“To live is to choose,” writes Kofi Annan adding that “to choose well, you must know who you are and what you stand for, where you want to go and why you want to get there”. No, Mr. Annan wasn’t trying to offer suggestions on how to run a 401(k) plan for his employees or even what to do when faced with a plan that suggests you can be somewhere it has no intentions of taking you to in retirement. Yet we repeat this thought when we approach our retirement options: choice is good, regardless.
We all understand the importance of preparing for retirement and using the tools at our disposal in our 401(k) is often placing at our efforts at risk in the markets. What we don’t understand is the cost of that risk.
We are repeatedly faced with information that should make us turn away from this preparation yet it isn’t transparency that forces us to step back, underinvest or otherwise take too little risk. In the run-up to the market downturn of 2008, investors put enormous amounts of cash into something they didn’t fully understand. And in a fashion we have come to expect, yanked enormous amounts of money out of the markets as they saw the value of their portfolios plunge.
Much of this can be attributed to human behavior. We follow crowds and in spite of repeated warnings, continue to do so. We like markets that are climbing and abhor situations where opportunity knocks. And don’t think for a moment you plan sponsor isn’t aware of this.
Even as Congress rangles with finding a way to let you peer into your 401(k), you have to wonder if it will make a difference in the long run. Let’s for moment, examine the industry’s resolve to keep you fooled.
Chances are, even as you lose money, your plan sponsor makes ends meet by charging a steady rate designed to keep them compensated in good times or bad. The expense ratio charged by funds includes a slice for the provider, who collects this fee regardless of your investment success or failure.
Even as transparency begins to evolve, a process that will allow the investor in these plans see where the cost-of-doing-business is actually going, the revenue sharing that comes from the underlying funds in your plan will still continue. Looking at expense ratios will not necessarily give you this information.
And because of this, the first in a series of dupes by the industry is laid at your doorstep. To compare the cost of your investment, you look to the ratios that you would pay had you bought the fund yourself. But 401(k) plans should be offering you steep discounts on quantity. They don’t and because of that, your future reward depends on the size of the investor group, those at the smallest companies often sacrifice a great deal of retirement quality as they pay more for what larger firms offer.
The funds inside a 401(k) plan aren’t different; just the number of participants in the plan. Of course you can expect to pay more for a commodity at a convenience store than you would a a huge box store. But this is an argument that doesn’t make sense considering you can’t shop around for a better price when it comes to your plan’s offerings.
The industry’s reaction to choice: eliminate it to cover costs. According to the Profit Sharing/401(k) Council of America, the average plan which holds about 18 different investment options is likely to shave a couple of those choices from their offerings. Less choice doesn’t mean better choices. Emir Kamenica, assistant professor of economics at the University of Chicago Graduate School of Business believes that every plan should offer a basket of core investments with a handful of additional options for the more savvy among us.
Even if that were the case, we are still choosing the wrong investments in many instances. We look to target date funds as a default for our own lack of interest. We think that these funds are all created equally, will provide for us well into our retirement and the fund managers have a knack we simply do not possess. They aren’t, they won’t and they don’t. In many cases, the failure to periodically check on these funds could lead to some shocking realities as you close in on retirement.
The allure of target date funds we believe is the gradual shift from risk to not-so-risky as we age. But this isn’t diversity. And even if we choose not to use the target date approach, many of the funds in our plans don’t offer enough diversity to qualify as diverse. As some financial professionals observe, a good job doesn’t mean a good plan and a bad plan is not that easy to change. Your employer does have a fiduciary responsibility. But few acknowledge it. In fact, the smaller the company, the more likely they are to focus on the business instead of the 401(K0 they are offering.
The key is to charge less and offer more. And if that fight can be won with legislation, we will all be better off come retirement. But that would require us to know who we are and what we need to get where we want to go. And that may be the biggest hurdle of all.
Related posts: