How To Reduce 401k Fees Through Portfolio Analysis

Are you wondering how to reduce 401k fees? You've come to the right place. I was paying over $1,700 a year in 401k fees until I finally did a 401k portfolio audit.

Now I'm hardly paying any 401k fees. Due to analyzing my portfolio with Personal Capital's free fee analyzer tool, I have reduced my 401k fees by over $100,000 over the next several decades. My goal is to help you reduce 401k fees as well.

How To Reduce 401k Fees Through Portfolio Analysis

Do you know how much in mutual fund fees you are paying a year? I didn't, so I ran my 401K portfolio through Personal Capital's free 401k fee analyzer and I was absolutely shocked by the results!

I always figured that from a percentage point of view, my 401k fees were small. But, when you take a small percentage multiplied by a big enough number, the absolute dollar amount starts adding up.

Take a look at my excessive 401k fees I was paying per year: $1,748.34!

In 20 years, I will have paid roughly $84,000 in 401k fees based on only this amount.

The second portion of the above chart shines a light on the specific fund that costs the most. In my case, it is the Fidelity Blue Chip Growth Fund with a 0.74% expense ratio.

I've got another fund worth about $22,000 as part of my 401K which does not show a fee, because it is a hedge fund whose fees are baked into the performance.

Typical hedge fund fees are 2% of assets under management and 20% of upside. This is called 2 and 20, which is egregiously high, but it's the only way I can get short exposure to hedge my bets.

I've been wanting to do a 401k/mutual fund fee analysis for the longest time, but was too lazy to do the analysis until I realized I didn't have to do the calculations myself. Every year I want my portfolio to be as optimized as possible.

How To Analyze Your 401k For Excessive Fees

Here are the steps analyze your 401k for excessive mutual fund fees. You can either do so manually or with Personal Capital's free 401k analysis tool. I've been using Personal Capital to analyze my 401k fees once a year since 2012. It has saved me a ton of money since!

1) Watch out for a huge spread in expense ratios.

In my portfolio, the cheapest expense ratio is 0.19% for the Vanguard IT Index Fund and a whopping 0.74% for the Fidelity Blue Chip Growth Fund. 0.74% is almost 4X greater than 0.19%. The reasons for the higher mutual fund fee is because they've got to pay the fund manager and analysts for providing alpha and outperforming the S&P 500 index.

If the fund manager(s) can indeed outperform the S&P 500 index by more than 0.5% a year, then their fee is on par with my cheapest Vanguard Index Fund. If not, I'm wasting my money.

The data shows that most actively run mutual funds underperform their respective indices over 10 years. Therefore, paying a high active fund fee is generally not a wise choice.

2) Watch for high turnover ratios.

A 100% turnover ratio means a $10 billion dollar fund sells 100% of its holdings every year. Buying and selling positions cost money. That's how the equities department of major Wall Street firms make money. I know because I worked in equities for 13 years.

Buying a large new $300 million position for a 3% weighting in a $10 billion dollar mutual fund can also cause the stock to rise in the open market. As a result, the potential acquisition cost of owning shares increases the more a fund turns over.

Yes, dark pools, algorithmic trading, and block trading have helped minimize the impact large transactions have on the share price. However, the more a fund trades, the higher the likelihood of an impact.

Shoot for a fund with under a 50% turnover ratio. The lower the better as that means there will also be less tax drag.

3) Know that fees add up over time.

In 20 years, I will have paid ~$87,000 in mutual fund fees if I keep my existing portfolio. I don't know about you, but that seems a lot, even if my 401k does grow to $1,500,000 as my 401K savings guide estimates.

Just doing the math here, 67% or $58,290 of the $87,000 in fees will have come from my Fidelity Growth Fund alone. Meanwhile, the Fidelity growth fund only accounts for 39.5% of total assets.

Long term growth has a way of compounding into great returns for consistent investors and savers, however it sure does a number on the total amount of fees as well.

4) Understand the tax cost ratio. 

The Tax Cost Ratio measures how much a fund's annualized return is reduced by the taxes investors pay on distributions (relevant for non-tax advantaged accounts). The range is usually between 0%-5%. The lower the better. 

For example, if a fund has a 1.5% tax cost ratio for the three-year time period, it means that on average each year, investors in that fund lost 1.5% of their assets to taxes e.g. a 10% return is really only a 8.5% return.

