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Chuck Talks to Us about Retirement Planning

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OK, so maybe it wasn’t Charles Schwab himself, but Walter Bettinger is the President and CEO of Charles Schwab, and he certainly has the authority to speak to us on Chuck’s behalf. On November 11th, 2013, Mr. Bettinger gave a speech to the National Press Club in which he outlined the basic problems facing the U.S. retirement system and how he would address them.

Like many before him, Bettinger lamented the demise of the traditional pension plan and the transition to the 401(k) plan in its place, and he acknowledged the reality that the 401(k) is here to stay and that we are never going back to the defined benefit pension plan. The problem, of course, is that it puts employees in the position of having to decide how much they need to save and how their savings should be allocated—tasks that the average worker is nowhere near qualified to perform. While the 401(k) has been beneficial to sponsoring companies (who eliminated a large expense by getting rid of their pension plans) as well as plan service providers, it has been an unmitigated disaster for the one group it was originally intended to help—workers. Regarding the current state of the 401(k) industry, Bettinger notes the following:

  • For half of the 60 million Americans who participate in a 401(k), it is their primary or exclusive source of savings.
  • More than half of the 60 million consider their 401(k) to be more complicated than their health care.
  • Nearly half have no idea how to invest their 401(k) account, and for nearly a third, it is a major source of stress.
  • According to the Investment Company Institute, the median 401(k) balance is slightly above $40,000.

For fixing the 401(k) mess, Bettinger makes two simple proposals. First, every 401(k) participant should be automatically enrolled for unbiased fiduciary advice that would address the questions of how much to save and how to allocate those savings. A qualified investment professional would help the worker avoid making catastrophic decisions such as selling out after the market has taken a large drop. It is difficult to overstate the benefit of a fiduciary advisor for plan participants. Schwab’s internal research determined that employees working with professionals have double the savings rate and far superior asset allocations than unassisted employees. A study by Financial Engines and Hewitt Associates found that a typical 45-year-old getting independent objective advice would have a 70% higher account value upon retirement.

Bettinger’s second piece of advice to the 401(k) industry is to cut fees, primarily by eliminating actively managed funds from 401(k) choices. Bettinger explains it in detail:

“The major service providers in the 401(k) world are principally asset managers who specialize in managing actively managed funds. That means that they charge anywhere between 0.75% and 2.0% per year to try to beat the market. Now we all know that study after study shows that only a tiny percentage of asset managers can actually beat the market, and an even tinier percent can do it year after year… This idea of beating the market does not need to be part of 401(k) plans. The goal in a 401(k) shouldn’t be beating the market. The goal should be offering a secure retirement with consistent performance.”

Bettinger hits upon the main reason why this seemingly modest proposal is so unpopular not only with asset managers but with plan consultants as well.

“Many of them [plan consultants] make their fees by telling employers that they are wise enough to select, monitor, and suggest replacements among these active managers that they somehow know which are the funds that are going to beat the market. Why do they hate what I am talking about today? Because no consultant is needed to monitor index funds—they simply perform at the index. The idea is simple—it is called self-preservation.”

And this is the reason why, although it is obvious that these reforms are needed, actually implementing them will not be a simple matter.

Bettinger cites internal Schwab data showing that if the total fees paid by plan participants were cut down to 0.5%, then the average participant would have $100,000 more in retirement. The 401(k) system as a whole would have an astonishing $10 trillion of additional savings by 2050. Of course, that means $10 trillion that is not going into the coffers of plan service providers, asset managers, and consultants. Bettinger stops short of calling for a government imposed solution to this enormous problem. He conveys his optimism that the industry will eventually do the right thing (having no other choice), and as he points out, “In the financial services industry, if you will simply do the right thing by your client, you will win.” These are words that we at Index Fund Advisors live by.