401k Tutorial

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401k Tutorial

Postby AlexPKeaton on Wed May 01, 2013 11:42 am

I feel like us 99%ers need to band together.

The trick to retiring with a lot of money is to take a look at your 401k options. Pick the ones with the lowest fees no matter what. The reason?

The Math of compounding fees, and the fact that these fund managers are making an absolute killing with this and screwing everyone else over. I.e. High School math is really really important.

A 2% fee over the lifetime of your 401k will reduce your earnings by TWO THIRDS. That is 66%.

The reason? This table shows the well known effect of compound interest on a single $1000 investment.

Image

We all know this math very well I assume.

Now this table shows the same investment, but with a 2.5% fee.

Image

Notice that with the no fee investment, the final result was 160,682. In the fee option, the final result is 34,250. That is an 80% reduction in what you should have earned.

Why is this legal? Well pick your reasoning depending on your political persuasion.

I'm not a financial adviser, but what I am changing my investments to is those extremely low fee Vanguard Index funds. I found out my company has a self-directed option for a $50 yearly fee, and I'm making this happen. What you pay for in those fees is some faith that the people managing them are going to do very well with their trading. But there are thousands and thousands of managed funds. In trading, there are winners and losers in every single trade, so the odds that you are going to win more than average are very low. So why bother gambling on these odds, when you can simply buy an index of the entire market? You are guaranteed to get average, but pay no fees. And fees are what will destroy your 401k end result.

All of this knowledge came from this PBS special, which I highly recommend (available streaming online):
http://www.pbs.org/wgbh/pages/frontline ... nt-gamble/
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Re: 401k Tutorial

Postby bh on Wed May 01, 2013 11:51 am

Chance is the biggest player in the market.

Leonard Mlodinow’s terrific book The Drunkard’s Walk is an historical narrative on the philosophy of randomness and probability intertwined with modern statistical anecdotes. If the inner nerd in you enjoys a little mathematical philosophy like mine does it is definitely be worth the read.
The anecdotes in the book provide lessons on the cautious interpretation of statistics which are as relevant today as ever. This is especially the case given that econometrics, the statistical other half of economics, is often used in practice simply as an ‘economic trick’. In fact, I have my own criticisms of Mlodinow’s interpretation of the experimental outcomes that show people are poor at intuiting probability (which I cover below).
The final two chapters are by far the most interesting, covering human propensity to see patterns where there are none (including confirmation bias and the need to perceive control), how experts are routinely fooled by randomness, how success is often chance rather than the result of hard work, and how the butterfly effect was accidently discovered by Edward Lorenz in the 1960s (a random event itself).
An important lesson is found in Mlodinow’s analysis of the chances of a single fund manager’s success at beating the market for 15 consecutive years. It was simple down to chance.Bill Miller was that fund manager. The probability that his long term success was simply down to luck was widely quoted as 1 in 372,529 (or 0.00026%). But this is the chance that if we had singled him out at the start of his 15 year streak, then followed his performance, and his only, for 15 years, that luck alone explained his success. But in reality this did not happen.

In fact this is a startling example of silent evidence. At the beginning of his 15 year ‘winning’ streak there were literally thousands of fund managers in the race to beat the market. It is only in retrospect that we praised Miller and forgot the rest. So the question then becomes what are the chances that one of these thousands of starters will beat the market for 15 consecutive years.

Since he was praised as the only fund manager in the past 40 years to beat the market for so long, Mlodinow then calculates that if 1000 fund managers (a huge underestimate) are in the race, that one of them will beat the market for a 15 year period by chance alone is around 75%. Conservatively, that means that it is 75% likely that Miller’s success was simply random chance, and only a 25% chance his skill contributed at all.


http://www.macrobusiness.com.au/2011/10 ... %99s-walk/

Found this today too.
http://www.nerdwallet.com/blog/investin ... ket-index/
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Re: 401k Tutorial

Postby JeffDFD on Wed May 01, 2013 11:56 am

Just reviewed some of my 401k stuff today actually. 0.45% fee for what I am using. Not bad considering the choices in my company's portfolio options. Vanguard is not an option. I think their fees are around 0.2% for a lot of their index stuff.
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Re: 401k Tutorial

Postby AlexPKeaton on Wed May 01, 2013 12:04 pm

JeffDFD wrote:Just reviewed some of my 401k stuff today actually. 0.45% fee for what I am using. Not bad considering the choices in my company's portfolio options. Vanguard is not an option. I think their fees are around 0.2% for a lot of their index stuff.


