Experts see many problems in employer-sponsored 401(k) retirement plans, which one BusinessWeek columnist jokingly called “201(k)” plans. A big failing in the system is the way fund plan managers like Fidelity, State Street, Putnam, Metlife and others lock in company executives and naïve investors to a system of fund choices that are too restrictive, fees that are often hidden and excessive, while trusting corporate managers and employees remain vulnerable to exploitation and manipulation. College tuition plans have similar problems.

Several years ago economist Bill Wolman and Anne Colamosca, authors of The Great 401(k) Hoax, said it’s “a time bomb ready to go off.” In fact, America’s 401(k) plan has already “bombed” because $40,000 is no long-term retirement nest-egg in an age where a retiree’s money must last 20-30 years, and need a million invested to generate a comfortable cashflow in retirement. As the authors point out, many employees don’t even bother to enroll, and of those that do, 80 percent spend the money when they change jobs, rather than rollover into a IRA. Worse yet, during the 2000-2010 decade, many 401k plans actually lost big money. This would be funny, if it wasn’t such an ever-increasing disaster.

Perhaps the biggest enemy is your 401(k) plan manager. Wolman and Colamosca say investors are making a huge mistake letting employers, Corporate America, Wall Street and politicians do your thinking for you. Why? Because they’re your enemy, they created and they control the 401(k) for their benefit, not yours. The fact is, 401(k) managers get rich off naïve investors.

How bad is it? A recent Forbes article, “Retirement Rip-Off,” lambasted the industry. Using data from Dr. Mundell’s Center for Retirement Research at Boston College: “Even as 401(k) balances grow in size and importance, fees remain high and poorly disclosed.” There are $2.9 trillion savings in 401(k)-type accounts. Fees on these 401(k)’s are estimated to exceed those of traditional pension funds by 1%. That means 401(k) savers are paying $29 billion in excess fees to the fund industry. And in a Bloomberg Markets report, retirement planning consultant Stephen Butler says, “Hidden fees of 1% can reduce a workers 401(k) returns by 15% over 30 years.”

The biggest 401(k) plan manager—the biggest problem?

Since Fidelity is the biggest manager with over 11 participants, they’re often cited as an example of what’s wrong with the system: During the three bear market years prior to publication of The Great 401(k) Hoax, Fidelity’s two key stockholders saw their net worth increase on the Forbes 400 list of the richest Americans. Their wealth increased more than $1 billion between 1999 and 2002, a bear market—while Fidelity’s equity funds lost 37% of their net worth for investors. Today the owners are worth a total of $20.5 billion.

Excessive fees help: Fidelity’s largest fund, Magellan, manages about $60 billion in assets. It’s an “index-fund-in-disguise,” yet its expense ratio is three times comparable index funds, generating about $500 million in annual management fees during the bear market. Compare Magellan’s fees to Vanguard 500 Index, with about the same size assets. Magellan fees were several times greater for a fund that was actually an index fund in disguise. And to add insult to injury, Vanguard was out-performing Magellan during the bear market—while Fidelity’s investors lost.

Big plan managers love adding assets, piling on fees

Fidelity’s investors, of course, were not as lucky as Fidelity’s insiders. In the three-year bear market from 2000-2002, Fidelity Magellan managed to lose an average of 15 percent each year, about 45 percent of its investors money, in … while Fidelity’s owners, directors and fund managers were still getting rich.

And to add insult to injury, Fidelity’s board of directors ten directors were getting between $250,500 and $316,500 annually for part-time work. That’s over ten times what the average American makes full-time. And while Fidelity refuses to disclose the compensation paid its managers, we know that of 43,000 American fund managers the average is paid $436,500 a year, so we can assume Fidelity’s managers are doing as well or better. Bottom line: America’s biggest 401(k) plan manager lost an awful lot of your money in the three year bear market, and yet Fidelity’s owners, directors and portfolio managers continue to live like rock stars. Something’s seriously wrong with America’s 401(k) system.

