers (as well as employers) aren’t doing a better job (or even an adequate job) orienting participants to the in-s and out-s of this employment benefit. As I wrote in another article, when done with due diligence combined with patience, your 401(k) account can be your vehicle to millionaire status.

Retirement Plan Fees Aren’t Intuitive

One of my mentees recently graduated from a master’s program and secured a job at a nonprofit of about 150 employees. At her orientation, Human Resource specifically reminded her she had the option to contribute to a 401(k) plan plus receive a 3% match on her salary. As I later learned, HR at the time failed to mention anything about plan fees or the fact that they were using a third party providing 401(k) consultations.

Setting up a 401(k) account and contributing to it was my mentee’s first exposure to investing and the stock market. She didn’t know about trading fees and/or commissions associated with buying and selling shares of equities. Moreover, she wasn’t aware that she’d have to spend money (on fees) to participate in her company’s 401(k) plan. Who would have thought?

Even if there were to be fees associated with participating in the plan, wouldn’t it be a fair guess to assume that her employer would have the fees covered? After all, having the option to contribute to a 401(k) and getting the company match was part of her compensation package. My mentee looked at the 3% company match as bonus pay. She had no reason to think there was a price attached to it. It was not intuitive to her. In my mentee’s own words, “I thought my 401(k) was free!”

Why Employers Aren’t Doing a Better Job?

When you are provided the option to participate in a 401(k) plan, don’t automatically assume your employer has your best interest in mind. They provide a retirement plan to help them attract and retain skilled workers, but might not have the incentive to ensure that they’re selecting the best possible retirement plan for you. Some retirement plan fees are inevitable due to the nature and complexity of the market structure of retirement plans. In addition, running a mutual fund involves costs. When your employer is given a choice to either have themselves cover the costs or pass those costs onto you, many choose the latter.

If your employer falls in the latter group, this doesn’t necessarily mean they aren’t good people. Your employer might not have purchased the most competitive plan for their employees, due to lack of of time, resources or other reasons. Shopping for a competitive 401(k) plan can be a long process. Making a good decision requires your employer having onboard competent staff who have the appropriate knowledge and skills (or they themselves know this kind of stuff). Unfortunately, many small companies don’t have these kind of resources and lack the leverage of economies of scale that a large company uses to obtain lower costs. So, they might resort to taking shortcuts.

Second, your employer might not know how to negotiate (or even aware that’s possible) for lower fees. Once again, this requires having the right staff onboard to take on the task.

Third, your employer might not be aware of the financial burdens their 401(k) plan’s fees can have on you.

Fourth, your employer might not even know you are paying investment management fees.

Your Money Compounds; and So Do Your Fees

My husband has been contributing to an employer shared-profit plan for about a decade now. That specific portion in our investment portfolio is the second largest. During this past decade, his contributions and gains have compounded many times. With the help of a financial calculator, it’s easy to get a good estimate of how much his contributions have compounded over the years.

However, what has been less clear is the amount of fees he got charged over the years, compounded. According to a study done by the the public policy think tank, Demos, most people don’t know that there are fees involved with their 401(k)s.

These fees are typically taken ‘off the top’ of investment returns or share prices. Even in light of the new 401(k) rule that implemented in year 2012, many 401(k) plan administers still don’t make it easy for participants to see (on statements) how much in fees they have paid and/or how to read the charges. As planadviser stated, while the regulations certainly made much more information available to plan participants, relatively few retirement plan investors take full advantage of the increased disclosures.

If you’re someone who pays detailed attention to your money, you’d have likely benefited. Unfortunately, few people pay attention, according to the planadviser team.

Why do we care about 401(k) plan fees?

While my husband’s contributions and gains have compounded over the years, his fees also have compounded. Yet, it’s not easy to compute how much those fees are costing us over the past decade (and in future years if he doesn’t do a rollover–read my article on 401(k) rollover here).

When you start looking at the expense ratios (or fees), you might see percentages ranging from .025 to 1.5% (or much lower or higher, depending on your plan). Even though some of these fees may seem small at first, but when the time factor is taken into account, these fees can have huge impacts over time. Fees function as a drag on your returns much like a car with poor aerodynamics having its fuel efficiency shot down by increasing wind drag at higher speeds.

As the Demos study demonstrated, an “ordinary” American household (details provided in this brief ) will pay, on average, nearly $155,000 over the course of their lifetime in effective total fees. This large sum of money can have a profound impact on many people’s lives, such as (1) the difference between being able to retire and not being able to, (2) whether they would have a paid off house at retirement, or (3) the quality of life during retirement.

Then, what is a reasonable expense ratio?

