Making self-directed retirement savings plans like the 401(k) the foundation of old-age income is as economically inefficient as making pins one at a time.
Specialization makes for economic efficiency. We do not all know how to wire our homes for electricity or plumb them to carry fresh water in and wastewater out without spilling a drop. Using self-directed investment through 401(k)-type plans is the economic equivalent of expecting every worker to be her own roofer and surgeon.
Most people lack the necessary time, knowledge and highly specialized skills to manage investments and time in order to accumulate enough wealth to sustain them from the day they stop working until they die. The result of creating a population of financial do-it-yourselfers is proving to be shocking and painful, leaving people worse off than need be.
Look at it this way: if investing was something just anybody can do, the average job on Wall Street would pay average wages. But stockbrokers, investment advisers and others who become expert at subtle concepts like the time value of money, asset allocation and risk and opportunity costs make more than most people because those skills add value by reducing inefficiency and increasing returns.
The Labor Department publishes data going back to 1989 comparing investment returns of traditional pensions and 401(k) plans through 2008. The professional managers of traditional pensions performed better than individuals in their 401(k) plans in fifteen of twenty years. In every year when the stock market was down, the pension plans lost less than the 401(k) plans, numbers that reflect the steady hand of professional money managers as opposed to the less informed and sometimes panicked hands of individual amateur investors.
In 2008, when the stock market fell sharply, pension plans lost almost 20 percent of their value, but 401(k) plans lost 24.9 percent. That means that for every dollar pension plans lost, the 401(k) plans lost $1.25. Recovering from those losses will be a lot harder for 401(k) savers than those denied their benefit pension plans.
Steve Butler, a San Francisco Bay Area financial adviser who calls himself “Mr. 401k,” praises 401(k) plans—if the costs are held down through smart shopping by the employer. His studies show that many workers pay one percentage point a year more in costs than necessary because their employers chose high-cost plans.
Again, a single percentage point may not seem like much but, over time, it adds up to a lot. Consider what happens if you put $1,000 in a 401(k) annually for forty years and earn 5 percent a year instead of 4 percent. After forty years, earning 5 percent annually would yield more than $181,000, but the other account would hold less than $137,000. That one percentage point a year of extra fees robs you of a third of your 401(k) savings at retirement.
Employers also shortchange workers by paying them with debased currency. It’s an old trick, dating at least to the sixteenth century, according to David Hackett Fischer, the Brandeis University historian, in his book The Great Wave. In that era, Fischer tells us, the merchants of Venice and Florence got laws passed “that allowed them to insist on being paid in gold l orins or ducats, which held their value, but permitted them to pay wages and taxes in silver coins, which were much debased.” The result?
“As a consequence rich merchants grew richer and the poor sank deeper into misery and degradation."
Excerpted from THE FINE PRINT: How Big Companies Use “Plain English” to Rob You Blind. Published by Portfolio/Penguin. Copyright (c) David Cay Johnston, 2012.
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