Think about this: You're a 401(k) participant with $100,000 in a combination of funds from a popular financial institution, and you receive an annual bill from that fund company for $800 - 0.8 percent of your account balance.
They ask you to write a check within 30 days. It seems excessive, you think. What are they doing for that much money? In a few more years, with earnings and future contributions, it will be $200,000 and the annual bill looks like it will become $1,600 at that 0.8 percent rate.
Furthermore, they are demanding that you subtract the money from your retirement fund and only use that source for paying the bill. For someone with a larger balance, the fee amounts to half of what they can contribute in a year.
This is a disaster. Your retirement plan constitutes the most efficient asset management tool you have. Funds can compound and be traded and rebalanced without triggering any taxable events. This valuable, irreplaceable money represents the last dollars that anyone should be forced to use when paying a bill.
What I just described is everyone's current billing relationship with the financial institution managing their 401(k)'s, IRA's and other retirement plans. The billing procedure is baked into the cake and not subject to negotiation. What the industry needs is the mutual fund that charges no internal annual expense ratio, but that sends a bill to the participant for money management and recordkeeping services.
In the case of 401(k) plans, the client is the company sponsoring the plan for its employees. Any company could pay all of those costs as a tax deductible business expense. What would this simple sea change mean for all employee participants over time? How about one-third more money by the time they reached retirement 30 years later, assuming the same underlying investment products.
Why doesn't this happen? Because it's more convenient for the mutual fund industry to just collect money from the accounts. The nuisance factor of having to send a bill and collect it, not to mention calling attention to it, is anathema to an industry that thrives in an environment where clueless buyers are not price sensitive.
In the current environment, it's easy for company retirement plans to pay for the costs of operating a 401(k) and offer their participants investments that can charge as little as 12/100ths of one percent per year.
The cost to the company (but not to the plan) can be, on average, about 1 percent of plan assets which they would pay just like rent or phone bills. In smaller companies, where company owners and key management personnel have large portions of the money in the plan, Machiavellian interests hold sway. In most cases, these plans set a standard for how all plans ought to be operated by choosing more cost-effective vendors.
In larger companies, by comparison, plan decision-makers can often be management people whose own accounts are a relatively small portion of total plan assets. Here, the imperative is to reduce costs to the company - usually at a cost of higher expenses to employees.
Last year, according to CFO magazine, companies electing this approach paid $1.7 billion in legal settlements across the country for violating a fiduciary obligation to make "all decisions in the sole interest of plan participants."
For IRA money, the same billing format could be conducted on an individual basis. IRA accounts could be billed on a periodic basis with the understanding that if the bill went unpaid for over 90 days, the money would be rolled out into the same investments that have the current annual expense ratios automatically deducted. In other words, back to square one for those who don't "get it."
That extra 1 percent so many of us pay under the current entrenched system is brutally punishing. In a case where underlying investments earned an average of 10 percent per year on a $10,000 annual retirement plan contribution, the damage done by an "internal charge of one percent" amounts to $75,000 in 20 years and $350,000 in 30 years.
It's the "magic of compound interest" working against us when we pay bills with money that could otherwise be compounding tax-free. The same bill paid out of a checkbook or as a tax deductible business expense would have amounted to about one-quarter of this opportunity cost.
In spite of television's ill-informed expose on ``60 Minutes'' that trashed 401(k) plans, we should not be deterred. Retirement plans (many up 30 percent since March 4th) still represent by far the best opportunity to accumulate wealth, even if they have become the Rodney (no respect) Dangerfield of financial tools.
Too many "wanna-be experts" are trying to throw the baby out with the bathwater.
Meanwhile, not letting a good crisis go to waste, U.S. Representative George Miller's efforts to improve fee transparency may be bear some fruit before the end of the year.
If better transparency leads to a more cost-effective fee structure, we could be rocking in retirement with a lot more money.