2012 Study of Indexing in DC Plans

By Neil Plein
View Neil  Plein's LinkedIn profileView Neil Plein’s profile


A PDF Version of this White Paper is available here


Despite the popularity of index funds and their accompanying perception of being low cost, small plans are paying quite a premium for this investment type. This study supports the use of index investments in defined contribution plans, but finds that nearly 88% of such plans in the United States are overpaying by using Mutual Funds instead of Exchange Traded Funds (ETFs).

Given the substantial number of plans which fall into this category (88% of plans have less than $200 million in assets), the increasing popularity of index investing and new fiduciary regulations that require companies to ensure the reasonableness of investment expenses; the practical decision to replace index mutual funds with ETFs will likely serve as the “breakout” point for ETFs in retirement plans.

This study will show that for plans with less than $200 million in assets, ETFs should be used for index investing rather than mutual funds.


New federal regulations on Fee Disclosure in retirement plans have brought discussions on investment expense to the forefront of consideration. With mandates requiring companies to take a good hard look at the costs incurred in their plans, many are taking greater notice of index investing; the benefits of which have been well popularized recently through stories written and syndicated by major names like The New York Times[1], Forbes Magazine[2] and the Huffington Post.[3]

A consensus opinion among retirement plan experts is beginning to form that, for the future, retirement plans are positively trending towards a greater embrace of index fund utilization and asset allocation.[4]

But not all index funds are created equal. Plans can invest in one of two types of index fund, a mutual fund or an Exchange Traded Fund (ETF). Both types of funds, following the S&P 500 index for example, would own shares in the 500 companies that make up the index. There is no management style, target or objective outside of tracking the index. So when it comes to index funds, the element of substantial competitive advantage is effectively removed; implying an expectation of uniformity in pricing structure.

This study examines whether or not that is the case in defined contribution plans. As ETFs have a low, uniform pricing structure, many boldly argue that there is no benefit in adding them to retirement plans, claiming that index mutual funds can be added to any plan for virtually the same expense ratio. Justifying the legitimacy of such claims necessitates a closer look at the presence of index funds in plans of various asset levels.

Sample Pool

Ninety-two (92) defined contributions plans from throughout the United States participated in supplying data. The largest concentration of plans was in the Northwest, followed by the Southwest, Midwest, Southeast and Northeast.

Figure 1. Sample pool by geographic region.

Plans provided their total asset level, number of participants, investment options (with ticker symbols), investment expense ratios, average participant balance and geographic region. Two-hundred-fifty-two (252) index funds were identified from these plans.

Figure 2. Sample pool by asset size.

From this information, plans were placed into one of 4 market segments based on the classification criteria used by PLANSPONSOR Magazine in their 2011 Defined Contribution Plan Survey:[5]

–          Micro Plan

–          Small Plan

–          Mid Plan

–          Large Plan

Organizing information in this manner allowed averages, such as expense ratio and other information to be calculated for each market segment. To approach a conclusion on how such findings relate to the national composition of defined contribution plans, data on each market segment’s share of total DC plan assets was referenced from the PLANSPONSOR survey.


The expected decrease in pricing was observed as a function of plan size. For the micro plan market (the largest pool of plans studied), the average cost of an index mutual fund was 52 basis points (0.52%). Relative to the average pricing of index funds at higher assets levels, the high average price paid by micro plans can largely be associated with the use of index funds that have multiple share classes (R1, R2, R3, R4, . . . . ) The different share classes reflect additional costs layered on top of index funds in order to pay marketing costs for distribution of the funds and for payment of plan services to third parties.  In general, the fewer assets in the plan, the higher the cost for the index fund.

 Figure 3. Average index mutual fund cost by asset level.

Although breakpoints for funds with multiple share classes are almost impossible to determine outside of internal documents from the issuing fund company, as a general rule of thumb, the lower the number (R1 for example), the more you pay; same fund, same index, just a different “R” share class number.

By comparison, ETFs do not have multiple share classes and despite the fact that no ETFs were present in the 92 plans studied, an average expense can be determined for comparative purposes. By taking the 5 major indexed asset classes from the study and the respective ETFs for each class from the 3 major service providers, an average cost of 18 basis points (0.18%) can be established; a number slightly higher than the 15 basis point (0.15%) average cost recently calculated by BrightScope®.[6]

Figure 4. Average ETF Costs

Given that ETFs do not have multiple share classes or minimum asset levels for investment, the expense ratio of ETFs for retirement plans would be the same regardless of plan size. At this rate, index mutual funds only become truly competitive in the large plan market ($200+ million in assets).

 Figure 5. Average Index Mutual Fund cost vs. average ETF cost.

Gauging the impact that ETF cost reduction could have, in terms of the number of U.S. defined contribution plans, can be determined by referencing data reported by PLANSPONSOR Magazine in their 2011 DC Plan Survey (which uses the same asset level breakpoints to categorize plans).

Figure 6. United States Defined Contribution plan assets by market segment.

The PLANSPONSOR data shows that the overwhelming number of plans (88%) in the united states have less than $200 million in assets and therefore would be better served by using ETFs rather than mutual funds for their index investments. 

Figure 7. Percentage of Defined Contribution plans in the United States on average that would have lower index investment costs with an ETF.


Whether you’ve read that “99.4% of actively managed mutual funds underperformed their benchmark indices,”[7] “Over 50% of active managers underperform”[8] or that “In seeking the best fund choices, investors have been steadily moving toward low-cost index funds,”[9] the one constant theme catching contemporary headlines is that passive investment strategies are the superior solution for long-term investors.

Recognizing this, retirement plans across the country are moving away from actively managed funds and toward a passive strategy by including index funds as plan investment offerings. This trend is growing, not simply in the number of index funds offered, but in the asset concentrations accumulating in index funds.

One of the hallmark advantages of index fund investing is the element of low cost; but for defined contribution plans, this benefit is not universally enjoyed. The conditioning of plans to the limitations of mutual funds has resulted in economies of scale which “punish” smaller retirement plans with higher expense ratio index funds. This model has burdened the majority of retirement plans with unnecessarily high costs to invest in a passive investment strategy.

As the popularity of passive investing grows, fueled by new federal regulations for Fee Disclosure which requires companies (especially smaller ones[10]) to ensure the “reasonableness” of investment fees, more plans will find by comparison, that participants will be better served using an ETF strategy to invest in an index rather than a mutual fund. This awakening will almost certainly be the much anticipated point of “breakout,” for ETFs in retirement plans.

[1] Lieber, Ron, “Why 401(k)’s Should Offer Index Funds,” The New York Times, May 13, 2011. http://www.nytimes.com/2011/05/14/your-money/401ks-and-similar-plans/14money.html?pagewanted=all

[2] Robertson, Stuart, “Three reasons index fund 401(k) plans are taking off,” Forbes, June 1, 2011. http://www.forbes.com/sites/stuartrobertson/2011/06/01/three-reasons-index-fund-401k-plans-are-taking-off/

[3] Solin, Dan, “Your 401(k) Plan Could Be Illegal,” Huffington Post, May 17, 2011. http://www.nytimes.com/2011/05/14/your-money/401ks-and-similar-plans/14money.html?pagewanted=all

[4] McKinsey, “Winning in the Defined Contribution Market of 2015,” published 2010. http://www.mckinsey.com/clientservice/…/~/…/DC_2010_Final.ashx

[5] Plansponsor Magazine “2011 DC Survey.” http://www.plansponsor.com/2011_DC_Survey.aspx

[6] Moeller, Phil, “ETFs Slowly Moving Into 401(k) Plans,” US News, June 15, 2011. http://money.usnews.com/money/blogs/the-best-life/2011/06/15/etfs-slowly-moving-into-401k-plans

[7] Barras, Laurent, Scaillet, O., Wermers, Russ, “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas,” March, 2008: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=869748

[8] DeLegge, Ron, “S&P Report: Over 50% of Active Managers Underperform,” ETF Guide, March 8, 2011. http://www.etfguide.com/research/520/7/S-P-Report:-Over-50Percent-of-Active-Managers-Underperform/

[9] Moeller, Phil, “Most Active Funds Continue To Trail Index Performance,” US News, August 30, 2011. http://money.usnews.com/money/blogs/the-best-life/2011/08/30/most-active-funds-continue-to-trail-index-performance

[10] Harvey, Lou, “A sense of disclosure,” CFO Magazine, May 1, 2011. http://www.cfo.com/article.cfm/14570384/c_14570395


A new rebalancing methodology to reduce risk and increase dollar cost averaging in defined contribution plans

By Neil Plein
View Neil  Plein's LinkedIn profileView Neil Plein’s profile


A PDF Version of this White Paper is available here

Summary of findings

This study was conducted over a 3 year period to determine whether or not the frequency of portfolio rebalancing in defined contribution plans had an effect on risk mitigation. A professionally constructed model portfolio designed to exist on the efficient frontier was used and It was hypothesized that that the higher the frequency of rebalancing the greater the degree of risk mitigation.

As methods of rebalancing have two primary components, cash flow management (plan contributions) and rebalance frequency; the traditional methods studied use plan contributions as being passively invested based on an originally designed asset allocation, followed by rebalancing (highest to lowest) at either quarterly, semi-annual or annual intervals.

These three methods were compared to a fourth method, that of the Self Aligning Portfolios™ methodology (U.S. Pat. 8,060,428) developed by Invest n Retire® (INR); which uses cash flows at each payroll period to bring a portfolio either wholly or partially back into balance followed by a quarterly rebalance as necessary. This method served as the highest frequency rebalancing method considered.

The data strongly supported the hypothesis, that the higher the rebalancing frequency, the higher the degree of risk mitigation (evidenced through higher returns and fewer losses when compared to traditional passive cash flow management and reduced rebalancing frequencies).

Furthermore, at the conclusion of the study, the Self Aligning Portfolios™ had generated larger asset positions than comparative methods; the result of utilizing cash flows at each contribution period to purchase more shares of underweighted positions and either few or no shares in over weighted positions.


In 1952 Harry Markowitz introduced Modern Portfolio Theory, which uses asset allocation to maximize returns from a portfolio exposed to a specific risk level. A portfolio which achieves this is said to exist at the ideal (tangency) position of the “efficient frontier,” as displayed in the famous Markowitz ‘bullet.”

Figure 1: The Markowitz bullet

In the above example, the red dot represents a portfolio that is ideally situated on the efficient frontier. The portfolio is the sum total of all the yellow dots, which represent the particular investments contained in the portfolio and their respective weightings.

This hypothetical “efficient” portfolio can easily depart from its ideal position on the efficient frontier. Over time, market forces can affect the weightings of positions within the portfolio, causing it to move to a position of moderately higher return exposure accompanied by substantially increased risk exposure (Fig. 2 Point A) or vice versa, moderately lower risk exposure with substantially reduced return potential (Fig. 2 Point B).

Figure 2: Departure of a portfolio from its ideal position on the efficient frontier

These market forces can be magnified to some extent by the traditional method of investing cash flows, which divide up plan contributions and invest them solely on the initial design of the portfolio. This further drives the portfolio away from its initial (efficient) design and introduces the necessity of periodic rebalancing.

Traditionally, these two combined forces (market and cash flow) are responsible for moving a portfolio away from its ideal position on the efficient frontier; as both produce a negative effect under the tenets of Modern Portfolio Theory. Yet, of these two forces, only market forces are beyond control, cash flow forces are not.

This study hypothesizes that utilizing plan cash flows as a mechanism to increase portfolio rebalance frequency will effectively reduce a portfolio’s movement away from its ideal position on the efficient frontier and hence, mitigate its risk as a result of the increased rebalancing frequency. This method, developed by Invest n Retire®, is known as Self Aligning Portfolios™ (SAP) technology.

Further, by utilizing plan cash flows for rebalancing purposes through the SAP technology, more shares in underweighted positions should be purchased and either few or no shares of overweighed positions should be purchased; resulting in greater dollar cost averaging effect compared to traditional cash flow management and rebalancing methods (quarterly, semi-annually and annually).

Data from an actual retirement plan participant was used over this study’s 3 year period, which extended from 2009 to 2011.

Traditional Methods of cash flow use and rebalancing

Keeping a portfolio in line with its intended design is important, that is why rebalancing occurs in nearly every type of investment portfolio.

In a defined contribution plan, when an employee contributes money to his or her retirement plan, there is an event where money is going into the plan. Currently, the process works in this way; say you’re starting a new retirement plan on January 1st. Hypothetically, your model portfolio is built with specific risk/reward characteristics, so your money is allocated across 2 funds, Fund A and Fund B, each receiving 50% of the money you put into the plan, $100 each payroll period. Your first contribution to the plan looks like this:

Figure 3: Initial Balance

The next time you put money into the plan will be January 15th. Hypothetically, between January 1st and January 15th say the value of Fund A tripled.

Figure 4: Changing values as a result of market conditions between Jan. 1 and Jan. 15

On January 15th, before you make a contribution to the plan, your portfolio is invested 75% in Fund A and 25% in Fund B. Now your $100 going into the plan, split 50/50 has this effect:

Figure 5: January 15th payroll contribution effect

Although your portfolio design is intended to limit your exposure to Fund A and Fund B to 50% each, market forces and additional plan contributions to the plan put your portfolio in a position of being inconsistent with its risk reward characteristics (off of its optimal position on the efficient frontier). For this reason, rebalancing is necessary, again, typically taking place quarterly, semi-annually or annually.

