A Simple Way to Add $100,000 to Your 401(k)

401(k) fees are likely to cost you thousands of dollars over the course of your career.

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The 401(k) plan you have is most likely geared to serve the interests of the brokers or insurance companies who advise the plan. The primary beneficiaries are the mutual fund families whose funds populate the plan. Your concern with saving enough so that you can retire with dignity comes last—if at all.

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By the time clients come to me, they are already persuaded by the overwhelming data demonstrating that investing in actively managed funds (where the fund manager attempts to beat a designated benchmark, like the S&P 500 index) makes no sense. All the available data indicates that anywhere from 50 percent to 90 percent of these funds fail to equal their benchmark in any year. Over a 10-year period, less than 5 percent of them succeed in doing so. By investing solely in a globally diversified portfolio of low management fee stock and bond index funds, you can significantly increase your returns over the returns achieved by the average investor in actively managed funds, and you can do so at a lower cost. As John Bogle, the founder and former chairman of Vanguard Group, famously stated: “In investing, you get what you don’t pay for.”

Unfortunately, implementing this simple investment strategy is impossible with most 401(k) plans. The most common question I am asked is, “Can you help me configure my investments in my 401(k) plan so they are more like my index-based investments outside of the plan?” This is not an easy task. The actively managed funds which dominate these plans have management fees, typically called expense ratios, ranging from 1 percent to 1.75 percent. Index funds have management fees as low as 0.08 percent and average 0.20 percent.

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The reason few 401(k) plans have an extensive selection of index funds is no mystery. Index funds do not pay revenue sharing payments to plan advisers. Actively managed funds do. Advisers to 401(k) plans are sometimes paid to include expensive, actively managed funds in your plan, which are statistically likely to underperform less expensive index funds, passively managed funds, and exchange-traded funds.

According to an article by Ron Lieber in the New York Times, a difference in investment costs of 0.75 percent can cost a new employee $100,000 over the course of her lifetime of employment. Here’s how you can put that money back in your plan assets.

Educate your human resources department or plan administrator about the benefits of a 401(k) that has only pre-allocated portfolios of low-cost index stock and bond funds, passively managed funds, or exchange-traded funds. There are many books and articles on this subject, including my book, The Smartest 401(k) Book You’ll Ever Read. A world-class 401(k) plan is lower cost and yields higher returns than plans with actively managed funds.

Mention to the person in charge of your plan that adopting an index-based plan has another significant benefit. There has been an explosion of lawsuits against large corporations alleging breach of the fiduciary duty owed by plan administrators to participants in these plans. The focus of these lawsuits is the alleged negligence of these administrators in controlling plan expenses. Tell your plan administrator he can litigation-proof your plan against similar allegations by having a plan consisting of low-cost index funds, instead of high-cost actively managed funds.

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When the data for an appropriate, legally compliant 401(k) plan is conveyed, you should find a receptive audience willing to make a change that will significantly increase returns to employees, without increasing costs to the employer. It’s a win-win solution to a very vexing problem.

Dan Solin is a senior vice president of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011.