The retirement plan industry, despite the pronouncements of the financial service providers and organizations who support it, is a complete disaster. It is dominated by service providers who not only subject participants to significantly excessive fees and investment complexity, but who also have major conflicts of interest because of the kickbacks they receive from the mutual funds.
However, it actually gets worse because the people who are in charge of the plans either don’t have the aptitude to understand how the plan works, don’t care to understand how the plan works, don’t have time to understand how the plan works, or in many cases, all of the above! Furthermore, there is often a relationship with a close friend or family member that precludes any sort of critical evaluation of the plan because the main goal of the plan is to simply direct business to the friend or family member – at least when the plan sponsor gets to pay these people primarily with other participants’ money (which is how it almost always works).
But what’s most disturbing are two psychological factors which prevent plan sponsors from acting in participants’ best interests. The first is the fact that despite some vague notion that there are costs, the actions plan sponsors take indicate a belief that everything is free. Because of this belief, plan sponsors and participants don’t even bother to consider what plans cost and make irrational decisions. To illustrate, professor Dan Ariely in his book Predictably Irrational, provides an example of how the concept of “free” causes people to behave irrationally. He cites an experiment where people had the choice between purchasing a Hershey Kiss for 1 cent or a Lindt truffle for 15 cents. About 73% of people chose the truffles. However, when the price of each candy was reduced by 1 cent – making the Kisses free – 69% of people chose the Kiss! As Professor Ariely says:
“What is it about “FREE!” that’s so enticing? Why do we have an irrational urge to jump to a “FREE!” item, even when it’s not really what we want?
I believe the answer is this. Most transactions have an upside and a downside, but when something is “FREE!” we forget the downside. FREE! gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is. Why? I think it’s because humans are intrinsically afraid of loss. The real allure of “FREE!” is tied to this fear. There’s no visibility of loss when we choose a “FREE!” item (it’s free). But suppose we choose the item that’s not free. Uh-oh, now there’s a risk of having made a poor decision – the possibility of a loss. As so, given the choice, we go for what is free.” (Predictably Irrational, p. 54, 55)
Consequently, we always tend to buy things we don’t need when we get something for free. In the retirement plan industry, plan sponsors make decisions to purchase retirement plan services that participants don’t need and don’t use because they think they’re free (this happens because most participants simply throw their money into a fund and leave it there meaning they don’t wind up using many of the services they’re paying for). What’s worse is that these plans are actually not free, but very expensive – at least in proportion to the utilization of the services.
The second factor has to do with a phenomenon known as the bystander effect which refers to the idea that fewer people will help a person in distress the greater amount of people that are present. Granted, retirement plan sponsors are not in a position to help people in distress in the way they would if they were witness to a car accident. However, they are in a position to help participants protect their retirement savings, yet despite my consistently calling many plan sponsors (often over a period of years!) with the simple request of doing nothing more than picking up the phone and calling their provider to negotiate their fees, they often refuse to take any action whatsoever. I believe the reasons are that they believe that everyone else is doing the same thing and that if nobody else is taking any action, then there must not be anything wrong. So many times have plan sponsors said to me: “Our fees are in line with other plans in the industry.” Statements like this one perfectly exemplify plan sponsors’ abdication of responsibility as a result of feeling proportionally less responsible because of the belief that their actions are visible to others who are behaving the same way.
What ultimately has to change is not making new rules that represent more “reform” that so many people clamor for, but the mindset of central planning which ultimately results in plan sponsors serving the goals of politically connected service providers rather than the participants who they have a fiduciary obligation to protect. As a consequence, plan sponsors spend most of their time and energy following a set of arbitrary bureaucratic rules instead of looking for ways to fill the unique retirement needs of each participant.
Unfortunately, those in power who benefit most from this system won’t give up their power any time soon. To stimulate change, we need to strike at the root which perhaps can only be done with a full scale consumer rebellion.