How Fees Can Impact Retirement

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For a financially secure retirement, you need to develop a solid plan as early on as you can. It’s also essential that you factor in every detail that goes into the planning. Unfortunately, some people overlook things they don’t consider important, only to wish they had.

When saving for the golden years, most individuals would readily choose an investment that offered an annual return of 20 percent. The issue is that seldom do they look at the associated fees. Okay, you might not think a few fees matter, but in reality, they do and in a big way.

Here’s a shocking claim. Research performed by a reputable trust company found that roughly 31 percent of people who put money aside for their retirement either didn’t know about the fees or they didn’t know the amount of the fees involved.

When we pay income tax as employees or property tax as property owners, based on that, our children will not go to a better school, nor will they repair our street a bit more than the neighbors who pay less taxes.

In contrast, with the payment of social contributions, there is always a right that is exercised now or in the future. For example, when we pay social contributions for health insurance, we have the right to be treated in state hospitals, and when we pay taxes for pension insurance, we can expect retirement in old age.

This same firm stated that approximately two-thirds of people planning for their retirement confirmed that when reading the details of various investments, they didn’t take the time to review the fee disclosures.

Yet another survey uncovered some interesting facts. One of those is that 81 percent of small business owners aren’t comfortable with the amount of money they or their employers pay specifically in fees for their plans. Included in this group were managers at companies that provide retirement benefits.

Calculating Investment Fees

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Recognizing the seriousness of the potential impact that fees can have on retirement accounts long-term, Pew Charitable Trusts developed a calculator. The innovative design allows users to go through several scenarios to determine the effect that fees have on two things. First, building retirement savings. Second, the length of time a retiree’s nest egg can last throughout their retirement years.

When putting money aside for retirement, this calculator is tremendously beneficial. To drive returns substantially higher throughout an investment’s life span, long-term savers depend on compound interest. For instance, say you invested $10,000 that yielded a 5 percent return in one year. You’d end up with $500. However, after 40 years and by compounding the investment, that $10,000 turns into $70,400. The overall return is 604 percent.

Compounding generates continually, thus increasing returns. This is because the earnings buy more of the investment. Now, flip the same $10,000 investment scenario around. If you withdrew the returns immediately after earning them, you’d have far less money in 40 years. In this case, you’d still have the original $10,000 but only $20,000 in returns at a 200 percent rate.

The Impact of Fees

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Keep in mind that the fees charged directly reduce the amount of money you save. Indirectly, they reduce that amount of money for compounding. As you can imagine, this prevents your savings from reaching optimal growth.

Fees, which you see in the form of a percentage of the assets invested, typically get incurred in one of two ways. The first one is a mutual fee or an index fund fee determined by the fund’s expense ratio. The second is a management fee that comes from a professional financial or investment expert. Most often, you’ll see these fees charged annually.

As someone investing for retirement, you want to weigh a fee’s value based on your circumstances. In most cases, the lower fees yield higher returns in the long term.

Here’s another example. Say you invested $200 monthly into a fund that earned 6 percent over 40 years. This had an expense ratio of 0.5 percent, plus a 1 percent fee charged by the financial advisor. With a total of 1.5 percent charged annually, you’d end up with $268,700 at the end of the 40 years.

You probably think 1.5 percent annually is pretty good. However, the same $200 monthly savings put in a passive target date fund connected to your anticipated retirement year would give you dramatically different results. For this, you’d have roughly $349,600 after 40 years.

Fees are also important if you want to preserve accumulated assets during your retirement. On average, people over the age of 65 have $200,000 in savings. Taking out $1,000 monthly, combined with a 0.1 percent bond fund fee and at 2 percent return, you’d run out of money in just 20 years. If the fund charges 1 percent, that drops to 18 years. Overall, you’d pay almost $24,000 in fees alone.

Another great calculator that will show you just how important low fees are to your retirement plan comes from WealthTrace. Unlike the Pew Trusts calculator, there are a lot of services that are not free , although they do offer a one week free trial. Regardless, these kind of fees calculators are more holistic in that it takes into account all of your financial assets and your specific situation regarding taxes, investment accounts types, and expenses. Because of this it is more accurate than free calculators. You can also then run what-if scenarios to see how much earlier you can retire if you can simply lower the fees you pay.

Get Help From a Financial Advisor

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Saving for retirement is sometimes tricky. Especially when it comes to the various fees involved, it’s easy to see why a lot of people feel overwhelmed and confused. To get the most out of the money you put aside for your golden years, consult with a trusted financial advisor. But make sure that financial advisor won’t do exactly what this article says you shouldn’t do: pay higher fees for investments. Some financial advisors are paid a commission to sell you high-fee investment products such as annuities. Steer clear of high-fee funds and stick with funds, such as Vanguard, that charge very low annual fund fees.