College Graduates Should Watch 401(k) Fees

Editors' pick: Originally published June 1.

College graduates embarking on their first career and opening their initial 401(k) and IRA accounts should be wary of the fees assessed.

A growing number of companies has adopted auto enrollment programs that signs employees up for their 401(k) plan unless they opt out of it. Many of these programs default employees into investments such as target date funds, but Millennials should examine the fees first.

While target date funds were structured to help investors who did not want to manage their retirement actively, this choice could create even more apathy among employees, encouraging them to be lazy, set-it-and-forget investors. Investors of target date funds choose the year they plan to retire and the allocations are picked for them, adjusting from a large percentage of stocks to a smaller amount as they get closer to retiring.

Many companies are still offering matching programs where for every dollar an employee invests, they will contribute 50% or an equivalent. Some of the programs require workers to have been employed for a minimum of one year or longer before this option, known as vesting becomes active.

"For many employees, 401(k) plans may be a great way to make automatic retirement contributions," said Stuart Robertson, president of ShareBuilder 401K, a Seattle-based 401(k) retirement plan provider using a low cost, index-based investing strategy. "Think about maxing out your 401(k) contributions, because if you can swing it, setting aside the full amount offered through your plan may be a great strategy for your long-term investments."

Fees Remain Under 1%

Scrutinizing the fees of the investments means Millennials can save hundreds of thousands of dollars, especially over the duration of a 40-year career.

"Every dollar paid in investment expenses is one less invested in the markets and paying even 1% more in investment fees can cost you," he said.

The lowest cost options include mutual funds or ETFs which track an index such as the S&P 500, a benchmark and popular investment choice.

"When reviewing your plan and the funds it offers, think carefully about the expenses associated with each fund," Robertson said. "If you are looking to keep costs down, we recommend investment expenses stay below 1%."

Some plans offer more actively managed mutual funds, which typically have higher fees.

"Closely examine expenses as you consider your investment selections," he said.

Index ETFs can be a "great fit" for Millenials, said Scott Mazuzan, a Millennial and a financial advisor at F.L. Putnam Investment Management Co., a Portland, Maine firm.

"For someone investing in an IRA for the first time, there are a lot of great tools online for building a personalized asset allocation," he said. "Keeping fees low will maximize the growth of the money in the crucial early years.

Allocating money into a 401(k) or IRA will lower the amount that Gen Y-ers pay in taxes since these funds in these accounts are not taxable.

"Having pay withheld can sting, especially if you are balancing low income with student debt or other expenses," Mazuzan said. "Failing to enroll in a matching plan is giving up on 'free' money from your employer, money which is also tax-free and will enjoy a lifetime of tax-sheltered growth. Short-term pains can equal long-term gains."

Failure To Invest

Retirement strategies which encourage investors to be content and lackadaisical about their investments are risky, said Jim Mitchell, a portfolio manager on Covestor, the online investing marketplace, and partner at The Rockledge Group, a registered investment advisor in Brooklyn, N.Y.

"These 'set it and forget it' strategies are dangerous for individuals, as well as for society," he said. "People need to be paying attention more frequently, not less Target date funds are pushing a hands-off approach to the entire investment process."

Another pitfall that many younger investors fall prey to is "failure to invest," when they neglect to choose their investments, allowing their contributions to automatically default into a target date fund or low-yield money market fund, said Robertson.

"I've seen people with good intentions make regular contributions to retirement accounts, but forget to invest the funds," he said.

Instead of attempting to time the market or buy stocks when they think they are cheaper, investors should engage in a more disciplined approach of dollar cost averaging, Mazuzan said.

"Or better yet, they can sign up for automatic trading or rebalancing and avoid the temptation to time the market as they nurture their nest egg," he said. "Millennials benefit from a long time horizon. It's a shame to sit on the sidelines in the early years without meaning to."

The fear of losing money in equities can outweigh the benefits of investing in stocks such as a low cost index fund. Equities such as the S&P 500 generate returns of over 10% compounded annually since 1926 while government and corporate returned slightly over 6%.

"Bonds and money market funds are inappropriate for most Millennials because equities have much higher returns on average over long periods of time," said Robert Johnson, president of the American College of Financial Services in Bryn Mawr, Pa. "When markets fall, many investors get scared and move money from equities into less volatile asset classes such as money market funds. What ends up happening is that investors sell near market lows and get back in only after the markets have rebounded."

No Investment Is Too Small

Even Millennials saddled with high levels of student loans or credit card debt can start saving for retirement by allocating small amounts each week into a 401(k), taking advantage of compound interest and tax sheltered growth.

"No matter the amount, saving towards retirement is a wise move," Mazuzan said. "Even $25 a week can really add up. Automating your contributions can make it even easier to save and can add up to $1,300 in the first year. Even the most modest current contributions can have a huge impact in the future."

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