MUTUAL FUNDS ARE DYING!

A short history of mutual funds and why they are dying.
For a while I have become more and more frustrated with the mutual fund
industry. Many investors in mutual funds have been complaining loudly about the
performance of their funds and the huge capital gains taxes that are tacked on by
the IRS.
Many investors in mutual funds would like more transparency in their funds so
they could find out what specific stocks that they are invested in. Most mutual
fund investors are feeling like they have lost control over the decision-making
process regarding their funds. I truly believe that there are better wealthbuilding
methods that an investor can adapt to protect their assets and financial wellbeing.
The reason I am writing this review is as a wake-up call. In my opinion mutual
funds have become a dinosaur in the financial industry. Investors have been
slowly draining their wealth away for many years in mutual funds; fees and
excessive costs are taking a toll in their pursuit to beat the market. During the
boom years of the 1990s we saw plenty of double digit returns, and there seemed
to be a happy marriage between the investor and mutual funds. We see now at
the beginning of the 21st century, there are red flags flying high and bright giving
a warning to investors. Mutual funds have a record of underperformance, hidden
fees, higher income tax consequences, and a lack of investor control. Many
investors are now beginning to realize that they're wasting their time and wealth
in mutual funds.
Don't get me wrong, mutual funds did not start out as a bad investment. In fact,
mutual funds have let many Americans amass fortunes during their working life
into their retirement since the 1940s, when the security and exchange
commission or, as we know them, the SEC founded the Investment Company act
that created the concept of putting multiple stocks and/or bonds in separate
funds. Since their invention, mutual funds have been good for Americans for many
decades.
Mutual funds were supposed to create an opportunity for the average middleclass
American to invest like those with more substantial resources. These funds
became the investor's new best friend, offering professional management, many
choices, and, for a long time, stress-free investing. It was truly a powerful force in
the marketplace. These pools of equities offered investors diversification and
more safety than most single securities at a price that was affordable.
Soon mutual funds increased even more in popularity due to the government
offered retirement plan. We know these plans as our 401(k)’s, SEP’s, and IRA’s.
The fact is, today, over 40% of mutual fund assets come from these retirement
plans. IRAs were as low as $2,000. This sum is a major reason that vast sums of
money were pumped into mutual funds. American investors finally had an
affordable investment for the middle class family.
Times have changed. The mask is off and the real face of mutual funds is being
exposed. If you read this full report you will see what I am talking about.
In the early years mutual funds were all about making money for clients, but now
it seems that they're focused only on gathering as many assets as they possibly
can. Now they are sidestepping the spirit that was born in the 1940s. They're also
optimizing as much market share as they can get even if they have to break a few
laws to do it.
Let's look at some statistical facts. In 1980, there were 500 mutual funds available
to choose from with a total of $100 billion invested. In 2005, can you guess what
the numbers of mutual funds are? Go ahead take a guess before you read below.
Here is the answer. In 2005, there were 8,300 mutual funds with a total of $8.1
trillion invested according to the Investment Company Institute. This is not a
misprint; this monster keeps growing and growing.
Before around 2003, the worst thing we could say about a mutual fund was that
most of them lost money. From 2003 on, we can now say something even worse
about mutual funds. A large number of mutual funds are now losing money
fraudulently! In 2003, New York State Atty. Gen. Eliot Spitzer crusaded
ineffectively to put the brakes on the likes of major financial companies or
improper trading of mutual fund shares. Blue-chip companies such as Bank of
America, Strong capital management, and Bank One, were implicated along with
small trader hedge fund Canary capital partners in schemes to milk investors of
billion’s each year, according to Spitzer.
Spitzer exposed the more than 60 years of backsliding. An industry entrusted with
nearly $8.1 Trillion of the American public's money, mutual funds used to be the
investment vehicles that investors relied on to finance the American dream of a
home in the suburbs, the kid’s education, and a comfortable retirement.
Today we see that the nation's 93 million mutual fund investors are basically
overwhelmed by the competing claims of some 8,000+ mutual funds. Most of the
time, these investors are clueless about how to enhance their wealth with mutual
funds. The average stock fund lost 12% during the year 2000, 2001, and 2002.
