Expenses are a high priority for 401(k) investors

While 401(k) investors' choices of mutual funds vary widely, one element of concern seems to be constant: cost. Last year, the average asset-weighted expense ratio for a stock mutual fund in a 401(k) plan fell to 0.74%, from 0.76% in 2005, according to a new report released by the Investment Company Institute in Washington. The report, "The Economics of Providing 401(k) Plans: Service, Fees and Expenses, 2006," concluded that 55% of the $2.7 trillion held in 401(k)s at the end of last year was invested in mutual funds. Of that, 88% was invested in stock funds, the report said. The majority of stock fund assets, 77%, was invested in funds with expense ratios of less than 1%. Of that, 23% was in funds with expense ratios of less than 0.5%, the ICI said. Not surprisingly, 401(k) participants pay close attention to expenses, said Sarah Holden, senior director of retirement at the ICI. They also pay attention to a fund's historical performance and its riskiness, she added. 401(k) investors also gravitate to funds with relatively low turnover, the ICI report said. The industrywide average asset-weighted turnover rate in stock funds was 47% last year, compared with 46% for 401(k) accounts. Investors aren't the only ones paying attention to 401(k) costs. More employers are reducing costs associated with saving for retirement, said Michael Hadley, assistant counsel for pension regulation at the ICI. The study "suggests that employers who have a fiduciary responsibility are also being cost conscious," he said. "The study is more evidence that the 401(k) plan is usually the best way for an employee to save for retirement," Mr. Hadley said. Plan administrators also need to be mindful of underlying costs, said Wayne Titus III, a certified public account with AMDG Business Advisory Services PLC of Plymouth, Mich. Turnover costs, for example, aren't included in expense ratios but are reflected in net returns. "In addition to administrative costs, there are costs associated with holding cash and turnover," Mr. Titus said, adding that these factors affect performance. The biggest problem that he encounters is employers' not understanding their role. "They have to review the costs and minimize the costs to participants." Mr. Titus said. Mutual fund costs in general have declined in recent years, the ICI said. Last year, it found in one study that mutual fund fees and expenses had dropped to their lowest level in more than 25 years, by more than 50% since 1980. Researchers at Morningstar Inc., a Chicago-based investment research firm, suggest that the reason is market driven. Mutual fund expense ratios have declined for the past three years, said Russel Kinnel, director of fund research. In a report, he noted that in 2006, the average individual investor paid 0.94% for U.S. stock funds, compared with 0.96% in 2005. The trend continued in most asset classes, with the largest price break in international funds — at 1.06% last year, compared with 1.14% in 2005. The overwhelming driver, Mr. Kinnel noted, is rising assets — thanks in part to a strong stock market. The industry has seen more asset inflows into low-cost funds, said Christine Benz, director of mutual fund analysis at Morningstar. "401(k) plans have lower-cost funds because typically they have plans with vanilla funds, such as core large-cap funds, core intermediate-bond funds or life cycle funds," she said. "These asset classes are less expensive than specialty technology or emerging markets." Cost is also part of the regulatory piece. "You also have [the Employee Retirement Income Security Act] operating here that says plan administrators need to act as fiduciaries in selling these funds," Ms. Benz added. "So they need to make a good choice, which is often the low-cost choice." Sue Asci can be reached at sasci@crain.com.