Why are high 401k fees maintained in competitive equilibrium

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rca1824
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Why are high 401k fees maintained in competitive equilibrium

Post by rca1824 »

I have been thinking about this issue very deeply lately. I cannot understand how high-fee 401k providers survive in a competitive market. Why doesn't the company simply choose a low-cost provider, such as Vanguard or Fidelity? Why do they go with horrible companies that gouge employees with 1-2% fees? What is failing in the market here? Is it because the company is just too lazy to make a good decision, since the company doesn't directly benefit, and they know that no employee will switch firms over a lousy 401k plan?
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
sport
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Re: Why are high 401k fees maintained in competitive equilib

Post by sport »

Companies choose those plans so the employees will pay the fees instead of the employer. This makes it a low cost plan for the company. The plans that are low cost for the employees generally cost the employer more than the other ones. In other words, someone has to pay the fees.
Jeff
EarlyStart
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Re: Why are high 401k fees maintained in competitive equilib

Post by EarlyStart »

rca1824 wrote:I have been thinking about this issue very deeply lately. I cannot understand how high-fee 401k providers survive in a competitive market. Why doesn't the company simply choose a low-cost provider, such as Vanguard or Fidelity? Why do they go with horrible companies that gouge employees with 1-2% fees? What is failing in the market here? Is it because the company is just too lazy to make a good decision, since the company doesn't directly benefit, and they know that no employee will switch firms over a lousy 401k plan?

Perfect competition only exists in theory and models. Even within the constraints of perfectly competitive markets, people derive utility from all sorts of things, not just expected return. Also, everyone's interests are not always aligned.

Nonetheless, I agree with your sentiment here.
Rysto
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Re: Why are high 401k fees maintained in competitive equilib

Post by Rysto »

I think that a comparison to Canada might be instructive here. In Canada, there really isn't any equivalent to a 401(k) plan. Instead, we have accounts that are very similar to the tIRA and Roth IRA, but the tIRA equivalent (the RRSP) has a contribution limit that's much higher, and more in line with the 401(k) limits. Also, RRSP contributions in Canada are deductible for all taxpayers; there's no such thing as a non-deductible RRSP.

In Canada, it is certainly quite simple to open an RRSP with a discount brokerage and get access to a wide range of investments. The low-cost segment of the market is not very well served by mutual funds here in Canada for whatever reason, and ETFs dominate the index fund market. On the other hand, if you do what I did when I first started investing for retirement and go to your local bank to open an account, you will almost certainly find yourself signed up with the bank's mutual fund provider, paying an annual MER somewhere between 2% to 3% (no, seriously). I can assure you that a great many people end up starting as I did, but pay those MERs all of their lives.

I definitely believe that it is a serious problem that individual employees don't have choice in 401(k) providers and that contributes to high cost 401(k)s. However I think that the larger problem is a lack of knowledge both on the part of the general investing public and the people selecting the 401(k) provider.
livesoft
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Re: Why are high 401k fees maintained in competitive equilib

Post by livesoft »

Because the plan provider is run by the brother-in-law of the company owner perhaps?
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rca1824
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Re: Why are high 401k fees maintained in competitive equilib

Post by rca1824 »

EarlyStart wrote:Perfect competition only exists in theory and models. Even within the constraints of perfectly competitive markets, people derive utility from all sorts of things, not just expected return. Also, everyone's interests are not always aligned.

Nonetheless, I agree with your sentiment here.
Competition exists in reality, also. For example, when I shop for an IRA, I can choose a low cost provider like Vanguard. Vanguard serves the need of low-cost investment funds. Competition also thrives in millions of other markets.

And it is not enough to say that competition doesn't exist. Only a theory can kill a theory. So what theory explains why 401k fees are so high? I think other posters gave a much more informative response.
jsl11 wrote:Companies choose those plans so the employees will pay the fees instead of the employer. This makes it a low cost plan for the company. The plans that are low cost for the employees generally cost the employer more than the other ones. In other words, someone has to pay the fees.
Jeff

This is a really, really interesting response. It makes sense why firms would pass the costs on to employees if employees are ignorant. But in competitive equilibrium, the total compensation should be the same, as new firm creation competes economic profit back to zero. So higher 401k fees are accompanied by higher wages and the employee is no worse off.

Unless of course it's not a simple passing of costs, but a passing and an amplification of cost. That is, when the employee gets charged instead of the firm, are the total 401k costs higher? I would suspect so. Standard 401k fees are in the 1.5% ballpark. Vanguard is 0.05%. I doubt that if an employer hired Vanguard to be their 401k broker, Vanguard would charge the firm 1.45%... or do they?

So then the end result is rent-seeking by the 401k brokers and a deadweight loss as more people go into the 401k brokerage industry to capture these excess fees.
Rysto wrote:On the other hand, if you do what I did when I first started investing for retirement and go to your local bank to open an account, you will almost certainly find yourself signed up with the bank's mutual fund provider, paying an annual MER somewhere between 2% to 3% (no, seriously). I can assure you that a great many people end up starting as I did, but pay those MERs all of their lives.
Then that's very similar to the IRA market here. Despite free choice, many ignorant investors are suckered into high-fee funds. But the key difference between the 401k market the IRA market is that in the IRA market at least investors have a choice, so the sophisticated investors can exercise that choice and benefit, and it also creates an incentive for the ignorant investor to educate himself. In the long run, as investing knowledge becomes more widespread (as I believe it is--practically all my friends know about index fund investing), competition will eventually eliminate all high-cost providers in the market. The 401k market on the other hand faces far fewer of these competitive pressures because of broken incentives in the principal-agent problem.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
dbr
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Re: Why are high 401k fees maintained in competitive equilib

Post by dbr »

I have the impression megacorps are very sensitive to peer comparison of compensation and benefits and consequently tend to have very competitive low cost plans. I could be wrong.
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JamesSFO
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Re: Why are high 401k fees maintained in competitive equilib

Post by JamesSFO »

rca1824 wrote:Unless of course it's not a simple passing of costs, but a passing and an amplification of cost. That is, when the employee gets charged instead of the firm, are the total 401k costs higher? I would suspect so. Standard 401k fees are in the 1.5% ballpark. Vanguard is 0.05%. I doubt that if an employer hired Vanguard to be their 401k broker, Vanguard would charge the firm 1.45%... or do they?
It's tricky, there is something of a fixed cost of offering a 401K plan which is on the order of say $2K/year minimum. Someone has to bear that cost. If you go to Vanguard and you are a small employer they will try to send you somewhere else because their minimums start around $3-6K to run the plan for you with Ascensus. On a small plan that could easily be >1%.

