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Is Your 401(k) Robbing You Blind?

Recently there's been a brouhaha stirring over 401(k) retirement accounts. In a report entitled, The Retirement Savings Drain--The Hidden and Excessive Costs of 401(k)s--research firm Demos makes some startling claims about our beloved retirement accounts.

For example, the Demos report includes the following findings:

-- Over a lifetime, fees can cost a median-income two-earner family nearly $155,000 and consume nearly one-third of their investment returns.

-- A higher-income dual-earner household, one where each partner earns an income greater than three-quarters of Americans each year, can expect to pay an even steeper price: (as much as) $277,969.

-- The median expense ratio of mutual funds in 401(k) plans was 1.27 percent in 2010.

-- Trading costs vary from year to year, but have been estimated to average approximately 1.2 percent a year as well.

Taken at face value, one might be inclined to shun 401(k) retirement plans like the plague. But there's more to the story.

The Demos report brings to light a little known fact about mutual funds: The expense ratio does not include all of the fees investors will pay to own shares of the fund.

The expense ratio covers predictable expenses, such as sales and administrative costs. Because the fund knows these costs in advance, they can disclose them to investors in the form of an expense ratio.

But funds also incur costs to buy and sell the stocks and bonds that make up the fund. And it's these trading costs that cannot be predicted in advance. Trading costs vary based on the trading activity in the fund. So while they are paid out of the fund and lower investors' returns, they are not included in the expense ratio. I've written about these trading costs and how to find out how much a fund spends trading on my personal finance blog, The Dough Roller.

But here's the catch: These trading costs are not peculiar to 401(k)s. Every mutual fund has trading costs that are not disclosed in the expense ratio. In this way, the Demos report unfortunately singles out 401(k) accounts, when in reality the issue will affect your returns regardless of where you hold your investments.

So what can you do about these fees? As an initial matter, choose investments with very low expense ratios. While these expenses do not cover trading costs, keeping them as low as possible with low cost index funds will allow you to keep more of your investment returns for yourself. Even half a percent of additional costs can have a huge impact on your retirement account over a lifetime of investing.

Second, consider a fund's past trading costs when making investment decisions. You can find these fees in the fund's Statement of Additional Information, a form all mutual funds are required to file with the SEC.

Third, you may consider investing in individual stocks and bonds to avoid both the expense ratio and trading costs. You'll of course have trading costs when you buy and sell your investments. But if you are not an active trader and use a discount broker (we maintain a list of the best online discount brokers at The Dough Roller), the costs will be minimal.

Finally, if your 401(k) investment options are expensive, talk to your HR department about getting more investment choices. Several employees did just that at my previous job, and while the change didn't happen immediately, eventually our employer added more mutual funds. They were not all great choice, but several of them offered us lower cost options.

DR is the founder of the popular personal finance blog The Dough Roller, and the credit card review site Credit Card Offers IQ.

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