Touching The Third Rail

August 06, 2007

Representative George Miller (D-Calif.) has stirred up a quite a fury with his new bill requiring all 401(k) plans to offer at least one broad-based index fund. Reading the response from the active fund industry, you'd think Miller had put us on the fast-track to socialism ... one day index funds, the next day gulags.

"Everybody should protest it (the proposed index fund requirement), because it's making a proclamation about investment returns that I'm not sure can be backed up," said Ed Ferrigno, vice president of Washington affairs for the Profit Sharing/401(k) Council of America, Chicago.

"The bad idea is some government bureaucrat mandating investments," said William Schneider, managing director, Dimeo Schneider & Associates LLC, Chicago. "There is almost nothing the government can't screw up."

Hell hath no fury like the active fund industry staring down indexed competition.

Frankly, I'm baffled. The bill doesn't require participants to choose index funds. It just says that one should be offered. To my mind, it doesn't go far enough - it should require a fund with average or below-average fees in its category.

The truth of the matter is that the government does a great job with index funds. The government-sponsored Thrift Savings Plan (TSP) is an excellent 401(k) plan - we should all be so lucky - offering a small number of low-cost index funds that investors can use to build a decent, diversified and low-cost portfolio. Detractors say it doesn't provide enough options, but studies show that adding options just confuses people and lowers participating rates ... so keeping it simple may be the best strategy.

TSP offers just five funds, tracking the following indexes:

  • Short-term Treasuries
  • Lehman Aggregate Index
  • S&P 500 Index
  • DJ Wilshire 4500 Completion Index
  • MSCI EAFE Index

Investors can also buy lifecycle funds that blend those five asset classes into Current, 2010, 2020, 2030 and 2040 target dates.

That's it! Five choices, or a "one-and-done" lifecycle plan.

And here's the real kicker: Fees on these funds are 0.03%. That's right -- 3 basis points -- even for EAFE.

I haven't seen performance statistics, but I'm guessing that both participation and long-term returns in the TSP are significantly higher than the industry average.

In fact, maybe Mr. Miller has it wrong, after all. Rather than requiring plans to offer one index fund, why not let any U.S. citizen opt out of their corporate plan and into the TSP?


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