It's good my highest fund with a 0.74% expense ratio has only a 0.11% tax cost ratio. One can simply combine the two to figure out the fund's total expenses. The Fidelity Growth Fund is therefore 0.85% vs. 1.94% for the Vanguard Precious Metals fund. The Vanguard IT Fund is the lowest 0.31%.

5) Vanguard funds are likely your best bet.

The Vanguard family of funds have some of the lowest, if not the lowest fees in the mutual fund industry. The reason is because of their scale and also because they run passive index funds.

There's no team of analysts to pay. There are no business trips to expense to go kick the tires of the companies they hold. The index is rebalanced usually once a quarter, or whenever there is a big index addition or subtraction to reduce variance risk.

Three out of four of my funds are by Vanguard. After I finish typing this post, all of my funds will be by Vanguard!

6) You can create a portfolio of index specialty funds.

If you don't want only want to invest in the S&P 500 index, you can diversify by buying speciality index funds. Buying speciality index funds gets you a little closer to buying individual stocks that are usually not allowed with 401k programs.

In the example above, 60% of my entire 401K allocation is invested in three speciality index funds: Energy, Metals & Mining, and Technology. If you have conviction in particular industries which you think will outperform, there is an index fund for you.

I did buy some ARKK, a fund by Ark Capital once it sold off about 32% from its high in 2021. I want to gain exposure to high growth stocks. Unfortunately, the fund has a 0.75% expense ratio.

401k Fee Pro Forma Analysis Of Lost Retirement Value Over Time

The below chart is what makes me sick about paying too much in 401k fees. Let's say I continue to max out my 401K like I have been doing since 1999. Let's also assume I get a full employer match. Finally, let's assume an annualized return of 5.8%.

After 30 years, I will have paid $489,014 in 401k fees and lost out on two years worth of retirement income! That is just way too much in 401k fees to pay.

The funny thing is, my blended expense ratio is 0.43% compared to Personal Capital's target benchmark of 0.5%. At any rate, the public is paying a tremendous amount of mutual fund fees over our lifetimes. We really don't know exactly how much in fees w pay until we do the analysis.

The 401k plans and mutual funds are counting on the public to be lazy and not analyze their portfolios for excessive fees. Many fund companies and 401k providers like to bury their fees in the fine print so it's hard to find.

If you want to make big bucks in your life, you should consider a career in money management. It's all about leverage. A fund manager can run $1 billion dollars under management as easily as he can run $10 billion dollars under management. If he or she does, he or she will make millions of dollars.

Take Action To Save Big Money In Your 401k

Please don't let your 401k administrator and mutual fund companies take advantage of you. Now that you know how to reduce 401k fees through portfolio analysis, take action.

Personal Capital helped me realize that I am paying at least $1,700 more a year in mutual fund fees than I should be paying thanks to the Fidelity Growth Fund. I've simply swapped the fund out for the S&P 500 ETF, QQQ, SPY, which costs hardly anything to own. I did this back in 2013, and as a result, I've saved over $12,000 in fees in seven years.

I wouldn't have been able to see what an outlier the fee is without the 401K fee analyzer that aggregates all the data and provides a side by side comparison. Not bad for a free online financial management huh? I suggest everybody take a hard look at their finances to see where they are paying unnecessary fees.

Step By Step Instructions To Reduce 401K Fees

If you want to figure out how much in 401k fees you are paying, do the following:

1) Spend one minute to sign up with Personal Capital. It's free and secure.

2) Click the “+” button on the top left to add/link an account. For my Fidelity hosted 401K, I typed in the search box “401k.com” since the Fidelity pre-populated button just linked to my Fidelity rollover IRA.

3) After your 401K account is linked, click the “Investing” tab on the top right then choose “401k Fee Analyzer”

4) Adjust your contributions, estimated returns, employer match, and estimated future fees to get an idea of how much you could have in your investment portfolio over time.

5) Research alternative ETFs and index funds that can replace your expensive actively managed funds. Figuring out the proper equity exposure is the most important part of your retirement planning. I encourage you not to waste time trying to pick stocks or trade in and out of sector ETFs. Instead, focus your on things you can better control or enjoy.

About the Author: Sam began investing his own money ever since he first opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working in finance. Sam received his MBA from UC Berkeley with a focus on finance and real estate.

Never stop maxing out your 401k! At the same time, never stop analyzing your 401k for excessive fees.