Empire of the Fund: The Way We Save Now

William Birdthistle is professor of law at Chicago-Kent College of Law. This post relates to a new book authored by Professor Birdthistle.

In my book, Empire of the Fund: The Way We Save Now, just published by Oxford University Press, I examine the challenges to our new system of individual investing. More pointedly, the book is an attempt to consider the possible consequences of a failure of our large national experiment with personal finances.

Over the past thirty years, the decline of defined benefit pensions and the rise of defined contribution plans has directed trillions of dollars into the hands of investing amateurs. The implicit hypothesis of our experiment has been that ordinary citizens can successfully manage 401(k) plans and IRAs to provide for their future needs and retirements—but the evidence we have so far suggests otherwise. In the book, I worry about the inadequacies of our new system of investing and suggest possible ways to improve our individual and collective prospects.

So, are we failing? Yes, it would seem so. Two statistics are particularly startling: first, one-third of Americans have zero in retirement savings; second, the median amount in the retirement accounts of fifty-five to sixty-four-year-olds (that is, those on the cusp of retirement) is $111,000. As large as that six-figure sum might appear, when amortized across the average twenty-year retirement window, it amounts to just $7,300 each year. For the next fifteen years or so, ten thousand baby boomers will retire every day, so America may feel the pressure of insufficient funds very soon.

What is causing these shortfalls? In the book, I discuss three impediments to successful saving, focusing particularly on the most popular instruments for personal investing: mutual funds and their $16 trillion. First, the structure of mutual funds privileges asset accumulation over investment success by remunerating investment advisers on the basis of assets under management. Second, the 90 million Americans attempting to negotiate mutual funds generally lack the training and the time to forecast their economic requirements decades into the future, to set aside income today that they will need for the years ahead, and to calculate the investment options that will provide them with the best mix of risk and reward to reach those goals. Third, our counterparties in the investing world do not always behave themselves, and several chapters in the book catalog the variety of malfeasance in mutual funds over the past decade from market timing to late trading to unfair valuation and more.

So if the way we save now is flawed, how can we fix it? One approach is to focus on filling our retirement bucket by enhancing and escalating default settings so that we increase the amount we contribute to our savings. I think those efforts, by Sunstein, Thaler, and others, are admirable and important. My approach, though, focuses more upon mending the leaks in our bucket.

First, I propose opening the Thrift Savings Plan to all Americans. With an open TSP, the unemployed, the self-employed, those employed at small businesses, and anyone else who wishes, could participate in a system run by an excellent private adviser (BlackRock) at remarkably low rates (like the TSP’s astonishingly low 2.9 basis points). This plan would capitalize on the benefits of substantial bargaining power without requiring the government or employers to provide any financial guarantee (which often misjudges the ultimate burden). Some states, such as California, are exploring such a collective pool of their own (and multi-employer pools are possible but have been ineffective so far), but I believe the larger the pool, the better the economies of scale.

Second, I would encourage the SEC to bring an enforcement action against one or two funds with the most exorbitant fees. Although the critical importance of fees on mutual fund investing is widely understood, the SEC has only ever brought one or two cases against advisors for charging inordinate fees. Section 36 of the Investment Company Act gives the SEC and private plaintiffs a cause of action in these cases, but the SEC has largely ignored it. Private plaintiffs, on the other hand, often bring cases against the ill-suited defendants: large funds with deep pockets but relatively reasonable fees. A case by the SEC could police the outer bounds of those smaller funds charging the highest fees.

Third, I propose a financial licensing regime for any investors who wish to direct their 401(k) investments into funds that are not QDIAs (qualified default investment alternatives, such as large, diverse, passively managed funds). The objections to this proposal are obvious, and I attempt to address them. One, it’s too onerous, how dare the government limit anyone’s use of their money? I point out, however, that 401(k)s are voluntary plans by which the government provides a tax benefit, and they already impose lots of requirements. (An even stronger alternative would be to disallow actively managed funds from 401(k) plans altogether.) Two, it’s too weak, financial licensing simply won’t work. I argue that it has a good chance of working in this setting, since it would provide detailed guidance just as investors are about to manage their savings. At the very least, even a simple licensing regime would provide an in terrorem signal of the importance and dangers of personal investing. Three, it’s too much government. But, again, the entire 401(k) concept is a governmental construct, and this plan would at least provide a libertarian bulwark against investors who ask for a government bailout if our system leads to an investing disaster: anyone who chooses to get one of these financial licenses, then invests in actively managed funds and does poorly in them, will have waived their demand a post-hoc bailout from the government.

My largest concern is that if our system of defined contributions does fail, millions of Americans will suffer impoverished futures that will trigger severe individual and societal challenges for the United States.

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