Retirement Q&A: How to Choose Accounts, Manage Risk, and Cut Fees
Do you have concerns or unanswered questions about investing for retirement that have kept you from getting started? It's time to get more clarity so you can move your finances forward with confidence instead of staying stuck and never building wealth. Laura answer three questions about how to choose the best accounts, cut investment fees, and manage risk the best ways possible.
The financial actions you take (or don’t take) today affect the lifestyle and security you’ll have in the future. That’s why retirement planning is such an important topic, no matter if you plan to work full-time into your 80s or you want to become an expert vagabond by the time you’re 40.
When you’re young, retirement may seem too far off to worry about. But what’s critical to understand is that you can get away with saving less money and still end up with a much bigger nest egg if you start investing sooner rather than later.
Putting time on your side gives you a huge leg up due to the power of compounding, which happens when the growth in an account gets continually reinvested. The longer your earnings continue to make more earnings, the more wealth you’ll accumulate.
Even if you’re late to the investing party and haven’t already heeded this advice, it’s never too late to get on a better financial path. Investing consistently is a simple, but extremely powerful way to grow your retirement savings at any age.
If you have concerns or unanswered questions about investing for retirement that have kept you from getting started, it’s time to get more clarity. That can make the difference between moving your finances forward with confidence or staying stuck and never building wealth.
In this post, I’ll answer 3 questions that I recently received about retirement. You’ll learn how to choose the best accounts, cut investment fees, and manage risk the best ways possible.
Free Resource: Retirement Account Comparison Chart (PDF download) - get this handy, one-page resource to understand the different types of retirement accounts.
3 Questions & Answers About Retirement
Retirement Question #1
Michelle M. says, “My husband and I are 29-year-old newlywed professionals with generous combined income and hopes for an early retirement. I’ve heard you suggest maxing out your 401k before contributing to an IRA. But we have only been contributing enough to max out the match from our employers and then maxing out our IRAs. That’s because I’ve read that 401k fees are generally higher than IRA’s. How do you evaluate fees when choosing the right retirement account?”
Thanks for this great question, Michelle. Investment fees are an important consideration because they can slowly eat away at your nest egg over time.
While there’s no free lunch when it comes to investing, there are some easy ways to lower fees. There are three different kinds to be aware of: administration fees, service fees, and investment fees.
While there’s no free lunch when it comes to investing, there are some easy ways to lower fees.
Administration and service fees of a 401k or an IRA are largely out of your control. They may be included in the investment fees or charged to your account separately. They cover the many costs of maintaining your retirement plan, such as fund management, service representatives, websites, accounting, and tax reporting.
Service fees are one-time charges associated with using certain features of a retirement account, such as making a hardship withdrawal, taking a 401k loan, or doing an IRA rollover. These pay for the personnel, paperwork, and reporting required.
Investment fees are the largest, but are also within your control, to some extent. These pay to have your money managed in any fund you choose and are known as an investment’s expense ratio or ER. Investment fees are not unique to 401ks or 403bs offered by employers; they’re also charged on investments in IRAs and taxable brokerage accounts.
You simply can’t avoid investment fees; however, you can choose funds with low expense ratios because they’re clearly listed on any investment menu. Even one percentage point can really add up when you do the math.
Let’s say you invest $10,000 a year for 40 years in 401k. Getting an average net return of 6% instead of 7%, means you’ll have $1.5 million to spend in retirement instead of $2 million. Paying just 1% in fees over four decades would cost about $500,000.
If you want to own stocks and see two similar growth mutual funds on a 401k or IRA menu, look at their expense ratios. If one charges 1.25% and the other charges 0.25%, I’d choose to invest in the cheaper fund. Ideally, you’ll have several options with expense ratios lower than 1% and if you can go lower than 0.5%, even better.
There’s no truth that investment options in a 401k are always more expensive than those in an IRA. It just depends on the investment firm and the types of funds offered. You’ll find that index funds are some of the least expensive because they’re passively managed.
There’s no truth that investment options in a 401k are always more expensive than those in an IRA. It just depends on the investment firm and the types of funds offered.
In some cases, additional administrative fees of a workplace retirement plan can be more than offset by having access to institutional funds with extremely low expense ratios. I’d prefer you max out a 401k with low-cost funds than to invest less in an IRA. For 2017, you can contribute up to $18,000 (or $24,000 if you’re 50 or older) in a workplace plan, but only $5,500 or $6,500 in an IRA.
So, my advice is to first max out your 401k or 403b because they offer so many benefits such as company matching, a high annual contribution limit, a Roth option with no income threshold, and automatic payroll deductions. Give workplace retirement plan fees healthy consideration in how you select investments, but don’t let them keep you away from leveraging these great accounts.
If you really don’t like your investment choices, let your employer know that you’re interested in having different options. And if you really feel strongly that your 401k choices are far inferior to those in an IRA, I’d say that maxing out an IRA is better than not investing at all.