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Thursday, August 28, 2014

What Fidelity's 401k Lawsuit Teaches The Rest Of Us

If you’re in tune with what’s going on in 401k lawsuit land, you may have heard about the recent $12 millionLaw settlement reached by Fidelity and its plan participants.  For those of you not in the know, Fidelity was recently sued by its own plan participants.  They claimed that Fidelity violated ERISA because they were only offered Fidelity funds, that those funds had high costs and that there were not enough index funds offered in the plan.

A recent commentary observed "the settlement could enhance Fidelity’s image as an employer.”  How could anyone come to that conclusion?!  Fidelity's plan rakes in huge fees for the company—because they are not just a plan sponsor, but the actual recipient of all the excess fees being siphoned off their employees' retirement accounts.   Fidelity was well aware of that, as they are aware today that the actively-managed funds they offer cost many times what index funds cost and yet underperform them more than 80% of the time. 

Fidelity did nothing it wasn't forced to do and despite this settlement, gave up almost nothing to get off the hook, admit no wrongdoing and minimize bad publicity. They certainly deserve no pats on the back.  A $12 Million settlement on a $10 Billion plan is a drop in the bucket and most of the real problems in the plan remain—and allow Fidelity to go on over-charging—but now with an aura of propriety that belies the facts.

The reality is that every employer with mostly actively-managed funds in their plan—Fidelity’s or anyone else's—is causing at least as much harm to his participants as Fidelity was to theirs.  This is due to both the high cost of the funds (and add-on fees) and their persistent underperformance against index funds.  Rest assured that the average employer/participant is paying much higher fees than the Fidelity mega-plan participant is paying.

In a twisted sort of way, Fidelity has something of an excuse for their bad behavior toward employees.  They are in the business of creating and selling actively-managed funds.  What else would they offer their employees?  If they didn't, how would they ever sell them to anyone else?  This lawsuit put Fidelity in tremendous jeopardy.  If it ever got to the real heart of the matter—that there is no empirical evidence or justification for high-cost, actively managed funds in a 401k plan—Fidelity would be out of business.  Instead, they "settle" for $12 Million and rock on.  A huge win for Fidelity.

There are more than 30 similar suits underway right now—at their core, cost is nearly always the issue.  Most suits pit the participants against the plan sponsor (employer) or the plan sponsor against the provider (like Fidelity, Merrill Lynch or John Hancock).  Few are like Fidelity, where the plan sponsor and provider are one in the same. 

Fidelity is thus defending its very existence—they have no choice.  If the court declares actively-managed mutual funds to be abusive, they are out of business.

Providers are defending big profits and quite possibly a portion of their business, but not their very existence.  Merrill Lynch and Morgan Stanley have been financially impacted by the many suits they have been forced to defend—win, lose or settle—but their survival is never really threatened. The profits continue to outweigh the legal fees—so they carry on making tiny, incremental tweaks to reduce future jeopardy.

But what of the Plan Sponsor?  These are the folks (along with their employees) that we care about.  They are not mutual fund companies or investment sellers.  They are engineers, car dealers, shipping companies, office furniture companies, sporting goods companies, etc.  You're trying to succeed in your business and attract, retain and reward the people you need to make it happen.  You have every reason to help your employees minimize their cost of saving for retirement and maximize their savings.  There's nothing about your business that's enhanced by offering the stuff pedaled by the likes of Fidelity, Merrill Lynch or Mass Mutual.  They have a major business reason to keep putting themselves in harm's way.  You have every business reason not to.

The suits against investment sellers will continue and accelerate because all the evidence, over decades of data, says that actively-managed funds are a bad deal.  Participants pay most of the cost and suffer the poor results and they are beginning to realize it.   It helps you and your employees tremendously to quickly walk away from anyone who offers actively-managed funds or advises you to put them in your plan or invest in them personally.

