Retirement plan sponsors and advisers try to teach employees to save in retirement plans early because of the effect of compound interest on savings, but there is also a compound effect on fees.
A research report from NerdWallet notes that a dollar taken out of a participant’s account to pay plan fees is one less dollar to invest, compound and grow.
In one scenario NerdWallet analyzed, paying just 1% in fees would cost a Millennial more than $590,000 in sacrificed returns over 40 years of saving. In another scenario, a Millennial with the option of investing in either of two commonly held funds can save nearly $215,000 in fees—and, with compounding, retire nearly $533,000 richer—by choosing the one with fees that are 0.93% lower.
The numbers seem high, but the point is, investment and other plan fees do have an effect on participant outcomes—something plan sponsors can consider when monitoring investments or negotiating administration fees.
NerdWallet suggests it is especially important to scrutinize fees of actively managed mutual funds. “Paying more for a mutual fund that is actively managed would be justified if the fund consistently outperformed its index-based peers,” the company says.
“Everyone talks about the benefits of compounding interest, but few mention the danger of compounding fees,” says Kyle Ramsay, NerdWallet’s head of investing and retirement. “We would not suggest only looking at fees when making investment decisions. However, plan sponsors need to think carefully about what they hope to get from an investment service or product, and whether that benefit is worth the fees. As [we found], 1% versus 0.5% may not feel like much over the course of a year, but when saving for retirement, it could mean the difference between retiring at age 70 versus retiring at 73.”
NerdWallet’s report can be found here.