How to Win with Mutual Funds

In our last post we talked about different ways to invest in cash, bonds and stocks. For stocks and bonds these included individual investments as well as mutual funds and ETFs. In this post we’re going to dive deeper into the world of mutual funds. Boring you say? If you want to be a successful investor, please read on to learn how to win by investing in stock and bond mutual funds!

As we talked about last time, mutual funds pool investors’ money together. These funds are classified as either actively managed or passively managed. In active management, a fund manager tries to find investments they think will go up in value. Passively managed funds in contrast just follow an index (they are usually referred to as “index funds” like the S&P 500 for example).

Index Funds versus Actively Managed Funds

Wouldn’t it seem obvious that investment professionals with years of training and experience should be able to beat “the market”? Shouldn’t they give you better returns than index funds? Unfortunately that’s not been the case. According to The Wall Street Journal:

  • Only 43 percent of active stock funds beat passive funds for the 12-months ending June 30th 2017.

 

  • That was better than the 12-months ending June 30th 2018 when only 36% of active stock funds beat their passive competitors.

 

  • In a future post we’ll talk about stock capitalization (or “market cap”). For now think about stocks as large company, mid-size company or smaller company. In the five years through 6/30/17, 82% of large-cap managers, 87% of mid-cap managers and 94% of small-cap managers all underperformed their respective indexes!

 

And longer comparison periods look even worse for active managers versus passive index funds. So, can I say this again? Yikes!

There are really good reasons why active fund managers underperform their passive counterparts.  Our next post we’ll take a look at these reasons. But for now, the facts speak for themselves: As a group, active mutual funds have underperformed their passive competitors. And for a long time.

That isn’t to say there aren’t managers that can beat the market. There are! But there are two big problems with this: first, a manager has to beat the market by their investing skill (or luck) and second is YOU have to be able to find that manager. Which means that out of the 9,356 mutual funds in the U.S. in 2017 (according to statista.com) you have to be able to find the one(s) that can beat the market. Better to go with a passive index fund in the first place.

 

Coins in increasing amounts with soil and sprouting plants

Ways to Grow Your Investment Dollars Through Mutual Funds

No-Load versus Load Mutual Funds

There are also mutual funds sold as “no-load” and “load” funds. Here’s the easiest way to remember the difference: No-load funds don’t charge you sales fees, while loads are sales commissions. Typically, load funds have “share classes” and the classes can come with a dizzying bunch of terms like Class A shares, Class C, Class F4 and so on. And keep in mind: this means the same fund, with the same investments can have multiple of these different share classes!

Do you find this confusing? You should. The effect of these different classes means it’s nearly impossible for just about anyone to calculate how much they’ll pay in management costs to own different classes of the same fund. So, in my (and many other peoples’) opinion – these different share classes aren’t for your enrichment, but for the fund company that’s trying to sell you the funds.

And the fees (remember as a “load fund” they are sales charges) come out of the funds you invest. So you’re paying for the privilege of investing. Some are up front loads and some are deferred (not charged until you sell the investment). Let me give you an example of how the math works:

If invest $10,000 and you’re paying a 5.75% sales up-front load, you end up paying a $575 sales commission. This means that of your original $10,000, you’re only investing $9,425. So please make no mistake: this means that from the start you have lost 5.75% of your hard-earned investment dollars.

OK, But Aren’t There Good Load Fund Managers?

Like actively managed funds, this doesn’t mean that there aren’t talented managers of load funds. What it does mean is that when investing in these funds, you are already starting with a loss of your investing dollars from day one due to sales fees. Not paying the sales fees up-front, for a different share class? Whether up front or deferred, you are, in the end, paying higher fees in order to invest in a load fund.

So, in every case that I can think of, please stick with no-load, passive mutual funds.

OK, I’m not trying to make you angry or righteously indignant. There’s no reason for that because there are investments that are structured to work in your best interest. These are, again, passive, no-load index funds.

But if you do want to get angry you should tune in to my next post. Because I’m going to drop the F-Bomb! You’re won’t want to miss it!

In the meantime, if you like these posts please drop me a line at andy@andyproctor.com. And better yet, drop me a line and then pass this post on to a friend or two who you think may benefit from these insights!

Till next time!