Yeah that is pretty good. I took a look at mine and I had like 1.25% fee funds in there. These fees are the worst thing you can do to your 401k.
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Re: 401k Tutorial

Postby shafnutz05 on Wed May 01, 2013 12:20 pm

I am extremely, extremely fortunate to a) have full access to Vanguard funds and b) have a wife that works for said fund provider. They are the most respectable company in the business, and their fees are virtually nonexistent.

Prior to getting married and her actually taking a closer look at my funds, I had no idea how badly I was getting ripped off. Vanguard is fantastic.
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Re: 401k Tutorial

Postby columbia on Wed May 01, 2013 12:25 pm

So I'm getting hosed, even at .8%?
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Re: 401k Tutorial

Postby Pitt87 on Wed May 01, 2013 12:31 pm

AlexPKeaton wrote:I feel like us 99%ers need to band together.

The trick to retiring with a lot of money is to take a look at your 401k options. Pick the ones with the lowest fees no matter what. The reason?

The Math of compounding fees, and the fact that these fund managers are making an absolute killing with this and screwing everyone else over. I.e. High School math is really really important.

A 2% fee over the lifetime of your 401k will reduce your earnings by TWO THIRDS. That is 66%.

The reason? This table shows the well known effect of compound interest on a single $1000 investment.

Image

We all know this math very well I assume.

Now this table shows the same investment, but with a 2.5% fee.

Image

Notice that with the no fee investment, the final result was 160,682. In the fee option, the final result is 34,250. That is an 80% reduction in what you should have earned.

Why is this legal? Well pick your reasoning depending on your political persuasion.

I'm not a financial adviser, but what I am changing my investments to is those extremely low fee Vanguard Index funds. I found out my company has a self-directed option for a $50 yearly fee, and I'm making this happen. What you pay for in those fees is some faith that the people managing them are going to do very well with their trading. But there are thousands and thousands of managed funds. In trading, there are winners and losers in every single trade, so the odds that you are going to win more than average are very low. So why bother gambling on these odds, when you can simply buy an index of the entire market? You are guaranteed to get average, but pay no fees. And fees are what will destroy your 401k end result.

All of this knowledge came from this PBS special, which I highly recommend (available streaming online):
http://www.pbs.org/wgbh/pages/frontline ... nt-gamble/


2.5% is a massive fee, about 75% above what the 401k Averages Book finds in their survey:

http://www.shrm.org/hrdisciplines/benefits/Articles/Pages/401k-Feeseclined.aspx

It is absolutely part of the equation to monitor and factor fees into your investment decisions, but your example is a bit misleading; EVERY plan has fees associated with them. There are a few different types of fees, like admin and record keeping fees; these are usually expense-based and are well documented in find-level reports. What can be considered a 'hidded' cost is investment fees; these are the fees that can vary from .5 to 1-2%. A big swinging gate that needs to be monitored actively. These fees can also be at the plan level or at the investment level, and some even hit at the management level... thats frightening stuff, since you probably throw away all those proxy statements and disclosures that you get in the mail... amirite?

Bottom line... read the junkmail your fund managers and plan administrators are sending you. I know its boring, but you have no right to complain about fees you failed to learn more about.
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Re: 401k Tutorial

Postby AlexPKeaton on Wed May 01, 2013 12:49 pm

Pitt87 wrote:2.5% is a massive fee, about 75% above what the 401k Averages Book finds in their survey:

http://www.shrm.org/hrdisciplines/benefits/Articles/Pages/401k-Feeseclined.aspx

It is absolutely part of the equation to monitor and factor fees into your investment decisions, but your example is a bit misleading; EVERY plan has fees associated with them. There are a few different types of fees, like admin and record keeping fees; these are usually expense-based and are well documented in find-level reports. What can be considered a 'hidded' cost is investment fees; these are the fees that can vary from .5 to 1-2%. A big swinging gate that needs to be monitored actively. These fees can also be at the plan level or at the investment level, and some even hit at the management level... thats frightening stuff, since you probably throw away all those proxy statements and disclosures that you get in the mail... amirite?

