The product cycle on Wall Street generally goes something like this: development of great idea, huge success of great idea, commercial exploitation of great idea leads to other ideas that are terrible for consumers. It's sort of like the typical s-curve of any new product -- but on Wall Street, it can often be shaped more like a middle-finger.

The active ETF is a perfect idea of a great idea leading to a terrible idea. Traditionally, exchange-traded funds have been index funds, and the thousands of different breeds allowed investors to track an infinite number of indexes and strategies without the high costs of hiring a fund manager.

Now Wall Street is trying to sell investors on actively-managed ETFs. Why? They can make more money that way by charging exorbitant fees for performance that is unlikely to be any better than an index, especially after fees and tax consequences.

According to Hedge Fund Research, the average hedge fund returned less than 13% last year, versus a 14% rise in the S&P 500. But it's important to keep in mind that hedge funds aren't necessarily correlated with a particular index, which makes benchmarking difficult. Hedge funds can go short, trade commodities and currencies, and all kinds of exciting derivatives. So it's hard to know whether the 13% average is good or bad -- some hedge funds take more risk than an index, others take less.

But I'd still rather invest in a hedge fund than an actively managed mutual fund. If there's one thing that you have to remember from economics, it's this: incentives matter. Hedge funds have a compelling reason to earn big returns: They often get to keep around 20% of the profits as a management fee (in addition to 2% of assets under management which can, sadly, give big funds with lousy performance big paydays). Mutual funds are compensated solely based on their ability to gather assets. If that seems bizarre, it is. It's like paying a an executive at a record label a flat fee for every musician that he signs. You don't need a PhD in Economics to figure out that that executive will focus on signing artists, not developing hits.

I'd be interested to see what would happen if mutual funds switched to a compensation structure based on returns rather than assets under management. There would be less focus on slick marketing, and more effort would be put into making money for shareholders.

Until that happens, I think your best bet is a passively managed index fund.

SEC Chairman Chris Cox called on the mutual fund industry to join him in the "war on complexity." Cox discussed the difficulties that investors have in comparing mutual funds using the SEC's Edgar Database. He also called for more disclosures about 401(k) fees and performance, saying that "We will continue to purge all the legalese and convert it to plain English. But getting rid of the gobbledygook is no easy task. But we want to give every investor the info to achieve sound investment decisions."

I'm highly skeptical about the odds of mutual funds making it easier for investors to compare expenses and performance because, if they did, most people wouldn't buy most mutual funds. If people had a solid understanding of mutual funds and the factors impacting their performance, pretty much everyone would buy the lowest cost index fund they could find. Needless to say, that wouldn't be good news for most investment management companies.

However, instead of complex disclosures and spreadsheets that 99% of individual investors really don't care about, I have a plan. Every mailing/advertisement/prospectus discussing a mutual fund should be required to contain a red piece of paper with the following:

DEAR INVESTOR:

Most likely, the mutual fund that is soliciting your business brags about its track record and its management team's expertise. As an investor, there's something you need to know: None of that matters.

Past performance, Ivy League credentials, and colorful promotional literature have very little impact on a fund's future performance. Here's what matters: The expense ratio. By keeping your costs as low as possible, you will beat more than 80% of actively managed funds.

Investment legends including Warren Buffett, John Bogle, and Burton Malkiel (to say nothing of Ben Stein and Suze Orman) have all said that most investors should stick with passively managed, low-cost index mutual funds. If the fund being advertised here does not fit that description, we strongly advise you to toss the mailing into your recycling bin.

Best of luck in your pursuit of wealth.

Your Friends at the Securities and Exchange Commission