Thursday, September 1, 2011

Why Mutual Funds are Stealing your money - Pt2

Yesterday, I looked at some of the reasons why a Mutual Fund steals your money.

Today, I will look at some simple calculations to show you how they steal your money.

Lets do a quick and dirty calculation:

Investor Investment: $10,000
Mutual Fund advertised return potential: 8%
MER (Management Expense Ratio) 3%
By-In Fee: 0.25%
Cash-Out Fee: 0.25%
Total gains if advertised rate is achieved: ~ 4.75%
Average annual return of index: 5%

Now, it's obvious here that 5% is better then ~4.75%. But the ingrained belief of people is that with someone 'minding' their money, it will grow faster.

Past market conditions have generally shown this to be false.

Now, lets imagine that we leave that money in there for 10 years, as if we are 20 years old, and want to take it out to make our first house down-payment with it when we are 30 years old.

All market fluctuations are removed, and the mutual fund manager is a star, hitting his return percentage target every year (highly unlikely).

 1 : 10197.91
 2 : 10666.4
 3 : 11156.41
 4 : 11668.94
 5 : 12205
 6 : 12765.7
 7 : 13352.15
 8 : 13965.55
 9 : 14607.13
10 : 15278.17

Seems pretty good. making a ~52% increase over the 10 years.
Remember that the cash-out fee is still looming though, and drops our final value to $15239.97.
That fee is just a tickle in the ribs at ~$39, but it doesn't help our investor.

Now, lets look at it with some market instability (like in reality):

 1 : 9946.79
 2 : 10147.56
 3 : 10152.38
 4 : 10561.34
 5 : 9774.51
 6 : 10091.99
 7 : 12213.86
 8 : 11440.2
 9 : 9671.12
10 : 11506.69

Whoa - That's a pretty rocky ride there now. But this time, our investor still made a profit, netting a 15% return when he cashed out.

The mutual fund didn't return the advertised amount; in-fact it was an average ~ 1.5%, when the average market index returned 5% . Those MER and cash-in/cash-out fees put what many call a 'drag' on the fund, crushing it's ability to perform.

Add to that the fact that the Mutual Fund manager made many trades, and wracked up quite the commission bill (as well as more then a few losses on trades), and you have the reason why the MER is 3% every year.

Disaster strikes our fragile fund

But what if our investor was investing during the late 90's, and the mutual fund manager didn't see the 2008 crash coming?

 1 : 10197.91
 2 : 10666.4
 3 : 11156.41
 4 : 11668.94
 5 : 12205
 6 : 12765.7
 7 : 13352.15
 8 : 13965.55
 9 : 12607.13
10 : 5687.91

Our investor gets off the coaster right at the bottom, and lands on the cement like an exploding watermelon.
He loses over 30%, and to top it all off, the mutual fund manager still collects the 0.25% cash-out fee.

During the 1999-2009 period this pattern was quite common; investors would see the spectacular gains of the bull 2000's market, and invest a great deal of cash , hoping to ride the wave to wealth.

But in late 2008, the market crash came, and decimated many, many, mutual funds. Some were hurt even worse then our example here. But it wasn't the mutual fund managers that 'went hungry' so to speak.

It was the investors that were left out in the cold.

Tomorrow, I'll look at some of the ways that Mutual Funds are sold, and how they are stealing your money, right before your eyes.

What are your thoughts on mutual funds?
Do you like or hate mutual funds?
Let me know :)!

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