Mutual Funds for the Utterly Confused: Low-cost Mediocrity
Because I am a fan of mutual funds, and this blog discusses not only their overall benefit but their shortcomings as well, the attacks on these unique investment tools has me concerned. Stock pickers would have you believe that owning mutual funds is mediocre at best, offering paltry returns as compared to their “actively” traded counterpart the Exchange Traded Fund and the much more actively traded individual stock.
The naysayers suggest that your returns will not be what you expected. And they say this because they understand what you expected? Hardly. Nassim Nicholas Taleb, author of the Black Swan was on CNBC the other day. He explained that key to his wealth was the preservation of it in cash. As a trader, he suggested that his clients also stay in cash, committing two-thirds of their wealth to this investment. He remains a wealthy man because of it but does not shove the notion down anyone’s throat. Unlike the active stock traders, he rests on his record, mediocrity and all. It should be noted, that he keeps the other third of his portfolio invested more actively, the part he is willing to sacrifice to the risk of the unforeseen.
Many traders would have you avoid mutual funds for the same reasons, offering you a very interesting road to travel. Many would have you bail on funds, which in terms of expenses is still far less than a broker, and buy ETFs (essentially index funds that you can buy and sell - incurring transaction costs at both ends) and while you are it, buy some stocks.
But this is much easier said than done. Individual traders must first learn to control their impulsive natures, which has most investors buying on the way up and selling on the way down, the way they look at returns in terms of taxes-owed, trading costs and whether you beat an index or not, and even more importantly fully understanding and come to grips with the fact that what you are doing as you build your model portfolio, is, in essence, a very expensive and time consuming personal mutual fund with only one investor (no one to be accountable to but yourself).
Throwing stones at mutual funds as an investment is easy. Mutual funds have had a rough go of it, as have all investment tools. But as a cornerstone of most retirement portfolios, it is far less expensive and provides greater stability than attempting to beat the markets. After last year, the future of any comparison by anyone, individual investor or fund manager to any index will be suspect.
Most will point out your returns as the try and persuade you to get out from under the diversification umbrella that funds offer. Yes, you would have done better in cash - the most mediocre of all investments, but you would have beat the market handily had you done that - and had you used 35% of what you had left to invest to “play the markets for more control and the opportunity to make money”, you would still have more or less broken even.
Is mediocre the new wealth? Probably. Will it generate great wealth? Probably not. But it would certainly be almost fee-free, risk-free and worry-free. And that surely has a calculable cost.
