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Why actively managed mutual funds are hurting your 401(k)

09/19/2011:

Historically, index funds have whooped actively managed mutual funds. It’s not even close. It’s like Notre Dame playing Navy in football. Many Americans are emotionally rooting for Navy to pull the upset, but Notre Dame dominates the series (Notre Dame holds a 71-12-1 edge through 2010 for those interested).

Most 401(k) plans are built completely, or darn near completely, with actively managed mutual funds. That means fund managers are using research, their experience, etc. to try and beat the market.

Beating the market sounds great and seems like a worthy goal. Unfortunately, so few managers have done so over the long run it’s astounding. Picking stocks is like predicting the weather; very hard to do with any real consistency. Managers have to not only be good, but they also have to find enough winners to overcome the costs of research, personnel, and added trading costs common with actively managed funds to outperform an index.

The Statistics Speak for Themselves

Over a five year period, market indexes outperform 65% to 85% of actively managed funds depending on the asset class. Take a longer view and the numbers get even more lopsided. One independent study evaluated the performance of 2,100 actively managed funds over a 31 year period and found that only 0.6% of fund managers had stock picking success. As one writer stated, 0.6% success is “....a number which is statistically indistinguishable from zero.”

If you have a 401(k) plan loaded with index funds be thankful. If you don’t, ask for them or switch to a provider that has an indexing philosophy. It’s your money. Invest it wisely.

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