I have been looking for a way to describe most of the guidance provided by those in the financial services industry. I’ve struggled with the best way to put it.
However, the quotable Warren Buffet provided a great take on how investors waste money on investment advice. In this case, he is referring to “sophisticated” investors. However it applies to everyone. It’s happening as well with those we work with – middle class individuals and smaller organizations.
Here it is:
“Supposedly sophisticated people, generally richer people, hire consultants, and no consultant in the world is going to tell you ‘just buy an S&P index fund and sit for the next 50 years.’ You don’t get to be a consultant that way. And you certainly don’t get an annual fee that way. So the consultant has every motivation in the world to tell you, ‘this year I think we should concentrate more on international stocks,’ or ‘this manager is particularly good on the short side,’ and so they come in and they talk for hours, and you pay them a large fee, and they always suggest something other than just sitting on your rear end and participating in the American business without cost. And then those consultants, after they get their fees, they in turn recommend to you other people who charge fees, which… cumulatively eat up capital like crazy.”
And he had more:
“And the consultants always change their recommendations a little bit from year to year. They can’t change them 100% because then it would look like they didn’t know what they were doing the year before. So they tweak them from year to year and they come in and they have lots of charts and PowerPoint presentations and they recommend people who are in turn going to charge a lot of money and they say, ‘well you can only get the best talent by paying 2-and-20,’ or something of the sort, and the flow of money from the ‘hyperactive’ to what I call the ‘helpers’ is dramatic.”
I haven’t come across a better summation of what I have learned about the value of investment advice. Keep your money. Set up a well diversified portfolio of extremely low-cost index funds and…that’s it!
I suppose it had to happen. LaMettry’s Collision in Minnesota, clearly a small employer, has been sued by a couple of its employees (not sure if they still work there) for excessive plan fees. This is not the precise reason, but it’s effectively the situation. From what I can tell, the fees are truly ridiculous. Not sure I would call it a scam but…ok, it’s a scam!
While not a tiny plan – it has $9 Million and 114 participants – it is certainly not large. So, what does this mean for other smaller employers? Are micro plans going to be targeted? Plans under $5 Million? Or what about plans under $1 Million?
I have mixed feelings about this. Running a small business presents many challenges. I am sympathetic to the owners’ circumstance. Maybe they have been doing the best they can to satisfy the needs of their consumers, grow their business, and provide for their employees as well.
For competitive and personal reasons, I assume they felt like they needed to offer a 401k. And I’m sure they relied on the professionals calling on their plan. But now that they that have been sued, wouldn’t they have been better off just paying their employees more and letting them do whatever they wanted with the money?
Yet, is there a reasonable excuse for a plan with absurd fees? I’m not talking about average fees – which are too high anyway. This plan is just plain awful. Some plans for smaller employers are so filled with excessive fees and conflicts of interests that it is hard to feel sympathy for the fiduciaries.
I come across employers who have virtually never bid their plan. I am not exaggerating. They have not compared options in 15 to 20 years. A review of the plan might involve a conversation with their current custodian, vendor, agent, broker, or whomever. They ask how their plan is doing. Their contact tells them they are doing fine, and they get on with their business.
I don’t know how this case will shake out. The suit claims that the per participant costs for plans with more than 100 participants should be $18 per participant a year. This is preposterous. On the other hand, I also know this plan is grossly, grossly overcharged.
Regardless of what happens, smaller employers have to take notice. Fixing a plan, and severely limiting liability, is just not that hard. Do the following: 1) Eliminate revenue sharing – period: 2) Always, always use the lowest cost share class; 3) Pay flat or per participant fees for advisory support and record keeping; 4) Offer an array of low-cost index funds; and 5) Eliminate insurance or broker/dealer charges. If you can’t do all of these at least do some of them!
Unfortunately, employers don’t know what they don’t know. This is not good when they carry the responsibility and liability. Cases like this will make the liability less theoretical and more real!
I’ve heard skeptics on the quality of media reporting say that people would be better off being uninformed than misinformed. Whether this is true or not of the media, it is certainly true of the financial services industry! I don’t advocate that people be ignorant of developments in the financial markets or economy. But I think they need to be careful about determining what type of information is helpful to their financial well-being.
This brings me to market updates and newsletters provided by advisory firms. We decided when we founded PlanVision that we would not put market updates on our website. Why? For our clients, who invest and plan for their long term future, this information is not relevant. It’s just noise which distracts from long-term goals.
