What’s 1% worth? In terms of an increased retirement benefit – a lot of money! Paul Secunda over at the Workplace Prof Blog provides us with an Illustration of How 401(k) Management Fees Add Up, and shows us the effect on earnings of even one percentage point difference in annual fees on a 401(k) balance of $20,000 invested over 20 years.
That’s during the accumulation phase. But what impact does a 1% increase in return have during the distribution phase. The chart above shows us that a 1% increase in returns, compounded over a lifetime, makes an enormous difference. In this example provided by Alliance Bernstein, it translates into about $220,000 extra at retirement—and an extra 10 years of spending.
So whether it’s during the accumulation phase or during the distribution phase, 401(k) fees really do matter.
For the mathematically inclined, following is the methodology Alliance Bernstein used to develop their chart:
Results are simulated. This is a hypothetical illustration only and its results are not indicative of any specific investment, including any AllianceBernstein mutual fund. The savings phase simulates a defined contribution participant salary of $45,000 at age 25, linearly increasing to $85,000 by age 65, making yearly contributions of 6% of salary at age 25 increasing by 0.5% per year to a maximum 10% with a 50% company matching contribution up to the first 6% of salary. In the spending phase, $63,750 (75% of final salary) is deducted at the beginning of each year. A yearly investment return of 9% is assumed at age 25, linearly decreasing to 6% at age 80 and remaining constant thereafter. In the “1% Greater Return Scenario” a yearly investment return of 10% is assumed at age 25, linearly decreasing to 7% at age 85 and remaining constant thereafter. Inflation is assumed to be a constant 3% and dollar values are expressed in real purchasing power terms.