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Thayer Partners Blog

Are Mutual Funds a Rip Off?

[fa icon="calendar"] Sep 14, 2016 9:00:00 AM / by Chris Wilmerding

Chris Wilmerding

Are_Mutual_Funds_a_Rip_Off.jpgAs an investor, you know that you have to diversify your portfolio. Diversification reduces your investment risk and helps ensure that you don’t lose all of your hard-earned retirement savings if things go south. So you might have already invested in real estate and in your company’s stocks, and now you’re looking into mutual funds.

But you’ve heard they might be a rip off and you’re wondering if you should invest in them.

The thing is, mutual funds can be a rip off, but they can also be worthwhile investments. It just depends on how you invest in them.

Actively Managed Funds

When people talk about mutual funds being a rip off, they’re talking about traditional actively managed funds. These are funds that are managed by a team of highly paid financial professionals who are buying and selling equities. The goal of actively managed funds is to beat the benchmark in order to get a bigger return. It might seem like a smart idea to have experts managing your funds, studying the markets,timing the markets, and deciding what to buy and when to sell.

It might seem like the best way to invest. After all, that’s what the financial industry has been drilling into you for years.

But actively managed funds don’t always work. They underperformthe S&P 500 more often than not every year—and 2016 is no exception. Theyoften fail to meet their benchmarks.

So essentially, you’re paying more to get less with actively managed funds. You’re paying men in expensive suits big money every month to manage your funds, and you’re paying transaction costs, fees, and taxes on top of that. The average expense ratio you’ll pay for these actively managed funds is approximately 1% of your assets—or more. So your mutual fundsoften underperform the market, and you’re paying top dollar for them to do so. Therefore, it’s no surprise that you’re not getting the return you expect to receive.

Indexed Mutual Funds

Don’t despair and totally write off mutual funds from your portfolio, though. They’re not all a rip off. In fact, passively managed index funds can be a great investment.

You don’t actually need to have financial professionals managing your funds for you. You don’t have to pay their salaries and all the fees that come with it, and you can still make more money in the end.

Index funds are passively managed. That means that computer programs are automatically maintaining the right weightings so your funds track the performance of their benchmarks. Your money goes into an index fund that is invested proportionally into separate stocks and bonds, automatically, based on the percentage their market capitalizations represent in the index.Their portfolios mirror the components of a market index. They’re essentially funds on autopilot.

Although positive returns aren’t guaranteed, as with virtually all investments, these types of funds deliver the performance of the markets they track, while slashing your fees at the same time.

Index funds are relatively safe, they’re easily understood, and they require no work. They make diversification and asset allocation easy. The quality of management is superior because there aren’t any concerns of management tenure or human error. There’s a low portfolio turnover, which means fewer taxes and costs. And they have low operational expense–their expense ratio ranges from 0.05% to 0.20%.

Bottom Line

Mutual funds can be a rip off, yes. But usually only if they’re actively managed. So you don’t need to completely ban funds from your portfolio when using investments to pay for retirement. In fact, you shouldn’t. You just need to ditch the expensive financial managers and all the fees and taxes that come with them. You can save money and better perform the market with index funds.

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Asset allocation programs do not assure a profit or protect against loss in declining markets. No program can guarantee that any objective or goal will be achieved.

Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.

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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