In an informative article, Eleanor Laise at the Wall Street Journal laments the limited progress the U.S. Department of Labor has made with its new rules for 401(k) fee disclosure.
Ms. Laise bemoaned the lack of transparency concerning 12b-1 fees, which she correctly described as "the murkiest of mutual-fund expenses."
Unfortunately, the thrust of her article misses the forest for the trees. Why focus on disclosing how bad the system is, rather than fixing it?
Full disclosure of 401(k) fees, while a step in the right direction, will do little to remedy a system that practically insures most Americans will retire, if at all, with a sharply diminished quality of life. Here's what real reform would entail:
1. Require all advisers to 401(k) plans to be "real" fiduciaries. Technically, this would mean their agreement to serve as as "ERISA 3(38) fiduciaries". They could have no conflicts of interest and would be required to act in the best interest of the beneficiaries of the plan. The advisers would confirm their fiduciary status in a written agreement and would agree to accept 100% of the liability for the selection and monitoring of investment options in the plan.
2. Abolish revenue sharing: The practice of accepting kickbacks from fund families as the price of admission to a 401(k) plan's investment options destroys both the appearance and the reality of objective investment advice. Plan advisers should be required to select funds based on merit alone, and not on the size of the kickback.
3. Require all plans to have at least five pre-allocated, globally diversified portfolios of low cost stock and bond index funds, passively managed funds or Exchange Traded Funds in the plan. The portfolios would be of varying risk levels, ranging from conservative to aggressive. What sense does it make to provide plan participants with a dizzying array of investment options? Most employees have no idea how to put together a risk adjusted portfolio suitable for them.
The only reason most of the funds in a typical plan are high expense ratio, underperforming, actively managed funds is because those funds generate the maximum revenues for the fund families and the advisers. Returns of plan participants could be increased by as much as 200% if low cost, indexed based portfolios were substituted for these funds. That's the way the massive $240 billion 401(k) plan for government employees is structured. It's difficult for most Americans to understand why their congressional representative have a better plan than theirs. Those employees who persist in the discredited belief they can "beat the markets" could have the option of a directed brokerage account where they could freely gamble with their retirement funds.
4. Require advisers to plans to provide real investment advice to plan participants. Currently, most advisers "educate" but will not provide "investment advice" to plan participants. Why? Because they are concerned about liability -- as they should be under the present system. An adviser who is providing the options I am recommending has nothing to fear. His advice is based on reams of academic data. Advisers collect a hefty fee for their services. If they won't stand behind their advice, what value are they to the plan participants?
Of course, fees should be transparent and unbundled. They should also be low. Low fees correlate directly with higher returns. But the fee tail should not wag the 401(k) dog.
The entire system is broken and needs to be fixed. Taking baby steps is not the answer.
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.
Here is the trailer for my new book, Timeless Investment Advice.