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Cutting Investment Fees – A Key To Secure Retirement?

Charles D. Ellis wrote a thoughtful article in the Financial Analysts Journal recently about the hard choices that people– and institutions – must face sooner than later regarding retirement and pension systems.

One of the main facets of the article’s thesis:

We need to make hard choices on how much to save, how long to work, how to invest, and how much to draw from our savings for spending in retirement.

The article is full of great discussion on these points. After someone stops working, a big part of their financial security stems from controlling costs – not just living expenses, but investment expenses, as well.

From the article:

Most investors somehow believe that fees for investment management are low. Fees are not low. Here’s why: By convention, fees are shown as a percentage of the assets, say, just 1%. But that’s seriously misleading. The investor already has the assets, so the manager’s fee should be stated as a percentage of the benefit (i.e., returns).

If returns are 7%, then the same fee in dollars is 15% of returns. And because index funds deliver the full market return with no more than the market level of risk for a fee of 0.1%, the real cost of active management is the incremental cost as a percentage of the incremental benefit of active management. That’s why the true cost of active management is not 1% or even 15%. Because the average active manager falls short of his chosen benchmark, the average fee is more than 100% of the true net benefit.

Increasingly, investors are learning that one way to reduce costs—and increase returns—is to save on costs by using low-cost index investments, particularly with their 401(k) or other retirement plans.

How your retirement funds are invested is important because many of those dollars are invested for a very long time—20, 40, even 60 years.

The article, titled “Hard Choices: Where We Are”, is available for free from the Financial Analysts Journal.

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Study: Retirement Savings Have Grown Across All Age Groups Since 2007

Data shows that nest eggs, on the whole, are smaller these days. But a recent survey suggests a bit of good news: since the financial crisis, median retirement savings across age groups have grown by leaps and bounds.

From the Christian Science Monitor:

Despite all the attention paid to insufficient total savings, median retirement savings among working-age households have grown considerably over the past five years, according to the 15th Annual Retirement Survey from the Transamerica Center for Retirement Studies. The survey tracked median retirement nest eggs among employed American baby boomers, Generation Xers, and Millennials between 2007 and 2014. For each age group, median savings either doubled or tripled within that seven-year span.

“We’ve seen a healthy increase in savings for employed people,” says Catherine Collinson, president of the Transamerica Center for Retirement Studies based in Los Angeles, in a phone interview. The recession, she notes, “set off the alarm bells in a way that they weren’t ringing before and took [saving money] to a new level of urgency, and that’s a good thing. If we look at the national dialogue, it’s difficult to turn on the Internet, TV, or radio without hearing some form of conversation about the need for people to plan and save and think about their loved ones.”

Millennials, perhaps predictably, reported the most robust savings growth of the three groups, more than tripling their savings from $9,000 in 2007 to $32,000 in 2014. Xers, the first of whom will start turning 50 next year, doubled their nest eggs, from $32,000 to $70,000. For boomers, median savings increased from $75,000 to $127,000.

There are a host of reasons for the savings increase. Perhaps the biggest is that in a world where defined-contribution plans are overtaking defined benefit plans, the bullish stock market has been a boon for 401(k)s.

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Time To Blow Up the 401(k)? These Researchers Think So

A recent white paper by Russell Olson and Douglas Phillips, investment officers at the University of Rochester endowment, argues that its time to blow up the 401(k) plan and replace it with a new system—“Trusteed Retirement Funds”.

From Main Street:

The researchers say it’s time to simplify the system, noting that over 40 years more than 14 variations of employer-sponsored defined contribution (DC) retirement plans have evolved, including 401(k)s, 403(b)s, SEP IRAs, SIMPLE IRAs, Roths, Keoghs and more.

“Their proliferation has been complex and bewildering. Each has its own deduction or contribution limits, distribution restrictions, and nondiscrimination rules, and there are many variations of each vehicle,” Olson and Phillips write. “Some are available through employers, others not. Some workers have retirement assets in multiple DC plans as they change employers. While the details for each vehicle seemed to make sense when created, the resulting rules and options can be confusing for many workers, and this confusion can lead to insufficient or poorly invested savings.”

“Without radical reform, our nation will have a rapidly growing percentage of impoverished elderly in need of government support,” they say.

Citing the examples of countries with successful retirement strategies, the authors note that Australia, Denmark, Netherlands and Switzerland all mandate high-percentage employee deferrals to savings plans – without offering an “opt-out” choice.

“We don’t believe Americans would agree to the mandating of large pension contributions in addition to what we already contribute to Social Security (through FICA taxes),” the researchers admit. “But we believe we can best meet the challenge by establishing high levels of retirement contributions by employees to Trusteed Retirement Funds, from which employees have the right to opt out. And by adapting the best of Australia’s superannuation concepts, we can sharply improve the effectiveness of our retirement savings.”

More details of the Trusteed Retirement Fund from Main Street:

The “Trusteed Retirement Funds” would have several key features, including:

– Supervision by a fiduciary trustee with strict requirements regarding investment objectives and fees

– Employee contributions would automatically increase by 1% every time an employee received a pay raise, unless the employee directed otherwise

– At retirement, a portion of the assets would be placed into a deferred annuity to provide for guaranteed income later in life, unless the participant declined the option

Employers would have fewer responsibilities under this new system, and participant education would be mandated – and provided by the government, as it is in Australia.

Read the white paper, which was written last June but released this August, here.

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Pension Policy: Taking Stock of Where Florida’s Candidates For Governor Stand

Pension policy has become an important issue in the race to be Florida’s governor, and the two major candidates (incumbent Rick Scott and challenger Charlie Crist) both have very different views on how the pension system should be altered, or not.

A rundown of their respective positions, from the Ocala Star Banner:

If Rick Scott is re-elected, you can expect a renewed push to move more public workers out of the traditional pension plan and into a 401(k)-type plan — which is currently an optional plan in the retirement system.

It was under Scott that public workers began making an annual 3 percent contribution to the state retirement fund in 2011. Scott’s criticism of the current system includes keeping a list of public workers who qualify for more than $100,000 in annual pension benefits on his state office website.

Under the changes, employees can choose whether their contributions and state contributions go into the traditional pension plan or into a 401(k)-type plan in which they can direct the investments.

If Charlie Crist wins, he is more likely to side with major labor unions that are supporting his campaign, including the Florida Education Association, which argue that Florida’s pension plan should not be changed.

The positive returns on the pension fund for the fiscal year that ended in June will bolster the argument that change is not needed.

Florida’s pension funds returned 17.4 percent in fiscal year 2013-14.

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