Arguably some of the problem is that 401Ks are heavily regulated and the testing and compliance requirements drive costs up.

But, as you get larger, e.g. >1K employees, the costs do not keep increasing in the same ways and you also if your HR department is serious can get you amazing options like institutional funds, etc.

There are services like Brightscope that help employees AND employers get a better sense so some market transparency is coming.
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rca1824
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Re: Why are high 401k fees maintained in competitive equilib

Post by rca1824 »

JamesSFO wrote: It's tricky, there is something of a fixed cost of offering a 401K plan which is on the order of say $2K/year minimum. Someone has to bear that cost. If you go to Vanguard and you are a small employer they will try to send you somewhere else because their minimums start around $3-6K to run the plan for you with Ascensus. On a small plan that could easily be >1%.
Depends what we mean by "small". I've worked at a 250-person company where each quarter I would get a 401k report in the mail which would state the plan's total assets. I think it was around $10 million ($40k par capita). A 1.5% annual fee on $10 million is $150,000/year. That's 25x your top-end estimate of $6k/year. I now work at a 100-person company that has a different broker and the fees are still 1.5%.

Could it depend on industry? I work in software, but my friends in the financial sector, even the ones who work at small, 30-person firms, have access to 401ks at Fidelity and other low-cost providers. Maybe people in software are just more ignorant. But they should have a finance department that knows these things?
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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TomatoTomahto
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Re: Why are high 401k fees maintained in competitive equilib

Post by TomatoTomahto »

Competition in the 401k space reminds me of competition in cable. For most people, switching to a different 401k provider means switching employers, which is as unlikely a tactic as moving from your home in order to switch from Comcast to Time Warner.

Fwiw, I know that Verizon changes the picture (ha, pun!) on competition in some areas. I cannot get a satellite view at my house, so that's not a factor.
I get the FI part but not the RE part of FIRE.
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Re: Why are high 401k fees maintained in competitive equilib

Post by ERISA Stone »

I know it will fall on deaf ears (or skeptical ears?) so I'm hesitant to even make the comment - but retirement plan administration is not a commodity, or maybe I should say the service of the administration is not a commodity.

A few thoughts off the top of my head:

Vanguard is a horrible company to work with within the industry. Several companies I have worked for literally charged clients a premium if Vanguard were the custodian of their assets. It may have changed because I don't think I've touched a Vanguard plan in 4+ years but their reporting is atrocious and they do not do a good job of providing information/reports to parties in a timely manner.

From the TPA perspective, you can absolutely spend more money and get a more customized plan, most times to the benefit of the owner. IMO, you probably don't want a low cost provider setting up these plans because the likelihood that they've actually been trained on how to design plans/maximize plan benefits is low. Most of the people who work in low cost settings are good at operations and processes, and focus less on the nuts and bolts of regulation within the industry. I see several people comment on this website alone who could benefit from spending a little more $$ upfront to create an efficient retirement plan for their particular need but they are so skeptical of spending $$ on the benefit that it's pointless to even mention it.

Most low cost TPAs do what we call "garbage in, garbage out," meaning they take the data you provide at face value. They don't check it. Premium TPAs scrub your data to minimize the probability of errors, which in turn, reduces big issues down the road. Premium TPAs ask questions, most low cost providers don't. It's terrifying some of the lack of quality in things like testing, vesting issues, etc, I see when we take a client over from, most times, a low cost provider.

As with virtual every service industry, some websites are easier to navigate and are more intuitive for the end user. There is generally an extra cost for this added benefit but some employers would rather have this feature than go with a low cost provider.

I have also worked with many financial advisors that are absolutely worth the basis points they charge each quarter. Everyone on here just sees someone who offers overpriced investments but don't consider that an advisor that is valuable does so much more. I don't have an FA because it's just me and my wife and we're newbie bogleheads. However, the moment we have another participant in the plan, I have a list of FAs on hand that I will call to discuss hiring and will have zero issue with their fees. I see the significance in having a solid FA.



This isn't really an appeal to for you to realize the value of a higher cost provider. Most of the time, there is more value. You just don't have the utility for it. It's the same as someone who drives a Lexus even though a Toyota it serves the same function.
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Re: Why are high 401k fees maintained in competitive equilib

Post by rca1824 »

TomatoTomahto wrote:Competition in the 401k space reminds me of competition in cable. For most people, switching to a different 401k provider means switching employers, which is as unlikely a tactic as moving from your home in order to switch from Comcast to Time Warner.
So the bundling of 401k providers with employment makes it difficult for employees to exercise any margin of control over their 401k. Only by disaggregating them into separate decisions can people properly optimize.
ERISA Stone wrote:Most of the time, there is more value.
I don't see how a high-cost provider, who drains up to 50% or more of a client's retirement savings over their lifetime, can add any more value than Vanguard can by simply investing that individual in a Target Date fund.

It's true that a "Lexus" 401k broker will offer free financial advise to clients, but does that really justify 50% of their savings? The client is far better off hiring an advisor at an hourly rate and sticking with low-cost plans. There's no reason the plan provider and the advisor need to be the same person. By separating them, the client is made far better off. Hence the oft-shared advice to hire advisors by the hour--not on commission. When someone is working for commission, they have an incentive to sell you a more expensive product than you need just to get commission. But when you pay them by the hour, they can be disinterested and give you objective advice. What's worse is that 401k fees are compounded over time, so when people read the "1.5% expense ratio" it doesn't look like much at face value. They probably think it's 1.5% of profits or something. They definitely don't see that it's 1.5% of their total savings subtracted each year over their whole life and that it adds up to 50% of everything they slaved for.
Last edited by rca1824 on Wed Dec 10, 2014 10:50 am, edited 1 time in total.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Why are high 401k fees maintained in competitive equilib

Post by Middle »

My 300 person firm looked into changing providers and in fact both Vanguard and Fidelity were suggested as potential providers.

