Taking Candy From Babies

08/05/2007 08:30 pm ET | Updated May 25, 2011

Get them while they are young. Every ad agency knows the value of a young demographic. They tend to be brand loyal for life. Now the securities industry is getting in on the act by offering mutual funds intended to "educate" young investors.

"We want a fund that teaches financial literacy," stated the president of Monetta Financial Services, which runs the Monetta Young Investors Fund (MYIFX).

This is a worthy goal. The stark reality is that parents of children are terrible investors, typically earning less than 50% of market returns that are easily achievable with index funds. Based on this dismal track record, most parents certainly cannot be entrusted with the important and oft-neglected task of educating their children about this important subject.

Unfortunately, the idea of having active fund managers "educate" young children about investing is much like allowing the fox to "educate" the hens.

Maybe we can turn the tables and educate the active managers of this particular fund about "financial literacy." Here are some questions I wish young children and their parents would ask them. I have some suggested answers for their consideration.

Q. In your prospectus, it says that "Under normal market conditions, the Fund seeks to exceed the total return of the Index by investing the remaining assets in individual stocks that the portfolio manager believes to have above average growth potential." I am confused. If you have the ability to beat the markets, why aren't you trying to do so with all of the assets invested in the fund instead of with just 50% of them?

A. Well, there is a limit on the amount of confidence we have in our ability to actually beat the markets.

Q. If I want to be assured of always achieving the returns of the S & P 500, less transaction costs, why wouldn't I be better off investing in a low cost, S & P 500 index fund?

A. Actually, you would.

Q. I see that the total annual operating expenses of your fund are 1.44%, which are reduced to 1.01% until the end of 2008, but could go up after that date. How do these expenses compare to investing in an S & P 500 index fund?

A. Very badly. You could buy the Vanguard 500 Index Fund (VFINX) and pay only 0.18% as the expense ratio.

Q. Wow. That seems like a big difference. Your fund is costing me more than 500% more than the comparable Vanguard Index Fund. What am I getting for my money?

A. In all likelihood, with us you are getting a fund that will underperform the Vanguard Index fund over the long term. In no small part, this is due to the fact that our costs are so much higher than the Vanguard fund.

Q. How about the short term? How does your more expensive fund compare to the Vanguard Index Fund?

A. Poorly. Year-to-date returns for our fund is 5.43%, compared to 6.88% for the Vanguard Index Fund.

Q. How have similar funds performed?

A. Very badly. The Columbia Young Investor fund was merged out of business in 2006. It had a dismal performance record. USAA First Start Growth is another expensive, underperforming fund.

Q. Why should I invest in any actively managed fund, including yours?

A. That's a really tough one. Over any long term period in the 80 years of available data, less than 5% of actively managed funds have been able to equal or exceed their benchmark. For example, the benchmark for my fund is the S & P 500 index. One study reviewed the performance of 1,446 large cap blend mutual funds, which are very similar to the Monetta Young Investors Fund. For the ten year period ending October, 2004, only 35 of them (2.4%!) outperformed the S & P 500 index.

On a positive note, I applaud efforts to educate young people about investing.

It isn't realistic to expect kids to digest the hundreds of academic studies by Nobel Prize winners. Or to heed the advice of Warren Buffet or Peter Lynch. Or to read books by John Bogle, Burton Malkiel, Bill Bernstein and Larry Swedroe.

But surely we can do better than leaving the financial education of our children up to the same industry that has so terribly misled their parents.