The Concept of Self Aligning Portfolios

Think about the example above. Look back at the January 15th contribution again; the contribution is going into a portfolio with the following conditions:

Figure 6: Changing values as a result of market conditions between Jan. 1 and Jan. 15

The technology of Self-Aligning Portfolios™ (SAP) intelligently allocates the contribution going into the plan by first valuing the portfolio and then determining how the money should be allocated to bring the portfolio back to or as close to being balanced as possible. Rather than splitting the contribution money up 50/50 and continuing to allow the portfolio to remain out of balance with its intended risk/reward characteristics, the portfolio is first valued, which shows that Fund A has tripled; so then the entire contribution of $100 will be invested into Fund B.

Figure 7: January 15th payroll contribution effect using Self-Aligning Portfolios 

Data basis for the study

A retirement plan participant was selected at random from a plan on the INR platform. The only qualification for consideration was that the participant had been enrolled in the plan for more than 3 years.

The participant’s information was then used for the study, including:

Starting balance
Asset allocation
Contribution dates
Contribution amounts
Trade execution prices
Rebalancing dates
Dividend rates
Dividend dates
Plan expenses
Investment changes

As the participant was enrolled in a plan utilizing the SAP technology, this information would serve as an independent variable. The dependent variables would be the comparative outcomes resulting from the replication of the participant’s information under methods of rebalancing which occurred quarterly, semi-annually and annually.

As trades on SAP technology occur intra-day, the execution prices also served as the execution prices for the comparative methods, collectively referred to as hypothetical rebalancing methods (HRM’s). If a trade did not occur for a security under the SAP technology, the execution price for the HRM’s was taken from end-of-day Net Asset Value (NAV) pricing supplied by Morningstar™. An example of this difference can be seen below when comparing the SAP portfolio during at a contribution period to a quarterly HRM at the same period (note that no purchases are made in SAP to positions valued and deemed to be over weighted- AGG, DFEMX, DISVX and DFSVX):

Figure 8: SAP Portfolio (left) compared to quarterly HRM portfolio (right)

116 events like the above (Figure 8) provided the data points for each rebalancing frequency, resulting in a total of over 464 points of measurement.

Dividend rates were also replicated, if an actual dividend was paid for a security under the SAP technology, it was paid at the same rate for HRM’s. Additionally, as actual plan expenses occurred for the participant under the SAP technology as a percentage of assets, the same rate was applied to account for plan expenses for the HRM’s based on their asset levels.

During the 3 year study period, several investments were replaced and portfolio asset weightings adjusted. These instances include:

–          10/5/2009: Rebalance, BND replaces AGG, DISVX and VGK removed, portfolio weightings changed.

–          2/24/2010: VWO and VNQ added, portfolio weightings changed.

As the effects of these changes could be observed under the SAP technology, they were implemented the same way for the HRM’s; even if the change occurred away from a rebalancing event, it was assumed that if an investment were dropped from a plan and replaced by another, the assets would be mapped to the new investment.

Portfolio valuations were taken at the end of each month before dividends. In order to accurately compare the performance between the SAP technology and the HRM’s given the frequency of these valuation periods, the Modified Dietz Method of performance reporting was used for comparative purposes.

Study Results

The 3 year study resulted in data which strongly supported the hypothesis. Through its use of cash flows to increase rebalance frequency, the SAP technology demonstrated an ability to mitigate risk at a higher degree than the comparative HRM’s; evidenced through the SAP technology achieving higher returns (2009, 2010 and 36mo ROR) and fewer losses (2011) at each measure.

Figure 9: Annual and total returns

By taking the total number of shares for each position in the SAP technology and HRM’s, then ascribing a weighting to each asset’s total proportionate with allocation weighting for the portfolio, the effect of increased dollar cost averaging as a function of rebalance frequency can be observed and cash flow use can be observed.

Figure 10: Dollar cost averaging calculations presented by asset allocation weighting 


Modern Portfolio Theory defines the nature of an efficient investment model; that which optimally balances risk and reward. Such a design occupies a particular location on the efficient frontier and any movement away from that location results in an increased risk, such as moderately higher return (and loss) exposure accompanied by substantially increased risk exposure. This risk emerges over time due to market and cash flow forces. Mitigating this risk is accomplished through mitigating the degree of movement for a portfolio away from its ideal position on the efficient frontier.

This study hypothesized that increasing rebalancing frequency through the use of cash flows (SAP) would result in a greater degree of risk mitigation than rebalancing methods which did not use cash flows and instead rebalanced only at quarterly, semi-annual or annual intervals.

To test this hypothesis, 3 years of actual participant data was used form a plan with SAP technology. Over the 3 year period, there were 116 events which provided data points. These events were then replicated in rebalancing methods not utilizing cash flows and only rebalancing at either quarterly, semi-annual or annual intervals; resulting in 464 total points of measure between the four methods of cash flow use and rebalancing.

The data supported the hypothesis that the SAP technology successfully mitigated risk to a higher degree than the other 3 methods compared.  Additionally, the SAP technology resulted in a greater dollar cost averaging effect, evidenced through larger position ownership at the end of the period.

401k Manifesto™ – The New Standard

By Neil Plein
View Neil  Plein's LinkedIn profileView Neil Plein’s profile

Where’s the evidence for a 401k revolution? Right here.

The 401k Manifesto calls for a revolution in the retirement industry, the core of which is an entirely new structure designed around exclusively offering Exchange Traded Funds as investment options. This presents the only truly viable way to enact the type of technological change participants urgently need to build higher average retirement balances on a macro scale.

 A PDF Version of this white paper can be downloaded here.



There is a general structure to the mainstream 401(k) plan; one which has become solidly defined by the limitations of its outdated technology. You will know this as the mutual fund dominated, education laden, manual process driven juggernaut; the variation of which is only slightly measurable between major service providers.

In this model, commonly understood as the “status quo,” fundamental change moves at a glacial pace, as seen in the history of major 401(k) milestones:

1978- The Revenue Act of 1978 allows for the development of 401(k) plans through Internal Revenue Code (IRC) Section 401(k).[1] Plans are launched with annuity products as the dominant investment option. Front-end loads for these products range as high as 40% and with such generous compensation, unsurprisingly the industry claims that there is no demand for any additional investment types; especially not the drastically lower cost “mutual fund.” As a result, no technology exists or is pursued to make mutual funds available in 401(k) plans.

1984- Despite dominating sentiment against mutual funds in 401(k) plans, over the previous two years Vanguard® has paid SunGard® to make the developments needed to offer mutual funds in 401k plans, the technological leap was accomplished through the advent of a recordkeeping system that could accommodate such funds; the missing link which previously served as a barrier to entry.

1996- For the first time mutual funds become the largest segment of assets in 401(k) plans.[2] After a decade of booming demand, mutual funds have been solidified as the dominant investment option for 401(k) plans and in this same year, 401(k) plans’ next major milestone is reached when companies begin offering online account access for the first time.

From this recitation, it is evident that the last major milestone to reach your 401(k) plan was the addition of Websites back in the 90’s and the fundamental technology at the core of the mutual fund 401(k) system, the record keeping technology which accounts for plan data and how it can be used, is nearly 30 years old.

Record keeping is the at the core

The success of a 401(k) plan is based on the primacy of the record keeper’s technology, but the critical role record keeping technology plays in America’s 401(k) system is rarely discussed. It is considered more of a “behind the scenes” element that very few understand or even pay close attention. But the record keeper sits at the absolute core of a retirement plan. The record keeper’s capabilities are the building blocks of the 401(k) system, the elemental components that define what can be offered within a plan and how it can be offered to plan participants. These aspects together define the “experience” of a plan.

Consider automatic rebalancing. If the record keeper does not have the ability to automatically rebalance a participant’s portfolio, the service provider using that record keeper cannot offer rebalancing as a feature to their clients. As a result, since rebalancing is important,[3] the service provider must educate the participants to perform rebalancing manually, which involves education on the importance of rebalancing, as well as the frequency with which one needs to consider rebalancing. After this instruction, performing the actual task depends on the will of the participant.

Automatic rebalancing may be just one of many plan features which may be missing from your plan. The point is many participants face a myriad of unnecessary and difficult tasks due to the technological limitations of the record keeper.

Once you understand that the technological capabilities of the record keeper dictate the ease with which every task in a plan is completed, you will look at the delivery of services to plans in a different light. Enrollment, investment selection, using a retirement calculator, even the simple task of changing your contribution rate, these are all examples of common tasks within a plan. The ability of the record keeper’s technology, to assist in the completion of these tasks, dictates how difficult each task will be for the participants.

 Figure 1: Difficulty of reaching your retirement goal using outdated technology  

The sum of the individual tasks forced on participants make up the plan, as a whole, and the more difficult those individual tasks are to perform the less effective the plan will ultimately be in helping participants build adequate retirement funds.

A conditioned system

Consider the typical 401(k) experience with Joe Employee. Joe is 30 years old and his company is offering a 401(k) plan. Joe sits though a 60 minute educational seminar where he is instructed on how to enroll in the 401(k) plan; determine, set and adjust his contribution rate; analyze pick and manage his investments; access, use, and understand his retirement calculator; assess, examine and monitor his financial plan and make all necessary adjustments over time to each variable as conditions change.

This process is tedious and dated. Nearly all of these tasks require the participant to perform numerous manual processes because the record keeping technology, behind the 401(k) plan, lacks the ability to perform these tasks in an efficient and simple manner.

Realistically, the retirement industry has been suspended in a time warp, operating and building on top of antiquated systems, whose origins date back to the ‘70s.[4]Retirement plans simply have not evolved in a way that makes them satisfactory to today’s modern standards of ease, simplicity and power; and this excessive lack of change results in a firmly entrenched conditioning.

This paradigm has become so developed that the ideas about how to change for the better mirror what Christian monks discussed in the middle-ages, pouring over questions like, “How many angels can dance on a pin?”

It’s not that bad of course, but the monks’ pondering does reflect, in terms of importance, what’s being discussed and what grabs headlines. What you see is a continuous cycle of the same topic; participants must be educated, despite numerous studies which reveal that educating participants is failing to produce positive results.[5] This emphasis on educating participants is a direct result of outdated technology which requires that participants must be ”educated” or trained in using these antiquated systems due to the numerous manual processes a participant must go through before an instruction from the participant can be implemented; otherwise the plan does absolutely nothing.  

So industry magazines print stories like: “10 secrets to educating on investment selection” or “5 best practices for examining prospectuses;” engaging in a constant struggle to teach an old dog new tricks. Very few people have the opportunity to consider real, fundamental change.

Ignoring the fact that America workers are in great need of modern 401(k) technology,[6] the retirement industry wants to live in the dark ages. Why? Simply because these antiquated systems cannot evolve at the pace consistent with modern standards of interaction.  

Sometimes it takes an entrepreneurial company to make that giant leap forward. By using low-cost investment vehicles, Exchange Traded Funds (ETFs), Invest n Retire, LLC, a record keeper in Portland, Ore., quickly realized that the record keeping systems of yesterday are inadequate for trading ETFs. That one simple fact required new modern technology.

Facts: ETFs trade like stocks, throughout the day at market price, and can only be purchased and sold in whole shares. In contrast, mutual funds trade at net asset value (NAV) closing price and can be purchased or sold in whole and fractional shares. Since old legacy record keeping systems were built to trade mutual funds in dollar certain orders, these antique systems simply have no ability to:

          (a) buy in share certain orders or

          (b) track residual cash[7]

Going forward, Invest n Retire® (INR) ignored the promoters of mutual funds who claimed that no one wanted ETFs in defined contribution plans and INR proceeded to build its patented system and method for record keeping and trading ETFs in tax-deferred retirement plans (pat. US 8,060,428). This paper is the road map for a new way forward.

A point of structural consideration

Some get involved, some don’t

The basic equation for retirement success is The 3 C’s Costs should be low, Compounding returns should improve and Contributions should increase.

There is a bit of an initial challenge here logistically. The fact is most participants do not get actively involved with their retirement plan. Dimensional Fund Advisors (DFA) refers to the reverse as being “engaged.” The discovery of noninvolvement is the conclusion of a study commissioned by DFA in which DFA found that only 41% of participants actually engage their plan. What’s more, when you look at how many participants engage in order to plan for retirement, the number falls to a dismal 19%.[8]

Obviously an ideal plan must be designed to address two basic principles:

1.)    Un-engaged participants need to receive the best default solution

2.)    Engaged participants need to receive a benefit which exceeds the option of being un-engaged

From these two foundational characteristics, plan design must aim to motivate (not educate) participants to get involved. A simple, ease of use design which encompasses an intuitive structure and reduces or eliminates manual processes is optimal.

What can be gleaned from mutual fund technology

Auto enrollment

Obvious technological shortfall: “To enroll in your plan, would you rather fill out a stack of paper or just have technology take care of all that for you?”

The employee retirement savings experience begins with enrollment in the plan. Unfortunately, studies show that between 25-34% of eligible participants do not enroll in their plan. Perhaps the problem starts with all of the paperwork required for participants to manually enroll in the plan.[9]

A practical solution would be to eliminate manual enrollment with auto-enrollment so eligible employees are automatically placed in the plan. Dean Kohmann, Vice President of Charles Schwab and Co., says that companies can easily boost their participation rates from 60% to 90% by adding this one feature,[10] numbers recently echoed in a Towers Watson study.[11]  

Participants still have the ability to opt-out of the plan if they choose; but numerous studies have shown that there is little resistance to implementing this approach and, in fact, auto enrollment can increase a company’s ability to attract and retain quality employees.[12]

With participants auto-enrolled, the next questions are: What do they invest in and how much do they contribute?