The feedback someone got from Vanguard was that there would have to be a third party administrator for the plan. We found one and they wanted much higher admin fees from the company than we are currently paying at Merrill Lynch.

Fidelity was also a little more and their average ERs were only a little less than what we currently have. Combine that with the onerous task of making the change which includes a two to three week blackout period and tracking down all the former employees that have left assets in the plan, and you've got some hurdles to overcome in order to make the change.

From that process, I learned that there is a difference between the individual investor and a company 401k plan. Companies that have great low cost funds to offer similar to that of what the individual can get must be bearing a lot of administrative costs.
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Re: Why are high 401k fees maintained in competitive equilib

Post by rca1824 »

Middle wrote:My 300 person firm looked into changing providers and in fact both Vanguard and Fidelity were suggested as potential providers.

The feedback someone got from Vanguard was that there would have to be a third party administrator for the plan. We found one and they wanted much higher admin fees from the company than we are currently paying at Merrill Lynch.

Fidelity was also a little more and their average ERs were only a little less than what we currently have. Combine that with the onerous task of making the change which includes a two to three week blackout period and tracking down all the former employees that have left assets in the plan, and you've got some hurdles to overcome in order to make the change.

From that process, I learned that there is a difference between the individual investor and a company 401k plan. Companies that have great low cost funds to offer similar to that of what the individual can get must be bearing a lot of administrative costs.
Also very interesting. So all the regulation and reporting inflates the cost of 401k plans relative to IRAs?

It seems we would all be better off if individuals had the right to completely replace 401ks with IRAs, and have their employer match paid directly into their IRA of choice. I think the only reason we don't is because of the lobbying and rent-seeking by 401k brokers to keep the market broken.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Why are high 401k fees maintained in competitive equilib

Post by jstrazzere »

rca1824 wrote:I cannot understand how high-fee 401k providers survive in a competitive market. Why doesn't the company simply choose a low-cost provider, such as Vanguard or Fidelity? Why do they go with horrible companies that gouge employees with 1-2% fees? What is failing in the market here?
Companies do not have a fiduciary responsibility to their employees to do what is in the employee's best interest.
Thus, they (can and often do) do what is in the company's best interest instead (and sometimes in the middlemen's best interest).

That said, employees are beginning to bring lawsuits against their company:
http://www.forbes.com/sites/johnwasik/2 ... uing-over/

Not so much a market failing, as a regulatory/legal failing.
sport
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Re: Why are high 401k fees maintained in competitive equilib

Post by sport »

rca1824 wrote:It seems we would all be better off if individuals had the right to completely replace 401ks with IRAs, and have their employer match paid directly into their IRA of choice.
This is certainly true. The reasons this does not exist are political and beyond the scope of this board.
Jeff
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Re: Why are high 401k fees maintained in competitive equilib

Post by ERISA Stone »

rca1824 wrote:
TomatoTomahto wrote:Competition in the 401k space reminds me of competition in cable. For most people, switching to a different 401k provider means switching employers, which is as unlikely a tactic as moving from your home in order to switch from Comcast to Time Warner.
So the bundling of 401k providers with employment makes it difficult for employees to exercise any margin of control over their 401k. Only by disaggregating them into separate decisions can people properly optimize.
ERISA Stone wrote:Most of the time, there is more value.
I don't see how a high-cost provider, who drains up to 50% or more of a client's retirement savings over their lifetime, can add any more value than Vanguard can by simply investing that individual in a Target Date fund.

It's true that a "Lexus" 401k broker will offer free financial advise to clients, but does that really justify 50% of their savings? The client is far better off hiring an advisor at an hourly rate and sticking with low-cost plans. There's no reason the plan provider and the advisor need to be the same person. By separating them, the client is made far better off. Hence the oft-shared advice to hire advisors by the hour--not on commission. When someone is working for commission, they have an incentive to sell you a more expensive product than you need just to get commission. But when you pay them by the hour, they can be disinterested and give you objective advice. What's worse is that 401k fees are compounded over time, so when people read the "1.5% expense ratio" it doesn't look like much at face value. They probably think it's 1.5% of profits or something. They definitely don't see that it's 1.5% of their total savings subtracted each year over their whole life and that it adds up to 50% of everything they slaved for.
I'm not going to argue your numbers, because they look extreme but mainly I simply don't have the time to research them, but your comment is part of my point. Good advisors do much more than provide investment advice. Also, there is more to retirement plan administration than the investment side. I understand that is what most participants see and know but the simple reality is it is much more complex than that.
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TomatoTomahto
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Re: Why are high 401k fees maintained in competitive equilib

Post by TomatoTomahto »

ERISA Stone wrote:I'm not going to argue your numbers, because they look extreme but mainly I simply don't have the time to research them, but your comment is part of my point. Good advisors do much more than provide investment advice. Also, there is more to retirement plan administration than the investment side. I understand that is what most participants see and know but the simple reality is it is much more complex than that.
For those who want an advisor and what they provide, great. But for those who don't want it, the cost shouldn't be forced on them. Going back to my cable analogy, the industry direction is to alacarte pricing; I don't want to pay for The Golf Channel because you could not force me to watch it with a firearm. My neighbor probably is an avid watcher.

Since advisors are readily available outside the 401k space, it is suboptimal to bundle it. Just my $0.02.

