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401(k) Deception

We have all been in a situation where we have received completely conflicting information when shopping for products from different companies.  It can sometimes be easy to determine the right choice – other times its much more difficult.

It happens in other areas of life too.  For example, after our daughter’s birth, one of the nurses working with my wife told her that her mobility would be very limited – it was likely she wouldn’t be driving and moving around actively for three to four weeks.  A few hours later, the physician dropped in for an update and told her that she would be fine in a couple of days and encouraged her to resume her schedule as soon as possible!

Many fiduciaries at smaller employers are not well-versed in the ins and outs of 401k administration and compliance.   They are at the mercy of industry practitioners (like me). Understandably, it can be difficult to distinguish the truth from the BS.   It’s hard for large firms and even more difficult for smaller firms.  Unfortunately, in the small retirement plan industry, the BS is rampant.  Here are three examples I just recently came across:

EXAMPLE 1

I was reviewing the fiduciary liabilities and obligations with the office manager of a small firm. She had been tasked with the responsibility of exploring 401k options.  As a part of our discussion, I introduced her to the fiduciary codes 3(21) and 3(38).

I explained how these two types of fiduciaries are different and how advisers can share or take some of their liability.  Some advisory firms like PlanVision are willing to accept the liability of the 3(38) Investment Manager for plans.

She had discussed this issue with another consultant.  The consultant explained that they didn’t want to hire a 3(38) because they would not be able to change the investments in their 401k lineup on their own if they hired a 3(38) adviser.

In a literal sense, this is correct.  But how often is a smaller employer interested in making changes to their fund lineup based upon their own research?  Does it make any sense at all for a plan sponsor to do this?   NO.  It’s ridiculous.  Why would an employer, who has more than enough to do already, want to take on the liability of making changes to their 401k fund lineup based upon their own selection of funds?  Also, if they went insane for a while and decided they don’t want the 3(38) service from their adviser, they could just take it out of their contract.

EXAMPLE 2

I was contacted by an employee of a plan sponsor with a relatively smallish plan.  Not tiny, but small.  About 350 participants and $5 million in the plan.   She was doing research and, smartly, was hoping to include index funds in her plan.

Her employer’s plan adviser, however, told her they were not available for her plan – it was too small.   What???  Nonsense!  Their plan is not too small.  Plans of any size, including start-up plans, can use Vanguard Admiral Share Class index funds.

The real reason they can’t offer these funds is because many low-cost index funds won’t support revenue sharing! Too small?  Pathetic.

With low-cost index funds there will be administrative and support costs.  However, the record keeper can clearly separate out those costs so the employer can include low-cost index funds and the employees or employer can pay for all plan support services separately.

EXAMPLE 3

Similar to example 2.  An overseas employer with American expats inquired with PlanVision.  They are interested in implementing a 401k or 403b plan for their American staff.  During the evaluation process, they have become educated about the benefits of low-cost index funds.  They have a relationship with a large, well-known broker-dealer.  When they asked their broker if they could include index funds, they were told they could not.

Why not?  Why can’t their broker simply offer index funds and bill the plan sponsor directly for their guidance?  Because this would be too transparent!  It is simpler for the broker to hide their overall revenue if they can build it into the investments in the form of revenue sharing.  And, once again, it’s harder to share revenue from low-cost index funds.

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I’m an advocate of innovation and competition and believe they help consumers receive more value.  In the marketplace of ideas and services, there are legitimate differences in philosophy and process from firm to firm.  Understanding these distinctions is a buyer’s responsibility.

Yet many financial service firms intentionally deceive plan sponsors.  Yes, intentionally.  They know better.  In many cases, unfortunately, their business model relies on this deception.

Vanguard is a great success story.  John Bogle attribute much of their marketing success to candor. It’s easy to see why candor works so well in an industry with so little of it.

 

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The Truth About Investment Consultants and Advisers

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!

 

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How Are Your Employees Influenced?

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.

