Thursday, February 22, 2007

The flimflam man works for Goldman Sachs

Mutual Funds are the greatest con of the 20th century.

It's astonishing how many people tie up their savings and pensions into investments that continually underperforms the market. By now, it should be a well known fact: mutual funds suck. And yet, when the average Joe puts some money aside and wants it to earn some interest, they never call up State Street for information on SPDRs. They see a commercial for T. Rowe Price that proudly boasts, "for each 1-, 5-, and 10- year period, 70% of our mutual funds beat their Lipper averages", and they think, why earn the market when I can BEAT the market?

And so thousands of ego driven fund managers go out every year and do their best to do just that - beat the market. Some years are good. Some years are bad. And all in all, these fund managers - some of the brightest people in the world that spend the vast majority of their waking life working the market - over time, are almost always ineffective. Why?

A well known scam is to mass mail a large number of people a letter: mail half those people a letter that says that the market will go up in January, and the other half a letter predicting that the market will go down. If the market subsequently went up, those people that got the correct prediction for January will get another for February - again, with the prediction split evenly between the recipients. The scammer does this for a year, when he then solicits those people that got 12 correct predictions for money, saying that he could make them a fortune. He then takes whatever money any poor fool is willing to give him and runs away.
The same concept is at work in the discussion of Mutual Funds. If you look at the top performing mutual funds, it'd be common sense to assume that those funds are made up of the best and the brightest making extraordinarily sound investment decisions. And while results could vary, one would think that over the long term, these funds would continue to outperform the market.
The reality is nothing of the sort. Let's look at the ten top performing mutual funds of 1996, and see how they fared in the next ten years (click on the image to get full sized):
This graphic, in my mind, says volumes. Of the ten top performing funds, seven were liquidated out of existance in ten years.
Not enough people hear this messege. If you really want to save for retirement, or your kid's education, your money should be going into investing in low cost index funds, not in fees for some hotshot broker.

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