By Pam Martens and Russ Martens: May 11, 2016
A new report from the Government Accountability Office (GAO), the nonpartisan investigative arm of Congress, shows that Black workers experienced devastating declines in their defined contribution plan balances (mostly 401(k) plans) between 2007 and 2013 – an experience not shared by White workers.
According to the GAO, Black working households’ median 401(k) balance declined by a stunning 47 percent between 2007 to 2013, the latest date for which data is available. The median balance for Black working households in 2007 stood at $31,100 versus $16,400 in 2013. To put that 47 percent decline into sharper focus, the GAO found that the 401(k) balance for White working households “did not change significantly over the same period.”
That isn’t actually good news for White workers either since they were likely making regular contributions to their 401(k) plans while the account value went nowhere.
Unfortunately, the GAO report leaves one to draw their own conclusion as to precisely why Blacks experienced this devastating hit to their wealth during the financial crisis years of 2007 through 2009 and its aftermath into 2013. The GAO drops only hints as to what might have happened.
One hint is that Black working households likely experienced greater levels of unemployment during the financial crisis years and had to take loans from their 401(k) plans. The report found that 15 percent of Black working households took loans in 2010, compared to 9 percent of White working households.
The GAO also cited an Ariel/Aon Hewitt study in 2012 that found that 63 percent of Black workers (versus 39 percent of White workers) cashed out their 401(k) plan when they left their job, rather than rolling it over into an IRA.
Another possibility that we came up with is that from peak to trough, the Standard and Poor’s 500 index of stocks declined a devastating 56.8 percent from October 9, 2007 to March 9, 2009. Many investors will sell out when their account value loses half of its value, fearing they will lose it all if they stand pat.
Based on our own research, most workers, regardless of race or ethnic background, do not understand or appreciate the compounding impact of holding financial assets in a tax-deferred plan over a working lifetime. If they did, they would certainly grab those 401(k) funds in their old plan when they leave a job and roll them into their own IRA to continue that tax-deferred compounding for the remainder of their working life. Only when funds are withdrawn from the 401(k) or IRA are they taxed. The ideal plan is to allow the assets to compound without taxes eroding the growth until the worker retires and begins withdrawals to supplement income in retirement, when he or she will likely be in a lower tax bracket.
The self-directed IRA, where the employee can avoid the stock market if they don’t have the stomach for that roller-coaster, can be moved to an FDIC insured community bank where insured investments like Certificates of Deposit with staggered maturities can be selected for those seeking safety.
Unfortunately for all workers, the 401(k) has been turned into a wealth transfer system for Wall Street. In 2013 the PBS program, Frontline, brilliantly dissected what is actually going on behind the dark curtain of the typical 401(k) plan. Frontline investigators confirmed that if you work for 50 years and receive a long-term return of 7 percent on your 401(k) plan and your fees are 2 percent, almost two-thirds of your account will go to Wall Street.
The Frontline program, The Retirement Gamble (which can be viewed here) was written by the outstanding team of Martin Smith and Marcela Gaviria. Smith interviewed John Bogle, founder of The Vanguard Group, which is known for its low fee index mutual funds. Bogle is something of a brain trust when it comes to investing. He was Chairman and CEO of Vanguard from 1974 to 1996 and graduated magna cum laude from Princeton University with a degree in Economics.
A key portion of the exchange between Bogle and Smith went like this:
Bogle: Costs are a crucial part of the equation. It doesn’t take a genius to know that the bigger the profit of the management company, the smaller the profit that investors get. The money managers always want more, and that’s natural enough in most businesses, but it’s not right for this business.
Smith: Bogle gave me an example. Assume you’re invested in a fund that is earning a gross annual return of 7 percent. They charge you a 2 percent annual fee. Over 50 years, the difference between your net of 5 percent — the red line — and what you would have made without fees — the green line — is staggering. Bogle says you’ve lost almost two thirds of what you would have had.
Bogle: What happens in the fund business is the magic of compound returns is overwhelmed by the tyranny of compounding costs. It’s a mathematical fact. There’s no getting around it. The fact that we don’t look at it— too bad for us.
Smith: What I have a hard time understanding is that 2 percent fee that I might pay to an actively managed mutual fund is going to really have a great impact on my future retirement savings.
Bogle: Well, you have to rely on somebody to get out a compound interest table and look at the impact over an investment lifetime. Do you really want to invest in a system where you put up 100 percent of the capital, you the mutual fund shareholder, you take 100 percent of the risk and you get 30 percent of the return?
We did just what Bogle suggested. We pulled up a compounding calculator on line. Here’s how we checked the math: Take an account with a $100,000 balance and compound it at 7 percent for 50 years. That gives you a return of $3,278,041.36. Now change the calculation to a 5 percent return (reduced by the 2 percent annual fee) for the same $100,000 over the same 50 years. That delivers a return of $1,211,938.32. That’s a difference of $2,066,103.04 – the same 63 percent reduction in value that Smith’s example showed.
Not all mutual funds, of course, charge 2 percent fees. Some charge a lot more and some charge less. Passively managed index funds charge the least. Unfortunately, most workers are ill-equipped to sleuth out the seen and unseen fees embedded in their 401(k) investment choices.
There is now more than ample evidence that we have a retirement crisis in the U.S. There is also more than ample evidence that Wall Street will continue to loot Main Street until we have a meaningful political revolution in this country.