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Your 401(k) Plan: Maybe the Most Tedious & Consequential Problem You’re Not Dealing With

18 November, 2014 by Matthew O'Brien, Ph.D. in Commentary

Below is a round-up of current 401(k) plan news.  First, however, I must acknowledge that the subject of 401(k) plans is intrinsically tedious and boring.  Think of how many more pressing problems or interesting issues there are that merit our attention.  The list is nearly endless.  For me, however, the subject of 401(k) plans has become extrinsically very interesting.  Why?  Because the tedium of researching and understanding a 401(k) is responsible for making Wall Street a lot of money at the expense of ordinary retirement investors.

wall street

Not fiduciaries

This presents a opportunity for me and my firm, because our business model in the retirement plan arena is to act as a fiduciary investment advisor — motivated exclusively by our clients’ best interests — and to prevent Wall Street from making a lot of money at the expense of our clients.  This isn’t all we do, of course, since our primary job is to preserve and grow our clients’ capital over the long-haul.  Avoiding excessive fees and counter-productive investor behavior doesn’t accomplish this job entirely, since we still have to buy good, growing companies at a reasonable price,  but it makes the whole task a lot easier.

People tend to ignore their 401(k) plans, and in the relatively few cases where people do try to understand them, they tend to fail because the plans are too complicated.  The employers who sponsor 401(k) plans tend to ignore them too.  Employers usually want to fund the plan as a perk for their employees and then stop thinking about it, so they can attend to the vagaries of their business.  This malign neglect is what has allowed Wall Street — banks, brokers, and insurance companies — to gouge 401(k) investors with excessive fees and design plans that allow the provider to scale up the assets under management, even though the plans encourage counter-productive trading and foolish asset allocation.

The only feasible solution to this problem is for 401(k) plan sponsors and participants to work with a genuine fiduciary advisor, such as O’Brien Greene.  In any case, if you’re still reading this far, you’re probably interested enough in 401(k)s to hear more about the current state of things.  Therefore, here’s a round-up of some recent news regarding 401(k) plans:

Supreme Court won’t hear 401(k) excessive fee case

BenefitsPro reports that the U.S. Supreme Court denied the plaintiffs petition for review in Tussey v. ABB Ltd.  Tussey, which the New York Times profiled recently and I wrote about here, has embroiled ABB, Inc., its retirement plan participants, and Fidelity in a dispute over excessive fees and fiduciary duty.  The class action suit was initially filed in 2006 and in 2012 the plaintiffs won $35 million in damages when a U.S. district court decided the Fidelity, the plan provider, and ABB, the plan sponsor, had breached fiduciary duties to plan participants.  However, earlier this year the 8th Circuit Court of Appeals in St. Louis complicated this result by upholding part of the plaintiffs claim against ABB while overturning the judgment against Fidelity.  401(k) fee litigation isn’t over, because the Supreme Court is expected to address  other cases that raise similar issues.  The Court is already slated to hear Tibble, et al, v. Edison International, et al.

The Tussy case demonstrates why the conventional 401(k) plan is structurally flawed: most 401(k) plan providers like Fidelity do not operate exclusively under a fiduciary duty to the participants in the plans they provide, in spite of the fact that the plan sponsors who hire the providers have a fiduciary duty to the participants.  This creates interminable conflicts of interest that are only resolved when a qualified investment fiduciary takes discretionary responsibility for managing 401(k) assets.  The employer plan sponsor is better off by being partially relieved of its fiduciary responsibility to manage plan investments, and the employee participants are better off because they have a manager who is incentivized to produce the best results for them.  The only looser is Wall Street, which stands to make less money from the excessive and hidden fees that fund companies and insurers typically pack into the retirement plans they provide.

To learn more about how we at O’Brien Greene manage retirement plans differently, click here.

ETFs becoming popular in 401(k) plans

Thus the Dallas Morning News reports.  Charles Schwab, which is one of the custodial firms we work with at O’Brien Greene, is the largest 401(k) provider to have begun offering exchange-traded funds (ETFs) within 401(k) plans.  ETF assets under management have been growing steadily for the past decade, at the expense of mutual funds.  Part of this growth is justified, because for taxable investors ETFs offer greater tax efficiency at a lower operating cost than most comparable mutual funds.  But the rush into ETFs is also driven by the herd instinct for novel financial products and an indiscriminate (and therefore misplaced) response to the low-cost investing mantra chanted by Jack Bogle and Vanguard, which is echoed uncritically by much of the financial press .  But as even Bogle has noted, ETFs often end up being bad for investors because they tend to induce excessive and counter-productive trading behavior.  I wrote the other day about how silly the admiration for exchange-traded products has become.

The Dallas Morning News article quotes a statement from Fidelity, which doesn’t offer ETFs in its retirement plans: “Fidelity believes index mutual funds are more suitable than index ETFs for workplace savings plan participants seeking passive exposure to the capital markets.”  Fidelity’s policy is quite sensible, especially since, for a number of technical reasons, an ETF effectively has to be “wrapped” in a mutual fund in order to function properly within a defined contribution plan that receives salary deferrals and employer matching contributions in an incremental and piecemeal way.  There are many low-cost index mutual funds available, and since tax-liability isn’t an issue with qualified retirement assets, the ETF-only retirement plan doesn’t offer any distinctive value and is basically a marketing gimmick.

The rise of the ETF-only retirement plan is a consequence of the increasing attention being paid to the impact of excessive, hidden fees.  This attention is a good thing, but employers and their employees need the guidance of an investment fiduciary — not brokers, banks, or insurance salesmen —  in order to translate the desire for reasonable costs into a genuinely superior set of investment options.

Don’t make the mistake that cost Boeing employees $98 million

The Wall Street Journal’s MarketWatch has run an article with some bracing statistics about just how much money Boeing employees have left on the table within their 401(k), presumably due to neglect, distraction, and procrastination.  MarketWatch reports that Boeing employees “collectively left $98 million on the table in 2013 by not taking advantage of matching funds in the company’s 401(k) plan.”  This figure puts a price tag on just how important the structure of a 401(k) plan is, quite apart from the substance of the investment options that it offers.  Relatively low-cost, well-managed funds will have good investment returns over the long-term, but the investors in these funds will have good returns to match only if they know what they’re doing when they buy and sell the funds.  Most people don’t know that they’re doing, or if they do they don’t have the discipline to stick with their resolutions.  This isn’t surprising, because most people aren’t professional asset managers.  They have day jobs.  They have families.  Therefore, in order to get investors returns to match their fund returns, a plan needs to be structured with built-in default contribution and investment options that benefit plan participants.  Plans should be designed so that a participant’s neglect and distraction automatically result in reasonable long-term investment strategies, and stupid decisions require deliberate and active choice.