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The Do Nothing 401k Plan

What if your company’s retirement plan never required your employees to do anything!  Would this be a good way to run your plan?  How would it work? Consider this:

Your new 25 year old employee starts and on his/her first day of employment he is automatically enrolled at 6% and receives the company match of 3%.  The beneficiaries use standard defaults and the investments are defaulted as well to very low-cost target date funds.

Each year, with auto escalation, the contributions increase by 1%.  When your employee reaches age 35, the contributions cap at 15%.  They stay at 15% until they hit the IRS maximum or until the employee retires at age 67, whichever comes first.

Along the way, this employee never looks at statements.  They never change their contribution amount; never borrow or withdraw their money, and never have a question about their account. The contributions keep coming in – year after year. They spend their time budgeting, controlling their expenses, managing their health, and enjoying their life and their family.   They concentrate on the things they can control and don’t worry about the things they can’t.

Could you really have a retirement plan like this?  What would become of this employee (assuming they won’t go crazy working for the same company for 42 years)? Wouldn’t you be concerned that, without the help of the experts in the financial services industry, they would end up far short for retirement?

An employer would never do this because, ya know, you just can’t.  It wouldn’t be prudent, would it?  You have to hire experts to monitor your plan and make sure of whatever you need to make sure of.

And to be sure, no person would behave this way and I am not advocating for it. In fact, our business is based upon the notion that the value we provide in the form of guidance to organizations and individuals on their retirement plans will produce a better outcome for the plan participants.

But the financial services industry is simply filled with too much nonsense and jargon that passes for professional assistance.  Much of this guidance comes at a steep price – which acts as a drag on the earnings of plan participants.  It is an unnecessary transfer of wealth from people trying to save and plan for their future to the careers of those in the industry.

I am confident that this simple, do nothing approach would, in most cases, produce a better outcome than relying on an industry that spends millions on investments that try to beat the markets, more millions providing consulting services evaluating these investments, and even more millions on marketing dollars to promote these investments and consulting services.

 

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Why I Recommend Vanguard

BY USING VANGUARD FUNDS, I think my clients will have a higher likelihood of having more money in their accounts in the future than if they use comparable investments from other mutual fund companies.  Sounds like something Captain Obvious might say.

OF COURSE NO ORGANIZATION IS PERFECT.  Within Vanguard I am sure there are large and small disagreements on company direction. However, there are specific long-term aspects of the Vanguard approach which should help my clients achieve the best results.  The following are the top four reasons, in no particular order, that Vanguard helps me help my clients:

PROMOTION OF LOW-COST INDEXING.  Behind the legendary efforts of John Bogle, Vanguard has been the major driver in promoting the benefits of low-cost indexing, also known as passive investing, as the smartest way for people to invest.  They are not the sole provider of index funds, and there are many other champions, however they are clearly the leading proponents of this approach.

CONSISTENT MESSAGING.  By and large, the Vanguard message has been the same throughout the years.  Set-up a well diversified portfolio of low-cost investments and, thru the ups and downs, let the markets work for you.   Sure, they offer active funds and ETF’s.  However, their active funds are significantly less expensive than most and this has not diminished their advocacy of indexing.

VANGUARD DOESN’T PAY ADVISERS.  In an industry full of conflicts of interest, this is critical.  I receive no compensation or commissions from Vanguard to promote their investments.  Nothing. Zero.  Zip.  Nor do they assist my firm by sponsoring events or paying for our marketing efforts.  It has been liberating to provide my services to clients in a direct way.  My clients know exactly how much I make and who pays me (they pay us on a flat fee basis).  The guidance that I provide is no longer compromised by how I am compensated.

NO HYPE.  In all of my dealings with Vanguard, they have never hyped returns or products or “new” angles on investing.  This is very refreshing.  In my experience, I have come to believe that the more an investment is hyped by the financial services industry, the less good it is for the investor.  Of course education and guidance are important and part of the process in helping people become better investors and aware of their options.  But hype is something entirely different.  And I don’t get hype when I interact with Vanguard.

IT’S QUITE SIMPLE.  With my 20 years of experience, when I consider the factors important to investor success, I am confident that recommending Vanguard will give my clients the best chance to get the most return on their investment.

Happy Senior Couple Looking Over Beautiful Custom Kitchen Design.

