The 401(k) is broken. Year-end 401(k) assets were $2.4 trillion, down $600 billion from year-end 2007 including the inflow from employer match and employee contributions. Average participant investment performance was down 27%. That’s average. Many did much, much worse and some people are retiring this year facing the grim possibility of outliving their money.
In fact, four of the top five holdings in 401(k) plans by asset value had one-year returns through March 9, 2009, of -46.2%, -53.3%, -41.5%, and -40.8%. The S&P 500 was down 47%. Nearly four dozen target-date funds did even worse than that. What were retirement investors doing in these funds?
As a government creation, the 401(k) has become a bureaucratic disaster bogged down by rules and regulations. Employers and investment companies (read: mutual fund companies) have chosen to offer the more popular participant-directed plans to avoid fiduciary liability. These plans burden the individual with the responsibility of making investment choices using an incredibly limited menu of investment options. And the participant education that’s offered is close to useless. As is most often the case, it’s the participant who is left out in the cold without the desperately needed impartial investment advice they seek.
Mutual fund companies are in no rush to see the 401(k), in its present form, disappear, or even change. After all, they have a fine axe to grind. Look at how their cash cow, fee-generating mutual funds, have grown. $1.4 trillion, or 90%, of 401(k) assets invested in mutual funds are actively managed mutual funds, which carry higher expense ratios. A much better option is the lower-cost index fund. Good luck finding them in your plan. The increases in 401(k) assets and the number of actively managed mutual funds today go hand in hand. And Washington is further complicating matters in an attempt to “fix” the problem.
The government has made this too complicated from the beginning. I know the ERISA rules all too well, having started my investment career out of Babson College at the country’s largest 401(k) provider. That was 14 years ago, and not a lot has changed with the lack of participant access to investment advice. On days with high participant-call volume, everyone was asked to man the phones. I remember, as if it were yesterday, being asked by a wealthy gentleman for some advice and being prohibited from helping him. I was only able to answer questions by reading word for word from a prospectus. I was not allowed to ask about his retirement goals, his children’s college expenses, or his overall personal situation. I felt so bad for him.
In reality, participants need and want advice. Participants are not investment experts. They have day jobs and don’t have free time to research markets. The menu of offerings and plan education are of little help because they’re not catered for specific participant needs. And of course the closer participants get to retirement, the greater the pressure. For most, this is the largest sum of money they’ll ever manage. Mistakes must be avoided at any cost. If the average Ivy League endowment had a loss of 25% for the fiscal year ending in June, how is the individual investor expected to fare? Unfortunately, we already know: badly.
The solution is to allow investors access to investment advisors in a way that relieves the advisors of liability. A simple solution is to offer participants the freedom to manage their money much as they do in an IRA rollover, with control over the cash and freedom to move it out of the plan at will. The ERISA rules must be simplified. Deferred savings and the company match are your money. You should have the freedom to invest with someone you trust. Employers need to be released from the terrifying liability they face. Investment companies need to offer more advice or advisor options.
If you have a 401(k) that can be rolled over, do it today, or be faced with the potentially negative impact of additional rules currently being discussed by Congress. Your employer isn’t involved with what you do with your salary and should not be involved in how you manage your investments. Most of my day is spent speaking directly with investors. If you would like to speak with me about your investment situation, give me a call at (800) 843-7273 or set up an appointment at www.younginvestments.com.
Click here to watch a chilling 60 Minutes segment on 401(k)s and decide for yourself if investors could use some more investment advice.
E.J. Smith is Managing Director of Richard C. Young & Co., Ltd. an investment advisory firm managing portfolios for investors with over $1,000,000 in investable assets.