Kimber made a post about why Mutual Funds Aren’t for Losers, which was a good article and I see her point of view, however, in this case, I thought I would show the other side of Mutual Funds, which, in my opinion, suck to the point where vacuums should be named after them, or maybe they could rename the Chicago Cubs the Chicago Mutual Funds.

First problem is, they are overly diversified, bringing your risk down, but also bringing down your profits. Hugely bringing down your profits. Bringing down your profits to the point where you have to wonder why you bought it in the first place. You’re essentially saying, “I don’t care what I get, as long as I get something. Sometime. Maybe.” According to the Christian Science Monitor:

The average US diversified equity fund grew 6.7 percent in 2005, the third upside year in a row, according to fund-tracker Lipper Inc. “

I’m sorry, but 6.7% returns, on average, just isn’t good, no matter what the freaks on CNBC say and if you consider beating a risk-free CD by a measly 2.2% an ‘upside’, that’s pretty sad.

Secondly, you can’t trade them when the market is open. I know this goes against my strategy of only trading on weekends, however, if the world is ending, I want to know I can get out. You can’t get out with Mutual Funds.

Thirdly, the mutual funds are stuck at a limited percentage each stock can be within their portfolio. Let’s say Amgen finds a cure for cancer tomorrow. Can the mutual fund capitalize on this? Barely. You’ll be screwed watching everyone buy Amgen and seeing it go through the roof while the mutual fund sits with approximately 20% of their assets in the rocket ship and the rest in sinking stocks and you can’t even sell your mutual fund shares until the market closes to get the cash to jump on the bandwagon.

Fourthly, you pay taxes on trades you don’t make. You’re still invested in the fund, yet you pay taxes on the trades! Heck, in a mutual fund you can lose money for the year and still pay taxes because the fund could have had positive trades for some stocks and losses for others. It depends what year they sell the stock. (IE: if they buy a stock in 2000 for $10, it goes to $30 in 2001 when you buy the mutual fund, and then drops to $25 in 2002 and they sell that stock, you pay capital gains on $15, even though your fund lost $5 since you bought into it.) Not a good plan and not a good unexpected bill you have to pay at the end of the year. I’d rather take profits from my stock trades, set aside 25% of the profit for capital gains and know it’s there, or just hold my stock and not pay taxes until I feel like it or, better still, sell my stocks in January and invest my tax money for 16 months before I have to pay the capital gains on the sale. In any of the scenarios, if I’m trading stocks or Exchange Traded Funds, my taxes come out of the profits I’ve made, not out of my cash at hand.

The fifth reason they suck are the fees. Fees here, fees there, tons of hidden fees, added fees and for what? To pay a guy a million dollars a year to not beat the market? A big waste of money.

The sixth reason why they suck is they rarely beat the market. To quote our good friends over at Motley Fool:

“On the whole, the average mutual fund returns approximately 2% less per year to its shareholders than does the stock market in general. ”

and on the Smith Business website, in an article saying how great Mutual Funds are, they quote Motley Fool too:

About three-fourths of all managed mutual funds underperform the stock market’s average return, according to investor-run Web site “The Motley Fool.”

That essentially means, you’re better off buying Diamonds (DIA) or Spyder (SPY) (disclosure, I have SPY and MDY, which is the mid-cap index, as my ‘safe money’ investments), than to buy a mutual fund.

92 Million people currently own mutual funds, but how many people do you know who are invested in mutual funds say anything overly positive about them? Sure, when the market booms, things look swell, but realistically, over time, mutual funds don’t make people extremely wealthy, if they did, we’d have about 92 million millionaires saying how great mutual funds are and that’s simply not the case, not to mention all of the top traders trade stocks, not mutual funds, and I can show you dozens of people I know who have watched their mutual funds sit and do nothing or next to nothing while active traders killed the market consistently. Way back in 2003 I wrote an article over at my Undertrader.com site about dollar cost saving and buying ETF’s instead of mutual funds. If you had purchased Spyder (SPY) on the day of that article you’d be up $28.22 a share or 25.7% in 3 years and if you had bought the Mid-Cap (MDY) that day you’d be up $38.94 or 37.2% in 3 years and that’s without anyone managing anything, just a straight index.