Since that time the results have not been much better.
The real fact is that investors pay upwards of $72 billion in funding costs and fees
per year. What do they get in return? They almost always receive mediocre
performance, and when you factor taxes in, many actually suffer a financial loss. A
stable bond fund, real estate, individual stock, or even a treasury bill may perform
as well as the average mutual fund with risky high trading equities.
Let's get to the real problem of mutual funds. It is the expenses. Average investors
are so confused by these expenses that they have no idea what they're paying.
The sales commissions for the most active managed funds are tacked on by the
stockbrokers and are usually around 6%. The fund deducts .05% from your
account for its service. Cash drag, a reserve set aside for opportunity cost or to
pay off redemptions, will add another 0.6%.
The buying and selling of stocks that fund managers perform all year long causes
these transaction costs. In fact, the average return of the stock is 90% or higher
yearly for nearly every stock and mutual fund portfolio. By conservative
estimates, this wraps up an expense of 0.7%, not including capital gains tax, which
will also eat away at your profits. On top of this, add another 1.5% for
management fees and expenses including the dreaded 12 B1 that those outside
the industry criticized. You better believe those inside the industry exploited for
all that it's worth!
Let's take an example. Let's say your fund is generating a good return in today's
market of 12% of total assets as a long-term investor. The commissions, cost,
Cash drag, and fees reduce this to 8.7%. In short, your fund manager is close to
3.3%. Therefore, the fund is underperforming the market by 3.3%. After taxes,
which I estimate conservatively to be around 0.7%, you will have no more than
8% of the original 12%. This is only two thirds of your fund's return that you get to
take home and put in your pocket, but in reality it is probably less than this.
The bottom line is that mutual funds cost way too much. The typical investor is
averaging 3.5% in cost. The reason that you see conflicting fee charges for mutual
funds is that there are multiple fee revenue streams and many fees that are
charged, but are hidden to you.
Did you know that around 15 years ago there was not one TV channel that
covered detail market news? Today there are according to Robert B. Jorgensen:
· Hundreds of radio stations that report financial news
· Specialized financial newspapers and magazines
· Three major cable channels that are devoted to financial news
· Most major and minor newspapers have business pages
· Thousands of newsletters that cover financial topics
· Hundreds of thousands of websites that pertains to financial investments
· Financial salespeople to make calls
· Advertisers, slick brochures, and mailing pieces abound with financial offers
Literally hundreds of websites are positioned to reveal the latest hot investment
opportunity. All these triggering devices want you to believe they’re rubbing the
lamp with one rub that will propel you to untold riches.
“Investors today are being fed lies and distortions, and are being exploited and
neglected”, says Arthur Leavitt, former chairman of the SEC. “In the wake of the
last decade’s rush to invest by millions of households, and Wall Street's obsession
with short-term performance, a culture of gamesmanship has grown amongst
corporate management, financial analysts, brokers, and mutual fund managers,
making it hard to tell financial fantasy from reality, and salesmanship from honest
advice.”
It's time for you to know the truth about mutual funds or you will suffer the
consequences.
· The tax consequence - if fund managers sell stock at a profit, you take a
capital gains hit even if your fund lost money.
· The quick change consequence - you invest in the fund to fulfill a certain
investment strategy. Be careful, the manager can change the strategy.
· The power vacuum consequences - the fund managers make the entire buy
and sell decisions, not you.
· The no diversification consequence - unless you're diversified across fund
sectors, you may wind up owning the same stock in different funds.
· The name’s the game consequence - a stock fund’s name doesn't always
reflect its investing intentions.
· The moving manager consequence - managers come and go. If you lose
your manager, your account will probably suffer.
· The huge fund consequence - the more assets a fund takes in, the
higher the chances of lower performance.
· The fee consequence - you'll pay myriad fees and commissions.
The bottom line is mutual fund companies fall short in regard to performance
and returns with investors’ stock funds, yet they are a master at charging
exorbitant fees and add-on charges. In short, mutual funds are a marketing
success, not an investing success.
