By James Kwak
Ted K. points out (and comments on) Stephanie Fitch’s article in Forbes on Wal-Mart’s 401(k) plan. The crux of the matter is that Wal-Mart seems to have done a lousy job creating a good 401(k) plan for its employees. Until recently, it had ten funds, only two of which were index funds; the other, actively managed funds all had high expense ratios (the ones Fitch quotes are above 1 percent).* More shockingly, the expense ratios paid by plan participants were the same as the expense ratios paid by individual investors in those mutual funds. It didn’t even pool its employees’ money together to get institutional investor rates. The irony, of course, is that Wal-Mart is the world’s best, most powerful negotiator when it comes to getting low prices for the stuff it sells, yet it exercised no negotiating power in getting low prices for its employees — even though it had $10 billion in assets to swing like a club.
One allegation of the current lawsuit is that Merrill Lynch, which administered the plan, may have chosen funds for the plan because of (legal) kickbacks it was getting from the fund managers. In other words, Merrill was pushing specific funds onto Wal-Mart employees because it was effectively getting sales commissions for those funds. This is classic banking behavior, of course, but it’s a bit of a mystery to me why Wal-Mart would put up with it; since it’s just as easy for Wal-Mart to create a good 401(k) plan for its employees as a bad one, why did it create a bad one? (I don’t actually think Wal-Mart would actively go out of its way to screw its employees if it didn’t benefit it some way.)
I say it’s classic banking behavior, because of course banks will try to sell you products that give them bigger profits; it’s their interests they have in mind, not yours. The basis of the lawsuit, however, is that Wal-Mart violated its fiduciary duty to plan members under ERISA. Unfortunately, the fiduciary duties under ERISA seem (as far as I can tell on a very cursory reading) to be pretty flimsy, having to do mainly with disclosure. In other words, you can create a lousy plan for your employees; you just have to tell them all about the plan so they can figure out that it’s lousy. (And in any case, since most employees are effectively captives of their employers, there’s nothing they can do about it, anyway.)
401(k)s are in many ways a feeble substitute for traditional defined-benefit pensions. Among other things, unless you get an employee match, it’s all your money — your employer isn’t contributing anything. The tax deduction you get from a 401(k), like all tax deductions, is valuable in direct proportion to your marginal tax rate and the amount you are able to put aside, meaning that it is extremely regressive. But still, it’s a modest benefit for working people (and a better benefit if there’s an employer match). However, like all investments, the tax benefits can be rapidly swallowed up by fees.
One hundred years from now, people will look back and say we were all suckers for paying expense ratios of over 1 percent to fund managers who generally fail to beat the market. Unfortunately, we will all be dead before then, and in the meantime we’ll be paying those fees.
(This is what Wal-Mart had to say about the issue: “We are proud to provide a high-quality, innovative retirement plan to help more than one million of our Wal-Mart associates prepare for the future.” Reminds me of something Google recently said.)
* I don’t think having a small number of funds is bad in itself. Too much choice can be counterproductive, especially if some of the choices are bad; it’s better to have three cheap funds than to have three cheap funds and seven expensive ones.