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TheStreet Open House

You May Be an Index Investor and Not Know

NEW BERLIN, Ill. ( TheStreet) -- For those of you using actively managed mutual funds, I imagine one of the primary reasons is because you believe active management produces superior results. After all, these fund managers are smart guys and gals who spend their careers analyzing and picking stocks for their accounts. How can they not achieve superior returns?

Well, in practice, these superior returns don't occur as often as you hope. Too often (especially after a short stint in the limelight) the fund manager gets caught up in the short-term incentives so pervasive in our industry and avoids risky behavior. The incentive programs are typically geared toward meeting or beating the "average" -- generally defined as the applicable index. With that kind of incentive, the fund manager has a tendency to devolve any innovative processes and risky actions into following the index rather closely.

Funds promising large returns for your retirement are often no more than part of a classic investment firm shell game.

This doesn't happen to every fund, but probably to more than you think. Look at the life cycle of an active fund a bit more closely to understand what happens.

Under the covers
Mutual fund companies introduce lots of funds every year. As an example, let's say a fund company introduces 10, each with a fair-haired boy or girl managing it and doing his or her best to produce a superior return. Since these funds haven't been marketed to the public, the fund company often puts in some of their own money; called "incubation," this is a way for a fledgling fund to build a track record before investing a lot of money in marketing.

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