It’s time to examine my mom’s 401(k) plan. The first thing that I wanted to do was to get an idea of what kind of fees she was paying. There are three basic types of fees, according to the Dept. of Labor:
- Plan Administration Fees – Like the description states, this is for things like record-keeping, mailing statements, and other accounting duties.
- Investment Fees – Often the largest and most hidden, these are fees that are wrapped into the investment options that you are given.
- Individual Service Fees – These are for specific things like processing loans or for self-directed investments.
Smaller companies often can’t afford a top administrator like Fidelity or Vanguard, which can absorb most administrative costs. Instead, they must find a cheaper firm (at least for them). Guess where the costs get shifted to? The workers. Thankfully, my mom isn’t subject to any administrative fee, at least that I could find. But investment fees…
Types of Mutual Fund Investment Fees
Investment fees for a mutual fund are usually broken down into
- Front-end loads – Also known as sales charges or just front loads, this fee is charged when you buy a share of the fund. For example, if you have a 5% load and put in $1,000, only $950 worth of shares is actually purchased. Essentially a sales commission, the $50 goes to the salesman (in this case, the plan administrator). Avoid whenever possible!
- Back-end loads – Also known as deferred loads, this is essentially the same setup, except that it is charged when you sell.
- Expense Ratio – Also known as annual management fees, these are ongoing fees charged by the mutual fund company for running the fund. It is usually expressed as an annual percentage of fund’s net asset value (NAV), although the fee is subtracted a little bit each day. The expense ratio may also include a sales portion, called 12b-1 fees.
- Early Redemption Fees – Supposedly to deter market timing, such fees are usually the same as back-end loads, unless the money is direct back into the fund itself and split amongst the shareholders (instead of going to the fund managers).
What is sneaky about all these fees is that they are usually not marked on your account statements as a fee, and in the case of 401k’s I bet many investors are never told about them and how they can seriously hurt your potential returns.
Do You Know What Share Classes You’re Buying?
Now, of course by law they must give you the prospectuses for each fund. You know, those thick booklets that most people file away, never to see it again. But if you don’t know, dig them up and read them! For one, one mutual fund may have several different shares classes, with different combinations of front loads, back loads, and annual expense ratios. Don’t just assume you are buying the cheapest class, either.
For example, the only Real Estate option my mom’s plan is the AIM Real Estate Fund, Class A Shares (IARAX). I was sad to see that this has a fat 5.50% front load and a 1.29% expense ratio. The Investor Class shares of this fund (REINX) had no loads and 1.27% expense ratio. I don’t know how happy she’ll be to find out that 5% of every dollar she put in was being taken away instantly.
I still have to sort through the other details of the funds like investment objectives and asset classes, but by better understanding the fees, she can already start to choose between her available options more wisely. For instance, your 401k might offer a great International Fund with reasonable expenses, and an S&P 500 fund with horrible expenses. If so, you can buy the better fund in your 401(k) and find a good alternative for the bad one in your other brokerage accounts.