In my last blog I criticized PBS Frontline’s “investigative” reportThe Retirement Gamble for its claims that investment fees, actively managed mutual funds and lack of fiduciaries are the cause of our current retirement crisis. After watching the piece I had written down approximately 10 pages of notes on inaccuracies and simply dangerous ideas that through my next few blogs I will address.
One piece of PBS’s criticism of retirement funds was that the costs were simply too high. Their answer? Index funds. In fact, their website has a follow-up article titled “Index Funds: The Key to Saving for Retirement?”
But in the real world is finding a low-cost 401(k) retirement plan as simple as including index funds?
While the piece provided no real life examples of high cost plans, we can look at past research one of the retirement “experts” provided for a comparison of what is available on the market versus a so-called “high fee” plan. The relevant question being did our experts actually have a solution we can implement in the real world at a lower cost, or were they just creating a fictional problem to present themselves as an expert with a solution?
Robert Hiltonsmith, an “economist” for the left-wing think tank Demos, became an overnight expert on retirement plans when he repeated past criticisms of the costs of retirement accounts. He pointed to the high costs of his own plan as an example, whose actively managed funds cost and index funds cost more than a low-cost provider, presumably preferring one such as The Vanguard Group.
In this case we can actually look at what a Vanguard small business 401(k) would cost, versus the options in Mr. Hiltonsmith’s own employer’s 401(k) plan.
I believe in investing in the markets via passively managed and index funds, and the index funds available in the Demos 401(k) analysis done by Mr. Hiltonsmith range in cost from 0.70% to 0.95%; the weighted average of the three stock funds being 0.78%. The plan includes two bond funds with fees just under this average so that a portfolio of funds can be created for approximately this weighted average. It should be noted that the report says this would be considered a small 401(k), and the fees as a percentage are higher due to that fact.
A colleague of mine recently requested a 401(k) analysis from Vanguard’s Small Business division. Including all fees and offsets to those fees provided by Vanguard, the weighted average of the total fees for the plan came to 0.63% per fund. This plan in particular used half ETFs which have lower expense ratios than funds, and half investor share class funds.
0.78% versus 0.63% may be different, but not as much as the piece leads us to believe. When the fees for the low-cost provider come dangerously close to those evil plans and their high-cost actively managed funds, it would appear that those who simply criticize 401(k) fees are not aware of real world costs of alternatives.
So, Vanguard is a great investment provider, but perhaps there are lower cost providers of 401(k) accounts where we can access Vanguard funds? There may be. However, as is the case in any field you most often will get what you pay for. As an advisor who researches and offers small business retirement accounts, I have had and have heard of horrible experiences with low-cost plans, despite the fact these plan providers claim to be fiduciaries. Sitting on the phone for hours to correct problems and being told you are paying enough to get good service can be overlooked in an investigative report, but for employers in the real world poor service has costs.
And failed to be mentioned in the analysis are perhaps two of the largest costs of many 401(k) plans: the staff time required to run the plan, and the expert investment advisor who is paid to select the funds, manage the individual portfolios, enroll participants, and provide education. In his report Mr. Hiltonsmith glosses over the cost to the employer to pay staff to learn the in’s and out’s of 401(k)’s, investment performance, sit on the phone requesting corrections or marketing information, etc.. He simply states that this is often just one employee and “just a small portion of their job responsibilities.” Ignoring the high costs of employing an individual to not produce, but to manage benefits is careless.
As for the investment advisor, Mr. Hiltonsmith notes a normal cost of advice may be between 0.50% and 1.00%, though he fails to note many advisors are paid from the funds they sell and their fee is a reason their plan expenses may appear higher than a low-cost mutual fund. To compare apples to apples, the Vanguard plan cost may need to be increased further to include an independent advisors fees.
So, what are the reasons for all of these costs? One simply needs to take a look at Sharebuilder’s menu for its low-cost plans that many of my fiduciary fee-only colleagues recommend (though I personally have not). How many fees include the terms IRS, DOL, or references to tax forms? The reason your 401(k) fees are high very often has little to do with fund selection. It has a lot to do with government involvement in a retirement system they don’t need to be as involved in. See my solution for a more competitive retirement plan model that could be handled with less fees, accountants, attorneys and bureaucrats with only current IRS information returns and direct deposit.
In my quest to change the retirement dialogue from those who only criticize, I want to make sure we are including solutions: so, what can the average individual do to avoid paying too much in fees in their 401(k)?
If you have a large employer and believe you pay high fees, consider asking if they have received proposals from independent advisors on alternatives, and provide them some alternatives like Vanguard. On an individual level you should speak to an independent financial advisor to review if your 401(k) is the best place for you to save. You give up control, and though the experts won’t tell you this you do pay the costs of any employee benefit either through your plan or reduced wages. Individuals are generally best off investing up to the match provided, and then review their options.
My goal in providing the above piece is to move the retirement conversation from fictional criticisms which are being used to promote dangerous agendas that would increase your costs to invest and take away your ability to become self-sufficient through tax-advantaged savings plans. Those in the personal financial planning profession should combat these wrong ideas, no matter if we agree with the nature of what was recommended; the alternative will be for false solutions and individuals without real world experience to enter the conversation.
The preceding blog was originally published by Forbes. To view the original blog please visit our blog at Forbes. http://www.forbes.com/sites/feeonlyplanner/