Do You Know the True Cost of Your Retirement Plan?

That a relationship between investment performance and fees exists is hardly news. Fees matter. However, it's not quite as simple as it may seem. Fees vary by amount, timing and form. A two percent fee, charged upfront, hurts more than a two percent fee that is levied on the back end. A no-load fund that charges higher annual expenses might cost an investor more than a fund with an upfront charge but lower annual expenses. For mutual funds and exchange-traded funds, the U.S. Securities and Exchange Commission provides a handy calculator with the qualifier that "the results should be compared for several funds or different classes of a single fund".

Importantly, lower may not necessarily mean better. Consider performance fees such as those charged by numerous hedge funds. If an investor understands and willingly acknowledges likely risks, a performance fee may be an acceptable price to pay for participating in returns that exceed a pre-specified benchmark.

However, good decision-making cannot take place in the dark. As described below and in a GAO report about mutual fund disclosure, transparency is not always easy to come by.

1. Database vendors typically provide returns on a gross basis because that is how they are reported by participating money managers. Evaluating a large number of funds requires manual adjustments to facilitate an "apples to apples" basis. This is time consuming to say the least and sometimes difficult to do.

2. Fees vary by type of fund, strategy and timing. Care must be exercised to take into account relevant factors.

3. Fees change over time. Past fees may not be a bellwether of future fees.

4. Reported performance may not reflect all elements of a portfolio as would be the case with side pockets or similar mechanisms. Refer to Barry Schachter's hedge fund blog for comments about side pockets.

5. Mutual fund expenses may not be reflected in published performance reports, forcing one to review the Statement of Additional Information.

6. Institutions and retail clients do not bear the same costs so fee analysis must incorporate any differences.

According to BenefitNews.com, New York Attorney General Eliot Spitzer announced plans to "examine how 401(k) investments are allocated and whether fund managers are exacting higher fees than participants believe they are paying".

What this portends is anyone's guess. Investigations have the potential to shed light on the important topic of investment fees. Of course, institutional investors should be asking lots of tough questions before they commit dollar one to any particular manager. In fact, it's their duty to behave prudently and proper inquiries, during the RFP process and in-person interviews, are a perfect time to dig deep. posted by Susan Mangiero at 5/14/2006 07:48:00 PM