Index funds cost next to nothing. That’s still too much.
So says a class-action lawsuit filed this month against H-E-B LP, which alleges that the San Antonio-based company has been overpaying for index funds in its employees’ retirement plan. Annual expenses on some of those market-matching funds run between 0.11% and 0.14%—but should instead be as low as 0.015%, the lawsuit argues.
It’s starting to look as if any fee you don’t need a microscope to see may be too big to last. The suit against H-E-B is among the newest of several recent cases to contend that merely cheap isn’t good enough for retirement investors. And it’s the latest sign thatthe cost of investment managementis on its wayto zero.
H-E-B, which operates about 400 supermarkets in Texas and Mexico, declined to comment. Its retirement plan had more than 62,000 active participants and nearly $2.5 billion in total net assets as of year-end 2017, the most recent data available from the U.S. Department of Labor.
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How low should the fees on retirement funds be? In 2018,says the Investment Company Institute, a trade group for the asset-management industry, 401(k) investors paid an average of 0.41% in annual expenses on stock funds and 0.34% on bond funds.
By that standard, H-E-B’s index-fund expenses between 0.11% to 0.14% seem like a bargain. But costs have fallen so far in recent years that those low-sounding fees are up to seven times higher than essentially identical funds charge, the suit alleges.
Fees in 401(k) and other federally regulated retirement plans must be reasonable—although the law doesn’t define what that means. In deciding such cases, “the courts have not said ‘the cheapest option is the only thing that’s reasonable,’” says
a principal at the Groom Law Group in Washington, D.C., who advises retirement-plan sponsors. Several other factors, such as the quality of service and the possibility of superior investing results, can justify fees above rock-bottom.
Active funds, whose managers seek to use human judgment and expensive research to pick the best and avoid the worst investments, often don’t look exactly alike, and their fees can vary widely. Index funds, however, use computers to buy every stock or bond in a market; they charge peanuts and tend to be as similar as peas in a pod.
Therefore, “if you have some index funds that are charging, say, 0.01% to 0.03% and others charging 0.1% or more, then there’s a pretty good argument that it’snotreasonable to pay the higher fees,” saysFred Reish, a partner at Drinker Biddle & Reath LLP in Los Angeles who specializes in retirement plans.
As of June 30, within 401(k) and similar retirement plans,index funds totaled $1.1 trillion, or 22.9% of their total mutual-fund assets, up from 15.8% five years ago, says the Investment Company Institute.
The next area where fees may fall farther is target-date funds–those prepackaged retirement portfoliosthat bundle stock and bond funds together and automatically adjust their risk as workers age. These popular portfolios held nearly $1.72 trillion at year-end 2018, according to investment-research firm Morningstar. They can be assembled from active funds, index funds or both.
Morningstar reckons that target-date portfolios with more than 80% of their assets in index funds held approximately $480 billion at year-end 2018; those with at least four-fifths of their holdings in actively managed funds had about $570 billion. On average, target-date portfolios investing entirely in active funds charge about 0.6%—twice as much as those that hold only index funds.
“A 0.01% difference is very small,” says Jerome Schlichter, founding partner at Schlichter Bogard & Denton, a law firm in St. Louis thatpioneered suits against retirement-plan sponsors over fees. “The bigger the difference, the bigger the red flag gets, until it’s neon red.”
All this suggests that the future will be leaner for asset-management companies;their share prices are bound to sufferas fees continue to shrivel. Some investment advisers charge 1% a year to do little more than shuffle clients’ portfolios; unless they add vital services like financial planning, they’ll go out of business.
Back in 1992, when I began writing about mutual funds, the average stock fund charged about 1.2% in annual expenses. Invest $10,000, and you’d pay $120 in fees a year. That isn’t counting commissions, which often cost buyers up to 8%.
Today, commissions are virtually extinct, and dozens of index funds charge 0.05% or less in expenses, or $5 a year. The cost of ownership has fallen by more than 95%, and the end may still not be in sight.
As portfolio management becomes nearly free, anyone who touches your money is going to have to work harder and do more to justify any extra fee.
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