What does this mean to you as an investor of your hard-earned money into
mutual funds? You've entrusted your money and your wealth to mutual funds but
guess what? You’re getting the short end of the stick. This is surprising because
we've always been told that the stock market is the single best place to build
wealth for your families and your retirement. This is true if you're getting the most
value for your dollar by putting those dollars in the right investment
vehicles. If you're not, your portfolio is on a treadmill going nowhere along with
the assets of millions of other dejected mutual funds and mutual fund investors.
My purpose here is to get you off of the mutual fund treadmill, and I hope by this
point I at least got you thinking.
So the question is what went wrong with something so right? In 2005, mutual
funds assets totaled over $8.1 trillion. This increase calls for companies’ priorities
to shift. It's evident that the mutual fund industry does not hold the individual
investor in the highest regard.
John Bogle, an outspoken critic of mutual funds and the founder of Vanguard
financial, says his biggest complaint of the mutual fund industry is that it's now
run like a business. Bogle traces the industry's demise to a 1956 federal court
ruling allowing mutual fund firms to become public enterprises. This changed the
playing field, according to Bogle. “That opened the door to look at this business as
an entrepreneurial business in which the focus was on making money for the
stockholders,” he said. “Once you change the investment profession into a
marketing service business, you put management in the backseat and marketing
in front.”
These changes in priorities will hasten the downfall of mutual funds in much the
same way that the catastrophic changes in their environment wiped out the
dinosaurs. This doesn't mean that mutual funds and the companies that produce
and market them are going to become extinct. In fact the opposite is true. At the
time of this writing, mutual fund companies are evolving. They're developing new
alternatives and investment strategies in order to hold on to their client base and
secure new clients. Eventually, though, mutual funds will take a backseat to new
forms of investing for the emerging affluent investor. Mutual funds as we know
them are going by the way of the dinosaur.
Mutual funds are dying in their original state because of the unfairness of fees,
unnecessary taxes, lack of investor control, and a host of other reasons. Investors
have never grasped these points until now. Today, a lot of investors understand
the drawbacks of mutual funds because the events of the last five years have
brought the message home. They discovered that they're paying out millions of
dollars in excessive cost in running needless risk, all in the hope of outperforming
the market.
We need government to rise to the occasion. As the government examines more
critically the operating policies of mutual funds, things will change (in much the
same way we transformed transportation from the horse and buggy to the
automobile). If you are like me and don’t want to wait on the government to fix
your problems then the only choice is to take your financial future into your own
hands.
Increased federal and state scrutiny will trigger more reforms that will probably
get the ball rolling in Congress, like the mutual fund integrity and fee transparency
act that the mutual fund industry successfully lobbied against.
Meanwhile, underperformance is the norm for mutual funds. In recent years, the
mutual fund companies could perhaps be forgiven for the huge marketing
expenses and increased salaries of their star managers if the product delivered as
advertised. But this is no longer the case. Underperformance is the norm rather
than the exception. It's a fact. In spite of our respectable pass during the 1980s
and 1990s, the average mutual fund returned 2% less than the returns of the
market each year.
“In the mutual fund industry, we used to be in the business of long-term investing;
now we're in the business of short-term speculation.” John C. Bogle, founder of
Vanguard financial.
Not only do the fund managers tend to underperform the S&P 500 yearly, but the
underperformance also has grown more pronounced over the years. The
individual managers responsible for funds are now marketed as stars. The truth is
they're not stars, but comets.
Investors and potential investors are subject to the billions of dollars of
advertising promotion of the virtues of funds and mutual fund managers who are
supposedly skilled in handling their money. The chances of the fund manager
beating the market are small, so small that the average mutual fund only
outperforms the market two times out of every five, according to mutual fund
researchers.
If you're still not convinced, consider this
· Through the end of 2001, there were 1226 actively managed stock funds
with a five-year record. Their average annualized performance trailed the
S&P index by 1.9% per year (8.8% for the funds and 10.7% for the index).
· Through the end of 2001, there were 623 active managed stock funds with a
ten year record. Their average annualized performance trailed the S&P 500
by 1.7% per year (11.2% for the funds and 12.9% for the index).
· The figures above include the sales loads charged by many funds. Loads are
akin to brokerage commissions, which come straight out of your returns.
