Salmon: Beware Schwab's High-Cost Index-Fund 401(k)
In other words, Schwab has given us no evidence at all that the people enrolled in its new index-based 401(k) plan are saving more money as a result of paying 45bp a year for advice. I'm sure that a small minority of people who want to save more will ask for advice on how to do so -- but that doesn't mean that the advice causes them to save more. Indeed, the causality probably runs exactly in the opposite direction.
It seems to me that Schwab is looking a bit desperate here. It used to be able to make lots of money by charging high amounts for its 401(k) plans, but now that everybody understands the superiority of index funds, Schwab is being forced to offer its own index-based service. Obviously, the only way to sell such a service is to talk about how much participants will save on fees. But Schwab doesn't want lower fees, it wants higher fees. So while removing management fees with one hand, it simultaneously inserts huge new advice fees with the other -- and the advice fees probably have even bigger margins than the management fees did.
What's more, Schwab's messaging around this product has always been less than fully honest. Here's the launch press release :
"Fund operating expenses for index mutual funds and ETFs are typically lower than those associated with most actively managed mutual funds offered in 401(k) plans today. We believe index funds can provide employees with a better opportunity to accumulate more savings for retirement," said Steve Anderson, head of retirement plan services at Charles Schwab. "Through such low-cost investments, fund operating expenses could be cut significantly. For the average worker in a 401(k) plan, that can mean nearly $115,000 more at retirement."
The irony here is deeply hidden: In order to end up with $115,000 more at retirement, you would have to opt out of the advice plan that the Schwab index-fund offering automatically enrolls you into. But actually, "the average worker in a 401(k) plan" is never going to wind up with an extra $115,000 at retirement just by switching to index funds.
If you look at the assumptions behind that $115,000 figure, you'll find that our "average worker" is, in fact, very far from average. For one thing, she starts saving money at age 25, when she's already earning $50,000 per year. That's pretty much the median income for a U.S. household, within just a couple of years of entering the workforce. Well done, that person! She then gets a 3% raise every year for the next 30 years -- and once she's in her 30s, she manages to sock away a full 10% of her income into her 401(k) account every year until retirement. Oh, and she managed to save 66bp by switching to index funds: That's significantly larger than the real-world 50bp that we saw with the Schwab participants. And all the while her investments are growing by 7.5% per year, even when she's near retirement and ought by rights to have switched largely to bonds.