If you're dealing any of the big name 401k companies (or the advisors who recommend them), don’t think for a second they have more of an incentive to look out for you and your employees than they do for their own profits or business.  Or, in the case of Fidelity, the motivation to look out more for your employees than they do for their own.



Posted by 401K Revolt at 1:51 PM
Tuesday, August 26, 2014

Are 401k Fund Expenses Destroying Your Employees’ Savings?

There’s no shortage of writing (and debating) going on about 401k costs.  They’re too high, they’re on a 401k_fund_expensedownward trend, they’re justifiable because of service offered….we’ve heard it all, and maybe you have too.  If you’ve read any of our blogs on the matter, you know where we stand.  Fund costs ARE ridiculously high, they are not declining to any meaningful degree and nothing justifies them. 

Maybe you aren’t sure where you stand.  Maybe you don’t write any checks (or at least you’re not writing a big check) to anyone.  So you may think, “what’s all the fuss about 401k costs?  We’re good!”

But the costs are there, quite well-hidden, and being absorbed by the very participants you’re aiming to help.  How much are they paying?  That’s a little tricky to decipher, even with the legally-required disclosures you should now receive annually.

But if you examine your participant fee disclosure (not the 30-page plan sponsor monstrosity) you might see "expense ratios" to the tune of 1.33, 1.60, 1.72. Or, you'll see investment expenses expressed as cost per $1,000 invested. What does that cost Joe Participant with a $30,000 account balance today by the time he retires 20 years from now?  What is Joe contributing each month?  How are expenses affecting that amount over time?

The numbers are scary, and with the vast majority of plan expenses tied to assets, the cost compounds in lock step with investment returns and contributions.

We’ve done the math on some actual examples of what fund expenses do to long-term savings.  It’s crucial for plan sponsors (as fiduciaries) to both uncover, and to attack these costs.  Would you ever want your employees to learn that they could have $100,000 MORE in their retirement accounts if only you’d taken the time to address this basic issue?



Posted by 401K Revolt at 7:30 AM
Friday, August 22, 2014

Friday 401k Fix: How NOT To Fail Your 401k Non Discrimination Test

A recent article on stated that “Nearly 60,000 401(k) plans failed their most recent non discrimination tests, according to research by Judy Diamond Associates.”   That’s a lot of plans.  The fail_non_discrimination_testarticle sub-head says that nearly $800 million in contributions was returned to higher compensated employees.  That's a lot of money.  But that's not the main problem.  The real headline should be, 401ks continue to fail two types of employees:   participants and non-participants.   That's pretty much everybody and that is a lot of failing.

401k non discrimination tests are failed because of lack of participation, in its several forms—"percent participating" and "amount/percent deferred" are the main ones.  As Judy Diamond’s managing director observed, these results “may also mean that the plan is not designed to encourage workers to contribute sufficiently.” We would have to agree.

So what's a plan sponsor to do?  From the numbers above, we know the status quo is not working.  In one brief paragraph, what is the status quo?

Employees are offered an array of high-cost, actively-managed mutual funds in which to invest after they have received "education materials" and/or attended an education session delivered by an investment seller.  A third of employees are repelled and don't join.  The rest join but most save inadequately and invest poorly—either too conservatively or too aggressively for their own needs and risk tolerance.  When the market goes down, they switch to more conservative investments and forfeit any opportunity to recover.

This is a reasonable, basic description of most plans.  If we're being honest,it may well describe your plan.  It's also what causes the failure that is documented by the Judy Diamond study (and every other study, by the way).   Add a match, and participation will increase, but the rest of the ineffectiveness of the plan remains. 

The solution is quite simple—but you can't look to the big advisory firm, the big mutual fund or insurance companies to deliver it.  Why?  Because they are the only ones the status quo is NOT failing.  And conversely, the best solution for you and your employees will ultimately be fatal to them. 