Auto escalation

Obvious technological shortfall: “Do your odds of building a comfortable retirement fund improve if you put less money in your plan or more?”

The same lack of resistance to auto-enrollment is also present with auto-escalation. Traditionally, the alternative has been a default contribution rate at some fixed level, like 3%.

In considering “un-engaged” participants, contributing 3% will never get them to their savings goals. Auto-escalation is a better solution for solving this dilemma by increasing the participant’s default contribution rate by some percent each year, such as increasing 1% per year up to a maximum contribution rate of 6%.

If a plan started at a 3% default contribution rate in year 1, then increased to 4% in year two, 5% in year 3 and finally a maximum of 6% in year 4, participants would have a 94% greater balance over 35 years than if they simply contributed a flat 3% over the same period.

For the un-engaged participant, reaching the escalated 6% contribution rate may still not be enough. If the employer can step in to make a match, the un-engaged participant’s experience can change radically for the better, while the company receives incentives as well.

Safe Harbor

Obvious technological shortfall: “Should you be required to contribute less than the maximum amount allowed by the Internal Revenue Service (IRS)?”

If you work with 401(k) plans, you’ve undoubtedly digested some form of pain reliever or fever reducer during the process of plan testing. But testing is important; it ensures that plans are not simply in place for the exclusive benefit of those with the highest pay. But this may be unfair to higher paid employees since they also need to adequately save for retirement. How can everybody win? Include a Safe-Harbor matching contribution as a plan provision.

In order to offer a Safe Harbor provision, the sponsoring company must be willing to match the contributions of participants. For example, the company would match 100% of the first 1% contributed, and 50% of the next 5% contributed to a maximum match of 3.5%. This can be understood as follows:

Employee contributes 1% of their salary ($1,000), then employer matches 100% of that 1% of salary ($1,000); the total deposited into the employees plan is $2000. If that same participant had Auto Escalation and was contributing 6% ($6,000) then the employer would match 100% of the first 1% ($1,000) and 50% of the remaining 5% contributed ($2,500); and the total amount deposited into the employee’ account would be $9,500 ($6,000+$3,500).

The employer benefits since matching contributions are tax deductible and the company saves money by avoiding testing. Now, the higher compensated employees can contribute the maximum amount to the plan, and the un-engaged employees have contributions going into their account which are 300% higher than if they were simply receiving a flat, non-escalating 3% default. If auto-escalation were present with a Safe Harbor provision, the un-engaged participant now has a total contribution rate of 9% at the highest point, 600% higher than the a default rate of 3%.

With auto-enrollment, auto-escalation, and a safe harbor provision in place, the focus turns to investing the money.

With investments: cost is king

Obvious technological shortfall: “Would you like to pay more or less for your investments?”

The process of selecting a menu of investment options, for most companies, involves sitting down with an advisor to review a list of actively managed mutual funds with “high” star-ratings. Unfortunately, star ratings have little to do with the actual success of the investment compared to its cost historically.[13] Additionally, actively managed mutual funds have very poor track records, underperforming their benchmark indexes 99.4% of the time over the past 30 years.[14]

Using some exceptionally uncomplicated logic, one can conclude that if cost is a better determinant than star rating, low cost would be preferable; and if actively managed mutual funds underperform their benchmark indexes 99.4% of the time, then buying the index instead would mean outperforming an actively managed fund 99.4% of the time. The conclusion here is that the best investment options for a 401(k) plan are low cost investments which track an index.

Lowering cost also provides a risk-free opportunity to increase returns by the reduced cost. According to the Department of Labor (DOL), reducing your retirement plan cost by 1.00% (100 basis points) can result in a 28% higher balance at retirement.[15] With increased contributions and lower cost investments, the road leading to a comfortable retirement just got a little easier for participants.  

ETFs and the new technology

Choosing ETFs over Index Mutual Funds

Obvious technological shortfall: “Would you like to use the very best type of index investment or the second best type of index investment for the long term?”

Proponents may claim that ETFs are not needed because plans can add low cost index mutual funds.  These claims may remind you of the same claims made against mutual funds in the early ‘80s.  

Opponents to ETFs in retirement plans continue their argument against ETFs with statements like: ETFs are not necessary because index mutual funds are an available option, behave similarly to ETFs, and can be offered without the major technological evolution required by ETFs. However, looking back at the first principle for the un-engaged participant, the goal is to deliver the best solution at the lowest cost. Since both an ETF and an index mutual fund can track the same index, which is the better investment option for the 401(k) plan? The answer is obvious, lower-cost ETFs.

In “Debunking the myth that ETFs have no place in 401(k)s,” Darwin Abrahamson, CEO of Invest n Retire®, elaborates on his reasoning that ETFs are the preferred investment choice over index mutual funds. His position centers on the all-important topic of cost and specifically, the fact that mutual funds have internal trading costs which can be as high as 0.27% (27 basis points), where ETFs have costs nowhere near that high.

Abrahamson states: “In 1994 John Bogle, Founder of The Vanguard Group, coined the term, invisible costs, in reference to the high costs of trading shares in a mutual fund. Bogle was referring to the fund’s expenditures for trading the securities in the portfolio. In contrast to fund fees, which are reported as the expense ratio. trading costs within a mutual fund are invisible because they are not included in the expense ratio which makes them difficult to assess.” 

These internal costs affect all owners within the mutual fund, no matter if the owner is the buyer or seller of the fund. The costs are incurred from the mutual fund’s trading activity internally (thus the distinction between external and internal transaction costs). These transaction costs arise from trading activity, buying and selling shares internally, which results in paying things like brokerage commissions, “market impact costs” and spreads (the difference in cost between what you can buy and sell something for). You will not be able to find a line item expense anywhere in the fund’s prospectus for these costs. But they do create a drag on your investment returns.

If you were to compare an ETF against a mutual index fund that were both tracking the same index, the ETF would be a better investment, over the long term, in comparison to the mutual index fund because the expenses would be lower, resulting in a smaller tracking error than the index mutual fund. Given this inherent design benefit of ETFs, which allow ETFs to perform better over the long term, ETFs clearly are the better index investment option for 401(k) plans.

Professional investment management by default

Obvious technological shortfall: “Would you like to pick your own investments or have a professional investment manager do that for you?”

Most participants simply do not want to pick their own investments, whether “un-engaged,” or “engaged.” Selecting the proper mix of investments and allocating the right amount of money to each is a task that requires professional training. Modern Portfolio Theory teaches us that market timing and stock picking are not the way to generate consistent, long term returns. Yet, most plans continue to force participants to pick their own investments or follow guides to build model portfolios rather than providing them with model portfolios, designed by professionals, to choose from.

Professional investment management has been shown to outperform participant directed investment selection 84.6% of the time,[16] which also leads to higher average portfolio balances;[17] indicating that participants should be defaulted into professionally designed asset allocation models, built using ETFs as the underlying investment options.

Age based asset allocation models over target date funds as a plan’s default option

Obvious technological shortfall: “Should your investments be designed to simply target a date somewhere within a few years of your retirement date; or should your investments be designed to target your specific savings goal for your specific retirement date?”

Target date funds are seen as beneficial because their asset allocation changes over time automatically, from aggressive to conservative. In contract, asset allocation models, traditionally, appeared inferior because they did not offer an “automatic” change in investments as you age. With the enactment of the Pension Protection Act of 2006, investment managers recognize the value of age-based models which move with participants as they age.

Ideally, professionally designed ETF asset allocation models should be age-based; allowing them to serve as default investment options (Qualified Default Investment Alternatives or QDIAs) for participants. Participants will be defaulted into a model, based on their age, then automatically move from one asset allocation model to the next without initiating any trades themselves or becoming engaged in any way. When focused on the un-engaged participant, age-based model portfolios make perfect sense.   

Figure 2: Asset Allocation models that automatically move participants as they age

ETF age-based asset allocation models automatically change allocations over time, similar to Target Date Funds, but with substantially more benefits; low cost and, perhaps more important, ETF models provide an essential element of clarity; something target date funds lack.

This element of clarity highlights a significant difference between Target Date Funds and Model Portfolios. With model portfolios, the historical investment gain or loss for each ETF can be used in order to calculate the historically investment return (rate of return) for the model, which helps participants make well-informed decisions. On the Invest n Retire® (INR) patented system, INR uses the performance information to pre-populate INR’s retirement calculator with the historical rate of return (ROR) for the participant’s model in order to perform projections for retirement savings needs. The participant may also compare the historical return of other models, which the participant may select for comparison purposes, in performing projections.  

Rebalancing Intelligently

Obvious technological shortfall: “If rebalancing your portfolio is advantageous to keep investments in line with your risk/reward characteristics, would you like this to happen infrequently and cost you more or would you like for this to happen as often as possible and cost you less?”

With professionally managed model portfolios, the investment manager factors in the risk/reward characteristics for each model in a specific way, with specific intentions. Keeping the model portfolio in line with this design is important in order to avoid increased risk. For this reason, it is important to keep a portfolio in balance as often as possible and the ideal way to accomplish this feat is to use regular payroll contributions to continually rebalance the model, as Invest n Retire® designed into its patented system (pat. 8,060,248) for managing tax-deferred retirement accounts.

When an employee contributes money to his or her retirement plan, you have an event where money is going into the plan. Currently, the process works in this way; say you’re starting a new retirement plan on January 1st. Hypothetically, the investment manager has built you a model portfolio with specific risk/reward characteristics, so your money is allocated across 2 funds, Fund A and Fund B, each receiving 50% of the money you put into the plan, $100 each payroll period. Your first contribution to the plan looks like this:

Figure 3: Initial Balance

The next time you put money into the plan will be January 15th. Hypothetically, between January 1st and January 15th say the value of Fund A tripled.

Figure 4: Changing values as a result of market conditions between Jan. 1 and Jan. 15

On January 15th, before you make a contribution to the plan, your portfolio is invested 75% in Fund A and 25% in Fund B. Now your $100 going into the plan, split 50/50 has this effect:

Now your $100 dollars going into the plan, split 50/50 would result in the following:

Figure 5: January 15th payroll contribution effect

Although the investment manager intent is to limit your exposure to Fund A and Fund B to 50% each, changing market conditions and additional contributions to the plan put your portfolio in a position of being inconsistent with its risk reward characteristics. For this reason, quarterly rebalancing is necessary.

If the same values above ($200 in Fund A and $100 in Fund B) existed at the end of the quarter, how would rebalancing occur? Fund A would sell off $50 which would then be used to purchase $50 of Fund B; this is two transactions, each with a cost associated.

When considering a portfolio with a larger number of investments, the negative effects are magnified; portfolios become more out of balance and require more expense due to more transactions needed in order to bring the portfolio back in-line with the risk/reward characteristics of the model (in balance).  

A solution to both problems is accomplished through INR’s patented technology, referred to as “Self-Aligning Portfolios™.” [18]

Think about the example above. Look back at the January 15th contribution again; the contribution is going into a portfolio with the following conditions:

Figure 6: Changing values as a result of market conditions between Jan. 1 and Jan. 15

The patented technology of Self-Aligning Portfolios™ intelligently allocates the contribution going into the plan by first valuing the portfolio and then determining how the money should be allocated to bring the portfolio back to or as close to being balanced as possible. Rather than splitting the contribution money up 50/50 and continuing to allow the portfolio to remain out of balance with its intended risk/reward characteristics, the portfolio is first valued, which shows that Fund A has tripled; so then the entire contribution of $100 will be invested into Fund B, resulting in one transaction:

Figure 7: January 15th payroll contribution effect using Self-Aligning Portfolios

Self-Aligning Portfolios™ offer participants three benefits:

1.)    Magnifies dollar cost averaging by purchasing more of the shares that are down in value and fewer or none of the shares that are up in value.

2.)    Keeps the portfolio in balance or as close to achieving alignment as possible with the model’s intended risk/reward characteristics.

3.)    Minimizes the amount of quarterly rebalancing required which reduces transaction cost.

Maximizing benefits and using performance information to calculate savings projection needs, brings true synergy to the sum of the parts of the plan for the benefit of the participants.

Integrated retirement calculator and the engaged participant

Obvious technological shortfall: “Would you like to be responsible for entering your personal information and investment target return correctly or should your retirement calculator just do all of that for you?

A turn to plan tools means entering the world of the engaged participant; which is to say, exploring how an engaged participant can use plan tools to their benefit. The quality of plan tools means nothing unless they are used. To encourage the use of tools, the tools should be designed to actually do some good, come as close as possible to ensuring that if a participant uses the tools they are better off having done so than they would have been if they had never used the tools at all.

The traditional tools available to participants lack the technological capability of bi-directional integration with payroll providers. If your 401(k) website feels more like an Easter egg hunt than an easy to use and effective retirement planning tool; it probably lacks a basic element of clarity and perhaps bi-directional payroll integration. The finest example of just how unclear and archaic most technology offered in the retirement industry is can be seen in retirement calculators.

Think about a savings goal, say a million dollars. Assuming, only basically, that you can somehow start your retirement planning process with an understanding of what you will eventually need to save. From here, your task becomes, “How do I get there?” Reaching your retirement goal is a challenge.  

