“Target-date funds are an expensive tool. It’s like taking a taxi to Vegas.”
– John Graves, financial author, in the Huffington Post.
Part 2: Are You Paying for Retirement Fund Conflicts of Interest?
In part one of “Target-Date Investing: Ten Investment Mistakes Wall Street Hopes You Make,” we uncovered investing mistakes such as giving up control of your money, substituting target-date funds for financial advice, and being advised by unqualified (if well-meaning) people who are not trained or certified to give financial advice.
What other investing mistakes does Wall Street hope you’re making?
Mistake #4: Trust your investments to advisors and managers with conflicts of interest.If an investor goes beyond their plan administrator or HR staff and talks with someone representing a brokerage firm about the funds found in their 401(k) options, they are now speaking with a salesperson who is not an objective advisor. And while they may be well-informed about the funds they are selling, they will not be informed about investments they don’t sell, nor will they be fiduciaries who must act in the best interest of those they advise.
The Investigative Fund put it this way:
“While many Americans rely on 401k plans for their retirement, few are aware that their financial advisors are often working based on commission, and have no legal obligation to have their best interests in mind. The vast majority of 401k advisors, around 85 percent, are not actually fiduciaries. Critics say brokers often steer small investors into funds that may not be suitable, or are burdened by an array of high fees.”
Once your money is invested in a target-date fund, things can go from bad to worse as far as conflicts of interests. Even after substantial losses in 2008, many target-date fund managers have continued to manage for growth (and risk) right up to and even many years beyond the target retirement date, in spite of marketing-speak that assures investors of a “conservative” approach with an emphasis on “stability” or “preservation” as retirement nears.
Additionally, TDF’s tend to contain a majority of proprietary mutual funds. In other words, they are designed, in part, to sell the other mutual funds managed by the company. Also by design, recommendations and decisions are often made from a sales standpoint rather than an advice platform.
To muddy the waters further, revenue sharing between mutual fund companies and 401(k) plan providers creates further conflicts of interest. Financial author Dan Solin stated in a Huffington Post article,”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 advisors should be required to select funds based on merit alone, and not on the size of the kickback.”
Investors beware! While more pressure is being put on plan administrators to behave as fiduciaries when selecting funds, the reality is that no one in the 401(k) food chain tasked with managing funds or discussing investments with plan participants can do so completely free from conflicts of interest.
Mistake #5: Pay substantial fees for the poor advice, sales pitches, conflicts of interest and mismanagement.
In a Forbes.com article, John Wasik laments, “Whenever I asked the question “how much are 401k savers being overcharged” over the years, I haven’t been able to get a decent answer. The government doesn’t really track it and the middleman and your employer don’t want you to know.”
Ever wonder why your 401(k) doesn’t offer those inexpensive index funds? Revenue sharing, that’s why. Someone else would make less money from your investments. In many cases, mutual fund companies offer incentives to 401(k) plan providers to include certain funds on their roster of options. 401(k) plan packagers influence which investment choices get included and steers plan investors toward mutual funds – usually more expensive ones – that route a portion of their fees back to the packager.
Your 401(k) plan provider may have their hands in your pocket through administrative fees, too. The fee is typically .35%, and it will be described in vague language such as “basis points.” And yes, some of that goes to pay for legitimate costs of record-keeping (about 1/3 of it). It may sound insignificant, but that fee alone can cost the typical investor tens of thousands of dollars over time.
According to a recent analysis by research and public policy center Demos, a median-income, two-earner household will pay nearly $155,000 over the course of their lifetime in 401(k) fees! High-income households easily average over $200k in fees. Demos’ report, “The Retirement Savings Drain: The Hidden and Excessive Costs of 401(k)s,” details how the nation’s shift in retirement policy toward individual retirement accounts has made savers vulnerable to losing almost one-third of their investment returns to a complex, inefficient market.
Illustration from “The Retirement Savings Drain” report.
While all 401(k)s are vulnerable to overblown fees, an issue specific to target-date funds is the layering on of essentially hidden fees. TDF’s are mutual funds that contain other mutual funds within them, and investors often absorb fees for both the main target-date fund plus the funds it contains. An online article, “3 Reasons Not to Use Target Date Mutual Funds in a 401(k),” explains:
For example, if you were to buy a 2050 target date mutual fund, it could contain 10 other mutual funds, with five stock and five bond funds. The target date mutual fund charges an expense fee of .75%. While .75% is inexpensive for an actively managed fund, you have to consider that the 10 funds held within your target date funds also charge fees. Thus, a target date fund comprised of funds with a weighted average fee of 1.25% and its own expense of .75% per year would cost a whopping 2% per year from top to bottom!
(As of 2007, the SEC began requiring that these fees be disclosed in a line called “Acquired Fund Fees and Expenses” (AFFE), so read the fine print!)
If fees that strip six-figures from retirement funds sound horrific, consider this: due to the “one-size-fits-all” philosophy of target-date funds, those fees don’t pay for objective financial advice or the management of individual portfolios. Rather, thousands of investors are pooled together according to target-dates, enabling companies collect enormous fees to manage a single fund. As policy analyst Robert Hiltonsmith told Frontline in “The Retirement Gamble” investigation, “We are being charged a lot by these financial firms to not do a lot.”
Between expense fees, layers of hidden fees within some target-date funds, 401(k) administrative fees and potential sales load and/or redemption fees, substantial money is being skimmed every year from investor portfolios. The flow-chart below illustrates how the complex retirement system generates additional costs, most of which are passed onto savers. And according to the Demos report, sixty-five percent of retirement savers have no idea they are paying “off-the-top” administrative, investment management, and trading fees.
Chart from Demos.org. (For an enlarged view, click on flow chart of system from “The Retirement Drain” report here. )
The truth is hard to swallow:Wall Street money managers and inefficient 401(k) plans have been far more successful skimming profits FROM American investors than making profits FOR American investors.
And we haven’t even started calculating how high the fees get when investors LEAVE their retirement invested in mutual funds over a lifetime!
Stay tuned for the next episode of… “Target-Date Investing: Ten Investment Mistakes Wall Street Hopes You Make!”
Is There a Better Way? Yes! Prosperity Economics offers a true alternative to “typical” financial planning that tells you to max out your 401(k), sink your savings into mutual funds, cross your fingers and hope. We invite you to learn more about the strategies and principles of Prosperity Economics through Kim D. H. Butler’s latest book, Busting the Retirement Lies.