Where Should You Save Extra Money: Into Your 401(k) Or IRA?

When I was a financial advisor, one of the key messages I shared with my peers and prospective clients was that the best way to save their money was to put just enough into their 401(k) plan at work to capture their employer’s match, but that any extra they wanted to save should go into an IRA (with me, of course.)

What I was taught by all the financial firms I worked with prior to finding my dream role at Financial Finesse was that the fees in 401(k) plans are “so high” that investors are always better off using non-employer based investment vehicles for their retirement savings beyond the match. This is a sentiment that’s often echoed back to me by employees who I work with via our Financial Helpline – they’ve been told the same fallacy.

I was SO WRONG in pretty much every instance

One of the biggest “aha” moments I had upon starting my work here as a financial coach was that this “rule of thumb,” which I had blindly subscribed to without ever actually verifying it, was wrong for pretty much anyone who works for a company with more than just a handful of employees.

Here’s why it’s wrong

When a company decides to offer a retirement plan such as a 401(k) to its employees, they assume what’s called a fiduciary duty – basically they become bound by a federal law that says that they have certain responsibilities around protecting the employees who participate in the plan. One of those things is making sure that their employees aren’t overcharged for the services provided by the 401(k) plan provider, including investment fees.

The thing is that mutual funds, like those offered in your 401(k) plan, HAVE FEES. But they can vary, often depending on how much is being invested in those mutual funds. So when large companies with thousands of employees offer a particular mutual fund to their 401(k) participants, they are typically able to negotiate much lower fees than you would be offered should you try to buy that fund yourself through a brokerage account.

Situations where you may pay more in your 401(k) than with a financial advisor

There are still instances where you might have investments that cost more inside your workplace retirement plan than you would pay outside:

  • When you work for a very small employer who may not have the negotiating power to get the fees any lower than retail rates (aka what you’d pay outside).
  • Your retirement plan offers unique investment options that aren’t typically available to average investors, therefore making it hard to compare those options to more standard mutual funds.
  • You choose actively managed mutual funds, where the fund managers try to beat the market, and you’re comparing those to passively managed mutual funds, where the fund objective is just to match the market it’s designed to mirror – actively managed funds are always going to have higher fees than passive/index funds due the nature of the fund itself.

How to figure out what fees you’re paying in all your investments

Every provider is different, so it would be impossible for me to give you exact directions on how to find this information inside your specific retirement account, but generally if you look under the investing or fund information area of your 401(k) website, you’ll find something that says “Fees and Performance” or “Fund Information” or something similar.

The fees are typically presented as a percentage of what you have invested, and are sometimes called “basis points.” When you see basis points, you just have to move the decimal two places. A fund that charges 20 basis points (in financial jargon, we sometimes say “bips” for bps) will cost .20% of what you have invested. So if you have $1,000 in a fund with a 20 bps fee, your fees would be $20 per year.

Other times you’ll just see the percentage, which is pretty straightforward. The bottom line is that if someone is telling you that you’ll save money in fees by investing with him/her instead of in your 401(k), check the facts. Ask for the expense ratio of what he/she is suggesting you invest in, then compare that to the expense ratio of the funds available in your 401(k) to be sure.

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