Let me start with the obvious (or what should be obvious, but isn't):
1. Retirement plans of all stripes should have only index funds or passively managed funds as investment options. There should be no actively managed funds (where the fund manager attempts to beat a designated benchmark).
2. Advisors to these plans should be 3(38) ERISA fiduciaries, which requires them to accept in writing 100 percent of the liability for the selection and monitoring of the investment options in the plan. This requirement eliminates all brokers and insurance companies. They accept "revenue sharing payments" from mutual funds as the cost of admission to the list of plan options. Legally, they cannot be 3(38) fiduciaries.
3. Acceptance of items 1 and 2 above is not going to happen in 99 percent of the retirement plans in this country, to the great detriment of plan participants.
The evidence that passive trumps active is so overwhelming you have to marvel at the ability of the securities industry to persuade plan administrators to ignore it. One study looked at the performance of 2,100 actively managed funds over a 31 year period. The highly credentialed authors of this independent study concluded that only 0.6 percent of the fund managers studied had genuine stock picking ability -- a number which is statistically indistinguishable from zero.
Nobel Laureates William Sharpe, Merton Miller, Daniel Kahneman, Paul Samuelson and Harry Markowitz all reached the same conclusion. So did authors of many financial books, including William Bernstein, Allan Roth, Burton Malkiel, John Bogle, David Swensen, Larry Swedroe, Mark Hebner, Jason Zweig and many others. Malkiel said it best:
It's like giving up a belief in Santa Claus. Even though you know Santa Claus doesn't exist, you kind of cling to that belief. I'm not saying that this is a scam. They generally believe they can do it. The evidence is, however, that they can't.
The explanation for why plan administrators continue to punish participants by investing in actively managed funds may be found in a 1998 PriceWaterhouseCoopers study, which concluded:
...even as better information on indexing becomes available, emotional factors may continue to constrain the growth of indexing. Many institutional fund managers feel driven to beat the market, even while recognizing the arguments in favor of indexing.
My personal experience in presenting passively managed options to CFO's and Human Resource Departments validates this conclusion. They are either unaware of this data or choose to ignore it. The cost to plan participants of their ignorance is substantial. One study found that investing in actively managed funds rather than passively managed ones costs investors $80 billion a year. It's no wonder many are predicting a "retirement tsunami" as baby boomers confront their diminished 401(k) plan balances and wonder whether they will ever be able to stop working.
The "Arab Spring" might be a lesson for 401(k) participants. They need to familiarize themselves with the data and demand a fundamental change in the way their retirement plans are being managed. It's time to stop the gravy train for mutual funds, brokers and "market beating" advisers and focus on the needs of plan participants.
I am not suggesting demonstrations in the street (yet!), but participants need to educate themselves, organize, sign petitions and insist on retirement plans consistent with sound, academically based investment practices. Leaving these decisions up to your plan administrators simply is not working.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.