In case you haven’t noticed, I don’t like mutual funds. They don’t offer the wealth building power many people seem to think. But I’m not the only saying this. If you want to see a somewhat shocking realization, checkout this linked video.
In the video, the presenter takes 50 years of S&P 500 historical data, and examines what would happen if you invested money at the get-go. It shows how an average rate of return may be 7.4%, but you are only getting a 6% of actual return.
But it doesn’t stop there. The presenter plugs in a 2% annual fee, which is pretty standard combined with a 28% tax bracket. That leaves a paltry 3.1% actual growth rate. To summarize, he shows that if you started with $1000, the market would have grown it to about $18,000. But with fees and taxes, it gets knocked down to a little over $4000. Can you imagine someone else taking $14,000 out of your $18,000? It’s ludicrous! That’s swiping 78% of your total growth. Who wants that?
Let’s look at a column written by someone that tried to get into the mutual fund business as a fund manager, but seemed to have trouble. It’s ripe with examples of all the fallacies that go into mutual fund management. For one thing, there is a real lack of innovation. This guy had some new ideas, realized by his career, but were considered too radical to get hired as a fund manager. Instead, he points out that they seem to prefer hiring straight out of business school. It brazenly points out that mutual funds are aimed at making their money in fees, not gains in the market. That’s right. They would rather rope in lots of clients so claim their fees rather than earn you money. The fund he looked at getting hired for had high fees and low results, yet still had buyers. The hiring manager’s response was kind of like, “why change it? It works.” Mutual fund managers are driven by selling their fund and making money, not on earning good results for you. The final point (and I can’t list them all) is that mutual fund managers think they really know what is going on inside companies. The truth is, they don’t. Mutual funds usually have holdings in 100-200 stocks. There is no way they really have the time to sit down and read every press release, every financial statement, and every balance sheet for that many stocks and keep up. So instead they rely on other things like technical fundamentals, charts, and other outputs. Essentially, they think that by monitoring some basic indicators, they think they can time the market just right and do better than everyone else.
This might surprise you, but study after study shows that actively managed funds lag their relative indies all the time. Read this column about the Myths of Mutual Funds and you will see more proof. For example, from 1984-1998, only eight of 203 mutual funds that exceeded $100 million in assets actually beat the the Vanguard 500 index. That is a 4% chance of success. What’s even more amusing is how this author points out that getting dealt two face cards and shouting “Hit me!” has a higher chance of winning. Yikes!
A quote from David Swensen, who grew Yale’s endowment from $1.3 billion to $14 billion at an average annual return of 16.1%, says, “Overwhelmingly, mutual funds extract enormous sums from investors in exchange for providing a shocking disservice.”
Mutual funds are definitely not the way to build retirement wealth. Instead, they are they way to sponsor an MBA.