We don’t help people time the market or make speculative plays on stocks or bonds. This is not part of a sound investment strategy. As such, we’re not going to provide this information. If we put it on our site, this would imply we think it’s helpful – that our clients should use it or be interested in how it affects them.
MOST IMPORTANTLY, THIS INFORMATION DOESN’T INDICATE WHAT WILL HAPPEN. It is not predictive in the short or the long-run. In fact we think its misleading or, even worse, harmful. Many professional and amateur investors use it to make investment choices. Armed with recent market knowledge, they’re under the impression that they can predict how the markets or individual stocks or bonds will perform. Good luck with that!
Do you or your employees really need to know what happened the last 30 days and why? How one asset class may have performed compared to other asset classes? What happened to short term rates in Japan? How about leading market indicators? The price of oil? Trends in clown shoe sales? Virtually all of this information that might pass for interesting facts, statistics, or ideas are useless in predicting market performance. Cause and effect in investing, like many things, can be very evasive. For a little fun, check out some of these correlations from Tyler Vigen.
However many advisers present this information on their site and in newsletters as though it means something and is somehow useful. The truth is it just gives them something to talk about – a way to add value. They can explain what happened and why it happened and how it may impact something next. And based upon what is happening, and what might happen, they make recommendations. Of course they’re guessing – but this is beside the point. They are being paid a fee so they have to figure out what to do with all of this impressive data they collect.
As a plan sponsor, what you expose your employees to matters. Don’t provide information that doesn’t help. The smartest approach for people preparing for their future is to budget, save, and plan. And when it comes to investing, keep costs low, diversify, and select an appropriate level of risk.
Most non-profit organizations can offer either a 403b or a 401k plan to help their employees save retirement. Since for-profits cannot use the 403b plan they commonly use the well known 401k.
When I talk with non-profits, we generally discuss the pros and cons of using a 403b plan. Even though there are many technical differences between the two, they are quite similar. Yet there are key differences which impact their effectiveness. A big advantage of the 403b plan is that it does not require the ADP test, which is applied in non-Safe Harbor 401k plans. This is huge! Without this test, the Highly Compensated Employees (HCE) – yes, non-profits do have HCE’s – will not have their personal contributions limited by the average of the non-Highly Compensated Employees (NHCE). Many for-profits use Safe Harbor 401k plans just to avoid this specific test.
Another advantage of the 403b plan is that employees who work for more than 15 years can use a special catch-up provision. Known as “Cap Expansion,” they can save an additional $15,000 more in their accounts (no more than $3,000 a year) after 15 years of service.
Other administrative requirements between 403b and 401k plans are similar. But if you think they would be charged about the same to administer and support, you would be wrong.
With all of my experience with non-profits, I know fees in many of their plans are just awful. I mean really, really bad. I think it has to do with the fact that the 403b has been around longer than the 401k and was originally targeted by many insurance carriers. Many 403b plans have been using annuity based products or other broker-based products with excessive sales or AUM charges. Unfortunately, these excessive fees damage how much their employees accumulate for retirement.
How did this happen? I don’t know. Maybe they were just easier targets for the agents back in the day and many of these relationships are still dominant to this day.
Another possibility might be non-profits willingness to provide guidance to staff. I believe that non-profits tend to be more supportive of their employees receiving personal guidance than comparable for-profit businesses. This is to be commended. Unfortunately, the fees for this support are disproportionately large to the amount of real guidance the employees receive. The fees are not directly tied to the services provided – they are just wrapped into the insurance product, investments, or assets under management.
And to top it off, many of their employees are sold additional products and services – that are also overpriced! It’s a double whammy.
There are plenty of overcharged 401k plans. But 403b’s have it worse! Small non-profits can have much better plans – but it is up to the plan sponsors to get rid of the crappy, fee-laden providers that overcharge their plans and their employees.
Every once in a while I recall how much influence I have on the people that I work with at my plan sponsor clients. I provide guidance on their retirement plan and they often ask for additional assistance on other financial matters.
It is gratifying that I don’t feel the need to persuade them to buy other investment products or ideas. I derive no additional compensation from them from the decisions they make on how to invest their funds in or outside the plan. In fact, our contract with our clients makes it clear that we cannot generate any additional revenue from staff (we have nothing else to sell anyway, so it doesn’t matter).
Last year I submitted a guest post for the White Coat Investor on sales tactics used by financial advisers. I saw a very cynical though likely accurate comment in the follow-up to the blog. In the thread I mentioned that it was disappointing that an employer was not vetting the presentations provided to residency students. The follow-up comment was: “No one vets anyone, anywhere.”
