25 Years of Mediocrity

November 12, 2006

I'm not sure where Mr. Reid hangs out, but I live in, um, reality, where I have seen first hand a general culture of huge credit card and mortgage (and second mortgage) debt. THAT is reality, and I know it intuitively no matter how you want to spin the data. Even by the ICI's accounting, less than 20 percent of plans provide for automatic enrollment, and about one-third of workers don't participate at even the most minimal level when plans are offered to them.

And I'm sure you've all seen the ICI pronouncements about how expense ratios have continued to go down over the years. Here's the ICI chart on that:

Looks pretty good, right? Fees have PLUNGED. Let me show you another ICI chart. This one the is very first one that appears in their annual factbook, something that in itself is quite telling:

This shows that investors have over $9.5 trillion invested in registered investment companies (mutual funds), where they pay 1+ percent in fees annually, not to mention fund maintenance fees, transaction and other "soft money costs," etc. That amounts to around $95 billion in fees charged to investors in 2005. In 1985, when fees were at an ungodly 2+ percent, the total was around $12 billion in fees charged. So yes, fees have fallen, they BETTER have…that's what we call scale.

Unfortunately, the reduction in scales is still about four-times what it ought to be by one very rough measure. I took out an inflation calculator, and if you run the inflation calculator on the $12 billion in fees collected in 1985, it amounts to $21 billion in fees collected in 2005 (remember, the actual number collected was $95 billion). Sure, the growth in equitization and assets is worth something in maintenance costs, but is it worth an industry that is nearly five times bigger in real terms?

In short, a system where most -- not just many -- investors don't even have options with expense ratios under 1 percent, and where investors generally pay chunky built-in maintenance fees on top of that, is a broken system, and the recent reforms to the system are unfortunately too little, too late. We have worked ourselves into a morass of increasingly well funded interests that are essentially writing the laws governing retirement savings. Much like a medical system of unsustainably spiraling costs, there needs to be some vision and leadership in what should be a complete overhaul of the existing system.

I'm not saying that index funds or ETFs in 401(k) plans is a panacea…given a wide array of ETFs, many investors would probably try to trade them in their plans, and as we know, most investors couldn't trade themselves out of a paper bag. Still, low-fee, broadly diversified index options, which largely didn't exist when the current system was put together, would seem to be a basic first step.

We would favor regulations that would force every plan to have low-fee options, above all opening up 401(k) platforms to competition. And if we're going private, the plans need to default to 1) plan participation and 2) investment in a low-cost, broadly diversified fund. One of the few things the government has actually done well - the federal Thrift savings plan (www.tsp.gov) -- could be used as a model for a new overhauled retirement investment system.

Right now, all we're doing is building on 25 years of mediocrity.

 

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