Using the analogy of an engine, consider an engine’s performance. If you know your destination, getting there becomes a matter of asking, “What type of gas mileage can I expect so I have a good understanding of how much fuel I will need to put in?” In retirement plans, the gas mileage and engine performance equivalent is called “target rate of return;” the rate you expect your account as a whole to grow at in the future.

Once you have an understanding of this “gas mileage” equivalent, you can reasonably determine how much contribution or “fuel” needs to go into your plan. If you have a target date fund, determining your “target rate of return” won’t be easy, in fact, even your financial advisor may not know how to answer that question. But if you hope to use your retirement calculator, its ability to function depends on your ability to figure out target rate of return, otherwise you won’t have an accurate understanding of how much you need to contribute in order to be on track for reaching your retirement goal.

You will quickly begin to understand that the value added by becoming engaged depends on the clarity to see whether you’re on track to realizing your goal and, if not, what exactly you can do to get there.

Where ETF asset allocation models pull away from the status quo towards a real effective solution is how they solve this dilemma. First of all, let it be repeated that, if you own a target date fund (the direction plans are currently heading with increased momentum[19]) you cannot determine your target rate of return! Why?

Because a target date fund is one investment option. It changes its asset allocation over time, depending on a multitude of factors. The primary point of this scenario is there is no way to determine a singular “target rate of return” from this type of investment; thereby, limiting or even preventing you from using the retirement calculator effectively.

 Figure 8: A target date fund’s changing asset allocation over time

 Automatically changing asset allocation models, over time, is beneficial for the un-engaged participant. Keeping low cost in mind, let’s say an investment manager designs five age-based ETF model portfolios which range from aggressive to conservative. The un-engaged participant moves from one model to the next automatically over time. For the engaged participant, since ETFs track indexes, the historically long-term performance of the index can be used to calculate the historical rate of return for each model, which the engaged participant can use in the retirement calculator. 

 Figure 9: Asset Allocation Model performance history can be used as data points to calculate contribution rate. The asset allocation models and historical returns are for illustrative purposes only.

Indexes: What you gain by using ETF asset allocation models are data points. Asset allocation models built from index-based ETFs can have their performance history determined based on the historical returns of the indexes (which are long term) (see example above). By appropriately weighting these returns based on the current asset allocation, the information can be wrapped up for the model as a whole, which provides an appropriate long term rate of return which can be used as the target rate of return needed by the retirement calculator.

Finally, the Invest n Retire® patented system integrates the historical return for the model , as the “target rate of return” in the retirement calculator, along with the participant’s personal information; such as salary, contribution rate and employer matching contributions. The calculator then performs its task without manual intervention. If a participant finds that he or she is not on track for retirement, the participant will need to take manual action, by performing tasks which are beyond the control and legality of automation; such as increasing contribution rate, beyond default amounts, or changing asset allocation models to something which doesn’t strictly match the risk/reward characteristics of the participant’s age group.

Aspects for computational consideration:

Figure 8: Retirement calculator data elements

With this information automatically entered, a single click can yield the amount a participant needs to save by the time the participant reaches retirement age. The calculator will also provide feed-back as to whether the current mix of projected investment return and contribution rate puts the participant on track to reach the savings amount needed. If a shortfall exists, minor modifications are all a participant needs to focus on, 4 simple areas of decision that technology absolutely cannot make for someone:

1.)    Increase contribution rate (exact increase is shown)

2.)    Change to a model portfolio with a higher historic rate of return

3.)    Adjust replacement income percent down to retire on less income

4.)    Adjust retirement age up to retire later

Rather than focusing on input management, that which has been the intent of extensive education under the mutual fund system, plan participants can shift their focus to making small adjustments to their output which requires far less effort and involvement.

Mastering a delivery method incorporating simplicity is paramount for success. Imagine participants going online to use the calculator; maybe increasing their contribution rate, or making other adjustments so they have a better chance of reaching their retirement goals.[24]

Focused video demonstrations over lengthy investment education

Obvious technological shortfall: “Would you rather sit through a 60 minute investment education session or watch a 5 minute video demonstration?”

401(k) plans are a complicated thing. What makes them complex to the point of nearly guaranteed confusion is their underlying technology; which mandates lengthy demonstration of manual processes on top of already complex education on investments and how to pick them. This confusion usually produces two outcomes; inaction or action resulting in poor choices.[25] There are two fundamentally responsible elements at work here:

1.)    Underlying technology: What if the technology requires participants to be educated on how to use the technology?

2.)    Educational approach: How is education delivered to participants?

Dated technology generates dated processes. Some plans require manual enrollment by filling out forms, some require participants to read prospectuses and pick their own investments from a list of 40 fund options, some require participants to read lengthy manuals on asset allocation and market volatility, some require contribute rate changes to be completed by manually filling out sheets of paper and hand-delivering it to HR, and some have impossible retirement calculators that expect the average person to understand projecting investment returns. Each and every one of these manual processes should be seen as detrimental to your plan; the more you have, the worse off your plan -exponentially.

It’s true that all manual processes cannot be completely eliminated from a plan, although there is a framework to determine if a manual process is actually needed or not by asking a simple question: “Is this something the participant absolutely must do that technology cannot do for them?” Enrolling in the plan, defaulting into an age-based model portfolio, populating the performance history of that model into a retirement calculator- all things technology can do for someone. Deciding to retire later in life or on less income; these are choices technology cannot make for someone.

Seeing plans in this light illuminates the stage that outdated technology has set for retirement plan professionals. Retirement professionals are acutely aware that the average participant cannot be turned into an investment professional after a 60 minute seminar. Yet, the technology provided to most participants requires them to become investment experts by forcing them to “pick” their own investments. This scenario begs the question, “Just what is all this education supposed to be teaching them?”

Even with the advent of simplified investments, like target date funds, the traditional investment education topics (along with all the others required by manual processes) still dominate the landscape; being required for so long they are ingrained and, as a result, accepted as standard practice. So with years of practice, why is it that investment education still doesn’t work? Lou Harvey, CEO of Dalbar®, one of the nation’s premier research and due diligence firms explains, “Continued efforts since 1996 to help participants make informed decisions through educational sessions have been futile.”

Clearly the problem is fundamental, the “how” education is approached. The point of education is to convey a message and have it be both understood and retained by the recipient. The debate over “how” best to accomplish this is centuries old, originating with great thinkers like Rousseau, Emerson, Pestalozzi, Froebel and more recently by names like Steiner, Montessori, Jung and Maslow; all unanimously identify one common trait leads to genuine success in comprehension; your will to learn.

This will, as it is driven towards inquiry, is unique to each and every individual. As a result, the primacy of standardization to educate someone is fundamentally the incorrect starting point; each person learns differently and in different ways, so the method of tomorrow’s education should be designed with this in mind, rather than how the system standardizes the delivery of information to plan participants.

The result will be a system far more efficient and effective, where participants who decide to engage their plan (the minority as we’ve already established) can do so in a way that gives them exact answers to the exact questions they have; and the nature of these questions can be predicted with a great degree of certainty because they will depend on the depth of understanding required for a participant to gain that “engaged” positive benefit.

This brings things back to technology. The “output” based retirement calculator presented in this paper automates nearly all of the unnecessary, formerly manual processes; leaving only those decisions to be made by manual process that the participant must absolutely perform on their own. By constructing the plan in this way, auto-enrollment, auto-escalation, safe harbor, low cost investments, professional management, age-based asset allocation models and information from each area already prepopulated into the retirement calculator; all the power of the plan is built behind the scenes- and with one click the calculator can show someone if they’re on track or need to make a change.

Clearly, if a participant learns that he or she is not on track for retirement, then education should squarely focus on four areas exclusively so that the participant can make the decision whether to change or maintain their contribution rate, asset allocation model, level of income needed at retirement, or maybe consider retiring later.

Participants have an appetite for information, but they don’t want to receive it in boring meetings or print media. Participants also don’t want to be overloaded with useless and confusing information. Therefore, by focusing on the four factors which each participant must decide allows plans to narrow their educational efforts in the right direction.  

Even CNN acknowledges the death of lengthy printed instruction, saying it has “never really worked;” and instead acknowledges a new frontier of immediate, on-demand, effective web-based video instruction.[26] By limiting the range of topics, this simplified approach can be presented in a clear, concise and focused manner through online videos.

In collaboration with Apple®, Medical Media, LLC proved just how effective short videos can be for educating people on some of the most complicated topics imaginable within medicine. Aside from improving a patient’s understanding of complicated topics, doctors acknowledge that despite years of formal standardized education, there are clear benefits of simplified, on-demand, short video demonstrations to address specific questions relating to complicated topics. Dr. Daniel Price explains this finding in a recent article:

 “All 14 of the health care providers were able to find the brachial plexus within about 15 seconds from the time they placed the ultrasound transducer on the patient’s skin, which is really quite amazing,” Price notes. “The brachial plexus is a relatively subtle and difficult finding, and they were able to find it in less than 15 seconds after a short, two-minute presentation on the iPod.”[27]

Presenting simplified areas of focus, complimented by an educational opportunity that accommodates unique learning styles and unique questions, offers an effective and efficient way to fill any gap in understanding that would prevent someone from having clarity on what their retirement goals are and whether or not they’re on track to reach them.

Of course, the opportunity to review investment information through online prospectuses, as mandated by the Department of Labor (DOL), and perhaps seeking the advice of a financial advisor may be useful to participants, the mere fact that a plan is now directing its educational efforts to focus on the four factors each participant must decide for himself or herself, assists plans in shifting from old educational “instruction” to the delivery of meaningful and useful information through simple technology which assists participants in making well-informed decisions that are at the core of their retirement success.

Participant Fee Disclosure

Obvious technological shortfall: “Would you like to know approximately what your 401(k) plan costs or exactly what it costs you?”

Fee disclosure has been a big deal for a long time. The Department of Labor under President George H.W. Bush first started pushing for fee disclosure. Then with the election of President Bill Clinton fee disclosure was pushed to the back burner, as part of deregulation, until President Barack Obama took office. With the passage of ERISA §404(a)(5) plan sponsors will be required, starting April 2012, to disclose to participants the fees they pay for plan services. You may wonder why it took so long since it’s obvious that most people want to know how much something costs. Part of the delay relates to the fact that mutual funds have different types of fees; including, hidden fees which are difficult to uncover.

Hidden fees, often referred to as “revenue sharing,” may be used for payment of marketing, bonus compensation, syndicated distributions, sub-transfer agency fees, networking fees, and “other” revenue sharing payments. This type of payment conflicts with shareholders’ interests as they directly reduce assets and returns, and many believe they should be prohibited as a result.[28] Not surprising, mutual fund companies are fighting hard to avoid fully disclosing revenue sharing payment arrangements; which may dilute fee disclosure to merely listing charges for plan services “per $1,000 invested” rather than disclosing in dollars and cents the actual amount each participant is paying from his or her account for services provided to the plan.

A practical way to avoid addressing complexities surrounding concealed investment costs is to eliminate those hidden fees altogether; something which can be accomplished by using ETFs, which have no revenue sharing or hidden fees. On an ETF platform all expenses would be deducted directly from the plan and easily disclosed in totality on participants quarterly statements; not in an amount per thousand or some other derivative formula. In this way, each participant sees the cost he or she pays for the services provided and the investments chosen, full transparency in dollars and cents.

Payroll integration

Obvious technological shortfall: “When you make a contribution rate change online, would you like that change to take effect in a few days or instantly?”

In the world of low-technology manual-task ridden headaches, few administrative aspects can compete with the duties of HR/Payroll. As eluded to above, under the current structure, some processes are so outdated that people literally have to print and fill out a form to change their contribution rate. Those that claim to have “improved” this process offer an ability for participants to change their contribution rates online; obviously a step forward by comparison- but both pieces of information still land at the same place; the doorstep of HR/payroll. Upon arrival, one could say that “step 1” is complete; a participant has changed his or her contribution rate. However, there are still a few steps remaining before the change takes effect.

Step 2 involves HR/payroll receiving the information. Step 3 is the act of HR/payroll either notifying the payroll provider of the change, by phone or email, or HR manually enters the change into the payroll system. With email and phone notification, a few more steps are required. Step 4 involves the payroll provider receiving the change request. Step 5 is the act of the payroll provider manually entering the contribution change into the payroll system.

Can you imagine what this must be like at a large company? Contribution rate changes are just one piece of the puzzle, when you factor things like loan payments and other changes; at least 5 steps for each, clearly there is room for improvement. Required manual processes reflect cause and effect: technological limitations of out-dated record keeping systems and non-bidirectional payroll integration demands manual processes. 

 Figure 11: The manual participant / manual HR model

A benefit of modern technology is integration. Someone using a Microsoft Xbox gaming console can now play games from Atari in the 1980’s, then go on the internet and start a Jacuzzi at their home on the other side of the world, all because of seamless integration among many platforms; an afterthought benefit of today’s programming capabilities. 401(k) and bi-directional payroll interaction have no reason to behave any differently, and integration delivers benefits which makes everyone’s lives easier.

Beware of claims of functional integration by some payroll providers and record keepers. True functional integration is rare since it involves “bi-directional” data flow capabilities; meaning that the record keeper and payroll provider can quite literally talk to each other and share information in real time.

For example, you go online to your 401(k) Website with the intent of changing your contribution rate. After seeing your current rate, maybe 6%, you decide to change it to 7%. You enter the new amount and click “submit.” The change bypasses your HR payroll department and goes directly to your payroll provider where it is updated instantaneously in their system. Simultaneously the confirmation of your change is returned and presented on the Website; and all the work is done, instantly.


