In this blog we will look at the real cost of owning an IRA.
I know you may be thinking that there isn’t any cost to own
an IRA, or a 401k. I mean, you didn’t have to pay anything extra to start the
account. All the money you paid them to start the account went into your chosen
investments. Your Advisor doesn’t make you write them a check every year to
manage your account, right? And you certainly haven’t seen any fees written on
the quarterly statement telling you about what it costs to own and IRA or 401k.
You have probably had one, or several, of these accounts for years, so it’s
obvious that you know how these things work, right?? Right??
The real cost of owning an IRA, or 401k, can be found in a variety of different places. We will look at the places inside these accounts that cost you money. We will also look at the hidden places that these accounts can cost you money..
Let’s start with the places that are the most obvious.
Depending on what company your account is invested through you may be paying an annual Account Maintenance Fee. This fee, if charged, will usually run between $25 and $50 per year. I understand that is a pretty small sum, but it’s a charge that comes from your account for basically nothing. There is no additional service that is provided for this fee. They simple charge this fee because they can, and there is nothing you can do about it. Unless you move the account from them.
The next most common is the Investment Advisor Fees. There
have been a number of studies done on this subject and they typically come out
with about the same result. The advisor will, on average, charge their clients
around 1% of the accounts value. This is basically their commission. The reason
you have never seen this is because they are not required to tell you about it.
They have always been pretty clever hiding this fee since it generally comes
out each month. Rather than charging the entire amount once a year, it’s
divided up so that 1/12 of this fee will come out each month. Only the most
astute observers, that watch pennies like a hawk, will ever notice these fees.
Sales Loads are the next on the list. This is essentially a
commission that the Advisor is getting paid to sell you a specific Mutual Fund,
or Mutual Funds from a specific company. The problem this creates is that what
is being recommended may, or may not, be in the client’s best interest. The
average investor doesn’t have the time, or knowledge, to manage their own
account. That’s what you’re paying them for. So, you simply have to trust that
the advice they are giving you is in your best interest, not theirs.
Trading Commissions are another fee that must be dealt with.
Every time your advisor buys or sells a stock, bond, ETF or Mutual Fund there
are Trading Commissions attached to it. How much the fees are will depend on
what you are buying or selling. Stocks and ETF’s typically don’t cost too much
to trade, however Mutual Funds are a different story. They are almost always
much more costly to trade, sometimes running as much as 3 or 4 times the cost.
Also, keep in mind that is the cost for each individual transaction. If you
want to sell one mutual fund and buy another, you will pay the trading
commission once for the sale and once for the purchase.
Expense Ratios are fees that are charged by all Mutual
Funds, Index Funds, and ETF’s. They are almost always listed as a percentage of
the fund value. ETF’s and Index Funds generally keep these fees fairly low.
Mutual Funds do not. According to many studies that we have looked at the
Expense Ratio for a mutual fund can easily be 4x higher than that of an Index
401k fees are also on the list. This may come as a surprise
to most, but there is an administrative cost for an employer to offer a 401k.
In many cases this cost is merely passed on to you.
I’m sure that by now you are wondering how much all of these
fees are adding up to. Well, let me give you a quick rundown. As we stated
earlier, the typical Advisor will charge 1%. The national average for a 401k
fee is 1.5%. The average Expense Ratio for a Mutual Fund is between 1.25 and
1.5%. Trading commissions can range from
$5 up to $70 per transactions. As far as Sales Loads, they are legally only
allowed to charge up to 8.5%, I will let you do the math on that. And if all
those weren’t enough, don’t forget about the Account Maintenance fee if there
The reality is that it’s impossible to give you an exact
number of how much you are paying for an IRA or 401k. But I hope that you now
realize they are not cheap. Oh, and by the way, when you look at the mutual
fund options in your 401k do you think those specific funds were put in there
because they are the best funds for you, or for them???
Now let’s look at the Hidden costs of an IRA.
Yes, I know that we already covered all the costs that are
hidden inside your IRA. These are the hidden costs outside of your IRA.
The first hidden cost is quite possibly the most unassuming
and that is Market Risk. The reason this can be so unassuming is because
“everybody knows” that the markets go up and down. The timing of when they do
this can have a very lasting impact on your life. If you are young, this may
not sound like that big of a deal but talk to someone that retired several
years before the last major market correction in 2008. Has it affected their
lifestyle during retirement when they lost around 30% of their account value??
Especially since they are not contributing to that plan, rather they are taking
out of it. Talk to someone that was planning on retiring between 2009 and, say,
2012. Did they end up working a few extra years trying to get their retirement
account back to the same value it was??
The next hidden cost is not having compound interest work in
your favor. One of my problems with IRA’s is that you can never benefit from
Compound Interest. There is a reason that Albert Einstein called it the most
powerful force in the universe. Unfortunately, most will never really get to
know how powerful of a force it can be in the creation of wealth.
Another hidden cost is the lack of access to your money.
Sure, you can access your money from
an IRA or 401k, but it’s costly. You will have to pay any and all of the taxes
that are due, plus the early withdrawal penalty if you are under age 59 ½. It
doesn’t matter what is going on in your life or why you want access to your
money. Not having liquidity, use and control of your money sucks.
Another hidden cost is the cost of debt. We all have, or
have had, debt. It’s a fact of life. We buy houses on debt, we buy cars on
debt, we finance our college educations. But, honestly, does it really make
sense to invest while you have debt? Think about it. Let’s say that your 401k,
after all the fees, averages getting 5% interest each year. But you are paying
5% interest on your Mortgage. At the end of the day you are no farther ahead.
Now, what if the interest rate on your car loan is 6%. That makes even less
sense. If you have Student Loan debt you likely know that it will NEVER go away
until it’s paid off.
The last hidden cost I will talk about is the cost of the
unknown. We have no idea what tomorrow will bring, let alone 5 years from now.
Will your IRA start to fund itself if you become disabled? No, it won’t. What
if you have a Heart Attack, Stroke, or Cancer. Does your 401k allow for access
to your money? No, it doesn’t. What if you pass away unexpectedly, will your
mutual fund give your family lump sum, tax-free cash? No, it will not.
As you can see there are many costs associated with an IRA
or 401k. The good news is that there are better options.