They are charged when you buy or sell shares of your fund. Even with these
load funds excluded, the five-year average trailed the S&P 500 by 1.4% per
year, and the 10-year average return trailed by 1.4% as well.
· These figures include discarded mutual funds, which would reflect poor
performance and bring these averages is down significantly. The
exclusion of these mutual funds is called “survivorship bias”. With returns
correlated for survivorship bias, average actively managed funds trailed the
market by about 3% per year.
Cost will drag down your performance. Fund managers are supposed to be good,
and some of them are, only we don't know which ones are good until the returns
come in. Most managers, unfortunately, will only equal the market as a whole
before cost.
What drags performance down are the management fees, trading costs, sales
loads, and other incidentals. And thus, direct and indirect costs defeat the
performance of mutual funds before you get your feet wet.
Mutual funds must disclose that past performance is not indicative of future
results. Unfortunately, most investors and financial media use past performance
as their primary selection criteria. The truth is, most mutual funds rarely
outperform the markets for a significant period of time. Let me put this fact in
bold so you can see it with your own eyes and comprehend the power of this
statistic. Only one fund in the history of mutual funds has outperformed the S&P
500 for more than 10 years straight!
Next let’s take a look at taxes associated with mutual funds. There are no tax
advantages to mutual funds, only disadvantages. If you pay taxes in all mutual
funds, you have created a natural adversarial relationship. You'll probably have to
pay taxes when your stocks are sold in the portfolio. Not only that, you may also
have to pay taxes when your stock fund loses money.
Mutual fund companies during the tax year are required to distribute capital
gains and the dividends to their shareholders. Unless you own a nontaxable
mutual fund (i.e., municipal bond fund, retirement account, etc.), you probably
are going to have capital gains.
Mutual fund companies are not looking out for you when it comes to taxes.
Shareholders pay capital gains taxes; mutual fund companies don't. Your capital
gains are taxed at the standard tax rate: 28% to 36%, depending on your reported
income, for stocks held less than one year. If you hold funds for more than a year,
it's 15% across-the-board.
Statistics show that American households paid 345 billion in capital gains taxes on
mutual funds in the year 2000. These gains have accumulated throughout the
1990s. When the air came out of technology stocks, portfolio managers began
dumping them.
But even if the stocks have lost their original value, they still accumulated capital
gains. Remember, even if your stock fund loses money, you're still liable for
capital gains because during the fund’s history it made money, making its capital
gains embedded. I haven't even mentioned dividends. Even if you reinvest your
dividends back into the fund, the IRS says you're still subject to tax on your
dividends. Wow!
There are ways to cut your tax bill with mutual funds if the companies were
responsible. Critics charge that fund companies could lower their capital gains
distributions if they wished. One way is through improved bookkeeping. The fund
companies were programmed to sell their highest cost years first once they
reduce the large block of stock, it could result in the tax savings for the investors.
This is called HIFO (highest in, first out) accounting, according to Vanguard, the
low-cost index fund company, because it could save investors as much as 1% of
assets each year due to lower cost.
Trading this often would hinder the capital gains explosion, but because the
average mutual fund turns over its stocks once in the course of a year (on which
the commission is on average five cents a share every time a share is traded), this
seems unlikely.
“This is much higher than most investors pay for online brokerage “says Business
Week. The mutual fund structure prevents “tax harvesting,” the timing of
securities by its manager to utilize capital losses or defer capital gains.
Regardless of when you buy into a mutual fund, you become the proud owner of
the liabilities that were incurred before you even put your money down. So you
buy into a fund for $10,000 on December 12 at $10 a share. Shortly before the
year ends, your mutual fund company calculates a yearly capital gain of two
dollars a share. Guess what? Because you have 1,000 shares, you shortly will
receive the distribution of $2,000, all taxable to you. Even though you've only
been in the fund for a couple weeks, you will have to pay the same amount of
taxes as the fellow that had been in it all year. Your original $10,000 investment
may still be intact, but now you have a $2,000 tax bill.
