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.

Where should I invest my money?

So, where do I put my money, Jack?

I strongly believe that no one can tell you what investment strategy is right for you. If you are looking for guidance, I would employ a fee-based financial adviser.

That is not what I wanted to hear!

I realize that, but lets be frank: I don't know you, or your lifestyle.

You may have a unusually high or low risk tolerance, or a new, intricate investment pattern you know it 'fool-proof'. Or you may have insider information about the state of the fundamentals of companies - more then an adviser, or a blogger on-line can possibly have access to.

I would advise anyone that is looking into investing, especially in stock markets, is to READ. Read everything you can about everything to do with your investment before putting your money into it.

Good places to help you get a grasp of investing:

• Investorpedia
• Finance Blogs
• Magazine-based sites (Globe & Mail, Moneysense, etc.) - Beware the rampant bias.
• Library books

There are many others sources for information on investing, because, lets face it, everyone likes to believe they can get rich from investing, and everyone wants to know how, so writing about it (and selling that 'advice') is very popular.

I think it's fair to say that almost all financial advice is a little bit biased, and I think that is due to the fact that so many people feel 'strongly' about the subject matter. This can lead to some people having some very intense (and often, unhealthy) emotions about dealing with income, bills, and investments.

Jack, I feel nervous about my money.

I believe a little nervousness is not a bad thing. Obviously, if you have trouble sleeping at night (a popular sign that you invested in a risky venture above your tolerance), then you need to make a change.

If you don't feel any nervousness investing your life-savings in a risky emerging markets stock, then you may need to speak with a financial adviser, and be told, in person the risks and repercussions of such actions.

If you are interested in learning about two of the most popular amateur investing styles, please read my post on Dividend investing vs Index investing.

In the end, no one can tell you what is perfectly correct for you; not even a highly-trained financial adviser can read your mind and know exactly what you really want.

Only you can know your investing inner-desires through conscious effort and learning.





Have you invested your money already?
Where did you invest it?
Let me know!

Dividend investing vs Index investing

Today, I wanted to share some of my thoughts about one of the more popular amateur investor debates:

Dividend investing vs Index investing.


I'm a busy investor. Just tell me which one is better!

If only it were this easy.

There are many proponents on one side or the other. Here are a few of each, for your perusal:

Dividends:
Dividend Monk
Dividend Ninja
The Dividend Guy
Dividend Pig
Invest It Wisely

Indexes:
Oblivious Investor
Millionaire Teacher (Andrew Hallam)
Canadian Couch Potato

Most of these folks respect the 'other sides' investment choices, but generally prefer to go with one or the other.

I haven't decided my primary investment strategy yet (other then a handful or dividend stocks that I cut my teeth on), so I'm very interested figuring this out myself.

I'm going to compare the two in a general way (I am not an expert, and these lists are not exhaustive).
 

Why Indexes are great:

• Similar to a mutual fund in that it holds many stocks, in this case, from a tracked index, (such as TSX, S&P, etc).
• Attempts to follow the trends of it's market index - Which in the past have been generally 70% positive, 30% negative.
• Will never 'bust' unless nearly the entire stock market 'disappears'
• Generally has very low MER (Management Expense Ratios) so it is inexpensive to invest in.
• You can invest in multiple indexes, and have a portfolio that virtually covers many countries and markets, offering unparalleled diversity.
• You can profit from the shifting currents between indexes (during your 'rebalances').
• You don't need to buy and sell often, just 're-balance' your portfolio perhaps a few times a year to bring it back into line. I like to refer to this as The Ratcheting Effect.

Why Indexes are bad:

• Since indexes track the market, they can also track it off a cliff into a crash (although you will be in a better position then most).
• It's 'boring' (no thrill of the hunt for excellent stocks, just the same index funds, over and over)
• You won't need to trade often, so that can mute any excitement about investing.
• The upcoming markets may slow to the point where you are not 'gaining' very much in capital gains over time, but this is universal for most any stock.

Why Dividends are great:

• You can pick and choose exactly companies to invest in.
• You can leverage insider knowledge about company performance to purchase your dividend stocks when they are at their best 'value' (lowest cost).
• You can enjoy a constant, small stream of income as these companies pay out dividends to you at regular intervals.
• Long-term dividend paying companies tend to be well-run, and more resistant to wildly fluctuating stock prices and values, helping to keep your investment stable-ish.
• During a 'crash', you may be in a better position then non-dividend investors due to the continual income from dividends (but only if your companies manage to keep up the payments during the slump).
• Some companies offer what is known as a 'DRIP' or Dividend Re-Investment Program' - This program will reinvest your dividends into more stock from the same company, often at no additional cost to you, and sometimes at a discount to the regular market price. (Some investors swear by DRIPs).
• Dividends paid by qualifying Canadian companies in Canada are given a *very* preferable taxation rate.

Why Dividends are bad:

• Low Diversity - You will only invest in companies that pay enough dividends to interest you - This limits your selection of stocks, and will almost definitely keep you from picking up any high-capital growth stock.
• Companies may drop dividends for any reason, or no reason at all. They are not beholden to pay them (Unless you are purchasing preferred shares, or shares with other, special conditions).
• The few companies you invest in (compared with the hundreds in an index) leaves you open to losing all your money if the company folds.

But which one is better?

Dividend stocks simply pay out the dividend from their market value, so they generally have slower growth. But, you are being paid with 'today's' dollars, which means that they are worth more then 'future' money that is felt the effects of inflation and market growth (devaluation).

Indexes tend to slowly gain over time, when you filter out the market noise. You can also profit quite handsomely when you re-balance due to one sector doing much better then another.

You will have to make up your own mind about which investing strategy you will use, but I hope this simple primer will provide you with some insight when it comes to dividend and index investing.





What are your thoughts when it comes to dividend and index investing?
Do you use one style or another yourself?
Let me know :).