Your Retirement Fund Is Slowly Evaporating
Whether you know it or not, your 401(k) is likely being devoured by marketing fees, investment-management fees, administrative fees, and broker commissions—along with trading fees that pass on to you every time a mutual fund buys or sells a security.
There's at least one scene in Martin Scorsese's The Wolf of Wall Street that speaks to a higher truth about the financial industry—and, incidentally, to why almost no one you know will have enough money for retirement. Early in the movie, Matthew McConaughey's character takes Jordan Belfort, played by Leonardo DiCaprio, to lunch to teach the young broker how the game is played.
"I gotta say, I'm incredibly excited to be a part of your firm. I mean," DiCaprio stammers, "the clients you have are absolutely..."
"Fuck the clients," McConaughey interrupts, going on to explain that no one can predict the market. Brokers, he says, make money through a Ferris wheel of nonstop fees, not client interest. "We're taking home cold hard cash via commission, motherfucker," he barks as he orders another martini.
The modern American retirement system of 401(k)'s and IRAs is really no different. Defined benefit pensions are a thing of the past. Pretty much every American is now in control of his own retirement and must figure out his own path on the stock market through a confusing array of retirement-planning options. But there's a catch: Like the dupes who entrusted their money to the brokers in The Wolf of Wall Street, you're being fleeced on your retirement, and the opportunities are endless. And while a simple regulatory approach could help millions of investors, it has been fought for decades by the industry, and we may now be facing the last chance in years to address the situation.
As things stand, around 85 percent of financial advisers—including those helping you and your family plan for retirement—have no legal obligation to act in your best interest. That mutual fund you were advised to invest in? That annuity? That so-called growth fund? Chances are the fund is laden with hidden fees that eat up your savings. And there's an even better likelihood that the fund your adviser selected wasn't in your best financial interest. Instead, your adviser was probably paid a kickback to sell you that plan. Mutual funds benefit from planners who push clients in their direction, and often they reward planners with a piece of the action through a special commission or fee. The retirement-planning industry, which serves the $10.5 trillion American retirement system, has every incentive to place self-enrichment over retirement security.
Whether you know it or not, your 401(k) is likely being devoured by marketing fees, investment-management fees, administrative fees, and broker commissions—along with trading fees that pass on to you every time a mutual fund buys or sells a security. The fees—nearly impossible for the average person to uncover, buried as they are in page after page of small type—can represent between 1 and 3 percent of a total retirement portfolio.
Small as that may seem, the fees eventually reflect the tyranny of compound interest, with the result that they can add up to the difference between retiring in comfort or working until you're 80. The average two-person household in the United States, according to one analysis, pays $155,000 in fees over the lifetime of a 401(k).
And to make matters far, far worse—those actively managed funds with high fees statistically underperform passive index funds that broadly track the market. That's not to say there's no room to hedge your portfolio with an actively managed fund or two, but it's clear that most mutual funds are overhyped junk. But index funds carry very low fees, and financial advisers have little reason to encourage them.
How inappropriate are the funds that financial planners are recommending? The journalist John Wasik, working with the New York–based think tank Demos, has collected stories of American retirees who have been royally screwed over by the financial planning industry. One, a retired Houston cop, recalled being told by his broker that investing in preferred Lehman Brothers stock would be "similar to a CD" in terms of safety. He lost more than six figures when Lehman went bust. UBS Investments, a brokerage owned by the Swiss Bank, peddled more than $1 billion in Lehman funds as low-risk investments.
The hunger for retirement-fund profits is so great that some planners have turned to cannibalism. Ameriprise Financial, one of the nation's largest financial planners, has been sued by its own employees after pushing them into high-fee proprietary funds that ultimately cost employee accounts more than $20 million.
Which brings us to one of the less discussed aspects of financial reform—a simple regulatory fix known as the Fiduciary Rule, which the administration and the Department of Labor could push through without the support of Congress. Meaning that in the twilight years of the Obama administration there will be one last shot to clean up the financial planning industry.
