Gonnella, executive vice president of corporate development at Lincoln Trust, said the industry and the government need to make sure plan sponsors are better educated about investment costs and have access to better investments.
Because Lincoln Trust has always disclosed fees, Gonnella said, the roll-out of fee disclosure last August was not an issue. “We are a hard-dollar, fee-for-service provider,” he told PLANADVISER. “I think where these disclosures needed to come into play were, a lot of providers in the 401(k) industry sell product. That’s the conflict.”
He describes some providers as providing recordkeeping services in addition to selling some kind of investment product, whether a mutual fund or insurance product. According to Gonnella, the companies that sell investments have been, in effect, selling the product and giving away the recordkeeping service. But the cost burden is shifted to the plan participant through higher investment costs. This can feel like a free 401(k) plan to the plan sponsor, according to Gonnella, until they realize they are the bigger balance in the plan, and they’re paying for it through the investments.
Lincoln Trust uses a personalized expense ratio for its clients, which details every penny that goes through a retirement plan. “It’s a true all-in cost,” Gonnella said. The firm gives its clients the data annually, and has it benchmarked to a plan of a similar demographic by an independent firm so that they can how much they are paying for each service—recordkeeping fees, revenue-sharing offset, the adviser’s fee, third-party administrator fees—and more to the point, if they are paying too much for a service.
Most often where they see the overpayment or the egregious fees are in their investments, Gonnella pointed out. “Over 84% of a retirement plan’s costs are in the investments—that’s where the DOL fell short,” he said. “If you look at the disclosure requirements, there’s no specific calculation for investment costs.”
Education for Plan Sponsors
Gonnella believes the reason is some product providers would not want all that information to be disclosed. “Money drives a lot of decisions in Washington, so I don’t see that changing soon,” he said. “But we can change the education to plan sponsors.”
Employers need to know the information so they can make an informed decision. Whether or not they choose a higher-cost investment is not the issue, Gonnella said. “Let them know what they are paying. Some people are going to choose above-average costs. You’re always going to have products with above-average costs, and people who willingly choose them. Just don’t hide that information.”
There has been improvement, he admitted, and people are becoming more aware of the fees in their plans. Gonnella said he thinks of the first wave of fee disclosure requirements as a 1.0. “They dipped their toe in, and I commend them for that, but it doesn’t attack the investment costs, the biggest costs in a retirement plan,” he said. “That’s where they need to go with 2.0.”
Another area of improvement is the actual investments in a retirement plan, according to Gonnella. “No one talks about this because there’s no money in it, but I do think it’s going to become a hot topic over the next five years,” he said. “We’re starting to make a lot of progress for plan sponsors to get access to better investments in their plans, more institutional investments, and getting more understanding around their costs so they’re paying attention to the investments.”
But the investment process for participants is another weak area, he said. How does the participant choose among the 15 funds he might be presented with, given his risk profile and specific financial situation? “Who is going to help him invest? I call it the investment gap,” Gonnella said.
Allocation Is Critical
“Over 90% of your returns as an investor come from how you allocate your assets,” Gonnella said. “Some say it’s as high as 98%. Your investment return comes from how you allocate your assets. If that’s the case, then why aren’t we paying more attention to this? Allocation makes up over 90% of the return. It’s not how well you select stocks or time the market. It’s how you allocate your assets in an up or down market. Your ability to get 8% a year comes from how you allocate your assets. It’s well within reach, if you allocate properly. But no one’s paying attention to that. That investment gap needs to be solved.”
Gonnella described Lincoln Trust’s approach for its own employees as a radical step. “We took away all that core fund lineup. We have five investment models from conservative to aggressive, and we had each employee fill out a risk profile questionnaire,” he explained. Each employee was then defaulted into one of those models, which are professionally managed, at 100%. The models eliminate the need for target-date funds, which he called problematic on several levels. But the biggest problem is that they are all one fund family. “If you look at the studies,” he said, “only 25% of those are going to outperform. That’s a huge negative for these target-date funds. We try to give the participant a higher percentage likelihood of success. Now we have to figure out how to do it for the industry.”
“That’s how the industry’s always been sold,” Gonnella said. “I think the DOL is at least trying to educate people.” They are not trying to stop the practice, he said, but plan sponsors should be educated so they know what they are getting.