Ps. The Vanguard funds available in my wife's 401k are low cost, but I should check if they added a few bp to cover their cost. It is a large employer, which might be a factor
I get the FI part but not the RE part of FIRE.
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Re: Why are high 401k fees maintained in competitive equilib

Post by placeholder »

rca1824 wrote:It seems we would all be better off if individuals had the right to completely replace 401ks with IRAs, and have their employer match paid directly into their IRA of choice.
Employers wouldn't want to deal with potentially hundreds of different custodians for payroll to direct the contributions to so the likely result of your plan would be an end to employer matching and other contributions not mention saying bye to the backdoor Roth and the handy after tax contributions to qualified plans etc.
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TomatoTomahto
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Re: Why are high 401k fees maintained in competitive equilib

Post by TomatoTomahto »

placeholder wrote:
rca1824 wrote:It seems we would all be better off if individuals had the right to completely replace 401ks with IRAs, and have their employer match paid directly into their IRA of choice.
Employers wouldn't want to deal with potentially hundreds of different custodians for payroll to direct the contributions to so the likely result of your plan would be an end to employer matching and other contributions.
Well, that would be their excuse. It would not be unreasonable to have a list of a dozen preferred providers, where matching can take place. I don't know the percentage of pay checks and other payments that are Direct Deposited, but I think HR can handle it. If it's a hardship, exempt small companies.
I get the FI part but not the RE part of FIRE.
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JamesSFO
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Re: Why are high 401k fees maintained in competitive equilib

Post by JamesSFO »

rca1824 wrote:
JamesSFO wrote: It's tricky, there is something of a fixed cost of offering a 401K plan which is on the order of say $2K/year minimum. Someone has to bear that cost. If you go to Vanguard and you are a small employer they will try to send you somewhere else because their minimums start around $3-6K to run the plan for you with Ascensus. On a small plan that could easily be >1%.
Depends what we mean by "small". I've worked at a 250-person company where each quarter I would get a 401k report in the mail which would state the plan's total assets. I think it was around $10 million ($40k par capita). A 1.5% annual fee on $10 million is $150,000/year. That's 25x your top-end estimate of $6k/year. I now work at a 100-person company that has a different broker and the fees are still 1.5%.

Could it depend on industry? I work in software, but my friends in the financial sector, even the ones who work at small, 30-person firms, have access to 401ks at Fidelity and other low-cost providers. Maybe people in software are just more ignorant. But they should have a finance department that knows these things?
Per Wikipedia:
In July 2011, the European Commission said it would open a consultation on the definition of SMEs in 2012. In Europe, there are three broad parameters which define SMEs:

Micro-enterprises have up to 10 employees
Small enterprises have up to 50 employees
...
250 employees is not small by that or most definitions. [edit though to be fair the US uses 500 as its limit but that seems not very useful]

The point being under a certain size, and particularly for newer plans, the plan balance can end up being quite low and the fees as a percentage of plan balance high.

As for 30 person plans with Fidelity, I've had 20 person startups that had decent lineups from Fidelity when Fidelity was in the mood, they don't consistently offer the product to small businesses.
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Re: Why are high 401k fees maintained in competitive equilib

Post by Jozxyqk »

ERISA Stone wrote:I know it will fall on deaf ears (or skeptical ears?) so I'm hesitant to even make the comment - but retirement plan administration is not a commodity, or maybe I should say the service of the administration is not a commodity.

A few thoughts off the top of my head:

Vanguard is a horrible company to work with within the industry. Several companies I have worked for literally charged clients a premium if Vanguard were the custodian of their assets. It may have changed because I don't think I've touched a Vanguard plan in 4+ years but their reporting is atrocious and they do not do a good job of providing information/reports to parties in a timely manner.

From the TPA perspective, you can absolutely spend more money and get a more customized plan, most times to the benefit of the owner. IMO, you probably don't want a low cost provider setting up these plans because the likelihood that they've actually been trained on how to design plans/maximize plan benefits is low. Most of the people who work in low cost settings are good at operations and processes, and focus less on the nuts and bolts of regulation within the industry. I see several people comment on this website alone who could benefit from spending a little more $$ upfront to create an efficient retirement plan for their particular need but they are so skeptical of spending $$ on the benefit that it's pointless to even mention it.

Most low cost TPAs do what we call "garbage in, garbage out," meaning they take the data you provide at face value. They don't check it. Premium TPAs scrub your data to minimize the probability of errors, which in turn, reduces big issues down the road. Premium TPAs ask questions, most low cost providers don't. It's terrifying some of the lack of quality in things like testing, vesting issues, etc, I see when we take a client over from, most times, a low cost provider.

As with virtual every service industry, some websites are easier to navigate and are more intuitive for the end user. There is generally an extra cost for this added benefit but some employers would rather have this feature than go with a low cost provider.

I have also worked with many financial advisors that are absolutely worth the basis points they charge each quarter. Everyone on here just sees someone who offers overpriced investments but don't consider that an advisor that is valuable does so much more. I don't have an FA because it's just me and my wife and we're newbie bogleheads. However, the moment we have another participant in the plan, I have a list of FAs on hand that I will call to discuss hiring and will have zero issue with their fees. I see the significance in having a solid FA.



This isn't really an appeal to for you to realize the value of a higher cost provider. Most of the time, there is more value. You just don't have the utility for it. It's the same as someone who drives a Lexus even though a Toyota it serves the same function.
I would really appreciate if you would expand on some of these concepts. I can understand that some companies will have better websites. I can understand that some people like financial advisors (though, like tomatotomahto below, I don't see why an employer should insist on its employees paying for FAs if they won't use them).

But what does it mean to spend more money and get a "customized" plan? What is an "efficient" plan?
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rca1824
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Re: Why are high 401k fees maintained in competitive equilib

Post by rca1824 »

jstrazzere wrote:
Companies do not have a fiduciary responsibility to their employees to do what is in the employee's best interest.
Thus, they (can and often do) do what is in the company's best interest instead (and sometimes in the middlemen's best interest).

That said, employees are beginning to bring lawsuits against their company:
http://www.forbes.com/sites/johnwasik/2 ... uing-over/

Not so much a market failing, as a regulatory/legal failing.
What you said is completely incoherent because if markets didn't fail, employers wouldn't be allowed to "get away with" hurting their employees. If you've ever studied economic theory at the graduate level and probably even undergraduate level, you would understand that employers cannot just arbitrarily steal from employees in a competitive equilibrium. You need to have a more intelligent theory of how and why the market fails. Legal intervention is only necessary if you have a theory of market failure because perfect competition requires no legal intervention outside enforcement of contracts and private property rights.
jsl11 wrote:This is certainly true. The reasons this does not exist are political and beyond the scope of this board.
Jeff
Is it beyond the scope? This board is titled "Theory" so I assume all theory goes, including economic theory and political theory. Or if you do restrict it to investment theory, political theory ought to be permitted due since politics directly effects investments.
placeholder wrote: Employers wouldn't want to deal with potentially hundreds of different custodians for payroll to direct the contributions to so the likely result of your plan would be an end to employer matching and other contributions not mention saying bye to the backdoor Roth and the handy after tax contributions to qualified plans etc.
Or the employer can just pay the employee cash and let the employee contribute to a Traditional IRA or Roth IRA of their choice, and mark it on their tax returns. And remove the income limit for deducting Traditional IRA contributions.

