But he nabs the wrong villain.
Earlier this month, comedian John Oliver took on 401(k)s on his weekly HBO show, Last Week Tonight With John Oliver. To judge by the sparse audience response, this won’t be the first show aired should there ever be a John Oliver retrospective. But I appreciated the effort. Although Scott Adams gave it a shot, and quite successfully at that, one doesn’t often see humorists honoring my subject with their attention.
The show opened with some general financial-services hilarity. Oliver highlighted fine print that notified prospective investors that “Financial Analyst, Financial Advisor, Financial Planner, Investment Consultant, and Wealth Manager are generic terms or job titles, and may be used by investment professionals who may not hold a specific credential.” He wouldn’t be much of a comedian if he couldn’t hit that target.
He blasted fixed annuities, showing various prizes that annuity providers offer, in addition to cash payouts, to those who sell their wares. (The rings were tacky indeed.) The commission for an $80,000 annuity, Oliver reported, is $4,000. My shock was minimal--a load mutual fund would cost a similar amount, and if one could find an asset-based advisor to accept an $80,000 account, it wouldn’t take many years to reach that $4,000 mark, either.
There was some predictable fun with the idea that only some financial advisors are required to work in their clients’ best interests (that is, fiduciaries), a few kicks at active portfolio managers, and then a Jack Bogle-style attack on fees. Financial-services companies, Oliver stated, delight in extolling the magic of compound interest when praising the power of investing but are strangely silent about the subject with expenses. Compound interest is not always a positive, he says. It cuts “both ways.”
(For a well-executed rebuttal to this segment, see Charlie Epstein’s video. Curiously, the man who bills himself as “America’s 401(k) coach” does not address Oliver’s 401(k)-related comments. He does, however, make a reasonable attempt at defending Oliver’s villains in his opening general segment: brokers, commissions, annuities.)
On to 401(k)s.
The sacrificial lamb was John Hancock. Mamas, if your babies ever grow up to run a fund company, tell them to avoid late-night comedians as customers! As Oliver tells the story, he wanted to set up a 401(k) for his 35-employee company. The plan got up and going--and then he realized, after combining through the plan documents, that the costs were 1.69% annually before fund expenses, along with a $24 per-participant fee.
That sounds awful--and is. There is, however, more to be said on the matter. (Some of the following material comes from John Hancock’s response, which was far more polite than what you hear on late-night television shows, or in political campaigns. Financial-services executives are well paid, but they have no fun.)
To start, the plan’s underlying fund expenses are very small, as the average expense ratio is but 0.18%. Oliver and team had done their homework on the damage caused by the “termites” of ongoing mutual fund expenses and thus had requested a lineup of low-cost index funds. Total plan costs, aside from the $24 per-participant fee, were therefore at 1.87% per year, rather than the near-3% that one would first assume.
Too high? Absolutely. Almost 2% per year in costs at a time when Treasury notes return no more than that amount, and the typical 10-year stock forecast ranges from 5% to 7%, is unsupportable. Nobody should be happy paying anything near 2% in annual expenses.
By the Numbers
But ... John Hancock hasn’t made a dime on Oliver’s business and won’t for some time. (Actually, it won’t ever, as Oliver indicated that he will be moving his business.) The plan currently has $30,000 in assets, which leads to a whopping $54 in annual fund fees, at 18 basis points per year. I don’t know what company runs those funds, John Hancock or another party, but for the near term it matters not: The fund-based revenues are a pittance.
Which brings us to that 1.69% in plan costs. (I’ll skip the $24 per-participant fee, which is likely for recordkeeping and which Oliver’s company covered for its employees.) That percentage was based on the plan’s startup assets, which were of course very low, that being pretty much the definition of a startup. That percentage will decline as the plan grows, presumably by a substantial amount.
John Hancock will not receive all that amount, nor perhaps even most of it. In the first year, the third-party financial advisor that put Oliver’s company into the plan will get 1% of plan assets. After that, the annual cut will be 0.50%. If those plan costs drop below 100 basis points because of asset growth, then John Hancock’s will be the minority share.
Bad Rules, Not Bad Actors
My point? There is a villain here, and it’s not John Hancock. Neither John Hancock nor other providers to the tiny-company 401(k) marketplace have particularly high margins on this business line. The villain is also not Oliver’s third-party advisor, even if he did test Oliver’s faith by sending him an errant spreadsheet. (Oops!) Setting up 401(k) plans is a respectable living, to be sure, but you won’t find many such people buying an Aspen estate.
(Yes, I know, Vanguard serves this market at a lower cost than do other 401(k) plan providers. That doesn’t make Vanguard the only honest vendor in the industry. It makes it the thriftiest vendor, due to various decisions as to how it runs its business. And Vanguard can be cheaper yet, if current regulations are changed.)
The culprit is the system. Oliver’s company knew what it wanted in a 401(k) plan, but it did not know how to find the provider, what steps were needed in the search, the legal and fiduciary issues, the plan’s many technical details, the requirements for documentation, and so forth. Neither do other small-business owners. So they each reinvent the wheel--or, more likely, they hire somebody to do the task for them.
It is a pointless, repetitive, costly, time-consuming task, repeated again and again and again each U.S. workday. It could be replaced by a single, national-based system, one that could be researched in a single afternoon, that would come without legal liability and would cost Oliver and his employees a fraction of today’s fees. That can happen. It should happen. It is just a matter of political willpower.
That Washington cannot fix what should be a simple problem is, unfortunately, a different sort of comedy.
John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.