The big hoax America’s sweeping under the rug

The Great 401(k) Hoax, was an eye-opener. And the recent work of Drs. Alicia H. Munnell and Annika Sundén of the Center for Retirement Research Boston College adds a big exclamation point, telling us that things are getting worse, not better. Listen to the 2006 conclusion updating their book, “Still Coming Up Short: The Challenge of 401(k) Plans: 

“Policymakers and the business community have come to recognize that 401(k) plans must be easier and more automatic if they are to serve as an effective vehicle for retirement saving. These plans have shifted all the risk and responsibilities for retirement saving from the employer to the employee and many employees make mistakes at every step along the way. A significant percent of eligible employees fail to join the plan, few contribute the maximum, most do not diversify their investments or re-balance their accounts over time, many over-invest in company stock, and roughly half of participants cash out when they change jobs. Automatic enrollment, automatic increases in the deferral rate and automatic rollovers will all help workers accumulate larger balances in their 401(k) plans. But the challenge is great, because the median 401(k)/IRA balance in 2004 for household heads with a plan was only $40,000. Moreover, the focus to date has been on the accumulation phase of 401(k) plans—that is, the buildup of assets during the employee’s working years. The real challenge will come as those dependent on 401(k) plans arrive at retirement and have to figure out how to allocate their 401(k) balances over their remaining lifetime.”

Our hats are off to experts like Munnell and Sundén, Wolman and Colamosca for exposing the problems. But the hard reality is things are getting worse because Washington politicians favor Corporate America, Wall Street and 401(k) plan managers like Fidelity over the individual investor. Add all these 401(k) difficulties to the mounting problems with Social Security and Medicare and the under-funded corporate, municipal and state government pensions and it’s likely that matters will get worse rather than improve—making the 401(k) an even bigger hoax until 2011 when this retirement bomb will explode in the faces of the 76 million boomers as they reach retirement age, shake their heads and ask, “what the #@&% happened?”

FirstPubDate: Dec’02

One rare institutional manager caught our eye because he was the only one willing to break this Mafia-like code of silence and reveal exactly where his own taxable money was invested. This was exciting news from the start: Actually meeting someone who in fact bought Bogle’s Vanguard 500 Index Fund way back in 1976 when it was launched. Not only that, he still owns this dull, boring, passive fund that does nothing but sit quietly in his portfolio and track the S&P 500 index … chalking up a cumulative gain in excess of 2,500 percent since inception.

One rare fund manager … what are the others hiding from you?

Ted Aronson has a reputation for integrity. In fact, TheStreet.com called him “the world’s most honest money manager,” which may explain why, during 2002-2004 the years of the fund scandals, Ted was Chairman of the Board of Governors of the Association of Investment Management & Research, the professional society for 68,000 money managers. Unfortunately, he’s extremely rare, 99.9% of the other managers still hide behind the great Wall Street code of secrecy, with no disclosures.

Even more fascinating: This guy who has been adding money to the S&P 500 and other Vanguard index funds “forever,” although he’s an active money manager. His firm, AJO Partners manages roughly $20 billion for fifty clients, all institutional money, retirement portfolios, endowments and corporate pension funds. And not only has Aronson been in Vanguard 500 Index since day one, he also has all of his personal taxable accounts in ten other Vanguard index funds! And he adds, “I’m proud to say we’ve owned many of them for as long as they’ve been in existence.” Now that sure makes him a true-blue buy’n’hold investor.

Active manager investing in passive index funds?

But wait a minute: Isn’t this all a bit contradictory? Isn’t it a bit strange that a successful institutional money manager is putting his own personal money in dull, boring, passive index funds, not actively trading in the stock market? You ask: He’s got the experience as an insider, couldn’t he do a lot better investing his money in the accounts he actively manages, where he’d presumably make more money? Or at least to show his clients he’s confident of his ability to beat the market?

