Small to Medium Corporate 401(k)s are a National Disgrace
By: John Burke
Email: jburke@starboardasset.com
The 401(k) world is full of target and life cycle mutual funds which are loaded with high cost and feel good marketing material . These funds do not work in down markets as witnessed by their poor performance last year. They are just another gimmick from Wall Street and the mutual fund industry. According to a recent article in the Financial Times, target date funds geared toward 401(k) participants due to retire in 2010 lost an average of 24% in 2008.
It’s a tragedy that a worker due to retire in two years saw almost one-quarter of their retirement savings disappear. We believe these strategic cookie-cutter asset allocation approaches that pile into more and more bonds the closer one gets to retirement are doomed to additional failure in the years ahead. These static models do not factor in relative strength of asset classes or the fact that inflation may eat away at the value of bond portfolios.
We believe tactical strategies that are able to adapt as the market changes will be of much more value to a retirement portfolio. An argument can be made as to whether the majority of mutual funds really do investors any good at all. David Swenson, the manager of the Yale endowment funds, had the following to say about mutual funds in his book Unconventional Success; a depressingly large number of situations mutual fund companies crossed the line moving from immoral acts to illegal behavior.
The mutual fund management company’s quests for profits whether licit or illicit trample individual investors interest year in and year out. He has also said the mutual fund industry will be responsible for a social crisis in this country that is an entire generation of the baby boomers will not have enough money to retire because mutual funds have overcharged and underperformed.
A recent study by Dalbar showed that individual investors gave away 6.5% of performance every year for the past twenty years due to poor timing and decision making. During this period, the average equity mutual fund investor returned 1.87% versus an 8.35% average annual return for the S&P 500. The reasons cited for the performance discrepancy mainly center around investor psychology issues (i.e. most small investors are not rational in their decision making causing them to panic buy and sell at exactly the wrong time). However, high mutual fund fees certainly did not help the situation.
Compound this performance gap over the life of the average worker and it could very well be the difference between a meager retirement and a comfortable one. Our firm has developed a 401(k) which allows us to bypass the mutual fund industry and the notion that people are able to manage their own money as well as a professional can. Our vision began with the idea of finding a solution to what we feel are structural flaws with the current 401(k) system. It is our belief that a total rethinking of the 401(k) was needed in order to solve the retirement crisis that faces our country.
When 401(k) plans became popular in the mid-1980s, mutual funds simply decided to slightly tweak their legacy IRA platforms. They slightly changed the administration model, but didn’t change the fiduciary relationship with the investor. As a result, the mutual fund industry, not the workers, became the prime beneficiary of the 401(k) system. High fees and profit sharing arrangements enriched many financial industry players at the same time that employee investment performance chronically underperformed.
This industry profit motive has led to complete disregard for fiduciary responsibilities and is a prime reason for the breakdown of the retirement savings system. This abandonment of the novice retirement investor is unacceptable. Our 401(k) platform combines several unique features including; low fees, employee contributions, professional management, tactical asset allocation and fiduciary responsibility. This product functions much like a defined benefit pension plan with a balance-forward annual accounting and a combined asset pool for each company. This is a lot less expensive than the administrative costs associated with daily access plans.
One of our 401(k) clients is a coal company with 50 employees. These hard-working individuals have great knowledge of how to extract coal from the earth, but understandably have little time to devote towards learning the complex world of investing. We take this burden away from them and take on fiduciary responsibility for managing the plan assets. Yet, given the requirements of a typical 401(k), employees of companies like this all over the US have been left alone to choose investments they think are suitable for them. This was why the mutual fund industry originally came up with the concept of “set and forget it” target funds a few years ago. They use simple phrases like target maturity and invest according to your life cycle i.e. age. This is feel-good snake oil salesmanship and is costing the employees of small-to-medium businesses billions of dollars every year.
Dollars that should be going towards worker retirement either goes to financial industry fees or is lost through poor performance. We believe now is the time for companies to take back their retirement plans for the sake of their workers. Let’s cut out the middle man and create a new system that won’t be run for the benefit of the mutual fund industry.