Monday, June 16, 2008

Retirement Planning: Better than Mutual Funds?

Fellow blogger Old School Value cited all of the reasons mutual funds are not for him in a recent post. But many of those same missteps, I suggested could also be attributed to any investment.

The alternative I suppose would be buying individual stocks. How would these six mistakes stack up in such an environment?

OSV suggested the following list of reasons why he doesn't like mutual funds.
1. I looked at the percentage gains and chose funds based on the previous years returns.
How many people buy stocks for the exact same reason. Herd mentality is human nature and mutual funds tend to moderate herd sentiment much better than individual traders do.
2. I chased after rising funds.
It takes quite a bit of investor acumen to resist selling into a rising market and buy one at the bottom. At least the fund will temper the fall provided you didn't invest too specifically.
3. I somehow always seemed to look at "growth" funds.
Who doesn't? Value suggests something that would be too staid and conservative although they do provide a nice income pop via dividends in man instances from companies long past their growth prime. Growth is sexier.
4. I switched between funds like a race driver switching lanes.
If you do this too often it is because you have fallen prey to the re-balance myth. It is okay to review each quarter and research each year, but if you bought a fund based on its long-term history, the tenure of its manager and less-than-sector-average fees it charges, you can avoid switching with each change of the season.
5. I figured a 2% expense ratio didn't affect my investment returns.
Index... If all else fails, index...
6. I had no idea what I or what the mutual funds were doing and I didn't do anything about it.
As do most stock investors. Market shocks come when investors didn't see this or that piece of news coming and were caught unaware. And it can happen to the best mutual fund managers as well but I'd be willing to bet that they will be able to spread those losses much better than the individual will.

For all that is wrong with mutual funds, they are still better than most of us give them credit for.

1 comment:

Jae Jun said...

Hi Paul,

Nice observation, and yes, the 6 points can be attributed to any investment.

Personally, the difference I find between mutual fund investing and stock picking is that with mutual funds, I am betting on the jockey more often than the horse. In a business world where ponies and retired workhorses race against thoroughbreds, I've found it easier to do my own research and pick the horses myself rather than rely on the jockey.

For people that have no interest in investing, finance or business, I recommend they put their money in an index rather than a mutual fund. I believe people invest in mutual funds only because they are 1.led to believe they are incapable of investing on their own since there are "pros" and "experts" who do it daily and are supposed to be better and 2.they have no time or interest in doing it themselves.

Now to answer all 6 points. After I realised the whole concept of investing, I have never fallen to mistakes 1-5 with my stock picking philosophy. On the other hand, I would probably keep doing the same thing with mutual funds because I don't know about the companies in the fund or what the outlook is. Not knowing and not understanding will continually tie me to the herd mentality.

Again, it boils down to one question. Do you know what you are doing? If not, we'll all end up doing exercises 1-5.