That's why you should never buy into a fund in December when mutual fund
companies record the year’s performance (my full opinion is that you should
never buy a mutual fund, period). Examine funds by their after-tax returns, rather
than pretax. You won't find these figures in the fund advertisement or the colorful
brochures. You can find these figures in the fund's prospectus, in very small print.
Thanks to the SEC’s February 2003 ruling requiring mutual fund companies to
include pretax and post-tax information in their prospectus, companies cannot
conceal this information.
The only problem is that most investors don't read the prospectus. For example, a
lot of investors who bought into a popular fund that year saw the capital gains
were spread amongst a lot of people. A bear market emerged because many
investors rushed to liquidate that particular fund and its manager had no choice
but to sell as many stocks as possible to raise enough capital for those
redemptions. A huge capital distribution was left for the remaining stockholders.
There are examples of investors who put a few thousand dollars into a fund and
later were hit by Uncle Sam for a five figure tax bite. Was there a chance that the
mutual fund managers could have foreseen the taxpayer's dilemma and altered
their selling strategy? Not a chance. Mutual fund managers are not paid to
maximize tax efficiency, only to generate returns.
We can look at mutual funds as a billing iceberg. Most of an iceberg is unseen,
underwater. Mutual fund companies have become increasingly adept to apply
extra hidden revenue streams to their funds, in addition to standard fees, which
are climbing. In fact, as returns have diminished during the post-2000 era, mutual
fund companies have actually been raising fees.
The average mutual fund investor isn't even aware of these fees he is paying,
disclosed or undisclosed. In fact, shareholders are paying for mutual fund
advertising and promotions through 12 B-1 fees. Unfortunately, as mentioned
earlier, most investors don't read their mutual fund prospectus, where a lot of
essential fee information can be found. All 93 million mutual fund investors
reward mutual fund companies annually with about $70 billion in operating cost --
and most investors don't realize they're paying it.
What is investing in funds really costing you? You can expect to pay
approximately 3% to 4% of your fund assets yearly in total cost (upfront or
backend cost) for a load fund. For no load fund, you'll still be paying around 3% to
3 .5% for your portfolio mutual funds. If you do some serious checking into these
costs over the life of your portfolio you'll see some serious money going into the
coffers of the mutual fund companies over and over again.
Unlike paying your gas bill or your light bill regularly, you'll hardly ever receive a
bill from your mutual fund company. Your costs are simply deducted from your
portfolio returns right off the top when the broker executes a trade. You may
scream if your daughter makes an unauthorized credit card purchase, but where
are you when you pay a 5% load on a $25,000 mutual fund investment?
With the boom of mutual fund returns in the 1990s, wouldn’t you think the fund
companies with these huge infusions of cash coming in and internal expenses
stabilizing reduce fees for their shareholders? Don't count on it. In fact, because
the fixed cost of fund companies (staffing, accounting, research, and so forth)
became smaller, fees actually could've been reduced. Remember, fund companies
increased revenues many times to over 7 trillion in the year 2000 from 371 billion
in 1984. Instead, the internal fees these companies charge investors have risen by
approximately 30%. Go figure!
John Bogle says “the drive to make money for others - the fund's shareholders -
may not be as powerful as the drive to make money for oneself through
ownership participation in the management company. There are two sides pulling
against each other in mutual fund companies: the shareholders (the investors in
the mutual funds) and the stockholders (the investors in the mutual fund
company).”
The Mutual fund industry profits by keeping the lights off. As long as the fund
companies keep you ignorant, the negative elements of mutual funds won't ever
be brought to light. Most investors traditionally have to make do with minimum
information. That’s the bare minimum ruled by the SEC. Twice a year, you get to
see what's going on in your account.
Investors said they want their financial information 24 /7. Even though the
internet has sped up the tracking of investments considerably, major fund
companies have been painfully slow to keep investors current. This means that
when you check your holdings on the web, your figures are out of date, and
possibly flat out wrong or altogether missing because fund managers are
changing your portfolio so rapidly.
Arthur Levitt, former chairman of the SEC says “investors simply do not get what
they pay for when they buy into a mutual fund; most investors don't even know
what they're paying for. The industry has often misled investors into buying funds
on the basis of past performance. Fees, along with the effect of annual expenses,
sales loads, and trading costs, are hidden.