What are these simple, effective elements for success?  Most importantly, plan investments are strategic, pre-built portfolios that reflect a range of risk tolerances and time horizons.  They are comprised of low-cost index funds and they are professionally managed and monitored.  This approach succeeds because employees are not confronted and/or scared away by investments or investment jargon.  Education is now focused on savings and plan cost is as low as possible.  All the reasons for failure are eliminated.

A properly designed plan paired with savings education WILL boost your participation—and great participation is the way to stop failing these tests.   But the much bigger accomplishment is that it's the way to stop failing your employees and participants.



Posted by 401K Revolt at 11:30 AM
Tuesday, August 19, 2014

Leveraging Your 401k Match For Love and Money

Plan sponsors can readily look up trends in all 401k-related topics, including matches.  But we think it's better to be guided primarily by your own leadership's objectives and not follow the401k_Match trends or movement of the "herd". 401k plans are broadly failing, so copying what everyone else is doing can't be a good strategy.  Take a look at the survey, yes, but don't be overly influenced by it.

On a topic like 401k matching, this is certainly sound advice, as one's match probably isn't a big factor in the best candidates' decision to work for you.  So why does an employer decide to invest in matching?  What does he expect to gain from it?  Should he do it at all?  We think the best place to start is to articulate the organization's definition of a "successful plan".  Why do you have the plan and what would make it successful in your eyes: Do you want everyone in it?  Saving as much as they can?  Invested in a way that makes sense for them?  Avoiding self-defeating investment behavior?  Maximizing their chances for a secure retirement?  Minimizing all unnecessary cost?  Staying compliant?

Once you have that definition, your "match strategy" should come into focus.  Technically, matching's biggest impact for the employer is compliance—because it increases participation in a variety of ways.  It gets more people in the plan and, it tends to boost how much they save to gain the maximum match.  In turn, higher compensated employees are able to save more in the plan and non-discrimination test challenges are reduced.  It obviously can also beget employee appreciation—but be careful.

Matching is "free money", so everyone should love it, it any form.  But if you get too creative—perhaps make it "profit dependent" or add elaborate vesting, employees will quickly see it simply as "strings attached" and you'll get more resentment than appreciation for your money.  The most effective matching motivation is to help an employee maximize his savings.  That will get appreciation!

Do you need to match to get better-than-average participation?  It helps a lot but it doesn’t need to be overly generous.  IF (and this is a big "if") the employer is truly helping the employee to invest in the plan—then participation can get a big boost from a good match.  Does this mean more investment education?  No, quite the opposite.  Employers who really want to help employees and take their fiduciary care to a new level (and we would argue the desirable level) need to help them learn how to save—and then help them choose the investment that makes most sense for them—not try to teach them how to be investors.  Employees have been saying (screaming really, if data can scream) for decades that they don't want to learn how to be investors.  They've also shown that they are terrible at it, so the continuing effort to do it serves no one.  Participation levels remain unchanged at 60-65% because of fear, confusion and useless investment education.

Finally, plan costs need to be torn apart, reduced dramatically and then communicated.   Consumer advocates often point out that 401k's can (and usually do) have higher fees than IRA's.  On top of that, the individual has more flexibility in an IRA than he does on a 401k.  So without a match, why participate in an employer plan?  Because if I've been assured that the costs are low, I'm getting help from a source that I trust and it's easy (via payroll deduction)—that’s better than any IRA.

Now all the employer has to do is make sure all that's true!  If he truly does, he can probably spend less on his match if he wants to.  Employees will join, succeed and be appreciative of a plan like this—and they won't need to be bribed to do it.


401k Participation

Posted by 401K Revolt at 11:53 AM
Wednesday, August 13, 2014

High 401k Costs: Beating A Dead Horse?

We blog frequently about high 401k costs—and with all the other problems (and ready solutions) in these failing plans, I High_Cost_Blogsometimes worry that we talk about cost too much!  But then I'm reminded of yet another way that actively-managed funds over-charge and conceal what they are charging, or I analyze another plan, and my outrage (and sanity) returns.  If you think we overdo our rant on cost, please, please, take a closer look!   You and your participants are getting fleeced and there is no redeeming value for your overpayment.

