Coming Soon to Your 401(k): Advice?
On Monday the Department of Labor issued new rules that are likely to expand the number of 401(k) participants who receive investment advice. But how much will retirement plan participants benefit?
Under the old rules, retirement plan providers (i.e. mutual fund managers) were required to hire an independent third party to provide advice for plan participants. This restriction -- put in place to prevent fund managers from offering self-serving recommendations that padded their own wallets -- had the functional effect of limiting advice to participants in only the largest retirement plans; plans that were large enough to justify the expense of hiring a firm like Financial Engines or Morningstar to provide advice.
The DoL's new rules allow the plan provider to offer advice themselves, as long as they meet one of two requirements that are designed to minimize their conflicts of interest. Either the fees they receive must not vary based upon their recommendations; or the advice must be generated by a computer model that's been verified as unbiased.
So is this great news for investors? Perhaps.
There's little doubt that a great deal of 401(k) participants would benefit from good, fundamental advice. I wrote last month about a study (conducted, admittedly, by a firm that offers advice) which found that 401(k) investors who received advice outperformed those who didn't by nearly three percent per year. That, combined with the new rules, is good news, right? Of course. But before we do an end zone dance and declare that we're finally on the path to resolving our nation's retirement crisis, let's keep a few things in mind.
Under the DoL's proposal, the independence of the advice will be confirmed by an outside auditor, whose job it will be to make sure that the advice being provided isn't somehow being colored by monetary incentives. Perhaps I've grown overly cynical but I'm not entirely sold on the ability of regulators to root out behavior that financial services firms have a large monetary incentive to obscure. (See: Mortgage crisis.) When the stakes are sufficiently large, boundaries get stretched, envelopes pushed -- it's human nature.
Also, the value of this advice will depend almost entirely on how successful it is at getting clients to a) construct a well diversified portfolio of low-cost stock and bond mutual funds; and b) avoid doing something stupid like bailing out a the market's bottom or loading up at the market's top. That's it. There's no hocus pocus; no black box from which participants will learn the secret to market-topping performance.
Given this, as I read over the DoL's release (available on their website if you're a true glutton) in which they described the new rule in painstaking detail, along with all of the comments they did or did not decide to address, with painstaking detail on those decisions, I kept thinking that we were making it all about a thousand times more complicated than it has to be.
The DoL already allows employers to auto-enroll employees in retirement plans, and to use target date funds as default investments. Why not view those target date funds the same way many fund managers do -- as embedded advice products -- and provide some simple restrictions on what they can own and how much they can charge?
Every plan participant, by default, would be invested in an age-appropriate target date fund, which in turn is composed of broad based index funds that own the entire stock, bond, and international markets, with fees capped at, say, 30 basis points.
If you want to get really restrictive, make participants demonstrate a basic competency in investment fundamentals before they're allowed to take over the wheel.
That's it. No conflicts of interest to navigate, computer models to vet, or independent auditors to hire. Instead, a solution that's simple, straightforward, free of conflicts and, oh by the way, likely to end up providing returns that outpace the returns produced by the vast majority of the alternatives, advised or not. Too simple, alas, to be recommended by either Wall Street of Washington.
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