Americans feel insecure.
One reason is that their 401(k)s look too empty. As people peer into the contents, they see a retirement disaster coming. Even after years of working and saving, people just 10 years away from retirement age have accumulated little.
Half of all Americans with incomes up to $91,000 and 401(k)s have reached age 55 to 64 with $100,000 or less saved for retirement, according to the Center for Retirement Research at Boston College.
While this fragility has barely gained a peep from politicians in this presidential election year, think tanks and college professors have been seeking solutions. Some have called 401(k)s a failed system. Some long for a return of old-style pensions even though some companies and states have made a mess of them.
Now, William Birdthistle, a Chicago-Kent College of Law professor, has joined the 401(k) critics. In his new book, “Empire of the Fund: The Way We Save Now,” he describes how mutual funds let people down and how the government fails to police them. He talks about what he saw when working as an attorney for mutual funds before teaching law. The interview has been edited for length and clarity.
Q: Why do you think the 401(k) system is failing many people?
A: Mutual funds are a good tool, but they are like a power tool or a car. You wouldn’t give a person a car and not give them any driver’s education, seat belts or air bags. Over the last 30 years we’ve wanted everyone to be an investor, to be in charge of their own 401(k). And we do practically nothing to give them any training. It’s a fundamentally unfair bargain.
Q: A lot of people who are critical of 401(k)s are demanding that government bring back guaranteed pensions.
A: I can understand why, but pensions just don’t work. Every time we use them there are problems because of longevity. People have a way of living a long time. The people who are supposed to fund the pensions fail to set aside the money needed to fulfill the obligations, and they fail to disclose.
Q: And the problem with 401(k)s?
A: The problem is, we each have our own 401(k) bucket, and we have to make sure it’s as full as possible when we retire. And a lot of initiatives go into pouring more water in the bucket, but the leaks are ignored.
Q: A popular solution comes from University of Chicago professor Richard Thaler, author of “Nudge.” He says: Don’t wait for people to take care of themselves. Instead, employers should pull money automatically out of each person’s paycheck and stick it into their 401(k) account.
A: It’s a little cheeky to tell people: “We give you this new bucket system. You have no training for it, but the bucket doesn’t have much in it, so pour more into it.” Too much of their money leaks out. We have to stop the leaking.
Q: By leaks, you mean the mutual fund fees that people pay without knowing it – the fees that drain their money away the moment they put anything from their paycheck into the 401(k) or IRA.
A: Yes. If you have a house that’s leaking air conditioning, the solution isn’t to turn the air conditioning up higher without shutting the windows. It’s just foolish to keep pouring money into a system with a lot of leaks.
Q: Many people don’t realize that they always pay fees for their funds in 401(k)s, IRAs and 529 plans. But when I tell them to beware they say consumers pay for everything: sweaters, phones, computers; so why not pay for mutual funds?
A: Of course, you should pay for that service, but studies have demonstrated that the more you pay a mutual fund in fees the worse its performance. The more you pay, the more you are handicapping your funds.
Q: You argue that funds take advantage of individuals knowing full well that people with 401(k)s are unsophisticated.
A: When you are sold a mutual fund, the fund management knows exactly how sophisticated you are because you tell them when you buy for a 401(k). If you buy $100,000, you are sophisticated and you will get institutional shares, which will be a better bargain. If you show up with $135 dribbling in from your 401(k), they know you are not sophisticated. So you have no bargaining clout. Simply because people operate as individuals they are handicapped.
Q: You also draw a distinction between a customer buying products like phones and mutual fund investments.
A: When you buy a phone, you pay the money and get the phone. But with funds, it’s very different. You give the fund $10,000, they keep $100, and then you wait to see if they will make your $9,900 bigger. And some of your fees go toward advertising so the fund can attract more customers.
Q: You emphasize that people must pay attention to fees because small numbers are deceptive. I find people are surprised when I say that if they invest $10,000 and pay half of a percent in fees and earn 10 percent on the investment they will have about $61,160 after 20 years, but if they pay 2 percent they will only have about $49,160.
A: One solution is for the federal government to open the Thrift Savings Plan to any American who wants to join. You could get your investments at a 20th of the price you would pay for the average equity mutual fund. So the compounding factor over long-time horizons is just enormous.
Q: What do you think of states offering IRA savings plans at work – plans like Illinois’ Secure Choice Plan?
A: It is not a good idea for California, Oregon, Illinois and many states to each spend money and charge for their own plans. We already have a really good working model at the federal level. If we opened up the federal plan to everyone it would be great for the buyers, but not the mutual fund industry.
Q: What about the fiduciary standard? Will that help make sure that people aren’t sold expensive mutual funds when cheaper ones are better?
A: It won’t solve everything. Instead, I think the solution is for the SEC to pick the worst mutual funds, to line up 8,000 and find those with the worst fees, and sue them. This would be the difference between knowing there’s a speed limit and knowing there’s a cop out there to pull you over when charging outrageous fees. Now we have sheriffs, and they are meek.
Q: The U.S. Department of Labor has blessed target-date funds as a solution to 401(k) complexity. Are they a solution?
A: Target date funds have a halo around them because they were blessed by the government. But you still have to worry about the fees. On average they charge 0.74 percent, but Vanguard charges only 0.15 percent. What scares me is people think all they have to do is pick the target-date fund with the right year in it and they will be safe. And I say, “no,” you must pay attention to fees or they are going to be ravaging your account forever.
Gail MarksJarvis is a personal finance columnist for the Chicago Tribune and author of “Saving for Retirement Without Living Like a Pauper or Winning the Lottery.” Readers may send her email at firstname.lastname@example.org.