Question Your 401(k)
Recently a post on social media caught my attention. The original poster lamented that she had lost thousands in her 401(k). Responses in the thread varied. Some said they had also lost money. Some said their 401(k) hadn’t budged even though the market had been doing well. Others posted substantial gains. But no one could explain why. I find this disturbing.
In, Take Control of Your 401(k), I discussed the history of the 401(k), and why Americans need to educate themselves on precisely what they are buying and from whom they are purchasing their retirement funds. The Obama Administration estimated that Americans were losing $17 billion a year due to conflicting advice from brokers. Yet the 401(k) still seems to be one of the only products that Americans buy without understanding the price, quality or inherent risk. Why is this?
The Death of the Fiduciary Rule
The mutual fund industry has been able to protect itself for years from having to fully disclose the price and the risk of the 401(k). Although the Department of Labor had been fighting to change this for a long time, the Fiduciary Rule, set to go into effect July, 2019, which would have bound all financial advisors dealing with retirement products to the status of fiduciary, bit the dust last June . While I won’t go into the protracted history of the political fight for a Fiduciary Rule to protect investors, I will say that the future, as it stands, doesn’t look too optimistic in this arena. This means that the burden of ensuring that you are not getting ripped off when trying to save for retirement remains in your hands alone.
The brokerage community and the big banks are just so wealthy that running the risk of taking them on is just too difficult. All I can say, is it’s just not the right era. – James Cox, Professor of Securities Law, Duke University.
The lack of a Fiduciary Rule means that you, the buyer, must do due diligence and learn about the products you are buying, their inherent risk, and exactly whom you are purchasing them from. You could be paying outrageous fees that are cutting into your retirement income. This is because your broker, financial advisor, or whatever they want to call themselves may not be obligated to put your interests before their own. This makes them a salesperson. Do you know what they have sold you? Do you know how much it will cost you over time?
If you are using a 401(k) as a retirement planning vehicle, and you don’t understand it, how can you depend on it to plan for your retirement? A decade has passed since The Great Recession, and it seems that people may have forgotten about the inherent risk of a 401(k).
The dotcom bubble of 2000 was the first warning sign that 401(k)s were putting people’s retirement plans at risk. Many took a big hit and lost their retirement savings. Eight years later, the subprime mortgage crisis of 2008 hit retirement savers again, devastating many who not only lost their plans to retire, but also equity in their homes. The rash of bonuses handed out by bailed out banks was a slap in the face to those Americans left teetering on the financial edge. – WellWallet, Take Control of Your 401(k)
And now that the battle for the Fiduciary Rule is in the dust, it is critical that people remember that their broker may not have their best interests in mind when they sell you their products. That’s right, I said “product.” Please remember that the 401(k) is not a savings account. And when you sign up for one, you are also signing up to pay for its management.
So, let’s talk about it.
Who Is Your Financial Advisor?
Beyond the obvious questions such as “what exactly am I invested in,” people need to ask about whether or not the seller of their funds is bound by a fiduciary duty to put their interests first, or whether the seller of these funds is merely choosing what they feel is “suitable” for their client. And this comes down to what kind of professional they are. The distinction lies between fee-only fiduciaries who are free to act in your best interests and commission-based agents and brokers who are required to act in the best interest of the companies that employ them. To better illustrate this distinction, we need to understand “fiduciary.”
What is Fiduciary?
The word fiduciary comes from Latin and means trust. For investment advisors, fiduciary duties mean acting with undivided loyalty, in good faith, with due care, absent conflicts of interest and with prudence.
There are Registered Investment Advisors that have a fiduciary duty (called Fiduciaries) who are obligated by law to act in their clients’ best interest. Those operating as a Fiduciary must avoid conflicts of interest and operate with full transparency which includes completely disclosing all plan costs and fees.
But the vast majority that call themselves “Financial Advisors” are not fiduciaries. They have no obligation to give you advice that is in your best interest. They are merely salespeople. And there is nothing stopping them from not just recommending products that happen to have high fees, but recommending products precisely because they have high fees. This is an obvious conflict of interest. No matter what they have on their business cards, employees of a brokerage firm should be characterized as brokers, and should be required to identify themselves as such to consumers who walk in the door. But they aren’t.
Financial Advisors who are not Fiduciaries have to conform to something called a “Suitability Standard.” This means that they can sell you products that they think are “suitable” according to your stated goals or financial situation. But they are not required in any way to make sure that the advice they give you and the product they sell you is in your best interest or has a reasonable fee.
How Can You Find Out if Your Advisor is a Fiduciary?
“Will you be serving as my fiduciary? Are you legally obligated to put my best interests ahead of yours?”
And ask to see their credentials.
- Under the Investment Advisers Act of 1940, Investment Adviser Representatives (IAR) are required to act as fiduciaries at all times with their clients.
- Advisors holding the Accredited Investment Fiduciary (AIF) designation are also required to be fiduciaries. The AIF designation is put out by Fi360.
- Certified Financial Planners (CFP) are held to a fiduciary standard in order to retain their certification. (The CFP Board was active in urging congress to adopt a fiduciary standard for all financial advisors.)
“Are you fee-only or fee-based?”
