For years there has been one lament heard throughout the defined contribution and 401(k) plan industry: plan participants are poor investors!

No wonder a few startup firms are catching the interest of the industry. A list of the usual defined contribution plan providers reads like a who's who of the conservative of the nation's conservative financial services industry. Yet, the firms capturing the interest of the market are Silicon Valley startups featuring everything out of the myth: venture capital funding, massive losses with little revenues, an unproven business model, and CEOs lacking the grey hair found in other industries. This mix of conservative financial services institutions and startups with corporate curriculum vitae shorter than a kindergartener's is where the future of the industry might be found.

First, a little history.

The Players

401kForum Based in San Francisco and now reorganized as a unit of Emergent Advisors. The firm is located in the SOMA district of San Francisco -- an area associated with hot dot com firms. Its founder, Drake Mosier, came from Smith Barney where he was familiar with the broker's "TRAK" program. Ted Benna, widely noted as the "father" of 401(k) sits on the company's board.

Financial Engines A prototype Silicon Valley tech startup of the Nineties. Located in Palo Alto just down the road from Stanford University and the offices of Profs William Sharpe and Joseph Grundfest. The pair reportely hatched the concept for the idea in a Stanford cafeteria. CEO Jeff Maggioncalda is a twenty-something with a Stanford MBA. The company also boasts a high profile board featuring Olena Berg Lacy, who formerly headed the PWBA.

Rational Investors Founded by Francois Gadenne and Ben Williams. CEO Gadenne hails from BankBoston and Arthur D. Little where he was team leader of the group that developed a weather forecasting expert system for NASA following the loss of the Challenger space shuttle. Williams, programmer, developed the DOS memory extender in his previous job. The pair sold the Rational to Standard & Poor's, a unit of McGraw-Hill, this year.

Ibbotson Associates Founded by Yale professor Roger Ibbotson, the Chicago-based firm has a long track record as a consultant to the pension and investment community. First moved into the advice market as the developer of the advice model for TCW. Has since provided its capabilities to education firms including Weisenberger and Newkirk.

The Rest of the Field TeamVest A Charlotte, NC-based administrator and recordkeeper serving the small plan market and founded by executives from TrustMark. Recently formed an alliance with Intuit to provide advice through Web portals. Investment Technologies A New York-based firm founded by Brian Rom in 1986. IT announced its entry into the 401(k) advice area in 1998. DirectAdvice A Hartford, CT-based startup that initially targeted the retail investor as Mentum. It has raised money from Japanese investor SoftBank Group and is said to be eyeing the 401(k) market. It is also rumored to be working with E*Trade, which has also raised money from SoftBank. AdvisorNet, LLC Owned by Chicago-based Marquette Associates this service was announced at the end of 1998.

The advice firms are basing their business on a simple premise: technology -- specifically the Internet -- now allows the efficient distribution of top-quality investment advice to the average average individual with an account balance in the low tens of thousands of dollars, or less.

Taking the idea one step further, these firms targeted the defined contribution system as the ideal market into which to launch the advice concept. Unlike the retail advice business in which customers would have to be won over one at a time in what amounts to expensive trench warfare, the retirement plan industry held out the promise of a relatively quick sale to the plan sponsor (think strategic bombing). The plan sponsor would then act as the distributor of the advice to its employees.

For revenues, the advisors' business plans typically called for payments based on the number of participants in the plan. Usually, the hoped for fee landed somewhere in the $30 to $50 dollar range.

Through 1996 an 1997 the first wave of advice firms built their business based on these ideas. The two leaders down this path were Financial Engines and 401k Forum.

On the East Coast Rational Investors was working on a similar product with a different distribution twist. Rational's plan called on selling its product to bundled 401(k) providers rather than directly to the plan sponsor.

Meanwhile, Trust Company of the West (TCW) took a third path. The investment manager applied for and received a profit transaction exemption from the Department of Labor to provide advice to 401(k) participants. TCW's model was to offer a series of seven asset allocation funds to plan sponsors. TCW would then use a model developed by an independent advisor (Ibbotson Associates) to direct participants to one of those investment options that best fit their needs. Unlike the other firms, TCW would be paid an asset-based fee from the funds.

In November of 1997, Fidelity helped kick off the excitement over advice when FIRSco head Bob Reynolds held a press conference in New York City to introduce the concept to the media. Fidelity was careful to stress, though, that Portfolio Planner was not technically advice even though it picked specific funds for participants. Think of Fidelity's product as "aggressive education." 

Fidelity's announcement both put advice on the map as a must-consider feature of plan design. At the same time it had the effect of freezing the market as rivals waited to see the DoL's reactions to Fidelity's step.  

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