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Tuesday, July 29, 2014

Why We Love Index Funds (And All The Facts Say You Should, Too!)

Every day, we wake up, scratch our heads and ask, “Why do 401k plans still have actively-managed fundsWe_Love_Index_funds in them?!”  It’s common practice, we know.  We’ve heard all the arguments.  “We only use the best funds so your participants make higher returns;” or, “The service we provide is worth the higher cost of actively-managed funds;” or, “You need actively-managed funds in your plan for compliance reasons—you must offer enough choice to employees.”

The fact is, virtually no actively managed funds outperform their index with any regularity whatsoever. Decades of data and numerous empirical studies show that index funds, at approximately 1/5 the cost, outperform active funds about 80% of the time.  Not only that—recent studies show that when active advisors recommend changes in funds, plan costs increase and the new fund does worse than the one it replaced!  How could that be?  Think about it.  No one replaces a fund that’s doing well (so you are “selling low”) — and no one adds a fund that’s doing poorly (so you’re “buying high”).  Is that not exactly the opposite of what you’re supposed to do?  Is that not the very definition of “chasing returns”?

Your problem is that you have actively managed funds in your plan and you have an advisor that told you to include them (and now performs the diligent service of making periodic changes to find you better ones).  The data says that strategy fails with amazing frequency.  Everybody thinks their advisor is the exception to the data-proven rule, or you wouldn’t have him around.  But think about this: The fund your genius is telling you to buy….someone else’s genius is telling them to sell.

If you take the time to see how your actively-managed funds perform against their corresponding index, one of two things should happen: You dump your advisor and your active funds or you insist that your advisor start taking you on lavish vacations to Pebble Beach.  It’s important to ask yourself if the price you’re paying for these funds is REALLY buying you or your participants anything significant.  It’s even more important to get to the right answer.

Some plans are including index funds alongside active funds.  As the plan’s fiduciary, you should know that index funds regularly outperform active funds.  So why put options on the table that are proven to always be more costly and almost always return less?  Is your plan’s strategy to help participants get to a secure retirement or “Buyer Beware”?

What's your definition of a successful plan?  Great participation?  Low cost?  Helping employees maximize their retirement savings?  Preventing harmful participant decision-making?  Compliance?  Fiduciary excellence?  

The questions we pose in this blog are designed to get you thinking about where your plan is today, and where it might fall short of your own definition of success.  Click the button below to read our free whitepaper and get on the road to 401k plan success!

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Posted by at 2:00 PM