Avoiding hidden 401k fees
TEXT OF INTERVIEW
Tess Vigeland: If you have a 401k retirement plan, you’ve probably spent the last few weeks watching your returns head south for the winter.
But did you know that even in good times, you’re still losing? That’s because the average 401k plan costs its participants 3 to 3.5 percent in fees and other hidden charges.
Next week is the final week for the public to comment on new fee disclosure rules proposed by the Department of Labor. For a closer look we’re joined by pension consultant Matthew Hutcheson:
Tess Vigeland: Thanks for coming on the show today.
Matthew Hutcheson: Thank you. It’s wonderful to be here.
Vigeland: Is it possible to estimate just how much we’re all losing because of these hidden fees?
Hutcheson: Over a 20-25 year period, if you are being charged a total of 1 percent in your retirement account, the ultimate benefits that you will receive when you retire — let’s say age 65 — will be reduced by approximately 20 percent.
Vigeland: So we’re talking thousands of dollars?
Hutcheson: Over a regular working lifetime, we’re talking about $80,000, and to make that shortfall up, a person would have to work three or four additional years just to break even, based on an excess 1 percent fee.
Vigeland: How high do some of these costs go? Are we talking 3 percent? 5 percent?
Hutcheson: The average plan, which is really 90 percent or more of all of the 401k plans in the United States, is paying approximately 3-3.5 percent. However, there are some plans, especially those that are associated with insurance companies, that have additional layers of fees added on; I’ve seen as high as 5 percent.
Vigeland: Is it possible to figure out how much money you are losing in fees?
Hutcheson: It is possible. There is a rigorous way, a scientific way that’s based on some rigorous mathematical application, where you can determine what you’re paying over a long period of time, but a normal participant wouldn’t know where to look.
Vigeland: There are some mutual fund companies that have publicly argued “look, if we give people who are investing — employees — more information about fees, they’re going to get so confused that they stop investing.” What do you say to that?
Hutcheson: It seems odd to me that they would require a participant to take on the most difficult aspect of investing, which is selecting the investments themselves and constructing a proper portfolio. That is far more complicated then just having fees presented to them. When the FDA required food companies to disclose nutritional information on the back of food packages, soup cans, bags of potato chips, whatever, did you stop eating? Did you become overwhelmed and stop eating? Look, participants are going to invest; it’s just that we need to give them the right information so that they can construct a portfolio that is not fast food, but is a healthy well-balanced meal.
Vigeland: What is necessary and what’s not in terms of mutual funds charging for their services. They do have to make money somehow — obviously it’s a business. How do you know what’s a good, justified fee and what’s a ridiculous one?
Hutcheson: That is a very good question and there’s some relativity to that. The relativity comes in the presumption that a mutual fund company can, over time, outperform ordinary market returns.
Vigeland: In other words, the whole reason we hire these companies is because we assume these professionals will get us a better than market return?
Hutcheson: That is correct, and, what we know is that a simple portfolio of 60 percent equities — that would be stocks — and 40 percent bonds outperforms 90 percent of the best and brightest portfolio managers in the country over the long term. So any dollars spent trying to chase returns when you do not have a guarantee that they will actually yield the results you are seeking are excessive. Now, some people may say, “well, those fees are reasonable because the fund manager is actually doing the work to try to get the better returns.” I understand that. Are those expenses justified when we know that they’re probably not going to be able to outperform the market over the long haul?
Vigeland: If I’m contributing to a 401k, a 403b plan, is it possible to say potentially how many people have their fingers in my money?
Hutcheson: Yeah, I estimate it’s 14 or 15 potential individuals or companies who could be payed from your account for a variety of services. You’ve got the fund company, you have, potentially, an independent investment adviser who is directing that company, you have salespeople who could be selling for a commission, record keepers, fund custodians, you have accountants, actuaries, lawyers, outside consultants and the list goes on, and most of those things I mentioned are not stated in the prospectus.
Vigeland: Is it possible that any one 401k participant — an employee — could be paying an expense ratio, revenue sharing commissions, 12b-1, Sub-transfer agent, contract fees, early redemption fees, brokerage commissions, custodial fees, wrap fees, investment advisor fees and soft dollar revenue?
Hutcheson: Absolutely, I have seen that and I have seen accounts that pay well over 4 percent when you add all those up.
Vigeland: Why aren’t more people angry about this and what’s the most important thing that can be done to fix this?
Hutcheson: Good question. Most people aren’t angry because they don’t really understand what’s happening. They presume that in our society today, everything’s disclosed — why wouldn’t it be? What to do about it is, regulators and legislators need to understand that we can’t have our society paying for services they don’t use and we need to make sure that where the risk is, full disclosure exists also. So, if we have a system that is placing the investment decisions on the shoulders of novices (i.e.: participants: regular workers), then we need to honor them by providing them all of the relevant information, even if they don’t understand it at first — they’re smart, they’ll have the capability to learn and understand over time — but we can’t withhold it from them under the guise that it will overwhelm them. Don’t dishonor us by withholding important elements that are going to reduce our ability to have a dignified retirement in the future. That’s not OK and that’s what’s got to stop right now.
Vigeland: Matthew Hutcheson is an independent fiduciary located in Portland, Oregon. That’s so much for coming on the show today.
Hutcheson: Thank you Tess.
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