When you really think about, there's no reason retirement legal accounting can't be simpler than it currently is. I suppose the reason its so complex is because special interest groups have an incentive to lobby for legal complexity for their own benefit, and due to the nature of concentrated benefits and dispersed costs, we let it happen.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Why are high 401k fees maintained in competitive equilib

Post by sport »

rca1824 wrote:
jsl11 wrote:This is certainly true. The reasons this does not exist are political and beyond the scope of this board.
Jeff
Is it beyond the scope? This board is titled "Theory" so I assume all theory goes, including economic theory and political theory. Or if you do restrict it to investment theory, political theory ought to be permitted due since politics directly effects investments.
From the board regulations:
In order to avoid the inevitable frictions that arise from these topics, political or religious posts and comments are prohibited.
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Re: Why are high 401k fees maintained in competitive equilib

Post by TradingPlaces »

There is a website called Bright Scope that reports comparative statistics on 401K plans.

I think some of this information is public, and that's how they get it.

Unfortunately, there are no actual numbers.

E.g., here is for Exxon Mobile:

http://www.brightscope.com/401k-rating/ ... ings-Plan/
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Re: Why are high 401k fees maintained in competitive equilib

Post by TradingPlaces »

jstrazzere wrote:
rca1824 wrote:I cannot understand how high-fee 401k providers survive in a competitive market. Why doesn't the company simply choose a low-cost provider, such as Vanguard or Fidelity? Why do they go with horrible companies that gouge employees with 1-2% fees? What is failing in the market here?
Companies do not have a fiduciary responsibility to their employees to do what is in the employee's best interest.
Thus, they (can and often do) do what is in the company's best interest instead (and sometimes in the middlemen's best interest).

That said, employees are beginning to bring lawsuits against their company:
http://www.forbes.com/sites/johnwasik/2 ... uing-over/

Not so much a market failing, as a regulatory/legal failing.
I agree with the need for regulatory overhaul.
401K is a deferred compensation plan, true, but it is the employee's money. Thus, the employer should have an explicit and large fiduciary under severe legal penalties.
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Re: Why are high 401k fees maintained in competitive equilib

Post by EarlyStart »

rca1824 wrote:
EarlyStart wrote:Perfect competition only exists in theory and models. Even within the constraints of perfectly competitive markets, people derive utility from all sorts of things, not just expected return. Also, everyone's interests are not always aligned.

Nonetheless, I agree with your sentiment here.
Competition exists in reality, also. For example, when I shop for an IRA, I can choose a low cost provider like Vanguard. Vanguard serves the need of low-cost investment funds. Competition also thrives in millions of other markets.

And it is not enough to say that competition doesn't exist. Only a theory can kill a theory. So what theory explains why 401k fees are so high? I think other posters gave a much more informative response.
jsl11 wrote:Companies choose those plans so the employees will pay the fees instead of the employer. This makes it a low cost plan for the company. The plans that are low cost for the employees generally cost the employer more than the other ones. In other words, someone has to pay the fees.
Jeff

This is a really, really interesting response. It makes sense why firms would pass the costs on to employees if employees are ignorant. But in competitive equilibrium, the total compensation should be the same, as new firm creation competes economic profit back to zero. So higher 401k fees are accompanied by higher wages and the employee is no worse off.

Unless of course it's not a simple passing of costs, but a passing and an amplification of cost. That is, when the employee gets charged instead of the firm, are the total 401k costs higher? I would suspect so. Standard 401k fees are in the 1.5% ballpark. Vanguard is 0.05%. I doubt that if an employer hired Vanguard to be their 401k broker, Vanguard would charge the firm 1.45%... or do they?

So then the end result is rent-seeking by the 401k brokers and a deadweight loss as more people go into the 401k brokerage industry to capture these excess fees.
Rysto wrote:On the other hand, if you do what I did when I first started investing for retirement and go to your local bank to open an account, you will almost certainly find yourself signed up with the bank's mutual fund provider, paying an annual MER somewhere between 2% to 3% (no, seriously). I can assure you that a great many people end up starting as I did, but pay those MERs all of their lives.
Then that's very similar to the IRA market here. Despite free choice, many ignorant investors are suckered into high-fee funds. But the key difference between the 401k market the IRA market is that in the IRA market at least investors have a choice, so the sophisticated investors can exercise that choice and benefit, and it also creates an incentive for the ignorant investor to educate himself. In the long run, as investing knowledge becomes more widespread (as I believe it is--practically all my friends know about index fund investing), competition will eventually eliminate all high-cost providers in the market. The 401k market on the other hand faces far fewer of these competitive pressures because of broken incentives in the principal-agent problem.


I said "perfect competition".
DEFINITION OF 'PERFECT COMPETITION'
A market structure in which the following five criteria are met:1) All firms sell an identical product;2) All firms are price takers - they cannot control the market price of their product;3) All firms have a relatively small market share;4) Buyers have complete information about the product being sold and the prices charged by each firm; and5) The industry is characterized by freedom of entry and exit.Perfect competition is sometimes referred to as "pure competition".
This is the economic assumption referred to when we refer to an "equilibrium price". So the terms you use answer your question. When we refer to an equilibrium price at which firms have to sell, the underlying assumptions are that firms have a small market share- not true here, buyers have complete information- basically true here, the industry is characterized by freedom of entry and exit- NOT true at all here.

There are legal restrictions on selling securities, high start up costs, etc. Not every Tom, Dick, and Sally can just start a firm.

Nobody said that competition doesn't exist. Competition exists everywhere except a pure monopoly without substitutes, which also is a theoretical construction.

