Is Your 403(b) And Roth IRA Retirement Investing Supporting Predatory Lenders?

When I talk to prospects and clients about retirement investing, no one usually thinks about what companies are inside their portfolio. They often have a shocked reaction thinking that they might be making money on the backs of the unfortunate prey of predatory lenders. Research provider YourStake defines predatory lending as “Companies that have received 25 or more Consumer Financial Protection Bureau complaints for predatory lending complaints, including payday loans, installment loans, pawn loans, title loans, tax refund anticipation loans, personal lines of credit, and check cashing, over the last 3 years”. In this article, we break down how this can happen and offer guidance on making smarter, values-aligned choices for your retirement investing.

What Is Retirement Investing?

Retirement investing refers to the strategies and tools used to build a nest egg that can support you once you stop working. Common vehicles include employer-sponsored plans like 401(k) and 403(B) plans, as well as individual accounts such as Roth IRAs and rollover IRAs.

Many investors choose mutual funds or target date funds within these accounts. While these funds are managed by reputable companies like Vanguard, Fidelity, and T. Rowe Price, the underlying research and investment selections may not always align with your personal values. The way an index fund may be created might include companies that generate significant revenue from predatory lending practices.

How predatory lending can slip inside of your investing?

The majority of people find themselves investing for their retirement, inside of mutual funds through their employer sponsored retirement plans. These plans can take the form of 401(k), 403(b), SEP IRA and others. In these plans, your employer facilitates the saving and investing by coordinating with a payroll company, custodian, and investment provider. Often employers hire a financial advisor (either a registered representative or an investment advisor representative). Often times, well-meaning employers will reach out to directly investment companies like Vanguard and Fidelity, foregoing a financial professional. They often pick investment companies known for their brand names as mutual fund providers. While this should cut costs to the employee, it exposes the company and its fiduciaries to unshared or distributed risk with a professional fiduciary.

They typically select funds from well-known companies based on cost efficiency without consideration for ethical research. As a result, funds that replicate broad market indexes without thorough screening can include companies that benefit from predatory lending practices.

I recently worked with an economic justice non-profit that specifically focuses on eliminating anti-predatory lending. In fact, they have fought for legislation that has helped either eliminate or reduce the impact of predatory lenders. When I started working with them, they proudly said that they were working with Vanguard through a direct relationship. Typically, most employers pick the target date mutual funds of the investment provider that they work with. This company had done the same. While many people exalt, the value of reducing the fees inside of investments, they don’t have the investment research to question whether or not that is actually the best option (see my fee adjusted returns article).

This organization, that proudly partnered with Vanguard due to its low fees, discovered that their investments inadvertently included companies benefiting from predatory lending. This raised serious questions about the real cost of chasing lower fees without understanding what lies behind the index funds.

In their pursuit for looking out for they employees, this organization had unknowingly allowed predatory lenders to slip into their investments, compromising their own mission statement.

How does that happen?

Unlike companies like Fidelity and T Rowe Price, Vanguard is in the business of replicating research that it gets from other research providers. For example, the often referenced S&P 500 simply is research from Standard and Poors. They take all of the publicly traded companies across the world and do various analysis. The S&P 500 is one of the most basic. It simply is the largest by market capitalization 500 companies in the United States. It doesn’t question what business or businesses these companies are involved in. It simply rank orders them by size.

As you might expect, there are companies that have a substantial amount of their business derived from predatory lending. That doesn’t mean that their company name includes the words predatory lending. In fact, I’ve yet to find someone who has actually investigated what they’re actually invested in. The Vanguard target mutual fund series link is here.

The As You Sow Invest Your Values 401k website rates target mutual funds. If you go to the page where the subheading is, you’ll see that index funds usually get an F grade as they don’t have built in exclusions in their prospectus. Non excluding companies on the basis of not fitting a social criteria doesn’t necessarily mean that you’re gonna make any more money. Fidelity and T. Rowe Price for example, do not follow Vanguard‘s lead. They spend time and research deciding which companies to include and not to include in their investments. This is known as active investing.

The MSCI KLD index is an index that has been combed for certain values. You can find more information on it here along with its methodology. iShares makes it possible to invest in this index.

