| Many people think that investing in mutual funds is | | | | If a mutual fund makes money, both you and the |
| the way to go and the best method for getting | | | | mutual fund company make money. But if a |
| rich. I think mutual funds are horrible investments. | | | | mutual fund loses money, you lose money and |
| Here are 8 reasons why you should not invest in | | | | the mutual fund company still makes money. |
| mutual funds. | | | | What?? That's not fair!! Remember: the mutual |
| 1. Mutual funds don't beat the market. | | | | fund company takes a bite out of your returns |
| 72% of actively-managed large-cap mutual funds | | | | with that 1.3% expense ratio. But it takes that |
| failed to beat the stock market over the past | | | | bite whether you make money or lose money. |
| five years. Trying to beat the market is difficult, | | | | Think about that. The mutual fund company puts |
| and you're better off putting your money in an | | | | up 0% of the money to invest and assumes 0% |
| index fund. An index fund attempts to mirror a | | | | of the risk. You put up 100% of the money and |
| particular index (such as the S&P 500 index). | | | | assume 100% of the risk. The mutual fund |
| It mirrors that index as closely as it can by buying | | | | company makes a guaranteed return (from the |
| each of that index's stocks in amounts equal to | | | | fees it charges). You, the investor, not only are |
| the proportions within the index itself. For | | | | not guaranteed a return, but you can lose a lot of |
| example, a fund that tracks the S&P 500 | | | | money. And you have to pay the mutual fund |
| index buys each of the 500 stocks in that index in | | | | company for those losses. (Remember also that, |
| amounts proportional to the S&P 500 index. | | | | even if you do make a return, over time the |
| Thus, because an index fund matches the stock | | | | mutual fund company takes about half of that |
| market (instead of trying to exceed it), it | | | | money from you.) |
| performs better than the average mutual fund | | | | 6. Mutual Funds are unpredictable. |
| that attempts (and often fails) to beat the | | | | The holdings of a mutual fund do not track the |
| market. | | | | stock market exactly. If the market goes up, you |
| 2. Mutual funds have high expenses. | | | | might make a lot of money, or you might not. If |
| The stocks in a particular index are not a | | | | the market goes down (the way it is now), you |
| mystery. They are a known quantity. A company | | | | might lose a little bit of money . . . or you might |
| that runs an index fund does not need to pay | | | | lose A LOT. Because a mutual fund's benchmark |
| analysts to pick the stocks to be held in the fund. | | | | isn't a particular market index, its performance |
| This process results in a lower expense ratio for | | | | can be rather unpredictable. Index funds, on the |
| index funds. Thus, if a mutual fund and an index | | | | other hand, are more predictable because they |
| fund both post a 10% return for the next year, | | | | TRACK the market. Thus, if the market goes up |
| once you deduct The expense ratio for the | | | | or down, you know where your money is going |
| average large cap actively-managed mutual fund | | | | and how much you might make or lose. This |
| is 1.3% to 1.4% (and can be as high as 2.5%). By | | | | transparency gives you more peace of mind |
| contrast, the expense ratio of an index fund can | | | | instead of holding your breath with a mutual fund. |
| be as low as 0.15% for large company indexes. | | | | 7. Mutual Funds are sales items. |
| Index funds have smaller expenses than mutual | | | | Why don't all these money and financial magazines |
| funds because it costs less to run an index fund. | | | | tell you about index funds? Why don't the covers |
| expenses (1.3% for the mutual fund and 0.15% | | | | of these magazines read "Index Funds: The Most |
| for the index fund), you are left with an | | | | Obvious And Rational Investment!" It's simple. |
| after-expense return of 8.7% for the mutual fund | | | | That's a boring heading. Who would want to buy |
| and 9.85% for the index fund. Over a period of | | | | something that isn't exciting or that doesn't tickle |
| time (5 years, 10 years), that difference | | | | one's imagination of immense riches? A magazine |
| translates into thousands of dollars in savings for | | | | with that headline won't sell as many copies as a |
| the investor. | | | | magazine that boasts "Our 100 Best Mutual Funds |
| 3. Mutual funds have high turnover. | | | | For 2008!" Remember: a magazine company is in |
| Turnover is a fund's selling and buying of stocks. | | | | the business of selling... magazines. It can't put a |
| When you sell stocks, you have to pay a tax on | | | | boring headline about index funds on its front |
| capital gains. This constant buying and selling | | | | cover, even if that headline is true. They need to |
| produces a tax bill that someone has to pay. | | | | put something on the cover that will attract |
| Mutual funds don't write off this cost. Instead, | | | | buyers. Not surprisingly, a list of mutual funds that |
| they pass it off to you, the investor. There is no | | | | analysts predict will skyrocket will sell loads of |
| escaping Uncle Sam. Contrast this problem with | | | | magazines. |
| index funds, which have lower turnover. Because | | | | 8. Warren Buffett does not recommend mutual |
| the stocks in a particular index are known, they | | | | funds. |
| are easy to identify. An index fund does not need | | | | If the above seven reasons for not investing in |
| to buy and sell different stocks constantly; rather, | | | | mutual funds don't convince you, then why not |
| it holds its stocks for a longer period of time, | | | | listen to the wisdom of the richest investor in the |
| which results in lower turnover costs. | | | | world? In several annual letters to the |
| 4. The longer you invest, the richer they get. | | | | shareholders of Berkshire Hathaway, Warren |
| According to a popular study by John Bogle (of | | | | Buffett has commented on the value of index |
| The Vanguard Group), over a 15- or 16-year | | | | funds. Here are a few quotes from those letters: |
| period, an investor gets to keep only 47% of a | | | | 1997 Letter: "Most investors, both institutional and |
| cumulative return from an average | | | | individual, will find that the best way to own |
| actively-managed mutual fund, but he or she gets | | | | common stocks is through an index fund that |
| to keep 87% of the returns in an index fund. This | | | | charges minimal fees. Those following this path |
| is due to the higher fees associated with a mutual | | | | are sure to beat the net results (after fees and |
| fund. So, if you invest $10,000 in an index fund, | | | | expenses) delivered by the great majority of |
| that money would grow to $90,000 over that | | | | investment professionals." |
| period of time. In an average mutual fund, | | | | 2004 Letter: "American business has delivered |
| however, that figure would only be $49,000. That | | | | terrific results. It should therefore have been easy |
| is a 40% disadvantage by investing in a mutual | | | | for investors to earn juicy returns: All they had to |
| fund. In dollars, that's $41,000 you lose by putting | | | | do was piggyback corporate America in a |
| your money in a mutual fund. Why do you think | | | | diversified, low-expense way. An index fund that |
| these financial institutions tell you to invest for the | | | | they never touched would have done the job. |
| "long term"? It means more money in their | | | | Instead many investors have had experiences |
| pocket, not yours. | | | | ranging from mediocre to disastrous. |
| 5. Mutual funds put all the risk on the investor. | | | | |