Bottom line... read the junkmail your fund managers and plan administrators are sending you. I know its boring, but you have no right to complain about fees you failed to learn more about.


The problem of course is that virtually everyone has 401ks now. And when the average person sees a 1.5% fee, they don't realize how absolutely terrible that really is, when the math of compound fees applies. I feel like this knowledge needs to be more widespread.
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Re: 401k Tutorial

Postby eddysnake on Wed May 01, 2013 1:12 pm

where do I find my fee %?
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Re: 401k Tutorial

Postby ExPatriatePen on Wed May 01, 2013 1:15 pm

Quick question for those with tax knowledge.

If a person fully funds their 401K by say, May 31st, switches to a new employer on June 1st and repeats the process of fully funding the 401K again, what happens at the end of the year when you have 2x the max? Obviously you can't claim half of it, so how is that situation dealt with?

You're probably wondering why someone would do that. Simple. The first employer has no matching contribution and the second one does.

I haven't been able to find an answer to this one.
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Re: 401k Tutorial

Postby Beveridge on Wed May 01, 2013 1:25 pm

I do a return for a client who does a simple plan for himself and his employees and he always, every year, without fail, over funds the stupid thing. He then pays a 10% fee (penalty) on how much he over funded the simple plan while having to get the money back out.

I'm assuming it would be the same for an individual. IRS will catch it. He has gotten letters in the past when the return was filed right up against the due date.

I believe for the individual, the place where your 401k is, is required to distribute the excess back to you and you'll get a 1099-R on it (which you will then pay tax on and possibly a 10% penalty depending on the circumstance).
Last edited by Beveridge on Wed May 01, 2013 1:28 pm, edited 1 time in total.
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Re: 401k Tutorial

Postby AlexPKeaton on Wed May 01, 2013 1:25 pm

eddysnake wrote:where do I find my fee %?


http://www.moneycrashers.com/calculate- ... 5-minutes/

This one goes into a longer discussion. The fees are convoluted and are intended to obfuscate how much they are ripping you off.

http://www.kiplinger.com/article/retire ... -fees.html
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Re: 401k Tutorial

Postby Pitt87 on Wed May 01, 2013 1:40 pm

AlexPKeaton wrote:
Pitt87 wrote:2.5% is a massive fee, about 75% above what the 401k Averages Book finds in their survey:

http://www.shrm.org/hrdisciplines/benefits/Articles/Pages/401k-Feeseclined.aspx

It is absolutely part of the equation to monitor and factor fees into your investment decisions, but your example is a bit misleading; EVERY plan has fees associated with them. There are a few different types of fees, like admin and record keeping fees; these are usually expense-based and are well documented in find-level reports. What can be considered a 'hidded' cost is investment fees; these are the fees that can vary from .5 to 1-2%. A big swinging gate that needs to be monitored actively. These fees can also be at the plan level or at the investment level, and some even hit at the management level... thats frightening stuff, since you probably throw away all those proxy statements and disclosures that you get in the mail... amirite?

Bottom line... read the junkmail your fund managers and plan administrators are sending you. I know its boring, but you have no right to complain about fees you failed to learn more about.


The problem of course is that virtually everyone has 401ks now. And when the average person sees a 1.5% fee, they don't realize how absolutely terrible that really is, when the math of compound fees applies. I feel like this knowledge needs to be more widespread.


Your example demonstrates HOW fees affect performance, but is not an example of reality. Fees are a component of an investment, but one of many; load, performance, activity, management, holdings... all of these are factors that should be considered. . If someone only used your example -- 2.5% and an 8% yield, which I would argue is a bit extreme -- they would be surprised to learn that performance greater than 8% is possible, and that lower fee funds/plans may not perform as well overall.

