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With 401(k)s and Other Defined Contribution Plans, Watch Your Wallet

When financial matters are opaque, there must be a large discount to prices representing clarity to interest people to buy.  Unfortunately, with 401(k)s and other defined contribution plans, it is sometimes akin to being limited to the “company store.”  I’ve written about these issues before, both here and at RealMoney.  Here’s a good example of one of them:


David Merkel
Pension Consultants: Watch Your 401(k) Expense Levels
9/27/2006 5:36 AM EDT

I want to point you to an article of John Wasik’s of Bloomberg. Having worked in the pension business while an actuary at a mutual life insurer, I had the experience of reviewing the pension services proposals of a number of competitors, and of complementary service providers. Most players were honest, but there were a number of players, while technically not breaking the law, would stretch ethics by finding ways to disguise fees by wending them into the change in unit value of the funds inside a deferred compensation plan. Why embed them in the unit value change? Slice up a fee over hundreds or thousands of participants, and over 365 days a year, and it is remarkable how little people notice it, because most people don’t bother to go and look at plan expenses as disclosed in the Form 5500. Even if everything were disclosed in detail there (some charges don’t get unbundled), an individual doesn’t see that the pro-rata expenses are coming out of his hide. Unless the plan sponsor goes the extra mile to try to minimize costs to participants, there is little that an individual can do.

We had a rule at our firm. We only take fees from one source, and we disclose them. We had a second rule: we only pay commissions once, and they can be disclosed to the ultimate client, or nondisclosed, but not both, but if nondisclosed, the ultimate client must know that.

Oe reason why we did not hire certain investment consultants was the potential for conflict of interest. We eventually hired a consultant to aid us in manager selection that took no fees from the managers, so we could get unbiased advice. There were other consultants that were less than scrupulous in that matter. Without naming names, we terminated our first investment manager consultant because we learned they would not recommend managers to us, unless they were receiving a fee from the manager. That fee would get built into the expenses would into the unit value, or, come out of my firms profit margins, which were for the good of the participating policyholders.

Now that was just my experience, so take that for what it’s worth, perhaps I’m just an investment actuary with a axe to grind. If you want a more general view of the problem, you can review this 2005 study of conflicts of interest done by the SEC. Now, as John Wasik notes, “The commission didn’t take any enforcement action after the report was issued, nor did it name any of the firms surveyed.” The problem is still there, and I’m afraid your only advocate is for you to appeal to your plan sponsor to watch out for the best interests of all participants, which is the duty of trustees under ERISA.

Position: none, but at the mutual life insurer, we had a saying, “We’re out to save the world for 25 basis points on assets, plus shipping and handling.” Beats a lot of other deals out there…

Now, here is another piece from Bloomberg: Fees on 401(k)s Rock Boomers Facing Flawed Disclosure.

The difficulty here is that fees on small plans are sometimes high, and defined contribution plans don’t allow for easy examination of the total fee structures.  How much are the investment managers taking?  The recordkeeper? The custodian/trustee?  The marketer?  It is not always clear.  What can be worse is the manager selection, which are usually random on average (before fees) in terms of any outperformance versus indexes.

Now, in fairness, anytime you have a large number of small accounts, the costs will be high as a percentage of assets.  But there are limits.  Disclosure needs to be improved, but until then, ask your plan sponsor for all of the Form 5500 documents.  There are two classes of expenses.  Explicit: what the fund pays for directly.  Implicit: what gets deducted from investment returns.  Add the two together, because that is the total load.  Insist on as full of an accounting as the plan sponsor will give you.

If you are paying more than 1% of assets per year, then something is wrong, unless the asset classes are esoteric, which should not be the case for DC plans.  Remember, you have to be your own guardian with defined contribution plans.  No one will do it for you.  And, if a few of your colleagues complain at the same time, you will be amazed at how quickly it will be taken seriously, because the administrative staff of the plan sponsor usually doesn’t get that much feedback.






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2 Responses to With 401(k)s and Other Defined Contribution Plans, Watch Your Wallet

  1. You forgot to mention Sub-Transfer Agent fees! This is a great post. Here are a few tips I would add:

    1. Never use an insurance company or insurance products (i.e. variable annuities).
    2. Run away if the service provider says they will service the plan for “free.” (See #1)
    3. Use a service provider that ONLY receives fees based on assets under management AND provides investment advisory services AND is held to a “fidcuciary” standard of responsibility.
    4. In addition to reviewing the 5500, ask for the Investment Policy Statement.
    5. Generally, plan service providers should ONLY be paid by the client and no other source. This creates transparency and a “revenue-neutral” vantage point.

    “A wise man should have money in is head but not in his heart.” ~ Jonathan Swift

  2. Louis Hill says:

    Hi David

    Some while ago you asked a question about what folks use for an economic indicator for the consumer. I think the baltic dry is a good one but it involves heavy euro-influence. One I really like is the National Restaurant Association traffic index. It is difficult to find on their site because they would like you to buy a $ 3500. Association study. But it can be found.

    http://www.restaurant.org/pdfs/research/index/200712.pdf

    Go to the NRA site and use their internal search for: “restaurant traffic” and look through the links and eventually you will come upon the past month traffic study.

    I think if you reflect on the Fereral Government information and the U of Mich. Consumer Sentiment index that this may be more germane. This is a great indicator of what a large number of people with money in their pocket are willing to do with that money.

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.


Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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