Mutual Funds: The Greatest Crime Perpetrated to Humankind

“Why should you have to pay a fee when your portfolio actually declined in value?”

Written by Alex Vo, Contributor

You probably know someone who has money invested in a mutual fund. Maybe you have money invested into a mutual fund. And who wouldn’t, right? With benefits such as diversification, high liquidity, small up-front investments and professional management, it doesn’t seem like we need any more convincing. It’s a way where less wealthy people can get into the action of the stock market without having to check their stock prices on a daily basis. Your money is safe with a professional.

Or is it?

Investing in mutual funds is generally much more beneficial than leaving it in a savings account. That’s where the knowledge of it ends, while they pretend to understand what the mutual fund salesperson is saying to them.

Fees are the most obvious negative to mutual funds, as they easily eat into your returns. Management fees, for example, get paid whether the fund achieves a gain or a loss. If your job is to make money for other people, why should you be paid if you aren’t doing your job? Why should you have to pay a fee when your portfolio actually declined in value? Because of the recent economic downturn we experienced, you might have postponed your summer vacations. These people probably didn’t.

In addition to the fees, returns are not guaranteed. You will not know how much money you will gain or lose and the funds are not covered by insurance, as opposed to a savings account.

Secondly, they are not designed for short term investors. As many people know, stock markets go through a business cycle with ups and downs. Mutual funds are designed for long-term investors if they want to profit, as well as the fact that fees may be charged for liquidating them prior to maturity.

Third, mutual funds have tax consequences depending on an individual’s situation. You may still end up paying taxes from your mutual funds even if it loses money.

Furthermore, mutual funds cannot short sell and that is probably the most important fact to be aware of. This means that in a down-trending market, like the one we had recently, you will lose money. It will be inevitable. It is illegal for mutual funds to short stocks, which is when you profit when share prices decline.

How much do these “professionals” know anyway?

Most mutual fund holdings include businesses from the S&P/TSX 60 index. This means that an individual who would like to invest in stocks could purchase the index or create a portfolio similar to a mutual fund’s portfolio, without having to know anything about stocks. Less than half of Canadian mutual fund companies produce a higher rate of return than the index and therefore purchasing the index could be a much better alternative.

Anyone, even busy individuals who would like to invest, will be able to do so without a lot of work and avoid the expenses that come with mutual funds. ETFs (exchange-traded funds) are another alternative to mutual funds, but that’s a different topic on its own.

As a final point, diversification is useful for those who want to preserve wealth, hence those who have a large sum of money. Because of the expenses incurred when purchasing a mutual fund is percent based, it will cost a wealthy investor more money. On the other hand, less wealthy individuals don’t have the goal of preservation. They instead want to make capital gains.

There’s a saying in the mutual fund world. “Two out of three ain’t bad.” So, tell me, where’s the mutual in mutual funds?