Hip Hop and the Hidden Costs of Defined Contribution

Posted on June 1, 2015

Author Name By Steve Gordon

How Dr. Dre Exemplifies the Hidden Costs of Recordkeeping in Defined Contribution

Dr. Dre is often looked at as a pioneer. Legendary rapper, music producer and Founder of Aftermath Entertainment, the man born Andre Romelle Young is now 50 years old and worth an estimated $700 million dollars. Surely, this rough-and-tumble kid from Compton, California made a name through his music, but he sustained his wealth by means outside of the music industry that he’s so frequently associated with. Though many still assume that performance is his main breadwinner, Dr. Dre made much of his wealth with the popular line of speakers and headphones, Beats by Dre™. Before he sold the company to Apple, Dr. Dre’s income model was not unlike many Defined Contribution (DC) plan recordkeeping models:

  • Explicit Fees: Explicit fees would be similar to the money that Dr. Dre earned as a recording artist. These are plainly stated and well-known fees.
  • Proprietary Mutual Funds: This is a slightly hidden cost of recordkeeping, similar to artists crediting Dr. Dre in songs and other media to follow our analogy. Many people hear artists give Dr. Dre “shout-outs”, but few realize that he earns quite a great deal of money from these collaborations.
  • Proprietary Stable Funds: The above two points are pennies on the dollar compared to the amount of money Dr. Dre made with the Beats by Dre™ brand. Likewise, if a recordkeeper can get their Stable Value (SV) or General Account (GA) fund in the lineup, they have access to a significant percentage of the plan assets and the opportunity to earn huge multiples of what they would have earned otherwise.

Because of the lesser-known nature of SV and GA funds in particular (compared to Dr. Dre’s lesser known, but substantial income from Beats by Dre™), it is imperative that we evaluate providers in an “open architecture” environment. However, ensuring this transparent, open architecture environment may not always be as easy as it sounds. The incumbent, for example, can make assumptions that assets will be retained in proprietary SV or GA due to restrictions, politics or simple inertia. This will result in a bid that appears far more competitive than it actually is, comparatively. A couple of years ago, an incumbent provider for a public DC plan bid -5 basis points on their recordkeeping Request for Proposal (RFP), fully recognizing that they could generate excessive fees from their General Account and believing that the fund would not be removed for political reasons.

This is only one example of how venders can skew the facts and make it difficult for a Sponsor or procurement department to accurately compare competing offers. As a result, they often reward, or even hire, the vendor that most effectively hides their total fees! For this reason, Sponsors should never conduct an RFP for bundled recordkeeping without leveraging an advisor with extensive experience in conducting similar searches. Similarly, using the wrong advisor (one with brokerage associations or other conflicts of interest) could provide you with equally poor results.

More importantly, the inability to accurately understand fees and the value that will be delivered for those hidden costs not only rewards murky vendor practices, but forces participants to bear the ultimate cost of a poor process, adding up to substantial loss in savings over time and jeopardizing your ability to obtain a dignified retirement.