Mutual Funds: a bad investment?

Lately, I’ve seen a bit of ink spilled on how mutual funds typically underperform major indices. (See here for an older example.)

I wonder how much of this is due to funds having lots of new captive business from defined contribution plans. Most investors don’t have brokerage accounts; they instead are participants in a 401(k) or 403(b) that typically offers them a handful of funds in a walled garden – they can’t go outside the funds in the plan. Which means that even if they had a premium Morningstar account and could see what the supposedly best investments were, they couldn’t do anything about it. The explosion in the supply of mutual funds doesn’t seem driven by informed demand (why would a perfect market demand bad, expensive funds?), but by the growth of the defined-contribution plan and maybe by lots of making nice with personal financial advisors.

Another thought: has anyone studied whether the analysts are any good? Mutual funds as a whole might only outperform the indices 29% of the time, but how often do Morningstar’s 5-star funds outperform?

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  1. Have you read Ramit Sethi’s “I Will Teach You To Be Rich”? I’d be curious to hear your opinion on it, because he does go into some detail about the overall fluffiness of analyst performance data versus mutual fund performance.

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