Why Mutual Fund Investing May Not Make Sense
Kenneth L. Fisher is a featured columnist at Forbes magazine. In a recent column, he explained why it is that he hates mutual funds, and he makes good sense!
The original purpose for mutual funds was to provide a professionally managed portfolio to serve those with too little to diversify on their own. A fund is a good tool for someone with only $50,000 to invest in the market. Anyone with greater assets to invest should be buying stocks directly.
What's wrong with mutual funds? Start with performance. Over the long term the average fund in pretty much every category has fallen short of the S&P 500 index or whatever other benchmark is relevant. Yes, there are some winners, duly publicized in fund surveys, but you don't know about these in advance. Published numbers, moreover, overstate average results experienced by investors, because loser funds disappear.
Next problem: costs. The average expense ratio for the U.S. equity funds tracked by FORBES is 1.23% a year. Foreign funds cost an average 1.46%. Then there are sales charges, (both upfront and imposed on redemption), plus all sorts of hidden costs. Funds can legally overpay brokers for commissions and then get kickbacks in the form of "soft dollar" services like free research (which the fund management company should be paying for out of its own pocket). The other trading cost is the spread between bid and ask prices. For a fund that trades heavily and owns stocks in smaller companies, portfolio transaction costs could easily add a few percentage points to your annual cost burden. Add it all up -- the sales loads, the published expense ratio and the invisible transaction costs -- and you could be spending 4% a year to have your assets in a mutual fund.
Costs can be minimized in an index fund, but then there's a third problem: taxes. Funds cannot pass through losses to their shareholders. Say you have $1 million in the market and you earn 9% or $90,000. Maybe you have $130,000 in appreciation on winning positions and $40,000 in losses on the other stocks. If you own these stocks directly, you can switch out of just the losers and use the $40,000 loss against other capital gains. But if the stocks are tucked into a mutual fund, you're walled off from the $40,000 deduction.
There is an interesting book entitled, Stop Wasting Your Wealth in Mutual Funds by the author, Don F. Wilkinson, and published by Dearborn Trade Publishing. The first 35 pages of this book are worth the price of the book!
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The original purpose for mutual funds was to provide a professionally managed portfolio to serve those with too little to diversify on their own. A fund is a good tool for someone with only $50,000 to invest in the market. Anyone with greater assets to invest should be buying stocks directly.
What's wrong with mutual funds? Start with performance. Over the long term the average fund in pretty much every category has fallen short of the S&P 500 index or whatever other benchmark is relevant. Yes, there are some winners, duly publicized in fund surveys, but you don't know about these in advance. Published numbers, moreover, overstate average results experienced by investors, because loser funds disappear.
Next problem: costs. The average expense ratio for the U.S. equity funds tracked by FORBES is 1.23% a year. Foreign funds cost an average 1.46%. Then there are sales charges, (both upfront and imposed on redemption), plus all sorts of hidden costs. Funds can legally overpay brokers for commissions and then get kickbacks in the form of "soft dollar" services like free research (which the fund management company should be paying for out of its own pocket). The other trading cost is the spread between bid and ask prices. For a fund that trades heavily and owns stocks in smaller companies, portfolio transaction costs could easily add a few percentage points to your annual cost burden. Add it all up -- the sales loads, the published expense ratio and the invisible transaction costs -- and you could be spending 4% a year to have your assets in a mutual fund.
Costs can be minimized in an index fund, but then there's a third problem: taxes. Funds cannot pass through losses to their shareholders. Say you have $1 million in the market and you earn 9% or $90,000. Maybe you have $130,000 in appreciation on winning positions and $40,000 in losses on the other stocks. If you own these stocks directly, you can switch out of just the losers and use the $40,000 loss against other capital gains. But if the stocks are tucked into a mutual fund, you're walled off from the $40,000 deduction.
There is an interesting book entitled, Stop Wasting Your Wealth in Mutual Funds by the author, Don F. Wilkinson, and published by Dearborn Trade Publishing. The first 35 pages of this book are worth the price of the book!
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posted by Bob Moser at
7:56 PM
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