Understanding 403(B) and Roth IRA Options

Many employees participate in 403(B) plans, especially those working in education, healthcare, or non-profit sectors. A 403(B) is similar to a 401(k) but is tailored to certain organizations. The investment options available within a 403(B) might mirror those in a 401(k), including mutual funds and target date funds. However, if the chosen fund does not screen out companies engaged in predatory practices, you could be supporting business models that are not in line with your values.

Similarly, a Roth IRA is an individual retirement account where contributions are made with after-tax dollars. The money in a Roth IRA grows tax-free, and qualified withdrawals in retirement are also tax-free. Because Roth IRAs are typically self-directed, investors have the flexibility to choose funds that align with their ethical standards. You might decide to invest in funds that consciously avoid companies with ties to predatory lending practices.

Is it necessary to invest in predatory lenders to make money?

First, I compare the Russell 1000 index versus the MSCI KLD index and a custom developed index based on excluding predatory lenders (YourStake Anti-predatory). You can quickly see the substantially better values adjusted returns for the KLD and the Anti-predatory, lending custom index from YourStake.

What about the effect on returns?

You see that the Anti-Predatory did the best with the Russell 1000 slightly besting the KLD. In this case, YourStake considered companies from the MSCI All Country World Index (ACWI). The MSCI ACWI captures 2,647 large and mid-cap representations across 23 Developed Markets (DM) and 24 Emerging Markets (EM) countries. The Russell 1000 only considers the largest 1000 US Companies and the MSCI KLD extracts 400 companies from 2,312 US Companies (MSCI USA IMI)^*.

While companies most often look for a qualified default investment alternative (QDIA) to aid their employees and investing for retirement, there are more choices than simply the target date mutual fund. I prefer asset allocation funds or balance funds. Asset allocation funds align to a specified static combination of stocks and bonds. For example, 65% stock and 35% bond. Balanced funds typically have a 60% stock and 40% bond and significantly pre-date the target date fund.

Making Smarter Choices for Your Retirement

So, what should you do if you’re concerned about the potential inclusion of predatory lending in your retirement investments? Here are a few practical steps:

1. Review Your Funds:
   Research companies like The American Friends Service Committee and As You Sow allow you to screen for certain values. Look for any mention of screening criteria related to social concerns like predatory lending.
2. Consult with a Trusted Financial Advisor:
   It is vital to work with a financial advisor who understands both your financial needs and your ethical concerns. You could also look for advisors with this focus and that have access to research such as that from YourStake. InvestmentNews is even capturing an ESG Advisor in its Advisor of the Year Categories. First Affirmative is another network of advisors aligned with this practice.
3. Leverage Self-Directed Accounts:
   If you have a Roth IRA or a rollover IRA, consider choosing funds or individual stocks that match your ethical standards. Self-directed accounts give you more control over your investment choices. It can be the reason you decide to rollover an old 401(k) or 403(b).

Concluding thoughts on predatory lending and retirement investing

It’s much easier to exclude predatory lending from your retirement investing if your retirement money is in a rollover IRA or Roth IRA. If you are an employer selecting investments for your employees, you should be thinking about whether or not predatory lending might have you seen by your employees negatively. This and many other issues may push your employees not to invest at all.

Retirement investing should be about more than just chasing returns—it’s about building a secure future that also reflects your personal values. By taking a closer look at the funds in your portfolio, you can avoid unknowingly supporting companies engaged in predatory lending. Whether you’re saving in a 403(B), a Roth IRA, or a 401(k), make sure you understand where your money is going and the research behind those investments.

If you’re a employer, a retirement plan is to be for the benefit of the employee. Forcing them into something that goes against their interests and beliefs does not completely keep their interest in mind. I believe you owe it to your employees to at least consider issues like predatory lending in the decision-making process of your investment menu. This is especially true if you are an organization like the one discussed earlier, where your charter may have a social aim.

With careful research and the right guidance, you can build a portfolio that not only grows your wealth but also stays true to your values. In the end, a well-considered approach to retirement investing will provide you with financial security and peace of mind for years to come.

_{*The performance of the YSO hypothetical lookback is hypothetical and doesn’t guarantee any future results.}

_{*The YSO portfolio returns are presented without considering fees, whereas the funds would have expense ratios.}

_{*Comparing individual securities vs. funds in a portfolio snapshot is subject to “survivorship bias”. For example, any company that was dropped from the index [e.g. going bankrupt] wouldn’t show up in the optimized portfolio, but it did play a role in bringing down the historical performance of an index fund that held it at the time.}