An eye-opening, controversial report about the investment fund fees paid by South Carolina’s pension system is a good reminder about the importance of fees people pay on retirement and investment accounts.
The amounts that companies charge to manage 401k and IRA accounts and regular investment accounts don’t appear large to most investors. An investor might pay fees amounting to less than 1 percent of their assets each year, or maybe somewhat more than 1 percent.
But here’s the important thing: investments grow over time by compounding returns. That is, you earn money on your contributions, and on your previous earnings.
That’s how, if you were to put $1,200 yearly in a retirement account for 30 years, earning a return of 7 percent each year, the $36,000 you invest would grow into more than $121,000.
But fund fees reduce the amount of money in your account each year, and those small reductions have a big impact over time.
Take just a half-percent of the annual fund balance away each year, to account for fees, and by my calculations your $1,200 a year would turn into $110,000 after 30 years instead of $121,000.
Notch those fund fees up from a half-percent to 1.5 percent annually, and your eventual balance after 30 years of investing drops to about $90,000.
Wow. Those small fees turn into real money.
For that small-time investor saving $1,200 a year, an annual fee of 1.5 percent would eat up $31,000 of their retirement fund.
Now we all know that you can’t really find a retirement fund that will produce a positive 7 percent return each year for 30 years, though a fund may average those returns over time.
Stocks and bonds might have stellar returns one year and terrible returns the next — that’s hard to control — but what you can control are the fees that chip away at your investments year after year, in good times and in bad.
In South Carolina, pension officials disputed a report that said the state was paying the highest fees of 35 states studied, while getting a 5-year average rate of return of 1.46 percent.
States paying the lowest fees had annualized returns averaging 2.38 percent, partially because of the fact that less of their money was going to pay fees.
When you’re managing billions in pension funds, small improvements in average returns are a huge deal.
So, how can you take this information and use it to your advantage?
If you participate in a company-sponsored retirement plan such as a 401k, you may have limited investment choices, but you should still learn about the fees associated with those choices.
If you have investment or retirement accounts that aren’t tied to an employer, then you have an extensive range of options, as far as where to invest the money. It’s not hard to find large, reputable fund management companies that offer funds with annual fees below a half-percent yearly.
For example, Vanguard and Fidelity, the two largest fund companies in the U.S., both offer funds with annual net expenses of less than a quarter-percent (less than $25 per $1,000 in the fund).
According to Vanguard, the average expense ratio industry-wide is 1.11 percent. That’s nearly 12 times the expense ratio for Fidelity’s Spartan 500 fund, which tracks the performance of U.S. stocks and has an expense ratio of 0.095 percent.
Another lesson personal investors could learn from the extensive reporting about South Carolina’s relatively expensive, under-performing pension fund, is that pursuing riskier investments with higher expenses in an effort to increase total returns is no sure thing.
What the stock and bond markets will do this year or any year is beyond your control.
But what you pay companies to manage your investment funds is up to you.
Reach David Slade at 937-5552 or Twitter @DSladeNews.