Figure 11: The automated participant / automated HR model

The administrative time savings annually from bi-directional payroll integration with your 401(k) record keeper, for the average small company, is in excess of 100 hours (that’s about 2.5 weeks of work per year). For larger companies, the benefit could be much more substantial.

This process allows for real time updating when changes are made, such as in the use of an integrated retirement calculator. The moment an increase in salary is recorded in payroll, the new salary is automatically updated in the participant’s personal information in the retirement calculator, no manual process required. This ensures that everyone at all times e has current, accurate and usable information with as little work as possible.

A win for employee and employer

Obvious technological shortfall: “Would you get more benefit from having a higher cost plan with a lot of manual work or a lower cost plan with almost no manual work?”

Up to this point, the focus has been on improving the participant experience. While improving this experience through technology, companies also derive significant benefits with lower cost, reduced liability, decrease workload, and improved compliance. Now the HR/payroll departments can take a back seat with the elimination of numerous manual tasks once required in order to implement various participant requests.  

There is automation

Plans sponsors often fight an uphill battle in their attempt to increase participation in the company’s retirement plan. To initiate the enrollment process, a company starts with an enrollment meeting and stacks of paper. The first problem employer’s encounter is the requirement that employees must make decisions about how much to contribute and what investments or model portfolio to choose. Studies have found that employee behavior is typical in these situations and inertia kicks in with employees doing nothing. 

Why not make increasing participation easy with automatic enrollment? With automatic enrollment, employees are automatically enrolled at the default contribution rate and invested in the default investment option or default model portfolio. Now, all an employee has to do to increase the benefit of participating is to become engaged in the process.

There is fiduciary relief

Professional investment managers, who design and manage age-based model portfolios (Qualified Default Investment Alternatives), often act as an ERISA §3(38) investment manager. Plan sponsors may transfer their fiduciary responsibility and legal liability for selecting, managing, and monitoring the investments to an ERISA §3(38) manager when the manager accepts this responsibility in writing.

Plan sponsors often misunderstand that, unless the investment advisor is willing to accept the responsibility and legal liability for the investments –in writing, the sponsor has not transferred this responsibility to the advisor. In fact, the liability for the investments is usually never transferred from the plan sponsor to an investment advisor since most advisors are unwilling to act in the role of an ERISA §3(38) investment manager.

It is easy to understand the reason for this confusion since logically anyone would assume that if you hire a professional to make investment recommendations, that professional would be held accountable for those recommendations. However, that is just not the case.  

Instead, the responsibility and legal liability remains with the named fiduciary of the plan who may also sign and file IRS Form 5500 and any other person who may participate as a member of an Investment Policy Committee (IPC). Therefore, it is important for plan fiduciaries, who are by default responsible and legally liable for the investments, to understand the different responsibilities investment advisors will accept as compared to the responsibilities an ERISA §3(38) investment manager will accept.

There is thorough Due Diligence

Since the plan sponsor can never delegate away its fiduciary responsibility (and legal liability) for appointing the ERISA §3(38) investment manager, the sponsor is obligated to document its due diligence process in: (a) selecting the 3(38) manager and (b) monitoring and reviewing the manager. The DOL has issued minimum due diligence requirements which a manager must meet before the sponsor can transfer the responsibility and legal liability for the investments to the manager. For plan sponsors, unfamiliar with the DOL’s requirements for §3(38) managers, attempting to perform the due diligence process can be daunting.

There is an alternative available to sponsors. Plan sponsors can hire an investment manager that has already undergone an extensive due diligence process by either the Centre for Fiduciary Excellence (CEFEX®); Roland/Criss® or Dalbar® Each of these organizations not only meet the DOL’s minimum requirements, but generally exceed them. For ongoing monitoring, ERISA §3(38) investment managers typically maintain their certification by undergoing an annual review by the organization that certified them. This annual review furthers assists sponsors in documenting their ongoing obligation to monitor and review the manager.

The plan is low cost

Speaking of fiduciary duties, making sure costs are reasonable is a top priority. You could battle for a better mutual fund share class, but with ETFs that’s not necessary since ETFs are the lowest cost investment options available.[29] When you consider that the overwhelming cost of a retirement plan is the expense associated with the investments, using low cost ETFs seems obvious since the plan can drastically lower its total, “all-in” cost. In fact, using ETFs can easily reduce the s total cost by half.[30] Now, before you start screaming “low cost is not always the best solution,” followed by some catchy story about a mutual fund that performed well this year, consider performance as a whole; bad performance is bad for a plan (another liability) good performance is good for a plan (reduced liability).

The investments have better performance on average

As mentioned previously, ETFs track an index and compared to actively managed funds, regardless of which study you cite, ETFs are unquestionably a better performing investment compared to actively managed mutual funds. And, the range of ETFs available enables an investment manager to diversify model portfolios across a broad spectrum of market segments allowing asset allocation policies to be implemented with precision.

The methodology of diversification is a widely regarded and generally accepted principle of asset allocation ascribed by Modern Portfolio Theory (MPT), as pioneered by the esteemed Nobel Prize winning economist, Harry Markowitz. In 1952 Markowitz demonstrated that there is an “efficient frontier,” a point where the maximum return can be achieved for a specific risk level. Reaching this efficient frontier comes from asset allocation and as the Brinson Study outlined long ago, nearly 94% of historical investment returns have come from asset allocation (owning the right mix of stocks and bonds), while around 6% of historic returns have come from market timing- picking the hottest investment.

Adding a Safe Harbor avoids testing

By adding a Safe Harbor matching contribution provision, ADP and ACP testing can be avoided. This means that even high income employees can contribute the maximum amount to the plan without going through the hassle of having contributions returned at the end of the year. Companies also receive the benefit of tax deductions for matching contributions, as well as adding a feature to attract and retain quality employees.

The plan is compliant with fee disclosure

The recent DOL regulatory changes, known as Fee Disclosure, provide irrefutable evidence that the world of retirement plans is in need of some major changes. If you’ve heard, “everything’s alright,” or “there is nothing to worry about” or “we’re taking care of it,” think again. It is estimated that companies will spend an estimated 39 hours in order to address fee disclosure.[31]

If everything was just “alright,” the DOL wouldn’t be taking unprecedented steps to force every single company in America to thoroughly examine their retirement plan; specifically with regard to understanding and examining a wide array of previously hidden fees and activities that negatively affect retirement plan returns and are only now being disclosed as a result of federal intervention.

There are two regulatory components at play here, known as 404(a)(5) and 408(b)(2). 404(a)(5) mandates fees charged and deducted from participants accounts for plan services. 408(b)(2) mandates that plan sponsors obtain, verify, and assess the fees charged for services provided to the plan by each service provider and further, that sponsors confirm the reasonableness of the fees charged for the services provided. Dalbar® estimates that the average small company will need to spend around 39 hours annually to ensure that their plan is compliant; which includes the time and expense of learning compliance requirements, securing the information required to comply, determining accuracy and completeness, accessing success of the plan as a result, assessing necessity, assessing cost through benchmarking and comparison and finally, assessing the reasonableness of services and costs.

Since ETFs have no hidden fees, using ETFs as the investment of choice means there is nothing hidden so there is nothing to verify. On an ETF platform, fees are a direct deduction from plan assets instead of a payment to the service provider or other third party from fees charged within the investment (revenue sharing payment arrangement). As illogical as this may sound, some plan sponsors believe that it is better to choose the highest cost investments, which pay the most revenue sharing, under the misguided belief that this arrangement makes the “cost for managing the plan fee.”

Eliminating hidden fees simplifies the reporting requirements for disclosing the cost, in dollars and cents, to participants on their quarterly statements; resulting, in full fee transparency. The ideal 401(k) plan will require information to be fully disclosed, not simply as a basis for understanding, but so that the information can be useable, allowing an entirely new experience for someone using the plan to save for retirement.

Signs of optimism

The investment world is changing. The era of mutual fund dominance is starting to show measurable signs of approaching dissolution. In the beginning of 1984, mutual funds had no assets in retirement plans. A couple of years later after the completion of the record keeping programming necessary to make mutual funds available in retirement plans, it took little over a decade for mutual funds to become the largest segment of assets in retirement plans (1996).

This sharp rise in asset accumulation within retirement plans paralleled that of conditions for the U.S. market as a whole, which saw steady new cash flows into mutual funds for another decade, until peaking in 2007.[32] What followed, for the overall U.S. market, was an exceptionally steep decline in mutual fund assets, with assets flowing out of mutual funds at an ever increasing pace.

 Figure 12: Mutual Fund net new assets in billions of dollars.[33]

Where was all this money going? The answer is into ETFs, which despite the volatile market conditions of 2008, continue to see record setting positive cash flows, indicating that the market was experiencing a committed process of fundamental change.

Figure 13: ETF[34] vs. Mutual Fund[35] net new assets in billions of dollars.

There is evidence that the momentum of this fundamental change is building. Since 1996, ETF assets have grown nearly 1000%, dwarfing mutual fund asset growth by comparison.

Figure 14: ETF vs. Mutual Fund asset growth rate.[36]

The result has been a growth in assets for ETFs that increased from around $1 billion in 1996, to $1 trillion at year end 2010.

Figure 15: ETF Asset growth in billions of dollars.[37]

Finally, this surge in assets in ETFs has been accompanied by a rise in popularity, as indicated by Google® Trends.[38] Just as 2008 saw the beginning of massive capital outflows from mutual funds, it was also the year that the search volume index for ETFs exceeded that of mutual funds (Fig. 16 Location A), a shift of preference that continues to this day and has been accompanied by a spike in news reference volume as well (Fig. 16 Location B); ETFs are catching headlines and gaining in popularity.

Figure 16: ETF rise in search volume and news reference volume compared to mutual funds.[39]

The result of all this change has been an ETF asset presence that is approaching 10% of U.S. investment company total assets at year end 2010, a rise of 26% from year end 2009.[40] However, in retirement plans, ETFs make up less than 1% of assets, a disparity distanced 10 fold from the mainstream market.[41]

What can be seen is that mutual funds are losing assets and popularity. The market is heading unquestionably in the direction of ETFs with ever greater momentum and there is no indication that this will change. As a result, it is unrealistic to expect that mutual funds will retain their asset dominance in retirement plans for much longer.


Joe Employee’s company switched to an ETF 401(k) plan for the past few years. Joe is sitting at home watching the news with his family where stories are presented on a troubled economy, talks of recession and wide spread confusion across the Euro-Zone affecting American markets. Wondering about the effect of these events on his finances and not having checked his 401(k) in some time, Joe reaches for his iPad® and clicks the app for his 401(k) site. He enters his retirement calculator and clicks next, where he sees that while the world is in pandemonium, his world has only been minimally effected; raging down markets have changed things in his plan and now to get back on track, he needs to contribute 1% more from his paycheck to be on track. He confirms the change, logs out and goes back to his family.

This is how our world is, this is how people interact with their plan and this is how a plan needs to be designed to interact with them.

The current mutual fund systems in place do not accommodate this modern reality, whether they could ultimately become capable or not is a matter of some debate, but the fact is, they are not at this point in time and they do not appear to give any indication, either historically or currently, that they will be able to modernize in any way and timeframe required to bring the benefits urgently needed and desired by America workers.

The only way this technological leap can be accomplished is by changing fundamentally at the core, with the record keeper. The record keeper’s technology dictates how plans come to life, what benefits can be offered; how people can receive those benefits and how easy the process as a whole can be from start to finish.

What has been outlined is a road map, a way to enact change on a macro level, to deliver a real opportunity to not only answer the question “do you know how much you need to save for retirement and whether or not you’re on track to reach that goal?” But do so in an effortlessly positive manner..

Delivering this is a matter of clarity and utilization. To draw on a familiar analogy, if a retirement plan were an engine, it would need to be built from the best parts (ETFs), assembled by the finest mechanics (ERISA §3(38) investment manager) and put into service speeding towards a destination with total transparency about how much fuel would need to go into the engine to get that driver there (contribution rate).

ETFs present the only truly viable way to make these realities possible on a large scale. They demand a new technology, meaning the core of our retirement system gets a much needed upgrade. From here a new modern method of plan design can be implemented, one based on simplicity and ease, adhering to The 3 C’s and diligently working to benefit the “un-engaged” using the best methods possible.

From here the plan has the latitude to crossover and serve the needs of the “engaged” with expert accommodation, drawing on technology to bridge the old gaps and leave the participant only with the decisions they absolutely have to make, with the opportunity to make those decisions in a clear and meaningful manner that results in a benefit exceeding the option to do nothing.

From a business and economic standpoint, what makes this approach so feasible is its cost effectiveness. By using low cost ETFs, plans remove the majority of their expense. Fee disclosure supports this and with full disclosure, low cost investments and low cost services, plans can negotiate reductions in expenses directly with the parties involved, rather than attempting to lower costs through negotiating different share classes that are additionally nestled with hidden fees.

This is the future; this is how the ideal plan will be designed. People will get all of these benefits and, the employers will benefit as well, by simply offering their employees the finest accommodation. It is time to make a change, move things forward in a truly measurable and positive way.

