Investing in mutual funds has been promoted to the average investor for a few decades now, as a way to get into the market without having to know how to buy individual stocks. Yet when the market tanked, both in 2000 during the crash of the dot-com debacle, and in 2008 due to the big investment banks playing games, the average folks with mutual funds didn’t do so well. In the best case, you may be back to where you started, if you started investing in mutual funds ten years ago. In fact, if you run a screen of “top” funds based on Morningstar ratings, you’d be hard pressed to find any fund that did better than 8% returns average for the past ten years.
So where is this mythical “good growth stock mutual fund” that you hear people like Dave Ramsey talk about? Good luck finding one. First, there is no such thing as a “good” “growth stock” fund. What does the word “good” mean here? High returns? Safe? Investing only in “good” companies, whatever that means? If good companies were easy to find, Warren Buffett would not be famous. The fact is, when you are choosing mutual funds, you are going to be subject to lots of information that is under the radar and impacts your returns, your earnings, and your safety. While you don’t need to pick individual stocks, if you don’t know how mutual funds work, you will be risking your money in an investment you know nothing about.
For example, when talking about a “growth” stock, this often means a mid-cap or small-cap stock. What does that mean? It means these are smaller companies compared to the biggest most stable corporations, which are large-cap. “Cap” refers to the capitalization, or assets, that the company has outstanding in stocks held by its investors. Companies like McDonald’s or Microsoft are large cap. But mid- or small- cap companies may have higher risk, that does lead to higher returns, but also possibly more losses. Only you can decide what level of risk is right for you. Are you prepared to learn enough about what a mutual fund invests in to be secure in giving the fund your money?
And fees. This is the big piece you never hear of. (For example, is Dave Ramsey talking about 12% after fees? If so – that would be a miracle.) There are fees to buy in to a fund in some cases, but not all, known as a “load”. This means you pay a percent of your money up front just to buy shares in the fund. Then there are annual management fees, known as 12b-1 fees, which are a percent of your total investment in the fund. Then there are fees when you decide to sell and get out of the fund. And then there are taxes. A mutual fund buys and sells stocks, and each time they do, there is, or could be, a tax ramification as many of these sales might be at high capital gains rates. You receive the bill for those taxes. On top of all these fees, you may be paying your broker a commission to buy into the fund. What does your broker charge to “help” you buy these funds? Is there a per fund, per purchase, or annual fee, or all of the above? Some discount brokers offer “no load” funds, meaning you don’t pay a load, and since you manage your own account, you are avoiding the broker commission. But you could be paying management fees and taxes anyway.
How do you learn enough to buy into mutual funds? It is not easy, and it never has been, despite how it has been sold to the average investor. You still need to learn about investing, about the market, about what companies are good investments, and you need to read and understand the prospectus, or detailed brochure, about any fund you think you want to buy into. For this reason, it’s a joke to think that the average investor can just go down to the local brokerage office, plop their money on the table, and say “Give me some o’that good growth stock mutual fund” and walk away twenty years from now having earned 12-14% average returns. It just does not happen. Even one of the top mutual funds in the country, with the lowest fees, Vanguard has NO index funds that earned better than 8.60% over the past ten years. You can earn high returns only if you have a lot of money to invest, are investing in something in addition to stock mutual funds, and can afford a very good high-paid broker who will charge you an arm and a leg. Heck, it’s even been shown now that hedge fund managers do better than the rich hedge fund client they supposedly serve. There’s little likelihood you’ll do better if you are investing only five or six figures.
OK, so given all of the above, what are your options? Our take: Don’t invest in mutual funds unless you learn more about them. And the best idea right now is – don’t even buy mutual funds! WHAT? you might say. If you have been invested in mutual funds, you might think instead not of being in cash, but of investing in Exchange Traded Funds instead – called ETFs. These are a great – and lower cost – alternative to mutual funds. We’ll post again about this shortly, in the mean time, get those prospectuses and start reading!