In the past, a distinction could be made between fiduciaries and brokers by whether they were fee-only or commission based. Then brokers came up with the term fee-based which complicated things and muddied the distinction. And it can be mind-bogglingly difficult to decipher these brokers’ fees. They are buried in fine print and ambiguously described with a variety of names. You need to make sure you understand how your advisor is compensated on all of the products and services they sell you as this will greatly affect the outcome of your portfolio performance.
But I Get My 401(k) Through My Employer…
Many Americans get their 401(k) through their employer – if they are lucky. Especially if the employer matches contributions. Free money! Perhaps they sat through a seminar at their workplace with a broker representative who walked them through some PowerPoint slides. Employees may then have been asked to fill out some form to assess their “risk tolerance” before choosing from products with labels like “Growth Fund” or “Value Fund.”
Limited fund choices as well as a lack of transparency of what is actually in the fund, however, can lead employees to choose sub-standard funds with high fees. High fees can greatly affect the performance of the retirement account. Not only are the fees withdrawn, but they are lowering their investment amount upon which gains cannot be realized in the future. A double-whammy. This can snowball into an enormous amount of loss over time.
These fees can be substantial: over a lifetime, fees can cost a median-income two-earner family nearly $155,000 and consume nearly one-third of their investment returns. – Robert Hiltonsmith, The Retirement Savings Drain
As your employer chooses your fund provider and plan, regulations under under Employee Benefits Security Administration (ERISA) make your employer responsible on a fiduciary level for the plan they have selected for their employees. This opens your employer up to liability should they choose a provider’s plan with excessive or hidden fees and/or conflicted interest.
While the Department of Labor requires employers to provide employees with fee disclosures, these disclosures are considerably difficult to understand. Fee disclosures are the market’s response to the demand for transparency of a fiduciary role. But if employees don’t understand fee disclosures, what good are they?
Some experts argue that in situations when a conflict is present and the client clearly appears to not understand the conflict and its ramifications, by definition, there can be no informed and independent consent. In such situations, disclosures are ineffective and should have no role in fiduciary responsibility. Unfortunately, however complicated they are, your fee disclosure is your only key to knowing whether fees are draining your 401(k) account. You must question your 401(k), and in order to do so, you must understand your fee disclosures.
Question Your 401(k)!
What it comes down to is this: you are trusting your employer to make decisions about your retirement. Are you sure your employer has chosen a plan without unreasonable and excessive fees? Do you understand the fee disclosures you are given? Do you understand exactly what you are invested in?
This topic is a hot and ongoing debate in the financial industry, the Department of Labor, SEC and the White House – and you, the investor, are in the middle of it. While Wall Street and the Department of Labor go back and forth about the who/what/why of fiduciary duties, compound interest, excessive fees, and conflicts of interest in your investment portfolio could be eating away at your ability to have the future you are planning for.
So, if you are wondering why your plan isn’t moving, or you are losing money while your friends are boasting gains, it’s time to do your homework and figure out why. If you discover that you are paying high fees or you don’t like what the funds you are invested in are doing, approach your employer and discuss it. Remember that your employer has a fiduciary duty to keep your fees reasonable. But first, you need to do your homework.
Here are some links that can help you start to question your 401(k):
- You can find out about your broker is by using FINRA’s free BrokerCheck Tool.
- You can find out what funds you are invested in with FINRA’s free Fund Analyzer Tool.
- You can also use Morningstar or Google Finance to help you research your funds.
- Get a copy of your Fee Disclosure Statement. It is usually included in your 401(k) prospectus. Understanding your fees is going to take some effort. Check out the SEC’s Guide for Investors – Mutual Funds and Exchange-Traded Funds (ETFs)
- Demos.org’s The Retirement Savings Drain: The Hidden and Excessive Costs of 401(k)s which is a free booklet that you can download.
- You also have the power to incorporate Socially Responsible Investments into your portfolio. A new rule passed by the Department of Labor in 2015 makes it easier for you to invest in your 401(k) along with your values.
- The Forum For Sustainable and Responsible Investing (USSIF) offers some tips and resources that may help you incorporate Socially Responsible funds into your 401(k) plan.
The Bottom Line?
It is unclear at this point whether the SEC will ever adapt a stricter standard of care for financial advisors, especially in this politically climate. Nevertheless, if you have a 401(k) you don’t have time to wait for the SEC to figure it out. This is because, although time is your friend with a 401(k), it could be your enemy with a fee-based broker managing your funds. Those fees, taken as percentages and compounded over time can take a huge chunk out of your retirement.
Furthermore, a broker without a fiduciary duty could have you in a sub-par product because it gave him or her a higher commission at the time. Your employer may or may not understand their role as a fiduciary. They may or may not have you in the best plan. They are human, too. You have the right to approach them if you see something fishy in your retirement plan. But the only way you can find out, is to question your 401(k).
What the lawyers make us say: WellWallet is an informational platform for personal finance, and unless specifically stated otherwise, the content is provided to you without charge. WellWallet is not a financial planner, broker, or tax advisor. We cannot provide any advice for your specific financial situation. Our goal is to help you understand how to better manage your finances and how your finances affect your life goals, but we can never make any guarantees about your financial future (or present). The material here is meant for informational purposes only. It should not be considered legal or financial advice. See our Terms & Conditions for more information.