What 80% of Wharton MBAs Don’t Know About Retirement Planning

by JT McGee

staff may be brilliant, but not with their moneyBy 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.

The test:
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.

{ 13 comments… read them below or add one }

Shawanda August 1, 2011 at 04:58

Your post reminds me I need to suspend my 401(k) contributions and switch to funding my Roth IRA until I reach the maximum for 2011.

It’s amazing how big of a difference fees can make. I believe fees are the main reason all 4 of the funds in my 401(k) are the stinkiest investments I own.

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cashflowmantra August 1, 2011 at 05:04

Sad, truly sad. This is why it pays to educate yourself and watch out for your own money. No one else is going to do as careful a job as you are.

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Paula @ AffordAnything.org August 3, 2011 at 12:41

Can I just say “ditto” to exactly what cashflowmantra said?! I just wrote a post about this today … it’s totally up to you to manage your own money; no one else will do as good of a job as you can.

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John Hunter August 1, 2011 at 06:25

Interesting. I do think past returns (for the same periods) in the past are a useful piece of data. But paying attention to past returns while looking at different periods is silly.

Low cost is key. I had an employer that let a fund offer 2 S&P 500 index funds, one with a .28 fee rate and another with a .68 fee. There is no reason to allow that as an employer. The only reason to do it as a fund company is to make more money at the expense of your foolish fund holders.

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No Debt MBA August 1, 2011 at 08:04

Ouch. Maybe I need to start blogging more about the fundamentals to educate some of my peers. Or I should start a financial planning practice to serve them and make more 😉

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Dave @ Money In The 20s August 1, 2011 at 08:28

I read about this study not too long ago. Pretty shocking that these MBA students couldn’t come up with the simple solution. They don’t care though because they will still get hired by the big investment banks and hedge funds because of the Wharton reputation.

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JT August 1, 2011 at 08:55

I guess the running joke is true: managing directors go to a top 5 b-school, where they hang out at the right fraternity. The traders come from other top 10s, and the back office is full of NASA-quality mathematicians.

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Dave @ Money In The 20s August 1, 2011 at 15:50

That sounds just about right!

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Hunter @Mapblog August 1, 2011 at 12:01

Being in high school, I know that school teaches absolutely nothing that relates to finances. I think this is a huge flaw that needs to be corrects. I would think that Ivy League schools would be more likely to teach some fundamentals of investing. I guess the only way to learn is to teach yourself.

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krantcents August 1, 2011 at 16:36

Graduate Business programs are geared to big business. Although the question was very reasonable, I can see that they could blow it. Brilliance does not equal common sense.

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Matt Wegner @ Financial Excellence August 1, 2011 at 17:50

Great post JT. I’d go with the 2nd takeaway. Book knowledge is not synonymous with practical knowledge or experience. Nor is it an indicator of your ability to apply the knowledge. I totally agree with krantcents – personal finance is lacking in college education programs in general.

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Money Matters Guy August 1, 2011 at 21:18

Fees can have an enormous impact on your retirement savings, and it’s a shame that most people don’t seem to realize that. The average investor would do a lot better by investing in a simple index fund from Vanguard instead of chasing after the latest and greatest funds that charge fees up the nose.

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Ashley @ Money Talks August 4, 2011 at 10:48

“Maybe that an MBA doesn’t mean you understand the basics of your own finances?” Bingo!

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