Yes, indeed, all veeery good questions! So stick with us and you’ll see the very simple reasons why Aronson puts the bulk of his own family’s money into eleven no-load Vanguard index funds, and why virtually all other portfolio managers refuse to admit the truth about their own investments. Listen closely, because there is a powerful lesson here for all investors in America, you can‘t trust most managers..

$10,000 in first S&P 500 fund now worth 250-times more

To begin with: That fab-u-lous S&P 500 index fund has served Aronson very well. It has averaged over 12.1 percent annually since Jack Bogle introduced the fund over 30 years ago, as the “First Index Investment Trust.” That means, if you’ve been in the fund since 1976, you’d have made a cumulative return in excess of 2,500 percent. In other words, if you gave Bogle $100,000 in 1976, your investment would now be worth $2,500,000, including the original investment. Twenty-five times as much as you put in. Now folks, that is exciting news!

And it’s even more exciting to know is that you would have made that kind of money even if you had stop reading the newspapers … avoided online trading … never watched CNBC … and simply stuffed your shareholder statements about Bogle’s totally boring, dull, passive index fund into a shoe box in your attic and never looked at them the past thirty years.

Vanguard sets the standard all funds have to beat

But still, that begs the real question, doesn‘t it: Because why would Aronson—a guy who actively manages $29 billion for other people with the goal of maximizing returns and beating the averages—put all his own family’s money in dull, boring, passive index funds? Why? Well, the fact is the money he manages for institutional clients is non-taxable money. And while “all of my family’s retirement money is in our funds,” says Aronson, “because the fund trades a lot, it’s not suitable for taxable investments. So all our taxable money is in Vanguard’s no-load index funds.”

Here’s why he says Vanguard sets the gold standard for performance: “My partner Kevin Johnson used to run the entire indexing show at Vanguard, where minimizing costs is crucial. By contrast, we’re active managers with annual turnover of 100 percent. I never forget that devil sitting on my shoulder, meaning the low-cost passive funds. They are stiff competition. Vanguard has it nailed. They win because they lose less. Their costs are lower. Quarter after quarter, year after year.” So please take a very close look at the eleven no-load Vanguard index funds in the Aronson family’s well-diversified portfolio. The percentages are the approximate asset allocations in the current portfolio; forty percent in domestic equities, thirty percent in foreign stocks and another thirty percent in fixed-income:

· Wilshire 5000 (VTSMX) (5%)
· S&P 500 Index (VFINX) (15%)
· Wilshire 4500 Mid-/Small-Cap (VEXMX) (10%)
· S&P Small-Cap 600/Barra Growth (VISGX) (5%)
· S&P Small-Cap 600/Barra Value (VISVX) (5%) 
 · Emerging Markets MSCI-EMGFree (VEIEX) (15%)
· Pacific Stock Index MSCI-PAC (VPACX) (10%)
· European Stock Index MSCI-EUR (VEURX) (5%) 
· TIPS: Inflation-Protected Securities (VIPSX) (10%)
· High-Yield Corporate (VWFHX) (10%)
· Long-Term Treasury (VUSTX) (10%)

Then, with an impish smile and tongue-in-cheek, Aronson summarizes his overall strategy here: “I obviously follow a highly complex, sophisticated strategy: Diversify. Keep costs down. Buy what’s wounded; sell what’s done well!” Bottom line: When it comes to protecting his family’s taxable money, Aronson is a real keep-it-simple buy’n’hold money manager, not the high-turnover, hyper-active trading quant at the office.

Why active managers can’t beat indexes – high costs!

Like most money managers, Aronson has a split personality when it comes to investing—he has one personality in his institutional office, another when he‘s at home, where he tells me he rarely looks at his portfolio and almost never changes his asset allocations, he simply adds new money to rebalance the actual assets to match the above model. Ted Aronson is incredibly blunt when it comes to his own business of active fund management. When asked why most fund managers can’t beat the indexes, he gave this simple reply:

“They can’t beat the indexes. Why? Costs. Funds charge annual expenses of one percent or more. Then it costs another 1.5 to 2 percent to buy and sell their stocks each year. It’s hard to imagine them doing anything but just following the crowd, because if they don’t mimic the index, they’ll get beaten by it.” They can’t beat the indexes, but they can still pocket billions in extras. His costs are under one percent, with fees tied to performance incentives.