To put it simply, it's not a pure commodity, so there will be a range of prices. The answer is that the 401k products are not in a perfectly competitive market.
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Re: Why are high 401k fees maintained in competitive equilib

Post by EarlyStart »

rca1824 wrote:
jstrazzere wrote:
Companies do not have a fiduciary responsibility to their employees to do what is in the employee's best interest.
Thus, they (can and often do) do what is in the company's best interest instead (and sometimes in the middlemen's best interest).

That said, employees are beginning to bring lawsuits against their company:
http://www.forbes.com/sites/johnwasik/2 ... uing-over/

Not so much a market failing, as a regulatory/legal failing.
What you said is completely incoherent because if markets didn't fail, employers wouldn't be allowed to "get away with" hurting their employees. If you've ever studied economic theory at the graduate level and probably even undergraduate level, you would understand that employers cannot just arbitrarily steal from employees in a competitive equilibrium. You need to have a more intelligent theory of how and why the market fails. Legal intervention is only necessary if you have a theory of market failure because perfect competition requires no legal intervention outside enforcement of contracts and private property rights.
jsl11 wrote:This is certainly true. The reasons this does not exist are political and beyond the scope of this board.
Jeff
Is it beyond the scope? This board is titled "Theory" so I assume all theory goes, including economic theory and political theory. Or if you do restrict it to investment theory, political theory ought to be permitted due since politics directly effects investments.
placeholder wrote: Employers wouldn't want to deal with potentially hundreds of different custodians for payroll to direct the contributions to so the likely result of your plan would be an end to employer matching and other contributions not mention saying bye to the backdoor Roth and the handy after tax contributions to qualified plans etc.
Or the employer can just pay the employee cash and let the employee contribute to a Traditional IRA or Roth IRA of their choice, and mark it on their tax returns. And remove the income limit for deducting Traditional IRA contributions.

When you really think about, there's no reason retirement legal accounting can't be simpler than it currently is. I suppose the reason its so complex is because special interest groups have an incentive to lobby for legal complexity for their own benefit, and due to the nature of concentrated benefits and dispersed costs, we let it happen.

I have a degree in economics.

I understand that the market for managed financial products is not perfectly competitive. There IS competition in the market, so a fund can't charge a 50% expense ratio and stay in business, but they can charge a little more than their competitors and not necessarily price themselves out of the market.

The perfectly competitive markets you may have learned about in a principles class assume perfect competition, which means no government regulation, no taxes, an unlimited number of firms, etc.etc. etc.

A close example we have to a perfectly competitive market might be drinking water. Almost anyone could gather clean water and sell it. There aren't many legal barriers, etc, so the prices are very competitive. Even this isn't perfect competition, in reality. So managed financial products are on the other side of the spectrum.
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Re: Why are high 401k fees maintained in competitive equilib

Post by TomatoTomahto »

I don't have a degree in economics, but when you refer to a market where one fund charges an order of magnitude more than what another one charges for essentially the same thing as "not perfectly competitive," I have to smack my head and wonder what went on in those classes I didn't sign up for. Honestly.
I get the FI part but not the RE part of FIRE.
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Re: Why are high 401k fees maintained in competitive equilib

Post by TomatoTomahto »

I just realized that I was too kind referring to an order of magnitude range:
From http://www.cbsnews.com/news/beware-of-t ... dex-funds/
Indeed, the range of expense ratios for S&P 500 index funds is amazing. According to Lipper data, the average S&P 500 index fund carries an expense ratio of 0.62 percent. The cheapest option, a Vanguard institutional fund, charges a mere 0.025 percent annually. At the other end of the spectrum, the Rydex S&P 500 fund levies a 2.28 percent annual fee.
I get the FI part but not the RE part of FIRE.
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Re: Why are high 401k fees maintained in competitive equilib

Post by Tony_L »

It would be interesting to know how many companies apply rigorous cost/benefit analysis to the topic of this post.
To the extent they do, whose costs would they analyze?
To the extent they do, whose benefit do they analyze?
How do they perform a ROI analysis? If yes, how is their investment measured?

The typical company/supplier relationship which they are so adept at managing (at least theoretically adept) is significantly different than fiduciary/client relationship they are put into when managing the 401k scenario.
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Re: Why are high 401k fees maintained in competitive equilib

Post by gabriel1970 »

I have asked myself a similar question. I feel a big reason is the human resource / benefit department's unwillingness to take responsibility for the decision of which funds to choose. They tend to spend a large sum of money to hire a outside consultant, whose resume shows it has a lot of experience picking 401K fund for other corporations, and let this third party expert pick the funds. If the funds perform sub par, the HR / BD could say, look, we did our due diligence to have hired a guru to pick for you, and we checked the guru's resume.

The outside consultant, of course, will not pick Vanguard. Otherwise he has just made his last penny with this corporation.

The consultant would even custom make a bunch of "target date funds" which comprise of half active managed fund and half index fund for the corporation. Of course, the expense ratio will be twice those of the Vaguard funds.

I have also found many employees do not really care about what funds are in his/her account. Most of them will go with the default choice picked by the consultant.
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Re: Why are high 401k fees maintained in competitive equilib

Post by EarlyStart »

TomatoTomahto wrote:I don't have a degree in economics, but when you refer to a market where one fund charges an order of magnitude more than what another one charges for essentially the same thing as "not perfectly competitive," I have to smack my head and wonder what went on in those classes I didn't sign up for. Honestly.

The point remains. Yes, they're pretty non-competitive. OP is asking how it's possible within the market.
From OP: "I have been thinking about this issue very deeply lately. I cannot understand how high-fee 401k providers survive in a competitive market."


I mean, come on. We don't have to get very technical to explain why a fund can charge a couple percent while Vanguard charges .05 without pricing itself out of the market, particularly given the type of business it is. The same orders of magnitude exist in perfumes, sunglasses, certain medicines, etc. etc. It's not pound of cotton or an ounce of copper, so people perceive differences when there are none.

