You May Be Giving Away Half of Your Retirement Fund

Here’s a dose of reality for you: you may be unwittingly giving away half (or more) of your retirement fund.

Our Broken Retirement System

According to multiple studies about the savings habits of Americans, three out of four of us will not have enough money to retire at age 67. Not even close.

Our current “Defined Contribution” retirement system of 401(k)’s and IRAs is deeply flawed and completely inadequate. “Defined Benefit” pensions – the old system that actually provided meaningful retirement security – has been replaced with a voluntary savings scheme that was originally intended to provide a tax shelter to the most highly compensated corporate executives.

Nearly every American is now responsible for funding his own retirement, and must figure out how to navigate through a confusing array of account structures, investment strategies and security selection options.

But here’s the thing: if you’re like most Americans, you’re probably getting fleeced on your investments, and the financial service industry is very good at hiding the true cost of their services.

Our Broken Advice Model

Today, around 80 percent of financial advisers have no legal obligation to act in your best interest. That mutual fund you were sold? Chances are it’s loaded with hidden fees that eat into your returns. And there’s an even better likelihood that the fund your adviser selected will underperform the market. And just to add insult to injury, your adviser was probably paid a kickback to sell you that product.

Mutual funds benefit from advisers who steer clients in their direction, and often they reward them with a special commission or fee. The retirement-planning industry, which serves the $14 trillion American retirement market, has the means, motive, and opportunity to place their own self-interest ahead of yours. And thanks to a powerful lobby, it’s all perfectly legal.

The Hidden Costs of Investing for Retirement

Whether you know it or not, your 401(k) and your IRA is likely being consumed by marketing fees, management fees, administrative fees, and broker commissions—along with trading fees that you pay for every time a mutual fund buys or sells a security. These fees, buried in page after page of small type, can rob you of 30, 40, 50 percent or more of your retirement nest egg.

They may seem small at first, but the fees eventually reflect what Bogle calls the tyranny of compounding costs, with the result that they can make the difference between retiring in comfort, or working until you’re well into your 80s. The average two-person household in the United States, according to one study, pays $157,000 in fees over the lifetime of a 401(k).

And to make matters worse, those actively managed funds with high fees underperform passive index funds that simply and efficiently track the market. Index funds carry very low fees, and so financial advisers have little reason to recommend them. A low cost index fund might be in your best interest, but not in the adviser’s. It would hurt his compensation.

The Truth Shall Set You Free

Listen to what Charles Ellis, a leading light in the investment industry, has to say on this subject.

“Most active managers underperform because of fees. Some 80% of them would slightly beat the market, but after fees, their returns end up being below the market.

We’ve been describing fees in a way that really is nonsense. We ought to look at fees not in terms of assets, but as a percentage of the incremental returns of a fund — how much extra return you can expect over a comparable index fund.”

Think of the 7% expected long-term real (after inflation) returns of stocks. A 1.5% fund expense ratio is a big fraction of that 7%. (21.4% to be exact.) Now add on top of that the 1% annual fee charged by the adviser, and you’re giving away 35.7% of your returns, every year. If you compound that over let’s say 30 years, you end up giving away 50% of your retirement nest egg to financial intermediaries who put up no money, take none of the risk, and yet somehow feel that they are entitled to make as much money as you did.

A better way

I view the problem with the current system in terms of a flawed business model. The industry is based on assets under management, or AUM. The bigger your account, the more attractive you are as a potential customer because fees are based not on performance or value added, but on the size of your account.

I advocate for a different business model, one that’s based on work performed. Paying an adviser by the hour makes more sense to me. But advisers hate this idea. They hate it because it will drastically reduce their total compensation. But that’s exactly why I like it. I believe advisers should be compensated – even highly compensated – for their expertise. But I don’t believe they deserve to be paid more than a lawyer or a doctor, or even a plumber. These professionals are highly compensated, but none of them charge for their services based on how much money the client happens to have.

So I suggest that any investor who wants to engage the services of a professional investment expert, should look for one that charges an hourly fee. They’re out there, but right now there aren’t very many. The hourly fees start at about $150 and can go as high as $400. You get what you pay for, and it should be up to the investor to decide how much the advice is worth to him or her.


Compared to the traditional advice model, the robo-advice model is an improvement. But it’s far from perfect. The main benefit from this model is a lower cost. Most robos use low cost index funds – a big positive. They charge low fees (still based on AUM, unfortunately) of 0.35% to 0.60%, compared to 0.9% to 1.5% for traditional advisers.

So it’s an improvement from a cost perspective, but the actual advice you get is kind of sketchy. They use an automated system to recommend a portfolio for you, based on a questionnaire you fill out. It’s very general, even generic, and seems a little too cookie-cutter for my taste. But it’s probably a good choice for anyone who has less than $500k to invest.

Shameless promotion

In my opinion, the best business model for investment advice is the coaching model. Yes, I’m an investing coach and so I’m biased, but I wouldn’t have adopted the coaching model unless I believed that it was a superior business model.

Under the coaching model, there are no commissions, no hidden fees, no kickbacks from fund managers, and no conflicts of interest. A coach has only one job – to educate his clients about the options available, and provide guidance about which of those options are the best fit for them.

I’m not the only investing coach out there. Google “investing coach” and do some research. Make some calls, and ask questions. Fees vary, but they should be based on time spent on your case, not on how much money you have. Look at the services offered, compare fees, and choose someone who you feel comfortable with.


About the Author

Former head of equity trading, Northern Trust Bank, Chicago. Teacher, trainer, mentor, market historian, and perpetual student of all things related to the stock market and excellence in investing.