Stop Paying High Investment Fees in your 401(k) or Brokerage Account!
If you are out of debt and on the path to financial independence, you are likely involved in investing in some type of mutual fund, perhaps through your work 401(k) program. Mutual funds can be a great way to invest in a diversified way, which can minimize your risk of loss to some extent. However, those brokerage houses aren’t providing mutual funds for the public good; most brokerage firms are public companies and are profit-seeking entities.
The Problem With Mutual Funds: Fees
One of the major problems with mutual funds is the high fees charged by actively-managed funds. This article states that fees for such funds are, on average, nearly 1% of assets under management. Thus, if the market returns 4% a year on average, and you are paying 1% of your assets each year to your investment house, your returns are now 3% a year and you have lost 25% of your annual returns. If you are retired and living off of your investments, this is a whopping 25% reduction in pre-tax income. If you are accumulating assets for retirement, you know that returns compound much more slowly at 3% than at 4%.
The argument for actively-managed mutual funds, as well as hedge funds and private equity funds, is that returns for such funds are higher. However, John Bogle, the founder of Vanguard, in his book “Enough,” explains that actively-managed funds are fighting in a zero-sum game for returns. Thus, on average, actively managed funds will return the market average returns less their high management fees. Trying to pick the guy who will pick the right stocks is no simple task, and the fund manager with high returns this year may “regress to the mean” next year.
To add to the problem of high management fees, one must also beware of “loads” – which are sales commissions for “investment advisors,” whose real job may in fact be to sell you high-cost funds and other products. The Zacks article linked above states that loads can be 4%-5% of invested assets at the time of investment.
Feeding The Beast
All of these fees – management fees and commissions – are “feeding the beast” of the massive financial services industry. Imagine ordinary middle-class Americans freely giving 1% of their money each year to fund wall street debauchery. Perhaps that’s an exaggeration, but maybe not!
Saner Alternatives: Vanguard
When I got my first job and had a bit of money to invest, many of my friends recommended Vanguard. Fortunately, I followed their advice. I now know that the reason Vanguard is so well regarded is because it is organized as a mutual company, which means that it is owned by it’s investors and does not serve profit-seeking shareholders. This removes much of the incentive to collect high fees, which is a problem with other investment advisers. This is also one reason that John Bogle is viewed as a sort of selfless demigod of individual investing. He even has his own online fan club forum over at BogleHeads.org.
Vanguard is generally regarded as the low-fee investment house. They primarily run index funds, which means that you buy, for example, the equivalent of the entire market-cap weighted S&P500 index. This reduces the amount of highly-paid analysts and traders needed to run the fund, because it is very simple to administer. In exchange, the fees are as low as .05% of assets under management with sufficient investment. Compare that to 1% for active funds! Vanguard makes up for their low fees through volume – they are the second-largest investment house in the US, and likely the world, when measured by assets under management (the sum of all investors’ invested money).
How to index invest the low cost way
It is quite easy to invest with Vanguard by going to their website and opening an individual investment account. It takes about 10 minutes to link a checking account and send some money over to a low-cost index mutual fund like the S&P 500 Admiral Fund (with .05% management fee!).
However, if you still have your old 401(k) from your old job hanging out with your employer’s broker, you may want to get your money out of that brokerage if the fees are high. You could do this by opening an IRA with Vanguard, and then getting Vanguard to help you roll your 401(k) into your IRA without taking a taxable distribution from your 401(k). It is essentially a transfer, and Vanguard can help you to get your old employer’s brokerage to send a check directly to Vanguard on your behalf. This process should not trigger a taxable event for your 401(k).
Lastly, if you work for a smaller company and they do not currently use a low cost index fund vendor like Vanguard for the company 401(k) program, you may consider lobbying your HR department or owners to consider switching vendors to Vanguard.
A few Caveats
I provide the information above as a lay person and individual investor. I am not an investment advisor, and this is not advice. You should seek out tailored from investment advisors. I prefer calling Vanguard to get them to explain the details of starting an account. You could also get advice from an advisor who is paid hourly for their advice and is not trying to sell products. Good luck!