Personal Finance

Who's Profiting From Your 401(k)?

Dan Solin, The Huffington Post
Ken Reid | Workbook Stock | Getty Images

In this election year, there's a lot of talk about how the middle class has been decimated by our economic woes. In a sobering study titled "[T]he lost decade of the Middle Class", Pew Research Center defines this beleaguered group as those with household incomes between $39,000 and $118,000.

According to Pew, since 2000 the middle class "has shrunk in size, fallen backward in income and wealth, and shed some – but by no means all – of its characteristic faith in the future."

Their median income has fallen from $72,956 to $69,487.

It's not surprising that savings for this group have also declined. Most employees are relying on their 401(k) plans to secure their retirement. At the end of 2011, over $3.1 trillionwas invested in these plans. Workers in their sixties with more than 30 years of tenure with their current employers had average account balances of $202,329at the end of 2011.

This will hardly provide "retirement with dignity" even to this very limited class of hard working, loyal Americans. At a prudent withdrawal rate of 4.5 percent of savings, they had better be prepared to live on $9,100 a year ($758) a month, plus Social Security and any other savings.

At this income level, a family of two would be close to or below the 2012 poverty guidelines of $15,130 set by the U.S. Department of Heath and Human Services.

Another depressing studyfound that 46 percent of people die with less than $10,000 in assets. Their retirement years were anything but "golden." They relied almost entirely on Social Security benefits. Many of them didn't even own a home, after a lifetime of work.

A key reason for the low balances of the even those at the top of the pecking order for 401(k) plans is unconscionable fees imposed by the mutual fund industry. According to a report by Demos, the average mutual fund earns a 7 percent return but, after fees, the net return is only 4.5 percent.

Think of it this way: You work hard. You contribute the minimum to your 401(k) plan necessary to get the maximum contribution from your employer. The mutual fund industry takes over a third of the total returns they generate.

Few employees realize this stunning fact because the "expense ratio" of the funds is expressed as a percent of total assets. Demos found the average expense ratio of mutual funds in 401(k) plans was 1.27 percent in 2010. This doesn't sound very significant until you do the math.

It's not surprising that the mutual fund industry is one of the most profitable sectors in the U.S. According to Management Practice, the average return after all costs of mutual fund companies is "about 30 percent of revenue."

While these fat cats are reaping these profits and taking no risk, how are they doing as "investment managers"? Every investor should read David Swensen's scathing indictmentof the mutual fund industry. Mr. Swensen is the chief investment officer at Yale University. He correctly notes that "[F]or decades, investors suffered below-market returns even as mutual fund management company owners enjoyed market-beating results. Profits trumped the duty to serve investors."

It's time to stop the carnage.