I recently lost a competition to become the investment adviser to a 401(k) plan. I proposed limiting the investment options to ten portfolios, consisting solely of globally diversified, low management fee index funds, at different risk levels, ranging from very conservative to very aggressive.
The winning adviser convinced the plan sponsor he had the ability to select actively managed funds which could beat their benchmarks. At my request, the adviser was asked these questions:
- What is your methodology for determining in advance which funds will outperform?
- Can you demonstrate your methodology has worked by giving me the name of your five biggest clients, and sending me a list of every fund that went into and exited the plan over the past five- and 10-year period, with the dates when they entered and exited those funds?
Their response was:
- Their methodology was "proprietary" and they couldn't disclose it because their competitors would steal it.
- They could not provide any data about how it worked because sometimes their recommendations were rejected by their clients and they did not keep track of which recommendations were accepted.
You can't make this stuff up. In any other area of commerce, this kind of response would disqualify the vendor, but not in investing and especially not with 401(k) plans. Plan sponsors are typically not familiar with the data indicating the majority of actively managed funds underperform their benchmarks in any one year and over longer periods of time. They don't know there is no credible, peer-reviewed data demonstrating that anyone has the expertise to prospectively select outperforming actively managed funds. This lack of basic due diligence makes them easy prey for advisers who claim to have an expertise that doesn't exist.
Take a look at your 401(k) plan investment options. They are most likely predominately actively managed funds, with management fees of 1 percent or higher. Ask your adviser to justify including these funds in the plan. Don't accept the glib, patronizing response you are likely to get. Insist on a written answer detailing their methodology. Make them demonstrate their approach works by providing at least 10 years of data from their five or 10 largest clients, showing the dates when every fund entered and exited the plan. I can tell you with great confidence you won't get it. If you do, and you don't have the ability to analyze it, send it to me. I will do analysis and will publish the results without disclosing any names.
It's time to call their bluff and stop the carnage. You deserve better.
Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book is The Smartest Money Book You'll Ever Read. 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.