A small business owner using a bundled service provider for his/her 401(k) plan is akin to a farmer letting the fox guard the henhouse. Pete Kirtland writes that bundled service providers “don’t always pick…funds for the right reasons. They might have profit motives that aren’t necessarily in the best interest of the participants.” Furthermore, Mr. Kirtland explains, bundled providers frequently require plan sponsors to choose funds from a pre-selected fund lineup. Such pre-selected funds may be relatively expensive compared to other funds, such as index funds and ETFs, available in an unbundled environment.
Although bundled service providers often appear to cost less (in fact, the vast majority of small business 401k plan sponsors with bundled service providers believe they pay no costs for the plan), the investment costs alone for funds in the bundled service environment may heavily outweigh the overall costs of unbundled services. Tom Lydon, citing a study by Deloitte and the Investment Company Institute, writes that “investment expenses make up 84% of a plan’s cost.” The long term effect of even small investment costs on the growth of a 401k account balance can be staggering. For example, investment costs of 1.5% annually on $10,000 invested per year over a 30 year period with a 6% annual rate of return would net an account balance of $600,071. Merely reducing the investment costs to 0.5% annually under the same circumstances would net an account balance of $714,355—an increase of $114,284.
You can read Pete Kirtland’s article here and Tom Lydon’s article here.
