Recently, I reviewed the investment options available in a mid-size 401(k) plan. It was the usual fare: mostly high expense ratio, actively managed funds which historically underperformed their benchmarks. There was one index fund in the mix, which the plan administrator proudly pointed out to me. It was the Dreyfus S&P 500 Index Fund (PEOPX).
I checked the data on this fund from the Dreyfus web site. Here's what I found:
The fund has over $2.4 billion in assets. It has total expenses of 0.50%, including a management fee of 0.25% and a "service fee" of 0.25%.
The goal of this fund is simply to track the performance of the S&P 500 index. How difficult can this be?
Quite difficult, when you have an expense ratio of 0.50%.
The fund underperformed the index by 0.42% in the last year; 0.38% over 3 years and 0.46% over 10 years.
Expense ratios can clobber returns.
Since all S&P 500 index funds have the same goal -- tracking the returns of the S&P 500 index -- it would make sense to purchase the one with the lowest expense ratio. For example, Fidelity's Spartan 500 Index Fund -- Investor Class (FUSEX) has an expense ratio of only 0.10%. The minimum investment is $10,000. Most 401(k) plans qualify for the purchase of Fidelity's Spartan 500 Index -- Advantage Class (FUSVX) which requires a minimum investment of $100,000. This fund has an expense ratio of only 0.07%.
The Investor class shares underperformed the S&P 500 index by 0.03% in the last year; 0.02% over 3 years and 0.09% over 10 years.
Huge difference compared to the Dreyfus S&P 500 index fund.
Allan Roth raised some troublesome issues with high expense ratio index funds in an "Open Letter" he wrote to SEC Chair Mary Schapiro.
Roth had proposed to the Chairman of the Dreyfus board that he pursue a tax-free merger of the Dreyfus S&P 500 index fund with a fund tracking the same index, but with a third of the costs. He noted that the merger would guarantee higher returns to shareholders of the Dreyfus fund. The Board turned down his proposal.
Roth questioned whether the directors of this Dreyfus fund violated their fiduciary duty by turning down an option that would have guaranteed their shareholders higher returns. He further inquired whether the fund had an obligation to disclose to its current and new shareholders the rejection of his proposal.
Whatever the answer to these questions may be, about this I have no doubt:
A plan sponsor of a 401(k) plan is vulnerable to a breach of fiduciary duty lawsuit by plan participants if it includes high expense ratio index funds as investment options, when lower cost ones are readily available.
Here's a more challenging issue:
Why is $2.4 billion invested in the high expense ratio, underperforming Dreyfus S&P 500 index fund, when lower cost, better performing, comparable funds are readily available?
Check your 401(k) plan options. If you have a high expense ratio index fund, complain to your plan administrator.
The irony of all this is that all 401(k) plans should consist only of pre-allocated, globally diversified portfolios of low cost, stock and bond index funds, passively managed funds or Exchange Traded Funds.
But that's another story.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.
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I know that many experts (plan consultants and investment advisers) want to sell you managed mutual funds and/or their services for a fee, but not one expert has ever picked a core mix of managed mutual funds or packaged products such as asset-allocation, target-date, lifecycle, lifestyle, or balanced funds that beat a core mix of low cost index funds in performance--long term. Long term means more than ten years. If you don't believe me, ask for the expert's long term track record that shows the truth about his or her track record at picking mutual funds.
Want to save even more money on plan costs? Not only should participants (employees) invest in a diversified core mix of the lowest cost index funds that they can get for their plan, but they should pay not more than $30.00, per year, per eligible employee for recordleeping and administration. Many plans are unnecessarily paying double or tripple what they should for recordkeeping and administration. Yikes!
Don't worry! Whenf you pay less for index funds and services, you will still get good service and the usual bells and whistles that all plans have.
Just think about it. It makes no sense to pay more than you should for an IRA account, 401(k) plan, or 403(b) plan--right?
Best wishes,
Frank Cirullo