Why do 401(k)s breed such investor apathy?
Despite the best efforts and good intentions of the federal government, 401(k) investors remain stubbornly disengaged from their retirement plans. Most have no idea how much they are paying in fees and other expenses. Many assume naively that their plans are a free benefit or that the employer is paying all costs.
The U.S. Department of Labor, which has regulatory oversight over most types of employer-sponsored retirement plans, thought that more transparency about plan fees and investment choices would lead to more engaged investors. In 2012 they implemented new rules requiring 401(k) plan sponsors to disclose annually to plan participants how much the participants are paying in fees and other expenses and how the investments are performing.
The expectation was that disclosure would result in better informed plan participants and that better informed participants would make better investment decisions and encourage investor friendly changes in their plans. The results, however, have been underwhelming.
Nearly three years later there is little evidence that 401(k) participants are any more informed or engaged. Most still don’t know how much they are paying in fees and expenses. Almost certainly, many still assume that they are paying nothing.
The essential elements of the disclosure requirements are simple. Employers who sponsor a qualified retirement plan such as a 401(k) must disclose annually to the plan participants – their employees – basic information about the plan itself, the investment choices, and related fees and other expenses.
Plan related information should address the fees that are deducted from participants’ accounts for administrative services such as legal, accounting and recordkeeping services. Is the employer paying these costs or is the employee, and how much is it?
Investment-related information includes identifying the permitted investments, providing performance data and benchmark information and, most importantly, disclosing the fees or other expenses associated with the investments.
Disclosure is simple in concept, but problematic in practice. First, disclosure doesn’t follow any standardized format. This makes it difficult to locate the most critical information: how much does this plan cost? The most meaningful information – the numbers – typically is scattered throughout the text rather than neatly summarized in a table.
Second, disclosure documents are generally too long, often ranging from 10 to 20 pages. Third, there is too much legalese. Disclosures commonly include multiple footnotes or one or more pages of disclaimers and other notes – in effect, disclosures to the disclosures.
Fourth, participants suffer from information overload. Annual disclosures tend to get lost in the mix of other plan notices that are sent to plan participants over the course of a typical year. Like fund prospectuses and annual reports, the disclosure is largely ignored.
Too many disclosure documents look and feel like boilerplate. Consumers instinctively know that boilerplate is for the other party’s benefit, not their own. Boilerplate is designed to be ignored, not read. The current disclosures seem to be prepared not with the investor-participant in mind, but for the protection of the employer and plan providers.
Disclosure is the right thing to do but it has not been effective. The regulations were worthy attempt to move the needle on the financial literacy of plan participants, but there’s little evidence that it’s working. Plan participants, the employees, are mostly not paying attention.
How could this be done better? For starters, perhaps the whole discussion regarding plan disclosures is much ado over nothing. Investors aren’t paying close attention and perhaps they never will. Arguably there are bigger fish to fry.
Maybe it’s more important to get more employees participating by making retirement contributions and to get those already participating to contribute more. Maybe it’s more important to have a smart allocation plan than to fuss over fees. It is not uncommon to see plan participants over-allocate to money market funds and other “safe” investments rather than to asset classes like stocks with good long-term return prospects.
All the above are true, but adequate disclosure remains an important objective. Excessive fees can stunt investment growth and plan participants should know what they are paying. Over time, shining light on the issue should put downward pressure on plan fees.
Disclosures need to be simpler and easier to read. There is no reason, for example, why the most critical data cannot be summarized on one page.
In the meantime, if you have a 401(k) or 403(b), pay attention. The annual fee disclosure is a useful document with all its flaws. Read it and ask questions, or ask your advisor to explain it to you.
—————
David Peartree, JD, CFP® is the principal of Worth Considering Inc., a registered investment advisor offering fee-only investment and financial advice. Offices are located at 160 Linden Oaks, Rochester, N.Y. 14625; email david@worthconsidering.com.
