The Truth About Retirement Plans and IRAs by Ric Edelman

Author:Ric Edelman
Language: eng
Format: epub
Publisher: Simon & Schuster

The vast majority of retirement plans offer mutual funds, so that’s probably what you’re investing in — and I bet you have no idea how much your mutual funds are charging you. That’s because you don’t write a separate check to cover the fees. Instead, the fees are debited from your account — but don’t appear on the statements they send you. 41 But to conclude that you pay no fees merely because the fees are not apparent is just silly.

According to the Investment Company Institute, the average annual fee of all mutual funds is 1.4%. The impact of this fee is huge — as you well know, thanks to our earlier exercises involving lily pads and doubling pennies.

Just as you get wealthy through compounding, growth is equally hindered by the compounding effect of annual fees. Indeed, in 2010, the Department of Labor reported that every 1% you pay in annual fund fees reduces your future retirement plan balance by 28%.

And you could well be paying far more than 1% per year for the mutual funds offered in your retirement plan at work. 42

Mutual funds have been available in the United States since 1924. Today, there is a better option available to you, but it’s still quite rare to find this type of option offered in employer retirement plans.

I’m referring to exchange-traded funds.

Like mutual funds, ETFs offer extensive diversification. But they’re much cheaper than mutual funds — as much as 90% cheaper — which explains why my firm recommends them for our clients and why the ETF industry is growing so rapidly while the traditional mutual fund industry is languishing.

Indeed, U.S. investors invested a record $183 billion in ETFs in 2012, surpassing the previous record of $178 billion set in 2008, according to State Street. At this writing, ETFs have $1.3 trillion in assets, spread among 1,194 funds. Invented in 1993, ETFs now account for nearly one-third of U.S. equity trading, according to Barron’s, and are expected to replace as many as half of all mutual funds by 2015, predicts research and consulting firm Novarica.

The main reason for this is their low cost. If your mutual fund grows 8% but charges you the average 1.4%, your net return is 6.6%. But if your expenses are one-tenth as much, as is the case with many ETFs that invest identically to mutual funds, your net return is 7.9%.

If you want to look hip, try sporting a cool pair of shades.

But if you really want to be hip — as well as wealthier, younger and better educated — try putting your money into ETFs. They’re your ticket to join the “in” crowd.

That’s the conclusion of a 2012 study by Cerulli Associates and the Investment Company Institute. Their research shows that the wealthier, younger, hipper and better-educated you are, the more likely you are to have bypassed ordinary retail mutual funds and instead own ETFs.

According to the report, the median age of the head of household for mutual fund investors is 50 vs. 46 for ETF investors.

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