DOL Considers New Fiduciary Standard?

So you are the fiduciary for the retirement plan at work?   Do you like the responsibility?  How many hours a year do you spend ensuring that your employees have a good plan? Is your current plan overpriced?  Do you have any idea at all?  Or do you do the best you can, and, well, no one is complaining all that much, anyway?

What are the consequences if your plan has unnecessary fees?  What affect will it ever have on you? None of your employees is ever going to sue you, right?  Sure, you might have heard of a few lawsuits at other companies, but that will never happen at your business.

As it currently stands, you are held to a fiduciary standard in managing your plan. As such, you are required to always act in the best interest of your employees and behave in a prudent manner, blah blah blah.  But that sounds a bit theoretical, doesn’t it?  Doesn’t that really only apply to big companies?

What would be a sure fire way to get the attention of all employers?   How could the Department of Labor improve retirement plans overnight?  How could they make sure that all workplace plans, regardless of size, eliminated conflicts of interest and unnecessary fees.  Fee disclosure?  They tried that and it worked a little, but not much.

I would suggest the introduction of a new standard.  Let’s call it the YOUR EMPLOYEES MOVE IN WITH YOU standard.  With this new standard, if your employees can demonstrate that your plan has unnecessary fees (which they can for most plans), the court will calculate how much these fees have cost each employee over time, translate that cost to months of retirement income, and, let the fun begin!  

Look around your office.  Do you like your colleagues?  All of them?  Do you want them to move in with you?  Just for a while.  Maybe 2 to 4 months.  In extreme cases, 1 year or so.  Imagine this for a while.  How about crazy Jack?  Or Linda? OMG! No, not Linda.  How does your future look now?  This new standard would ensure that you have the best plan you can – today!!  This would instantly become the number one priority of all fiduciaries.

Managing other people’s money is serious business with real consequences.  Your decisions today directly impact your employees’ quality of life in the future. Most plans for smaller employers are riddled with unnecessary fees and can be dramatically improved.  Of course the DOL would never implement this type of standard, but if they did it would ensure that  every employee has a much better plan and better prospects for retirement.    

I’m just sayin’!  

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One Small Company in St Paul MN – One Great 401k Plan for America

Does a small company in St Paul MN have a retirement plan that is so good that it’s significance is worth comparing to the first moon landing?  That’s probably a stretch, but their plan is a great model for other employers, both large and small, to emulate.  It is likely one of the best plans in America.

John Kingrey is the recently retired Executive Director of the Minnesota County Attorney’s Association (MCAA) and responsible for implementing the new plan before he left.  MCAA has just 5 employees and uses a simple 401k matching plan.  With the new plan, the employees’ average cost is .15% per account.  The industry average for small plans is around 1.30 to 1.40%.  As you can see, the plan is very inexpensive for the employees.  And with just 5 people, the MCAA plan is far smaller than what is even considered a small plan.  John agreed to answer a few questions about their new plan.

Thanks for your time John.  You just recently retired as the Executive Director of a trade association in St Paul MN.  Can you tell us a little about the organization you retired from?

The professional trade association was a membership organization which provided training, public policy development, and advocacy for it’s members. It had a budget of approximately $750,000 funded through dues, product sales, and grants.

One of the things that you were able to implement prior to your departure was a change in your arrangement for your retirement plan.  Prior to the change, how long were you with your current provider?

We were with another provider for approximately 13 years. It was a provider that I recommended due to the positive experience with my previous employer.

How aware were you and/or your staff of the overall fee structure of your plan?

We did not appreciate and had only limited knowledge of the fees associated with our previous plan. When we reviewed how those costs could be reduced, it made sense to restructure our plan.

When you started to learn more about your plan and your options were you surprised at how much you could reduce the cost of your plan?

The staff was very surprised that the fees and administrative costs could be reduced by more than 50%. They were involved in the decision to switch plans.

As a trade association, how did your Board of Directors respond to the idea of changing to a new arrangement?

Since the Simple 401k funding was capped, the Board supported the move to a new plan as a sensible way to provide an additional benefit to employees through reduced fees.

