This essay is to enlighten investors on what they are getting into if they are relying on mutual funds as a way to provide for their financial freedom at the time of retirement.
Due to the complexities of following stocks and finding competent money management, unless you are a multi-millionaire, many Americans have turned to the quick fix known as a Mutual Fund.
In recent commentary, insiders have adopted the following opinions on mutual funds. “Most investors in mutual funds have no idea what they are invested in, which is the way the industry wants it.” In addition, mutual funds are troubled because the rewarded for the amount of money they Attract, not the amount of money they earn.
SEC Chairman Arthur levitt, Jr. warned of growing unfairness in the relationship between individual investors and mutual funds in January 2001. Mr. Levitt made the following comment:
“THERE ARE A NUMBER OF INSTANCES THAT, QUITE FRANKLY, DO NOT HONOR AN INVESTOR’S RIGHTS. INSTANCES WHERE…HIDDEN COSTS HURT AN INVESTORS BOTTOM LINE, WHERE SPIN AND HYPE MAKSE THE TRUE PERFORMANCE OF A MUTUAL FUND, AND WHRE ACCOUNTING TRICKS AND SLEIGHT OF HAND DRESS UP A FUND’S FINANCIAL RESULTS”
There are, in effect, FIVE separate bills that mutual funds charge. The best way to determine if something is effective for you or not is to dollarize the benefit or the burden. When you invest in the typical mutual fund (assuming outside of a qualified retirement plan), you face the following costs that erode your benefit and you probably were never aware of them, you won’t find them in your prospectus and your broker isn’t going to sit down and tell you about them. The five costs of mutual fund investing are:
1. Tax Costs – excessive capital gains from active trading.
2. Transaction Costs – the cost of trades themselves.
3. Opportunity Costs – dollars taken out of portfolios for a fund’s safekeeping.
4. Sales Charges – both seen and hidden.
5. Expense Ration (“management fees”) – no end to increases in site.
How do all these fund costs affect you? Well, with the expense ratio which averages 1.6% per year, sales charges 0.5%, turnover generated portfolio transactions costs 0.7%, and opportunity costs – when funds hold cash rather than remain fully invested in stocks – 0.3%. The average mutual fund investor loses 3.1% of their investment returns to these costs each and every year. While this might not seem like much on the surface, costs would consume 31% of a 10% market return. Add in the 1.5% capital gains tax bill that the average fund investor pays each year, and that figure shoots up to 46%, nearly half of a potential 10% return. Do you feel like you’re taking one or two steps back while trying to go forward yet?
In his book “The Trouble With Mutual Funds,” Richard Rutner shares that “No one denies that the average mutual fund returns 2% less per year than the stock market returns in general. Yet the mutual fund industry spends billions of shareholder dollars to promote its money managers as experts who can manage investor’s dollars with skill. The vast majority of mutual funds (94% according to a recent five-year survey by Lipper Analytical Services) have underperformed the stock market as a whole.”
Therefore, FIVE serious myths are conferred up on the public and you would be wise to educate yourself on these fallacies.
Myth #1: Mutual Funds are long-term investment vehicles
In the year 200, 451 funds simply disappeared, like Jimmy Hoffa.
Myth #2: Mutual Fund money managers are long-term investors.
The average fund traded 15 to 20% of the stocks in its portfolio in the 1950. Modernly, the rate of trading within the average fund has exceeded 95%. For the most part, fund managers are short-term speculators.
Myth # 3: Mutual Fund shareholders are long-term owners.
Today’s rapid rate of redemption is 75% higher than the average rate throughout the 1970s. This clearly violates the most fundamental principle of investing success: Buy and hold for the long-term.
Myth #4: Mutual Fund costs are declining.
In 1950, the average stock fund charged around three-quarters of a percentage point. By the beginning of the year, 2001 that figure had more than doubled.
Myth #5: Mutual Fund returns are meeting the reasonable expectations of investors.
In the greatest of bull markets, funds of all sizes seriously under performed the stock market. The inability of 85% of all fund managers even to match the performance of the market overall is the result of high fees (see above) short-term investment horizons and substantial transactions and tax costs.
If any of this scares you, rethink your investments. The asset allocation model where they show you a pie chart with so many stocks, so many bonds and maybe 3% cash is a failure. This was designed for institutions with 100% investible assets, not for individuals with lifestyle needs and expenses. You’ll never see any real estate in that pie chart, yet for most Americans, their home is worth more than their other investments. No one offers the idea of buying investment properties which appreciate and allow you to harvest dollars out of them by way of refinance and adjust the rents to cover your cash harvest. Once you harvest it is time to deploy and like the seasons, you can do the same cycle over and over again increasing your wealth.
However, having real property as an investment does not mean you do not manage it. What do I mean? You have to be responsible and manage your equity that your home accrues and if you have investment properties, you have to manage those properties like an investment portfolio with precision planning so that it does not create a negative cash flow because cash is king. In the business world, businesses that fail to manage their cash flow properly often fail to survive. Similarly, where individuals or families fail to manage their cash flows properly they end up in the same place, bankruptcy court.
The four-letter word that no business can live with out and is referred to as the lifeblood of any business is CASH. Accordingly, the individual investor is better served when they think like a business and create cash flows to deploy with leverage into arbitrages. What did he just say? If these terms are foreign to you and you claim to be an investor you better go look them up because they are as old as salt in the financial world and are the best investment advice three self-made billionaires on Forbes 400 ever heard. If you don’t know how to enlist cash flow, arbitrage and leverage into your investment plan then seek out a firm that does before it is too late.
If you would like to learn more about how leverage, arbitrage and creating cash flows can benefit your portfolio or rebalance it back to positive, give the author a call.
James Burns, Esq.
Attorney at Law
LEGAL WEALTH CONDUIT
“The Complete Solution”
18662 MacArthur Blvd.,
Irvine, CA. 92612
PH: (949) 440-3243
Fax: (714) 464-4448