If you have funds that require large fees, go for a higher risk profile to offset the fee. LIke any portfolio, find a balance that makes you feel comfortable with costs, risks, returns, as well as service. 1.5% may not be that bad if your returns offset or your administrators are working to save you money compared to market. Its not as simple as good or bad...
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Re: 401k Tutorial

Postby columbia on Wed May 01, 2013 1:44 pm

I just checked my 403b - current job - and it's clocking in at .75%; not much I can do about that, because that's where I get my matching contributions.
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Re: 401k Tutorial

Postby Digitalgypsy66 on Wed May 01, 2013 1:44 pm

Yep, it took me 15 minutes to find the prospectus where my fees are listed.

Also, I have multiple types of investments in my 401k (real estate, stocks, bonds, annuities) and each type has a different %. Most are under .5% annually.

I'm not sure what this means, and as always, looking at my retirement account makes me a bit lightheaded. :lol:
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Re: 401k Tutorial

Postby eddysnake on Wed May 01, 2013 1:55 pm

talked to my representative through work. I'm with ING now, looks like I have a .90% Investment mgmt expense and .65% insurance expense (no idea if these are the fund fees?). I work for the State of PA and had the option of going through 401k or through SERS. with my workplace putting in 10% towards retirement (and me at around 5%) and the uncertainly of time served with a pension, I chose 401k. other than ING, we have Fidelity Investments, TIAA-CREF, and VALIC. I'll have to check into fees from the others.
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Re: 401k Tutorial

Postby King Sid the Great 87 on Wed May 01, 2013 1:56 pm

ExPatriatePen wrote:Quick question for those with tax knowledge.

If a person fully funds their 401K by say, May 31st, switches to a new employer on June 1st and repeats the process of fully funding the 401K again, what happens at the end of the year when you have 2x the max? Obviously you can't claim half of it, so how is that situation dealt with?

You're probably wondering why someone would do that. Simple. The first employer has no matching contribution and the second one does.

I haven't been able to find an answer to this one.


Sounds like double taxation to me. Tax software isn't going to let you put more than $17K (or $22.5K if you are old enough) into the deduction box. So you won't be able to write anything over the limit off....you'll pay tax on it. Now you are screwed because you paid tax on it, and the money still sits in a tax deferred account, so you will pay tax on it again when you withdraw.

Just my guess.
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Re: 401k Tutorial

Postby Tomas on Wed May 01, 2013 3:06 pm

If you have access to Fidelity funds, one quick way how to make sure you pay the lowest fees possible is to invest only in funds that say SPARTAN. Those are Fidelity's index funds with the lowest fees they offer. Another keyword to look for - "Advantage Class." This is my own selection (with the gross/net expense ratios in parentheses):

Stock Investments LARGE CAP SPTN 500 INDEX INST 46% (0.05%/0.04%)
Stock Investments MID-CAP SPTN EXT MKT IDX ADV 15% (0.07%/0.07%)
Stock Investments SMALL CAP SPTN SM CAP IDX ADV 5% (0.30%/0.16%, but currently net capped at 0.09%)
Stock Investments INTERNATIONAL SPTN EM MKTS IDX ADV 7% (0.35%/0.20%)
Stock Investments INTERNATIONAL SPTN INTL INDEX ADV 27% (0.17%/0.12%)
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Re: 401k Tutorial

Postby eddysnake on Wed May 01, 2013 3:15 pm

I found this on my ING T. Rowe Price Capital Appreciation Portfolio - Service Class portfolio:

Gross Prosp Exp Ratio 0.90% of fund assets
Net Prosp Exp Ratio 0.90% of fund assets
Management Fee 0.64%
12b-1 Fee 0.25%
Other Fee .
Miscellaneous Fee(s) 0.01%


would that be .90% total then?
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Re: 401k Tutorial

Postby ulf on Wed May 01, 2013 6:19 pm

ExPatriatePen wrote:Quick question for those with tax knowledge.

If a person fully funds their 401K by say, May 31st, switches to a new employer on June 1st and repeats the process of fully funding the 401K again, what happens at the end of the year when you have 2x the max? Obviously you can't claim half of it, so how is that situation dealt with?

You're probably wondering why someone would do that. Simple. The first employer has no matching contribution and the second one does.

