If you missed Last Week Tonight with John Oliver: Retirement Plans (HBO) and his account of trying to set up a 401k plan for the show's staff, watch it here. This is part TWO of the highlights along with our commentary...and this time points out where our pal went a little off course.
In the last post we talked about how it's insane that any financial advisor could get away with selling a 401k plan to a business and not really providing any worthwhile services in exchange for the payment! Inexcusable! I'll stand by that all day. Now for three items that need more exploration.
Active versus Passive Management
Oh my, that was a terrible MFS commercial that he aired! However, there's been a looooong debate about whether having a person/team analyze stocks or bonds and make selections in a portfolio can get superior returns over just buying a slice of the market, also known as a passive index fund.
Let's first talk about how those studies were constructed. They took ALL of the actively managed mutual funds out there, lumped them together, and found the majority don't beat the market. But, that's like taking every type of moving vehicle with four wheels, no matter how rinky-dink, lining them up on a start line, and seeing which ones can beat an older model Honda Civic -- with no regard to their quality, the driver, how the ride felt, or what was under the hood. Some will beat the Honda, some won't. Some will make your teeth rattle out of your head too.
The same goes for mutual funds. There are stinky ones out there, and then there's a chunk that has performed better than the market. The debate isn't so clean cut, as outlined here in Baron's, and, adjusting the experiment to account for for certain parameters, active does beat passive, as you can read about here, here, and here. In fact, certain asset classes show a strong case that active beats passive.
(Before you complain that two of those white papers were written by actively managed investment companies, who do you think sponsors the studies that show that passive wins, hmm?)
Perhaps an obvious statement is that what matters MOST is that a person ACTUALLY SAVE THE MONEY. (Or, as John Oliver suggested, get a time machine and go back 10 years and start saving.) If you don't save the money, it doesn't matter which investment vehicle you choose.
Fiduciary versus Non-Fiduciary
It's our belief that if you manage an employee retirement plan, you should have fiduciary responsibility. End of story. But here's the thing that the end satirical commercial on John Oliver's show mentioned... in the part where they recommended you ask your advisor if they're a fiduciary or not, the spokesman mutters "WTF is a fiduciary" as he walks away.
Let's clear that up.
We believe any financial advisor/consultant who gives investment advice on an employee retirement plan, such as a pension or 401k, should ALWAYS be a fiduciary. That's how the Employee Retirement Income Security Act operates and financial advisors are the prudent experts being hired to help with the investments and decisions on whether employees leave their money in the plan or roll it out elsewhere when they leave. The employees need unbiased counseling. That comes from a fiduciary. Period.
Where it gets muddy: financial planning services. Insurance, annuities, and lots of products that you might need to have in place in a complete financial plan can't necessarily be sold by a fiduciary. (Neither can taking a company public or issuing bonds or several other financial transactions.) So, there's still a place for the traditional broker, and even in the world of financial planning too. Charlie Epstein explains it best in his video. The most important thing is you understand the nature of the relationship you have with the financial professional providing your financial planning, you understand the fees you're paying, and that you get a plan in place that is based on your best interest.
It's true that fees eat away at the assets an investor has, and thus can reduce the amount available later in retirement. However, if you want a retirement plan at a company, there are fees associated with that... because you're paying to get something in return. If you want advice and guidance regarding what to do with money to achieve goals, again, there's a fee because you're paying to get something in return. So, paying reasonable fees is the name of the game. The fees that were charged by John Hancock in John Oliver's 401k scenario very well could have been reasonable. (John Hancock published an open letter saying they were.) However, we got the information in a vacuum without any context as to what was being provided.
One thing that the John Oliver show didn't mention is that investment performance of mutual funds is reported NET of fees. Yes, they reduce the absolute return in the same way that taxes reduce your gross paycheck. Sadly, there is no free lunch. If you by an investment product, you will pay fees for registration, custody, and trading. If you buy a corporate retirement plan, you will pay fees for quality reporting, timeliness of information, accuracy of information, someone to pick up the phone and answer questions, the IT department to support the website and recordkeeping system, an attorney to review the documents, and the list goes on and on.
Fees are only an issue in the absence of value. YOU are the judge of the value that you (or your company) want and need. If crappy service is ok, go with the cheapest option. If you want bells and whistles, find them at a reasonable price. And that is where John Oliver fell short in both his explanation and understanding of the 401k world.