Cost-Cutting Plans

Darwin Abrahamson has noticed a troubling trend among retirement plan providers: a significant portion of them only offer mutual funds and variable annuities as investing options in their 401(k)s and other qualified plans. The problem is obvious: Some 70% to 90% of a 401(k) plan’s cost is derived from its underlying investment options, he says, and we all know that mutual fund and VA fees aren’t cheap.

In fact, by using index funds and exchange-traded funds (ETFs) instead of mutual funds and VAs, plan providers can dramatically decrease the cost for participants, Abrahamson maintains. That’s why he started Invest n Retire, LLC (www.investnretire.com), a Web-based 401(k) service provider based in Portland, Oregon, so he could “use institutional investment options to cut the pricing way down” on qualified plans.

When Abrahamson launched Invest n Retire in 1998, he began using index funds offered by Dimensional Fund Advisors in Santa Monica, California, as well as ETFs by other providers on 401(k) Solution, his firm’s 401(k) platform. A year or so later, Abrahamson added Barclays’ collective trusts to the platform. At the time, Invest n Retire was “the only 401(k) recordkeeper that had a contract with Barclays,” he says. Collective trusts are created by banks and trust companies and are not approved by the Securities and Exchange Commis-sion. These types of investments “can only be sold to tax-deferred entities,” Abrahamson explains. The collective trusts were working wonderfully until Barclays came out with a better option: iShares. Abrahamson switched to iShares in 2003 because Barclays offered a “very limited” selection of collective trusts that weren’t valued daily. Unlike the collective trusts, iShares also covered all of the major indexes, allowing “advisors and consultants to build much more efficient asset allocation models,” he says. In early September, Invest n Retire added ETFs that are listed on Nasdaq and based on the Nasdaq index to its 401(k) platform and to its model portfolios.

Invest n Retire offers advisors a Web portal where they can build asset allocation models and benchmark those models every quarter “for fiduciary reporting to plan sponsors,” Abrahamson explains. The “hot thing” now in the qualified plan space is managed accounts, he says, which is “putting together portfolios for participants so they’re investing in portfolios and not choosing their own investing options.” Invest n Retire helps advisors and consultants build managed accounts, he says, and then includes them in Invest n Retire’s database. “With our asset allocation models, we are a much lower-cost alternative than paying an outside firm to build and manage managed accounts.”

By using Invest n Retire’s platform, advisors can also help plan sponsors remedy one of their biggest headaches: benchmarking funds within their 401(k) plans. Advisors can save sponsors a lot of time and money by working with Invest n Retire and using the investments the firm provides “because all of the investment options are the benchmarks,” Abrahamson says. “This cuts down on the cost to the plan sponsor because they’re not having to monitor all of their investment options.”

Another huge benefit to advisors is Invest n Retire’s online fee proposal system, which allows them to “show fiduciaries what they’re paying their current provider.” When Invest n Retire or an advisor puts together a portfolio of ETFs, the average cost is 30 to 35 basis points. That compares to the typical 150 basis points that’s charged for a portfolio of mutual funds, Abrahamson says. So the cost savings by using ETFs or index funds is staggering. For example, take a manager of a mutual fund who gets 10% of the gross performance of the fund, and an index fund that gets the same 10% of the fund’s gross performance, Abrahamson says. “The active fund may have an expense ratio of 2%, which will mean that the return will be 8% after all of the fees and commissions come off the gross return,” he says. With an index fund “where the expense ratio is 10 basis points, we’ll end up with a return of 9.9% compared to the 8% net return.”