You’ve heard it said that compound interest is the investor’s best friend. This is true. But it’s not just returns that compound: Investment expenses, in your typical, off-the-shelf non-Self-Directed IRA or other conventional retirement account also compound over time. And these compounding costs can be a very nasty enemy as far as your long-term returns are concerned.
For example, a recent study, published by the Center for American Progress, calculated that investment and other fees of just 1 percent per year – an amount commonly reached in 401(k) plans, especially at smaller companies – average out to as much as $70,000 in costs over the average workers’ working career.
“”The corrosive effect of high fees in many of these retirement accounts forces many Americans to work years longer than necessary or than planned,” concluded the authors of the report. Indeed, most workers would have to work between three and five more years, saving aggressively, to make up the shortfall by contributing to a 401(k).
The study mentioned above was just released in April of 2014. But here at American IRA, we’ve been concerned for a long time that needless or excessive fees were taking too big a chunk out of our clients’ retirement returns. We frequently review our own fee structures with this in mind. Indeed, last year, in May of 2013, we significantly lowered our fees to a low set annual fee.
Our approach is very different from the norm in the financial services industry. To see how we’re different, click here (video at the link).
What are the fees?
As we mentioned above, we rely on a low set annual fee, rather than a percentage of the assets under management. Unfortunately, that’s the exception in the financial services industry, rather than the norm.
In most cases, the lions’ share of the fees are wrapped up in the expense ratios of mutual funds inside 401(k) plans, which can range as high as 1 to 1.3 percent, and even higher in some smaller 401(k) plans. This is one thing in an equity fund when stocks are zooming at 10-15 percent per year or more, but it is unconscionable in, say, a bond mutual fund when interest rates – and therefore long-term expected returns – are closer to five or six percent per year. In this case, you’re giving up a fifth of your profits right back to the investment house.
If your plan includes annuities – a common feature in 403(b) plans and very frequent in IRAs as well – you encounter mortality and administration expenses, which can be even higher than those in mutual funds because of the additional cost of providing insurance out of those funds.
How Can You Avoid Fees?
There are several effective ways to avoid or minimize fees in your retirement accounts. Here are some ideas:
- Choose index funds. These funds don’t attempt to beat the market. Instead, they just buy everything in the market, according to the outstanding float, or market capitalization, of every security they can get their hands on. These funds can be managed by a robot for next to nothing. You aren’t paying someone to sit around and pick stocks for you. As a result, these funds can be had for a fraction of the cost of a conventional, actively-managed fund. Besides, year in and year out, most index funds soundly outperform most actively-managed funds, once you take their expenses into account. That 1 to 1.3 percent handicap is simply too large for most funds to overcome compared to mutual funds.
- Use Self-Directed IRAs and other retirement accounts. You can set up your own Self-Directed Solo 401(k) plan, Self-Directed SEP plan, Self-Directed IRA, Self-Directed Roth IRA, SIMPLE or even a Self-Directed Health Savings Account. You can then use these accounts to invest in nearly anything except life insurance, jewelry and gemstones, art and collectibles, and a few other items prohibited by the IRS.
Otherwise, you can invest your funds in whatever you know best: Real estate, private lending, private equity, farms, ranches, land banking, tax liens and certificates, certain forms of gold and precious metals, partnerships and LLCs, and even stocks, bonds and mutual funds (though with mutual funds you’re back to paying expense ratios).
If you partner with American IRA to run your self-directed retirement account, you only pay a small fee per transaction. Overall, your expenses are normally much lower than a typical actively-managed mutual fund. Yes, you may have internal expenses, but these are expenses that you control. You are in charge, and you don’t have to make any transactions you don’t want to (until you run into required minimum distributions in retirement, which apply to any tax-deferred retirement account, anyway).
- Ask your employer for lower expense options, or, if you are self-employed or you own the company, shop around for a plan provider that offers index funds. Many 401(k) plans don’t even include index funds at all. There is simply not enough money in them for them to be attractive to a 401(k) representative to set up. Not every employer is going to listen, sadly.
- Work with American IRA, LLC. That way, you know you’re getting the benefit of a flat administrative or set annual fee, rather than a percentage that increases the amount you have to pay out every year. A penny saved is a penny earned, and the less you pay out in fees, the more you can keep for yourself.
Need help getting started with Self-Directed IRAs? Self-directed 401(k)s? SEPs? Join us for one of our free upcoming workshops and seminars on the topic. You can choose between a general look at self-direction in general, as applied to Self-Directed IRAs, or focus in on the advantages of using real estate within a self-directed retirement account.
Or call us at 1-866-7500-IRA (472). We look forward to working with you.
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