The Demos report is an eye opener as to the hidden costs which cause 401k programs to not only fail to keep up with inflation, but to fall behind even the base amount invested into these funds.
What they found was that, for the projected samples that the 401k would lose over $155k for its entire lifetime. Since the entire sample fund at the time of retirement would be $320k, that means a full third of the money which was put into the system was taken by the 401k itself in the guise of fees.
How does this work you may ask? The report goes into detail, but we shall give a simplified example here.
First, your 401k funds are typically put into mutual funds, so let us first address those.
If you put $10,000 into a mutual fund which lists a 3% return, it sounds good, yes? But that is after the fees are deducted. These fees are listed as a percentage of your total investment, but they are deducted from the revenue generated. You get $300 added to the $10,000, but that was after the $150 in “expense ratio,” mutual fund fees such as marketing fees, management fees, and administration feeds, as well as $150 in direct transaction fees have been removed. Your $10,000 had earned $600, but half of that was eaten up in fees. And it does this each and every year. $300 every year for 40 years gives you $12,000 in total fees deducted, more than your original investment.
Then there is the 401k itself, which has its own fees associated with the program. These fund ratio fees are typically around 1%, but over the life of the 401k this adds up to a substantial lump sum.
That original $10,000 over the 40 years of the fund ended up at just over $22,000. Without those fees, it would have been just over $102,000. That is a huge shortfall. Even if you invest an additional $10,000 every year, you are not catching up to this shortfall, as the $1.7 million the fund should have is reduced to $640k, a loss of over a million dollars. And that is if there has been no economic slowdown during the intervening 40 years, which an reduce the principal even further while not reducing the fees associated with that. In a downturn, the fees make the losses even more pronounced than they were before as a result.
Now, I used a high fee rate, typically double the average large mutual fund but not the highest fee currently in the market (which as of the time of writing is 1.53%, held by the HDGE Active Bear ETF Profile Fund according to my research), to best demonstrate the amount lost to these fees.
By comparison, a pension plan is a form of insurance, similar to what you would find for your automobile or your healthcare. Money taken in is used to pay out for those who have met the qualifications for payment. Many of these systems use surplus funds to invest in stable, fixed investments, such as treasury bonds. Social Security works in this manner, surplus funds paid in go into a special trust fund filled with US Treasury Notes, pre-paid cash in effect. The trade-off for this is that the amounts paid out are not directly owned by the individual, they are a large pool that all tap into.
By doing this, the overhead fees are minimal, typically under 1%, and as the amount is not accruing nor are large numbers of transactions being handled, this is not reapplied to the same funds repeatedly as with a mutual fund. As a result, a funded pension plan is far more likely to weather economic hardships without difficulty.
When planning ones retirement, risk is the last word you want to hear.