In your situation, the trade association decided that it would pay for some of the costs of plan support such as record keeping and advisory guidance.  Why did you do that?

The Board supported my recommendation to pay for some of the costs of plan support as a way to provide an additional benefit for our employees. Otherwise, those costs – albeit small – would have been picked up by the employees. Since our Simple 401k was capped, this was a reasonable way to provide an additional benefit to our staff.

With your new plan, your employees only pay the costs of the funds and then can also pay a small fee if they want personal planning assistance as well, is that correct?

The employees pay a small fee for personal planning. I was very impressed with the clear, straightforward information provided through the plan’s website at no cost. My only regret is that we didn’t make the move sooner.

Thanks John.  MCAA’s new plan is a nice legacy for the employees.  Congratulations!

You can contact John directly at jkingrey6849@gmail.com with questions.  

 

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Advisers and Brokers Square Off

There is quite a bit of buzz about the status of advisers in the financial services world. The Department of Labor is pushing to require an adviser to employ a fiduciary standard when providing guidance to their clients on retirement assets (both IRA and employer based plans). This has actually been a debate for some time now. However, the President has weighed in recently supporting a fiduciary standard for retirement advisers so it has gotten increased attention.

With a fiduciary standard, an adviser is required to act in the “best interests” of their clients. On the other hand, a broker/dealer is only required to provide recommendations that are suitable for the client. As such, the argument is that a client will always be better off by working with someone that is working in their best interests. That sounds right, doesn’t it? I am not sure it is and I think this argument misses the point.

An important aspect of the debate in determining what is suitable is adviser compensation. It is argued that if an adviser is paid on commission instead of by a fee directly from the investor, they are less likely to work in the client’s “best interest”. While certainly not complex, I don’t think it is quite that simple.

Let’s look at an example. Assume a 62 year old wants to (or is convinced to) transfer $250,000 from their low-cost 401k plan. How might two advisers handle this based upon whether or not they are a broker/dealer or a fiduciary? Adviser A, the broker/dealer, recommends the client transfer their 401k to A shares with American Funds and invest in a mix of bond and stock funds. We will estimate that the client pays 2.5% on the investment. That would total $6,250. The adviser gets a portion of that, right? (Some goes to the adviser and some to the firm). Good payday – but maybe the adviser has been providing service and guidance to the client for a long time and has “earned” it. The client still pays the ongoing management fees of the funds going forward. Also the adviser will continue to generate income in the form of trailer commissions on the account.

Adviser B, the fiduciary, recommends a managed program that charges the account 1% a year. That would work out to be $2,500/year. (Again, some of this fee goes to the adviser and some to their firm). But that fee would change as the size of the asset changes. As the asset gets larger, say it grows to $350,000, the annual fee is now $3,500. What a great income stream for the adviser! In addition, the client also pays the various fund fees used in the managed program.

So, which option is in the client’s best interest? First of all, was it even advisable that the client transfer their money from the 401k plan? Maybe it was, but maybe it was not. We indicate it was a low-cost plan. However, neither adviser is paid if they recommend that the client keep his or her funds in the plan. It doesn’t mean that an ethical adviser would not make this recommendation. However, they clearly do not have a financial incentive to do so.

It is obvious that the client will end up paying a lot more, and I mean a lot more, in fees with the fiduciary. Of course, the fiduciary will argue that they get all of this awesome service, investment guidance, and value going forward. Maybe they do, but couldn’t a broker provide this as well if they want to maintain and grow their business. Sure they could – and many do. So in which case is the client better off?

Frankly, I think both of these options are pretty crappy for the client. In both cases, they are paying too much for help. (They could leave the funds in the plan or use a well diversified index fund with Vanguard and be far better off in my opinion). But in both cases, the adviser has a strong financial incentive to promote the benefits of their approach, right? In fact, the fiduciary has a much stronger financial incentive to convince the client of the value of their 1% program, which continues to pay the adviser significantly year after year.

