What follows is the first of seven to-the-point articles highlighting poor investments you should avoid.
1 of 7: Mutual Funds
Our first loser is mutual funds. In case you missed it, mutual funds are being replaced, being replaced fast, and being replaced for good reason. When you look at fund flows, investors big and small are choosing exchange-traded-funds, or ETFs, and panning mutual funds. As long as there are lazy HR guys out there overseeing employer-based retirement plans, there will be workers with no better option, but alas more 401(k)s and similar employer-based plans are offering ETFs with each passing month. If you take part in an employer-based retirement plan, you should ask for a good selection of ETFs. Ask for a Roth option while you are it.
Now, back to your investments; when you look at your account statement, if you see ticker symbols with five letters like say MGGIX (meaning it’s a mutual fund), you should ask yourself why? If you have a financial adviser, you should ask them if mutual funds are the best investment vehicle. To be sure, large built-in gains or losses complicate things so let’s just leave this article as generic advice intended to address where to route new investment.
Mutual funds aren’t bad, just inferior! When you consider the options today’s investor has, here are three quick and dirty reasons why ETFs are superior to mutual funds:
- ETFs are far more tax efficient.
Mutual funds have internal costs related to fund sales, redemptions and taxes that often exceed 1%/year. It’s complicated, but ETFs basically escape taxation.
- ETFs are cheaper, carrying far lower expense ratios.
Mutual funds have expense ratios far exceeding that of ETFs. This would make sense in a world in which actively managed mutual funds outperform major indices such as the S&P 500, but, in the universe we inhabit, this is not the case. For example, 2018 marked the 9th consecutive year that the majority of actively managed, large-cap funds underperformed the S&P 500.
- ETFs trade like a stock.
The bid-ask spread is tight, and you can get in and out of popular ETFs any second of the trading day, and during extended hours. Comparatively, mutual funds are dinosaurs that the issuing company (for example, Goldman Sachs or USAA) buys back from you after the close. If you’re not a day trader, you might think this isn’t a deal breaker, but what are you getting in exchange for this limiting, inferior structure?
Perhaps you still have reservations, and will say, “Well, what about my mutual fund’s investment manager? I like him and I like his stock picks!” First of all, you didn’t say that because no one says that about mutual funds. If you’re into rock star money managers with dazzling track records, you won’t find them making picks for a mutual fund. The guys that have the long track records of winning picks aren’t hanging around for the $500,000 to $1.5M of compensation mutual funds shell out for fund management; they are chasing Chris Hohn at TCI and the other guys that made over $1B (that’s a B!) last year making their stock picks for leading hedge funds.
… In closing, let’s be honest, many long-term investors have made good green money in mutual funds over time by virtue of simply owning a wide swath of American business. It should further be noted that they collectively represent an inferior option when compared to today’s ETFs.
There are around 9,000 mutual funds from which to pick. In a world of too many options, you have permission to drop 9,000.
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