Let's go into the details of why non-indexed mutual funds are such a bad deal. When Arthur Levitt became the head of the Security Exchange Commission in 1993 he had to sell off all of his individual stocks so that people would not claim that he was doing any dirty inside dealing. He decided to put the cash from selling off his stock portfolio into mutual funds.
Mr. Levitt grew very angry when he tried to decipher how particular mutual funds divvied up their cash into specific stocks. He couldn't make heads or tells from the fancy brochures of the mutual funds called prospectuses. He had been a major player in the stock brokerages for over 25 years at that point and knew that if he couldn't understand the mutual fund's prospectus then he knew public investors couldn't either; it had to be a big scam to suck money out of the public.
In 1980 the US public invested $100 billion into the 500 mutual funds that existed at that time. By 1993 the public put $1.6 trillion into the more than 3,800 mutual funds that existed in that year; talk about growth! By the end of February 2003, at the bottom of the bear market there were 8,200 mutual funds and the public had pumped in $6.3 trillion dollars. Wow! That is a lot of money. What is important to note is that at least 40% of mutual fund money comes in from 401(k) retirement accounts. Today these mutual funds own about 20% of all publicly traded shares of stock. Mutual funds act like a herd of cows buying and selling the same stocks at the same time. This increases the wild price volatility swings in the stock market.
These funds are also sold and managed on pure hype, short term trading, and with key information withheld from the public. All of these factors I teach finance students and investors to avoid! The industry confuses investors by focusing on past performance, which should not be a factor to consider. Many mutual funds are able to cheat the public with excessive fees because investors don't understand how these big costs destroy their profit. Mutual funds have no interest in educating investors because it is easier to hoodwink the ignorant!
Don't put your trust in mutual funds unless they are fully indexed. Indexing means that the mutual fund simply uses a computer to buy and sell stocks in the mutual fund portfolio so as to mimic the composition of a major stock market index like the S&P 500. This means that there is no fund manager sucking out needless fees. A good example is the first fully indexed mutual fund called the Vanguard 500 (VFINX) which is also now the largest of its kind.
ABOUT THE AUTHOR: Dr. Scott Brown, Ph.D., a.k.a. The Wallet Doctor, is a successful futures trader, real estate investor, and stock investor. Dr. Brown holds a Ph.D. in finance from the University of South Carolina. His 1998 articles in Technical Analysis of Stocks and Commodities were prophetic in predicting an impending stock market crash. He has helped many people become profitable investors by teaching them to look out over many years to spot stocks that are low and primed for rise in the new bull market. His second article met with approval by Dr. Bob Shiller of Yale University. Dr. Shiller is the economist that Alan Greenspan most highly regards who coined the term Irrational Exuberance. In 1998 he shouted to the world to get out of the stock market but now he is shouting to everyone that it is time to get in! The Wallet Doctor is not only sought after for investment advice and coaching in stock investing but also in futures trading and real estate investing.
Visit Dr. Brown's site at http://www.BonanzaBase.com or sign up for his investment tips at http://www.WalletDoctor.com
1 comment:
Tell me I am wrong Mr. Brown:
Indexed mutual funds are too tax efficient to be locked inside a retirement account such as a 401(k).
While the low costs (fees) are always attractive and can lead to more profits, all index funds are not created equal nor do they charge the same fees. Some make up for their low fee structure by charging the individual investor $3,000 or more to make an initial contribution - far more than anyone would suggest the average investor plunk down at any one time.
Mr. Levitt did have a great deal of trouble back in 1980. But the industry has come a long way since and while it has further to go, the journey is at least headed in the right direction.
Actively managed mutual funds are far better for the average investor than buying individual stocks for three reasons: they can offer diversity and research; they can offer the ability to purchase new shares without charging each time you do, and they take they mental maniac out of the investor experience - the one that wants to sell on the way down, buy on the way up and mostly fails at determining their own risk tolerance.
Yes, far too many funds chase the same stocks. But it is the ETF that causes the wildest, end-of-the-day trading and market gyrations - not mutual funds.
Most folks equate the failure of 401(k) retirement accounts on mutual funds when in fact, more folks were invested in their own company stock, often upwards of 50% of the portfolio and often because this was the only way to get the company to match.
The creation of so many mutual funds is a result of the mimic effect. Those 500 funds that were in existence in 1980, that grew to over 8,000 by 2003 were the result of marketplace diversification. They sliced and diced the markets down into ever increasingly specific areas. Yet you fail to mention the same sort of slice and dice market done by the ETF markets.
Now that the SEC is back in the hands of an administration that cares, I expect their job will be much more focused and far less scattered than it was over the last eight years.
Mutual funds, while not perfect are much better than they were and are improving all of the time.
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