When I was hitchhiking home from college 50 years ago, a talkative guy picked me up in a nice, presentable car as he was on his way to service his string of gumball machines. His advice: “There’s money in pennies.”
In a similar vein, Planet Fitness, the chain of health clubs, discovered the holy grail of its industry with a “money in pennies” formula that has blown the doors off older, more established, health club companies. In simple terms, the secret has been to offer memberships at such a low price that many would sign up -- and then rarely show up. The low price of as little as $10 per month deducted automatically from the checking account of a would-be “fitness buff” was not enough to inspire any sweat or bother to cancel -- and keeping the membership left the door open to a customer’s belief that they might someday make good on a new year’s resolution.
So how simple is that? Two brothers founded the company in a small town in New Hampshire. They took it public a few years ago, and it now has a market capitalization of $2.5 billion. While Planet Fitness represents just a low-tech monetization of human behavior, the business world is full of similar success stories involving the packaging of expensive products into small bites that can be sold in large numbers for pennies. Streaming cuts from compact discs and selling them for $1 is a good example -- it saves consumers from having to spend $15 for an entire CD yet still brings in a good revenue stream.
The mutual fund equivalent these days is the target date/lifestyle fund phenomenon, which has become the dominant investment in 401(k) and 403(b) plans. These are mutual funds that, for a higher annual expense ratio, preselect the percentage mix of stocks and bonds based on the number of years between now and the employee’s projected retirement date. They have attracted well over half of all money in retirement plans largely because, since 2006, the Department of Labor has allowed financial institutions to use these highly profitable investments as “Qualified Default Investment Alternatives.” This defines an account that the employer can select for an employee who is receiving or depositing contributions but who has never chosen an investment allocation.
I have written repeatedly about the extent to which these funds generate more money for the providers at a cost of “just a few dollars a day” for investors -- all adding up to a cost of as much as 10 to 20 percent of account balances overall by retirement time. Compared with the value of force feeding the basics of investing, these funds allow major retirement plan vendors to avoid what used to be a sincere effort to encourage savings and teach the fundamentals. Instead, today’s message is just: “Go to the web.”
This desultory approach to fiduciary responsibility is a missed opportunity to educate, and this simplistic solution leaves a vacuum to be filled. An example: Participants in their 20s, in a fund with a target date of 2055, are left with 10 to 20 percent of their money in fixed income when it should all be in equities. There’s a drag right there that will cost 10 percent or more in opportunity cost over 40 years. Later, a few years away from retirement, participants have almost all their assets in bonds when they still need equities to protect against inflation.
Now it gets worse. The Labor Department just approved the sale of so-called lifetime income funds as an option of the QDIA, meaning the automatic sale of an annuity to provide lifetime income of, typically, slightly more than 5 percent of assets until the participant dies. As is the case with most annuities generally, the principal (the entire account balance) goes to the insurance company upon death. It totally disappears.
By comparison, a typical balanced fund over the past 30 years would have provided the same income just in dividends and interest combined with some growth in asset value equal to at least 5 percent, and the principal itself would have remained intact -- for spouses and heirs.
Moreover, dumping an annuity if you change your mind can be nightmare, which leads me back to the Planet Fitness analogy. If you Google the question: “What does Planet Fitness cost” it will lead you to post after post of those who have struggled, for months and years, to get their automatic Planet Health club bill turned off. So watch those pennies, and the dollars will take care of themselves.