Meet the People Who Run Your 401(k)
Dan Klein runs the 401(k) plan at a small New Jersey hazardous-materials company, so when it comes to investing advice, he’s the go-to guy for his coworkers. Ask for help and he’ll explain the difference between stocks and bonds, value and growth. He may even suggest a portfolio. It’s fun, Klein says: “I probably should have been a financial planner.”
Maybe so, but there’s just one problem: He’s not one. Klein does have a midcareer MBA, but he went to school for chemical engineering and spent much of his working life cleaning up toxic spills. Nine years ago he traded up to the brickyard view from the vice president’s office; one of his first initiatives was to start a 401(k) plan for the company’s 26 employees, and he aggressively encouraged everyone to sign up. “I only wish someone had done it for me,” Klein says. Now he’s in charge of not only the firm’s financial operations but also his colleagues’ retirement security—a far cry from his days in a hazmat suit.
With the economy and the markets showing tentative signs of a rebound, millions of Americans are focusing on their 401(k) plans with fingers crossed, hoping to make up the estimated $3.7 trillion employees’ retirement accounts lost during the crash. But at all except the biggest firms, the men and women watching over those funds need no special qualifications, no investing expertise or experience. In practice, the job often falls to the company president, a human-resources manager or a committee of employees—in other words, people who are experts at something else. At one $54 million construction company in Idaho, the company’s founder runs the plan. His main qualification? Four decades in construction. Ultimately, these people have authority over which funds will be offered, what fees employees will pay and how much education and advice workers will get—the kind of features that dictate how each worker’s investments will fare. “Your performance depends on the decisions they make,” says Mike Alfred, CEO of BrightScope, a California company that rates 401(k) plans.
Of course, few managers are truly flying solo; nearly all hire brokers or consultants to suggest funds and make sure the plan complies with the law. Some administrators devote long hours to the plans and take courses to bone up. But critics say retirement planning has become too complex to be left to amateurs, and even hired help needs oversight. Brokers, for example, are not legally required to pick funds with low fees, so 401(k) plan managers who sign off on pricey funds could cost their workers tens of thousands of dollars over the long haul. Officially, 401(k) administrators are also responsible for employee education about retiring, a task that often gets lost in the shuffle.
“They’re trying to do the right thing,” says Teresa Ghilarducci, director of the Schwartz Center for Economic Policy Analysis at New York City’s New School. “But they’re not as competent as investment advisers.”
This arrangement has come under periodic attack, and it’s facing another wave of criticism now, as baby boomers struggle to recoup lost savings and Washington buzzes about reforms. But with some 465,000 managers out there running 401(k) plans—under virtually no regulatory supervision—no solution will be easy. And given that large companies usually hire in-house experts to run their plans, the ad hoc nature of smaller companies’ plans can get overlooked in policy debates. So for the moment, workers at companies with fewer than 1,000 employees, which account for more than 90 percent of the nation’s labor force, must count on the resourcefulness of whoever happens to be running their plan. To get a rare, ground-level look at the folks in charge of so many people’s nest eggs, SmartMoney tracked down a few of these managers, including the owner of an RV dealership already dealing with layoffs and a group of physicians with their own theories about investing.
Doing Their Duty?
Whether 401(k) participants at a big company do any better—or worse—than employees at a small or medium-size firm is hard to say; no one tracks the plans that way. (Overall, the plans collectively have matched the performance of the market itself during the crash and since.) But at firms of all sizes, the 401(k) plan has taken on increasing importance; 401(k) assets generate retirement income for about half of Americans over 65, while just 34 percent get pension payments. That makes running the plans a fairly big responsibility, and it has some legal teeth behind it. Unlike brokers, for example, 401(k) managers are considered “fiduciaries” in the eyes of the law—they must act in the best interest of their coworkers, or they can be sued. What those best interests are is pretty clear, says Joshua Itzoe, a financial planner in Maryland and author of Fixing the 401(k): “Their job is to help you accumulate as much money as possible.”
