401k Fees That Matter
The DOL wants 401k Plan Sponsors to look at fund fees. The average ERISA fiduciary accepts the definition of “fees” without much deliberation. Will this casual acceptance eventually sting the fiduciaries in their collective liability posterior?
In his book You Are Here: A Portable History of the Universe, Christopher Potter devotes an entire chapter to the dilemma of measurement. This quandary confronts and, ultimately, may confound even our smartest scientists. Why?
Unfortunately, no matter how hard we try, we tend to base measurements on arbitrary and often purely convenient references. So, while modern instrumentation allows us to measure with ever increasing preciseness, the relevancy – or, more aptly, the irrelevancy – of those measurements haunt the dark shadows of the brightest minds. Should we use a yard or a meter? Fahrenheit or Celsius? The solar year or the lunar year? Yes, researchers can justify the impertinence of such choices by citing the mere need to identify relationships and trends. “The choice of measurement units,” they explain, “merely reflects a scalar translation.”
If you know what that means you probably should be reading an article with more intellectual heft.
So, what 401k fees really matter? Where should the fiduciary focus to reduce liability? For the purposes of this piece, the first in a series of two articles, we’ll concentrate on those fees associated with investment options, not administrative costs. The Department of Labor (DOL) says investment fees are “by far the largest component of 401k plan fees and expenses.” (For an excellent breakdown of all fees, see the DOL publication A Look At 401(k) Plan Fees.) To the extent the 401k plan sponsor uses a bundled service provider, the burden of justifying fees becomes more difficult not because of the raw size of the fee, but because it’s very difficult to really identify what fee goes to what service.
Even by looking solely at the fees associated with investment choice, the fiduciary can land in a state of confusion. Investment choices have both direct fees and indirect fees. Worse, professionals, academics and regulators don’t agree on how to reconcile the difference. Yes, a vested interest in certain investment vehicles may shade some points of view, but, for the most part, we most likely see what Potter describes in astrophysics occurring within the financial industry. If it’s easy to see, we tend to use it as a measurement of fees. If it’s inconvenient, we may neglect it, no matter how significantly it ultimately impacts long-term investment performance.
The typical 401k fiduciary will immediately recognize a direct fee. These fees offer the most convenient yardstick – plan sponsors must authorize their payment (either out of fund assets or by the plan sponsor’s pocketbook). Examples include brokerage commissions paid to brokers who sell the investments to the plan fiduciary (the DOL calls these charges “Sales Charges”) as well as investment management and fiduciary consulting fees paid to individuals and firms who select the investment choices on behalf of the plan fiduciary. These fees can (and should) remain consistent regardless of the type of investment pick. Of course, too often, these fees become obscured and hidden by 12b-1 fees, but that’s the subject of another article. The same goes for certain fees embedded within annuities and other brokerage products. The DOL is trying its best to shine daylight on these conflicts of interest (see “3 Great Ways the New DOL Investment Advice Rule Helps the 401k Fiduciary,” FiduciaryNews.com, April 6, 2010).
Notice what’s missing: The expense ratio of the mutual funds that make up the investment choices. Stay tuned for our next installment in this two part series entitled: 401k Fees That Shouldn’t Matter: How Overweighting the Wrong “Fees” Can Actually Increase Fiduciary Liability