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CHAPTER 14 CASE C-1
CHAPTER 14
YOUR 401k ACCOUNT AT EAST COAST
YACHTS
1. Before the fact, you would expect that mutual funds managers would be able to outperform the
market. This is due, in part, to the Darwinian nature of the business. Good performing fund
managers are richly rewarded, and poor performing fund managers are fired, often very quickly. In
reality, we should expect that less than 50 percent of all equity mutual funds would outperform the
market. This does not depend on the level of market efficiency. Consider the following question:
What percentage of investors will outperform the market in a given year? Answer: Fifty percent.
While there could be one really poor investor who takes all of the losses in a given year, in general,
We should also consider that mutual funds managers may be able to outperform the market before
expenses. Whether they can outperform the market on an after-expense basis becomes a question of
whether mutual fund managers can extract economic rents from the stock market. The evidence
2. The results in the graph tend to support the idea of market efficiency. Consider the case of the
Fidelity Magellan Fund, one of the largest actively managed equity mutual funds at the time this was
written. The total assets of the fund at the time this was written was about $22.4 billion. So the
question is this: What would Fidelity pay for one year to increase the return of the Magellan Fund by
.01 percent? If we multiply the fund assets by .01 percent, we get: $22,400,000,000(.0001) =
CHAPTER 14 CASE C-2
3. Given that the evidence presented tends to support market efficiency, you should invest in the S&P
500 index fund. However, this is not the entire answer. By investing the entire equity portion of your
account in the S&P 500 index, your portfolio is not diversified since the S&P 500 index includes
