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Makin' Money

High fees erode retirement savings

Chris Farrell May 10, 2012

Wall Street firms, mutual fund companies, and other money managers love to talk about compounding returns. But fees are critical to long-term investment performance. Too bad many employers in the public and private sectors don’t fight to reduce fees on retirement savings plans. Here’s a striking example sent to me by Henry “Bud” Hebeler as part of a correspondence he was having on the impact of high fees.

Three teachers contribute $250 per month for 35 years. Let’s assume for the exercise that they earn on average an 8 percent annual return. Look at the impact fees have on how much money the teachers have at retirement.

  • Teacher 1 pays 2.25% in fees (just about what the average California teacher currently pays) and ends up with $336,320.
  • Teacher 2 pays 1.25% in fees (about the average mutual fund charge) and accumulates $409,585.
  • Teacher 3 pays 0.18% in fees (which is about what a fee hawk will pay) and amasses $548,750.

The difference between the high-fee plan and the low-fee plan is $212,430.

Let’s look at the impact of fees on living standards in retirement, assuming a 4 percent withdrawal rate. It’s a standard number for running baseline simulations.

  • High-fee is getting $13,452/year or $1,121/month.
  • Medium-fee is getting $16,383/year or $1.365/month.
  • Low-fee getting $21,950/year or $1,829/month.

My hope is that new regulations requiring greater fee disclosure and transparency will encourage employers to negotiate lower plan costs with their money managers. Imagine, you don’t need to find a great money manager to boost returns. All you need to do is push for lower charges.

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