I haven't been able to find an answer to this one.

Can't say I've ever run into this one before :lol: . I can run something in our program tomorrow and see what it looks like. I want to say because they're on seperate W-2s, both deductions will generate, since each employer deducted it and your wages will be reduced on each W-2. Not sure that is correct though. Hmm
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Re: 401k Tutorial

Postby Pitt87 on Wed May 01, 2013 9:33 pm

ulf wrote:
ExPatriatePen wrote:Quick question for those with tax knowledge.

If a person fully funds their 401K by say, May 31st, switches to a new employer on June 1st and repeats the process of fully funding the 401K again, what happens at the end of the year when you have 2x the max? Obviously you can't claim half of it, so how is that situation dealt with?

You're probably wondering why someone would do that. Simple. The first employer has no matching contribution and the second one does.

I haven't been able to find an answer to this one.

Can't say I've ever run into this one before :lol: . I can run something in our program tomorrow and see what it looks like. I want to say because they're on seperate W-2s, both deductions will generate, since each employer deducted it and your wages will be reduced on each W-2. Not sure that is correct though. Hmm


401k limits are imposed on the individual, not individual per plan/employer... if you contribute more than your annual allowance, you'll owe taxes on the second $17k at the end of the year, and you can't take the cash from your 401k funds without paying taxes plus penalty... so there is a double tax situation that you need to avoid. You also can't match a rollover, but what you might be able to do is 'undo' your unmatched 401k, pay the taxes and any fees to recover the ability to contribute and get your match... sounds too good to be true, but also might not be worth it if you have a 10% fee and have to forfeit any of your gains.

Consider how much your MATCH is worth... company match is x% in each PAYCHECK and there is no catch up for total year, so in your case you will not be able to capture a full x% this year. Lets use 6% to make the math easy... If you start on June 1 and are eligible right away to participate in the 401k plan, you can only capture 3.5% of your income in the matching plan. That means the only way to max your match is if 3.5% of your income is $17k, and you make $485k or so to meet that amount. If you make $100k, your match is only worth $3500 this year.

So, the issues are taxes and fees for your current 401k vs. the value of your match. If you were to plan for the taxes appropriately, and the match amount is more than your fees, you may be able to pull it off. That said, if you are investing $34k this year, it may be a good idea to find a CFP and get good advice on this one.... its your best bet, because a bad calculation somewhere and you owe an extra $1000 for not getting good advice.
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Re: 401k Tutorial

Postby AlexPKeaton on Wed May 01, 2013 10:50 pm

Pitt87 wrote:
AlexPKeaton wrote:
Pitt87 wrote:2.5% is a massive fee, about 75% above what the 401k Averages Book finds in their survey:

http://www.shrm.org/hrdisciplines/benefits/Articles/Pages/401k-Feeseclined.aspx

It is absolutely part of the equation to monitor and factor fees into your investment decisions, but your example is a bit misleading; EVERY plan has fees associated with them. There are a few different types of fees, like admin and record keeping fees; these are usually expense-based and are well documented in find-level reports. What can be considered a 'hidded' cost is investment fees; these are the fees that can vary from .5 to 1-2%. A big swinging gate that needs to be monitored actively. These fees can also be at the plan level or at the investment level, and some even hit at the management level... thats frightening stuff, since you probably throw away all those proxy statements and disclosures that you get in the mail... amirite?

Bottom line... read the junkmail your fund managers and plan administrators are sending you. I know its boring, but you have no right to complain about fees you failed to learn more about.


The problem of course is that virtually everyone has 401ks now. And when the average person sees a 1.5% fee, they don't realize how absolutely terrible that really is, when the math of compound fees applies. I feel like this knowledge needs to be more widespread.


Your example demonstrates HOW fees affect performance, but is not an example of reality. Fees are a component of an investment, but one of many; load, performance, activity, management, holdings... all of these are factors that should be considered. . If someone only used your example -- 2.5% and an 8% yield, which I would argue is a bit extreme -- they would be surprised to learn that performance greater than 8% is possible, and that lower fee funds/plans may not perform as well overall.

