Thursday, June 4, 2009

Trash Talking Mutual Funds

As I drift around the web, I inevitably end up on some other blogger's site as they talk about investing, mutual funds or retirement. While everyone is guaranteed an opinion online, these missives may be as balanced as a morning spent watching Fox News.

And sometimes, I leave a comment of my own. Today, was one of those days.

Dr. Scott Brown, Ph.D., a.k.a. The Wallet Doctor, is a successful futures trader, real estate investor, and stock investor. Dr. Brown who hold a Ph.D. in finance from the University of South Carolina wrote: "These funds are also sold and managed on pure hype, short term trading, and with key information withheld from the public."

He continues after explaining briefly the history of how mutual funds grew, leaving out key tax code changes that created the 401(k) and the IRA during the time frame in question. He adds: "Many mutual funds are able to cheat the public with excessive fees because investors don't understand how these big costs destroy their profit. Mutual funds have no interest in educating investors because it is easier to hoodwink the ignorant!

"Don't put your trust in mutual funds unless they are fully indexed." And even though Mr. Brown suggest that he knows what the SEC really thinks about funds, he never does tell us what they are doing to regulate the industry.

So I asked Dr. Brown: "Tell me I am wrong":

Indexed mutual funds are too tax efficient to be locked inside a retirement account such as a 401(k).

While the low costs (fees) are always attractive and can lead to more profits, all index funds are not created equal nor do they charge the same fees. Some make up for their low fee structure by charging the individual investor $3,000 or more to make an initial contribution - far more than anyone would suggest the average investor plunk down at any one time.

Mr. Levitt did have a great deal of trouble back in 1993 (he referred to the former SEC chairman's divesting of common stock into mutual funds and some of the difficulty he had with transparency). But the industry has come a long way since and while it has further to go, the journey is at least headed in the right direction.

Actively managed mutual funds are far better for the average investor than buying individual stocks for three reasons: they can offer diversity and research; they can offer the ability to purchase new shares without charging each time you do, and they take they mental maniac out of the investor experience - the one that wants to sell on the way down, buy on the way up and mostly fails at determining their own risk tolerance.

Yes, far too many funds chase the same stocks. But it is the ETF that causes the wildest, end-of-the-day trading and market gyrations - not mutual funds.

Most folks equate the failure of 401(k) retirement accounts on mutual funds when in fact, more folks were invested in their own company stock, often upwards of 50% of the portfolio and often because this was the only way to get the company to match.

The creation of so many mutual funds is a result of the mimic effect. Those 500 funds that were in existence in 1980, that grew to over 8,000 by 2003 were the result of marketplace diversification. They sliced and diced the markets down into ever increasingly specific areas. Yet you fail to mention the same sort of slice and dice market done by the ETF markets.

Now that the SEC is back in the hands of an administration that cares, I expect their job will be much more focused and far less scattered than it was over the last eight years.

Mutual funds, while not perfect are much better than they were and are improving all of the time.

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