The U.S. Securities and Exchange Commission (SEC) doesn’t impose any specific limits on the size of fees that a fund may charge. With that said, I’ve read over and over again (both on the Internet and books) that expense ratios below 1% are considered good. My husband and I like to invest in funds that have expense ratios at or below 0.25% (keep in mind that we also consider many other factors and criteria, too, when selecting an investment). Of course, we highly prefer those with expense ratios more like 0.05 or 0.025. We also invest some into individual stocks which typically have no expense ratios other than the cost of acquiring. We only recommend individual stocks to those with the time, energy, and dedication to perform the necessary research into individual companies to satisfy their own heart, mind, and stomach.

The Mentality I Had Early On in My Investing Career and How that Has Changed

When I first started investing in the stock market back in year 2009 (I wrote about my first stock market encounter here), I didn’t pay much attention to the fees when purchasing index funds. My attitude at the time was that as long the fund was helping me make money, I’d be happy.

These were my internal thoughts:

What’s there to be unhappy about when I only have to pay a quarter (or half or ¾ or 1) percent of my gains when the fund brought in hundreds (and sometimes thousands) of dollars for me? Or,

When I make $100 on this fund, I’ve no problem paying 1% ($1) of this gain* to the fund manager(s)/brokerage.

Much of my thinking on expense ratios and fees back in 2009 and 2010 were along those lines.

*My notion of how expense ratios functioned during that time was incorrect. The expense ratio is charged on the fund’s total value and not just the gains.

As a graduate student whose monthly income was under $2,000 at the time, I would’ve been thrilled to be earning anything above $20 from any one of my stock purchases. Certainly, my scope of the stock market, investing, financial planning and retirement planning was very limited.

As Time Went On

That was, until I entered the workforce and had my own 401(k) account to manage. It was then that I started noticing how the high fees were dragging down my overall portfolio return. My husband and I were invested in very similar markets, yet, his portfolio performance (yearly return) was way better than mine. And I didn’t like what I was seeing.

My frustration with how much my 401(k) fees were eating away my savings further in 2016 when I learned about the 4% withdrawal retirement rule, which I wrote about here). In simple terms, if I plan to withdraw 4% of my investments each year to cover expenses, then spending 1% in fees would only leave 3% of the withdrawal I can spend to cover my expenses.

Taking a Closer Look at the Numbers

The 4% withdrawal rule example:

In number terms, let’s say my total assets in retirement is $1 million. At 4% withdrawal rate, I’d have $40,000 to spend. However, with 1% of that going to pay for fees, I’d be left with only $30,000 to spend. If you would to be living with that kind of fixed income, 1% makes such a big difference in terms of dollar amount you can spend. That $10,000 leaving your wallet is 25% of your withdrawal amount! Imagine what you can do/buy with $10,000 when it’s in your own pocket…

The compounding example:

Assuming the average expense ratios in your retirement savings account is 1%, for example, this would mean every year you would pay 1% of the balance you’ve got in your account. So, if you have $100,000, you would spend $1,000 on plan fees and expenses (amount of fees paid in year 1).

[What would you do what that $1,000 if you can keep it instead? If you choose to invest the $1,000, that $1,000 have the chance to work hard for you and might generate some sweet returns when you’re ready to retire.]

But, that’s not all. As long you keep the balance in that account, you’d be paying 1% in fees year after year. Let’s say your new balance is $120,000 the following year, then, the amount you’d pay in fees would be $1,200 (1% of $120,000). That $1,200 (amount of fees paid in year 2) includes the $1,000 paid on $100,000 and $200 on the additional $20,000 in gains.

What happens in year 3 after when your account balance is $150,000? You’d continue to pay the initial $1,000 in fees for the same $100,000 that you’ve already paid in the first year, second year and again in this third year year. Depending on how long you have your savings in the retirement account, the lifetime costs can be a shocking number once you realized the compounding pattern.

As example #2 illustrated, it’s not easy to track the lifetime cost of those fees unless you really have your financial life together. Even so, doing such calculations over your lifetime can be time consuming. Rather than overwhelming our lives with those numbers, my husband and I take preemptive actions to keep our investment costs low.

And how can you keep your investment costs low?

Self education on investing. The more you learn, the more confident you’ll become in selecting funds (often index funds while keeping mutual funds to a minimum). You’ll also gravitate toward keeping your investment expense ratios to a minimum.

What’s Coming Up?

One of the messages I like to share throughout this blog is nobody cares more about your money than you. And nobody should. If you want to protect your hard-earned money and are pursuing financial security, you owe it to yourself (and those you love) to learn all you can with regard to how your savings (and investments) are being managed. The great news is that you don’t have to face this challenge alone. You have plenty of free resources available if you’re willing to spend the time.

In an upcoming article, I will discuss some of the more common retirement plan fees (or expenses) your plan administer typically charge. I will also share the approach I took managing my 401(k).

Thank you very much for reading and for your continuing support. I’d love to hear from you in the comment section below.

If you’re participating in a 401(k) or other retirement savings plan, are you aware of the fees?

When (and how) did you first learn about them?

Are the fees showing up on your statements? Are the charges clearly displayed and easy to understand?

What would you say your average expense ratio is? Do you think that number is reasonable?

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