(March 11, 2014) – Roughly 16% of young US investors would
be better off opting out of their 401(k) plan and saving for retirement in a
retail index fund, a study has argued.
The fees charged by these defined contribution (DC) schemes would
outweigh the vehicles’
tax advantages over the course of a career, according to Yale School of
Management Professor Ian Ayres and University of Virginia Associate Law
Professor Quinn Curtis.
Their analysis of more than 3,500 DC schemes found an average fee premium of 86 basis points above a low cost index
fund. That spread would fall to 43 basis points for the typical member if he or
she chose the optimal 401(k) menu option.
data also cast doubt on the competitiveness and efficiency of plan fees,” Curtis
and Ayres wrote, noting that the problem of excess fees is especially acute in
small plans. “While we
find a strong relationship between the assets in a plan and the overall cost of
the plan, there is wide variation between similarly sized plans in terms of
A large DC plan on the high end of the fee spectrum would be
nearly twice as costly for members as comparably sized scheme on the low end,
according to the study.
While fees emerged as a “pervasive” problem among DC plans,
the researchers found that diversification was not. Investors could nearly top-out
the benefits of portfolio diversification using the typical employer’s 401(k)
options. For the plans included in the dataset, menu limitations shaved just
four basis points off of investor returns relative to an optimally diversified
However, the authors found that plan sponsors facilitated
poor allocation decisions as well as wise ones. Just over half (52%) of the
menus analyzed included at least one “clearly inferior” investment option. For
example, a plan offering two passive US small-cap equities products—one with
fees of 0.35% and the other costing 1.5%—would fall into this category.
While members are free to avoid such products, previous
research has indicated that investors tend to spread assets across whatever
options are on offer. By dropping “clearly inferior” menu items, plan architects
in Ayres and Curtis’ study could have cut schemes’ total cost by 11%.
advisors often defend their fees by claiming that they educate employees about
the importance of retirement savings,” the authors concluded. “But our results
suggest that high-cost plans are not inducing more employees to participate
more or to contribute more. In fact, they hint that the opposite may be the
case; it may be that costly plans discourage investor participation, reduce
investor contributions, and produce poorer allocation decisions.”
The full text of Ian Ayres and Quinn Curtis’ paper—“Beyond
Diversification: The Pervasive Problem of Excessive Fees and ‘Dominated Funds’
in 401(k) Plans”—is available here.
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