Mutual Funds Minimize Losses – and Miss Out on Returns
Editor’s Note: Time to get excited! Because today, we want to introduce you to one of the most famed investing experts to ever grace the pages of Wealthy Retirement. He started his own hedge fund… is a bestselling author and entrepreneur… and is a Dealmaker for the queen. His name is Alpesh Patel.
– Kyle Wehrle, Assistant Managing Editor
Early in my investing career, I put my money and my trust in the hands of mutual fund managers.
But when I entered the industry, I learned an important lesson about investing and money management.
Never delegate your money management.
I quickly learned that mutual fund managers are in the capital-acquisition and retail-client-retention business.
The first job of these fund managers is to acquire as much capital from retail clients as possible.
That means they need to create lots of different funds for all that money to go into.
The retail equity fund management industry has been quite creative in building countless funds distinguished by geography, style or sector. You can find U.S. growth funds, European income funds, global technology funds, etc.
As an investor, you’re enticed into buying lots of funds, with the promise that you’ll be more diversified that way. More funds of course means more fees. Your dollars get spread ever thinner.
After all, if each fund owns 50 stocks and you put your money into 10 funds, that’s 500 stocks!
This is not in the best interests of any investor. It forces you to overdiversify and pay lots of fees… which results in poorer performance.
What else can you expect from owning 500 stocks and paying the fees for them on top of everything else?
The second thing I learned about mutual fund managers is that they have to retain clients – as any business does.
It’s in their interest to minimize your losses, not maximize your returns.
This means they will try to lock you into investments for five years (the typical recommended minimum holding period so many mutual funds promote).
None of this is necessarily suited to you as an individual investor. Shouldn’t you be told the risk and reward of each stock and be able to make your own decision about whether the investment fits your risk appetite?
When you put your money in a mutual fund, you have no control over what is bought, how much is bought, whether it overdiversifies or whether it is too little risk for you.
Your individual needs and goals are left unmet.
And here’s the biggest problem with these fund managers…
They consistently underperform. According to S&P Indices Versus Active (SPIVA) Scorecard for funds, most equity fund managers fail to beat the market. The last SPIVA Scorecard showed that 69.33% of U.K. equity fund managers underperformed the S&P United Kingdom Broad Market Index over the past decade.
In the U.S. market, the picture is even bleaker: 87.2% of all actively managed funds underperformed their benchmark between 2005 and 2020.
During the COVID-19 pandemic crash and the early stages of the recovery, things weren’t much better. According to research published by the University of Chicago, almost 3 out of every 4 active funds underperformed the S&P 500.
Additionally, funds that do outperform their benchmarks over 15 years spend 60% to 80% of that time underperforming.
I say all this not to make it seem as if mutual fund managers are buffoons who are so incompetent that they fail to beat the market (although it sure seems that way).
I see hard data like this year in year out. I used to write about it in my weekly Financial Times columns and in my books, and I used to talk about it on my Bloomberg TV show.
Fund managers often leave the firm where they were the “star,” and then you’re left with the fund. How does that help you? It doesn’t. That’s one reason for underperformance – the fund may be “long only,” but the manager isn’t.
Also, because asset management firms like Fidelity create so many funds, each fund they create, by definition, can select from only the geography and style they have set.
So they can’t pick the best stocks in the market… only the best stocks from the small gene pool they are allowed to look at (e.g., “U.S. Growth Pharma”). That means they are not selecting from a large universe and can easily suffer if the style or sector they target is out of favor.
So don’t leave your investing decisions in the hands of these fund managers. Don’t let someone else have power over your money.
When you’re in control (even when you think the other guy is smarter or more experienced), you can make better decisions about which stocks to have in your portfolio… and when and why to have them.
And that will ultimately lead to better returns, cost savings… and empowerment.