When we do a cost analysis of plans and calculate what can be saved, we try to keep it simple and not overstate.  The easiest way to calculate the cost of a plan is to take the "total expense ratio" on each fund in the plan and then "weight" that cost based on how much money is in each fund.  Add to that any other costs that are billed to the plan sponsor or participants and you have a reasonable estimate of what the plan costs.  I can promise you this—this "reasonable" estimate is far more than you should be willing to pay.

But this calculation leaves out a very significant cost component.  The disclosed expense ratio does not include trading costs—the costs for buying and selling shares within an actively-managed fund. The more active a manager is in trading the underlying portfolio, the higher these costs will be.

I guess that plan sponsors with actively-managed funds in their plan would view some extra cost here as reasonable:  after all, you would be seething if your manager just sat on his butt all year!  But the irony is that for all that extra managing, studies prove that there is no correlating improvement in return.  In fact, the more managing and trading, the worse the return.

How much additional cost does trading expense add?   Generally between .09 and 1 percent.  On the high end, that nearly doubles the cost of the average actively-managed fund.  And keep in mind, active funds hardly ever beat their index!  All this trading and cost–and literally nothing to show for it.

Not moved by an extra 1% of cost?  Here's how it impacts savings:

A $7,200 investment growing by 7% each year will reach $14,163 after 10 years, before charges. A fund levying an annual charge of 1.55% would be worth $12,240 after 10 years, but a fund with an annual charge of 2.25% would be worth be $788 less, at $11,452, according to Lipper, the fund analysts.  Over 30 years, a 1% expense load depletes appreciation by roughly 28%.

Critics like to say that simplistic comparisons between the charges levied by actively-managed funds and index-tracking or passive funds miss the point.  That the two investment approaches incur different levels of cost, so the question is not whether stock-picking funds should be more expensive than index funds (they obviously are) but whether their higher charges are transparent and a fair reflection of the extra resources and effort involved.  This is nonsense.

The costs are not only non-transparent, they are hardly discoverable.  And what would "a fair reflection of the extra resources and effort" be? The simple reality is that actively-managed funds cost much more than index funds 100% of the time and they lose to their index more than 80% of the time.  That is a fair reflection.  Why would anyone knowingly pay that cost?  Why would any advisor instruct them to do so? 

What's your definition of a successful plan?  Great participation?  Low cost?  Helping employees maximize their retirement savings?  Preventing harmful participant decision-making?  Compliance?  Fiduciary excellence?  

The questions we pose in this blog are designed to get you thinking about where your plan is today, and where it might fall short of your own definition of success.  



Posted by Eric Kiesshauer at 10:38 AM
Thursday, August 07, 2014

Your 401k Service Providers Don’t Want You To Read This!

Most 401k plans suffer from high cost, poor participation, inadequate savings, missed match, over-investing401k_Secrets in stable value and participants running when the market goes down.  Certainly no one's definition of success includes these shortcomings! 

The vast majority of service providers in the 401k arena are driven to get “assets under management”.  Every fund family and every non-fee-only advisor gets paid from assets – yours and your participants’ assets.  The more assets they capture, the more money they make—regardless of how the investments in your plan perform.  There is nothing about this that works in your interest!

Think about it: the core competence of an actively-managed mutual fund is supposed to be the achievement of marginally superior returns over a particular benchmark or index.  Well, there are decades of investment history to evaluate, so it’s very easy to see how they’ve done, and the answer is: Not well at all.  In fact, index funds of comparable investments do better 80% of the time at about 1/5 the cost!   Index funds (like Vanguard) refuse to pay advisors the incentives, bonuses and other “revenue sharing” that actively managed funds do.  And who does that benefit? The only folks that matter – you and your participants. 

