Most are familiar with the excessive fee scandal in 401k plans, as documented in books like David Loeper’s Stop the 401(k) Rip-Off and the PBS television expose The Retirement Gamble, which aired on April 23, 2013. This scandal took years to be addressed. Books and videos did not work but lawsuits did—sticks not carrots. There’s another 401k scandal that has emerged in the past decade, compounding the widely publicized excessive fee disgrace.
This new scandal is not well documented …yet. Target date funds have rapidly attracted $3 trillion despite their iniquity. But before I go into detail, it’s important to understand that these are fiduciary scandals—breaches of fiduciary responsibility by plan sponsors and their advisors. Investment firms can’t be blamed for trying to make a profit; that’s what investment companies do.
By contrast, fiduciaries are responsible for choosing the best products for their dependents, which includes appropriate fees and meaningful risk management. The excessive fee scandal is being resolved in court and has resulted in required fee disclosures under DOL rule 408(b)2. One attorney, in particular, Jerome Schlichter, has single-handedly brought class-action lawsuits for excessive fees against the likes of Vanguard, Prudential, Cigna, Bechtel, Caterpillar, General Dynamics, International Paper, Kraft Foods, and many more.
Similarly, class-action lawsuits are on the horizon for excessive risk in Qualified Default Investment Alternatives (QDIAs), specifically target-date funds and balanced accounts, when the next market correction occurs as is likely sometime in this decade.
Baby boomers will be the victims
Unlike the excessive fee scandal that affects all participants, this scandal only affects defaulted participants who represent about 60% of all 401k beneficiaries. Even more to the point, baby boomers are most exposed to this scandal because they are currently in the Risk Zone spanning the 5 to 10 years before and after retirement when investment losses can irreparably ruin the rest of life.
Unfortunately, excessive risk near the target date will not be remedied before the next market crash. Like the excessive fee scandal, lawsuits will be required to remedy the excessive risk scandal, so the remedy will follow the harm.
Baby boomers need to act now before they become the basis for excessive risk lawsuits. Lawsuits, after the harm occurs, will probably not recover much of baby boomer losses.
Congressional inquiry identifies the scandal
On May 6, 2021, Senator Patty Murray, D-Wash., Chair of the Health, Education, Labor, and Pensions (HELP) Committee, and Rep. Robert C. “Bobby” Scott, D-Va.), Chair of the House Education and Labor Committee, sent a letter to Gene Dodaro, Comptroller the GAO. They are seeking answers to 10 questions dealing with concerns that some aspects of TDFs may be placing American retirement savers at risk. They wrote:
“…we write to request the General Accountability Office (GAO) conduct a review of target-date funds (TDFs). The employer-provided retirement system must effectively serve its participants and retirees, and we are concerned certain aspects of TDFs may be placing them at risk.”
The letter specifically asked GAO to explain why the Federal Thrift Savings Plan (TSP) is 70% safe assets at the target date while the industry is only 10% safe. I’ve written about this here and here. The critical point is that a couple of very influential people recognize the problem and have commenced a review.
I’m told that a resolution to excessive risk is not forthcoming so baby boomers cannot wait for the protection they need at this critical time in their lives. They need to act now.
This article lays out in detail what baby boomers need to do to protect their hard-earned lifetime savings from market corrections and inflation that lie ahead. These lifetime savings for retirement are in 401k plans and individual retirement accounts (IRAs).
Beware of Wall Street
Wall Street is more interested in baby boomers’ $60 trillion than their wellbeing and financial security. If boomers move to protect themselves, as they should, Wall Street will suffer. Baby boomer best interests are not Wall Street’s best interests. Wall Street is very skilled at gaslighting investors into believing that all is wonderful. Don’t be fooled. Baby boomers need to take control of their savings to protect themselves, now.
As discussed in the “Bad Advice” section below, Wall Street advocates a 60/40 stock/bond allocation regardless of age and circumstance. 60/40 is bad advice for baby boomers, doled out by those who earn a nice living by managing that mix.
