Wednesday, August 31, 2011

Why Mutual Funds are Stealing your money - Pt1

Mutual Funds.

Many, many people are invested in mutual funds. Savings, holidays funds, down payments, retirement pensions. A large share of these are in mutual funds.

And ~90% of mutual funds lose money compared to the index over the long term.

Investor geeks puts it nicely in their article Mutual Funds are for Losers.

The nuts and bolts of a Mutual Fund follow this general pattern:

1) Investors like you and me give money to a mutual fund's broker.
2) The broker reports there is a decent chance to make you back a good return for the risk.
3) Times goes by, and the broker buys and sells stocks to try and make money.
4) Eventually, we the investors need the money back, and asks the broker to cash us out.
5) The broker calculates how much of the initial investment is left (minus losses, plus gains), and gives it back to the investor.
6) According to the average, the investor will net a return less then the index (market median) ~90% of the time.
7) Loss :-(.

Why do mutual funds make less then the average?

1) Higher costs:

Mutual funds employ financial folks to buy and sell the stocks. These folks research, discuss, and communicate with companies to try and foresee how stocks will go (up or down).

These people cost money - in most cases quite a bit more then you or I make. The frequency of trades that a mutual fund makes (many times an hour, or even minute) cost alot as well.

Lazy Potato Investor puts it well in: Would you like fees with that?

2) Results Reporting:

Mutual funds managers have a set schedule in which to make the 'return' that investors are seeking. This time crunch means that they often don't have the luxury of 'holding' a large number of stocks. They have to 'stick and move', meaning buying low and selling high - usually in fairly rapid succession.

This often means a flurry of trades and adjustments, an upward battle as they try to time the market.

I am a firm believer in human capacity, but now-a-days computers are trading on the stock market at a rate of millions of trades a second.

No human being can keep up with that sort of frequency, and many mutual fund managers expect to beat these computers and make money doing it. I don't buy it, and history backs me up.

Tomorrow, I'll do some calculations to put all of this into play, and show you how mutual funds really do steal your money.

Do you believe that your mutual fund is performing better then the index?
How much better?
Let me know.

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