Your Fund Manager is No Albert Pujols, and Other Lessons from Larry Swedroe’s Investing Tales

Albert Pujols hits a home run against the Padres, May 19, 2008, photo: SD Dirk via Flickr

Corporate 401(k) plan sponsors pick bad funds for their plans, according to a 2006 study. Then the participants in the plans compound the problem, again picking funds headed for a fall.

Why? Because though the Securities and Exchange Commission mandates that funds put in any piece of marketing the disclaimer that past performance is not indicative of future results, it seems no one believes them.

In chapter 15 of his new book, Wise Investing Made Simpler, CBS MoneyWatch columnist Larry Swedroe acknowledges a logic to our apparent fiscal recklessness.

He starts with the example of Albert Pujols. Pujols had a fantastic rookie year with the St. Louis Cardinals. Then he tacked on eight more, to rack up, Swedroe writes, the greatest first nine years of any batter in the history of baseball.  No one would attribute 9 out-of-sight years to luck. Any general manager would have snapped up Pujols given the chance.

Similarly, a business looking to fill a management post looks at how each candidate has performed in previous roles.  If you need surgery, you go to the surgeon who’s done many, many successful operation.

In most walks of life, past performance is indicative of future results.

So it’s logical we’d think that would also hold true for fund managers. Unfortunately, according to this study, we’re wrong. The research conducted by Edwin J. Elton and Martin J. Gruber of New York University, and Christopher R. Blake of Fordham University, examined 43 401(k) plans from 1994 through 1999. Over those five years the 401(k) plans added 215 new fund options for participants and dropped 45 funds from their plans.

The authors found that the funds added had a strong track record, and those dropped had poor recent performance.  The new funds promptly underperformed those that had been given the heave-ho. Swedroe writes:

When a plan deleted a fund and replaced it with a fund with identical objectives, the deleted funds outperformed…by about 2.5 percent per year over the next three years

The funds investors — i.e. us — have to choose from are a bad lot, but we manage to make things even worse, the academics found, by repeating plan manager’s mistake and constantly chasing yesterday’s good performance. Rather than stick to an asset allocation plan and rebalance it periodically, we pour new cash into last quarter’s top performers.

(P.S. There’s a big price paid for all this. In their abstract of the study the three authors note: “We find that, for 62% of the plans, the types of choices offered are inadequate, and that over a 20-year period this makes a difference in terminal wealth of over 300%.)

Swedroe  is an avowed fan of indexing as the most effective method of investing for individuals. No one should be surprised that this book is an attempt to convince investors of the wisdom of doing less. But whether you’re sold on this philosophy or not, there are interesting connections drawn in this book between how we behave in most of our daily lives and how we behave when we put on our investor hat.

In an early chapter, he contrasts a child’s method of learning how to ride a tricycle without banging into a wall with investor’s moth-like attraction to stock picking.  In another, he compares driver’s dubious self-confident assessment of their own skills to investors’ inflated opinion of themselves. In a 1965 study by two psychologists, 2/3 of drivers said they were at least as competent as usual, though all had ended their last trip in an ambulance. Police reports indicated almost 70% of them were directly responsible for their accidents.

The conceit of this book, and its predecessor, Wise Investing Made Simple, is that it’s true-life stories (often horror stories) that really stick in people’s minds.

In this book, Swedroe uses story telling in an attempt to convince investors to get out of their own way, and ends the chapter on 401(k)s with the well-known quote from comic character Pogo, “We have met the enemy and he is us.”

One thought on “Your Fund Manager is No Albert Pujols, and Other Lessons from Larry Swedroe’s Investing Tales

  1. Simon Napper

    I think that investing is an area where people are under-educated and overwhelmed with conflicting messages.

    Of course we use past history as an indicator of future performance. We need something to on which to build a decision matrix and past performance is usually what we use in assessing somebody’s performance.

    I think we can contrast two types of analysis before making a selection that will help show the difference. Compare picking somebody for a fantasy football team and interviewing somebody to join your company.

    In the former case, you have public information, a ton of stats. and even more news, comment, gossip, innuendo. However, you don’t get to speak to the player yourself and, unless you are or have been a pro, you don’t really know what goes on behind the scenes or what really makes a player long term successful. If you could get access to the player — maybe they wouldn’t want to tell you what their special sauce is because they don’t want it getting out to the competition. There is certainly a strong whiff of that in the investing community.

    In the latter case, you get much more access to the individual and you have a much better understanding of what you are looking for, not just in terms of past performance but a number of intangibles that allow you to make the decision as to whether this person will fit into your team.

    I think that we should recognize that for most people, having a good asset allocation strategy and picking the best funds is the most important thing. Whether it’s index funds or not. On top of that, in today’s market having some form of tactical asset allocation seems to make a lot of sense.

    Keeping it that simple gives us a prism through which to examine experts and have more of an idea of whether this person is going to work for you.

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