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Remember Jim Carrey in that movie, "Dumb and Dumber"? If you're in a 401(K) plan, there's a good chance that it's run by Fidelity -- a company that dominates the industry with 11 million participants.

Some former Fidelity marketing executives shared some inside knowledge with me that might make me feel like Jim Carrey if I happened to be in a Fidelity plan. I know that sounds harsh, but here's a little background:

Institutions in the 401(k) industry have to pinch themselves now and then to believe that their profits can be real. Where the annual cost of doing the work on a $50,000 account is about 6/100 of 1 percent of assets, (that would be $30 a year) the average fund charges about 1.5 percent or 150/100 of one percent. That would be $750 on the same $50,000. A typical Vanguard fund charges about 0.2 percent or $100 on $50,000 -- a standard of comparison that drives the rest of the industry nuts.

With 401(k) accounts, a group of employees make up a single account that can be $50,000 or $50 million. The actual cost of keeping the records straight and splitting single company accounts among all the employees is a flat cost -- about $100 to $200 per year regardless of the amount of money involved.

The problem for Fidelity is that increasingly sophisticated 401(k) investment committee members, many with their personal money at stake, recognize the value of offering winning funds regardless of who provides them. The term "open architecture" describes a 401(k) format -- a better mousetrap -- that selects fund offerings from throughout the entire fund industry.
Some funds have consistently outperformed their competitors. The original "hot hands theory" (now called "persistence,") first described in a Harvard Business School doctoral thesis, made the case that past fund winners tended to be fund winners into the future. Superior past performance against funds of the same fund type combined with low cost are the two most important success factors.
Profit takes hit

Fidelity is stuck. It has built an organization of more than 40,000 workers that thrive on what for them was a 40 percent profit, and the company made that kind of money as long as it could be stuffing its 401(k) plans with its own in-house funds.
Now that the market is demanding funds with superior performance, Fidelity is being dragged into offering other companies' investment products where they are paid just a sliver of that usual profit.
Under marketing pressure, Fidelity will offer what amounts to a "veneer" of other company funds in its plans, but a condition of a Fidelity plan is that the "core funds," those with most of the money, have to be their own in-house funds.
Christopher Davis writes in Morningstar Advisor that "(Fidelity's) "... lineup offers a few stellar choices, but most funds don't stand out." My own research indicates that a group of funds in a typical open architecture plan will have a weighted average return in rising markets of from 2 percent to 4 percent per year better than a Fidelity packaged program.
In falling markets, open architecture formats outperform by 1 percent to 2 percent. Applying the magic of compound interest, that advantage can generate as much as twice as much value by retirement in 20 or 30 years.
Target retirement

Don't get me started on target retirement date funds.
Using them as default options, Fidelity herds indecisive employees into relatively expensive stock-owning products and subjects them to risks they would otherwise avoid.
The U.S. Senate has voiced concerns regarding the false expectations of these controversial funds.
Finally, Fidelity offers employee education but carefully avoids specific employee advice.
Instead, they push everyone out to the Web -- offering what passes as service and education at little cost to the company.
New strategy needed

It's probably time for Fidelity to reinvent its 40,000 employees and consider how many layers and layers of management overhead they really expect American 401(k) participants to support.
All those middle and top managers could be costing 11 million 401(k) participants as much as half of what otherwise could have been their retirement nest egg.
Vanguard, an investor-owned cooperative, has shown us that it doesn't have to be that way.
What costs an annual 0.8 percent at Fidelity can be just 0.2 percent at Vanguard.
Vanguard's $1.3 trillion in assets now eclipses what has been Fidelity's industry dominance.
Investment committees should be wising up and voting with their feet.

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