“Did you know that mutual fund sellers have their own saying? It goes something like, “Two out of three ain’t bad.” To explain, the two are the mutual fund seller and the manager, who always profit. The person at loss is the mutual fund purchaser”
By Alex Vo, Contributing Blogger
From Vo Industries
Mutual funds are the greatest crime perpetrated to mankind. Theoretically, they should like great investments. It came with benefits such as diversification, high liquidity, small up-front investments, and professionals investing it in the stocks they believe will do well in the future. Mutual funds are a way where less wealthy people can get into the action of the stock market without having to read the newspaper on a daily basis and have a large sum of money. Statistics also showed that there has been a significant increase in investments in mutual funds in Canada and the United States. “If other people are doing it, I should too,” may be your thoughts.
Many people know or believe that investing in mutual funds is 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.
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.
Firstly, the acquisition costs, also called the load, are the commissions paid to the mutual fund brokers. This may either be up front (front-load) or when the shares are sold (back-load). For front-loads, the fee is paid at the time of the purchase. This commission rate may be as high as 8%, but it is usually negotiable. As for back-loads, the fee is determined when you redeem your “unit” purchased from the mutual fund agency. The earlier you redeem your unit prior to maturity, the more commission you will have to pay. Already, you can see a counter for one of the benefits; high liquidity. Although they may be liquidated easily, you will have to pay for the fees incurred and thus cutting into your potential yield. There are mutual funds which can be purchased with a “no-load option”, but over the long term it can decrease your returns due to additional management costs which are covered next.
Management costs—all mutual funds charge them, but a lot of people are unaware of them. These costs cover the wages and bonuses of the fund managers. These fees are already deducted from their quoted expected rate of return and hence why some people do not know about them. If you bought units in a mutual fund with total assets of $4 billion (which is likely, as RBC Asset Management Inc., the largest mutual fund company in Canada, has assets of over $44.1 billion) that charged a management fee of 2%, the fee for that fund would be $80 annually. This amount is paid whether the fund does well or not. In these times of economic instability, you may be postponing your summer vacations this year. However, these people will not, hence why it is another reason of why mutual funds are a crime.
Last but definitely not least, there are trailer costs that are incurred in the investment of mutual funds. Trailer costs are annual “service commission” fees paid by the mutual fund company to your sales representative. These fees range from 0.25% to 1%, which will compensate for answering your questions, if you had any, and advice. It does not come out of your pocket, but this fee is very important. You need to know if your sales representative is receiving a trailer fee because he or she may not be trying to sell you a particular fund because it is a good investment with a high rate of return, but perhaps it will gain more income for the representative themselves. This obviously should be illegal, but it is impossible to enforce. Once again, another reason of why mutual funds are a crime.
All of these fees, and many others, cut into your potential gain on your investment. However, there are other reasons why it can be considered a poor investment. On top of these fees, there are other disadvantages that are significant.
For one, 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. Therefore 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 a share price goes down. Lastly, the sales representatives are human. Some human individuals are greedy and will do whatever it takes to benefit themselves as opposed to you. They may also make mistakes which has happened many times in the past and therefore can jeopardize your life-savings, depending on how much you invested.
How much do these “professionals” know anyway? Most mutual fund company’s 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 the Canadian mutual fund companies produce a higher rate of return than the index and therefore purchasing the index is 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. They are a whole topic on its own, so I will be covering this on a different day.
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 occurred when purchasing a mutual fund is percent based, it will cost a wealthy investor more money. On the other hand, diversification will not benefit an investor not as wealthy that greatly.
As evident throughout this, I believe that mutual funds are a crime. It is also an act of being treated unfairly. Do you currently own mutual funds? Do you agree or disagree with my point-of-view? Let me know via comments!
Oh by the way, did you know that mutual fund sellers have their own saying? It goes something like, “Two out of three ain’t bad.” To explain, the two are the mutual fund seller and the manager, who always profit. The person at loss is the mutual fund purchaser.
By Alex Vo, Contributing Blogger
From Vo Industries
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