To end on this note requires a quick story. Last year, there was a fairly lavish Holiday dinner attended by none other than Darwin Abrahamson, a pioneer of ETF 401(k) plans and a champion of the individual investor. With glasses high, looking over a decedent meal and being in the financial services industry, one would expect a toast to capital gains, record setting revenue or the like, but instead, in referencing what has now become a patented system for offering ETFs in retirement plans, Darwin’s toast to the future was simply this, a suitable point to end this paper on; “We’re going to help a lot of people.”


About the Author

Neil Plein is Vice President of Invest n Retire, LLC, a Portland, Ore. Based 401(k) record keeper specializing in offering ETFs to defined contribution plans through its patented technology for managing tax-deferred retirement accounts (patent US 8,060,428). Neil’s passion is working to find the best macro solutions that genuinely help participants. He studied at Reed College, The University of Oxford and also worked at several major broker-dealers, including Merrill Lynch. Drawing on a background of high level excellence in academic and professional research, analysis and clearly presented solutions, Neil is a firm advocate of truly positive evolutions.

Disclaimer: Invest n Retire‚ LLC (“INR”) is not engaged in rendering tax‚ accounting‚ legal‚ investment advice or financial planning services. INR is not giving advice or offering any opinion with respect to the suitability of any security‚ or the advisability of buying or selling any security that may be referenced in this paper. The information contained in this paper is offered only for general information and educational purposes. The contents are not provided as and do not constitute either investment or legal advice. You should not act or rely on the information contained in this paper without first seeking the advice of your investment‚ accounting‚ and legal advisors concerning your own unique situation and any specific questions you may have.

[1] Employee Benefit Research Institute, “History of 401(k) Plans: An Update, ” February 2005: http://www.ebri.org/pdf/publications/facts/0205fact.a.pdf

[2] Pension and Welfare Benefits Administration, “Study of 401(k) Plan Fees and Expenses,” April, 1998: http://www.dol.gov/ebsa/pdf/401kRept.pdf

[3] Carthur, Shauna, “Rebalance your portfolio to stay on track,” Investopedia, May, 2009: http://www.investopedia.com/articles/pf/05/051105.asp#axzz1fsKavhAl

[4] Plein, Neil, “Beyond your control: What’s really to blame for America’s underperforming 401(k) system?” ETF Guide, November 2011: http://www.etfguide.com/research/712/29/Beyond-your-control:-What

[5]Is there any ROI for 401k Education Policy Statements? by Sanders Booze, Capital Advisors, Oct 2011 “ERISA, the federal law governing private-sector retirement plans, requires that the participants receive certain information about their plan, but does not require that the participants receive education.” http://sandersboozeblog.com/2011/10/is-there-any-roi-for-401k-education-policy-statements

[6] Anderson, Nancy, “The 401(k) is not working for Gen Y, but it can,” Forbes Magazine, October, 2011: http://www.forbes.com/sites/financialfinesse/2011/10/20/the-401k-is-not-working-for-gen-y-but-it-can/

[7] Abrahamson, Darwin, “Can exchange traded funds (ETFs) be traded just like mutual funds?” November, 2011: http://www.investnretire.com/Documents/Questions.pdf

[8] Plein, Neil, “Asset Allocation Models Are The Only Way Forward For 401(k)’s,” July, 2011: https://investnretire.wordpress.com/2011/07/30/asset-allocation-models-are-the-only-way-forward-for-401ks/

[9] Global Action on Aging, from the Associated Press “Auto Enrollment Grabs Reluctant Retirement Savers,” February, 2010: http://www.globalaging.org/pension/us/2010/auto.htm

[10] The Associated Press, “401(k) Results a Downer, Now What?” April, 2009: http://www.mainstreet.com/article/retirement/401k/401k-results-downer-now-what

[11] Towers Watson Perspectives, “New Strategies in Defined Contribution Plan Design,” January, 2011: http://www.towerswatson.com/assets/pdf/3537/Towers-Watson-Plan-Design.pdf

[12] John, David, “The Business Case for 401(k) Automatic Enrollment,” Date of publish not listed:  http://www.retirementmadesimpler.org/ResourcesAndResearch/BusinessCaseForAuto401ks.shtml

[13] Farrell, Paul, “Yes, You Can Pick A Winner! The “Expense Ratio” is #1 “Reliable Indicator” With Top Predictive Value: 10 of 11 Morningstar Statistics? No Help.” April, 2010: http://wallstreetwarzone.com/credit-rating-data-tracking-agencies/

[14] Barras, Laurent, Scaillet, O., Wermers, Russ, “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas,” March, 2008: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=869748

[15] United States Department of Labor, “A Look At 401(k) Plan Fees,” October, 2010: http://www.dol.gov/ebsa/publications/401k_employee.html

[16] PR Newswire, “John Hancock Study of 401(K) Participants Investment Outcomes Reveals Common Investing Behaviors,“ October, 2007:  http://www.prnewswire.com/news-releases/john-hancock-study-of-401k-participants-investment-outcomes-reveals-common-investing-behaviors-58702862.html

[17] Aon Hewitt / Financial Engines, “401(k) Participants Using Professional Investment Help Continue to Do Better Than Those Who Go It Alone,” September, 2011: http://www.marketwatch.com/story/401k-participants-using-professional-investment-help-continue-to-do-better-than-those-who-go-it-alone-2011-09-26

[18] Abrahamson, Darwin, “Self-Aligning Portfolios™” http://www.investnretire.com/Technology.aspx?ContentId=301&Offset=-2

[19] McLaughlin, Mark, “Popularity of Target Date Funds Soars,” May, 2011: http://www.cnbc.com/id/42767457/Popularity_Of_Target_Date_Mutual_Funds_Soars

[20] Brandon, Emily, “Average Retirement Age Grows,” August, 2011: http://money.usnews.com/money/blogs/planning-to-retire/2011/08/17/average-retirement-age-grows

[21] Trading Economics, “US Inflation Rate,” http://www.tradingeconomics.com/united-states/inflation-cpi

[22] Social Security Online, “National Average Wage Index,” online resource: http://www.ssa.gov/oact/cola/AWI.html

[23] Updegrave, Walter, “Current vs. retirement income: How much do I need?” Money Magazine, May, 2007: http://money.cnn.com/2007/05/03/pf/expert/expert.moneymag/index.htm

[24] Blumenthal, Karen, “Thanks but No Thanks on 401(k) Advice,” The Wall Street Journal, November, 2011: http://online.wsj.com/article/SB10001424052970204346104576638933476020932.html

[25] ibid 11

[26] Mollman, Steve, “Online How To Videos Rise In Popularity,” CNN, October, 2007: http://edition.cnn.com/2007/BUSINESS/10/03/video.howto/index.html

[27] Apple, “iPods in Bedside Medical Education:” http://images.apple.com/science/profiles/ipod_ultrasound/

[28] Haslem, John, “Issues in Mutual Fund Revenue Sharing Payments,” September, 2011: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1845827

[29] DeAenlle, Conrad, “The Low-Cost Power of Exchange Traded Funds,” The New York Times, April 2010: http://www.nytimes.com/2010/04/11/business/mutfund/11etf.html

[30] Karamcheva, Zhenya, Kopcke, Richard, Vitagliano, Francis, “Reducing Costs of 401(k) Plans With ETFs and Comingled Trusts,” Center for Retirement Research, Boston College, July, 2010: http://crr.bc.edu/briefs/reducing_costs_of_401_k_plans_with_etfs_and_commingled_trusts.html

[31] ibid 24

[32] 2011 Investment Company Fact book, 51st Edition: http://www.ici.org/pdf/2011_factbook.pdf

[33] ibid

[34] Data collected from the National Stock Exchange Monthly ETF reports: http://www.nsx.com/content/etf-net-flows-list

[35] ibid 32

[36] ibid

[37] ibid 34

[39] ibid 38

[40] ibid 32

[41] Plansponsor Magazine 2011 DC Survey: “Points of Hue:” http://www.plansponsor.com/2011_DC_Survey.aspx

Additional Information on the Invest n Retire Platform

Invest n RetirePlans using Ceridian Payroll

Plans with less than $5 million in assets:

401k Plan Information Sheet

403b Plan Information Sheet

Plans with more than $5 million in assets:

401k Plan Information Sheet

403b Plan Information Sheet

Plans not using Ceridian Payroll

401k Plan Information Sheet

403b Plan Information Sheet

Advisors, Investment Managers and Fund Providers

Email neil@investnretire.com for more information

U.S. Patent Office Grants Patent to INVEST N RETIRE, LLC

Contact: Neil Plein                                                                                                                FOR IMMEDIATE RELEASE
Tel. 503-419-2894 x 104
Email: neil@investnretire.com

U.S. Patent Office Grants Patent to INVEST N RETIRE, LLC

System and Method for Managing Tax-Deferred Retirement Accounts

PORTLAND, OR- Nov 15, 2011, the U.S. Patent Office granted Invest n Retire, LLC (INR) patent number 8060428, “System and Method for Managing Tax-Deferred Retirement Accounts.”

INR’s patented technology, among other functionality, allows employees in retirement plans to invest in a portfolio of Exchange Traded Funds (ETFs) according to a professionally designed asset allocation model (AAM). The system also uses regular payroll contributions to selectively buy underweighted ETFs in the portfolio so that the employee’s AAM maintains its balance, referred to as Self-Aligning Portfolios™.

Darwin Abrahamson, founder and CEO of Invest n Retire® and a pioneer in the retirement industry, calls this a “turning point.”

As a significant number of investors continue to leave mutual funds in favor of ETFs, the only obstacle blocking the way for employees in retirement plans was technological limitations which INR has overcome. Now employees can reap the benefits of ETFs, the fastest growing investment vehicle in history.

INR’s technology goes even further with the inclusion of online tools that make the job of managing your retirement account a breeze. If you want to know how much you need to save for retirement, you can find the answer easily using INR’s calculator. By designing a calculator that is integrated with payroll; employee information such as age, salary, and contribution rate prepopulates the calculator.

Even more important, the calculator also prepopulates the employee’s rate of return, based on the asset allocation model selected. Now, with a single click, the calculator tells the employee if he or she is on track for retirement. If the results indicate a shortfall, the calculator offers a few changes to consider implementing in order to get on the road to retirement success.

“Up until now, everyone essentially only offered mutual funds which operate on antique systems developed back in the ‘70s. Realistically, the retirement industry is suspended in a time warp. With our patented technology the industry no longer has to be constrained, moving forward with modern technology and better investment choices – ETFs. Our approach to solving the countless problems facing the retirement industry is unprecedented.” Abrahamson said.

About Invest n Retire, LLC

Invest n Retire‚ LLC (INR)‚ located in Portland Oregon‚ was founded in 2000 by Darwin Abrahamson in response to the overwhelming demand for leading edge technology that can deliver financial tools and services to tax-deferred retirement plans. INR’s uniquely designed patented system addresses and solves numerous problems confronting the retirement industry. http://www.investnretire.com/

To obtain a PDF version of this press release click here

To view Patent deatils from the U.S. Patent and Trademark Office click here and search Patent No: 8060428

Ceridian’s New “2.0” Integrated Payroll and 401k Option

By Neil Plein
View Neil  Plein's LinkedIn profileView Neil Plein’s profile

Employers: Save 100 + hours of administrative work each year with an integrated Ceridian and Invest n Retire solution

Invest n Retire® (INR) has partnered with Ceridian®, a leading national provider of human resource, payroll and benefits administration solutions, to offer a new, fully integrated payroll and 401(k) solution. This integrated solution relieves HR of most of the manual labor required each time a change is made to the record keeping system, and is also fully compliant with the Department of Labor’s April 2012 regulatory changes on fee disclosure.

The enhanced compliance aspect is a substantial competitive advantage compared to other integrated platforms available today. According to Darwin Abrahamson, CEO and Founder of Invest n Retire, “While other providers struggle to determine how they will comply with the new fee disclosure regulations coming from the Department of Labor, these monumental changes are also creating headaches for HR, not to mention the added costs: upwards of $35,000 in consulting fees. The good news is INR is already fully compliant.”

As a result, a number of plans are converting to our integrated solution for this very reason, citing a substantial time, cost and resource savings in doing so. However, this is merely one facet to a suite of new benefits. At the core of this approach is a fundamental shift in what defines retirement success, taking the focus away from education and placing it on technology.

According to Lou Harvey, CEO of Dalbar, Inc., “Continued efforts since 1996 to help participants make informed decisions through educational sessions have been futile.” In large part, this futility results from the purpose of such education, which has been directed at training participants to perform largely manual processes.

However, these processes have now become fully automated, so participant education can begin to focus on the bigger picture of achieving retirement peace of mind. Plus, we are now able to offer a “second level” of integration — a development available on Ceridian and INR’s fully integrated platform.

Two Levels of Integration

Level 1.0 Integration: Administrative

The first level of integration revolves around administration, with the goal being increased efficiency through automation of manual processes. This is best understood through a brief, somewhat comical story that came about after watching a demonstration by a large multinational conglomerate showcasing their technology.

The technology was offered by a major insurance company and payroll was delivered by an equally large, but separate company. The first stop on this guided tour was a demonstration of the accessibility to a few crucial pieces of information, starting with contribution rate. Unfortunately, after nearly 10 minutes of searching, the effort was abandoned as no such data could be found. The only promising development was the discovery of a brightly colored button that read, “Change contribution rate.” Upon clicking, a pop-up screen appeared with a low quality, scanned PDF file, laden with boxes and instructions — the sheer presence of which was almost certainly met by a spike in blood pressure for the HR director delivering the presentation.

