Sunday, May 17, 2015

Trade & Investment & Regulators & Markets

401(k) plans compete for employers but lock in investors

I like Twitter. At its best – remember, it's just an application that does its users' bidding – Twitter enables thoughtful, respectful conversations.

Last week Miles Kimball, professor of economics at the University of Michigan, authored a article obstensibly about the Trans Pacific Partnership (TPP) trade agreement. Mr. Kimball argued that if employers were required "to automatically enroll all employees in a 401(k) with a default contribution rate of 8% [it] could increase the national saving rate on the order of 2 or 3 percent of GDP ... One of the biggest benefits would be helping people arrive at retirement well prepared financially. But it would also have a major effect on the US trade balance. If the US ran smaller trade deficits, employment would go up beyond any particular business cycle."

Mr. Kimball and I are in violent agreement about the value of TPP, the need for increased retirement savings, and the benefits of decreased consumption. However we part ways at coerced savings – especially when there are no competitive substitutes for 401(k) contributions and when the plans cause investor lock in from their rollover restrictions.

So I posted to Twitter and Mr. Kimball replied.
And this is why I like Twitter at its best: the conversation made me think.

With his reply, Mr. Kimball suggests two things: that regulators – rather than markets – are an investor's best friend and that regulators know the right 401(k) fee level.

Markets are efficient. And when consumers – or investors in this case – have information and choice, they get the best deal. But in the case of 401(k) retirement plans, they have only the former. Employers have only one plan, and the plan offers a fixed slate of employer-picked investment options about which investors are given fund cost information. However if I want a different plan with different investment options, I have to change jobs. IRAs are an imperfect substitute with lower annual contribution limits and without the mechanism for employers to contribute. Further I cannot roll my 401(k) funds to a competitive, cheaper IRA unless I change jobs – thus the lock-in effect.

So regulators may require a low-fee plan but I cannot shop for a plan that's right for me based on investment choices and costs.

Then there's that bit about "regulation requires low-fee plans". What's the right fee level? Mutual funds use an expense ratio to express fund cost: a ratio of 1 percent means that my return is one percentage point lower than if the fund had no expenses. So should regulators set the plan fee at the industry average or some arbitrary number? If so, guess what? All plans will toe the line, charge the regulated fee level, and investors gain no benefit from competition.

So thank you, Miles Kimball, for making me think. And I agree: TPP and trade are great because they open markets, encourage competition, and benefit consumers. But I prefer greater choice in retirement investing as well and, with it, the lower mutual fund fees that competition brings.