If you knew of a way to have $125,000 more saved in your retirement accounts when you retire, would you be interested? It’s legal and doesn’t require any hard work. You can do it, simply by paying attention to fees. By owning funds with low fees, you keep more of your money in your account and out of the pockets of a fund company.

The best way to know what you are paying to own a fund is by looking at the expense ratio.

The Expense Ratio

From the Motley Fool: “The expense ratio represents the percentage of the fund’s assets that go purely toward the expense of running the fund. The expense ratio covers the investment advisory fee, the administrative costs, 12b-1 distribution fees, and other operating expenses.” A standard actively managed mutual fund has an expense ratio of around 1.5%. This means that your fund company takes 1.5% of your money every year. By contrast, some of the cheapest index funds have an expense ratio of only .03%.

The expense ratio of a fund includes the investment advisory (or management) fee, which is the money that is used to pay the fund manager. The person that manages your fund could be getting paid up to 1% of the fund’s assets to pick the investments that make up the fund. The manager gets paid the same 1% every year whether the fund does well or poorly. You’re on the hook for that 1% regardless of whether your fund earns value or loses value.

What Else Are You Paying For?

On top of the management fee, you may also pay the following fees:

• Loads (front-end or rear-end) – This is basically a fee for the privilege of owning a fund. There are too many no-load funds available to even consider paying a load.
• Financial advice – My 401(a) administrator charges .6% for their financial advice program. You are automatically enrolled unless you opt out. I opted out.
• 12-1 distribution fee – This means ‘marketing’ in English. That’s right – you’re paying for your fund company to advertise itself to other investors. No thanks.
• Transaction fees – You may be charged a fee if you try to buy a Vanguard fund from within your Fidelity account, for example. You will also pay a fee every time you make a trade using a brokerage outside your retirement accounts. These can add up quickly, negating any gains you’ve made.

How Much Is 1.5%?

While 1.5% of your money may not seem like a lot, it can have a huge effect over your career. I talked about the power of compound interest in this post, which is how your investments grow so large over time. The problem is that your fees also compound – as your account balances grow, so does the amount you’re paying in fees.

When you start out your career, you don’t have much invested. 1.5% of $10,000 is only $150. No big deal, right? Well, as you reach the end of your career and your retirement accounts are approaching $1 million or more, that same 1.5% now equals $15,000.  Per year. That’s $15,000 gone every year that you can’t use to fund your retirement. Big difference.

An Example

Let’s look at someone who makes $50,000 per year and saves 15% of their income. We’ll say that their investments had a relatively standard 6% rate of return over their 30 year career:

If they chose a standard, high-fee group of funds (1.5% expense ratio), they would pay over $126,000 more in fees than if they had chosen low fee index funds (.15% expense ratio). To find out how much you might pay in fees over your career, use this calculator, just like I did above. Simply enter a few basic numbers, and then try out different expense ratios. The report will give you an idea of what you are paying now, and what you might pay with different investment fees. It is eye opening.

Index vs. Actively Managed Funds

Few actively managed funds beat the market over a long period of time. A recent Vanguard study found that over five year periods, “actively managed funds were just as likely to underperform their peers as they were to outperform.” This means that all actively managed funds have winning years and losing streaks. You pay the same fees whether the fund beats the market or trails the market in a given time period.

Index funds cost less because there is no management team that needs to be paid for their time and research. An index fund tracks a benchmark index, which means that the fund is composed of largely the same investments as its benchmark. No guesswork or stock picking is needed. For example, the Vanguard 500 Index tracks the S&P 500, while the Schwab Small Cap Index Fund tracks the Russell 2000 Index. When the target benchmark does well, so does the index fund. When the benchmark falls, the index fund also takes a hit.

This is why, when you factor in fees, index funds generally outpace actively managed funds over time.

The Index Fund Race

Investors took nearly $265 billion out of actively managed U.S. equity mutual funds in 2016, while pouring more than $236 billion into index funds and ETFs. Fund companies know this, and so they’re competing for your money by lowering the fees they charge on index fund products. Taking advantage of Vanguard’s success, Schwab and Fidelity have recently lowered the expense ratios of several of their index funds in the hope of attracting investors looking to lower their costs.

How To Find Fees

It might take a little digging to find out what your fees are. Not all fund companies make it easy to tell what they charge for a specific investment. They are legally required to disclose their fees, but they don’t have to advertise it in large print or make it easy to find. A good place to start is on your administrator’s website. Once you log in, find a list of the funds that you own inside your account.

If you own a target date fund, it will be easy – that fund should have its own expense ratio. If your portfolio is made up of several funds, you’ll have to find the expense ratio for each individual fund. Vanguard (Roth IRA) and Prudential (401(k)) make it easy for me – the expense ratio is obvious on the first page after I click on a fund. ICMA-RC (401(a)) makes it more difficult, and hides the fee information behind a couple tabs.

If you can’t find it within your account, you can look it up using Morningstar’s website. Enter your fund’s ticker into the search box, find your fund, then click on the Expense tab. It will show you the next expense ratio, plus any other fees you might be paying.

What If Your Fees Are Too High?

ICMA-RC, who manages my 401(a) account, charges way too much. I only own index funds within that account, and the expense ratios range from .95% to 1.05%. In comparison, Prudential charges me between .03% and .09% for the exact same asset classes. I have no choice who my employer chooses to administrate my 401(a) account, but I do have a choice about how much money I contribute. My employer offers a 2% match if I contribute 2% to that account, but that’s all I put in there. I refuse to throw more money away with that company when there are other, cheaper options available.

If your plan administrator charges too much, it might be wise to contribute just enough to get any employer match, and then put the rest of your money elsewhere. An IRA or Roth IRA through Vanguard, Schwab, or Fidelity will offer low cost index funds and allow you to keep more of your money.

Fees, In A Nutshell

Fees will take a huge chunk of you savings, if you let them. If you’re like me, you hate to give your money away for nothing. If I can get the same or better performance for less money, I’m all in. There are a lot of passive index funds out there with very low expense ratios. You can make up a well-diversified portfolio using just index funds (like I do), and do it cheaply.

Take a few minutes and find your expense ratios. Then use the calculator and figure out how much you’d spend in fees over your career. Also look at each fund’s returns. Are the funds with high fees making enough to pay for themselves? If cheaper options are available to you in your retirement plan, take a look. Your retired self just might thank you for switching.