I recently was on national TV discussing 401(k) plans and my new book, The Smartest 401(k) Book You'll Ever Read. The producer of the segment wanted some controversy so she had an investment advisor appear with me.
The investment advisor recommended that employees select only actively managed funds in their 401(k) plans and use "independent advisors" (like him) to help them with their selections.
Most investors follow this advice.
How is this working for them?
In one study (that Wall Street really does not want you to know about) the authors looked at the performance of 2100 mutual funds from 1975-2006. How many of the fund managers of these actively managed funds exhibited an ability to outperform the markets? 0.6%, which is statistically the same as zero!
Why then do investors continue to flock to these funds? The authors of the study accurately conclude that "[P]erhaps a class of unsophisticated or inattentive investors remain shareholders in funds after they have clearly demonstrated (over time) their inferior returns."
Another study demonstrates the consequences of following the advice of brokers and advisors who push actively managed funds on their trusting clients.
The highly respected research firm, Dalbar, Inc., periodically takes a look at how investors have fared with their mutual fund investments. In its latest report, Dalbar examined actual investor returns for the twenty year period ending December 31, 2007. The results were not pretty.
The average equity investor earned a paltry annualized return of 4.48%, barely outpacing inflation, and underperforming the S&P 500 index by a whopping 7%!
The lessons to be learned from these two studies are clear: Avoid hyperactively managed funds and the brokers and financial advisors who tout them. Focus on your asset allocation and invest in a globally diversified portfolio of low cost index funds or Exchange Traded Funds.
There is just once catch. The securities industry, with the help of compliant employers, has rigged the 401(k) system (which has over $6 trillion in assets), so that following this advice is difficult, if not impossible. Most 401(k) plans have a confusing array of underperforming hyperactively managed funds and few, if any, index funds.
The expense ratio of the funds offered to plan participants is as much as 800% higher than the cost of index funds. You can do the math. By confining choices to hyperactively managed funds, the mutual fund industry profits handsomely at your expense.
Outside of your 401(k) or 403(b) plan, you have a choice. Be sure to make the right one.
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