The financial industry has continued to grow over the past 30 years, even throughout the Great Recession. In 2010 money flowing to financial services comprised an all-time high 9% of the Gross Domestic Product (GDP). Expansion of employer-sponsored retirement savings accounts managed by banks and financial services companies has fueled this growth. According to the Urban Institute, total financial assets invested in retirement accounts is now $10 trillion. This year, Wall Street has seen unprecedented growth, and the stock market has reached an all time high, despite the fact that the average American family continues to face financial challenges.
A recent PBS Frontline documentary uncovered how average consumers with actively managed employer-sponsored retirement plans are paying huge chunks of their retirement savings in fees to investment managers and financial advisors. The report, which focuses on data from a study by Demos, found that a median-income family pays $150,000 in fees over the lifetime of an average retirement plan. In fact, after adjusting for inflation, the average mutual fund management company collects approximately 50% of the total growth of the fund over the course of an account’s life.
Although actively managed mutual funds claim to collect, on average, approximately 1% in fees annually, that number is based on the total value of the fund, not on the value of the fund’s earnings. When mutual funds’ ratio of earnings are examined over a 40-year period, including hidden and compounded fees, and those earnings are adjusted for inflation, the average retirement savings fund plan is actually collecting about 50% of its earnings in fees. This includes 401(k)s, 403(b)s, 457s, IRAs, Koeghs, and SEPs.
According to the Frontline report, the fundamental problem with retirement savings accounts is that, more often than not, mutual fund managers and financial advisors work together to invest in such a way as to maximize profit for themselves and not their clients, the workers saving for retirement. The most common retirement account investment is called an “actively managed fund” in which an investment firm carefully selects a range of stocks and bonds and then actively trades these stocks and bonds on behalf of clients in an attempt to create an average return of approximately 7%. Since the firm is paid a fee for each trade, active trading generates more work and more fees that clients must pay. Because financial advisors and mutual fund companies earn more money through actively managed portfolios, they tend to market these more heavily than index funds. An index fund is a type of mutual fund that attempts to match the returns of a market index such as the Standard and Poor’s 500 or the Dow Jones Industrial. Ample evidence shows that index fund investments out-earn actively managed funds, require much less labor to manage, and are much more transparent for the consumer.
Despite the fact that an estimated 85% of financial advisors do not owe any fiduciary duties to their clients, many workers believe that their financial advisors have their best interests at heart. Instead, advisors who have no fiduciary obligations can, and do, use retirement savings accounts to maximize their fees. While attempts to require all retirement account managers to be fiduciaries have failed due to strong financial industry opposition, other efforts to make the fees consumers pay investment firms for managing their retirement funds more transparent have been successful.
On October 20, 2010, the U.S. Department of Labor's Employee Benefits Security Administration issued a final rule to help America's workers manage the money they have contributed to their 401(k) accounts, or similar retirement plan accounts, by requiring the disclosure of information regarding the fees and expenses associated with their plans. This participant-level disclosure rule requires plans to provide investment information in a format that enables consumers to meaningfully compare their plan's investment options—similar to the way that interest rates are disclosed by credit card issuers under the Credit Card Responsibility and Accountability Disclosure Act (CARD). A second and related fee transparency rule requires, in part, that certain covered service providers furnish specified information to plan administrators so that they in turn can comply with their disclosure obligations to participants. This second rule, published by the Department on February 3, 2012, requires disclosures to employers sponsoring pension and 401(k) plans about the administrative and investment costs associated with providing such plans to their workers.
As a result of these rules, plan administrators must provide plan participants with certain plan-related information and certain investment-related information, including an explanation of (1) administrative expenses, such as any fees and expenses for general plan administrative services that may be charged to or deducted from all individual accounts (i.e., fees and expenses for legal, accounting, and recordkeeping services), and (2) individual expenses, such as any fees and expenses that may be charged to or deducted from the individual account of a specific participant or beneficiary based on the actions taken by that person (i.e., fees and expenses for plan loans and for processing qualified domestic relations orders). Additionally, participants must receive statements, at least quarterly, showing the dollar amount of the plan-related fees and expenses (whether "administrative" or "individual") actually charged to or deducted from their individual accounts, along with a description of the services for which the charge or deduction was made. While these rules are a step in the right direction, 401(k) plans remain inherently unsuitable as the primary income supplement to Social Security for retirement since, in addition to high fees, they also pose a multitude of risks—such as losing one’s savings to a market downturn and outliving one’s savings—to workers’ retirement security.
The Shriver Brief has repeatedly highlighted the many ways that both the mainstream financial industry and the fringe financial market have found to get working middle- and lower-income Americans to hand over large portions of their paychecks. These include prepaid cards, payday loans, tax refund anticipation checks, overdraft fees, fees for checking and savings accounts, distribution of public benefits through electronic benefit transfer cards, and now, retirement savings accounts. Yet, most consumers are not aware of how their retirement funds can be drained. According to a recent study by NerdWallet, 9 in 10 Americans dramatically underestimated the amount of fees they incur through their retirement savings accounts. Most people thought the average lifetime fees were under $50,000, whereas in reality it is approximately $150,000 per household. Similarly, a 2007 AARP study on lay-person investment knowledge found that 65% of 401(k) account holders didn’t know they were paying any fees for their 401(k) accounts, and 83% lacked basic knowledge about what the fees were.
As wealth inequality continues to grow, it’s time to ensure that all financial managers and advisors are looking out for their clients and not their own wallets.