Wall Street rarely acknowledges current challenges to the stock and bond markets
It really is different this time
It’s usually not true when someone says, “It’s different this time”, but it is true this time:
- Interest rates have never been lower
- The US government has never printed more money
- Stock prices have never been higher
- The wealth divide in the US has never been wider
- There has never before been 78 million people simultaneously in the Risk Zone
These are challenges that most baby boomers are not prepared to deal with because most are not educated in finance and investing. Will Rogers said, “Everyone is stupid, but about different things.”
These extremes generate a host of threats, any one of which will cause a stock market crash, plus government money printing is going to cause accelerating inflation. Baby boomers need to trust but verify the investment advice they are receiving now.
Bad advice
According to the Employee Benefit Research Institute (EBRI), the average baby boomer is invested 60/40 stocks/bonds in their Individual Retirement Accounts (IRAs), 401ks, and their target-date funds. This is too much risk for baby boomers at this time.
The reasons for this mistake are revealed in the history of investment consulting. Consultants and investment managers use “models” for varying levels of investment risk. The model in the middle is the “go-to” model; it’s 60/40. Consequently, the typical balanced fund in 401k plans is 60/40. Balanced funds qualify as QDIAs (Qualified Default Investment Alternatives) along with TDFs and managed accounts.
Managed accounts and self-directed accounts of baby boomers can and should protect in the Risk Zone. The go-to model that should be used for today’s baby boomers is not in the standard list of models at all. It is 70% safe, where safe assets protect against investment losses and inflation.
Compounding the problem, investors are routinely advised to “stay the course” in the midst of a market correction. This is good advice if you’re on the right course, but most baby boomers are not on the right course.
Well-meaning fiduciaries make bad decisions
The fiduciary target date fund scandal arises from a misalignment of interests: participants bear the risk while fund companies enjoy the profits. Win or lose, fund companies get paid and they’re paid more to manage risky products, so they are incented to take risks in TDFs, especially near the target date when account balances are their highest.
The pretext for high risk is inadequate saving. The QDIA scandal is intertwined with the excessive fee scandal. Of course, this misalignment exists in all managed investment products because the investor bears market risk while the fund company gets paid, win or lose. The difference is that fiduciaries can choose a high-fee-high-risk product or a low-fee-low-risk, and their decision must be based on the best interests of the beneficiaries. The scandal is that TDFs are sold, not bought, so the high-fee-high-risk product is a common choice.
Good advice
We recommend baby boomers:
- Research your current asset allocation and risk
- Consider reducing risk, especially if you find that you’re 60/40 or higher
- Act to protect, along the following lines.
The pat 60/40 allocation might be OK when you are not in the Risk Zone, including beyond 5-10 years after you’ve retired. But we recommend a safe inflation-protected allocation in the Risk Zone, like 70% in TIPS (Treasury Inflation-Protected Securities) and Treasury Bills, with the balance in risky assets that protect against inflation.
401k investors might not have access to our recommended choices in the Risk Zone, in which case they should defend as best possible. Those who have defaulted into target date funds will need to take back control unless they’re in one of the very few TDFs that defend at the target date, like the TSP plan. This is a tough situation but leaving your lifetime savings in a very risky fund could lead to disaster.
Beyond investments
Happiness in retirement is based on health, wealth, and purpose.
“Purpose” is an individual matter and can be as simple as “enjoy life.” Health and wealth are influenced by investments and the following additional considerations.
- Social Security and Medicare can provide comfort for even baby boomers who are not very wealthy.
- Smart spending helps savings last longer
- Working in retirement can fulfill the purpose as well as provide income
Conclusion
Baby boomers are in the crosshairs of an irrecoverable disaster in the next market correction, a correction that many believe will happen in this decade. Even if the outlook were rosy, baby boomers in the Risk Zone should be protecting their life savings.
You only get to pass through the Risk Zone once. 60/40 at this time in a baby boomer’s life is a very bad gamble. Baby boomers will easily survive the Risk Zone if markets perform well in this decade. However, if there is a correction in the decade, the survivors will be those who protect themselves from investment and inflation losses. Is the risk worth taking?
Ron Surz is President of Target Date Solutions and CEO of GlidePath Wealth Management. He is also the author of Baby Boomer Investing in the Perilous Decade of the 2020s. He can be reached at Ron@TargetDateSolutions.com.