Fees. They’re part and parcel of every retirement plan. But how well do you and your employees understand how they work and how they impact retirement savings? A recent article from retirement plan provider Guideline spotlighted expense ratios and why it’s essential for employers and employees to understand them.
The article defines what an expense ratio is—the cost of investing in a managed investment, such as a mutual fund or exchange-traded fund (ETF). Many retirement plans use these types of funds for their accessibility and built-in diversification. Put another way, expense ratios are fees paid to a company for the management of a fund. According to Guideline, “It covers things like administrative fees, legal services, marketing and distribution costs. The expense ratio is the total of all of these fees charged by the fund.”
The article goes on to explain that expense ratios are a percentage, and they are charged based on an average net investment in the fund. Guideline gives the following example: “… if you have an expense ratio of 0.30%, you’ll pay $3.00 annually for every $1,000 you invest in the fund.” Expense ratios are typically charged annually.
Although determined by the fund manager, expense ratios differ from management fees, also known as an asset under management or AUM fee. As the name implies, an investment manager charges management fees to manage a portfolio. Generally, management fees are higher for more personalized, actively managed portfolios. Other common management fees are investment fees, plan administration fees, and individual service fees. Guideline provides additional details and definitions of each type of fee in the article.
Guideline also breaks down the average expense ratio according to current 401(k) plan data from the Investment Company Institute (ICI). In 2021, retirement plan participants paid an average expense ratio of 0.36%, although expense ratios can vary among 401(k) providers. Fund expense ratios can be found in the participant fee disclosure on a 401(k) statement.
Why should you pay attention to expense ratios? Simply this: As a plan fiduciary, you’re responsible for choosing funds that are reasonably priced, including expense ratios. The higher the expense ratios, the more they have the potential to eat away at long-term returns. Low expense ratios may help grow your participants’ retirement accounts by saving on fees. Reducing fees may be a priority, but keep in mind, you get what you pay for. Not all funds are created equal, and it isn’t prudent to choose your plan’s investment lineup based on expense ratio alone.
The good news is, you can outsource all or some of the investment selection and monitoring, although ultimately, the fiduciary responsibility still lies with you. A retirement plan advisor and/or fiduciary service provider can help guide you on fee vs. fund performance evaluations, for example. An advisor and/or fiduciary service provider can also work with you to periodically benchmark your investment lineup against peer plans to ensure the funds are performing in line with the guidelines set forth in your plan’s investment policy statement and that you are fulfilling your fiduciary obligations when it comes to investment fees and expense ratios.