This got me to wondering how many employers take the time to review and understand the guidance provided to their employees? Do they review the presentations to staff? Do they ask to see what a retirement projection might look like? Do they determine what interest rates their advisory firm is using in projections? Do they understand what other products their employees might be purchasing from the broker or advisory firm?
I could list several more questions but you get the point. I understand employers value the assistance advisers provide to their employees – this is what we do at PlanVision. It can clearly make a difference in how well employees understand and get the most out of their retirement plan. But it is also critical for employers to make a distinction between education and guidance and veiled sales presentations.
I am sure it is just me, but I think it would be great if the DOL added a field to the Form 5500 to indicate how much advisers or broker/dealers generate in revenue from non plan related transactions for employees still working at the employer. This could be required small plans and would be very revealing!
My wife took a new position and I was reviewing the paperwork she will use to set-up her 401k account. The provider is well known in the retirement plan industry – Principal. It struck me how the paperwork emphasized that she can transfer prior retirement assets into her new account. Is this a big deal? Maybe not. But her new plan has higher fees than her individual IRA.
I am skeptical that Principal is objective in explaining this. Based upon their revenue structure, they generate more revenue as the plan grows. Of course, plan assets will increase with new employees, more contributions, market growth, etc. This is good for the participants and the plan. But shouldn’t employees fully understand their options and the implications of their decision with funds they could voluntarily transfer into the plan?
It is virtually scandalous how financial services firms use smaller employers’ retirement plans as an opportunity to sell products to the plan participants. If pressed on it, I cannot image any of these organizations seriously denying their intentions. But until some employers make it a point to limit product sales to employees, it will continue to happen.
Recent developments affecting retirement plans – with our editorial comments:
VANGUARD REDUCES EXPENSES FOR TARGET DATE FUNDS. Not exactly known for ripping you off, Vanguard found room to reduce the costs on their Target Date Funds by 2 bps. Another great example of how they can provide a simple low-cost model and candid approach to investors of all tyeps. By the way, if you happen to have $5 Billion, two of their funds only cost 1 bp. I’m just sayin’. Read more here.
FIDUCIARY STANDARD MOVES FORWARD. Probably. Looking more and more like there will be a fiduciary standard in place for advisory firms that service employer based retirement plans. This would mean, theoretically, that plan sponsors will receive a higher standard care from the firms that service them. I get it and understand the motivation. Broker/dealers are not happy about this and are battling hard to maintain a lower standard of suitability. PlanVision is a fiduciary. We stand to gain on this. However, I think many, many fiduciaries overcharge and oversell. I am not all that impressed.
LAWSUITS ON 401K PLANS. Mega plans are being targeted left and right. Clearly, attorneys stand to gain a tremendous amount in fees so you can expect to see more of this. It will definitely have a short term impact on large plans and eliminate much of the nonsense with retirement plan fee payments. However, it will take longer for this to affect the small plan market. Many smaller employers simply don’t understand the payment systems and the conflicts of interest that impact the structure of their retirement plan.
STATES PROMOTING THEIR OWN PLANS. These efforts would target smaller employers and are designed to help make plans more affordable. Yes, the states are getting in on the act. We currently see many low cost options in this space and other technology firms invading as well. I see how this could help bring down costs for small plans. I am really uncertain, though, how the final product will look and how it will compare to employers’ current options. From what I have read, some advisers are not happy about this. Of course, I think far too many advisers overcharge for their services so I am not sympathetic.
FEDS TO PROMOTE A MEP (MULTIPLE EMPLOYER PLAN) OPTION FOR SMALLER EMPLOYERS. Similar to the idea on the states getting in on the market, the feds are promoting a method for smaller employers to join together in one plan and reduce the administrative costs of their plan. This could be a benefit, but I am simply not sure how it will look. Also, as I mentioned above, there are already low cost plans for smaller employers using 401k plans or even lower cost Simple IRA’s. Ultimately, it will depend upon just how competitive a MEP offered through one record keeper would compare to the independent service providers. I am cynical of large providers offering this platform to smaller employers. I think they will use it as a means to reach many “consumers” and sell them additional products and services. The financial services industry is relentless in pursuing distribution options for its overpriced products and services.
PLANVISION TO SPEAK AT MINNESOTA COUNCIL OF NON PROFITS. Not quite national news, but we are looking forward to speaking at a conference for non profits in Minnesota on Thursday March 3rd. We are pleased that Jon Pratt of the MN Council of Non Profits has taken the time to learn more about our efforts to help smaller employers improve their retirement plans. Non profits can learn the goals for a better plan and the steps they can take to make it happen.