Fact and Fiction Blur in 401(k) Fund Story

The spin game continues in Washington even as funds recover much of their losses.

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It is an out-of-body experience to hear the retirement fund industry talk about how well it has performed during the past two years. But that was the party line at a recent panel session in Washington. It was held to discuss recent research into public attitudes toward retirement accounts and the performance of the accounts themselves. The Investment Company Institute, the primary trade group for mutual funds, surveyed 3,000 people. It found overwhelming support for 401(k) plans and strong consumer opposition to government efforts that would curb the plans.

[See Best Affordable Places to Retire.] It is not a coincidence that this research comes out amidst a bull market in proposals for all types of government curbs. Following the meltdown in securities prices that begin in late 2007 and extended into last spring, the big mutual fund companies that dominate the 401(k) business have been hammered. People looked at 30 to 40 percent market drops in many retirement funds and, this being America, clearly wanted someone to blame. So they blamed the funds. They said investors had been mislead and that the funds had riskier investment strategies than people thought. They compared fund performance with Social Security, which continued to make payments, including cost of living increases. Give us more of those kind of guaranteed payments, they said, waxing nostalgic for the days of traditional pension programs.

They tended not to blame the market or the worst recession in our lifetimes. They did not talk about the risk of investing in stocks. They did not talk about the need to have a long-term retirement plan and to stick to that plan.

When markets head sharply lower, as they began doing in 2007, retirement-fund managers were exposed to the corrosive effect of investor naivete. People thought their investments would always rise in value. This was particularly the case when it came to funds in retirement accounts. And perhaps no group of funds was more misunderstood than target date funds. These are mutual funds designed to produce optimal results as their owners age and approach retirement. Over time, they automatically shift holdings into less risky bonds and other conservative investments. Yet many of them suffered large market losses in 2008, stunning their owners.

[See Best Places to Retire.]

So, let me ask you. How do you feel about your retirement investments? Do you have a lot of confidence that 401(k)s and other self-directed retirement plans can help you achieve your retirement goals? That's what people told the ICI pollsters. Are things actually much better than you've been led to believe? Maybe this is all a media conspiracy and things actually are OK on the retirement front.

If it weren't for those doom-seeking and largely uninformed critics, perhaps, we'd realize how good we have it. Markets do decline, and that's what happened from late 2007 to early 2009. Such is the nature of economic cycles and this has been a tough one. But retirement funds should be viewed over a longer horizon. For the most part, they performed as designed. Investors who did not panic but remained in their funds, and continued to put new money into them, are now benefiting from account balances that largely have recovered earlier losses.

That was pretty much the message of John Brennan, another panel speaker, who is chairman emeritus of Vanguard. Vanguard has long worn one of the whitest hats in the mutual fund business. It charges fees that are significantly lower than most competing funds. (Higher fees, by the way, do not appear to translate into superior account management and higher returns.) And it's long been seen as a straight shooter that advocates a steady-as-she-goes philosophy to retirement investing.

Brennan says most Vanguard customers have made up their past losses, and that 60 percent of them had higher account balances last September than two years earlier. "Savers are sticking to their 401(k) plans," he said. "There's been no panic in defined contribution investors." As for the widely maligned target date funds, he said they're down 5 percent over the past two years. "That's hardly a disaster. . . . They have served investors incredibly well."

Criticism of fund performance was not only misplaced but actually damaging, he suggested, causing some investors to bail from the market at its low point, thus preventing them from participating in the major upward swing that stocks later enjoyed in 2009. "The jargon that the 401(k) became the 201(k) was damaging," Brennan said. "It's cute, but it's deleterious to the effort to get people into" retirement investing.

Paul Stevens, head of the ICI, said it has long been a misconception that retirement prospects were brighter 30 years ago. There were no 401(k)s or other defined contribution funds at that time, and people depended on traditional, defined benefit pension programs. Yet fewer than one in five Americans actually retired with a traditional pension, Stevens said, and those who did had an average benefit of only $6,000 in today's dollars. The notion that 401(k)s replaced some kind of marvelous pension system is just false, he said.

Stevens and a lot of people make very good livings off of 401(k)s and similar employee-based retirement programs. Through fees, investment management charges and administrative expenses, the investment industry generates billions and billions of dollars each year from employee retirement funds. In good times, investors tend not to question the fees or even do much homework to understand them. So long as investment markets are doing well, people don't worry about the largely invisible charges that may take anywhere from one to several percentage points out of the investment gains on their accounts. Ignorance actually is bliss, and everyone's having a good time at this party.

But when the party ends, as it did in 2007, ignorance has nasty consequences. Most 401(k) investors are not financially sophisticated. Academic researchers have developed a cottage industry on the lack of financial literacy among consumers. It was, in fact, the history of poor employee investment choices that contributed to 2006 changes to retirement fund laws. Those changes, ironically, caused retirement plans to greatly expand their use of target date faults as a default option for 401(k) accounts. And so it goes.

[See Target-Date Funds Post Strong 3rd Quarter.]