This month's enactment of the retirement plan fee disclosure law brings to mind the definition of a true professional -- someone who gives others the same advice they would follow for themselves knowing what they know about their vocation. So a whistle-blower would be someone who steps forward to point out that their fellow associates are not acting professionally. Their collective behavior is self-serving, but nobody wants to mess up a good thing.
Considering the legions of MBAs and Ph.D.s that populate the nation's financial services industry -- and purporting to help people prepare for an adequate retirement -- I find it a little strange that few had thought to calculate the true opportunity cost of retirement plan fees.
All it takes is some punching up of some compound interest figures on a calculator. What it ultimately took was the action of a few whistle-blowers throughout the industry -- starting with John Bogle at Vanguard.
For the past 20 years, the 401(k) industry and the retirement advisory community were charging participants an unconscionable amount and they were accessing their fees from retirement accounts -- the most expensive money anyone could use to pay a bill. The mutual fund industry is arguably the world's most profitable industry because buyers are not price-sensitive. When you are charged a fee but never receive an invoice, or have to write a check, it's the silent spring of stealth billing.
The average equity mutual fund during that 20-year period was earning about 15 percent per year. Money compounding in a retirement plan at that rate doubles every five years. But fees can take a big chunk from the fund; $100 charged in fees in the single year of 1980, for instance, would otherwise have compounded to $1,600 by early 2000 if it had been left in the fund at the beginning of that 20-year stretch.
And remember, fees taken out of your fund also reduce your return. So, for instance, a fund earning 15 percent a year actually gives you a return of 14 percent a year if the fee is 1 percent. When you calculate that missing 1 percent over long periods of time, the opportunity cost goes off the charts: $1.3 million in 30 years on a $10,000 per year annual 401(k) contribution.
Even with more normal 10 percent returns, the cost of the missing 1 percent is $355,000 in 30 years on the same $10,000 annual contribution.
The earliest published attempt to compare the cost to employees among the major retirement plan vendors occurred in 1998. A cost index was the subject of articles in the New York Times followed by Money magazine with its eight-page cover article "Beware Retirement Plan Rip-off." The Labor Department held televised hearings in Washington and then published a pamphlet that warned company decision makers to avoid high fees -- and that was it.
Finally in 2009, some 10 years after initial calls for disclosure, Rep. George Miller took action as head of the Committee on Education and Labor. His efforts resulted in what is now the new fee disclosure legislation that just went into effect this month. Your plan committee now knows what all your costs are, and you will be told along with your September quarter-end statement -- by law. I could argue that this legislation has the potential to add a trillion dollars to retirement accounts over the next 30 years -- at no cost to anyone but the financial services industry.
Disclosure alone will not immediately overcome inertia or the status quo bias, but its effects are already becoming evident as retirement plan decision-makers and committees wrestle with the cost issue. Those plan committee members have a lot at stake as they are "deemed fiduciaries" and personally liable for making all decisions in the sole interest of the employees. Employees in an expensive plan may not be at the gate with torches and pitchforks, but every company has one or more self-styled "mutual fund expert." If those self-anointed whistle-blowers take the time to multiply their fees times the plan's total annual contribution, and compound that number at even a modest annual return, the cost of doing nothing becomes a very big number.
Steve Butler is CEO of Pension Dynamics. Contact him at firstname.lastname@example.org or 925-956-0505, ext. 228.