Was your mother wrong about retirement?

For decades now, almost everyone from the federal government to the proverbial guy at the water cooler has been an advocate for investing in a qualified retirement plan. Even our elderly mother, enjoying a comfortable income generated by her 401(k), has become something of an evangelist. So it’s rather shocking to read an article warning that you might want to ignore your company plan entirely and invest the money after taxes instead.

This isn’t a satirical ‘modest proposal.’ And it’s not a rant from the wingnut sector of the internet. The piece in question is a Forbes article. It cites recent research showing that as many as one in seven plan investors would be better off paying the taxes on their retirement money and putting it in very low-cost index funds. In a study of more than 3,000 plans, the authors found that the costs imposed by high fund management fees actually outweighed the tax benefit of qualified plans in 16% of cases.

Controversial research

The research was conducted by Ian Ayers and Quinn Curtis, controversial academics who are on something of a crusade against excessive fees in retirement plans. In their view the greatest threats to successful plan investing also include the imprudent behavior of investors themselves and limitations on fund choices. But the worst culprit is fees, particularly those of some target-date funds. The problem is aggravated by default investment choices, fund-switch mapping, and other circumstances that steer large amounts of plan assets into proprietary, high-cost offerings they call “dominated funds.”

As a whole, these factors wipe out an average of more than 150 basis points. As Ayers writes, the fee problem is “so bad that plans offering company stock often ameliorate participant losses,” contrary to another piece of near-universal 401(k) wisdom. So bad, indeed, that the authors have accused plan sponsors of widespread fiduciary breach.

To “reform” 401(k), Ayers proposes solutions that are even more farfetched, such as the DOL using algorithms to identify particularly high-cost plans and publicly labeling them as such. He even recommends a “sophistication test,” similar to tests for a driver’s license, that participants would have to pass before being allowed to make their own investment decisions.

A simpler solution

We have a much simpler solution: independent advice. The grain of truth in all this is that many plan participants do lack the skills or inclination to make prudent investment decisions on their own, much less to analyze whether plan providers are serving them well. But adding new layers of regulation and complexity to the system is not an answer that anyone will welcome – not participants, sponsors, providers, or even the DOL.

Independent, fee-based advice, however, benefits nearly everyone. Investors get what they overwhelmingly want: comprehensive, practical help from unbiased experts. Sponsors and regulators gain reassurance the participants’ interests are paramount and fiduciary obligations are met. And fixing problems within the system helps plan providers in the long run by forestalling more radical alternatives. Minimizing investment costs may deprive them of some revenue, sure, but that’s how a free market works. Nobody in the business of financial markets can seriously argue against a little price competition.

Thanks, Mom

It’s always been a bit counterintuitive that companies charged with offering a balanced range of investment options often stand to make a lot more money from some choices than from others. Mom would call that the fox guarding the henhouse, and she’d have a point. So even if Ayers and Curtis are extreme in their conclusions, and perhaps a bit dodgy in their methodology, it’s a good thing that they’re drawing attention to very real issues.

It's also good to know that your mother was right all along, as usual. 401(k) is still the best place for your retirement savings. But like much parental wisdom, following her advice is just a bit more complicated than it may seem.