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Focusing on 401(k) Fees Can Help Build Retirement Savings

They say, “What does not kill you will make you stronger.” Most 401(k) investors may agree having survived the bursting of the equity market bubble and a double-whammy of a few high profile corporations cooking their books and mutual fund misdeeds where some privileged investors got preferential treatment at the expense of the rest. However, the majority of these investors are left grumbling about how to rebuild their retirement fortunes and what will be the next investment hurdle.

If not the next hurdle, a recent Saint Paul Pioneer Press headline gave investors sage advice: “Don't fret the fund, fret the fees.” By paying attention to fees, 401(k) investors may not have to invest additional money, or try to find the next new, savvy investment, or look for the return of the go-go nineties of the stock market. They may be able to stop a slow and unnecessary erosion of their hard-earned retirement savings.

Although it seems counter intuitive to the American anthem, “You get what you pay for,” Hewitt Associates' defined contribution plan consultant, Pamela Hess points out, “Higher cost funds do not necessarily equate to better performing funds; typically it is just the opposite because costs eat into returns.”

Two recent studies by Standard & Poor's and Morningstar show higher cost mutual funds do worse on average than less expensive funds. As institutional investor guru, Charlie Ellis has explained for years, it is very difficult for investment managers to outsmart their competitors, let alone the financial markets. Plus, the elusive edge of higher returns is also reduced by fees.¹

Reducing fees can increase plan balances by hundreds of thousands of dollars. Let's look at an example: a 35-year old with $100,000 balance in her 401(k). Let's assume fees average 1.5% and gross returns average 8% for the next 30 years. At age 65, her 401(k) will have grown to $660,000, and if fees are cut to .5%, her 401(k) will grow to $875,000. That's $215,000 in additional retirement savings.²

According to Hewitt Associates, plan sponsors are taking the Pioneer Press' sage advice. In a survey of 140 employers with 401(k) plans covering 1.9 million employees, Hewitt found that 60% of plan sponsors said they were going to reduce fees with particular emphasis on investment management fees since these fees typically make up 70 to 80% of 401(k) costs.

The focus on fees should bode well for stable value funds from both a plan participant and plan sponsor perspective. Stable value funds have long-been the tortoise to the mutual fund world's hare. As the consistent plodder to the mutual fund hare, stable value funds have produced consistent, predictable returns in a cost effective manner.

Focusing on Stable Value Management Fees

SVIA recently surveyed 11 stable value managers on investment management fees. SVIA requested fees for stable value portfolios with up to $100 million in assets, with $200 to $499 million in assets, and $500 million or above in assets. Fees averaged .22% for portfolios with assets up to $100 million, .14% for portfolios with assets between $200 to $499 million, and .11% for portfolios with assets $500 million and above.³

While stable value management fees are competitive to the management fees in mutual funds, there are some differences to note. First, the management fees represented in the SVIA survey excludes a vital charge: the wrap fee, which provides the fund's protection or insurance that principal and accumulated interest, will always be provided. The wrap fee for a plain vanilla a wrapper contract averages between .08% to .10%. Second, the stable value management fees noted above do not include embedded fees in stable value portfolios underlying investments like such as guaranteed investment contracts (GICs), which typically make up about to 30% of all stable value investments today's average stable value fund portfolio.

Even with those cautions, stable value's investment management fees are a bargain compared to the typical 401(k) mutual fund fees according to a recent article in the ABA Banking Journal. The article reported average management fees for stable value fund competitors—money market funds and bond funds. The article reported fees for money market funds at 1.37%, long-term governmental bonds at .95%; intermediate governmental bonds at 1.15% and short-term governmental bonds at 1.03%.⁴

Institutional Funds Provide Economies of Scale

Stable Value funds illustrate another truism found in the Hewitt survey. That is separate accounts or institutional collective trusts offer lower expenses than most mutual funds. While only larger plans can take advantage of the separate account pricing, institutional collective trusts can use the power of big numbers to get similar economies of scale for smaller plans in search of a stable value option. Both fund structures avoid the marketing and communication charges inherent with mutual funds. Lastly, because stable value is so stable, calculating a daily NAV (net asset value) is easy, which also reins in cost compared to a mutual fund.

Disclosure: Spotlight Fees

Getting at fees can be tough even for public defenders like New York General Eliot Spitzer who has put the legal spotlight on mutual funds. He has found that “fees are poorly disclosed and investors deserve to know what these expenses are for.”

The 401(k) community has long struggled with this dilemma. The Department of Labor's Employee Benefit Security Administration (EBSA) has tried to encourage simple and meaningful disclosure of 401(k) costs only to find the process complicated by the different ways pension programs are put together and the various ways investments may be structured. The costs of bundled programs that may combine trustee, administration and management fees into one package, for example prove hard to evaluate for some plan sponsors.

In a 1998 report, the EBSA found that, “The literature reports that the disclosure to sponsors and participants of fees and expenses imposed on 401(k) plans is often not complete and that this lack of information may affect the costs to the plans. Incomplete disclosure may take the form, for example of the failure of the provider to disclose the fees used in the internal build-up of net asset values (NAV).” EBSA found this problem particularly vexing for stable value funds because of the difficulty of breaking out GIC costs, which at that time, comprised about half of the average stable value funds' portfolio. In fact, they use stable value funds as an illustration of this problem.⁵

Stable Value Fee Disclosure: Template for Information

View Stable Value Fund Fees in XLS (32 kb)

To borrow from Senator John Kerry's campaign or the movie, Mrs. Doubtfire: help is on the way! A working group led by JPMorgan 's Fleming's and SVIA Chairwoman Victoria Paradis developed a fee disclosure template unique to stable value to demystify stable value's fees. The disclosure template, which is provided as an illustration, attempts to provide uniform, meaningful information in a concise and simple manner for the major costs associated with the different variations of stable value funds.

Since the release of the template last summer, the response has been encouraging. Plan sponsors have commented that the template is very helpful in providing thorough information on their stable value fund. David Wray, President of the 401(k)/Profit Sharing Council and Chairman of the ERISA Advisory Council, an advisory group to the EBSA applauded the template for tackling this tough issue and untangling some of the costs associated with stable value.

Don't Lose the Forest for the Trees

While the improved disclosure provides a necessary tool for plan sponsors and participants to evaluate and compare investments, they are not a panacea. This is especially true when comparing an investment in one asset class to another. In such cases, you may be able to find the exception to Hewitt's observation that high cost funds do not often produce higher net returns. Of course, you may actually find the best of both worlds, a low cost investment that generates high gross returns.

When you compare the level of net returns for stable value funds with its competition: money market and bond funds, you'll see why stable value is attractive to retirement savers: solid, conservative returns with competitive fees. However, don't let that forest of information obscure what 401(k) investors know, unlike other investments, stable value provides an additional assurance of principal preservation, which explains why it is one of three core investments (stocks, employer stock and stable value) for 401(k) investors.

¹Gail Marksjarvis, “Don't Fret the Fund, Fret the Fees,” Saint Paul Pioneer Press, June 15, 2004, Business section, page 1C.

²Ibid, June 15, 2004, Business section, page 1C.

³Stable Value Investment Association, “Stable Value Management Fee Survey,” February 2005.

⁴Stephen B. Whipple, “401(k) Savings Plans or Shell Game?” ABA Banking Journal, April 2000, Section Forum, page 79.

⁵Economic Systems, Inc., “Final Report, Pension and Welfare Benefits Administration, Study of 401(k) Plan Fees and Expenses,” April 13, 1998.

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