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401(k) Mutual Fund Expense Ratios Continue to Drop

Practice Management

The downward trend in the expense ratios that 401(k) plan participants incur for investing in mutual funds continued in 2021, according to a new report from the Investment Company Institute. 

For equity mutual funds, the average expense ratios incurred by 401(k) investors declined from 0.39% in 2020 to 0.36% in 2021, the ICI notes in The Economics of Providing 401(k) Plans: Services, Fees, and Expenses, 2021

In 2021, the simple average expense ratio for equity mutual funds was 1.13%. However, when taking into account both the funds offered in 401(k) plans and the distribution of assets in those funds, plan participants who invested in equity mutual funds paid about a third of that amount—0.36% on average—lower than the industrywide asset-weighted average of 0.47%. 

This trend has existed since 2000, when 401(k) plan participants incurred an average expense ratio of 0.77% for investing in equity mutual funds—or a 53% decline over the period. 

The ICI explains that it uses asset-weighted averages to measure the expense ratios that investors actually incur for investing in mutual funds. The report notes that the simple average expense ratio, which measures the average expense ratio of all funds offered for sale, can overstate what investors actually paid because it fails to reflect that investors tend to concentrate their holdings in lower-cost funds. 

All told, at year-end 2021, 64% of the $7.7 trillion in 401(k) plan assets were invested in mutual funds, with 39% invested in equity mutual funds. Broken down further, 60% of 401(k) plan assets invested in mutual funds were invested in equity mutual funds at year-end 2021, including both active and index equity mutual funds. 

The ICI also reports that at year-end 2021, 95% of mutual fund assets in 401(k) plans were held in institutional and retail no-load share classes, while the remaining assets were held in load share classes, mostly in share classes that do not charge retirement plan participants a front-end load.

Hybrid and Bond Mutual Funds

Like equity mutual funds, the average expense ratios that 401(k) plan participants incurred for investing in hybrid and bond mutual funds also fell from 2000 to 2021—by 40% and 58%, respectively. 

For hybrid mutual funds, the average expense ratio edged down from 0.44% in 2020 to 0.43% in 2021. This was less than half the industrywide simple average (1.16%) and 25% less than the industrywide asset-weighted average of 0.57%. At year-end 2021, 28% of 401(k) mutual fund assets were invested in hybrid mutual funds. 

For bond mutual funds, the asset-weighted average expense ratio paid by 401(k) investors fell by 7 basis points, from 0.32% in 2020 to 0.25% in 2021. This was about a third of the industrywide simple average (0.84%) and 32% less than the industrywide asset-weighted average of 0.37%, the ICI notes. 

The average expense ratio paid by 401(k) investors in bond mutual funds is also lower than the industry average when disaggregated into investment grade, world bond, and other taxable mutual funds, the report further observes. 

As with investors in equity and hybrid mutual funds, 401(k) bond mutual fund investors have concentrated their assets in lower-cost bond mutual funds. At year-end 2021, 10% of 401(k) mutual fund assets were invested in bond mutual funds, including both active and index investment styles. 

Money Market Funds 

Here, the ICI found that only 2% of 401(k) mutual fund assets were invested in money market funds at year-end 2021. 401(k) participants holding money market funds had an asset-weighted average expense ratio of 0.12% in 2021—a decline of 14 basis points from 0.26% in 2020. Industrywide, the average expense ratio investors incurred on money market funds fell by 9 basis points between 2020 and 2021.

Lower-Cost Funds

The ICI explains that it uses asset-weighted averages to measure the expense ratios that investors actually incur for investing in mutual funds. The report notes that the simple average expense ratio, which measures the average expense ratio of all funds offered for sale, can overstate what investors actually paid because it fails to reflect that investors tend to concentrate their holdings in lower-cost funds. 

As for what contributes to these low expense ratios incurred by 401(k) plan participants, the report explains that it comes down to several factors, including: 

  • competition among mutual funds and other investment products to offer shareholders service and performance; 
  • plan sponsor decisions to cover a portion of 401(k) plan costs, which allow them to select lower-cost funds or fund share classes; 
  • economies of scale, which large investors such as 401(k) plans can achieve; 
  • cost- and performance-conscious decisionmaking by plan sponsors and plan participants; and 
  • the limited role of professional financial advisers in these plans.