A $17 Billion Annual Wealth Transfer

A $17 Billion Annual Wealth Transfer
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Pigs feeding at the trough have nothing on 401(k) plan administrators who permit high cost funds to populate 401(k) plans, when comparable lower cost funds, with the same or higher expected returns, are readily available.

The study

A recent study by RiXtrema analyzed 52,529 retirement plans. The purpose of the study was to determine whether participants in retirement plans with aggregate assets, as of March, 2015, of $6.8 trillion, were overpaying by purchasing expensive, actively managed funds.

The study determined whether a fund in a plan could be replaced with at least one alternative fund that was less expensive. In order to qualify as an alternative, the less expensive fund couldn’t significantly change the risk/return profile of the plan menu.

The study then calculated the annual savings from switching to these comparable, readily available, less expensive funds that had both “high similarity” to the fund already in the plan, and a track record of outperforming it over a ten-year period.

The findings

By including lower cost funds, plans of all sizes significantly reduced their expenses. For example, the smallest plans, with assets under $1 million, reduced expenses from 0.82% to 0.42%. At the other end of the spectrum, the largest plans, with assets over $100 million, reduced expenses from 0.49% to 0.26%.

The ramifications of this cost reduction are staggering. Here’s the stunning conclusion: “...the overall savings available to defined contribution plans are $17.07 billion per year only on the investment expense of the funds.”

This number — as huge as it is — is actually understated. If you include the aggregate outperformance of the lower fee funds, the “actual benefit could be twice as large.”

Another filter

Perhaps the most fascinating (and disturbing) finding of the study was a further analysis that excluded all index funds and exchange traded funds as possible alternatives. This filter was applied in anticipation of the argument that such a large flow of capital into these funds might create market instability.

Excluding these funds had almost no (or very minimal) effect on the savings available to plan participants. There were still many lower cost funds that could be substituted for more expensive ones.

How difficult, in this computer age, would it be for plan sponsors to insure the fund options in the plan were the lowest cost, comparable funds available, with a significant track record of outperformance?

High priced consultants to retirement plans, who currently spend their time hiring and firing mutual fund managers, could be replaced by the same technology that generated this study. The cost savings from not paying their fees — standing alone — would be considerable.

The conclusion

Here’s the key finding in this important study: “...most defined contribution plans in the US are very inefficient and retirees would be much better served by adoption of fiduciary best practices in the design of the plan menu. The savings available from applying quantitative approaches to fiduciary best practices could be $17 billion annually as a conservative estimate.”

That’s $17 billion (or more) in your pocket instead of transferring this massive wealth every year to the securities industry.

The views of the author are his alone. He is not affiliated with any broker, fund manager or advisory firm.

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