The 401(k) Casino  

Imagine a gigantic casino.

It’s an enormous room, larger than any you have ever seen. It stretches beyond countless gaming tables and battalions of slot machines. It has no windows, no obvious doors. It has no day, no night. The only thing that can hold your attention is the action of the moment. It’s like Las Vegas but much bigger.

 Better than a fool, you pass the slot machines. You know the slots are a loser’s game. You don’t want to be seen with the people who sit in a daze, committing one token after another and losing their money.

            You think about going to the Craps table— or maybe the Blackjack table. The first can be exciting if someone is on a roll. The second can be fun if you remember the combinations and can remain truly focused. You know from reading that the house ‘Vig’— what the casino makes on the game— is smallest on these two games. It’s as low as 0.8 percent on Craps and ranges as low as 1.5 percent on Blackjack, according to professional gambler John Patrick.

            But you’re drawn to the players at the roulette wheels. The ‘Vig’ can be as low as 2.6 percent and as high as 7.1 percent, depending on your bet. Either way, it’s a lot less than the 13 percent you’ll lose at the slots.

At the roulette wheel you can relax and put chips down how you want. You can bet on a single number. You can bet on odd numbers or even. You can bet on red numbers or black. You can bet on an intersection of four numbers. You can look for a favorable run.

            Then you notice something strange about the roulette wheel. It doesn’t have the usual numbers around the wheel. Instead, each slot is named after a mutual fund! 

Other tables have roulette wheels with other mutual fund names around the wheel and you realize that you are now in the 401(k) section of the Great Investing Casino, the one where people have placed two trillion dollars in bets.

            The croupier dislikes your distraction.

He asks you to place your bet. He suggests that you educate yourself about the beauty of each fund before you bet. He wants you to select a favorite and play it.

            What the croupier, like the house, doesn’t want you to do is think about how the house makes money whatever you choose. Win big and the house makes money. Lose big— and the house still makes money. The house wins when you play the game.

It wins more when you don’t notice how much it costs to play…

            If this strikes you as paranoid fantasy 101, hang with me for a few minutes.

There is evidence that we can do better things with our time than looking for good funds on the roulette wheel.

Why?  Because the odds are that vast majority of funds will underperform an index. At the end of October, for instance, an average of all domestic equity funds (7,112) looked pretty good. On average they did 2.52 percentage points better than the Standard and Poors 500 Index. A return advantage like that can, and should, get our attention.

            Unfortunately, the advantage disappears with time. Over the last 5 years managed funds trailed the index by 2.45 percentage points; over the last 10 and 15 years they trailed by 1.88 and 2.02 percentage points, respectively.

            If you make the same examination by fund family, as I did with 20 major fund groups, you find a similar relationship. While average domestic equity fund performance of 13 of the 20 fund groups beat the S&P 500 index over the preceding 12 months, only 6 groups beat it over the last 5 years. Only 3 groups beat it over the last 10 or 15 years.

            Of the three groups that beat beat the index at 15 years, the margin was only 0.22 percent for two (Janus and Legg Mason) and 0.09 for another (Fidelity).

(The averages for are shown in the table below. For figures on 20 fund groups, check my website.)  (www.scottburns.com/011211TABLE.htm)

In the 401(k) Casino, The Longer You Stay, The More The House Wins

(Figures show performance Gap between average fund return and S&P 500 return. For example, over the last 15 years the average of all domestic equity funds trailed the S&P 500 by 2.02 percent a year.)

Source: Morningstar Principia, October 31, 2001 data 

            We can get some improvement by limiting our search to the largest funds, witness the figures for funds with over $3 billion in assets. Unfortunately, that isn’t a random selection— funds usually grow because they’ve provided good returns and attracted more investment money than funds that don’t perform as well. Future returns are seldom as favorable.

            Bottom line: you can have fun playing mutual fund roulette, sometimes winning big in the first year. But if you stay in the 401(k) Casino picking funds for a long time, the house collects fees— and you lose return.

Table for website:

Fund Groups, Ranked by 15 year Return Margin over S&P 500 Index divided by average Expense Ratio*

Source: Morningstar Principia Pro, October 31 data

            If you examine this table closely, you find that the average of all fund families had expenses that were about equal to the amount by which they trailed the S&P 500 Index; that only three fund families provided an average return higher than the S&P 500 Index; only four fund families provided an average return that recouped a portion of their expenses, and thirteen fund families trailed the index by an amount greater than their expenses.

This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Photo: Pavel Danilyuk

(c) Scott Burns, 2022