I know it sounds radical, but I believe it's time to abolish 401(k) plans. Why? Because they are not working for those they are intended to benefit: employees saving for retirement.
They are working great for brokers, advisors, recordkeepers and others who "serve" these plans. By some estimates, over their lifetime, the average household will pay a shocking $155,000 in fees to have their money "managed" in these plans.
According to the Employee Benefit Research Institute, at the end of 2011, approximately $4.5 trillion was invested in 401(k) plans. That's enough money to bring out the best sharks Wall Street can muster.
What are employees receiving for these huge fees? Lousy investment choices. Little or no investment advice and terrible returns.
At year-end 2010, the average account balance for participants in 401(k) plans was $60,329. 39.2 percent of the participants had account balances of less than $10,000 and only 17.1 percent had account balances of more than $100,000. Even when you account for age and tenure, the results are depressing. You would expect that participants in their 60s with long tenure would have saved enough to retire. Not so. The average account balance for employees in their 60s with more than 30 years of tenure was only $202,329, based on the same report from the Employee Benefit Research Institute.
Clearly, if you accept the premise that 401(k) plans were supposed to serve as an important savings vehicle for retirement, they are failing.
There are many reasons for this failure. The primary ones are high fees and lack of investment education. Actively managed stock funds (where the fund manager attempts to beat a designated benchmark, like the S&P 500 index) dominate the investment options in most plans. The average expense ratio of these funds in 2011 was 0.93 percent. The average expense ratio of index funds during the same year was 0.14 percent. According to numerous studies, the majority of actively managed funds fail to beat their designated index each year. It gets worse. Studies show that those who have outperformed in the past are more likely to underperform in the future.
401(k) plans are also burdened by many additional fees. You can find a summary of them here.
Not only are investors given poor investment options, they are overwhelmed with them. One study noted the increase in the number of investment options in 401(k) plans. As a consequence, index funds represent a smaller fraction of total fund options. The authors of the study concluded that returns were likely to suffer.
It's time to recognize the harsh reality that 401(k) plans are primarily a giant skimming operation for vendors to these plans. Confronted with indefensibly high fees and poor and confusing choices, participants are thrown under the bus and expected to fend for themselves. No one is asked to remove their own appendix. Is it any more realistic to assume participants will be able to put together a risk-adjusted, globally diversified portfolio, in an asset allocation suitable for them?
Let's admit our failure and abolish these plans. I will discuss better alternatives in future blogs.
Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book is The Smartest Money Book You'll Ever Read. The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.