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…