No, 401(k) Funds Do Not Cost 2% Per Year

Clickbait

On Feb. 29, Yahoo Finance republished an article from a website called GOBankingRates. Its headline was bold: “‘Rich Dad’ Robert Kiyosaki Reveals Why the 401(k) is a ‘Horrible’ Retirement Plan.”

I clicked. “The unfortunate truth,” I read, “is that 401(k) plans come with high fees. This eats into your earnings in the long run. These fees are oftentimes hidden among legal jargon, according to the Rich Dad team. Fees can be, but aren’t limited to, transaction fees, legal fees, and bookkeeping fees. Mutual funds often take a percentage, usually 2%, of your investment.”

Quite peculiar. First, 401(k) plans rarely charge transaction fees. Second, as legal and bookkeeping fees are contained within the plan’s administrative fee (also called its recordkeeping fee), it is awkward to list them separately. Third, if the mutual funds within 401(k) plans do charge 2%, that cost would dwarf the previously mentioned fees. So, why mention fund expenses as an afterthought?

The Evidence

Even more peculiar is that 2% figure. Let’s investigate. As it turns out, a thorough study has been conducted on 401(k) plan expenses: “The BrightScope/ICI Defined Contribution Plan Profile: A Close Look at 401(k) Plans, 2020.” This 80-page document summarizes data gathered for almost 60,000 401(k) plans, representing 85% of total 401(k) assets.

(I should mention two caveats about that paper. One is the Investment Company Institute, or ICI, is the fund-company trade organization. Its research is never wrong, per se, but it’s fair to say that it does not design methodologies to make funds look bad. The other admonition is that the paper’s figures are somewhat dated. However, as the 401(k) industry is a supertanker, changing direction only gradually, that is a minor concern.)

Among the report’s statistics is what we have sought: “total plan cost by 401(k) plan assets.” In other words, the 401(k) account’s expense ratio, considering both the asset-management fees collected by the fund companies and the administrative fee (along with any other charges) paid to the recordkeepers. If the article’s contention that funds within 401(k) plans “usually” charge about 2% is correct, then the total plan cost will be even higher, since it includes additional fees.

That is very much not what the BrightScope/ICI paper finds.

Size Matters

To back up slightly, expense ratios for 401(k) plans are largely determined by the level of plan assets. Bigger means thriftier. Multinationals have Treasury departments staffed with benefits experts who haggle when negotiating with 401(k) providers. In fact, they often circumvent mutual funds altogether, insisting instead on cheaper collective investment trusts. In contrast, small-company sponsors are often ill-informed and possess little bargaining power regardless.

Whatever the company’s size, most 401(k) plans are far cheaper than the article alleges. The following chart shows the BrightScope/ICI’s total cost figures and demonstrates that average expenses rise sharply as plan assets shrink, but they never approach 2% even for the smallest plans.

Better yet for 401(k) investors—although worse for the article’s credibility—this display overstates what participants truly pay because it treats each size bar equally. That misrepresents the reality. Although 54% of all 401(k) plans contain less than $1 million, they are held by only 8% of investors. Smaller businesses by definition employ fewer people. Conversely, the handful of the largest companies, which have the lowest plan costs, serve one third of the 401(k) marketplace.

The Upshot

We can combine the data contained within the previous two charts to arrive at a single overall estimate for total 401(k) plan cost. The figures may be averaged by three different methods, each of which leads to a different conclusion. One approach is to weight all plans equally, such that the 401(k) system for Bob’s Widgets (seven participants) counts the same as Boeing’s (200,000 participants). That porridge is too hot. Another is to weight the results by account size, which means wealthier investors receive proportionately greater attention. That porridge is too cold.

The Goldilocks solution would be to allot each participant one vote, creating a participant-weighted average. I show that result in the chart below, along with the Papa Bear and Mama Bear outcomes. For amusement’s sake, I’ve added Kiyosaki’s 2% estimate—which, I remind you, applies only to 401(k) funds and thus excludes the administrative fees incorporated within the BrightScope/ICI report.

Conclusion

Perhaps I have belabored my case. However, I think the example is important, because it illustrates a large point: Media sources are not what they were. When I started working at Morningstar, in 1988, the sources for investment information were newspapers and magazines, and they edited their work. Frequently, reporters called me before they filed a story, to audit their numbers. And if they interviewed me for an article, those discussions typically were followed by a call from a fact-checker, to ensure the quotes’ accuracy. That doesn’t happen today.

The other lesson is to beware the claims of investment personalities. As the saying goes, they are entitled to their conclusions, but to not their own facts. Earlier this year, I wrote about how Dave Ramsey’s argument that retirees can withdraw 8% of their portfolio assets per year, inflation-adjusted, relies upon the false assumption that stock returns are consistent. Also wrong, in real terms, is Suze Orman’s bromide that investors can save $1 million by forgoing their daily coffee.

My suggestion: When you see an assertion that strikes you as remarkable, as with those made by Ramsey, Orman, and Kiyosaki, triple-check it via an internet search. Particularly useful are those publications that continue to employ editors, such as the major newspapers. Of course, it’s still possible that three separate sources could all make the same error, but the odds are fairly low.

Final Note

If you look at the Yahoo Finance citation closely, you will see that, as with a modern dissertation (small joke, don’t throw shoes as me if you have a Ph.D.), the author provides what appears to be a direct quote from Kiyosaki but does not use quotation marks. That raised my suspicions. Were those exact words the author’s invention? They were not. They appeared on Aug. 23, 2023, in an article called “The 401(k): Robbing Your Retirement Plan for Over 40 Years,” on richdad.com.

Guilty as charged.