I could write about why I hate mutual funds every day for the rest of my life and , I swear, I would never run out of material. At 58 years of age, and assuming I make it to my 70th birthday, that's only 4,380 posts - Not a big stretch, since the market and investors continue to provide a never-ending supply of new blunders five days a week. I hate mutual funds so much that I started this blog to push back against the dominating trend in the financial services industry over the last forty years, a ludicrous David to their entrenched and very well-compensated Goliath.
Hating mutual funds is not smart. They serve a valuable purpose. Most people don't like to think about their money because it makes them nervous. Besides, I made a very nice living for many years because I like to think about it and was more than happy to do it for my clients. Used appropriately, professionally managed portfolios can be very useful.
Of course I'm hardly alone in my skepticism about funds. The financial media sells a lot of advertising trash-talking problems in this investment class: funds often have high expenses, advisers get paid big bucks for recommending particular funds, money managers can change without warning, etc, etc, etc. But today I'm going to highlight the Number One reason it's so much harder to get rich using mutual funds.
You.
The average mutual fund investor is horrible at deciding which funds to purchase and when to buy and sell them. This is a very consistent, well-documented pattern.
As of October 26, 2012 the S&P 500 had gained more than 14 percent in
2012. Nonetheless, through October 24, investors had yanked more than
$101 billion out of stock mutual funds, according to the
Investment Company Institute. During the same period, they added more
than $272 billion to bond funds.
Why did they do this? They did it because people pick funds based on past performance, regardless of the disclaimer printed in every single mutual prospectus since the beginning of mutual fund history: "Past performance is no indication of future results."
Let's take a look at the number one fund in terms of new cash for the first nine months of 2012: Double Line Total Return Bond Fund (DBLTX). Started in 2011, the manager had a very good record for income investors that year: 9.51%. That's what attracted 16 billion dollars of new money the next year, doubling the size of the fund. Folks were chasing yield in a low interest rate environment and the 9% plus looked darn good. Now this poor guy - who is probably a very decent money manager, mind you - had a terrible problem. He had to invest all this new cash at the worst possible time, when nobody could find any decent bonds to buy and chances for rising interest rates were very high (which is bad for bond owners as prices decline when rates go up).
Sure enough. YTD return for Double Line Total Return Bond Fund in 2013? .09% That's right. Nine-tenths of one percent. And the saddest part of it all? That guy should get a medal for Money Manager of the year. His results came in #10 out of a total universe of 1,079 bond funds. But if investors had left their money in their stock funds they would have netted 24.24% during the same period.
This is what happens when human beings get scared and try to predict the future of a highly complicated global economy. The sky hardly ever falls and they end up disappointed, cursing the vagaries of the market and how the deck is stacked against the small investor, they rant about big institutional investors who get all the shares on the Twitter offering and tell themselves everything stinks.
Sorry. When it comes to mutual fund investing, we have seen the enemy and it is the uninformed, unthinking fear that hides inside us all.
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