This set of proposed rules would require virtually all financial planners to act as your fiduciary, meaning they would be paid a flat fee rather than by commission. Most important, it would mean they could only give you advice in your best financial interest. (At present, most financial planners must follow only a "suitability" standard, which means they may not invest your money in something extreme, like a potato-salad Kickstarter, though they may still plow your savings into mutual funds with sky-high fees.)
Why have regulators waited so long to attempt to ensure the most basic of rules for financial planners? In the past, the Department of Labor largely ignored the problem because of pressure from the financial services industry. And in 2010, when in the wake of the financial crisis the Obama administration finally moved to act on the issue, the industry knives were already sharp.
The Financial Services Institute, a coalition that represents financial planners including LPL Financial and Transamerica Financial Advisors more than doubled its spending on lobbyists that year. Records show brokers and mutual-fund interests hired 180 lobbyists to fight back on the rule, including several former members of Congress, like Republican Jim McCrery and Democrat Kenneth Bentsen Jr. Thomas Donohue, a lobbyist who runs the most powerful influence machine in Washington, the US Chamber of Commerce, was enlisted as well. Even Eugene Scalia, Supreme Court Justice Antonin Scalia's son, was retained to write a letter to the Department of Labor, criticizing the proposal.
A document posted online by the industry lobbyists—subsequently deleted—boasted that the effort had generated 5,000 letters to the White House against the rule, conducted 260 meetings with Congress, and mobilized congressional resistance. The metadata from one congressional letter, ostensibly from a group of House Democrats, revealed that it had been penned by a ghostwriter—a Financial Services Institute lobbyist.
Banks, mutual funds, and private investment advisers also flooded the department with highly technical complaints about the rules. In several letters, JPMorgan Chase and State Street griped that the proposed legislation was too vague and required greater exemptions. In one industry letter typical of Wall Street protests over the reforms, Northern Trust wrote that the rules "in our view create the very sorts of 'unnecessary burdens on businesses' that President Obama pledged to remedy in his recent State of the Union address." Besides, the letter noted, "individual retirement accounts are large and important parts of our business."
Opponents coalesced around a faux populist argument. By forcing a fiduciary standard, the cost of investment advice would rise, limiting choices for low-income and minority retirees. "We are especially concerned about the proposed rule's impact on small savers at a time when many Georgians are struggling to ensure themselves of secure retirement," wrote two Republican congressmen, claiming the rule would make financial advice too expensive for regular Americans.
The financial planning industry assembled an unusual coalition. Tea Party lawmakers joined leaders of the Congressional Black and Hispanic caucuses to denounce the rules. The seemingly unimaginable coalition was fused with the magic glue of Washington: money. Think tanks, economists, politicians, and even their families got in on the action. The Financial Services Institute, for instance, retained as a lobbyist William Clyburn Jr., a cousin to Congressman James Clyburn, the top-ranking African American Democrat in the House. The institute's PAC gave checks ranging from $1,000 to $5,000 to 38 lawmakers of both parties who signed anti–Fiduciary Rule letters.
In 2011, facing a wave of political opposition, the administration backed down. Even after the White House's retreat, an increasingly bank-friendly Congress has fired warning shots across the bow. In the last session, a bipartisan bill backed by Congresswoman Ann Wagner, a Republican from Missouri, would have created new hurdles for any Fiduciary Rule to pass and forced it into years of delays, running out the clock for the Obama administration. The bill passed with virtually all Republicans and a sizable bloc of Democrats voting for it. It lingered and died in the (then Democrat-controlled) Senate.
Regulators have since promised to re-propose but have punted on a time line. Now, insiders say, the rule will come out sometime in 2015.
"The thing is, you're paying for the advice in one way or another," Norman Stein, a professor at Drexel University's Thomas R. Kline School of Law, told me. "You're paying for it with no transparency because you're paying for it through fees, so even if it looks free, it's not free."
To Stein, many of the opponents have been trolling the issue. The financial planning industry, he says, will certainly make less money because of the rule—that's why they're fighting it. And it will force unwanted reforms within the industry, changes Stein says will force brokers "to be smart enough, thoughtful enough, and prudent enough to actually give good advice."
It might seem brazen for the financial planning industry to argue that they don't have to serve their own clients' interest. But this logic isn't peculiar to Wall Street: Washington clearly shares that view.