Greg Smith Missed the Point

I was fascinated by the enormous reaction to the op-ed piece in the New York Times by Greg Smith, a former executive director at Goldman Sachs. Apparently, it's newsworthy that the culture of Wall Street is "toxic and destructive." I agree with this response by Whitney Tilson, a Goldman client: "What's the next "shocking" headline: "Prostitution in Vegas!"?

It really isn't news that the securities industry is rife with greed and corruption. Goldman Sachs has a sordid history of being at the epicenter of this culture. It's not necessary to look any further that the 646 page report issued by the Senate Permanent Subcommittee on Investigations, which investigated the role Goldman Sachs played in the housing meltdown. The report found that Goldman misled clients and Congress about the firm's bets on securities tied to the housing market.

Carl Levin, the chairman of the U.S. Senate panel, wanted the Justice Department and the Securities and Exchange Commission to examine whether Goldman Sachs violated the law. He also said federal prosecutors should review whether to bring perjury charges against Goldman Sachs chief executive officer Lloyd Blankfein and other current and former employees. They denied under oath that the firm profited by taking financial positions against the mortgage market. Senator Levin was quoted as noting that "[I]n my judgment, Goldman clearly misled their clients and they misled the Congress."

With far less fanfare and little notice, Standard & Poors released its year-end 2011 S&P indices versus active funds scorecard. It again demonstrated an undeniable fact ignored by the financial media and unknown to most investors. Over the five-year horizon measured, a majority of active stock and bond fund managers failed to beat their designated benchmark. The results of this study were devastating:

--Between 70 percent and 82 percent of active funds were outperformed by their benchmark index for the five-year period ending December 31, 2011. The study looked at domestic stock funds, real estate funds, international stock funds, and fixed income funds.

--Between 61 percent and 86 percent of large-cap domestic stock funds, mid-cap domestic stock funds, and small-cap domestic funds were outperformed by their benchmark index over the same time period.

--Between 53 percent and 83 percent of active funds were outperformed by their benchmark index during the bear markets of 2008 and 2000 to 2002.

Greg Smith's message should have been: "I left Goldman Sachs because I could no longer tolerate deceiving clients by telling them that it made sense to engage in active management. A more prudent strategy would be to invest in a globally diversified portfolio of low management fee index funds, in an asset allocation appropriate for them."

The toxic environment described by Smith stems from the inherent dishonesty of brokers and many advisers who tell clients they have the ability to beat the markets and hide the overwhelming data demonstrating the probability that their clients would be better off in an index-based portfolio.

Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book, The Smartest Money Book You'll Ever Read, was published on December 27, 2011.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

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