Wall Street Is Gobbling Up Two-Thirds of Your 401(k)

Another reason to do this is that you can buy "anything" in your IRA account, including stock market ETFs, leveraged bond fund ETFs (which can be a nice diversification option since you don't pay the full income tax on the dividends that you otherwise would need to outside of a 401(k)/IRA), anything that your brokerage account has access to.

On the other hand, your typical 401(k) plan only has access to crappy financial products and shitty fund managers. My former employer offered a bare bones 401(k) plan with no employer match. I went through and looked at all ~20 of the funds available. There were 2 passively managed index funds, 17 active managers who had underperformed the market net fees, and 1 who had done decently well, maybe matched the Russell 2000 after fees (it was a mid cap fund). I looked further and found, exactly to my expectations, that every single one of the 17 bad funds were run by inexperienced, most likely young, managers. The one fund that did decently had two guys who had been running it for over a decade.

Not all money managers are bad. Some do actually provide some legitimate values, even after fees. But (a) most of the ones available to you in a 401(k) plan suck really really badly, and (b) even the good ones will break you with fees.

It is probably not that well known, but "The wealthy" combat (b) by negotiating fees that are significantly lower than the starting fee by saying, "I am bringing $N million to your account. What fee can you offer me? I am shopping you vs other banks."

This article does mention Bogle, but really just reading something by Bogle directly would be better than this piece.

Besides, how did they get 2/3 anyways? If I make 7% and 2% goes to someone else, I'm still left with 5%. 5% > 2%. So how does that 2% translate into 66.7%?

This point is extremely contentious. Particularly in the long run, there is a lot of data to show that actively managed funds do not beat market indexes. With fees, they come out considerably behind.

Often, 401k's offer few, if any, index funds and at drastically higher fees, even if the fees are lower than actively-managed funds.

To take a personal example, I have retirement accounts with Vanguard (Roth IRA), T. Rowe Price (solo 401k) and, through my employer, with MassMutual. All offer an S&P 500 index fund, but Vanguard's fee is 5 basis points (.05%), TRP's is 30 basis points, and MM's is 90(!). Why am I paying almost 20 times as much in fees through my employer?

Sure, you could put this back on my employer and say, "well, they should offer you a 401k with better options/lower fees/with a better vendor," and though I'd agree, it's not as though I have any say in the matter, which is the point that Bogle and Frontline are making.

Actively management mutual funds are pure snake oil. Anyone with a whiff of the ability to generate alpha goes to the hedge funds, where you get the pleasure of paying 2 and 20 for it. Even there, there are no guarantees (though SAC with it's all insider trading, all the time, comes close.)

p = 100000 w = 0 for i in range(50): p = p * 1.07 w = w * 1.07 w = w + (p * 0.02) p = 0.98 * p

print "Year: " + str(i+1) print "\t You: {:.2f}".format(p) print "\tWall St.: {:.2f}".format(w)

And what is remarkable is that around year 35, wall street starts making more money than you do even though you're the one putting the money into it (assuming wall street is earning the same interest you are. If you account for (reasonable) salaries and overhead, It changes the numbers quite a bit.)

How? Are you claiming that active management actually works?

You might be able to beat an index fund with active management, but you also might lose big. It's an illusion. Without foresight, you're just as likely to have chosen Warren Buffet as Bernie Madoff to manage your money :)

It is a bit more nuanced than that, basically it's saying you don't have any control over what sort of fee structure your 401k has in place, and goes on to suggest that banks abuse that lack of control. So yes, if you can, you need to reduce your management fees.

Even if I have to pay 2% to the management company, I'm still coming out ahead by putting money into my 401(k) because:

1. I can't put nearly as much money into a tax-deferred account on my own (the yearly limits on IRAs are much lower than on 401(k)s).

2. My employer doesn't match a percentage of my contribution if I invest the money on my own.

The important bit here is to look at the fees that you are paying with your 401k plan, and make sure they are acceptable.

The difference between a 2% management fee and a 0.05% management fee from Vanguard's Total Stock Market Index... or 0.09% fee from SPY ETFs (+$7/trade from your typical broker).

Run the math, if you are paying 2% fees, you are getting straight up robbed. If your employer doesn't offer low-fee index funds, it would be worth your while to make sure that they get some onto your 401k portfolio.

Whether Wall Street and/or its employees actually use the cash to "pay their bills" or invest over that same period to fully realize their portion of the return is irrelevant.

For that matter, Wall Street could (and probably would) invest that money elsewhere and may gain an even higher return. But, again, that's not the point. The point is that it's not in your pocket.

So some basic math to show how much a 2% yearly fee costs you:

  In[2]:= 100000 * (1 + 0.07)^50
  
  Out[2]= 2.9457*10^6
  
  In[3]:= 100000 * (1 + 0.05) ^50
  
  Out[3]= 1.14674*10^6
  
  In[4]:= Out[2] - Out[3]
  
  Out[4]= 1.79896*10^6
  
  In[5]:= Out[4] / Out[2]
  
  Out[5]= 0.610707

The 100k example isn't accurate, it's just trying to give people a sense of how much they'd be losing..

However - this article doesn't really do the full benefit calculation of company matching, effective interest rates of other types of accounts, etc.

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Smith: Take an account with a $100,000 balance and reduce it by 2 percent a year. At the end of 50 years, that 2 percent annual charge would subtract $63,000 from your account, a loss of 63 percent, leaving you with just a little over $36,000.

Is this math right? It doesn't seem like this is how the calculation would be done.

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The main thing however, is that the typical fee is closer to 1.1% or so. They are grossly exaggerating what the typical investor would pay. Nonetheless, compounding returns forces you to think about these things.

As I've stated in my other posts, you can get a Vanguard fund with 0.05% fees, or the typical SPY index ETF, which is currently at ~0.09%/year expense ratio. Focus on low-fee funds, and read the fine print on your 401k plans.