It's ironic that we designate April as "financial literacy month." I am reminded of Morgan Freeman's sage comments about "Black History Month": "You're going to relegate my history to a month? I don't want a black history month. Black history is American history."
I agree. I don't want a "financial literacy month." Improving your financial literacy should be an ongoing process. It's a process made all the more difficult by the financial services industry, which has a huge economic interest in keeping you financially illiterate.
The depths of financial illiteracy run deep. It pervades Main Street and the halls of the biggest pension plans in the U.S.
I was recently asked to review the performance of a large pension plan administered for the benefit of employees of a major city located on the East Coast. Over the previous decade, it has significantly underperformed an index benchmark of 60 percent stock and 40 percent bonds. Participants in the plan would have had an extra $150 million if the plan administrators fired their consultant and all their active managers, and invested in index funds.
How did the plan administrators react to this news? They didn't quarrel with the data, but they circled the wagons and defended their investment strategy. The endless cycle of hiring active managers based on past performance and firing them when their performance does not persist continues unabated.
It's worse on Main Street. The evidence is irrefutable that active investors are unlikely to consistently "beat the market" over long periods of time, except by chance. Yet, the mutual fund industry continues to thrive with thousands of active fund managers picking stocks and timing the markets.
According to Standard & Poor's Indices Versus Active Scorecard for the year-end 2012, most active managers, in all categories, underperformed their respective benchmarks in 2012. This dismal performance persisted over the five-year period ending December 2012.
On the fixed income side, while 2012 was a better year for actively managed bond funds, actively managed bond funds in almost every category underperformed their benchmarks over the five-year period.
A number of funds liquidated or merged over the past years, including a startling 27 percent of domestic stock funds.
You can learn a lot from the worst performing funds. 90 percent of U.S. mid-cap funds and 95 percent of investment-grade long fixed income funds failed to beat their index for the five years ending December 2012. Presumably the managers of these funds were well educated and highly skilled. If their track record is so pathetic, do you really believe you and your broker can do better?
The importance of this data is clear to all who choose to pay attention to it: After accounting for management fees, trading costs and other expenses, active managers as a group cannot outperform the market.
Your financial literacy begins with an appreciation of this irrefutable data. It provides you with a clearly defined action plan: Dump your broker or adviser who claims to be able to "beat the market." He is more likely to "beat" you by insuring his retirement at the expense of yours.
7 Steps to Save Your Financial Life Now is available on Amazon, B&N, and iTunes. Dan Solin is the director of investor advocacy for The BAM ALLIANCE and a wealth advisor with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information, and content on this blog is for information purposes only and should not be construed as an offer of advisory services.
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