On Monday, Bloomberg's John Wasik published a column on excessive expenses (and other problems) in 401(k) plans. We appreciate Wasik's perspective on these important questions and agree fully that most plans are too expensive, most expenses are poorly disclosed, and most participant outcomes fall well short of where they could, should, and would in retirement plans that live up to ERISA's fiduciary principles.
Notwithstanding all that common ground, we have some major reservations about Wasik's well-intentioned column.
In a list of questions he wants plan participants to ask their employers, Wasik suggests this: "How much are 401(k) account expenses reducing your total return in terms of dollars? Simply stating percentages doesn't clearly show the losses over time."* For all the importance of full disclosure, we just don't see this dollar-based reporting as remotely feasible, or even especially helpful.
First, how should service providers calculate these "return-reductions"? Relative to what benchmark? Is the relevant calculation the difference between the actual results of a participant's investment decisions and the same decisions with literally no fees at all? That's neither a plausible comparison nor a manageable calculation. After all, as Wasik points out quite correctly, true plan expenses aren't fully captured by explicit fund costs (i.e., mutual fund expense ratios). Given that reality, the dollar-based effects Wasik wants participants to see simply can't be precise. We think presenting information on the long-term effects of truly excessive fees is important. But it doesn't help anyone to pretend that these plans can be implemented at no cost whatsoever.
Second, railing about truly excessive fees--and, ideally, eliminating them--only gets us part of the way home. Thinking about fees in a vacuum, apart from the very real opportunity costs imposed by the typical participant-directed plan, leaves the most important part of the 401(k) story untold. Whatever the effects of excessive fees, it's the basic architecture of the typical plan--a design that forces ordinary workers to act as their own money managers--that imposes the greatest costs.
Think of a retirement plan in terms of the efficient frontier. In the adjacent chart, the top line represents the "zero-cost" boundary of risk and return. The next line down, in dark blue, represents the same boundary after some nominal (i.e., unavoidable) costs of plan delivery. If the blue boxes represent idealized portfolios--the potential results of optimal asset allocations and decision-making--the red boxes represent the real-world outcomes experienced by many participants. If the true costs of the plan are the vertical distance between a red box and the light blue line, it simply cannot be said that the only problem in this hypothetical plan is excessive fees. Those fees are, in the vast majority of plans, a problem. They just aren't the only one, and for many participants they aren't the most significant one. It's in their decision-making--in formulating an investment strategy and implementing it effectively through changing market conditions--where participants encounter the most devastating costs.
Naturally, the best-case scenario is a low-cost plan paired with good decision-making. But participants would enjoy better returns in a high-cost plan with good decision-making than they would in a low-cost plan with poor decision-making. With all the attention paid to plan expenses, the adjacent table--which suggests that a plan with high costs and good decision-making is preferable to one with low costs and poor decision-making, both of which are preferable to the typical plan and, of course, inferior to a truly fiduciary plan--may seem a bit counter-intuitive. But think again in terms of the efficient frontier. What would get those red boxes closer to the dark blue line? Better decision-making. Lower costs would get the dark blue line closer to the light blue one. That's a very important step, but it isn't enough.
Wasik concludes his column by calling for employers to cut their ties to retirement plans, which in turn would force employees to "shop" for their own 401(k) plan in a more free-wheeling marketplace.
For years, American employers were seen as paternalistic. In exchange for decades of your labor, they provided salaries, a pension, health insurance and other perks. Pressured by a global economy, they are offering fewer and fewer benefits.
You might as well have the ability to choose your own plan since you are already charged with picking individual 401(k) funds and allocations. Welcome once again to the ownership society.
We think this is backward. As we wrote just last week, sponsors simlpy must take a more paternalistic--and yes, more fiduciary--approach to their retirement plans. The Pension Protection Act of 2006 (and the Department of Labor rulemaking prompted by the PPA) both encourage and enable sponsors to do exactly that.
The two-decade trend in the defined-contribution marketplace has been to push more responsbility--and thus more risk--all the way down to plan participants. It's long past time for sponsors and the financial services industry to reclaim and fulfill some of that responsibility--out of fiduciary duty to plan participants and enlightened self-interest.
* Here are Wasik's other questions, all important:
- What are middlemen charging you for commissions, administration, Web sites, transfers and other fees? Are there 12(b)1, shelf space, wrap or finder's fees? If so, how much are they reducing your total return?
- What's the total cost to manage mutual funds within your plan? That would include transaction expenses to trade securities within portfolios, which aren't clearly disclosed in any U.S. mutual fund.
- Conflicts of interest. If a broker is involved, does he also include funds in the plan managed by his company? If so, they are "double-dipping,'' deducting one set of fees for commissions and administrative expenses and another for money management. Their greed is costing you dearly.
John Wasik, "Time for Employers to Cut Cord to 401(k) Plans," Bloomberg, November 5, 2007