Are we saying index funds are the answer to all your 401k woes?  No.  They are still just investments.  But they provide the most reliable returns at a very low cost, so they are a critical part of the solution.  Why should a plan sponsor spend even 2x (let alone 5-10x) higher fees on actively-managed funds in the hope of so unlikely an outcome?  You shouldn’t. 

What's your definition of a successful plan?  Great participation?  Low cost?  Helping employees maximize their retirement savings?  Preventing harmful participant decision-making?  Compliance?  Fiduciary excellence?  

The questions we pose in this blog are designed to get you thinking about where your plan is today, and where it might fall short of your own definition of success

Click the button below to see the solution to the investment problems in your plan!


Posted by 401K Revolt at 10:58 AM
Tuesday, August 05, 2014

401k Fiduciary Responsibility, The Titanic and SEC Football

We often talk about the how "broken" the 401k industry is.  High cost, actively-managed funds, poor 401k_Fiduciaryparticipation, ineffective employee education, self-defeating employee decision-making—you name the category, 401k plans are failing everyone but the guys who sell them.

The most important responsibility the plan sponsor has is in his role as a fiduciary. It's the 401k fiduciary's responsibility to safeguard participants' assets.  Drop the ball on this responsibility and it could mean a DOL audit failure or an expensive lawsuit.  Plan sponsor awareness has become more acute as the audits and lawsuits have begun piling up.  So, predictably, the "plan sellers" tout their "fiduciary services"—sometimes even calling them warranties—to differentiate themselves in the sales process.  The bottom line is that these warranties are no such thing and sponsors should never rely on them.  Heck, Morgan Stanley just prevailed in a whistleblower suit by convincing a naive judge that they really had NO effective fiduciary responsibility.

So conventional wisdom says you should use the services of an independent fiduciary—and we reluctantly agree.  Why reluctantly?  Only because if you are truly watching out for your participants' money, you shouldn't really need the protection. But judging by the failure of today's 401ks, it appears that most plan sponsors are more focused on protecting themselves in court than they are on protecting their participants’ money. Obsessing about shifting fiduciary responsibility is like rearranging the deck chairs on the Titanic—the ship is still sinking. 

What constitutes a successful plan?   Everyone (not 65%) is in a low-cost plan, maximizing their savings, invested in a way that reflects their risk tolerance, staying put when the market goes down and maximizing their returns over the long haul. And yes, any successful plan must also be compliant. But there are no SEC (or any Division I) football teams devoting most of their energy to NCAA rules and losing every game. Because winning is the clear goal.  Compliance keeps you from vacating victories already won - a key element in success, but it doesn't make you successful.

If you have one of the handful of successful 401k's, it's not likely you'll ever have to defend your plan, let alone yourself.  Who would the plaintiff be?   Your participants would love you.  Fidelity, John Hancock or Merrill Lynch wouldn't like you (because you wouldn't be working with them) but they can't sue you for that, so who cares?  If you have one of the many failing plans (like most of those with the afore-mentioned firms) it would be wise to make sure you have an outside, independent, co-fiduciary as a partner.  It's far more likely you'll need it.

One final point to consider.  A failing plan that's in compliance is still a failing plan.  Are you doing your utmost for participants or not?  An outside, competent fiduciary could help you defend yourself but he can't make your plan successful.   As long as it's accepted fiduciary practice to say that bench-marking to a universe of failing plans is rational or having high-cost, actively managed funds is OK just because they outperform their index occasionally, participants (including you) will never receive the kind of fiduciary protection they deserve.  But at least the deck chairs will all be neatly aligned as the ship goes down.

What's your definition of a successful plan?  Great participation?  Low cost?  Helping employees maximize their retirement savings?  Preventing harmful participant decision-making?  Compliance?  Fiduciary excellence?  

The questions we pose in this blog are designed to get you thinking about where your plan is today, and where it might fall short of your own definition of success.

Click the button below to read our case study-see what fiduciary excellence can achieve!


Posted by Eric Kiesshauer at 10:00 AM