Mutual Funds – Epic Fail

The mutual fund industry, reliant on unsophisticated and financially illiterate investors, just keeps chugging along without a care in the world.  And why should they care… after all, employees keep dumping their savings into their products, hoping to save for a grand retirement, ideally aged 60-65.  What a sad state of affairs!

Let’s explore some high-level facts:

1.    “Mutual funds are managed by expert, licensed, investment professionals.”   

While "expert" may be true for the guy at the top of the pyramid, it is only half-true for everyone else responsible for investing… aka as taking… as much of your hard-earned cash as possible. They're all obviously licensed... and "investment professionals" is a debatable designation.

Generally, the expert guy (yes, it’s usually a guy, and yes, he’s been raking in fees for his employer for a long time) at the top of the food chain has achieved outstanding returns in terms of fees generated for his employer.  A required, and a primary, expert skill.  That is, expertly managing and raking in fees for the company he works for, while expertly delivering some ideally positive returns, to the simple and poor saver, who is diligently contributing to his or her 401k.

While it is true and possible – occasionally – that mutual fund ‘investors’ achieve a nice return, most of the time the mutual fund under-performs the stock market.  But, you may say, my mutual fund is invested in blue-chip stocks, like $AAPL, $GOOG, $MSFT, etc.  That is true as well, and the difference in the returns achieved by these companies and the investment return on your mutual fund portfolio was gobbled up by your Mutual Fund Company and its employees.  The fees are generally referred to as the MER, which stands for Management Expense Ratio.

2.    “Mutual Funds are managed, that’s why they charge me a fee.  It makes me feel safer, knowing I have a professional managing my portfolio.”

Not really, mutual funds are required to publish a prospectus, showing investors exactly what/where they invest contributions into, for example as per the equities mentioned above.

Most mutual fund companies are fabulously inefficient and/or slow (or both) when it comes to actually managing the investments in their prospectus (i.e. your portfolio).  They mostly just buy and hold good stocks.  That’s why, when the stock market tanked in 2008/9, mutual funds tanked along with the stock market, because that’s where they invest!

In reality, you could simply copy the top-10 investments in their published prospectus, thereby building your own index of funds, cherry-picked by their “professional and expert team of advisors.”

3.    "Mutual funds simplify my investment choices, and mitigate my investment risk.”

What rubbish!  Simplify... yes.  Mitigate risk... absolutely not!

Firstly, saving for your retirement is a good thing, because government hand-outs are rapidly becoming a thing of the past.  The problem is more mathematical (or actuarial to be more specific) than political, mainly because people are living longer. The social systems in place since the 50’s were designed along the same lines as any insurance company’s business model: “contributions of many pay for the losses of few.” 

Back to the comment above about investment choice and mitigation of risk: On Friday (7/12) the Dow closed up 18.1% YTD.  Let’s imagine you are close to 50 years of age and you plan to retire around age 65.  For your employee 401k contributions, you selected the American Funds 2030 Target Date Retirement Fund^® $RBETX. 

At the time of writing, $RBETX is up 12.64% YTD… quite a delta between “the market” and this fund.  Why?  Poor fund management, fees, coupled with an inability to move as fast as e.g. a smaller investor, between different investment vehicles. 

I am not advocating that you stop making contributions to your 401k!  In fact; quite the opposite is desirable.  You should maximize your contributions to maximize your employer contributions.  If all your employer’s 401k allows is a basket of mutual funds to select from, you should still maximize your contributions in order to receive the employer contributions.  The generally poor returns and fees attached to your mutual fund choices will be topped-up by the additional money from your employer… possibly delivering a more competitive, market-related performance for your investment, overall.

Outside of your 401k, first get rid of your debt (especially expensive, short-term loans like credit cards) and then stay away from mutual funds.  Invest in ETFs (similar investment to a mutual fund, but lower fees), or ideally... build your own index of good quality equities, and hold these investments while reinvesting dividends!

Happy trading… and get onto a path to wealth creation asap!