Tuesday, August 20, 2013

401K plans are screwing employees!

Interesting paper making this point by Curtis & Ayres.

A lot can go wrong in 401k plans. Investors can make bad choices and fail to diversify. But, the plan provider can also cause problems by giving investors a menu with lots of high fee options. Apparently this is common.

My University took us out of TIAA-CREF a couple years ago and sold us to Fidelity, who were only going to offer actively managed relatively high-fee funds. Faculty complained and some index funds and some TIAA-CREF grandfathering were allowed. But we constantly get bombarded with emails from Fidelity.

Anyway, Curtis and Ayres find in their sample that, "investors incur fees both at the plan and fund level. The combination of plan expenses, mutual fund fees, and menu limitations account for a loss of 10.2% of the optimal risk-premium." So the excess return is on average 10 percent lower because of high fees. They even show that the seeming overweighting of investors into their own company's stock in these plans is not necessarily irrational given the high expenses associated with a lot of the other options in many plans.

It's easy to say, we need regulation! But, this is already a fairly highly regulated industry, and more regulation is not always better.

As always, what would help is better financial education for average people, but this is not easy. Tyler and Alex's textbook has a chapter on investing, but I absolutely could not convince my students that they couldn't beat the market on average. Nor could I convince them that the high returns earned by some managers or funds were likely due to survivorship bias.


14 comments:

Jeff said...

In addition to being highly regulated, it's also pretty competitive. I suspect that if 401(k) plan administrators really are sticking it to their clients' employees by only offering high fee, actively managed fund options, it's probably because the company's HR Department is falling down on the job and not demanding more/better options for themselves and their coworkers.

kebko said...

My HR department doesn't tell me where to buy groceries. The problem with 401k's is that the government created an arbitrary source of rents called a 401k.

Paul Gowder said...

Seriously, the students weren't convinced? Do you have any clue why not/what was going through their heads?

Angus said...

Paul they just kept chanting "George Soros" and "Warren Buffett". I couldn't get them to see that pure dumb luck would produce a Warren Buffett if you start with enough investors.

DL said...

Our Uni is thinking about "single provider" but is having trouble doing it. Amazingly, about 35% of our *total* retirement is in the "guaranteed" portion of the TIAA.

Angus, I have a competition in class where people guess heads or tails on a coin toss. I keep playing until there is one winner and then I consistently refer to him/her as that guy who is so good at guessing coin flips. "Seven in a row, you know what the odds of that are?" Believe it!

DL said...

That is, the faculty have allocated about 35% of their retirement savings into TIAA's guaranteed section, the one where you get some fixed return and can't get the money out ever.

I was like, wow, you know where we put all our money?

Paul Gowder said...

Really! Show them this:
http://www.cnbc.com/id/100518304

No less than Buffet himself saying "use an index fund, idiots."

John Thacker said...

The positive thing is that Vanguard and index funds in general do seem to be getting more and more popular over the years. Though there still are plenty of suckers, and more born every minute.

popshobby said...

One other thing. If you invest with pre-tax money, all the gains come out taxed at ordinary income.
No attractive capital gains rates for us, even though the prime purpose of most funds is to generate capital gains.

BR said...

Explain to your students that Buffet and Soros "beat the market" by actively participating in the companies they buy. Capital gains in their case is more akin to compensation for their contributions (both intellectual and financial) as opposed to an indication of their ability to determine which stocks will have the greatest rise in value from an unfathomable number of factors. That's why my IRA is in a hedge fund that buys influential shares and actively uses its influence. Unfortunately the government only allows "accredited investors" (ie. much wealthier than most)to invest in hedge funds.

Chris T said...

Frontline did a nice piece on this issue -

http://www.pbs.org/wgbh/pages/frontline/retirement-gamble/

Anonymous said...

As opposed to the chronically underfunded state teachers pension my wife should receive?

Angus said...

Anon, I am partly counting on a state teachers pension myself!

Jim Oliver said...

So why are people allowed to put more money in a 401K than in an Ira or an SIRA?