But some employers just don’t have much time to spend on that mission. Drive 20 minutes south of Seattle on Interstate 5 and, if you’re lucky, you’ll catch co-owner Rick Wakazuru in a rare quiet moment at Poulsbo RV, one of the biggest motor-home dealerships in the country. The lot is packed with luxury land yachts, the kind that come standard with flat-screen TVs and cost as much as an earthbound house in most cities. This economy hasn’t been kind to the RV business: Poulsbo RV has closed three of its seven stores and laid off more than 100 employees, and Wakazuru spends hours every day on the phone with banks and creditors. Officially, he’s in charge of the company’s 401(k) plan, responsible for acting in his employees’ best interests when it comes to choosing investments. But honestly, he has too many other worries. “The 401(k)? That’s the least of my problems,” says Wakazuru, who contributes to his own account but says he won’t need it for retirement.
Wakazuru says he only agreed to set up the plan on two conditions: It wouldn’t cost the company a dime, and he wouldn’t have to deal with it. So, like many small-business owners without the people power to get things going, he turned to a benefits-plan broker—in this case, Solomon Reeves, who has chosen and monitored the $1.8 million plan’s investments for the past eight years. The plan’s fees? Wakazuru doesn’t know. The company that provides the funds in the plan? He isn’t sure. Wakazuru also isn’t sure what advice his employees are getting from Reeves, who makes the majority of his money selling health insurance plans.
Not surprisingly, the funds in Poulsbo’s plans haven’t exactly soared—according to the most recent data available, the plan has done slightly worse than the S&P 500. Nearly a quarter of the offerings have been such poor performers over the past three years that they are now on the “watch list,” an orange alert status bestowed by Reeves before he boots a laggard from the plan’s menu. Because the company wants to keep costs low, the firm doesn’t match employee contributions, and administrative costs are passed along to employees in the form of fees on their accounts. As it is, those fees aren’t rock-bottom; at about 1.6 percent per year, they’re roughly 30 percent higher than the average plan of the same size. If Wakazuru were to negotiate for a better deal, and if the business could absorb a few thousand dollars in fees each year, the company might be able to cut the costs to participants by 60 percent—which would be a boon to their returns, says Itzoe, who reviewed the plan for SmartMoney. “But it would require major changes from the employer and the service providers.”
As it is, many employees at Poulsbo don’t participate at all. Salesmen can make more than $80,000 per year, but without an employer match and little incentive beyond Reeves’s urging, only about half of the workforce saves with the plan, and the average account balance is only around $20,000. “Without a match, what’s the point?” asks company comptroller Ondine Bonser, who, in spite of considerable financial savvy, still had reservations about joining the plan. To Wakazuru, all these details about fees and funds and participation just fuel his frustration with 401(k) plans in general. “It’s too complicated,” he says. “You can’t expect the owner or the employees to understand all this stuff.”
The Investment Diagnosis
When David Brown recruits doctors to Northwest Permanente, the Portland, Ore., HMO where he’s the head of human resources, he hits several themes. He lays out the benefits of practicing in community clinics where doctors can earn a healthy six-figure salary working eight-hour days, then bike home in the shadow of Mount Hood. He touts Portland’s big, affordable houses, easy access to sea and ski, and mild weather year-round. And last but not least, he hypes the company’s generous retirement plan. In addition to a pension plan, the firm will contribute as much as 11 percent of each doctor’s salary to the 401(k) plan. As a result, the collective’s 1,100 doctors have accumulated more than $500 million in the plan. Who’s in charge of that golden egg? More doctors.