We'd really be reinventing the wheel going any further at that point.
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Re: Why are high 401k fees maintained in competitive equilib

Post by TomatoTomahto »

EarlyStart wrote:The same orders of magnitude exist in perfumes, sunglasses, certain medicines, etc. etc. It's not pound of cotton or an ounce of copper, so people perceive differences when there are none.
It is almost impossible to sell a $2 bottle of perfume, no matter how good it smells. But, Vanguard has proven that it is easy to sell a "cheap" indexed fund. It's just that some employers only allow expensive choices. Some of the employees might be fooled, but even those that are not fooled have the choice of either walking away or paying the inflated prices.

I had a previous employer where I did not perceive a difference when there [was] none, but I had a very restricted choice.
I get the FI part but not the RE part of FIRE.
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Re: Why are high 401k fees maintained in competitive equilib

Post by EarlyStart »

TomatoTomahto wrote:
EarlyStart wrote:The same orders of magnitude exist in perfumes, sunglasses, certain medicines, etc. etc. It's not pound of cotton or an ounce of copper, so people perceive differences when there are none.
It is almost impossible to sell a $2 bottle of perfume, no matter how good it smells. But, Vanguard has proven that it is easy to sell a "cheap" indexed fund. It's just that some employers only allow expensive choices. Some of the employees might be fooled, but even those that are not fooled have the choice of either walking away or paying the inflated prices.

I had a previous employer where I did not perceive a difference when there [was] none, but I had a very restricted choice.
The reason you're even evaluating a 401k choice is because of laws passed on tax rates, so you have that incentive being counted in addition to any employer match, which of course doesn't hapoen for anything you choose to buy on a given day. Through and through we can find dozens of reasons these funds aren't pricing themselves out of the marketplace.
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Re: Why are high 401k fees maintained in competitive equilib

Post by Hank Moody »

I have often thought that a great solution is to the fee problem is to allow 529 plans to hold 401(k) assets. They're incredibly cheap nowadays. I think the proprietary aspect of our current 401(k) world is what keeps fees as high as they are.
jsl11 wrote:
rca1824 wrote:It seems we would all be better off if individuals had the right to completely replace 401ks with IRAs, and have their employer match paid directly into their IRA of choice.
This is certainly true. The reasons this does not exist are political and beyond the scope of this board.
Jeff
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Re: Why are high 401k fees maintained in competitive equilib

Post by Barry Barnitz »

HI:

News article, December 9, 2014 --->401(k)s Are Still a Problem, But They’re Getting Better | Money.com
The typical 401(k) plan has 25 investment options, up from 20 in 2006, and the average worker in a plan has annual plan costs equal to 0.53% of assets, down from 0.65% of assets in 2009, according to a study from BrightScope and the Investment Company Institute.
Change has come slowly. But the BrightScope/ICI study shows positive momentum in key areas.
Expense ratios are down by every measure: total plan cost, average participant cost, and average cost of invested dollars. Volumes of research show that costs are a key variable in long-term rates of return. That is why low-cost index funds, most often championed by Vanguard’s John Bogle, have become investor favorites and 401(k) plan staples. These funds account for a quarter of all 401(k) plan assets, the study shows.
For those in small plans, though, the news isn’t so good. Expenses remain high: In plans with fewer than $1 million in assets, the average expense ratio for domestic equity mutual funds is 0.95%, versus 0.48% for plans with more than $1 billion in assets. Small plans are also far less likely to include an employer matching contribution: Just 75% of plans with fewer than $10 million in assets provide a match, vs. 97% of plans with more than $100 million in assets. Small plans are also less likely to automatically enroll new employees.
The venerable 401(k) still has many problems as a primary retirement savings vehicle. Too many people don’t contribute enough, don’t diversify, and don’t repay loans from the plans; too many take early distributions and try to time the market. 401(k) plans don’t readily provide guaranteed retirement income, though that is changing, and because you don’t know how long you’ll live you have to err on the conservative side and save like crazy.

But we are headed the right direction, which is good, because for better or worse the 401(k) is how America saves.
regards,
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Re: Why are high 401k fees maintained in competitive equilib

Post by rca1824 »

Obviously the market for 401k is not perfectly competitive. Obviously "perfection" doesn't exist in reality. But that's a trivial and uninsightful statement. Many markets, if not perfectly competitive, do approximate perfect competition. The 401k market is no where close to approximately perfectly. It is deeply flawed. The useful question is why?

So far we have: regulatory burdens, tax incentives, bad incentives for the firm, bad incentives for the commission-based 401k broker, and the weird bundling of the 401k with one's job.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Why are high 401k fees maintained in competitive equilib

Post by Buysider »

The useful question is why?
I think you are asking an interesting question, but the answers you are looking for reflect your (this board's?) bias.

Cost is only one aspect of selecting a 401(k) service provider and designing a plan. Some folks (this board) rank costs very high, others don't. And as pointed out above, since this is a big OPM problem (other people's money). Employees don't leave their jobs over a 0.50% difference in expense ratios, but HR people do lose their jobs if they spend too much of the company's money.

Since I've been in the industry, cost has moved up considerably in clients radar, but only from # 10 on a list to # 5.

Even on this board, this is sometimes true. Why would anyone buy a Tesla, when you can get a Camry for a lot less? Is the car market not perfectly competitive, or do buyers have difference preferences that make a market?
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Re: Why are high 401k fees maintained in competitive equilib

Post by elgob.bogle »

"I don't want to pay for The Golf Channel because you could not force me to watch it with a firearm. My neighbor probably is an avid watcher."


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Re: Why are high 401k fees maintained in competitive equilib

Post by TomatoTomahto »

BuySider wrote:Why would anyone buy a Tesla, when you can get a Camry for a lot less? Is the car market not perfectly competitive, or do buyers have difference preferences that make a market?
That's an interesting example you chose: Tesla. I live in a state (NJ) that for a time limited the ease with which I could buy a Tesla, surely at the urging of the auto dealer lobby. Except for that anomaly, and some distortions caused by government incentives, the auto industry is a more competitive market than 401k.

