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A Smart Retirement Plan for Americans

01/26/2010:

Somewhere along the way, Americans were sold the idea that they must beat the market to be a successful investor. In reality, it is extremely hard for even the best money managers to consistently beat the market. The smart plan for Americans is to invest your money in the lowest expense funds possible that track a market – a.k.a. index funds.

Don’t let the wolf blow your house down

High expense funds can be a big drag on how much you have come retirement. Most 401(k) plans are built with many higher expense actively-managed mutual funds, and just a few index funds -- those that track a given market like the S&P 500. Index funds tend to have lower expenses to the tune of 2.5 to 10 times less than actively-managed funds.

Actively managed mutual funds typically incur greater costs due to research and trading costs as they try to outperform a benchmark index. Yet for each extra dollar spent, the fund must overcome these expenses to try to outperform its benchmark. And that’s the rub.

So how do these actively managed funds stack up historically? Well, depending on the asset category (growth vs. value, large vs. small company funds), 70-85% of actively managed funds fail to beat their target index over time.

Let’s work for something a little more concrete!

High-expense funds can be like a straw house and we don’t want to end up like that little pig. Sometimes these higher expense funds are chosen because the fund had a good year and beat the market. Yet, it’s very common for an actively-managed fund that beat its’ market index one year to fail to do so the next as economy, markets, and strategies change (this is called reversion to the mean).

This is one important reason among others that we believe low-expense index funds (in particular ETFs) are much better for retirement plans, and a way to move ahead of the pack and on track to meet your financial goals.

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