Cover:What You Don't Know Can Hurt You
Unreasonably high expense ratios can get you into
trouble
Far fetched? Not according to a growing number of
experts, who point to suits by participants at First
Union (now Wachovia) and NY Life, and certainly not in
the wake of suits by participants at Enron, Lucent, and
WorldCom, concerned that employers hid information that
affected their investment decisions in the 401(k)
plans.
Granted, the First Union suits (now settled) and NY Life
suit (still pending) both involved allegations of
employers who limited participant choice to proprietary
fundsthat is, funds that benefited the employer directly
on a financial basis by requiring an investment in those
funds. However, what about the employers that are not in
the business of offering investment services? Surely,
they are insulated from such actions.
Not necessarily. However, even plan sponsors who are not
worried about participant litigation (there must be one
or two) might want to consider the following. The program
and/or fund choices you offer to your participants can
make a significant difference in their retirement
security.
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Equal Impact?
The reason is as simple as this. All funds are not
created equal. Prudent plan sponsors routinely examine
the risk/return characteristics of the funds in their
defined contribution programs. Generally speaking, those
returns are, in fact, net of expenses. However, that does
not mean that the comparisons yield a true
apples-to-apples comparison. Among actively managed
large-cap funds with at least three years of history,
mutual fund fees range from 0.31% to 2.90% (average
1.10%). Hewitt Associates consultant Pam Hess notes that
even indexed mutual funds (with at least three years of
history on Morningstar's Principia) have fees that range
from 0.03% to 2.95%, with an average of 0.51%.
How much difference might that make to a participant?
Well, if you are a participant with $50,000 invested, and
you assume an annual growth of 8% per year, Hewitt's Hess
notes that investing in a fund with 0.50% fund expenses
would yield $263,000 at the end of 30 years. However, if
your investment were in a fund that had 1.25% in fund
expenses, the ending wealth value would be just $228,000.
That 0.75% difference in fund expenses adds up to a 15%
difference in return for the participant. These days, it
is not hard to imagine a scenario where some enterprising
attorney appears in court alongside a participant who
will argue that his retirement has been diluted by fees
taken from his accountfees that his employer, either
deliberately or through some fiduciary oversight,
sanctioned.
That is where fiduciary concerns should kick in. A
surprising number of plan sponsors are not aware of what
they are paying for the services they receive, despite
volumes of disclosures. One cannot even imagine a request
for proposal that does not call on the bidding vendor to
offer a detailed schedule of fees for services bid upon,
for example. Moreover,
there is no shortage of mutual fund prospecti in which
the various and sundry fees and expenses netted against
fund returns are displayed in excruciating detail.
Still, many plan sponsors remain ignorant of what Hewitt
has termed their "Total Plan Cost," the aggregation of
costs related to investment management, recordkeeping,
and trusteeship that comprise about 95% of the total
costs, according to Hewitt consultant Tim Murphy.
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