Specifically, year in year out, investors buy funds that have been given 4 and 5 stars by Morningstar and withdraw money from funds that have been given 1 and 2 stars. They do this despite the fact that even Morningstaradmits that the ratings aren’t predictive–that 4 and 5 star funds aren’t likely to do any better in the future than 1 and 2 star funds.What is predictive?
The lower the cost of a fund, the more likely it is to do well in the future (relative to other funds). The higher the cost, meanwhile, the less likely the fund is to do well. This is one reason that index funds outperform “actively managed funds” (funds with managers paid to pick good stocks and sell bad ones) year after year: The manager’s salary is deducted from the fund’s returns, and most managers aren’t good enough to offset the cost of their salaries and their employer’s profits.
Why don’t financial advisors tell their clients these simple facts?
Because financial advisors like to believe (or pretend) that they can add more value than that–that their acumen and relationships and experience will allow them to select funds that do “better than average.” (Even though index funds do distinctly better than average.) And also because financial advisors are often incented (paid) to recommend certain funds over other funds–and the commissions on high-cost funds are generally higher than those on low-cost index funds.
The best solution for investors saving for retirement is a globally diversified portfolio with low cost funds. More specifically, a portfolio with the risk characteristics relevant to their age and time horizon.
Please comment or call to discuss how this affects you and your company retirement plan.
- Real Financial Experts Won’t Go on TV (401kplanadvisors.com)
- What are appropriate upfront fees for mutual funds? (usatoday.com)
- The Mutual Fund Industry Is A Huge Scam That Costs Investors Billions Of Dollars A Year (businessinsider.com)