Great Info for Every 401k Plan Sponsor: Review of 401k Averages Book

Ninety-five dollars is a lot to spend on a 92 page book of statistics. In fact, its rate of one dollar per page doubles that of Morningstar’s (née Ibbotson’s) statistical tome Stocks, Bonds, Bills and Inflation (Sbbi) Yearbook, (at $175 for roughly 350 pages, it logs in at about 50 cents a page). So, which fee should you pay more attention to? Does total cost ($95 vs. $175) trump cost per page ($1.00 vs. $0.50)? Or is it the other way around? Ironically, the answer to this question reveals much about the nature of 401k fees in general and, quite frankly, ought to cause concern among the typical 401k plan sponsor and fiduciary. 401k Averages Book, published in November 2010 by Pension Data Source Inc. – if only accidentally – allows the typical 401k plan sponsor and fiduciary to discover at least some of the hidden truths regarding fees and their 401k plan.

But first, we’ll give you a hint of things to come by answering our first question.

So, which book is better? The one that costs more per page (401k Averages Book) or the one that costs more in total (Stocks, Bonds, Bills and Inflation (Sbbi) Yearbook). According to Amazon.com statistics as of April 23, 2011, 401k Averages Book had an Amazon Bestsellers Rank of #71,944 while Stocks, Bonds, Bills and Inflation (Sbbi) Yearbook ranked #945,336. If we are to believe Amazon, a lot more people are willing to pay a dollar per page versus half that rate.

If that’s what Amazon thinks, what does the typical reader think? Unfortunately, neither book has been reviewed. In that case, let’s get on with our review right now. We’ll save the surprise – and disappointing – truth about fees for the end.

One of the authors of 401k Averages Book provided Fiduciary News with a free review copy of the book. Don’t get the wrong idea. Fiduciary News actually called the distributor and requested a free review copy after a reference to it appeared in another publication. Getting right to the nitty gritty, 401k Averages Book uses the most recent (June 2010) data available on the fees charged by 198 products offered by 72 providers. While, in a sense, theoretical, the data is more timely than can be obtained from most Form 5500 data bases (which can often be 2-3 years out of date).

The book offers a five step process to compare 401k plan costs and services. Although it could be more comprehensive, the steps do reference free worksheets available on the web-site associated with the book. The steps also suffer from lacking flexibility – they assume you’re using the data as laid out in the book. As we shall see, if you fit into this template, the book begins to become helpful. If you’re a square peg, this round hole might not prove to be as useful as you might hope.

For one thing, 401k Averages Book assumes an asset allocation that might not accurately reflect either you plan or the investments of the individual participants. The authors – Joseph W. Valletta and David W. Huntley – don’t do this out of malice. As they explain, different investment asset classes generate different average fees. The asset allocation they choose – which remains static throughout the book – is: 43% Large Equity, 19% Stable Value, 9% International Equity, 7% Fixed Income and 22% Balanced. The book does not indicate where, if anywhere, Target Date Funds, small cap stocks and mid cap stocks are placed within this allocation. If your 401k plan’s allocation – or your personal allocation within a 401k plan – differs significantly from this asset allocation, it’s not clear how helpful this book may be.

Fiduciary News asked Valleta about this. Valleta said the he and Huntley “looked at multiple industry and provider studies to come up with the asset allocation.” He named both the Investment Company Institute and the Profit Sharing/401k Council of America as examples of some of those sources. He also said “small-cap and mid-cap are not included in the asset allocation in the book because many of the industry and provider sources we review do not break those categories out.” He added, “Target funds are included in the balanced/lifestyle category.”

Here’s what I really like about the book: There are a series of charts utilizing a fairly comprehensive range of plan asset sizes (from $250,000 to $250,000,000). That covers most plans that would bother buying this book. Here’s the catch, data is only given for plans where the average participant has either $10,000 or $50,000. Valetta said, “Based the sources we reviewed we believe the $50k best represents the industry average account balance. The $10k is a good number to use for plans with smaller account balances.” While the first edition of the book “illustrated only a $10k average account balance,” Valetta said, “We increased that over the years to $20k, $30k, $40k and have settled on $50k for the last couple of publications. Last year we added back the $10k average and illustrated two sets of scenarios for the first time.”

If your plan has an average participant size wildly different from these two points, all may not be lost. First, if your average participant size falls between $10K and $50K, you might get away with extrapolating between the two data points provided in the book. Of course, if you’re well outside this range, it’ll be tougher to use the data provided in this book. Perhaps, given the practical limitation of print, in the future the authors will offer an on-line matrix featuring a wider spectrum of average participant balance size.