Because the company is owned and run by its doctors, its 401(k) plan, like most other aspects of firm governance, is run by a committee of seven physicians (plus the company’s chief financial officer and its lead benefits administrator). Within that group, investment knowledge and sophistication is all over the map: One hospital-care specialist on the committee advocates shorting Treasurys, while a retired obstetrician-gynecologist favors Canadian real estate; others can barely remember what funds they hold in their 401(k). Nonetheless, they’re supremely confident in their analytical abilities, and when it came time to choose investments for the plan, the doctors sat down with fund fact sheets and debated costs, performance, betas and Sharpe ratios until they came up with a list of funds. “It was nice to think there was enough smartness in the group to help pick,” says Christopher Nelson, the general surgeon who chairs the committee.
Smartness isn’t always enough, though. With nine opinionated members meeting just once a month, progress, even on the most important decisions, can be glacial. A few years ago, the committee got fed up with the limits of its plan, which offered just four custom funds and a Web site straight out of 1999. So it undertook an exhaustive search, summoning 10 brokers and fund companies to the corporate headquarters, where the committee argued the merits and shortcomings of each, voted, adjourned and argued some more. The group took nearly a year to winnow the field, only to discover one of their finalists implicated in illegal stock market trading. Suddenly gun-shy, the group took several months more to make a decision. And until then, the participants were left with the same options that had fallen short in the first place.
By all accounts, the new plan is better. Participants have about a dozen funds to choose from, and if they don’t like them, they can invest elsewhere through the plan’s so-called brokerage window. In recent years, the plan has beaten the market by a little more than two percentage points. But now the committee is struggling with how much advice to offer. To paraphrase the old joke, seven doctors, 10 opinions: Some of the more sophisticated investors on the committee want to be able to encourage participants to invest more internationally, for example; others fear such counsel opens the group to legal liability. Unsurprisingly, they’re not moving particularly quickly. “We just haven’t been as aggressive about it as we should be,” Nelson said. So for now, mum’s the word, and doctors who want specific investing advice are on their own.
Following the Leader
Back between the speed traps in Piscataway, N.J., Dan Klein would never leave his coworkers hanging like that. “If I can help, I want to,” says Klein, whose desire to protect and serve is deep-rooted–he’s also a reserve police officer in the town where he lives. No one can say he’s not trying. He has instituted a generous 4 percent match for employees and says he’d like to raise it next year. And he has kept tabs on the brokers: He fired the company’s first middleman when he discovered there were steep penalties for anyone who left the plan within two years—a detail that escaped him when he first signed up. “I try to read everything,” he says. “But some of the documents are, like, 500 pages.” In search of a better deal for his employees, he found a broker who promised the company would pay no fees for three years if the company worked exclusively with one particular fund company.
Nothing, of course, is truly free, and the reason Klein was able to score such a deal illustrates the perils of good intentions. The reason it was free was that the fund company was paying the broker’s fees. That’s not uncommon or unethical. But it gives brokers an incentive to look for attractive fee deals, rather than hunting down the cheapest and best-performing funds. “Is it a good deal for the sponsor and the broker, or is it a good deal for the participant?” asks BrightScope’s Alfred. And in fact, within a year or two, Klein says his broker told him it was switching all its clients to another firm. “As long as you don’t charge us any fees,” Klein said, and okayed the change.
So far, Klein is satisfied, and the employees aren’t complaining. They have more than 50 funds to choose from, far more than at most companies this size, and Klein says he’ll add more if an employee asks. Still, in tough times like these, what most plan members seem to want is advice, and Klein has been happy to help them figure out where to invest. If asked, he says, he’ll show them his own portfolio, which includes an aggressive mix of growth stocks, energy and international companies. That’s a fine mix for Klein, since he’s not planning to retire for another two decades.
But it’s not for everyone, of course. Stephanie Burke, the office’s operations manager, says she has leaned on Klein for advice for years, with no regrets. Just before last year’s crash, her husband, an investment hobbyist himself, suggested she move some money to cash. But Burke stayed in stocks and took a heavy hit when the market tanked in the fall. “Whoops,” Burke says now. “Good thing I’m not planning to retire any time soon.” For his part, Klein says the crash has made him realize just how much responsibility he wields—for better or for worse. “I don’t want anyone to say, ‘You screwed me over,’” he says.
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