401(k) Shenanigans

I came across two interesting pieces on the sad state of the 401(k) industry in the past week. I'll talk about one today, and the other in a future post.

The lead story on last Sunday's edition of "60 Minutes" interviewed people who have lost a bundle in their 401(k)s as well as a main lobbyist for the 401(k) industry. It was interesting in that it really highlighted the fallacies that are trumpeted by both consumer advocates and the financial industry. I'll put my commentary in italics for reference.

On the consumer side, 60 Minutes grilled the lobbyist about the failure of the 401(k) system, asking how it served the 63 or 64 year old who had all their money in stock funds in their 401(k) and now can't retire in the next year or two. Someone is planning to retire in a year or two, and has everything in stocks? No cash or fixed income to lower volatility and provide income for retirement? A reasonable generic benchmark for allocation in retirement, without regard to one's unique individual situation, is half in stocks and half in fixed income. Even if someone used that old overly simplistic, mostly useless rule-of-thumb that '100 - your age is how much you should have in stocks' these people should have had more than half of their money out of the stock market last year.

A retirement plan consultant is quoted as saying the 401(k) system isn't fair to consumers because "the typical 401(k) investor is a financial novice. They don't know a stock from a bond." I don't disagree that 401(k) participants aren't astute investors, but how sorry should we feel for people who don't make the effort to educate themselves about their own financial well-being? Is the person who is obese because of eating fast food every day, does no exercise, and never goes to a doctor a 'victim' when he has health problems?

On the industry side, the lobbyist tried to lie and say that the financial industry is not opposed to fee transparency. When the interviewer called him on it and pointed out that Rep. George Miller (D-CA) hasn't been able to get a fee disclosure bill to the floor because (in Miller's words) he 'felt the full fury of that financial lobby', the lobbyist visibly choked on his words, saying "they want to keep things simple and not not make changes. They like things the way they are." Seriously? THIS is the answer to charges that the financial industry is ripping off working-class Americans - we like things the way they are? And the financial industry pays big money to lobbyists like him to convince lawmakers that the consumer doesn't deserve full disclosure of fees?

Congressman Miller, chairman of the House Committee on Education and Labor, is a staunch critic of the 401(k) industry, especially its practice of deducting more than a dozen undisclosed fees from its clients' 401(k) accounts. He showed the interviewer a prospectus and bet that after reading it the journalist would have found only half of the fees and commissions actually deducted from plan assets. I work with financial data for a living, and I bet I couldn't find all of the fees, either. And this document is supposed to 'protect' plan participants who are doctors, engineers, and tradesmen?

The bottom line is that individuals have to look out for themselves, and we can't complain when the average American spends more time planning their yearly vacation than they do their retirement. At the same time, the information to make educated decisions needs to be made available to regular people, who shouldn't need a degree in security analysis to figure out an investment plan and the costs associated with it.

Kroft, Steve. "Retirement Dreams Disappear with 401(k)s." 60 Minutes. April 19, 2009.

Roger Gibson on the Market Crash

Last summer I had the opportunity to meet one of the true thinkers in the financial advisory industry, Roger Gibson, and listen to him speak about developments in asset allocation theory since the publication of his seminal 1989 book "Asset Allocation: Balancing Financial Risk." He was interviewed recently in an industry publication and his commentary was thought-provoking as always. Some highlights:

In early 2009 his firm did a study of Morningstar's entire database of mutual funds: 3,734 invested primarily in U.S. equities, 978 invested in non-U.S. stocks, 144 in U.S. and non-U.S. real estate and 128 natural resource stocks. They found one U.S. equity fund that had a positive return in 2008. That's it. Almost 5,000 mutual funds, and all but one lost money.

He also talked about something this blog has discussed in the past: that the losses of 2008 were extreme, but not altogether unexpected. Using historical statistical mean and standard deviation figures, Gibson calculates that 5% (2.5% on the low side and the same on the high side) of returns in the market are expected to be more than two standard deviations from the average of about 12%; that is, higher than +52% and lower than -28% . (This assumes that returns are distributed on a relatively normal, although not exactly perfect, bell curve.) Looking back to 1926, market returns fell into the lower 2.5% of expected three years: 1931, 1937, and 2008. They also landed in the higher 2.5% of expected two years: 1933 and 1954. More proof that 2008 did not signify a new paradigm based just on poor returns.

The whole article only takes about 15 minutes to read, and is worth reading in its entirety. Find the link to it here on our website. I'll close with a direct quote from Gibson which should give optimism for those who have kept the faith in capitalism:

"During times of excessive optimism, people overshoot markets on the high side, and during times of extreme fear and panic, markets overshoot on the downside. In 2008, people panicked and dumped securities, which sets the stage for higher-than-normal rewards for people holding on."


Drucker, David. "Roger Gibson on the Market Crash." MorningstarAdvisor Online. March 26, 2009

What the Pros Said, Part III

In the fall of 2007, a prominent money manager and self-described 'contrarian' investor wrote in a Forbes article:

"Here are several stocks to look at:

CIT Group (CIT) is one of the nation's most diversified finance companies. Because of its small subprime business, CIT has dropped 34% from its June high. CIT presents good value at seven times trailing earnings, with a dividend yielding 1.4%.

One of my longtime favorite stocks is Fannie Mae (FNM), which I recommended last year and in my 2006 assessment column last winter and suggested that you keep it. If you don't own Fannie now, buy it. The company has taken its lumps in recent years, yet it should benefit from the subprime mortgage debacle. Fannie, along with sister entity Freddie Mac (FRE), has the industry's best mortgage acquisition standards, and a bucketful of cash."

And from his followup January 2008 column:

"You have to choose carefully here, since many financial stocks will not come back for a long time, if ever. . . . The safest plays are among the big banks."

"A panic puts a magnifying lens on risks, making them look much bigger than they are. Prime examples: Freddie and its sister agency, Fannie Mae. Freddie yields 3.1%."

"...I advise acquiring positions gradually. Who knows how close we are to the bottom of this very jumpy market? Still, those who buy bank stocks should be well rewarded over the next couple of years."

Outcome: Prices for the seven financial stocks mentioned in the January 2008 column, including Citigroup, Freddie Mac, and Wachovia, declined an average of 74.0% in 2008.

Dreman, David. "Panic No. 12." Forbes, October 15, 2007.
Dreman, David. "Seize The Day." Forbes, January 7, 2008.