On this platform, in order for a participant to change their contribution rate, he or she needed to print out this form, fill out their personal information, specify their current contribution rate, indicate the new rate they wanted, and (after a lengthy disclaimer which took them to a second page filled with even more disclaimers) “simply” sign the document and send it to their HR manager — in another state. Needless to say after talking with several participants, changing contribution rates was not exactly a favorite topic. (Figure 1)

Initial Problem (Poor)

Figure 1: The manual participant / manual HR model

An obvious step in the right direction would be to eliminate that form, not simply for the benefit of the HR director’s health, but also for the benefit of the participant. Automating the process online would mean that a simple click would deliver the information previously included in the form. But where did this information go? To the same place as the form went before, HR. (Figure 2)

Improved Solution (Better)

Figure 2: The automated participant / manual HR model

Therefore, eliminating the form, by offering a higher level of ease to the participant, would be a first step; after all, this would eliminate the manual work for the participant, but the manual work for HR still exists. In order to deliver the goal of increased efficiency through automation of manual processes for everyone; full integration is the superior solution. (Figure 3)

Full Integration (Best)

Figure 3: The automated participant / automated HR model

This level of integration automatically updates data in the payroll system when a change is made on the record keeping system — most manual HR duties are removed from the equation. According to a recent survey of small and medium-sized business, this could save around four hours per payroll period, or over 100 hours of work per year — numbers that would likely be much higher for larger companies.

Integration of payroll and 401(k) substantially reduces repetitive administrative functions and results in numerous additional efficiencies, including easily managing changes in deferral amounts, calculating loan repayments, gathering census data and more:

1)      Employees make contribution change requests online through the INR Participant website. Contribution requests are automatically sent to Ceridian through a secure FTP upload. Employee contribution changes are automatically updated within the Ceridian system and are processed the next pay period. (Contribution change requests include pre-tax, Roth, catch-up pre-tax and catch-up Roth).

2)      Each pay period, the INR system computes each employee’s contribution rate, for each elective source, based on the employee’s annual salary and the contribution information included in the payroll file. In this way, the employee can confirm the contribution rate for each employee elective source that is being deducted from his or her pay each pay period.

3)      INR collects census information from Ceridian through payroll files, which allow the third party administrator (TPA) to access the information through the INR Sponsor Portal. The census information can be electronically downloaded by the TPA for use in ACP, ADP, and/or Top-Heavy testing, if required by the plan.

Level 2.0 Integration- Participant

The second level of integration revolves around participants’ needs, with the goal being to deliver the best opportunity for participants to develop an adequate retirement fund. To accomplish this, every aspect of a plan needs to be “firing on all cylinders.” So, much like an engine, the plan not only needs to be built from superior parts, but in order to run correctly, all of those parts need to be working together.

The need for evolution in retirement plans is essential, as major sources like Businessweek, The Wall Street Journal, Reuters, Bloomberg, Forbes, CNBC, 60 Minutes and many others continue to report on retirement savings problems ahead for most Americans. The numbers are unavoidable, the problems are there — it is time for change.

There are three fundamental aspects that contribute to the long-term success of a retirement plan for participants: cost, compounding and contribution (The 3 C’s™). A brief example will demonstrate the power of this.

According to the U.S. Census, the average American worker makes $32,140 and, according to Dimensional Fund Advisors, the average retirement plan participant contributes 6.8% of their salary to the plan. This means that, by rough numbers, the average person has around $2185.00 going into their retirement plan every year.

Average American Income

Figure 4: Average individual salaries for Americans. Source: US Census Bureau

Without considering inflation or a host of other factors, consider an individual who just turned 30, has saved $10,000 already and is headed for retirement at 65. Say this person makes the average amount of $32,140, contributes the average amount of $2185, their money grows over that period at 5% and the plan costs near the average of 1.50%. Let’s call this starting point Option A.

If this cost were decreased by 1.00% of assets to a new cost total of 0.50% of assets, the balance over 35 years could increase by roughly 26%.

Impact of Cost

Figure 5: The impact of a 1.00% cost reduction over 35 years. Other than cost, values are the same, starting balance of $10,000, earning 5% and contributing 6.8% of a $32,140 salary. View Math.

Now say, rather than earning an average of 5% over that period, returns could be 1% higher, averaging a 6% return over the period. For a plan costing 1.50%, the projected balance could catch up to the asset level achieved by the cost decrease alone, $237,128 (therefore the plan would have 1 of The 3 C’s™).

However, under these new circumstances, starting with a cost decrease and then adding a compounding return increase (thus the plan has 2 of The 3 C’s™), the returns would be 27% higher than the $237,128; achieving a new projected balance of $302,109.

Impact of Compounding

Figure 6: The impact of a 1.00% compounding return increase (now 6%) over 35 years. Option A reflects the impact of this change without cost reduction (1 C) while Option B reflects the impact of this change with 1.00% cost reduction (2 C’s). View Math.

For the final element, contribution, consider again the starting option. With an increase in performance, this option was able to reach the projected asset outcome achieved by the cost reduction alone (the plan has 1 C). Yet, allowing the cost reduction option to also receive a 1% performance increase (the plan has 2 C’s) now improves the projected balance by 27% more. Finally, consider a 1% increase in contribution rate, from 6.8% of compensation to 7.8% of compensation.

Impact of Contribution

Figure 7: The impact of a 1.00% contribution rate return increase (now 7.8%) over 35 years. Option A reflects the impact of this change with 1.00% increased performance but without 1.00% cost reduction (2 C’s) while Option B reflects the impact of this change with 1.00% increased performance and 1.00% cost reduction (The 3 C’s™). View Math.

Now, with the plan possessing all of The 3 C’s™, the balance is again higher than if the plan only had lower cost and increased compounding performance (2 C’s); but more importantly, the increase in projected balance by adding the third C, contribution to the plan, was 33%.

What this implies, through basic mathematics, is that regardless of how your plan is designed, if you only have 2 out of The 3 C’s™; your plan is not delivering the fullest benefit to its participants. Only by offering all 3 can a plan deliver the most from its design.

The final point to examine in this example is the difference between the projected balance from the initial starting Option A, a plan with none of the C’s that projected a balance over 35 years of $187,539. Comparing this to plan Option B, containing all of The 3 C’s™, with a projected balance of $364,331; the difference is a 94% increase in projected balance.

Cumulative Impact

Figure 8: The compounding effects of The 3 C’s™ on projected retirement asset levels over the starting average.

The power in these examples will come as no surprise to most; because the problems created for participants by lacking any of The 3 C’s™ in a plan have been well publicized, while the solutions for such problems have also been presented.

Costs should be lower:

Problem: “over a 35 year period…the 1.00% difference in fees… would reduce your account balance at retirement by 28 percent. – U.S. Department of Labor

Solution: Using Exchange Traded Funds (ETFs) which track indexes instead of actively managed mutual funds “could reduce …fees and costs by 0.70% of assets or more.” – Center for Retirement Research at Boston College

For this reason, Forbes Magazine says that “ETFs are 401(k) Plans’ Next Big Thing” – Forbes Magazine

Compounding returns should increase:

Problem: With regard to investment options “90% of…401(k) and other defined contribution assets in mutual funds are actively managed” – The Wall Street Journal

Solution: By comparison, the benchmark indexes (which ETFs track) “outperformed 71.9% of actively managed…mutual funds.” – The New York Times

Further, when selecting the mix of these investments within a participant’s account as a whole, “84.2% of participants would fair better” with professional management than by selecting their own investment mix. – John Hancock® Study

Contribution levels should improve:

Problem: “Unless people begin… contributing more to their 401(k) plans, advisers say, they are destined to hit retirement with too little money. – The Wall Street Journal

Solution: ” INR’s integrated retirement calculator has led to increased deferral rates of “60% from 7.39% to 11.76% and plan participation has risen from 64% to 85%.” – InR’s Profit Sharing Council of America Award

Therefore, cost should be low, compounding returns should increase and contribution rates should improve and be correct to achieve a specific goal.

With a non-integrated plan, the dependency has been on education, largely ignoring these factors and instead attempting to turn participants into investment experts — an impossible task. But even if a non-integrated plan possessed these traits (cost, compounding and contribution), it would not be enough to simply offer them. Participants would then have to be taught how to manage each, both independently and simultaneously, in an effort to make them work together so the maximum benefit can be achieved. For participants, that experience feels much like sorting through this:

Figure 9: Heisenberg’s Uncertainty Principal in Quantum Physics which accounts for the effect that by observing one factor, all other factors are changed as a result- a slightly comedic parallel to the task asked of participants
in non-integrated plans.

Without integration there is very little automation for participants, requiring most tasks to be performed manually. The instructions in “how” to perform these tasks are delivered through participant education, which serves as the primary factor in defining how to achieve retirement success. An example of this can be seen very easily with retirement calculators; non-integrated plans require participants to enter information manually.

Non-Integrated Data Flow (input model)

Figure 10: Non-integrated platforms depend mainly on the participant to input data. The quality of the output from technology like retirement calculators depends on the quality of the input from the participant, which is dependent on the participant becoming educated to use the technology effectively.

The problem with this model is the burden it places on the participant; it is based on their input and therefore the quality of their education to provide such input. When thinking about a retirement calculator, for example, some pieces of data are obvious and easy for participants to enter, such as age and salary — data that payroll already has, but has not been factored because there is no integration.

However, when you get to something like target rate of return, which nearly all major retirement calculators require, now what? Does the number enter your mind as easily as age and salary? Does it even enter your mind at all? This information — return history, investment options, costs — this is data the record keeper already has, but again, has not been factored because there is no integration.

So without integration, the participant is required to understand and be responsible for interpreting and entering everything correctly, doing all the manual investment calculations (cost), portfolio adjustments (compounding) and attempted contribution rate changes (contribution).

Integration shifts these tedious duties to technology, allowing what defines achieving retirement success to move away from participant education and towards technology. The output-based model makes things far easier for a participant through a reduction in tedious, monotonous manual data input (age, salary) and rigorously difficult calculations.

Integrated Data Flow (output model)

Figure 11: Integrated platforms depend on technology to work by using data integrated between payroll and recordkeeping so the quality of output is no longer dependent on educating the participant.

This model demonstrates how integration allows data which had once been unavailable, to now become usable. Participants no longer have to become professional portfolio managers or retirement planners to reach their retirement goals; technology performs nearly all of the work for them.

However, as most plans know, not everyone uses the technology made available to them. Some participants are more un-engaged, using the technology rarely or not at all; while others are very engaged, using the technology frequently. The integrated model allows for the most benefit to be delivered to each type of participant.

Un-engaged participants:

Participants who choose to be un-engaged receive the best default solution (the example in Figures 5, 6, 7 and 8 above): Low-cost investments in a portfolio managed by professionals (cost, compounding and default contribution rate). The majority of participants fall into this category, according to retirement expert and distinguished MIT professor, Robert C. Merton.

Engaged participants:

Participants who then choose to become engaged have a meaningful experience that results in a benefit exceeding the option to be un-engaged — they receive clarity of retirement goals and the contribution rate required to reach them (cost, compounding and needed contribution rate)

Participants who engage the technology receive the greatest benefit, not simply cost and compounding, but contribution as well, because it can only be set to the needed level (above default) by participant-directed action (use of the technology).

In the previous examples of Figures 5, 6, 7 and 8, basic math illustrates the impact of slight 1% changes. But consider what would happen if a participant increased their contribution rate by several percent using this approach, to the needed amount determined by the calculator. The effect would be substantial. By allowing participants to harness the synergy offered by The 3 C’s™ easily and effectively with new technology, plans will not just see greater successes for those who are engaged, but also develop greater potential for influencing participants who had traditionally been un-engaged to use the technology and in turn, raise the benefits for everyone.

For the first time, all of the above benefits are available with Ceridian and INR’s 2.0 Fully Integrated Payroll and 401(k) option. A demonstration of this experience can be observed in this short video.

Joint efforts make a new experience possible

Joint efforts offer administrators and participants an entirely new experience. For example, participants log in to the INR Participant website and use INR’s proprietary retirement calculator, where they are presented with a pre-populated calculator containing all of their personal and investment return information. Simply clicking “submit” takes them to a screen that illustrates what they are projected to have saved at retirement based on the current information, followed by the amount they need to save for retirement, and if there is a shortfall, by exactly how much they need to increase their contribution rate to get on track.

If they see that they need to increase their contribution rate, all they need to do is make one click, confirm the change, and log out. Meanwhile, the contribution rate change is automatically updated with Ceridian and reflected in the next pay period.

As you can see, this is the essence of simplicity with a fully integrated, outcome-based approach. Rather than requiring participants to focus on input (picking investments, reading manuals, referencing statements), they simply have to manage a few key output factors (changing contribution rate, moving to a model with a higher historic rate of return, decreasing the percentage of income they estimate they will need at retirement, or delaying their retirement by working a few more years) and that’s it.

By focusing on four simple factors, with all aspects of their specific information integrated and working together, participants only need to make slight adjustments to stay on track and achieve retirement peace of mind quickly and effectively.

As a result, plan sponsors have been eager to share their successes using this approach:

Before, “It seemed like the participants, myself included, were putting money into the old plan and it just never seemed to be growing.” But now with the new INR platform, “Participants really appreciate what we’ve done…we can actually see our money growing…and the statistics on our plan will show that participation has increased…and contribution rates have increased… it’s just much easier.” Chris R., Plan Sponsor (Video Interview).

