After transparency regulations were put into effect in 2012, 401(k) investors are learning that fees have a large impact on overall returns. With exchange traded funds, savers can limit costs and maximize returns.
When it comes to investing, fees matter. Stuart Robertson on Forbes illustrates an example between two hypothetical 401(k) plans: An ETF portfolio, with all-in including administrative and other costs, has a 0.75% fee. A common actively managed mutual fund portfolio with all-in fees of 1.75%.
If an investor contributes $4,800 per year with a 7% annual return before fees, over a 40-year period, the mutual fund investor would pay about $77,000 more in fees than the ETF investor. Moreover, the mutual fund plan would cost an investor a total $200,000 less in total returns due to fees paid and the resulting cumulative drag on investment performance.
On average, the total expense ratio of an asset class ETF in the U.S. is 0.27%, compared to 77 bps with the average mutual fund. Fixed income ETFs feature the lowest cost, at an average of 23 bps, with alternative ETFs presenting the most expensive expense at 98 bps. The average equity based ETF has a TER of 23 bps, which compares to the affordability of fixed income funds. [Why ETFs Continue to Attract Investor Assets]
Additionally, overall performance is also a major factor, and the actively managed mutual fund track record has not been keeping up with passive indexing methodologies.
In the 12 months ended June 30, 59.6% of large-cap funds, 68.9% of mid-cap funds and 64.3% of small-cap funds underperformed their benchmark indices. The figures are also similar for active funds over the past three- and five-years. Performance for all domestic equity fund categories fell behind benchmarks in the past three- and five-years as well. [Passive ETFs are Looking Even Better Next to Active Funds]
For more information on ETFs in 401(k)s, visit our 401(k) category.
Max Chen contributed to this article.