Raiding the Returns

Hidden costs and high fees eat into 401(k) plan benefits.

“I think it’s a blessing in disguise that the trading abuses have come to light, because they have caused us to take a look at the whole industry,” says Sen. Peter G. Fitzgerald (R­Ill.), co-sponsor of the broad Mutual Fund Reform Act of 2004 (MFRA), which seeks to prevent future trading abuses while also improving fee disclosures. Compared to the problem of high fees, “the trading abuses can be addressed relatively easily,” he says. And trading improprieties “are far less costly to mutual-fund shareholders.” Spread over the decades-long life of a plan, he notes, a few excess basis points can cost retirees tens of thousands of dollars.

The senator, a former commercial-banking attorney who now heads the Subcommittee on Consumer Affairs and Product Safety, believes Congress is partly at fault for lax scrutiny of the mutual-fund phenomenon. After all, the industry got its biggest boost when government-created, tax-deferred investment vehicles, including retirement plans, fueled the rapid growth of the mutual-fund industry. “Mutual funds have grown from $115 billion to a $7.4 trillion industry in 24 years,” he says, while regulators “weren’t paying as much attention as they should have been,” and funds “had almost a guaranteed market.”

Over that long haul, mutual funds have not been the star performers they often claim to be, according to testimony before Fitzgerald’s subcommittee. “Eighty-eight percent of mutual funds underperform the market over time,” says the senator, with funds returning only 9 percent on average over the past 20 years, compared with 12 percent for the market in general. “The difference between the 12 percent and the mutual funds’ 9 percent,” he says, “is the fees.”

Beyond the costs represented in the standard expense ratio that funds now disclose, says Fitzgerald, transaction costs often add another 75 to 150 basis points. The MFRA seeks to require transaction-cost disclosure in order to give investors more guidance in deciding which funds to buy, among other benefits. The hidden transaction charges, reflecting commissions and spreads on trades, for example, “are a very real cost, and they eat into investment returns just like any other cost.”

While the act is designed primarily to help independent fund investors, who lack the clout to negotiate fees as corporate 401(k) sponsors might, “the dilemma of plan sponsors is very similar to that faced by individual investors, because it is virtually impossible to get all fee information,” according to the senator.

Confusing and Costly

“Fees are the next wave,” says David Wray, president of the Profit Sharing/401(k) Council of America. After dealing with concerns over the trustworthiness of plan providers, investors “now want to know about the amount of fees, the kinds of fees, and the quality of services those fees purchased.” But plan sponsors must consider that a 401(k) is more complex — sometimes far more complex — than an individual fund investment, he notes. While some of the fee is based on the volume of participants’ assets under management, plan customization also sharply affects the cost. “Employee retirement plans are not just a collection of savings accounts; they’re very different,” says Wray. “The more generic the plan, both in design and investments, the less the expense.”

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