Farrell: With investment fees, small differences add up over time

A time-honored insight in finance is that small differences can add up into big numbers over time.

You've probably seen calculations illustrating the insight when it comes to returns on investment. The same dynamic holds with fees.

Take this illustration by the Securities and Exchange Commission. A portfolio value with an initial investment of $100,000 that grows 4% annually over 20 years is worth $10,000 less if the fee charged is 0.50 vs. 0.25%.

A 1% fee cuts the portfolio's value by nearly $30,000 compared to the same portfolio with an 0.25% fee. Lower fees mean you get to keep more of the money.

A recent report by Pew Charitable Trusts highlights how critical fees are savers. The study "Small Differences in Mutual Fund Fees Can Cut Billions From Americans' Retirement Savings" focuses on a decision many employees face when they leave the company or retire: Keep the savings in the employer's plan or transfer the money into a rollover IRA?

There are good arguments for either depending on individual circumstances. The study persuasively argues that fees charges should play a major role in the decision.

The core argument runs along these lines: Mutual funds charge different fees depending on the type of investor. Institutional investors — including employer-sponsored retirement plans — gain access to lower fees since they have control over large sums. Retail investors — Wall Street jargon for people like you and I — typically pay higher fees for the same or similar mutual offerings.

Shifting money from a low-fee employer plan into similar investments in a higher-fee retail IRA "translates into significantly higher costs for retail investors, costs that can eat into their long-term savings significantly."

For example, in 2018 investors rolled over $516.7 billion from employer retirement plans into traditional IRAs. The Pew analysis of the fee differential over a 25-year retirement period is that the retail investors could see an aggregate reduction in savings of about $45.5 billion from just one year of rollovers.

"Savers who are happy with their investments may be better off leaving their assets in the plan when they separate from their employer," concludes the report. "Those who want to complete a rollover should seek investments with equivalent or lower expenses than the mutual funds they owned in their 401(k)."

The study is one more reminder that fees matter. One of the simplest ways for savers to boost returns is to keep fees low.