This morning we received the latest "Report to Plan Sponsors" from Fred Reish, a leading ERISA attorney working out of Los Angeles. Ranked the most important professional in the field by 401kWire.com, Reish understands the defined contribution marketplace as well as anyone in the country; plan sponsors, providers, and participants can (and should) learn a great deal from him and his work.
In his June newsletter, Reish takes up the question of plan sponsors' fiduciary responsibility to understand and manage plan fees and expenses. Reish notes that plan sponsors should collect and retain information on all fees and expenses, including indirect payments and any revenue sharing arrangements. But what to do with the information? And how to think of it in context of the available alternatives? Here's Reish:
Once gathered, the information should be reviewed by the fiduciaries should and compared to (i) the costs for similar services in the competitive marketplace and (ii) the value to the plan (that is, are the investments and services actually benefiting the participants and is that benefit worth the cost?).
And that's really the question, isn't it. Costs matter and we think most plans cost far too much. But the real problem with most plans is that they charge participants too much for things that aren't of value (i.e., actively managed mutual funds) and don't provide what is of value (i.e., high-caliber investment discipline).* Thus the value of the typical plan is actually quite low.
In general, participants pay four types of costs:
- The stated expenses of the plan's investment options
- The implicit expenses of the plan's investment options
- Any underperformance of the plan's investment options
- The performance penalty of flawed decision-making by participants themselves
Each one of those matters, but the last--the cost of behavioral errors such as poor asset allocation, buying high, and selling low--is massively important and badly under-appreciated.
We've written (here and here, for instance) on the nature and consequences of investors' behavioral breakdowns. And we think the next step in improving 401(k) outcomes, which is what this all about, is minimizing the effect of poor decision-making by combining the flexibility of a defined contribution plan with the pension-caliber investment discipline of a defined benefit plan.
In related news, plan participants suffered a setback Wednesday when a federal judge dismissed Hecker v. Deere, one of several class action suits filed against major corporate retirement plans and service providers. We'll have more to say about this unfortunate decision and its implications next week.
*In addition, participants with large balances pay significantly more for administration in plans that "bundle" services (i.e., pay for adminsitration and investment management out of bloated mutual fund fees, which most plans do). Charging administrative expenses on a per capita basis would serve two purposes: increase transparency and reduce costs.
Fred Reish, "Fiduciary Responsibility for 401(k) Fees and Expenses," Report to Plan Sponsors, Reish, Luftman, Reicher, & Cohen, June, 2007
"Judge dismisses lawsuit against Fidelity, Deere," Reuters, June 21, 2007