Actively Managed Funds Vs Index

Actively Managed Funds vs. Index

Index Funds Consistently Outperform Actively Managed Funds

A recent survey once again shows what has long been the case, that index mutual funds consistently outperform actively managed mutual funds (see below).  So if that’s the case then why do so many people invest in actively managed funds?

5 Common Reasons People Fall For Actively Managed Funds

Reason #1 – Ignorance

Some people simply do not understand the long-term performance of index mutual funds handily beats that of actively managed mutual funds.

Reason #2 – Sales Efforts

Firms make much more money off of actively managed mutual funds, often 1%-2% of principle per year vs. 0.18%-0.25% for many index funds.  As a result firms put relentless efforts behind selling actively managed funds (with great success!)

Reason #3 – Greed/Temptation

By definition you can’t beat the market if you’re in an index fund designed to mirror the market.  What are you, some kind of wimp?  And so people pour billions into actively managed funds only to see their returns lag year after year.

Investor Pride – This is a close cousin of “greed/temptation.”  Here’s how the story goes.  Yes, there are lots of lousy actively managed mutual funds out there, but by virtue of your penetrating insight you are smart enough to pick a fund that will beat the market…and that’s how the train wreck begins.

Reason #4 – Fund Manager Pride

So despite the sub-par performance of actively managed funds, show me one that doesn’t have a fund manager that thinks they can be the market every year.  If you can find one then I would love to see what the marketing material looks like, “Invest with us – we guarantee we’ll charge you more and underperform relative to the market in the process!”

Reason #5 – Performance Chasing

Maybe you’ve had a reality check and realize if you’re like most regular you can’t consistently beat the market (but don’t worry, the pros can’t either).  But wait, you don’t have to be smart enough to beat the market, right?  You’ll just find some mutual fund rankings and pick the ones that performed the best last 1-3-5 years, right?  That’s called performance chasing, which is another name for buying high and often selling low (instead of the other way around!).

Low Cost Index Funds are the Best Long-Term Investment Strategy

So what’s the solution?  What’s a good investment strategy for regular people?  Unless you’re able buy stock or another investment at an amount that’s comfortably below the market price (such as pre-IPO stock) then you’re best bet for the long-term is to invest in low-cost index funds (view Best Vanguard Funds for specific recommendations).  It may not get you riches anytime soon but hey, slow and steady worked out pretty well for the tortoise!

Safe Harbor 401k Plan

Safe Harbor 401k Plan

A safe harbor 401k plan is a unique type of retirement plan with two significant differences from a traditional 401k plan.  One, it requires mandatory employer contributions to employee accounts.  Second, it gives an employer an ability to offer a 401k plan to employees without any required discrimination testing.

The Safe Harbor 401k plan permits eligible employees to defer a portion of their salary to their own retirement plan account.  Employers then contribute to the participant’s account on behalf of eligible employees.  And, these employer contributions come in the form of either matching or non-elective amounts.

Safe Harbor 401k Plan Eligibility

Most any type of small business is eligible to establish and maintain a safe harbor 401k plan.  Sole proprietorships, LLC’s, partnerships, and corporations, including S corporations, are examples.

All eligible employees must be allowed to participate in the 401(k). An eligible employee is any one who:

  • is a minimum of 21 years old,
  • has performed one year of service and worked 1,000 hours in the year beginning with the date of hire.
  • Union employees and non-resident aliens without United States income may be excluded from participation in the plan.

One important thing to remember is that an employer may not establish more restrictive requirements than those listed above.  However, employers may set up less restrictive requirements for employee entrance into the safe harbor 401k plan.

Safe Harbor 401k Tax Benefits Tax Advantages

Employer contributions are tax deductible for the employer — up to 25% of compensation of all eligible participants.  Employee elective deferrals are excluded from the employee’s income for Federal Income Tax purposes.  Tax-deferred growth potential is possible — any investment earnings grow tax-deferred until withdrawn.


Vesting refers to the participant’s ownership rights in the value of his or her retirement account.  Often, a traditional 401k plan required participants to wait a certain number of years before they can access the employer matching contributions. 

However, a safe harbor 401k is unique in comparison to other types of 401k plans in that all employee and employer safe harbor contributions are fully vested immediately.  There is no waiting period for employees to access the matching contributions made by employers.

Plan Deadline

Generally, the deadline to establish a new plan is anytime between January 1 and October 1 of the applicable year.

Contribution Flexibility

Under a safe-harbor plan, an employer can match each eligible employee’s contribution, dollar for dollar, up to 3% of the employee’s compensation, and 50 cents on the dollar for the employee’s contribution that exceeds 3 percent, but not over 5%, of the employee’s compensation.

Alternatively, employers may make a non-elective contribution equal to 3 percent of compensation to each eligible employee’s account. Non-elective contributions essentially means that contributions are made by employers to employee accounts regardless of employee contributions. 

Plan Compliance Issues

Because of the vested matching contributions required of the employer, the safe harbor 401k does not call for broad discrimination testing.  The safe harbor employer contributions stand in the place of discrimination testing.

Employee Benefits

  • Attracting and retaining key employees is easier with a 401k plan.
  • A 401k plan can help in providing retirement income for eligible employees.
  • Elected Roth contributions are allowed in safe harbor 401k plans.

Early Withdrawal Penalty

A 10% penalty is typically applied to all early distributions on safe harbor 401k plans, as well as traditional 401k plans.  Early distributions are distributions that occur before the age of 59½.