The Flawed Premise of 95 Percent of 401(k) Plans

The financial services industry wants you to believe that there is someone out there who can tell you the best investments for right now. This is how they make the bulk of their money, by convincing you to move your money to the next hot manager. Avoid this and you will succeed in reaching your long term financial goals. There is no evidence that anyone can consistently and predicatbly beat the market.

Cover of "A Random Walk Down Wall Street:...
Cover via Amazon

Let’s put the daunting task of picking fund “winners” in perspective. How hard do you think it is for the most sophisticated fund managers in the world to beat the S&P 500 index, when that is their designated benchmark? It must be harder than it looks because less than 40 percent of these funds do so in any given year according to a studyby Standard and Poors.Presumably, each of the losing fund managers had every expectation of beating their benchmark at the beginning of the year. How likely is it that a broker could predict in advance that the fund manager would fail to meet this goal? Do brokers know something that has eluded these fund managers and their employers?

Many state pension funds retain brokers with this purported expertise to advise their plans. They are understandably eager to reap the extra returns promised by these “experts”. How has that worked out?

Not well. A comprehensive study compared the long term results of state pension plans with index based portfolios of comparable risk. Almost all of the plans underperformed.

The problem is not lack of data. It’s that plan sponsors are not aware of the data and brokers want to keep them in the dark. Burton Malkiel, in his seminal book, A Random Walk Down Wall Street, reviewed the research and concluded that “It does not appear that one can fashion a dependable strategy of generating excess returns based on a belief that long-run mutual fund returns are persistent.” The problem is not that no actively managed funds outperform. Some do. The issue is whether anyone has the expertise to pick them in advance.

Trying to pick the best fund managers which will beat the benchmarks is like trying to draft NFL players. You have no idea if their past performance will repeat and most do not.

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