Active Management

Ezra Klein points out that with another year gone by, it’s still the case that the majority of actively managed funds are outperformed by passive investment in a stock index. In other words, the fund managers are creating negative value. And getting paid handsomely for it as Kevin Drum reminds us.

One thing worth noting here is the structure of retirement plans. Tax law creates very strong incentives for most people to do the bulk of their stock investing via 401(k) plans or other employer-specific offerings. And in this case, investment decisions wind up being made at several different removes. What an employee gets is a big fat brochure and a series of forms drawn up by an investment institutions. If the employee is anything like a real person rather than an idealized rational agent, he’s going to be drawn toward picking one of the default options that just located you somewhere on the age/risk curve and not peer too closely into the details. In theory, a firm’s benefits manager could be keenly attentive to the question of whether or not the firm’s favored institution (in CAP’s case, John Hancock) is good about not steering unsuspecting workers into managed funds. In practice, nobody is.

Consequently, a lot of people wind up getting suckered into these managed funds without quite realizing what’s happening. And it’s important to keep this kind of thing in mind when thinking about issues like the legendarily long hours worked on Wall Street. The long hours are real enough, but long hours don’t necessarily indicate that valuable work is happening. A lot of financial services is a kind of sophisticated hustle—a scam—and it requires a lot of hard work precisely because it’s a hustle.