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The High-Cost, Index-Fund 401(k)

On the heels of Schwab’s recent announcement touting the success of their index-only 401(k) service — which garnered $4 billion of new assets in 12 months — one blogger takes issue with some of their claims. Felix Salmon of Seeking Alpha [free registration required] points out that while index funds are generally 50 BPs lower than actively managed funds, the Schwab service includes an automatically enrolled advice service costing 45 BPs which practically wipes out any savings.

So does the advice benefit participants? Schwab touted statistics that there was 90% uptake in advice service for the new product, and 70% of those who received and implemented advice doubled their deferral rates, from 5% to 10%.

Sounds good, right? Except that according to Salmon, the statistics on participants who doubled deferral rates were from older plans where participants had to opt in — only about 4% — which is further reduced by the qualifier “implemented” the advice. Salmon asks: Aren’t people seeking advice more inclined to increase deferrals anyway?

There’s no doubt that the use of index or passive funds is growing and warranted in many cases, and that it’s becoming harder for actively managed funds to beat their benchmark, justifying the higher expense ratios. But before we throw the baby out with the bathwater, we need good data, especially for relatively unsophisticated investors in 401(k) plans. Is the type of individual advice offered in the Schwab service better than hiring an active fund manager? Seems logical — but let’s make sure we have all the facts before we jump to conclusions.

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