Do You Need A Smarter Mutual Fund Manager?

Last Updated Jul 7, 2009 11:05 AM EDT

If you're like most investors, your 401(k) plan has probably taken a beating over the last 18 months. Maybe the problem is the people managing your mutual funds just aren't that smart. If you used smarter people, you should get better results. Right?

Unfortunately, intelligence isn't the issue when it comes to money management. How do I know? Consider the following:

  • Let's assume you hired the "smartest" people in the business to manage your retirement money. I think a good pick would be the Harvard Management Co., which oversees the Harvard University endowment. They're smart.
  • So, how did they do? Well, according to published reports, they expect to be down 30 percent for the most recent fiscal year, which means they're probably down more than that from the market's all time high.
  • These losses are close to what you might see from many mutual fund managers over the last year. And contrary to what you might think, most mutual fund managers are pretty smart.
What's the deal? Why can't smart people do a better job with your retirement money?

It's not intelligence that makes a difference. It's philosophy.

Too Aggressive. You see, many money managers believe they can own different types of aggressive investments and still avoid big losses. The basic theory is that when one risky holding declines, the others they have so intelligently selected would go up. That way, you get big returns without big declines. In a nutshell, they want to have their cake and eat it too. That's their philosophy. Turns out it didn't work too well.

When it comes to your retirement money, you may be better off taking a more conservative philosophy to managing risks and returns. By that I mean balancing your aggressive holdings with simple conservative holdings, like U.S. government bonds, FDIC insured certificates of deposit and high-quality corporate bonds.

Accepting Limits. If you adopt a more conservative strategy, it means you're accepting lower long-term rates of return in exchange for more stability in your portfolio. That's a lot different than owning lots of aggressive investments and assuming somehow you'll get big returns without big declines. You can't have it all.

Being more conservative has nothing to do with intelligence. It's all about your philosophy. It requires a basic acceptance of the limitations of money management, which is that opportunties for higher returns come with higher risks. That's how it has always worked, and it's how I expect it will work in the future.

Bottom line. Being smart won't save you from big declines. Being more conservative will.

As with all investment matters, consult your individual advisor prior to making any financial decisions.