09/09/2014 05:01 pm ET Updated Dec 06, 2017

Your Mutual Fund Manager Will Retire Before You Do

Your mutual fund manager has a solid plan for retirement. So far, it's working beautifully.

Your fund manager is fortunate to be part of a growth industry. Since 2004, assets under management have grown 124 percent. The number of U.S.-based stock and fixed income mutual funds has grown to more than 5,000. Collectively, they manage a staggering $9.1 trillion. This is big business.

The key to your fund manager's retirement plan is to inundate you with misinformation. It's part of an effort to distract you from the fact that you would likely be better off not using his or her services. Some startling facts your mutual fund manager goes to bed every night praying you won't uncover include:

A terrible survivor record

For the 10-year period ending Dec. 31, 2013, only 48 percent of actively managed stock mutual funds in existence at the beginning of the decade were still around at the end of the decade. That's astonishing news. The financial media, however, rarely pays attention to disappearing funds. They slip away quietly in the dead of the night.

The most common reason funds fail to survive is poor performance. Of course, it would be great if investors in mutual funds could identify which funds are most likely to fail. Unfortunately, no one has figured out how to do that.

A terrible performance record

Let's assume you are one of the lucky ones able to pick a fund that actually managed to survive for the entire decade ending Dec. 31, 2013. You are still not out of the woods. Only 19 percent of the funds that survived also beat their respective benchmarks over that period.

A terrible persistence record

Your fund manager is hoping you are still not deterred by the data. He wants you to believe you have the ability to pick not only a mutual fund that will survive, but also one that will outperform. Of course, he believes his fund meets both criteria.

The harsh reality is that the persistence record of outperforming mutual funds is pathetic. For example, for the period 2008-2010, 30 percent of stock mutual funds outperformed their benchmark. If you purchased one of those funds, based on the assumption that stellar past performance is predictive of future performance, you would likely have been disappointed. Only 39 percent of those funds repeated their outperformance in the period from 2011 through 2013.

Over longer periods of time, the data is more depressing. For the years from 2004 through 2010, only 23 percent of stock funds outperformed their benchmark. Only 36 percent of those funds also outperformed in the subsequent period, from 2011 through 2013.

A focus on costs, not expertise

Perhaps the most critical component of your fund manager's retirement plan is to keep you focused on his purported "expertise." He hopes it will distract you from looking at the cost of his fund, expressed as its expense ratio.

There is an inverse relationship between high cost and high performance. For the 10 year period ending 2013, 25 percent of stock funds with the lowest expense ratio outperformed their benchmark. Only 9 percent of the funds with the highest expense ratio outperformed their benchmark.

Fund managers running expensive funds are clearly not delivering better performance. Where do you think that money is going? Among other places, it's being used to provide fat salaries, a lavish lifestyle and a secure retirement for the fund manager.

High trading costs

Fund managers engage in frenetic buying and selling of stocks in their often unsuccessful effort to beat their benchmark. By doing so, they incur trading costs, which can be a drag on returns. The turnover of a portfolio is one way to approximate trading costs.

Your fund manager doesn't want you to know that funds with higher turnover are more likely to underperform their benchmarks. For the 10 year period ending 2013, 27 percent of stock mutual funds with the lowest turnover outperform their benchmark. For the same period, only 11 percent of stock funds with the highest turnover outperformed their benchmark.

Tips for funding your retirement

If you want to stop contributing to your fund manager's retirement savings and start reaching your own retirement goals, here are some tips:

  • Stop investing in actively managed mutual funds.
  • Recognize that past performance is unlikely to persist.
  • Understand the negative impact of high costs and excessive turnover.
  • Become an "evidence-based" investor, limiting your portfolio to a globally diversified mix of low management fee index funds, passively managed funds or exchange-traded funds. Arrange these funds in an asset allocation suitable for you.

The chances are that you don't even know your fund manager. Why are you prioritizing his retirement over yours?

2014-04-01-Hiresfrontbookcover.jpgDan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth advisor with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is The Smartest Sales Book You'll Ever Read.

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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