Millennials beware of the $590,000 hit from fund fees
Here's a good news/bad news situation for millennials when it comes to saving for retirement. While they have three or four decades to sock away a comfortable nest egg, those savings could be depleted by as much as $590,000 if they don't pay attention to investment fees.
Every generation needs to be aware of how investment fees can eat away at their retirement savings, of course. But given that millennials have more time than Gen Xers or baby boomers to save and that they also have wide range of low-fee options that weren't available when older Americans first began their careers, they have a chance to wisely structure their retirement accounts early on in their careers, which can help maximize returns, according to a new study from NerdWallet.
Investment fees take a double toll on retirement accounts. Because they're based on a percentage of a worker's investment, the fees increase as their account balance gets larger. Second, those fees reduce the amount of money that can grow and compound, which eats away at potential returns.
A 25-year-old with a $25,000 retirement account who's investing $10,000 annually and averaging an annual return of 7 percent will lose $590,000 in returns over 40 years if she picks a fund with a 1 percent fee, NerdWallet found.
"People say you have a lot of time for your money to compound and grow, but they also have a lot of time to suffer from investment fees," said Dayana Yochim of NerdWallet. "They could be handicapped over the long term by the fees they pay."
That outcome can be avoided if a millennial picks a fund with a lower fee, such as a low-cost exchange-traded fund (ETF). Instead of picking an actively managed mid-cap fund with a fee of 1 percent, an investor could choose a mid-cap ETF with an expense ratio of just 0.09 percent. In the latter scenario, the millennial would retire with $533,000 more in her account than if she had picked the fund with a higher fee.
"What was very surprising was how much they lost in investment power" from a fund with a 1 percent fee, Yochim said. "Every dollar you pay to cover fees is one less dollar you have to invest in the account."
Fees are increasingly facing scrutiny, especially as researchers are finding that actively managed funds -- which typically charge more than passive funds, such as ETFs -- rarely meet or exceed their benchmarks. Two-thirds of active large-cap managers failed to beat the market in 2015, according to a March study from S&P Dow Jones Indices.
But that doesn't mean it's always clear or easy for workers to figure out what their best options are. Yochim noted that it's up to investors to do their own due diligence on fees and to realize that not every ETF or target-date fund will offer the lowest fee structure available. Some ETFs, such as those with specialized strategies, can carry fairly high fees.
"There are plenty of pricey ETFs out there," Yochim said. "Don't let them hide behind the name of ETF."
That advice also holds true for Gen X and boomers, although Yochim noted that they don't have as much time to "right the wrongs" of their past investment decisions.
Robo-advisors can be a good choice for consumers who don't want to do the elbow grease on their own to figure out asset allocation and costs, but Yochim noted that they also come with their own expenses, on top of the funds' expense ratio. An investor may end up paying as much as 0.4 percent for a portfolio managed through a robo-advisor, NerdWallet said.
"You want every dollar as fully invested as you can from the get-go," Yochim said. "The more pennies of that dollar that are going to the investment, and not going toward fees, will start compounding faster. Compound interest is a beautiful thing."