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Thayer Partners Blog

3 Reasons You Should Hate Mutual Funds

[fa icon="calendar"] Dec 9, 2016 9:00:00 AM / by Chris Wilmerding

Chris Wilmerding

3-Reasons-You-Should-Hate-Mutual-Funds.jpgInvesting is a great way to achieve your financial goals. However, you might be investing in the wrong products without realizing it.

More than 90 million Americans are invested in mutual funds. If you’re like most Americans, you probably have some of your money committed to these actively managed funds, too. You’ve been told that investing in mutual funds can help you build wealth to save for retirement. Keep in mind we’re talking about actively managed mutual funds, those where teams of portfolio managers pick stocks and use strategies to try to beat the market.We’re not talking about passively managed mutual funds, which are a type of index funds.

We’re here to dispel that myth. The truth is you should hate actively managed mutual funds. Here’s why.

1. They Have High Management Fees

Though the management fees associated with mutual funds do continue to decline due to growth and competition in the industry, they’re still far too high, considering the fact that they add no value to your investment portfolio.

When you invest in actively managed funds, you commit to paying a team of financial professionals to oversee the fund, make investment decisions, time the market, and administer the fund.

Even though you don’t pay directly for these services, the more you end up paying in management fees, the less you’ll receive in portfolio growth. The fees are taken directly from your account. Paying an extra one or two percent for management fees on your investments can significantly affect your savings—it could add up to hundreds of thousands of dollars lost over time.

2. They Underperform the Market

Don’t think, however, that the high fees you pay for your team of financial professionals to manage your funds will lead to superior growth. In fact, 50 to 90 percent of the time, these funds underperform the benchmark index. At the moment, approximately 90 percent of fixed income funds and 89 percent of US equity funds don’t meet their benchmarks over 10 years. That’s right—you’re actually paying more for underperformance. Actively managed mutual funds are prone to human error. Portfolio managers often sell and buy too often, reducing performance. And over-diversification or under-diversification is also often a culprit.

And of course, the transaction costs, management fees, and taxes also reduce your earnings.

3. They Have Many Hidden Fees

Many investors are also unaware of the hidden fund fees sapping their portfolio growth. Above and beyond the management fees paid to the brokerage firm, there are many other expenses that you must pay in order to invest in mutual funds. These fees are quietly taken from your account and often poorly explained in your fund prospectus as well.

Here are three of the main hidden fees that you may be paying.

Account maintenance fees: You’re likely going to pay your broker, on average, $20 a year for each mutual fund that they maintain. The more funds you hold, the higher the account maintenance fees will be.

Servicing fees: Regulatory rules state that your broker can take an addition 0.25 percent of your assets, on top of his management fees, in order to “service” your account.

Revenue-sharing fees: You’ll also pay an addition 0.10 percent to 0.40 percent of your assets in hidden costs for marketing.

Though paying an additional 0.10 percent here and 0.25 percent there might not seem like a big deal, these hidden fees add up, and combined with management fees, they can easily top 3 percent of your assets annually. The more you pay in fees, the less you’ll ultimately gain from your investments. And when your funds are underperforming, that doesn’t leave much money on the table for you.

What You Can Do Instead

Take a stand against paying high management fees and additional hidden fees for underperforming funds. Instead, swap out these high-cost products for lower-priced, better performing investment products, such as exchange traded funds or mutual funds that are passively managed as index funds. These index funds cost significantly less and actually perform better than actively managed funds. 

An exchange-traded fund (ETF) is similar to a mutual fund that tracks a specific stock or bond index, such as the Barclays Capital 1-3 Year Treasury Index. ETFs trade on one of the major stock markets and can be bought and sold throughout the trading day, like a stock, at the current market price. And, like stock investing, ETF investing involves principal risk-the chance that you won’t get all the money back that you originally invested-market risk, underlying securities risk, and secondary market price.

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Topics: Investments

Chris Wilmerding

Written by Chris Wilmerding

Chris Wilmerding is Principal of Thayer Partners, an independent investment management firm located in Westwood, MA providing financial planning and wealth management counsel to individuals and their families.

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