What is an Expense Ratio 401(k)?

By ShareBuilder 401k

Don’t let high-expense funds cost you your retirement

401(k) plans are often saddled with high expense funds and investment options. In fact, there are different fund classes for the same mutual fund that your advisor/provider could offer (higher cost can mean more pass-through money to your advisor), and/or some providers just don’t have the agreements with some fund providers to offer great options or even index funds or ETFs at all.

Generally, the big reason many 401(k) plans, especially small business 401(k)s, don’t have low-expense fund rosters and are lacking many if any index funds is that most actively managed funds enable pass-through revenue to your providers. Most index funds don’t have pass through fees.

Unfortunately, paying more for funds has not historically been correlated with fund performance. In fact, higher investment expenses alone can be a very material drag on the growth of your nest egg. There is compounding impact of investment costs that can make a big difference over a 30-40 year career.

In this hypothetical example, Jill and Dan invested the same amount over 40 years, but because Jill paid 1% less in investment expenses, she saved an extra $376,321, which is 27% more than Dan.

Compounding Chart

What is an expense ratio?

An expense ratio is a measure of the total costs associated with managing and operating an investment fund, expressed as a percentage of the fund's total assets. It includes various expenses such as management fees, administrative fees, operating costs, and other miscellaneous charges incurred by the fund.

Expense ratios are important for investors to consider because they can directly impact the overall return on investment. A higher expense fund has to overcome these costs to beat a lower expense fund with the same goals in the same asset class. Funds with lower expense ratios typically beat higher expense ratios over the long run. Therefore, investors often look for funds with low expense ratios as part of their investment strategy.

What Should You Do?

In considering the funds that make sense for you in your 401(k) account, it’s important to look at the fund expense ratio. The lower the better. Each dollar going to fund expenses is one less dollar invested in the markets to grow over time. It’s one reason index funds (which tend to have the lowest fund expense ratios) have been so tough to beat by actively managed fund managers. While a fund manager may have a good year, they likely will be off in future years, and this is why you see index funds outperform most fund managers.

If your plan is loaded with high expense funds (expense ratios over 1% are a red flag) you may want to ensure you get the company match in your 401(k), and then consider investing more money outside your 401(k) in lower expense options.

Lastly, if appropriate at your company, mention to your benefits manager or owner there are providers that enable low-expense investing and use all or nearly all index funds – yes, full disclosure, ShareBuilder 401k is one of them and helped pioneer this approach in 401(k)s. Owners often have the most money in the company 401(k) and have the most to benefit from by switching. Learn Why ETFs Are a Great Fit for 401(k) Plans for more insights

Key Takeaways:

  • Many 401(k) fund line-ups, especially for small businesses, have higher expense investment rosters. Each dollar spent in investment expenses is one less dollar invested in the markets to grow over time.

  • Even paying 1% more in fund expenses can mean having hundreds of thousands of dollars less in your retirement account over a 40-year career.

  • Moreover, higher expense funds have historically underperformed low expense funds.

  • Index funds tend to have lower expenses than actively managed funds and have been tough to beat.

  • When selecting funds that meet your needs, consider lower fund expense options first.

  • If it makes sense, suggest your company consider providers with lower expense fund options or all index fund line-ups.

*Past performance is no guarantee of future result. You should carefully consider information contained in the fund's prospectus, including investment objectives, risks, charges, and expenses. Please read the prospectus carefully before investing. *

Meet the Author

Our low-cost 401k plans are easy to setup online and are supported by our 401k advisors and specialists. ShareBuilder 401k serves small business and medium-sized companies, as well as the self-employed. We offer Roth 401k, Safe Harbor 401k, Traditional 401k, and Solo 401k options. Your 401k plan is paired with investment management expertise and employee education to help you save more.