Sure, it’s pretty swell that you can get percentages of shares in Mutual Funds and sure it’s cool that you’re instantly diversified, (which I don’t think is necessarily a good thing), however, an ETF is so much better than Mutual Funds that it’s not even a competition. It’s like Carl Lewis racing Emmanuel Lewis and individual stocks are like Carl Lewis racing Jerry Lewis.

If you only have $25 a month to invest, which is great and I applaud the effort and it’s a great start, I would rather you buy individual stocks from Sharebuilder and pay the $4 fee than to buy a mutual fund. In the long run you’ll learn more, you’ll come to grow and understand at least one specific company and it’s stock, and you’ll be investing on your own instead of letting some millionaire schmuck in a suit do it for you.

Invest in peace…

Now that is a complete article. Made points, supported by quotes, examples , math. YOU ROCKED IT!! But the question remains now, what do you suggest for a casual investor? You trading stocks obviously you are a “active” investor.

J Dawg

If you only had $25 and a knowledge of investing, then sure, take a shot at stock picking.

However, starting out, I had neither. At the time, I had no problem earning only 6.7% while trying to figure out why fund managers bought and sold the stocks they did.

The reasons that I don’t like mutual funds are very similar to yours (especially the part about the cap on ownership).

I also think that the sweet spot between a stock being a pure spec penny stock and a stock deemed worthy of institutional investor notice is the best place to be.

I recently decided to open an account to actively trade some stock. Not much, but enough to have some fun. There is a time and place for trading stocks. Your personality will drive your decision more than anything else.

So, Spyder had a 8.56% annual gain for the last three years and MDY had a 12.4% annual gain. My grandma bought me 100 shares of a mutual fund as a gift one time… and I just did some math. Since 1998, its had an 11% average annual increase. I’ll take that.

“About three-fourths of all managed mutual funds underperform the stock market’s average return, according to investor-run Web site ‘The Motley Fool.'”
That means that one-fourth at least match or outperform the stock market’s “average return.” Maybe I got into that lucky quarter.

Wonderful article, don’t know if you answer your comments, but I was wondering what you would recommend a college student to do? Faithfully, and slowly learn and invest in stocks? How did you start out as an investor? I would like to be an active trader, and I know there are resources out there, but how do I crack it? Any good advice on how to get the ball rolling? Email me if you don’t answer posts on your blog!!

Hey sophomore,

Well, first thing I’d do is pay off all of my debt. No credit card bills, no car payments, nothing. Put 100% of your money into becoming debt free.

Then it would depend on how much income you have. If you have a relatively low amount to start with, I’d check out http://www.sharebuilder.com and start with one company you like and just trade that for awhile. Over on my site http://www.undertrader.com I’m doing some posts about the best investing books I’ve ever read. I’d pick up those books and check them out. Won’t cost you too much and if you just get them at the library it wouldn’t cost you anything.

It seems like you want to be a hands on trader, which is great! Don’t let those jackasses in the suits play with your money! The best advice I can give you is stay out of debt, pay cash for everything and put as much into savings as you can every month and read everything you can get your hands on for a few months and then practice trading on paper. Just practice until you come up with a strategy that works for you. Once you’ve gotten the kinks out of your strategy on paper, then use real money.

Even as an active trader I still put 20% of my money into two ETF’s which are SPY and MDY as my ‘safe investments.’ That’s probably a good place to start as well.

Good luck!

Invest in peace…

Steve,
Very good article. I believe that Mutual funds are not the fastest way to riches, however, it may be a good option if you are not very Market savvy or have very little amount to invest.

If you have a decent nest egg to splurge, well there are more than enough options to give you all sorts of returns, subject to your risk appetite. Show me 100k you have to invest, I will show you over 13% ROI, fixed rate of return. So that will beat all the mutual funds and most CD’s.

Please, i will be pleased if you can put me through. I’m from africa and i will like to invest in foreign companies. Please i need an advise. Thanks

I know this is a old article, but it still holds true in 2010. I just sold my mutual funds as I am tired of losing my hard earned cash. I can do much better investing on my own!

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[…] Day Old Bread – Odds and Ends 10/1/08 I am frequently asked by friends if they should jump into a mutual fund.  I tell them, “Not only NO, but hell no.”  You’d be better off jumping in a river.  You’d get refreshed and it wouldn’t cost you anything.  Why do I hate mutual funds?  They suck, that’s why.  Steve at InvestorGeeks wrote an article on it two years ago.  It’s all still true. […]