In our last blog, we said it was time to declare war on 401k fees and promised to break down the expense components, so that you can see clearly “where the villainy lives”. Here we go!
Overcharging becomes villainy when there is purposeful concealment of cost – and that describes the 401k world perfectly.
Why can’t the average CFO, let alone the average participant, easily figure out what his 401k plan actually costs?
Why didn’t fee disclosures exist until they were required by law?
Why are those disclosures are 33 pages long when they could be one?
Are you getting suspicious yet?
The most basic and nearly omnipresent practice of concealment has to do with actively-managed mutual funds. About 85% of plan assets are invested in actively-managed funds, yet they are, on average, 5x to10x the cost of passively-managed (index) funds. Most folks believe that the cost differential is justified by the fact that actively-managed funds outperform index funds. Why do they believe that? Because their advisors and the fund families constantly suggest that it’s true. But it’s utterly false.
Conservatively, index funds outperform actively-managed funds more than 80% of the time – some studies have it as high as 95% of the time. There are no studies that prove the opposite. There are no studies that say index funds win only 70% of the time. We cite studies elsewhere on our website, but there are many and they are conclusive. Every educated investment advisor knows the return history of actively-managed funds vs. index funds, so why don’t you ever hear about it from them? Because they don’t want you to.
Actively-managed funds employ a lot of people to do all that …managing! And those managers apparently need to make a ton of money. We’re not sure why. Maybe it’s to overcome the depression of being wrong 80+% of the time?
But hold on, why would an investment advisor that works for me suggest investments that don’t perform as well as others? Well, actively-managed mutual funds pay advisors and brokers to recommend their funds. Some pay more than others. They call it “revenue sharing”. Index funds pay little or nothing to be recommended. Are you getting suspicious now?
Is “revenue sharing” an every-day term for you? What does that mean anyway? Whose revenue are we talking about? That would be plan participants’ retirement savings. And who is it being “shared” with? That would be the investment advisor or broker. Did the participant generously decide to share his revenue with anyone? Nope, he doesn’t even know about it. Does it show up in his fee disclosure? Nope. Sounds like villainy to us!
So let’s review. Actively-managed funds court, entertain and pay advisors to recommend their funds using participants’ money and call it “revenue sharing”.
If you’re still not ready to think of the 401k industry as untrustworthy, stay tuned for parts 2 and 3 of this series. We’ll talk about the depth of deviousness in so-called “share classes” and the massive overcharging that is hidden in plain sight.
Remember: cost is only one of the issues inherent in today's 401k plans. There are several other areas you'll need to attack if you want a truly successful 401k plan. To read more, click the button below.