By the end of this article you’ll have a better understanding of basic retirement planning than 80% of Wharton MBAs and 90% of Harvard staff members. I have a feeling, though, that most reading this will know the correct answer from the get-go.
Three professors asked 400 Harvard staff and 250 Wharton MBA students to find the best allocation of $10,000 among four index funds. They were furnished with the fund names, historical performance, as well as the annual fees for each of the four funds.
Each index fund was based entirely on the S&P500 and designed to track all five hundred stocks just as the index itself does. So what is the best way to allocate the $10,000?
How do you know which fund is better than the other?
The answer is…
The simple answer to the above question is that you should pick the lowest-fee fund, since the funds are the same.
So how did the Harvard staff and MBAs perform? Not so hot.
The most critical error was made most frequently; each group preferred the funds with the highest annual returns over the funds with the lowest. As retirement planning 101 tells us, not only does past performance not guarantee future returns, but past performance is largely dependent on the date of inception.
Because the performance data was “since inception,” a fund that was launched in 2007, for example, would appear on paper to perform worse than a fund formed in 1988. On an annualized basis, the fund formed in 2007 would show a net loss while the fund formed in 1988 would show insanely impressive returns. Of course, whether you purchase the fund founded in 1988 or the one formed in 2007 doesn’t much matter—they own the same stocks, in the same weighting!
So what’s the takeaway?
I don’t know.
- Maybe that nothing stumps a group of geniuses more so than retirement planning?
- Maybe that an MBA doesn’t mean you understand the basics of your own finances?
- Or how about that only 50 of 250 MBAs understand an index that many of them will be hired to beat?
That last point is a little concerning.
You can read all about the experiment in a study championed by the Social Security Administration and explained in detail by either Yale students or faculty. Leave it to Yale to rag on their Harvard and UPenn cohorts. Link here.
One very interesting tidbit that I found was that the group with the prospectus (the group that had the most information) was never once the group that found the best performing funds. I guess we can conclude that too much information is just as dangerous as not having enough or only limited amounts of information.
Food for thought.