3.5 Billion Reasons Why Your 401(k) Plan Is a Loser

A recent article discussed the estimated $3.5 billion paid by mutual funds to advisers to 401(k) plans. These payments are euphemistically called "revenue-sharing." In reality, they are legal bribes.
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A recent Barron's article discussed the estimated $3.5 billion paid by mutual funds to brokers, insurance companies and other advisers to 401(k) plans. These payments are euphemistically called "revenue-sharing." In reality, they are legal bribes paid to plan advisers, who extract them as the cost of letting these funds gain admission to the investment options in the 401(k) plan.

PIMCO's Total Return Fund pays $145 million a year. The Growth Fund of America pays $75 million and the Dodge and Cox Fund pays about $20 million a year.

The securities industry considers these payments a "win-win," claiming they reduce overall plan expenses. I believe they are a "win-win," but not for plan participants. The mutual funds win because they are paying a small price to gain access to a huge pool of assets. More assets mean more fees for them. The advisers win because they pocket a big hunk of change for doing nothing -- unless you consider selling out plan participants doing something.

For hapless plan participants, this system is a disgrace, which should be illegal. It would be if our dysfunctional Congress really had the best interest of its constituents in mind. I guess it depends on how you define "constituents." Their real interest is in pleasing the securities industry which adds to their reelection coffers. No other reason could justify sanctioning this practice.

On merit alone, no actively managed fund should make the investment cut for any 401(k) plan. The majority of them underperform their benchmark index. Over the long term (which is the right way to measure performance since 401(k) investments are primarily for longer time periods), less than 5% of actively managed funds will equal their benchmark index. There is no way to predict which ones will be the next "winners."

The data is overwhelming that plan participants would be far better off with a small number of pre-allocated, globally diversified portfolios of stock and bond index funds at different risk levels. The primary reason most plans are populated with actively managed funds (and under populated with index funds) is that actively managed funds pay-off and index funds don't.

Because of this shady practice, advisers who accept these payments refuse to give investment advice to plan participants. They are worried about liability caused by their clear conflict of interest. I can understand their concern.

Since Congress is impotent, and most employers don't understand there is a better option, plan participants need to engage in self-help. Tell your plan administrator to dump your present plan. Replace it with an adviser who agrees in writing to be a "3(38) ERISA fiduciary." It's illegal for these advisers to accept "revenue sharing" payments or to have any conflicts of interest with the participants in the plans they advise. All plan participants deserve to receive completely unbiased investment advice and to have investment options that can be defended based on historical data (and not influenced by the size of the pay-off).

Your retirement with dignity -- and perhaps your being able to retire at all -- may depend on your taking charge of your 401(k) plan and wresting control of it from those feeding at the trough.

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