My first investment was in mutual funds which is what most people invest in because the mutual fund industry is very effective at promoting its products. There is a certain sense of security knowing that everyone else is also buying mutual funds.
Unfortunately for the most part we have been sold a product that does what it says but does not deliver what you need.
Yes, mutual funds do invest in the stock market.
Yes, mutual funds do diversify the risk over hundreds of stocks but no, most mutual funds do not give you the returns you need.
Diversify and Die?
Mutual Funds will give you built in diversification. Some of them invest in entire stock market indexes, others invest into a combination of stocks and bonds, and some invest into other company mutual funds (which are called Fund of Funds, yikes!).
Diversification of your investment money is important. You should never put all of your money into one company. Because you have no control over how that company does or how other investors react to the company’s news, it is best to hedge your dollars by spreading the risk around.
Yet it is possible to over-diversify. Because mutual funds have so much money to invest, they struggle with finding good companies to buy. To keep to the rules of diversifying the portfolio, they cannot invest usually more than 5% of their assets in one single company. This results in lots of dollars being invested into companies you would never consider.
Mutual Funds have to buy lots of mediocre or bad companies because they need to diversify and do something with the billions of dollars they have. It gives the fund shareholders the impression that their money is being invested and the fund managers gladly charge you a healthy management fee.
Active Management is an Expense
Professional management of millions of dollars does not come cheap for most mutual funds. You can expect to pay 2% up to 8% for some specialized funds. These means that if you make 5% return, you would have actually have earned 8% if the Management Fee is 3%. That means that the Mutual Fund has to earn 3% before they can even pay you.
Dollar Cost Averaging is not a benefit if you are getting poor returns. Believe me, I invested consistently for fifteen years directly into various mutual funds. I bought over $125,000 in mutual funds with the biggest dealer and ended up with an averaged return of a criminal 2.05% a year!
It makes far more sense to contribute to a money market fund where there are no fluctuations and then use that fund to make your investment purchases.
Mutual funds do have the advantage of providing liquidity. You can sell and have your cash within a couple of days. But the question is begged why are you pulling out? Investment money is money you should not need right away.
Mediocrity is the Name of the Fund
The sad fact about Mutual Funds is that most them rarely beat the market. It is estimated that only 1.3% of American Mutual Funds will beat the S&P 500. Mutual Funds are investment products and should not be seen as a complete investing solution.
Mutual Funds that get 20% returns in one year have a poor chance of duplicating their results. Companies do a better job of providing consistent performance compared to MFs. If you buy a mutual fund that did well you have a greater chance of it doing poorly the following year.
But just like the stock market where most of them are not worth investing into, the same thing exists in the mutual fund industry. There does exist a small segment that does capture decent, but not market-beating returns. If you want to delegate some of your investment dollars to the responsibility of another, then mutual funds are the way to go. But when doing so, you need to lower your expectations.
The Best Solution: Take Control
If you want diversity protection, low management expenses, and equivalent to market results get Exchange Traded Funds. They should make up a decent portion of your portfolio. You can only get those by opening up a brokerage account.
But while you are opening up a brokerage account and doing dome research into Exchange Traded Funds, you might as well look into investing into stocks. It is only in the stock market where you can get market beating returns and stay way ahead of inflation and taxes.
Stop accepting the pale imitation of stock market returns through the veil of mutual funds. Invest directly and take control.