Slashing investment fees–Schwab PCRA

Slashing investment fees–Schwab PCRA

My Charles Schwab employer 401(k) plan has limited investment options. It offers US stock index funds with low expense ratios, but only offers actively managed US bond and international stock index funds with high expense ratios. Target date funds are also available, although they have a high expense ratio as well (relative to index funds). Alternatively, Schwab lets investors open a self-directed account, called the Personal Choice Retirement Account (PCRA), that offers a much broader range of investment options. This article will show how taking one hour to enroll in Schwab’s PCRA will save me well over $100k in investment fees before retirement.

Three investment approaches with different fees

Below I’ve shown how my employer’s Schwab plan can be used to achieve similar portfolios using three different approaches: the target date fund (TDF), a portfolio using low fee US stock funds mixed with high fee US bond and international stock funds, and the low fee US stock funds with diversification through the PCRA. As you can see, the PCRA option results in fees that are an order of magnitude lower. I also want to point out that the yearly $100 fee is charged by the 401(k) plan administrator and not Schwab, so if you have access to this option, you need to check with your administrator to confirm what fees apply for your situation.

Approach 1 – Target Date Fund

In a target date fund, the fund manager gradually shifts your investments from more aggressive to more conservative over time. To manage the investments, they charge a fee, 0.54% in my case. As far as investment fees go, this is not terrible, but it is more than I need to pay.

InvestmentAllocationAnnual feeWeighted annual fee
Target date fund100%0.54%0.54%

Approach 2 – Using funds available in the 401(k) plan

As you can see below, I can achieve sufficient diversification using a combination of US stock index funds and actively managed US bond and international stock funds. However, the effective fee is only reduced to 0.42%, and I want even lower fees!

InvestmentAllocationAnnual feeWeighted annual fee
S&P 50035%0.02%0.007%
US small cap20%0.04%0.008%
US bonds20%0.55%0.11%
Intl. stock25%1.18%0.295%
Total100%0.42%

Approach 3 – Diversification using Schwab’s PCRA

By opening a Schwab Personal Choice Retirement Account (PCRA) and transferring funds into the PCRA, I achieved the same level of diversification while reducing investment fees by an order of magnitude. The setup process was simple, and from now on I can route a portion of my 401(k) contributions directly to the PCRA and then manually invest in the US bond and international stock funds noted in the table. Manually investing and re-balancing is a very small price to pay, as I’ll show next.

InvestmentAllocationAnnual feeWeighted annual fee
S&P 50035%0.02%0.007%
US small cap20%0.04%0.008%
US bonds20%0.04%0.008%
Developed markets15%0.04%0.006%
Emerging markets5%0.12%0.006%
Intl. small cap5%0.11%0.006%
Total100%0.041% + $100*

*$100 fee was charged by the plan administrator, not Schwab. Check with your plan administrator for applicable fees.

How much do fees end up costing?

The long term cost of fees depends on the magnitude of the fees and your investment plan. The table below outlines an example plan that is instructive for my investment plan, although round numbers have been used instead of exact numbers. In this example, the starting 401(k) balance is $100K because the retirement savings started well before learning about FI. The annual contribution is $24K, which assumes contributing the current maximum ($19K) plus an employer match of $5k. It also assumes that such individual and employer contributions will continue for 10 more years. After 10 years, contributions will stop and the account will compound for an additional 20 years before reaching traditional retirement. The example ends at this point because the success of the portfolio during draw down depends on the initial portfolio value–which is the subject of this post–and the draw down strategy, which is beyond the scope of this post.

Inputs for comparison
Starting balance$100k
Annual contribution$24k
Contributing years10
Compounding years20

The table below shows the ending account value for the investment scenario outlined above as a function of the investment approach and annualized market returns ranging from 6% to 8%. Most people would be happy to own any of those account balances. So what’s the big deal?

Approach6% Return7% Return8% return
TDF$1.386M$1.785M$2.295M
Plan funds$1.429M$1.839M$2.365M
PCRA$1.568M$2.018M$2.593M

The next table shows the total amount of fees paid over the 30 year growth period of the portfolio. The  PCRA will save between $139K to $299K, which can likely cover several extra years of traditional retirement. This additional coverage can either:

  1. Allow an earlier retirement date,
  2. Provide extra cushion against sequence of return risk, and/or
  3. Leave heirs with a larger inheritance.
Approach6% Return7% Return8% return
TDF$203K$260K$332K
Plan funds$160K$205K$262K
PCRA$21K$26K$33K
PCRA saves$139K to $182K$179K to $234K$229K to $299K

This example shows that you cannot afford to ignore investment fees. The highest effective fee shown here was 0.54%, which compared to many actively managed funds, is quite low and may appear reasonable. However, even this “reasonable” fee ends up costing the investor several hundred thousand dollars compared to the PCRA option. Actively managed funds, which may charge fees of 1-2% (or more), will cost the investor even more. 

Want another way to think of this? Say it takes approximately one hour per year to manage rebalancing the portfolio through Schwab’s PCRA. Over a 30 year investment horizon, this equates to $4,633/hr to $9,967/hr. Even if you earn $100k/yr, your hourly rate is $50/hr. Thus your time spent implementing the PCRA is multiplied by ~100X. Nice!

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