|Moving past 401(k) paralysis
Those in the 55-plus category are
not all that interested in these funds. For them, the first decision
would be to choose between a passive and active strategy and then
from there, make individual fund selections according to their asset
Passive funds mimic market indexes such as the Standard
& Poor's 500 or the Wilshire 5000 and generally charge smaller fees and incur
lower trading costs than active funds. Actively managed funds attempt to beat
their market benchmarks, but often trade excessively and charge higher expense
ratios to cover research expenses and the like.
Such highly esteemed folks as Vanguard founder John
Bogle and Princeton professor Burton Malkiel have argued persuasively
in favor of index funds for the past 30 years or so. Other market
pundits also offer compelling evidence.
In a recent column, Jonathan Clements pointed out
that U.S. stock funds gained nearly 12 percent a year over the past
25 years vs. 13.5 percent for the S&P 500 index. (A 1.5 percentage
point margin of victory is huge. Example: A $1,000 investment in
the average stock fund would be worth $17,000 after 25 years, vs.
$23,700 for an S&P 500 fund.) Indexing proponent Larry Swedroe
regularly writes articles in which he cites statistics that convincingly
prove the argument in favor of passive investing.
But at least one recent study offers compelling evidence
leading to the opposite conclusion. An article
in the October issue of the FPA Journal calls into question the
assumptions behind indexing's superiority.
One big gripe: Traditional studies tend to look at
a "snapshot in time," which may lead to inconsistent results.
The author, Christopher Carosa, analyzes asset-weighted
returns rather than equal-weighted returns of funds, because the
former "more accurately reflect the actual behavioral patterns
of investors." In other words, the investment returns of funds
with more money receive a bigger weighting than funds with less
His conclusion: "For investment returns in rolling
12-month periods from January 1975 through June 2004 ... U.S. equity
funds have historically beat the S&P 500 roughly two-thirds
of the time."
His finding is likely to cause a stir among
passive-investing enthusiasts for quite some time.
A recent article by Morningstar, "When
index funds go bad," also criticizes looking at snapshots
in time without regard to actual patterns of investment.
It begins by making a familiar claim to those who
follow indexing: "Vanguard 500, the most popular index fund
by far, has generated total returns over the past decade that trump
more than two-thirds of actively managed large-cap funds."
But the Morningstar piece goes on to say that the
dollar-weighted returns of index funds, which more accurately gauge
actual shareholder returns since they reflect actual money flows,
are significantly lower than the official returns of index funds.
What to make of it all
There isn't any one right or wrong way to invest. Basically, data
can be sliced and diced any number of ways and then interpreted
according to one's own rather biased perspective.
I tend to gravitate toward the middle ground
when presented with extreme viewpoints, at least in investment matters. So I use
a mix of index and active funds. The index funds serve as core holdings, and smaller
holdings of active funds will, I hope, enhance returns over time. In fact, a lot
of "active" money managers use a similar strategy. If I have a bias,
it's toward value stocks.
But investing doesn't have to be a hugely complicated
ordeal. In the beginning, you can opt for a one-solution fund, whether
that's a balanced fund, a life cycle fund, an asset allocation fund
or a target retirement fund. I'm sure you will see at least one
of these among your 401(k) options. But if you don't, corner your
human resources representative and demand a tutorial. If you're
getting on in years, have accumulated some assets and require more
sophisticated advice, then learn more about it yourself or seek
Just make sure you take advantage of your workplace
retirement plan. Ultimately, it's there so you can one day reap
the rewards of your labors.
Longtime financial journalist Barbara Mlotek Whelehan
earned a certificate of specialization in financial planning.
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