Sunday, April 30, 2006

Our Money's Worth

Last week, the LA Times ran a three-part series on 401(k) fees. The headline, “Fees Eat Away at Employees' 401(k) Nest Eggs,” didn’t seem to be a harbinger of real news. I figured it was just another one of those moments of journalistic “awakening” to things those of us in this business are already well aware of.

But as I skimmed the story, I realized that this was not just a story about outrageous 401(k) fees per se. While acknowledging that “Mutual fund management fees are the biggest expense,” the authors gave them a quick pass, noting that they are “prominently disclosed, have attracted wide publicity, and have been declining as fund providers compete for customers.” Well, they surely are the largest expense, they have been attracting publicity, and they surely are disclosed (“prominently” is another matter, IMHO). As for fees declining, well personally, I don’t see much evidence that most are, but that’s a point for another column.

So, if those mutual fund fees that are the biggest expense aren’t the problem, what is? According to the first installment of the series, administrative fees. Why? Because, according to the article’s authors, “They usually don't show up on quarterly or annual statements. Brochures touting the benefits of 401(k) investing rarely mention them. Employees have to work hard to find out how much they're paying — for instance, by scouring their plan's Web site for a record of all activity in their accounts.” (Ironically, the individual whose “plight” introduces the story, was tipped off by the reflection of those fees on his participant statement – go figure).

There was a time, of course, when those administrative fees were not only separately disclosed, but were often paid by the employer. Then, sometime in the 1980s, the mutual fund complexes introduced the concept of “free” 401(k) plan administration. They weren’t free, of course – but for the time, they represented an extraordinary expansion of service – call center support, daily valuation, Internet access – on top of education meetings, recordkeeping and compliance support, etc. - and all for no additional cost. Not only did most plan sponsors feel they had stumbled into a marvelous way to save the company money, passing up that range of capabilities (particularly at that price) would surely be a fiduciary faux pas.

Eventually the providers who weren’t fund managers were able to wrest revenue-sharing deals – and then they, like the fund complexes, could offer all those services “at no additional cost,” too. Today we widely recognize that services like participant recordkeeping are akin to shareholder servicing in a retail mutual fund, that participant call center support has a counterpart in the retail world, and that the part of the “prominently disclosed” mutual fund expense designed to cover the costs of distributing fund prospectuses has just as much applicability to a 401(k).

Of course, as the Times article cautions, in many, perhaps most, cases, we also sacrificed the “disclosure” of all the various fees and expenses associated with plan administration (actually, these expenses were generally netted against investment income, and labeled as such, in my experience). But I think it’s hard to credibly argue that these administrative fees are any less disclosed than any other mutual fund expense – and their purpose, if not specifically articulated in the prospectus, is no less obscure than the purposes associated with the rest of the operating expenses of the mutual fund.

But if they are no less obscure, they are obscure nonetheless. Participants and plan sponsors today have too little understanding for, and appreciation of, the cost of these programs, but it is doubtful that they were any better understood thirty years ago. However, it seems to me that in most cases, we’re still paying the same mutual fund expenses we once did – and getting a lot more for them.

- Nevin Adams

The LA Times series is online at,1,5289336.special

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