This has been a huge success; the feedback we get is all positive.” Mike K., Plan Sponsor (Video Interview)

Benefits of INR’s integrated 401k platform

It starts with low-cost investments: INR offers Exchange Traded Funds (ETFs) as investment options allowing participants to own whole and fractional shares of low-cost ETFs in their retirement account. Adding low-cost investments increases participants’ returns by the cost savings without increasing investment risk. New to ETFs? See the Wall Street Journal’s recent article: ETFs Roar Ahead, Shrug Off Criticism.

ERISA §3(38) Investment Manager: Through INR’s platform, a plan sponsor may hire an ERISA qualified §3(38) investment manager. This allows the plan sponsor to transfer his or her fiduciary responsibility, in writing, to the §3(38) manager for selecting, monitoring and managing the investment options offered to plan participants.

Model Portfolios: The §3(38) investment manager designs age-based model portfolios as qualified default investment alternatives (QDIA). Participants who still wish to choose their own investments may continue to do so, although studies demonstrate that only five percent (5%) of employees choose to pick their investments. This attests to the strong demand for professional portfolio management.

Retirement Calculator: Participants ask, “How much do I need to save for retirement?” To help answer this perplexing question, INR provides participants with a retirement calculator that is integrated with payroll information.

Record keeping and payroll integration: Full integration with payroll facilitates INR’s ability to pre-populate personal information into the calculator; such as age, salary, and contribution rate. The calculator also pre-populates the historical rate of return for the participant’s investment model so that the participant is not required to figure out target rate of return through an arduous task. With all this information automatically accounted for, a participant needs only to press a single button to clearly see what they need to save, whether or not they’re on-track to reach that goal, and if not, what can be done to get on track (such as increasing contribution rate; with the exact increase amount already calculated and clearly shown to the participant).

Mandatory Fee Disclosure: INR discloses fees for plan services, which are paid by participants by deducting fees from their retirement account, in dollars and cents on their quarterly statement. Since ETFs do not charge revenue-sharing fees, which are paid to third parties for plan services, INR eliminated the “revenue sharing fee payment arrangement” hurdle. This ensures that INR is in full compliance with the Department of Labor fee disclosure regulations under ERISA §404(a)(5).

Virtual Audit: INR provides auditors with a Statement on Demand which contains all of the information an auditor will need in order to perform the annual plan audit. The auditor can now work from the comfort of his or her office in performing this sometimes arduous task. This process not only reduces the cost for an audit by 25% on average, a virtual audit relieves HR from being saddled with the task of digging through records and providing the information to the auditor in order for the auditor to complete his job.

Simplifying the conversion process: INR works directly with prior service providers in determining timelines for the black-out period, receipt of employee records and transfer of plan assets so that HR is relieved of these burdensome duties.


Ceridian and INR’s fully integrated payroll and 401(k) solution drastically reduces administrative work and offers a powerful new retirement solution to participants.

Administration is eased in the short term by removing the burden of repetitious, mundane and time-consuming tasks. While over the long term, having a plan that is fully compliant with the April 2012 Department of Labor fee disclosure regulatory changes can save an untold amount in cost, time and resources.

The benefits of a two-layer, integrated approach are not just administrative. The average 401(k) balance in the United States for a person approaching retirement is only $60,000. A contemporary approach that magnifies each element of a 401(k) plan to deliver powerful benefits offers a new way forward to ease the stress and confusion of manual, non-integrated plans.

The technology behind this platform delivers a final benefit to the company. By streamlining payroll and 401(k) processes, avoiding costly fee disclosure compliance and reducing the cost of investments and lowering audit expenses, the potential impact is immeasurable and presents a compelling case for change — a process which has also been made easier through integration.

This option is now available to all Ceridian clients; there is no minimum asset level required. Download the brochure for this option here.

See also: Asset Allocation Models Are The Only Way Forward For 401(k)s and Retirement Calculators Threaten The Stability Of Your Entire Plan.

RIA’s looking to offer this solution to their current clients by serving as an ERISA qualified §3(38) investment manager are invited to contact the author for more information: Neil@investnretire.com

Beyond your control: What’s really to blame for America’s underperforming 401k system

By Neil Plein
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This is the transcript from an interview with Darwin Abrahamson, CEO and Founder of Invest n Retire®, whose slogan is “Record keeper of the future.” Darwin is considered a pioneer in the retirement industry and widely regarded as a true champion in the fight to enact industry standards that genuinely serve the average investor’s best interest. Since 1982 Darwin has worked with fiduciaries and pension administrators of qualified tax-deferred retirement plans. Mr. Abrahamson’s company has been mentioned in the New York Times, Washington Post, Wall Street Journal, Forbes Magazine and nearly all other major financial publications.

Neil: If you open any financial magazine, you’ll see an abundance of ads from every major 401k service provider stating that they have something different to offer, is that actually the case?

Darwin: No. Neil, the message may sound unique, but the offerings are not. The reality is, you’re going to get virtually the exact same thing on every platform; the only thing that will change is the person you talk to and the name of your plan. Fundamentally, however, the investments you use, the tools you access and the outcomes those things make possible will remain the exact same.

Neil: You mention that every platform offers basically the same things, which means that the “outcomes” continue to be the same; what do you mean by that?

Darwin: For a long time, the tide has been overwhelmingly against the average retirement plan investor. That is what I mean by a fundamental problem. The outcome as you can imagine, is exactly what we see everywhere; low balances, low participation, low contributions. There are ways to disguise this through catchy, colorful presentations made each time companies meet with their service providers, but the reality is, more and more people across this country are coming to the very rude awakening that they simply will not have enough money saved for retirement.

Neil: Why is this the case? Why hasn’t someone figured out how to really make things work for people on a large scale? It seems like a pretty obvious and major national problem?

Darwin: Neil, the real answer will surprise you and everyone else for that matter, because the real problem is something that’s totally out of almost everyone’s control; employees, companies, advisors; their struggle can be very clearly defined; because the efforts they make are based on a very narrow set of possibilities. The investments they have access to, the education they must deliver, the plan tools they must work with and explain, all are based on one thing; technology. That is the real problem with America’s 401k system, its technology.

Neil: What do you mean by that? People everywhere can go online to access their retirement plan, they have things like retirement calculators, where’s the problem?

Darwin: Sure they can do those things, but just barely. Retirement plans are one of the only aspects of our modern life that has not evolved technologically. The recordkeeping systems in place, the backbone of our industry, the technology, programming language and the like, at the core of nearly every major service provider; were developed back in the 1970’s.

Neil: Explain what you mean by that a little further:

Darwin: This is why plans have so many limitations, there are so very few meaningful changes made to improve things on a large scale, mainly because it just can’t happen at any realistic pace, large scale changes are unbelievably expensive. Can you even think of the last big change to hit your retirement plan? The last big thing that made the process a little easier? A website perhaps? That was significant in the 1990’s, what has happened since?

People have been using the same types of funds, relying on the same types of education and using the same types of plan tools for decades; because they had to! The industry as a whole has been held hostage by its dated technology for too long. And real change won’t come until that backbone is replaced by something modern. Think about your iPhone®, look at what has happened when the technology emerged to make “Apps” available, think about how much you can do now, how much easier things are. You can bet that Apple’s not accomplishing that by sticking with a decades old infrastructure.

Neil: Darwin, people may have a hard time wrapping their head around what you’ve just said, can you give a real life example?

Darwin: An example that comes to mind is with someone I recently spoke to who had their 401k plan with a large life insurance company. They actually had to print and fill out a form, then take that physical form to their HR department, just to get their contribution rate changed! Then think about your retirement calculator, you have to enter all of your own information in, the calculator has no ability to do that for you! Entering your age is not a difficult task, entering the return you anticipate from your investment portfolio is. The quality of the information coming out of retirement calculators is only as good as the information going in; and that information depends on the average person trying to turn themselves into an investment expert to perform all the manual tasks their technology should just perform for them.

The large 401(k) providers are all using legacy software that was developed 20 to 30 years ago before participant directed plans existed. This software is licensed, not owned and developed by the providers. Therefore, they do not have the advantage of designing software for participant directed plans that can use the latest investment options like ETFs or the latest Microsoft software.

Neil: Aside from the many benefits new technology would make available to people using 401k plans, what benefits would new technology offer major service providers who offer 401k plans?

Darwin: Well, new record-keeping technology for major service providers achieves three major goals that every business strives for; to decrease overhead, decreased errors, and increase revenues. The time savings and countless efficiencies will be crucial to remaining competitive in tomorrow’s 401k landscape. Providers should see this as a time for action, the longer you wait, the more behind you’ll be, the more expensive your inevitable transition will become.

Disclaimer: Invest n Retire, LLC does not provide tax‚ accounting‚ legal‚ or financial planning services or advice. Information provided is offered only for general information and education purposes and should not be used as the sole basis for making financial‚ investment‚ or retirement planning decisions. Past performance is not a guarantee of future performance. If you have specific questions you should consult with your advisors.

The Derivative Scare: Fear Mutual Funds, not ETFs

By Neil Plein
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A large, fundamentally false debate has been raging over allegations that Exchange Traded Funds (ETFs) are “derivative” investments; a term steeped in negative press and generally associated with high-risk investing. For this reason, many claim that ETFs are not suitable for your retirement plan, so instead, they advocate the continued use of mutual funds.

Unfortunately, the claim that all ETFs are derivatives is simply false. This is like saying all stocks are energy stocks, when the reality is, only some stocks are energy stocks. The same logic holds true for ETFs. To understand this, you must examine what a derivative is and what is really meant when something is labeled a “derivative.”

According to a recent Security and Exchange Commission (SEC) “Fact Sheet” a derivative is defined as: “a type of financial instrument whose value is derived from another underlying product, include such things as futures, certain options, options on futures, and swaps. A common characteristic of most derivatives, which are among a panoply of investments that a fund may make in managing its portfolio, is that they involve leverage.”

Leverage Remember that last word, “leverage.” Now let’s look at an example to help clarify the SEC’s definition of a derivative. Think of a farmer who grows corn. If you walked up to the farmer and bought an ear of corn from him, you would give the farmer some money and he would give you an ear of corn- transaction completed.

If instead, you approached the farmer and wanted to buy that same corn next year, but only wanted to pay today’s price because you think corn will be more expensive in the future;  you and the farmer (who thinks the price will be less next year) would enter into a contract “derived” from the actual corn.

You would give the farmer some small amount of money for the contractual right to buy the corn in the future at today’s price. If you’re right and the price of corn goes up a little, you have created leverage; your small investment has increased many times in value as a result of only a small change in the price of the corn it is derived from:

Derivative Example



Price of corn on January 1st


Price you pay for contract with farmer




Price of corn on March 1st

$105 (5% increase)

Value of contract on March 1st

$5 (500% increase)

Some ETFs are Derivatives ETFs that are priced based on the value of underlying derivatives do exist. This type of ETF represents an opportunity to profit in the same manner the buyer of the contract for corn profited. With an ETF derivative an investor may reap substantial gains or losses as a result of investing in the derivative portion of the corn contract, which changes radically, rather than investing in the actual corn itself, which changes far less radically by comparison (5% vs. 500% outlined above).

This is the distinction between an ETF being classified as a “derivative” or not- the underlying item; in this case the underlying item is “corn” or “contract.” The ETF itself is not the derivative. In a mutual fund, just as in a non-derivative ETF of say, the S&P 500, you own actual shares in 500 companies; not derivatives of those shares; actual shares.

If the ETF itself were defined as a derivative solely on the basis that it derives its value from another underlying product, then a mutual fund would be considered a derivative as well. But, the fact is, mutual funds are not considered derivatives so ETFs, which invest in a basket of securities, are not derivatives.

ETFs in Retirement Plans I do agree that derivative-based ETFs should be avoided in retirement plans. This conclusion is a no brainer since derivative based ETFs can create a potentially devastating effect, even from owning a very small amount; as their leveraging capabilities can have an exponentially magnified negative effect on the value of the fund as a whole.

On the other hand, including non-derivative based ETFs like (VOO, AGG, VEA) in the investment menu of a retirement plan is a positive step forward. ETFs benefit participants through low cost and improved performance, on average, when compared to actively managed mutual funds.

Raising Awareness Mutual fund proponents raised the bar in making derivatives a topic of concern in retirement plans. Unfortunately, this awareness has taken a wrong turn in misinformation concerning ETFs as a whole, to the point of stating that all ETFs should be avoided.

This misinformation is compounded by the fact that mutual funds also use derivatives. In fact, a recent study presented the top 3 mutual funds in 401(k) plans, all of which use derivatives as underlying investment options. If derivatives should be avoided in retirement plans, buy an ETF of the benchmark index for each mutual fund listed below:

Top 3 Mutual Funds in 401(k) Plans

Source: BrightScope study of over 50,000 plans released 10/3/10

Fund name


Benchmark ETF

American Funds Growth Fund of America (AGTHX)


(VOO) – No Derivatives

Pimco Total Return (PTTAX)


(AGG) – No Derivatives

American Funds EuroPacific Growth Fund (AEPGX)


(VEA) – No Derivatives

Disclaimer: Invest n Retire, LLC does not provide tax‚ accounting‚legal‚ or financial planning services or advice. Information provided is offered only for general information and education purposes and should not be used as the sole basis for making financial‚ investment‚ or retirement planning decisions. Past performance is not a guarantee of future performance. If you have specific questions you should consult with your advisors.