The Downside of Mutual Funds
Posted by Gail | Filed under Insurance
Big News At The End Of This Blog!
One of the biggest arguments against buying mutual funds is just how expensive they can be. A fund’s MER or management expense ratio refers to the management fees, administration charges, taxes, and trailer fees paid to the guy who sold you the fund. The MER is reported as a percentage of assets under management for the previous financial year and can vary from one year to the next.
The returns you see advertised already account for the MER but you should still pay attention to how much you are paying since higher fees do not always translate into better returns. In fact, some studies have shown that the lower a fund’s fee, the more likely it is to post better-than-average future returns. So at least with mutual funds it’s not a case of “you get what you pay for.”
Another downside to MFs is that they must distribute their capital gains at the end of each year even if a fund has declined in value. If you’re holding the fund outside of a tax-deferred plan you’ll have to pay tax on any capital gains distributions made. This lack of control makes some investors wary.
And mutual funds have the option to merge. When Mutual Fund Company A buys Mutual Fund Company B, and then proceeds to amalgamate, integrate, consolidate the funds, investors who bought one fund can end up holding quite a different fund. Two mid-sized funds that become a large fund can force the investment manager to stick with large cap funds, changing the very nature of the fund. With wheelbarrowfuls of money to invest, buying what amounts to itty-bitty pieces of teeny-weeny companies is too much work. A mega-fund can’t really afford to divert efforts to a lot of small companies since they’ll have little impact on the portfolio. Changes in management style may not be immediately apparent. But watch your fund move from having a wonderful performance because it is nimble, to the just-average performance of a well-managed monolith and you’ll become painfully aware that bigger is not always better.
And heaven forbid that a fund fall from consumers’ graces. When a fund fails to meet investor expectations, investors who were attracted by those flashy ads are apt to cash out. Now the manager is forced to commit a larger portion of investment dollars to cash as a cushion against redemptions. Or, worse, they must sell securities to meet redemptions at exactly the wrong time in a market cycle, selling high when they should be buying low. Transaction costs go up and remaining mutual fund holders have to eat the costs.
Of no small concern to some investors is the movement of managers in the industry. While a change in managers does not signal the demise of a fund, it can be pretty frustrating to buy into a fund manager’s philosophy, plunk down your money, and then have the manager leave with nary a good luck sucker! It feels like bait and switch. Having analyzed the fund manager’s track record, a management change means you’ll now need look at the performance history of the guys who are taking over in deciding if this fund should remain in your portfolio.
Regardless of the distractions and the detractors, mutual funds have allowed investors the opportunity to enter the investment marketplace in order to earn potentially higher returns than those available on traditional investments such as GICs. This is particularly true during periods of declining interest rates when consumers become less and less interested in the secure investments they’d held in the past because they just didn’t pay. But knowing the downsides is part of understanding what you’re buying. Do your homework, get smart about investing, and then you can buy whatever you choose with confidence.
Next week: The Many Styles of Mutual Funds
Last week: All About Mutual Funds
So, do you want to know what The Big News is? It seems that all you people who wrote to Slice to say you desperately wanted more episodes of Til Debt Do Us Part will have your way! Congrats of making the world turn in your direction. Yes, this summer, I’ll start shooting 15 new episodes of TDDUP. They likely won’t air until 2011, but they’re on their way. Stay tuned and I’ll let you know what Slice and Frantic are looking for when it comes to the families we choose, and how you can apply.