What’s Wrong With This Retirement Plan?

“The more complexity there is in the market, the more that something simpler stands out.” – John Maeda

Fidelity Investments, the behemoth mutual fund company that oversees nearly $4 trillion in assets, has gotten some bad press in the past few months.

Fidelity manages many 401(k) retirement plans for employers across the country.  One of their largest clients is actually the plan for their own employees.

As it turns out, some of the employees aren’t too happy about the way the retirement plan is run. A class-action lawsuit has been filed by dozens of employees that claim that Fidelity’s retirement plan doesn’t meet the company’s fiduciary duty to offer investment options that are in the best interests of their clients.

Here’s a brief explanation from CNN Money:

Fidelity’s employee retirement plan covers more than 50,000 participants and has roughly $8.5 billion in assets, according to court documents.

All of the more than 150 investment options available in the Fidelity plan were offered by Fidelity or a company subsidiary, according to the suit. And, at the end of 2010, nearly 85% of the plan’s assets were held in actively managed Fidelity mutual funds, which tend to have higher fees than passively managed index funds.

Fidelity provides a 100% match for up to 7% of a worker’s salary and typically makes annual profit-sharing contributions as well, according to court documents.

Do you notice anything wrong with Fidelity’s current retirement plan?

First of all, they offer way too many funds. You can build an extremely diversified portfolio with as little as three total market funds and to cover all of the main asset classes and sub-strategies would require maybe a dozen funds at the most. I’d say 150 funds is a bit excessive.

This can also lead to paralysis by analysis in offering far too many choices. The complexity in reviewing 150 funds can be mind-numbing especially for those that don’t have to time or expertise to do so (although they are a mutual fund company, so it shouldn’t be too hard to find some help).

The next big problem is that there are far too many active funds. This means that the fees are too high. If the employees are invested in-line with the 85% of funds that are actively managed, that would mean that Fidelity is making a lot of money off the fee income from their employees. Plus the majority of these funds more than likely underperforming simple low-cost index funds.

That means employees are losing money to high fees while also missing out on potential market gains. That’s a bad combination.

While Fidelity does have some solid active funds, history has taught us that actively managed funds with high fees underperform index funds again and again over multiple time frames and market environments.

I did a quick calculation to see how Fidelity’s large cap stock funds performed against the S&P 500 over 5 and 10 years through June 30. Over 5 years over 50% of the funds underperformed the S&P while over 10 years almost 80% underperformed the S&P.

Third, there is a huge conflict of interest in managing your own employee retirement plan. The CNN Money article actually said that TD Ameritrade, a large competitor, outsources their 401(k) plan to avoid any conflicts.

It’s nice to have some skin in the game, but this only increases the chances for problems with disgruntled employees or those that leave the firm.

I do give them credit for matching up to 7% of employee contributions. That’s a solid match considering the average is around 3%.

I don’t know all of the minor details behind this lawsuit but Fidelity could make a few simple changes to make this a better plan for their employees.

They could change their fund line-up to include just two funds for each asset class and strategy.  One active Fidelity fund along with an index fund to offer both options.

That would narrow down the choices to an active fund vs. an index fund and high cost vs. low cost while offering a much lower number of choices.

But the easiest solution would probably be to outsource the plan to another firm and focus on their clients instead of dealing with internal disputes with employees.

Source:
Fidelity sued by employees over its own 401(k) plan (CNN Money)

Further Reading:
The Government Actually Does Something Right

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