What I believe is most important is the total dollar amount of the adviser’s fee and how it is affected by the client’s decision, whether or not they are a fiduciary. In both examples, the adviser is well compensated – whether by commission or by fee. Fiduciaries have their own ”biases” and I get tired of fiduciaries promoting their “objective” advice while charging outrageous fees and claiming that they are working in the best interests of their clients.

FULL DISCLOSURE: PLANVISION IS A FIDUCIARY FOR ALL OUR CLIENTS. Regulation requiring a fiduciary standard would be, ya know, good for our business and all that – we would clearly gain from this requirement. But we would rather have our business promoted on its own merits than on misleading labels. We are proud of our model and how it supports our work with our clients. We decided to structure our business in this way for many reasons. However, it is not the idea that we can puff out our chest and call ourselves fiduciaries. We prefer being a fiduciary, but what is more important is the value we provide to clients at a low cost and how we have no financial incentive to push investors to invest their money in a certain way. So, in spite of the fact that it would theoretically be a boon to PlanVision if a fiduciary standard is required, we cannot get behind this.

By the way, while I am not a big supporter of this change, the argument of broker/dealers that the smaller investor will be left behind with this standard and no longer receive guidance is ridiculous. Give me a break! Whether or not this change goes through, there will always be opportunities for investors with modest portfolios to receive advisement. These investors don’t need hours of service, quarterly meetings, and endless reports they won’t read. They can do fine with straightforward, concise, affordable guidance.

In our recent Ebook How To Improve Your Employer’s 401K Plan, we encourage employers to work with a fiduciary. However, we are also careful to point out that there are many good broker/dealers and many overpriced fiduciaries. I have observed how “fiduciaries” make recommendations for products and ideas that I think are way overpriced. I also think they are guilty of many of the same misleading and ridiculous sales tactics used by broker/dealers. In fact, the word “fiduciary” might be one of the most overused words in the industry these days. It’s as if each firm is trying to outFiduciary every other firm.

Like everyone else, I do not know exactly how this will roll out (even though I think it will ultimately happen). I am not trying to be cute or contrarian with this viewpoint. I just don’t know if this will have the impact people think it might - it may have little effect on consumers. If people want real change, demand that all fiduciaries charge for their time instead of as a percentage of managed assets. I would be curious to see how many of the fiduciaries who promote the pristine nature of their model respond to that.

What do you think? Agree? Disagree?

 

Don't Know

PlanVision’s Predictions and Outlook for 2015

Based upon the events of the last year, our research and monitoring of worldwide political and market events, and reviews of the available economic and financial information, we have a forecast for the upcoming year:

We have no idea what will happen!

We anticipate that our forecast will be 100% accurate.

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Algorithms vs Nothing

Robo Advisors are the most recent development in investment management for individual consumers.  Robo Advisors provide on-line investment management services as an alternative to a personal investment advisor or firm.  They promote the use of sophisticated modeling techniques and algorithms in portfolio construction.  Initially I didn’t pay much attention to their introduction to the marketplace.

In the last year or so, as it has become obvious to me that investment management is essentially a commodity, I have become more intrigued in their role in helping consumers (investors) receive low-cost guidance.  The addition of the robo advisor is an excellent step in the evolution of the asset management market.  They assist consumers by reducing expenses, in many cases dramatically, and also by introducing more discipline into the process.

What I am not certain about though is whether or not using algorithms in ongoing management will provide any additional value over simply using an option like a Vanguard Target Date Fund or Lifestrategy Fund.  Or even using something like the No Brainer 4 fund portfolio recommended by Dr Bill Bernstein.

The models are designed to provide superior allocation by identifying predictive behavior among asset classes.  The argument is that by using engineering and math better, more efficient portfolios can be constructed in the short run, leading to better results in the long run.

I wonder how predictive this behavior is in reality.  Are the trends or behaviors used to model the portfolios really helpful in short term reallocation decisions? Are the efficient portfolios going to end up producing better returns than a well-diversified portfolio of low-cost index funds? I am not sure I am buying what they are selling.

By and large, I like what the robo-advisors are doing to help consumers receive investment management at a much lower cost, but if I had to bet, I would put my money with the No Brainer portfolio.  Adding complexity to money management for most people may not produce a better outcome.