Here’s another thing I like about the book: It breaks out data into three elements: Investments, Recordkeeping/Administration and Trustee. I am a little curious, though, regarding “Recordkeeping/Administration” and “Trustee” fees. According to the data provided in the book, these fees are “zero” for very large plans. It’s not spelled out whether the fees are merely approaching zero or are, in fact, zero. If they are zero, it leaves on to wonder if the large plans are self-trusteed and handling their own recordkeeping/administration, or whether fees for those services are bundled in with the fees listed in the “Investment” category. This also perplexed Valetta, too, who told Fiduciary News, within this high end range, “there are some products where the hard dollar recordkeeping fees are greater than zero but there are many products where the hard dollar fees are zero and recordkeeping fees are paid from the investment expenses.” This tends to overweight the true cost of investment fees and, in either case, may be resolved if the DOL’s new definition of fiduciary requires recordkeepers to disaggregate those fees from investment fees.

The book does offer a “Total Bundled” category, but this is merely the sum of all the other categories and not the average fee for exclusively bundled products.

Here’s what I don’t like about this breakdown: Most of the costs appear under the “Investment” category. It would have been more helpful to breakdown “Investment” costs between “indirect” or “product” costs, like a mutual fund expense ratio, whose impact is already registered in the investment performance of the product and “direct” or “sales” costs, like a load, commission, 12b-1 fee, or investment management fee whose impact can theoretically be reduced (or even eliminated) without impacting investment performance. Valetta says, “We do maintain that break down in our database but have not added it to the book.” He did not indicate if he would use this data in future editions but experience shows, over the years, the authors have tried to refine how the data is presented.

Here’s the one sure thing many 401k plan sponsors will immediately benefit from: The book provides a range of fee data for different investment types. Granted, it’s harder to use this for broad investment classes, the presentation makes it very easy to compare index funds. And what we discover is truly amazing. With revealing the actual range, we can say the difference between the lowest cost index funds and the highest cost index funds is substantial enough to immediately question if proper due diligence was conducted by the 401k plan sponsors and fiduciaries. (In other words, if you’re on the high end of this range, being that these are index funds we are talking about, you’ve got a whole lot of explaining to do.) Valetta couldn’t explain the variance, saying only the book “just publishes the results of our findings.” The variation in the other mutual fund classes are less meaningful.

Nonetheless, with this, we discover the truth about fees starting with our very first question. The fact is, fees are but one criteria a fiduciary must consider. In the case of the two books mentioned at the beginning of this article, one book (401k Averages Book) provides data specifically for 401k plan sponsors. The other book (Stocks, Bonds, Bills and Inflation (Sbbi) Yearbook) provides academic data on various asset classes. Clearly, regardless of cost, the only book a 401k plan sponsor would rightfully consider would be 401k Averages Book. Why? It doesn’t matter what the cost is. It doesn’t matter what Amazon ranks it as. It doesn’t matter what other people might think of the book (unless, of course, if they are 401k plan sponsors or media outlets that cater to the 401k fiduciary market). What matters is relevance. Clearly, 401k Averages Book is more likely to provide pertinent data to 401k plan sponsors as opposed to Stocks, Bonds, Bills and Inflation (Sbbi) Yearbook. This is not to say Stocks, Bonds, Bills and Inflation (Sbbi) Yearbook doesn’t provide useful information. In fact, if you’re an investment researcher looking for historical data, Stocks, Bonds, Bills and Inflation (Sbbi) Yearbook is probably the best book out there.

Why should this discovery concern the typical 401k plan sponsor and fiduciary? Over the next year or so, fee disclosures will become the trending topic among 401k plan sponsors and fiduciaries. It will be tempting to overweight this parameter, but proper fiduciary due diligence requires one to focus on what really matters to the beneficiary. Fees may matter (and, in certain circumstances like index fund expense ratios, they will matter). However, in some cases – like overall investment returns – fees may be of lesser concern. Unfortunately, the SEC, the DOL and most professionals agree past performance cannot guarantee future performance. Yet, in the end, all that matters to the participant is performance. A great example of how focusing too much one just one type of fee (the mutual fund expense ratio) is revealed in “Does the ‘Lost Decade’ Signal the End of Passive Investing?” (Fiduciary News, January 5, 2011). The article shows how what are generally considered the lowest cost mutual funds severely underperformed higher cost mutual funds. Could the typical 401k plan sponsor or fiduciary have predicted this? Probably not, but proper due diligence would have exposed the danger of putting all of one’s eggs in the “low fee” basket.

We’ll leave it to the ERISA attorneys to debate whether a lack of due diligence like this exposes the 401k plan sponsor to greater fiduciary liability.

As a matter of disclosure, if you click on the links to any of these titles, you’ll be sent directly to the Amazon page that allows you to purchase the book. If you purchase it on that page, you’ll be purchasing it through the affiliate program of Amazon which is linked to Pandamensional Solutions, Inc, the corporate owner of Fiduciary News. (The price is the same no matter which way you buy the book, so if you’d like to help fund this site, consider purchasing it through our affiliate link.)