The bundling of 401k and employer distorts the market.
I get the FI part but not the RE part of FIRE.
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Re: Why are high 401k fees maintained in competitive equilib

Post by jstrazzere »

rca1824 wrote:
jstrazzere wrote:
Companies do not have a fiduciary responsibility to their employees to do what is in the employee's best interest.
Thus, they (can and often do) do what is in the company's best interest instead (and sometimes in the middlemen's best interest).

That said, employees are beginning to bring lawsuits against their company:
http://www.forbes.com/sites/johnwasik/2 ... uing-over/

Not so much a market failing, as a regulatory/legal failing.
What you said is completely incoherent because if markets didn't fail, employers wouldn't be allowed to "get away with" hurting their employees. If you've ever studied economic theory at the graduate level and probably even undergraduate level, you would understand that employers cannot just arbitrarily steal from employees in a competitive equilibrium. You need to have a more intelligent theory of how and why the market fails. Legal intervention is only necessary if you have a theory of market failure because perfect competition requires no legal intervention outside enforcement of contracts and private property rights.
Perfect competition is an academic fiction.

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Re: Why are high 401k fees maintained in competitive equilib

Post by steve roy »

I've been a trustee on a 401(k) Plan with 2350 participants and $220 million in assets for fifteen years; here's some of what I've learned:

A small plan, maybe one that's just starting or one attached to a small company, is going to have higher fees because the limited amount of dollars being administered. Costs have to be borne by SOME entity, and it's either the company, or plan participants, or both. Some companies pay most administrative costs, in other situations, the participants bear all or most of the costs. Some plans have corporate matches, others don't. In a lot of cases, insurance companies are the administrators of smaller plans. For instance, Principle Financial Group (insurance company) has the bulk of its business with smaller 401(k) plans. Huge mutual funds like Fidelity and Vanguard have most of their 401(k) business with large plans.

As a trustee, I tried to get Vanguard to administer our Taft-Hartley, multi-employer 401(k) plan for YEARS. And for years Vanguard turned us down. They were not set up to administer Taft-Hartley plans, and stuck to large, single-company plans, which are a hell of a lot simpler to record-keep. In the beginning, our plan went with Principle because they were one of the few companies willing to administer a smaller start up. Over time, there were issues with Principle and we moved to Mass Mutual after doing Requests for Proposal (called an RFP) with multiple companies. (An RFP is putting a 401(k)' plan's administration out for bid; it's part of a due diligence requirement for all 401(k) Plans because they fall under Federal pension rules that have gotten more stringent over time. There's also the issue -- in the last few years -- of participant lawsuits.)

Our plan is now with Vanguard after being with Mass Mutual for most of a decade. (VG has gotten more flexible with the types of plans it will administer.) One major reason for the switch was lower costs. Since 2012, 401(k) plan trustees have been held accountable for higher costs in 401(k) Plans. If plan trustees, by reg fiduciaries for plan participants, can't show that they investigated plan costs -- for instance sought to use the lowest cost share classes of the Plan's mutual funds, or compared fees of different plan administrators by doing periodic Requests for Proposals -- they could be in legal trouble. Trustees, in 2014, are well-advised to seek out lower fees across the board; otherwise they might have an unhappy result with a participant lawsuit, also trouble with newer, more stringent government requirements.

I can tell you from first-hand experience, hurdles for 401(k) plans have gotten a LOT higher in the last couple of years.
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Re: Why are high 401k fees maintained in competitive equilib

Post by rkhusky »

Why do people use high-priced plans for their IRA's?
Why do people use banks that charge them high fees?
Why do people shop at expensive grocery stores?
Why do people buy a Rolex?

Answers: personal preference, inertia, desire for above-average performance, convenience, lack of knowledge, customer service, ...

Doesn't mean that an industry is not competitive.
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Re: Why are high 401k fees maintained in competitive equilib

Post by TomatoTomahto »

rkhusky wrote:Why do people use high-priced plans for their IRA's?i don't.
Why do people use banks that charge them high fees?i don't.
Why do people shop at expensive grocery stores?Because I prefer their produce.
Why do people buy a Rolex?i don't.

Answers: personal preference, inertia, desire for above-average performance, convenience, lack of knowledge, customer service, ...

Doesn't mean that an industry is not competitive.
Why does my wife buy a Range Rover? Because she likes it.
Why does my wife buy a Woodway treadmill? Because she likes it.
Why do we live in an expensive neighborhood? Because we like it.
Why do we send our kids to expensive private schools? Because it's our preference.
Why did I pay into an expensive 401k with crummy fund choices? Because it was the employer's way or the highway.

One of these is not like the others.
I get the FI part but not the RE part of FIRE.
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Re: Why are high 401k fees maintained in competitive equilib

Post by EarlyStart »

rca1824 wrote:Obviously the market for 401k is not perfectly competitive. Obviously "perfection" doesn't exist in reality. But that's a trivial and uninsightful statement. Many markets, if not perfectly competitive, do approximate perfect competition. The 401k market is no where close to approximately perfectly. It is deeply flawed. The useful question is why?

So far we have: regulatory burdens, tax incentives, bad incentives for the firm, bad incentives for the commission-based 401k broker, and the weird bundling of the 401k with one's job.
You can keep saying it's not insightful, but it's the question you've posed and your confusion about your own topic that's thwarting your understanding.

Which markets approximate perfect competition? Basically just pure commodities, currencies, and a few select consumer goods that are barely modified commodities.

If start up costs are big, prices aren't as competitive.
e.g. If your business requires a satellite in space, you can charge a high price because few people are going to or are able to launch satellites to undercut you.

If start up costs are low, prices will be more competitive, ceteris paribus. e.g. If Dasani bottled water started charging $4/bottle, any one of us could begin a small operation, sell for $2 and undercut them. The same cannot be said for managing mutual funds. It's expensive to start and the risk is high.

Also, the market being "deeply flawed" is a normative assertion. The level of competition in an industry is just a fact. Whether it's good or bad is an opinion, and the answer depends largely on whether you're a buyer or a seller. It's not that the market is "failing"... In fact, fund expenses have fallen over time because more people have become sellers due to the fact that they have some pricing power.

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Re: Why are high 401k fees maintained in competitive equilib

Post by Alex Frakt »

Locked. This is not actionable. Nor is it an investing question, it's an economics theory question.
Locked