My last post asked the question “Are Corporate Retirement Plans a Bad Deal?” My response, as in most of my posts, is not simply yes or no. I prefer to break down the question such that plan sponsors and business owners can better reach their own conclusions. In my experience, the costs associated with corporate retirement plans seem to be a “don’t ask, don’t tell” type of issue. Unlike most, I always ask and gladly tell all.
Pretend you are walking over to your human resource department because you’d like to enroll in the company 401k (or 403b) plan. As far as you know, you’ll get some forms to fill out, and shortly after your salary will be reduced by the amount of money you elect to put into your retirement plan each pay cycle. Retirement plans are convenient in that all the record-keeping and administration is generally done for you (yes, you do pay for that, even if you don’t realize). You might ask your friend which funds to choose because you don’t know exactly what the differences are between them. You probably understand at some basic level that lots of people are getting paid to make the plan available to you, but will you really ponder this issue? Will you carefully consider how your retirement plan performance might be inhibited by high fees and expenses? Probably not. But maybe you should.
What are the various expenses found within retirement plans?
In Hutcheson’s paper, he analyzes the fees and costs in a hypothetical growth portfolio of a ‘low cost” retirement plan. He notices that trading costs, on average, can actually approach or equal a fund management fee, which is often 1% or higher. In essence, if fund managers openly disclosed what they were paying for clearing and transaction charges, it would probably make the expense ratio a lot higher. Note: It obviously costs money to buy and sell securities. The underlying problem is not that this expense exists, rather how it could be minimized considering it falls on the shoulders of the unaware plan participants, not the financial professionals who make money without assuming costs or investment risk.
Management fees, which are among the expenses which many plan participants actually understand, are paid out from the fund’s total assets. They are paid to the fund’s advisory group for their portfolio management services. They also cover other management fees which may exist along with payments to affiliates. There may also be administrative fees paid from the overall management fees which are not included in the “miscellaneous expenses” area.
Miscellaneous expenses may include custodial expenses, legal fees, accounting fees, transfer agent fees, and other administrative jargon. Hutcheson estimates that these fees (outside of fund management fees) could also run about 1%, with the largest portion paying for investment advisor and participant education fees.
So, we’ve mentioned trading costs, management fees, and miscellaneous expenses, which equal approximately 3% in the above, “low-cost” example. I won’t go into too much mathematical detail here, but you can imagine what the long-term effect of getting a 5% return on an investment is vs. getting an 8% return. It’s a lot of money, especially when we’re talking about a 20-year or 30-year time frame.
I’d like to return to the paragraph about trading costs and transaction fees for a moment. Hutcheson emphasizes the impact that these (often undisclosed) costs can have on plan performance. He discusses other “revenue-sharing” relationships as well which can ultimately benefit most of the people on the administrative end, but rarely the plan participants.
The reason these fees aren’t disclosed to plan sponsors is most likely not with bad intention. On the surface, it’s not an issue for the organization which is making the plan available to its participants. It’s an operational issue between the fund manager and the brokerage firms which they maintain relationships with. While this may be “beneath the surface” in the sense that they are operational costs, they ultimately trickle down to the participant and can affect overall return. It is important that these brokerage relationships are disclosed so that decisions are made which are in the best interests of the participants.
My conclusion:
The ideal solution in terms of transparency for everyone involved would be a fee-based retirement plan model. All compensation to the plan advisers is disclosed and above the surface of the plan–not hidden in the expense ratios. This concept could probably become more widely adapted by plan sponsors, although plenty of plan sponsors don’t have a problem with these conveniently packaged costs which get shared by the plan participants. Whether or not we wish to “rock the boat,” and change the currently dominating industry compensation models is perhaps a larger issue.
What is crystal clear is that disclosure is more important than ever. Each company which administers a retirement plan for their employees should have access to all the costs, fees, and expenses of the plan written out in simple English. While participants continue to bear all the risk within the plan, shouldn’t they understand what they are paying as well?
Questions? Comments? E-mail me.
Russell Bailyn
Premier Financial Advisors
14 E. 60th Street, #402
New York, NY 10022
(212)752-4343 *31
rbailyn@premieradvisors.net
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: NASD & SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.