Sooner or later in your career, you are exposed to the 80/20 rule or, as purists term it, the Pareto principle. Simply stated, it suggests that 80% of the consequences stem from 20% of the causes. You frequently hear how you get 80% of your revenues from 20% of your clients (and sometimes that 80% of your aggravation comes from that same minority).
Similarly, with all the furor of late focused on cost sensitivity, revenue-sharing, and the call for greater transparency, it’s easy to overlook the fact that most of that scrutiny and regulatory angst is being applied to 20% of the “problem” of retirement plan fees.
"Out of" Proportions
Traditional logic held that the fees on your “typical” retirement account ran like this: 70% for investment management, 20% for recordkeeping, and 10% for miscellaneous things like trust/custody, audit, etc. That apportionment wasn’t perfect, of course, but it was a rule of thumb that has been applied fairly liberally over the years. Investment fees were typically drawn from plan assets and, thus, participants have been bearing more than two-thirds of the costs of these programs for a very long time now.
Of course, over the past 20 years, we have seen a gradual shift where more and more of the remaining third is also paid from plan assets—and then redistributed to the same parties that used to get a check from the plan sponsor. Despite the occasional “study” from the Investment Company Institute to the contrary, 20 years ago, my sense is that mutual fund expenses were pretty much what they are now for the average 401(k) plan, at least for institutional class shares*.
So, while there is a growing sense that the participant is picking up a greater share of the plan costs, I’m reasonably sure that most are paying about what they used to, at least on a percentage basis. What’s different is those shareholder servicing fees that once upon a time simply rolled back into the pockets of the mutual fund complexes - now go to reimburse entities that actually perform those services for a retirement plan.
But while we agonize over how that 25-basis-point shareholder-servicing fee is parsed out between recordkeepers and advisers, the current debate barely acknowledges the fact that 70% or more of retirement plan fees paid by participants are the 50 to 100 basis points that come out of every participant dollar for “investment management.”
I’m not suggesting that investment management isn’t a skill to be highly prized and reasonably compensated. Nor am I suggesting that current investment management fees are disproportionate in every case to the value received. There may even be legitimate reasons why these funds grow from millions – to billions – of dollars in assets with no reduction in the expense ratios.
The 80/20 rule notwithstanding, IMHO, you won’t solve 100% of the problem by probing just 20% of the fees being taken from those participant accounts.
- Nevin Adams
* The misuse of retail class shares, and the liberal application of “R” shares, is a topic for another column.