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Lower-priced 401(k)s
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November 26, 1999: 6:18 a.m. ET
Investing pros: Institutional funds may be less costly than big-name funds
By Staff Writer Martine Costello
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NEW YORK (CNNfn) - In a world where names count, it's not hard to see why people would spend more for a designer label or a top brand. But when it comes to retirement investing, it doesn't always pay to put the famous names in your 401(k).
Well-known mutual funds might put your mind at ease, but many retirement plans offer institutional products at less than half the cost. And a percentage point can really add up over 20 or 30 years.
"Why would you pay more for a big name?" said Frank Armstrong, a certified financial planner and president of Managed Account Services. "It comes out of your hide each and every year."
Big cost differences
You'll pay an average expense ratio of about 1.4 percent on your assets a year for a retail stock fund and 1.1 percent for a retail bond fund, said Patrick Reinkemeyer, director of Morningstar Institutional Investment Consulting, a division of Chicago fund-tracker Morningstar.
The expense ratio includes the management fee and any costs related to running the fund, including distribution. In addition, retail funds may also charge loads, or commissions, and so-called 12b-1 fees for sales and marketing.
By contrast, institutional funds charge about half the expense ratio -- and none of the other fees.
"If you expect returns to be similar, clearly you should select the lower-cost alternative," Reinkemeyer said.
For example, let's say you invest $10,000 and earn 10 percent a year, Armstrong said. In 20 years, you'd have $67,250. But if you pay an extra 1.5 percent a year in expenses, it reduces your annual returns to 8.5 percent and your profits drop to $51,120.
"The difference compounded over a long period of time is a lot of money," Armstrong said.
Your 401(k)
The size of your company will determine whether you'll have access to large institutional funds, institutional share classes of name-brand funds that have lower expenses, or retail funds, Reinkemeyer said. The numbers vary widely in the industry.
The problem is people feel better choosing a fund with a well-known name, said Mark Groesbeck, a certified financial planner with Stanford Group in Houston. They like being able to look up the fund's net asset value, or NAV, every day, he said.
"Institutional funds don't have the name recognition that retail funds do," Groesbeck said.
But Groesbeck said investors aren't necessarily sacrificing anything by choosing institutional funds. In fact, a retail fund might have to take more risks to make up for the extra costs.
"Lower fees are a big plus," Groesbeck said.
Making choices
Investing pros insist that you should set goals and an asset allocation plan before choosing your 401(k) options. You need to look at the investing strategies and long-term records of any funds -- institutional or retail -- before you make your choices.
Your plan's administrator will be able to tell you the annual costs of the funds. Many employees can get up-to-date information on performance and fees on Web sites, too.
"There's no evidence that additional expenses do anything but lower your returns," Armstrong said. "Lower expense ratios are more important."
But at the same time, you shouldn't choose an institutional account with a lackluster management just for the lower cost, Reinkemeyer said.
If a retail fund has a better manager and better returns, an investor shouldn't be afraid to pay a little more for it.
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