Rare managers in a sea of sharks

Translation: Most actively-managed funds are actually closet index funds. To stay competitive, they are forced to focus on and match their peer index. And unfortunately, the high operating costs they add, make it virtually impossible for the taxable funds to beat their benchmark indexes. No wonder they’re doing the same as Aronson put their own money in simple buy’n’hold accounts. Just remember, Aronson’s one of the rare managers among 70,000 out there. The vast majority operate behind a massive wall of secrecy that protects them, while they get very rich and their investors make mediocre returns. After all, these guys manage over $11 trillion, so they’d rather not talk too much about the fact that every one percent in fees gets them $110 billion a year.

FirstPubDate: Dec’02

 The Society of Professional Asset-Managers and Record Keepers says nearly 73 million Americans, or just under 50% of our working population, now have a 401(k). And collectively we pour more than $200 billion into these accounts each year. But retire rich? Don’t bet on it. The average 401(k) has a balance of $45,519. That’s not retirement. That’s two years of college. Even worse, 46% of all 401(k) accounts have less than $10,000. Today, just 21% of all U.S. workers are covered by traditional pensions, and the number shrinks every year.” A major overhaul is essential, “and the government seems to agree. This summer, the Government Accountability Office concluded, ‘If no action is taken, a considerable number of Americans face the prospect of a reduced standard of living in retirement’.” 

Worse, the recent Wall Street meltdown played a “cruel joke to many … closest to retirement. During the market downturn, the 401(k)s of 55-to-65-year-olds lost a quarter more than those of their 35-to-45-year-old colleagues. That’s because in your early years, your 401(k)’s growth is driven mostly by contributions. You control your own destiny. But the longer you hold a 401(k), the more market-exposed it becomes.”

Unfortunately, Wall Street is less help than your company’s boss. The “Fat Cat Bankers” that got mega-bailouts are more focused on generating average $500,000 bonuses for insiders. They do that by generating $100 million daily revenues from the same kind of high-risk “high-frequency” derivatives trading that triggered the 2007-08 meltdown. Their myopic focus on millisecond trading is a conflict-of-interest with the long-term 401(k) retirement needs of Main Street America’s 95 million small investors. Expect things to get worse. No wonder in dark moments skeptics call these plans “201(k)s.

There are major problems build into the 401(k) structure, as USAToday points out: “Efforts to raise 401(k) participation hit snags: Auto enrollment, targeted funds run into unexpected problems:”

“The thinking two years ago seemed logical enough: If more companies would automatically enroll employees in 401(k) plans, then offer them the simplest of investment strategies, the employees would get a leg up on retirement savings, and we’d all be better for it.”… But for “people living paycheck to paycheck who are automatically enrolled may eventually find themselves in financial distress. But if they cash out the saved money after the opt-out window, usually 90 days after enrollment, they will face income taxes and a 10% penalty if they’re not 591/2 or older.” … Plus, “auto enrollment could have a negative impact on savings, because it tends to cause employers to lower matching contributions for employees” Also “target-date funds are supposed to shift investments over time to become more conservative” yet last year some lost over 40% in the downturn.”

For more formation on plans: See “How Good is Your 401(k)?” in BusinessWeek: Read about “BrightScope, a San Diego startup, wants to help 401(k) participants and administrators” that “has created a massive database from corporate filings with the Labor Dept., Securities & Exchange Commission, and other sources, to rate 401(k) plans.” And if you’re a self-starter, check out Boston University Economics Professor Larry Kotlikoff’s ESPlanner, which “calculates your sustainable living standard and helps you find safe ways to raise it.” But overall, the 401(k) ship is slowly sinking, and these efforts to improve your plan may never compensate for the problems inherent with the 401(k) itself.