Another Reason to Distrust Wall Street: 401(k) Fees

The last thing that Wall Street and the securities industry needed right now was another black mark against it -- which was exactly what the bungled Facebook IPO has delivered. As reported today in the New York Times, Americans increasingly distrust Wall Street:

The portion of Americans invested in the stock market dropped this year to its lowest level since Gallup started asking, every two years, in 1998 — 53 percent said they were in the market in April, compared with a high of 67 percent in 2002 and 65 percent as recently as 2007, before the financial crisis. A Bankrate poll in April found that only 17 percent of respondents were more likely to invest in the stock market, even with the small amount of interest they earn on bank deposits. . . .

Perhaps the best indicator of the broader movement away from stocks is an annual survey done by the Investment Company Institute, which has shown that the percentage of American households invested in domestic stocks, including directly or through any other vehicle whether through mutual funds or exchange-traded funds, has fallen every year since the financial crisis to a low in 2011 of 46.4 percent, down from a high of 53 percent in 2001.

In a way, it's surprising that so many Americans still do trust the stock market. After all, as I wrote here last week, Wall Street insiders have betrayed ordinary investors again and again over the past 15 years. The dotcom boom was a big bait-and-switch game whereby insiders got rich, got out, and left Main Street holding a bunch of worthless tech stocks. Then, just a few years later, Wall Street peddled toxic mortgage securities to any investor who could write a check. And now comes the Facebook debacle.

Two major Wall Street meltdowns in the past 15 years have walloped investors. The true annual return rate on the S&P 500 between January 1, 1998 and December 31, 2011, accounting for inflation, was just 1.21 percent. That means if you invested $100,000 in an S&P index fund right before the big run up of stocks of the dotcom era and left it there for the next 14 years, you'd have made about twenty grand. That's not exactly the return rate that America's 70 million baby boomers are counting on to avoid poverty in old age.

(The dismal performance of the stock market also raises the urgent question of why nearly every public pension fund in America assumes future returns of between 7 and 8 percent, as reported in the Times recently. But that's a story for another post.)

Clearly, according to polls, Americans are wising up to the fact that the stock market is not a very reliable way to grow their money. But here's the scary thing: As wary as the public may be of Wall Street, it is not wary enough because the financial industry rips people off even more than most of us realize -- specifically, in the opaque or hidden fees associated with 401(k) plans.

A new Demos study, written by my colleague Robert Hiltonsmith, shows that the fees charged to retirement plans are substantial -- and excessive:

These include fees to cover the costs of advertising the plans and the companies who run them, fees to pay various investment managers of the funds in the plan, even fees to cover the costs of buying and selling the underlying stocks and bonds in which retirement accounts are invested. These fees, however, are taken “off the top” of investment returns or share prices—in other words, the rates of return and share prices reported to you in account statements and plan documents are post-fee. Because of this, retirement and bank account statements contain no evidence of these fees, and thus accountholders generally have no inkling how much all of this costs them.

Excessive 401(k) fees can take a surprisingly large bite out of the retirement savings of American families who are already struggling to save amidst long-stagnant wages and an idling economy. Dēmos has calculated that an “ordinary” American household (details provided later in this brief ) will pay, on average, nearly $155,000 over the course of their lifetime in effective total fees. To put this in perspective, this household could have bought a house with the amount they paid in fees.

Now, you would think that if you were on schedule to lose $155,000 you really needed for your golden years, you'd be pretty upset. But as the report points out, most of us don't have a clue that Wall Street is taking such a generous slice of our retirement package:

An AARP survey found that 65 percent of 401(k) account-holders had no idea they were even paying fees, and 83 percent, or 5 out of every 6, lacked even basic knowledge about the many fees and expenses that everyone with a 401(k) pays.

So, back my main point: Americans are pulling out of the stock market because of poor returns and fears, as underscored by the Facebook IPO, that the game is rigged against the little guy. But the public doesn't even know just how bad things really are. If they ever fully wake up, lord help the securities industry.