Exclusive Interview: Prof. William Sharpe     Page 2

The dominant factors that tend to predict relatively strong future performance in order of importance:

"The growth/return side is very hard to predict, but costs are easy to predict," he said.

"It is important to understand that if you think that index funds will beat Treasury bills by 6% and you pay 1% in fees, then you have given away about 17% of the advantage of taking equity market risk," he said.

"Some people who are really superior could add enough value to offset the costs," he said. The trick is separating the truly superior from the simply lucky. "It's really hard to tell what the benefits will be."

"Don't expect much persistence," he said. "The one area where past performance is helpful is if the fund is really rotten -- usually due to high expenses." Abysmal performance tends to signal poor future performance.

"Increasingly you have to help people do the arithmetic," he said, such as "how much will it cost me if I pay 1%?"

This is one reason he founded Financial Engines, whose Web site at www.financialengines.com lets investors see how basic allocation decisions affect outcomes based on currently available data. In real time the site runs Monte Carlo simulations after putting in risk thresholds, expected retirement age, and other factors. The current service is directed at corporate 401-K plans where employees have a limited number of fund options, but additional services are planned.
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