NEW YORK — My wife and I are retired and have noticed that the annual investment fees we pay really add up. We’re thinking of moving our retirement savings to reduce our expenses. Do you think this is a good idea? — Tom M.
It’s a great idea. In fact, I think all retirees living off their investments (not to mention people still building a nest egg) should at least take a hard look at how much they’re paying in investment costs, including any fees to advisers, to see whether they can do better. The reason: cutting expenses is one of the easiest ways to increase the amount of income you can draw from your nest egg without taking on extra risk.
To show you just how much you might be able to enhance your retirement prospects with this simple step, here’s a quick example I ran using the American Institute For Economic Research’s Retirement Withdrawal Calculator.
Let’s assume you and your wife are 66 and 63 years old respectively, have $1 million invested in a 50-50 mix of stocks and bonds and that you want a high level of assurance that your savings will support you for the next 30 years. If 1.5% of your retirement portfolio’s value goes to fees each year, the calculator estimates that you can withdraw 3% of your savings, or $30,000, the first year of retirement, increase that amount for inflation each year and have a 90% chance that your savings will last at least 30 years.
Look what happens, though, when you start paying out less in fees. If annual expenses drop from 1.5% to 1%, your sustainable annual withdrawal rises from $30,000 to $35,000, an extra $5,000 in inflation-adjusted income each year. And if you can trim annual expenses to 0.5%, your sustainable annual draw climbs to $40,000, an extra ten grand a year in inflation-adjusted income. Get expenses down to 0.3% a year, and income goes up to $42,000.
Then again, you could choose to enjoy the benefit of lower fees in other ways. Instead of drawing more money from savings after reducing expenses, you could withdraw the same amount and lower your chances of outliving your money. Or you could keep your withdrawal the same and choose to invest more conservatively so you don’t have to fret as much about setbacks in the stock market. For that matter, you could choose some combination of a larger draw, a smaller chance of running short and a more conservative portfolio. In short, by reducing the amount you shell out in fees and effectively raising the return on your savings, you gain all sorts of flexibility.
So as a practical matter how can you reap this benefit? Actually, it’s pretty straightforward. In the case of your retirement investments, the key is focusing on funds and ETFs that charge less than their peers. You can screen for such funds if you wish using Morningstar’s Basic Fund Screener. But it’s a lot easier if you just home in on low-cost index funds and ETFs, some of which charge as little as 0.05% a year in annual investment management fees. Indeed, you could conceivably build a diversified portfolio of such funds and hold annual expenses below 0.10% a year.
If you rely on an adviser or investment service for investing help, you’ll also want to see if you can reap some savings there too. Start by confirming exactly how much you’re paying for help each year. Some investors don’t know, whether it’s because they haven’t taken the trouble to find out or because their adviser may not have been especially forthcoming about informing them. In any case, the adviser or investment service you’re working with should easily be able to show you how much you’re paying. (If you have trouble getting that info, that alone suggests you should probably be investigating other options.)
Once you know how much you’re paying for advice, you can do some comparison shopping. There are plenty of choices. Most financial planning firms can put together a portfolio of mutual funds or ETFs based on your goals and risk tolerance, and many well-known fund companies and investment firms offer advisory services that do much the same thing. Fees can vary substantially from company to company, but I’d say that depending on the size your portfolio you might be looking at annual charges that run between 0.5% to 1.5% a year, plus the annual management fees of the underlying funds).
You can cut that cost substantially — say, to 0.5% a year or less, plus the costs of the investments themselves — by going to a robo-adviser, one of the relatively new breed of investment firms that use algorithms to create and manage a portfolio, usually of low-cost index funds or ETFs.
But if you go that route, you should be okay not only doing business with relatively new firms but dealing with them primarily, if not exclusively, online. If that’s a deal-breaker, you might consider Vanguard’s new Personal Advisor Services, which combines technology in creating portfolios with access to a Vanguard adviser for advice. The cost: 0.3% of assets per year, plus the cost of Vanguard funds or ETFs. All told, you’re probably looking at total expenses of roughly 0.5% a year or less.
There’s no guarantee, of course, that every dollar you save in expenses will translate to an extra dollar of return and retirement income. But Morningstar’s 2015 fee study as well as other research shows that low-cost funds typically outperform their high-cost peers, so the odds of a low-fee strategy gaining you extra income and return are in your favor.
That said, as you seek to reduce what you pay out in total fees, you also want to remember that while costs are important, so too is getting the attention and service you need. So if the ability to deal with a flesh-and-blood person in times of market stress or when you face particularly challenging situations is important to you, paying extra may very well be money well spent.
At the end of the day, though, the less you pay for the investing help and whatever other guidance you need, the more income you’ll be likely able to draw from your savings and the better you’ll be able to live in retirement.