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Boo on Mutual Funds

So in my quest to grow wealth through investments, I’ve had a lot of friends tell me that I should stick to Mutual Funds or GICs, as they have much “lower risk” and because I have no idea what I’m doing.

I must hand it to them, they are spot on in that I really have no clue as an investor as I’ve only been in the “game” for really a few months.  And mutual funds generally carry much less risk than direct investing since they’re super diversified and managed by professionals.  GICs are obviously gauranteed to make you returns, hence the “Gauranteed” in GIC.

Despite all this, I would still rather do my homework and invest directly into the markets.  At the LEAST, I should invest my money into an index through an ETF (exchange traded fund).  There’re plenty of reasons to completely skip passed mutual funds entirely (GICs too for that matter).

It is the simple matter that mutual funds underperform the markets as a whole.  The S&P 500, which is regarded as the benchmark to beat, will beat 80% of mutual funds out there.  So really, you have a much greater chance of earning more money if you simply just invested your money into an index fund (the market as a whole).  The S&P 500, over the last 30 year period, performs roughly at a 10% annual yield.  How many mutual funds can claim that?  Strike one.

Not only do mutual funds under-perform in general, but they carry high fees and commissions.  Sure, that 2% fee doesn’t sound like much to you, but 2% compounded over many years until your retirement do add up to quite a lot.  So not only do your hard earned savings yield you less, but you end up paying for someone to poorly manage your own money! Strike two.

Now the big kicker that most people aren’t aware of with mutual funds is something called “Survivorship Bias”.  Ever notice how some banks have stellar funds that yield 10, 15, even 20 percent?!  Or even how bank XYZ claims to have a variety of funds that average a strong performance of X%? Well, the banks are rigging the numbers in their favor to win you over.  Many banks will carry a variety of funds which cater to various aspects of your investments.  However, not all of their products will succeed and many will fail altogether.  The funds that perform terribly get removed from their line of products, so only the “surviving” funds are left over… with those funds obviously yielding a higher average now that the losers have been cut out.  So not only do mutual funds underperform and have high commissions, but they generally provide misleading information on performance. Strike three!

Alright alright, so mutual funds won’t give me tons of money, but at least they are yielding me some kind of return and I don’t have to monitor the markets, that’s at least worth the price right?  Absolutely not!  For one thing, a mutual fund has no gaurantees of yielding you any returns.  You may actually lose money in your mutual fund, because it really is an investment in the stock markets (albeit, a greatly diversified and “managed” investment). When the markets dip, your fund may dip as well.

Secondly, you can invest in the stock market without having to manage all your investments.  You can invest in an index directly through an ETF.  ETFs are just like mutual “index” funds in that they mirror the movements of the markets, with the exception that you can purchase ETFs much like any other stock.  That means you can buy/sell an ETF whenever the markets are open, and you gain dividends too like any other stock.  The beauty of ETFs is that there is very little commission involved in owning an ETF.  The company managing it takes a very small cut, something like 0.1%, which is a fraction of what the mutuals are charging.  At the same time, since ETFs mirror market indices, it will beat a majority of mutual funds in terms of performance and provide you with a great deal of diversification.  No need to manage your ETFs… you can buy into them and forget about them just like your mutuals.

So really, is there any reason not to buy into an ETF instead of a mutual fund?  It has all the advantages of a mutual fund (and then some), without all the disadvantages of poor performance and heavy commissions.

Of course, you could also invest directly into the markets.  It’s not as demanding as one would think.  Many great investors have built their wealth on researching a company, buying its stock, and holding it for years to allow it to grow in value.  The richest man in the world, Warren Buffet, built his wealth this way.  He wasn’t a day trader who stared at the stock ticker every 5 minutes.  Instead, he sought companies that he saw had a lot of value and invested into them, holding on those stocks for years.  That style of investing doesn’t require constant managing and monitoring either, and it can reap huge rewards.

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