To Graduates Entering the Mutual Fund Industry

Last Updated May 23, 2010 1:01 PM EDT

A few weeks ago, a friend asked me to chat with his son, who was getting ready to graduate with an MBA and begin a career with a large mutual fund firm. I was happy to do so, largely because I benefited enormously by receiving both well-timed advice as I began my career and more than my fair share of mentoring along the way.

After our chat, the graduate asked if I might put my thoughts down on paper, so he could share it with a few of his fellow grads. Following is what I sent him:

Congratulations, first and foremost, on not just earning your degree, but finding a job in this difficult economy. I'm sure that you're enormously excited about the opportunities that lie in front of you as you begin your career.

There's no denying that the world of finance is an enormously attractive place to build a career. It has grown tremendously over the past two decades, and -- even after the global recession -- remains a driving force in our economy.

And let's be honest. You can become quite wealthy in this industry. While there are no guarantees of personal financial success, a basic truism applies: as your proximity to enormous piles of money increases, so does your pay.

Even better (from the industry's perspective) is that the fees earned are largely invisible to clients, and are, for the most part, immune from being eroded by inflation. No monthly invoices need to be sent out; no uncomfortable conversations with clients about cost-of-living price increases need to be had. The fees are simply deducted from the returns the clients earn, and increase over time as their assets do.

The Nobel prize-winning economist Paul Samuelson recognized these economics way back in 1967, when he said "I decided that there was only one place to make money in the mutual fund industry, as there is only one place for a temperate man in a saloon: behind the bar and not in front of it."

Echoing Samuelson more than 40 years later was another Nobel-winning economist, Paul Krugman of the New York Times, who recently wrote "the modern financial industry generates huge profits and paychecks." Unfortunately (but correctly), he also added that in exchange for those profits, the industry "delivers few tangible benefits."

Just as it is impossible to deny the industry's profitability, it's also impossible to refute Krugman's assertion that the benefits investors receive are paltry. The evidence is overwhelming that mutual funds as a group lag the returns provided by the overall market over the long-term, and that the investors of those funds end up earning returns that are inferior even to those subpar returns.

As a result of that lag, the long-term growth that mutual fund investors have earned is a mere fraction of the returns that the stock and bond markets actually provided. In many ways, this record reflects a fundamental failure of the industry at large.

Chris Davis of the Davis Funds summed up the problem quite nicely. He noted that the role of professionals (as distinct from businessmen) is to prevent their clients from engaging in behavior that will harm them. Your doctor tells you to stop eating unhealthy food; your accountant tells you to be honest on your tax return; and your lawyer tells you not to lie under oath. In essence, a professional is supposed to tell you things you might not necessarily want to hear.

But in the profession of money management, too many participants seem to encourage behavior that is harmful. Want to try to play the hot sector? Here's a fund to do so. Looking for a home for your Roth IRA? Here's a manager who's earned stellar returns over the past three years.

So now that find yourself behind the bar, so to speak, ready to reap the rewards that this industry bestows, you have a choice. You can accept the status quo, knowing that if you declined to take advantage of your client's self-destructive behavior one of your competitors surely would. Or you can try to raise the bar, and act in a way that always holds your clients' long-term interests paramount.

The choice, essentially, boils down to a decision to see yourself as just another provider of goods and services seeking to maximize your own income, or to see yourself as a professional who puts your own personal interests aside, and whose training and experience is relied upon to help your clients reach their long-term goals.

It's quite black and white. And if anyone tries to convince you otherwise, rest assured that their judgment has been clouded by the source of their income. Personal financial success can accompany either approach, but deciding to act as a true professional -- as many, but far too few in the industry do -- provides additional rewards that are far more gratifying, if less quantifiable.

  • Nathan Hale

    View all articles by Nathan Hale on CBS MoneyWatch »
    Nathan Hale has spent decades working in the financial services industry, during which he has researched and written extensively about personal investing, the mutual fund industry, and financial services. In this role, he uses a nom de plume because many of his opinions about the mutual fund industry and its practices would not endear him to its participants.