If you have funds that require large fees, go for a higher risk profile to offset the fee. LIke any portfolio, find a balance that makes you feel comfortable with costs, risks, returns, as well as service. 1.5% may not be that bad if your returns offset or your administrators are working to save you money compared to market. Its not as simple as good or bad...


I'd argue that a 1.5% fee is guaranteed to be terrible, as the odds that you are going to beat the market at such a high rate to offset that fee are non-existant. Might as well just put your entire retirement savings into lottery tickets.
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Re: 401k Tutorial

Postby Tomas on Wed May 01, 2013 11:01 pm

Pitt87 wrote:
ulf wrote:
ExPatriatePen wrote:Quick question for those with tax knowledge.

If a person fully funds their 401K by say, May 31st, switches to a new employer on June 1st and repeats the process of fully funding the 401K again, what happens at the end of the year when you have 2x the max? Obviously you can't claim half of it, so how is that situation dealt with?

You're probably wondering why someone would do that. Simple. The first employer has no matching contribution and the second one does.

I haven't been able to find an answer to this one.

Can't say I've ever run into this one before :lol: . I can run something in our program tomorrow and see what it looks like. I want to say because they're on seperate W-2s, both deductions will generate, since each employer deducted it and your wages will be reduced on each W-2. Not sure that is correct though. Hmm


401k limits are imposed on the individual, not individual per plan/employer... if you contribute more than your annual allowance, you'll owe taxes on the second $17k at the end of the year, and you can't take the cash from your 401k funds without paying taxes plus penalty... so there is a double tax situation that you need to avoid. You also can't match a rollover, but what you might be able to do is 'undo' your unmatched 401k, pay the taxes and any fees to recover the ability to contribute and get your match... sounds too good to be true, but also might not be worth it if you have a 10% fee and have to forfeit any of your gains.

Consider how much your MATCH is worth... company match is x% in each PAYCHECK and there is no catch up for total year, so in your case you will not be able to capture a full x% this year. Lets use 6% to make the math easy... If you start on June 1 and are eligible right away to participate in the 401k plan, you can only capture 3.5% of your income in the matching plan. That means the only way to max your match is if 3.5% of your income is $17k, and you make $485k or so to meet that amount. If you make $100k, your match is only worth $3500 this year.

So, the issues are taxes and fees for your current 401k vs. the value of your match. If you were to plan for the taxes appropriately, and the match amount is more than your fees, you may be able to pull it off. That said, if you are investing $34k this year, it may be a good idea to find a CFP and get good advice on this one.... its your best bet, because a bad calculation somewhere and you owe an extra $1000 for not getting good advice.


Awesome explanation!!

All I can say is long life 457b, which gives me additional $17,000 worth of available contributions on top of my regular 403b.
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Re: 401k Tutorial

Postby AlexPKeaton on Wed May 01, 2013 11:05 pm

This is the math behind the compount interest:

M = P( 1 + i )^n where n i is the expected return and n is the number of years of investment.

(continuous vs yearly interest calculation is negligable, this is the yearly interest formula so it is slightly conservative but good enough to illustrate my point)

So 1000 over 40 years with a 5% return yields:

M = 1000*(1+0.05)^40 = 7040

But with compound fees, the formula becomes:

M = P(1+(i-f))^n where f is the fee

Therefore assuming a 1.5% fee and a 5% return over 40 years is:

M = 1000*(1+(0.05-0.015))^40 = 3959, a 44% reduction in your total amount. The more years, the greater fee, the greater the loss. But even a realistic 1.5% fee over a more realistic 40 years is a huge loss (44%)

Edit:

If you were going with a managed fund with a 1.5% fee, in order to match your original 5% return with no fees, you would need to earn 6.5%, a 1.5% greater than an index fund (average) over THE ENTIRE FORTY YEARS OF YOUR INVESTMENT. The odds of this happening are non-existant.
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Re: 401k Tutorial

Postby Pen48guins on Thu May 02, 2013 1:52 am

Crap. All of that may as well be in some alien language to me.

But I do have a question.

I have a 403b from an employer I was with a few years ago. There is not much in it and nothing gets added to it. Am I able to roll that over into my 457 that I currently add to?
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