Fund directors as a whole exercise scant oversight over management. The
cumulative effect of this has manifested itself in the form of late trading, market
timing, and other instances of preferential treatment that cut at the very heart of
investor trust. It would be hard not to conclude that the way funds are sold and
managed reveals a culture that thrives on hype, promotes short-term trading, and
withholds import information.”
We must never underestimate the rich man's appeal of mutual funds. Many older
and wealthier Americans in this country own mutual funds and are comfortable
with the investment process that has been around for some 60 years.
That feeling is disappearing. Today's investors are more comfortable with change.
Today, those with emerging affluence are asking themselves if they should stay
with the ultimate retail investment-one that is associated with mass market
investing and that is now viewed by many as a commodity.
Mutual fund managers don't differentiate between one investor and another.
Their job is to boost the inflow from the account and to get the numbers
regardless of who's investing in the fund. The bottom line is mutual funds do not
treat their investors like the good old days.
Unless you are totally shut out from the world, you have, like most of us, regular
contact with people. Family and friends are a given. You like human contact and
feel goodwill towards people most of the time.
The downside of human contact is when you find yourself in the overstuffed
elevator and get stuck between floors. It's uncomfortable, stressful, intimidating,
and even scary.
The same can be said of mutual funds. You'll have crowded elevator contact but
you still have contact with people. Dealing with other investors in your mutual
fund can invoke feelings similar to the overcrowded elevator-stress and
intimidation. The inflows and outflows caused by human nature may be some of
the more subtle difficulties of mutual funds. Fellow investors panic when the
markets fall and become greedy as the markets rise.
Instead of following the traditional words of investor wisdom-buy low and sell
high -just the opposite occurs. Every investor feels the impact of a bloated fund
with too much cash. It becomes too unwieldy for good management control. This
causes funds to grow too quickly, turning good performing funds into bad
performers from one year to the next.
“One advantage of mutual funds that's really a disadvantage is it’s easy to get out
of them”, remarked Peter F.Tedstrom, of Brown and Tedstrom, Inc. “this makes it
simple for an investor to call in an order as soon as the market dips,” said
Tedstrom, “consequently, in the end, the investor suffers poor performance
returns by frequently trading in and out of his or her portfolio.”
In conclusion, I want to ask the question: Is this the end of mutual fund
domination? I don't think so. You must understand that mutual funds are an
American icon. Since the first mutual fund was formed, it has been the building
block of our country's investment strategy and home to some 93 million
Americans today. Habits die hard, even in the face of the facts given above, my
guess is that only half of the readers take any significant action.
An investment pattern with this concept originally developed slowly. Americans
put about 20% of their discretionary wealth into mutual funds during the 1970s
and 80s. By the time the 1990s rolled around, investors were investing at a rate of
25%. In 1996, that rate rose to 60%. At the end of the century, the rate of
investment in the mutual funds by Americans climbed to a staggering 82%!
Let's face it; millions of Americans will continue to put their hard-earned wealth
into the mutual fund vehicle. They don't get the message. Did your parents ever
ask you “if everyone else jumps off a bridge are you going to do it also?” Just
because most people are too lazy to do their homework does not mean you have
to be.
We now have better options out there for you to accumulate future wealth. You
can retire comfortably, you can secure your family's future, and you can break the
chains of bondage that hold a lot of investors down. The more money you
accumulate by the time you retire, the more comfort and freedom you will have.
You could stay on vacation a week longer, you can take trips to see the grandkids
two or three times a year instead of just once.
Most likely the giant of the mutual fund industry will continue to grow and churn
away people's accounts. But I hope this special report has awakened a hunger to
gain knowledge, do research, and have the courage not to follow the herd
mentality of the average investor. If enough people read this report, understood
it and acted on it we would see the death of Mutual Funds.
You are not the average investor. You are above average! The fact that you have
read this whole report proves that to me.
You have the power and control to create your own destiny for your future and
the future of your children's children. There are better alternatives for your
investments than mutual funds. I hope by writing this report I have
encouraged you to take control of your own investments or at the very least to
never buy another Mutual Fund.
Helping you retire on time,
Big A