Janet, age 48, is married with 2 kids in high school, and she recently moved to a new company. Over roughly 15 years she grew 401k retirement account at her old company to $150K through annual contributions. Upon closer look, the value today is only slightly more than the value of her contributions.
As part of her investment due diligence process, Janet contacted us to evaluate the retirement plan and to present possible alternatives. Janet is smart to look into her retirement investments. These funds will likely be addressing her cash flow needs 15 to 40 years in the future so there is still time to generate significant growth. As with any investment management plan, there are three basic factors: fees, portfolio asset allocation, and individual manager performance.
In Janet’s case, all three factors were hurting performance. After some detective work we discovered fees to be about 2.46% per annum, roughly equally split between plan provider and investment fees. Asset allocation had been set to 40% stocks and 60% bonds. Stocks historically return significantly more than bonds but the environment of low bond yields has exacerbated the difference. We then deduced manager performance by calculating net growth and factoring in fees and asset allocation. For that allocation, net of fees, her portfolio grew roughly 1.5% less than would have been expected with the benchmarks. The end result was portfolio growth of roughly 2% per year.
We met with Janet to discuss the results. She was shocked about the fees. Her previous employer touted the quality of the plan, and the only fee she saw was a $30 admin expense on each of her annual statements. We explained that the remainder of the fees were deducted from investment returns, unseen by her, standard industry practice. That fee structure was about average for a small employer plan. Big employers typically have lower provider fees but similar investment fees.
We then addressed performance. While we were able to deduce that the underlying managers underperformed their benchmarks by roughly 1%, the real growth killer was asset allocation. Janet selected a plan labeled as “conservative growth”, assuming this would provide growth with limited risk. She commented that this seemed prudent given the riskiness of stock market. We explained that while short term stock performance could fluctuate significantly, long term growth of a diversified stock portfolio was very consistent. Since these funds would be addressing cash flow needs from 15 to 40 years in the future, she was sacrificing substantial growth to stabilize short term portfolio value.
Having changed employers, Janet had the ability to change her investment plan. We recommended she roll her 401k into an IRA. We could manage the account with the goal of long term growth at a fraction of the cost of the plan.